<PAGE>
As filed with the Securities and Exchange Commission on October 19, 2000
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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Zhone Technologies, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 3661 94-3333763
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of Classification Number) Identification Number)
incorporation or
organization)
----------------
7001 Oakport @ Zhone Way
Oakland, California 94621
(510) 777-7000
(Address, including zip code, and telephone number, including area code,
of Registrant's principal executive offices)
Mory Ejabat
Chief Executive Officer
Zhone Technologies, Inc.
7001 Oakport Street
@ Zhone Way
Oakland, California 94621
(510) 777-7000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
----------------
Copies to:
Gregory M. Gallo, Esq. Ora T. Fisher, Esq.
Andrew D. Zeif, Esq. William C. Davisson, Esq.
P. James Schumacher, Esq. Namee Lee, Esq.
Gray Cary Ware & Freidenrich LLP Latham & Watkins
400 Hamilton Avenue 135 Commonwealth Drive
Palo Alto, California 94301-1825 Menlo Park, California 94025-1105
(650) 833-2000 (650) 328-4600
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are being offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act") check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
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CALCULATION OF REGISTRATION FEE
<TABLE>
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<CAPTION>
Title of Each Class of Proposed Maximum Amount of
Securities to be Registered Aggregate Offering Price(1) Registration Fee
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<S> <C> <C>
Common Stock, $0.001 par value.. $345,000,000 $91,080
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</TABLE>
(1) Estimated solely for the purposes of determining the registration fee
pursuant to Rule 457(o) promulgated under the Securities Act.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act or until the Registration Statement shall
become effective on such date as the Securities and Exchange Commission,
acting pursuant to said Section 8(a), may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 19, 2000
Shares
[LOGO]
Zhone Technologies, Inc.
Common Stock
--------
Prior to this offering, there has been no public market for our common stock.
The initial public offering price of the common stock is expected to be between
$ and $ . We will apply to list our common stock on The Nasdaq Stock
Market's National Market under the symbol "ZHON."
The underwriters have an option to purchase a maximum of additional
shares to cover over-allotments of shares.
Investing in our common stock involves risks. See "Risk Factors" on page 5.
<TABLE>
<CAPTION>
Price Underwriting
to Discounts and Proceeds
Public Commissions to Zhone
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<S> <C> <C> <C>
Per Share.................................. $ $ $
Total...................................... $ $ $
</TABLE>
Delivery of the shares of common stock will be made on or about , 2001.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
Lehman Brothers
UBS Warburg LLC
Thomas Weisel Partners LLC
U.S. Bancorp Piper Jaffray
The date of this prospectus is , 2001.
<PAGE>
[Graphic of the Zhone SLMS network, including the Broadband Access Node, Z-
Edge, Sechtor products and the Zhone Management System]
<PAGE>
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 5
Special Note Regarding Forward-Looking Statements......................... 16
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 17
Capitalization............................................................ 18
Dilution.................................................................. 19
Selected Consolidated Financial Data...................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business.................................................................. 30
Management................................................................ 42
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Certain Relationships and Related Party Transactions....................... 52
Principal Stockholders..................................................... 56
Description of Capital Stock............................................... 59
Shares Eligible for Future Sale............................................ 62
Underwriting............................................................... 64
Notice to Canadian Residents............................................... 68
Legal Matters.............................................................. 69
Change in Accountants...................................................... 69
Experts.................................................................... 69
Where You Can Find More
Information............................................................... 69
Index to Consolidated Financial Statements................................. F-1
</TABLE>
------------
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
Dealer Prospectus Delivery Obligation
Until , 2001 (25 days after the commencement of this offering), all
dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to unsold allotments or subscriptions.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
You should read the entire prospectus carefully, including the section entitled
"Risk Factors," the consolidated financial statements and the related notes
included elsewhere in this prospectus, before making an investment decision.
----------------
Zhone Technologies, Inc.
Zhone Technologies, Inc. is a new breed of network equipment vendor. We have
developed a hardware and software architecture designed to redefine the way
network service providers deliver communication services to their subscribers.
Our Single Line Multi-Service, or SLMS, architecture is designed to extend the
speed, reliability and cost-efficiencies currently achieved in the core of the
communications network through the local loop to business and consumer
subscribers. Our SLMS products are both protocol and media agnostic, supporting
voice, video, data and entertainment services under a common management and
provisioning system. We have designed our SLMS products to interoperate with
different types of equipment already deployed in service providers' networks to
allow for efficient and seamless installation, and to enable flexibility in
designing and deploying networks. These products enable service providers to
migrate from existing network infrastructure to high-bandwidth, multi-service
platforms. All of the products, services and subscribers in an SLMS network are
managed by our Zhone Management System, or ZMS, which provides a single network
and subscriber management system to allow network service providers, as well as
their subscribers, to instantly and easily provision and upgrade their networks
and services. In addition, ZMS is capable of interfacing with and managing
other vendors' equipment already deployed in service providers' networks.
Most of today's business and consumer subscribers have limited or no access
to high speed communications services even though most access networks reaching
homes and businesses today are capable of delivering integrated voice, data and
video traffic in a high-bandwidth, cost-effective manner. This is due, in part,
to the scale and complexity of the access network infrastructure. This
complexity has resulted from equipment vendors introducing products that
address only a narrow set of service providers' needs. Current solutions do not
provide a comprehensive, architectural approach for delivering high-bandwidth,
enhanced communications services over access networks. Service providers are
demanding solutions that consolidate delivery of voice, data and video services
across any access media, allowing service providers to reduce costs and compete
more effectively. In addition, these solutions must leverage existing hardware
and network infrastructure, provide for ease of management and operations and
enable service provider and subscriber provisioning on demand.
Our SLMS architecture and products will enable service providers to offer
business and consumer subscribers direct access to a wide range of services,
including traditional voice, fax, broadband Internet access, broadcast
video/television and entertainment over any access media. SLMS products enable
both incumbent and competitive service providers to deliver customized packages
of services to any subscriber using the existing local loop infrastructure. We
have designed our SLMS products to integrate seamlessly into existing networks,
allowing incumbent service providers to leverage their investments in
traditional circuit switch equipment and copper plants. Incumbent service
providers will be able to use SLMS to respond to pressures from competitive
service providers by offering multiple services without the need for overlay
access network infrastructure. For competitive service providers, SLMS products
offer direct, high-speed access to large numbers of subscribers without
requiring new investments in local loop infrastructure. Our current SLMS
products include the Sechtor Universal Voice Gateway, the Arca-Dacs Digital
Cross Connect, the Z-Plex Multiplexor and the Broadband Access Node, or BAN.
All of our SLMS products are centrally provisioned and managed by ZMS.
Our SLMS architecture is the core of our product development strategy. The
design criteria for SLMS products include carrier-class reliability, multi-
protocol and service support and ease of provisioning. We will
1
<PAGE>
continue to introduce SLMS products that offer the configurations and feature
sets that our customers demand. In addition, we intend to introduce products
that adhere to the standards, protocols and interfaces dictated by
international standards bodies and service providers. We will continue to
leverage our expertise in both voice and data technologies to develop the SLMS
architecture to support new services, protocols and technologies as they
emerge.
To offer an architecture as broad as the SLMS to a wide variety of network
service providers, we have scaled our organization very quickly. We have grown
through a combination of strategic hiring and the acquisition of companies with
relevant technologies and skilled personnel, including CAG Technologies, Inc.,
Premisys Communications, Inc., Roundview, Inc. and OptaPhone Systems, Inc. As
of September 30, 2000, we employed approximately 490 people, including a senior
management team with significant experience in the communications industry and
in building, acquiring and integrating technology companies. We have built a
facility that allows us to test our products in a communications laboratory
with the capacity comparable to a network supporting approximately
240,000 subscribers, with hundreds of access infrastructure products from
multiple vendors. In addition, we operate six additional development centers
across the United States and Canada to support the continued technological
development required by our customers. We have established three sales
organizations to support large, global service providers, emerging service
providers and international service providers. We are building the
infrastructure, employee base, technological breadth and market presence to
provide a comprehensive solution to problems associated with the delivery of
communications services from service providers to subscribers.
Company Information
Our principal executive offices are located at 7001 Oakport Street @ Zhone
Way, Oakland, California 94621, and our telephone number is (510) 777-7000. Our
website address is www.zhone.com. Information contained in our website is not
incorporated by reference into this prospectus, and you should not consider
information contained in our website as part of this prospectus.
We have applied for trademark protection for the following: "ARCADACS,"
"BAN," "SLMS," "ZEDGE," "ZPLEX" and the Zhone logo. This prospectus also
contains additional trade names, trademarks and service marks of ours and of
other companies.
2
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered.................... shares
Common stock to be outstanding after shares
this offering..........................
Use of proceeds......................... For working capital, general corporate
purposes, including strategic
acquisitions and investments and
repayment of debt. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol.. ZHON
</TABLE>
The number of shares to be outstanding after this offering is based on
217,628,973 shares outstanding as of September 30, 2000, and excludes:
. 7,850,318 shares of common stock issuable upon exercise of outstanding
options at a weighted average exercise price of $2.73 per share;
. 100,000, 15,000 and 30,000 shares of common stock issuable to the City
of Oakland, Solectron Corporation and Broadband Infrastructure Group
Corporation, respectively, upon exercise of outstanding warrants at a
combined weighted average exercise price of $4.77 per share;
. 24,732,642 shares of common stock issuable upon exercise of options
available for grant under our 1999 Stock Option Plan; and
. 500,000 shares of common stock available for issuance under our 2000
Employee Stock Purchase Plan which will be effective upon the closing of
this offering.
----------------
Except as otherwise indicated, all information in this prospectus assumes:
. we will file our amended and restated certificate of incorporation
immediately prior to the closing of this offering;
. the automatic conversion of all outstanding shares of preferred stock
into 125,000,000 shares of common stock immediately prior to the closing
of this offering; and
. the underwriters' over-allotment option will not be exercised.
3
<PAGE>
Summary Consolidated Financial Information
(in thousands, except per share data)
The following table sets forth our summary consolidated financial
information. This information should be read in conjunction with the
consolidated financial statements and the notes to those consolidated financial
statements appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
Period from
September 1, 1999 Nine months
(inception) through ended
December 31, 1999 September 30, 2000
------------------- ------------------
<S> <C> <C>
Consolidated Statements of Operations
Data:
Net revenue............................. $ -- $ 60,511
Cost of revenue......................... -- 33,937
Gross profit............................ -- 26,574
Operating loss.......................... (29,921) (129,169)
Net loss................................ (30,025) (127,710)
Net loss applicable to common
stockholders........................... (30,220) (129,678)
Basic and diluted net loss per share
applicable to common stockholders...... (0.40) (1.73)
Weighted average shares used to compute
basic and net loss per share applicable
to common stockholders................. 75,000 75,034
Pro forma basic and diluted net loss per
share (unaudited)...................... $ (0.15) $ (0.64)
Weighted average shares used to compute
pro forma basic and diluted net loss
per share (unaudited).................. 200,000 200,034
</TABLE>
<TABLE>
<CAPTION>
As of September 30, 2000
-------------------------------
Pro Pro Forma
Actual Forma As Adjusted
--------- -------- -----------
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents....................... $ 124,735 $124,735
Short-term investments.......................... 18,152 18,152
Working capital................................. 134,527 134,527
Total assets.................................... 392,722 392,722
Long term debt, less current portion............ 39,375 39,375
Redeemable convertible preferred stock.......... 383,114 --
Total stockholders' equity (deficit)............ (113,478) 269,636
</TABLE>
See note 11 of our consolidated financial statements for determination of
shares used in computing basic and diluted net loss per share applicable to
common stockholders and unaudited pro forma basic and diluted net loss per
share data.
The pro forma information gives effect to the conversion of all outstanding
shares of preferred stock into 125,000,000 shares of common stock.
The pro forma as adjusted information gives effect to our receipt of the
proceeds from our sale of shares of common stock in this offering at an
assumed initial public offering price of $ per share, after deducting
estimated underwriting discounts and commissions, estimated offering expenses
payable by us and estimated amounts for repayment of a senior secured term
loan.
4
<PAGE>
RISK FACTORS
An investment in our common stock is very risky. You should carefully
consider the risks described below, together with all of the other information
in this prospectus, before making a decision to invest in our common stock. If
any of the following risks actually occurs, our business, financial condition
and results of operations could be adversely affected. In this case, the
trading price of our common stock could decline and you may lose all or part of
your investment in our common stock.
Risks Related to Our Revenue and Operating Results
We have a limited operating history, which will make it very difficult for you
to predict our future operating results.
We began operations in September 1999. Since our inception, we have been
focused primarily on product research and development, and have not
manufactured or shipped our Single Line Multi-Service, or SLMS, products in
significant quantities. Because we only recently began commercial sales of our
SLMS products, our revenue and profit potential is unproven and our limited
operating history makes it difficult for you to evaluate our business and
prospects. To date, we have generated substantially all of our revenue from
sales of our IMACS products, which we acquired as a result of our acquisition
of Premisys Communications, Inc. However, we expect that the SLMS product line
will account for substantially all of our revenue growth for the foreseeable
future. Further, due to our limited operating history, we have difficulty
accurately forecasting our revenue, and we have limited historical financial
data upon which to base operating expense budgets. You should consider our
business and prospects in light of the heightened risks and unexpected expenses
and problems we may face as a company in an early stage of development in a
new, highly competitive and rapidly-evolving industry.
If demand for our SLMS architecture and products does not develop, then our
results of operations and financial condition will be adversely affected.
Our business will be harmed, and our results of operations and financial
condition will be adversely affected, if demand for our SLMS architecture and
products does not increase as rapidly as we anticipate, or if our customers'
SLMS-based offerings are not well received by their subscribers. Critical
factors which will likely affect the acceptance of our SLMS architecture and
products include the successful testing and effective deployment of our
Broadband Access Node, or BAN, product, the Zhone Management System, or ZMS,
and other future SLMS product introductions that are both new to the
marketplace and important components of our SLMS architecture.
Most communications service providers have made substantial investments in
their current infrastructure, and they may elect to remain with their current
architectures or to adopt new architectures, such as SLMS, in limited stages or
over extended periods of time. A decision by a customer to purchase our
products will involve a significant capital investment. We will need to
convince these service providers of the benefits of our products for future
upgrades or expansions. We do not know whether a viable market for our products
will develop or be sustainable. If this market does not develop, or develops
more slowly than we expect, our business, financial condition and results of
operations will be seriously harmed.
Our future growth depends entirely on our SLMS products, many of which have not
been fully tested. Our SLMS products' failure to operate as expected could
delay or prevent their deployment and sale and could seriously impair our
business and prospects.
To date, we have produced our SLMS products in limited quantities and in
most cases only to specifications required to conduct our laboratory tests and
field trials. Because most of our SLMS products have been deployed and tested
in our laboratories and, to a limited extent, only in field trials, we cannot
assure
5
<PAGE>
you that our SLMS products will operate as expected or if and when the sale of
these SLMS products will occur. Failure of our SLMS products to operate as
expected could delay or prevent their deployment and sale, and could seriously
impair our business and prospects. If our customers do not successfully test
and deploy our network products, our business will not succeed.
We have a history of losses and may not be able to generate sufficient revenue
in the future to achieve or sustain profitability.
We have incurred significant net losses since inception. We had net losses
of approximately $30.0 million for the period from September 1, 1999
(inception) through December 31, 1999 and approximately $127.7 million for the
nine months ended September 30, 2000. As of September 30, 2000, we had an
accumulated deficit of approximately $157.7 million. We cannot assure you that
we will ever generate sufficient revenue to achieve or sustain profitability.
We have large fixed expenses, and expect to continue to incur significant
and increasing costs for research and product development, sales and marketing,
customer support and general and administrative costs. 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 on research and development than
originally budgeted to respond to industry trends. We may also incur
significant new costs related to possible acquisitions and the integration of
new technologies. Given our early stage of development, our increasing
operating expenses and the rate at which competition in our industry is
intensifying, we may not be able to adequately control our costs and expenses
or achieve or maintain adequate operating margins. As a result, our ability to
achieve and sustain profitability will depend on our ability to generate and
sustain substantially higher revenue while maintaining reasonable cost and
expense levels. If we fail to increase our revenue, or if we experience delays
in generating or recognizing revenue, we will continue to incur substantial
operating losses.
If our revenue and operating results fall below analysts' and investors'
expectations, the trading price of our common stock will significantly decline.
Our revenue and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control
and any of which may cause the price of our common stock to fluctuate. The
primary factors that may affect us include the following:
. the timing and success of field trials for our SLMS products;
. commercial acceptance of our SLMS products;
. fluctuations in demand for network access products;
. the length and variability of the sales cycles for our products;
. the timing and size of sales of our products;
. our customers' ability to finance their purchase of our products as well
as their own operations;
. our ability to forecast demand for our products;
. the ability of our company and our contract manufacturers to attain and
maintain production volumes and quality levels for our products;
. our ability to obtain sufficient supplies of sole or limited source
components;
. changes in our pricing policies or the pricing policies of our
competitors;
. increases in the prices of the components we purchase;
. new product introductions and enhancements by our competitors;
6
<PAGE>
. our ability to develop, introduce and ship new products and product
enhancements that meet customer requirements in a timely manner;
. the timing and magnitude of prototype expenses;
. our ability to attract and retain key personnel;
. our sales of common stock or other securities in the future;
. costs related to acquisitions of technologies or businesses; and
. general economic conditions as well as those specific to the
communications, Internet and related industries.
As a result of the potential negative developments relating to any of these
factors, our quarterly or annual operating results may fall below the
expectations of public market analysts and investors. In this event, the price
of our common stock will significantly decline.
Our target customer base is concentrated, and the loss of one or more of our
customers could harm our business.
The target customers for our products are communications service providers
that operate voice, data and video communications networks. There are a limited
number of potential customers in our target market. During the nine months
ended September 30, 2000, two customers accounted for approximately 47% of our
revenue, which was primarily from the sale of our IMACS products. In the
future, we expect that IMACS sales will decline as a percentage of our revenue.
Substantially all of our future revenue will depend on sales of our SLMS
products to a limited number of potential customers. Any failure of
communications service providers to purchase products from us for any reason,
including any downturn in their businesses, would seriously harm our business,
financial condition and results of operations.
The long and variable sales cycles for our products may cause revenue and
operating results to vary significantly from quarter to quarter.
Companies with substantial or complex networks have traditionally expanded
their networks in large increments on a periodic basis. Accordingly, we expect
that our prospective customers will purchase our products as part of a large-
scale network deployment. Our target customers will likely require a lengthy
testing and product qualification process, a portion of which will be funded by
us, prior to any final decision to purchase our products. Even after a customer
makes the final decision to purchase our products, a customer may deploy our
products slowly. Throughout this sales and qualification cycle, we will spend
considerable time and incur significant expense educating and providing
information to prospective customers about the uses and features of our
products.
The timing of deployment of our products may vary widely, and will depend on
a number of factors, including:
. our customers' skill sets;
. geographic density of potential subscribers;
. the degree of configuration necessary to deploy our products; and
. our customers' ability to finance their purchase of our products as well
as their operations.
As a result of any of these factors, our revenue and operating results may vary
significantly from quarter to quarter.
7
<PAGE>
A majority of our business will be generated by demand from new and emerging
service providers whose inability to obtain capital could cause them to reduce
or discontinue the purchase of our products at any time.
Many of the companies that are likely to deploy our products are new and
emerging and have largely unproven business models. These companies require
substantial capital for the development, construction and expansion of their
businesses. Neither equity nor debt financing may be available to these
companies on favorable terms, if at all. To the extent that these companies are
unable to obtain the financing they need, our ability to make future sales to
these customers and realize revenue from any such sales could be harmed. In
addition, to the extent we choose to provide financing to these prospective
customers, we will be subject to additional financial risk which could increase
our expenses.
The success of our business depends on our executive officers and key
employees, and the loss of the services of one or more of them could harm our
business.
Our future success depends upon the continued services of our executive
officers and other key engineering, manufacturing, operations, sales, marketing
and support personnel who have critical industry experience and relationships
that we rely on to build our business, particularly Mory Ejabat, our co-
founder, Chairman and Chief Executive Officer, and Jeanette Symons, our co-
founder, Chief Technology Officer and Vice President, Engineering. The loss of
the services of any of our key employees, including Mr. Ejabat and Ms. Symons,
could delay the development and production of our products and negatively
impact our ability to maintain customer relationships, which would harm our
business, financial condition and results of operations.
If we do not substantially expand our sales and marketing operations, we will
not be able to provide the support required to generate sales from our target
customers.
Our products are generally of a highly technical nature, and therefore
require a sophisticated sales effort targeted at several key people within each
prospective customer's organization. Our target customers include large
communications service providers, including competitive local exchange
carriers, or CLECs, incumbent local exchange carriers, or ILECs, inter-exchange
carriers, or IXCs, multi-service operators, or MSOs, and foreign telephone
companies. These customers will require high levels of service and support from
our sales and marketing organization. Due to our early stage of development, we
have not established a significant direct sales force. If we are not able to
hire the kind and number of sales personnel and customer service engineers
required by our product offerings and potential customers, we may not reach the
level of sales necessary to achieve profitability.
Our marketing efforts must focus on creating a national and international
awareness of our products, which will require significant marketing resources.
We may not be able to hire enough qualified, technically-proficient personnel
or establish and maintain a marketing budget as large as those of our
competitors. If our marketing efforts are unsuccessful, our ability to generate
sales of our products will be harmed.
We do not have significant experience in international markets, and we may not
be able to successfully establish and manage our international operations.
We plan to market and sell our products internationally. This effort will
require significant management attention and financial resources to
successfully develop international sales and support channels. International
operations may be subject to certain risks and challenges that could harm our
results of operations, including:
. expenses associated with developing and customizing our products for
foreign countries;
. unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;
. fluctuations in currency exchange rates;
. longer sales cycles for our products;
8
<PAGE>
. greater difficulty in accounts receivable collection and longer
collection periods;
. difficulties and costs of staffing and managing foreign operations;
. reduced protection for intellectual property rights;
. potentially adverse tax consequences; and
. changes in a country's or region's political and economic conditions.
Risks Related to the Communications Industry
The market we serve is highly competitive and, as an early stage company, we
may not be able to achieve or maintain profitability.
Competition in the communications equipment market is intense. We are aware
of many companies in related markets that address particular aspects of the
features and functions that our products will provide. Currently, our primary
competitors include large equipment companies, such as Cisco Systems, Lucent
Technologies and Nortel Networks. We also may face competition from other large
communications companies that may enter our market in the future. In addition,
a number of new public and private companies have announced plans for new
products to address the same network needs that our products address.
Many of our competitors have longer operating histories, greater name
recognition, larger customer bases and greater financial, technical, sales and
marketing resources than we do and may be able to undertake more extensive
marketing efforts, adopt more aggressive pricing policies and provide more
vendor financing than we can. Moreover, our competitors may foresee the course
of market developments more accurately than we do and could develop new
technologies that compete with our products or render our products obsolete.
Due to the rapidly evolving markets in which we compete, additional competitors
with significant market presence and financial resources may enter our markets,
further intensifying competition.
In our markets, competitive factors include:
. performance;
. reliability and scalability;
. ease of installation and use;
. interoperability with existing products;
. upgradability;
. price;
. technical support and customer service; and
. brand recognition.
If we are unable to compete successfully against our current and future
competitors, we may have difficulty obtaining customers, and we could
experience price reductions, order cancellations, increased expenses and
reduced gross margins, any of which would harm our business, financial
condition and results of operations.
The communications industry is subject to government regulations, which could
harm our business.
The Federal Communications Commission, or FCC, has jurisdiction over the
entire communications industry in the United States and, as a result, our
existing and future products and our customers' products are subject to FCC
rules and regulations. Current and future FCC rules and regulations affecting
communications
9
<PAGE>
services, our products or our customers' businesses or products could
negatively affect our business. In addition, international regulatory standards
could impair our ability to develop products for international service
providers. Delays caused by our compliance with regulatory requirements could
result in postponements or cancellations of product orders, which would harm
our business, financial condition and results of operations. Further, we cannot
be certain that we will be successful in obtaining or maintaining any
regulatory approvals that may, in the future, be required to operate our
business.
Risks Related to Our Products
Because our SLMS products are complex and will be deployed in complex
environments, our SLMS products may have defects that we discover only after
full deployment, which could seriously harm our business.
Our SLMS products are complex and are designed to be deployed in large
quantities across complex networks. Because of the nature of these products,
they can only be fully tested when completely deployed in large networks with
high amounts of traffic. Our customers may discover errors or defects in our
hardware or software, or our products may not operate as expected, after they
have been fully deployed. If we are unable to fix defects or other problems
that may be identified after full deployment, we could experience:
. loss of revenue and market share;
. loss of existing customers;
. failure to attract new customers or achieve market acceptance;
. diversion of development resources;
. increased service and warranty costs;
. legal actions by our customers; and
. increased insurance costs.
The occurrence of any of these problems would seriously harm our business,
financial condition and results of operations. Defects, integration issues or
other performance problems in our SLMS products could result in financial or
other damages to our customers or could negatively affect market acceptance for
these products. Our customers could also seek damages for losses from us, which
could seriously harm our business, financial condition and results of
operations. A product liability claim brought against us, even if unsuccessful,
would likely be time consuming and costly and would put a strain on our
management and resources.
If we fail to enhance our existing products or develop and introduce new
products that meet changing customer requirements and technological advances,
our ability to sell our products would be materially and adversely affected.
Our target markets are characterized by rapid technological advances,
evolving industry standards, changes in end-user requirements, frequent new
product introductions and changes in communications offerings from service
providers. Our future success will significantly depend on our ability to
anticipate or adapt to such changes and to offer, on a timely and cost-
effective basis, products that meet changing customer demands and industry
standards. The timely development of new or enhanced products is a complex and
uncertain process and we may not have sufficient resources to successfully and
accurately anticipate technological and market trends, or to successfully
manage long development cycles. We may also experience design, manufacturing,
marketing and other difficulties that could delay or prevent our development,
introduction or marketing of new products and enhancements. We currently
license technology, and from time to time, we may be required to license
additional technology from third parties to sell or develop our products and
product enhancements. We cannot assure you that our existing and future third-
party licenses will be available to us on commercially reasonable terms, if at
all. Our inability to maintain or obtain any third-party license required to
sell or develop
10
<PAGE>
our products and product enhancements could require us to obtain substitute
technology of lower quality or performance standards or at greater cost. If we
are not able to develop new products or enhancements to existing products on a
timely and cost-effective basis, or if our new products or enhancements fail to
achieve market acceptance, our business, financial condition and results of
operations would be materially and adversely affected.
Our business will be adversely affected if we are unable to protect our
intellectual property rights from third-party challenges.
We rely on a combination of copyright, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. We also
enter into confidentiality or license agreements with our employees,
consultants and corporate partners and control access to and distribution of
our software, documentation and other proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. Monitoring
unauthorized use of our technology is difficult, and we do not know whether the
steps we have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States.
In the future we may become involved in disputes over intellectual property,
which could subject us to significant liability, divert the time and attention
of our management and prevent us from selling our products.
We or our customers may be party to litigation in the future to protect our
intellectual property or to respond to allegations that we infringe others'
intellectual property. Any parties asserting that our products infringe upon
their proprietary rights would force us to defend ourselves and possibly our
customers against the alleged infringement. If we are unsuccessful in any
intellectual property litigation, we could be subject to significant liability
for damages and loss of our proprietary rights. Intellectual property
litigation, regardless of its outcome, would likely be time consuming and
expensive to resolve and may force us to stop selling, incorporating or using
our products that include the challenged intellectual property, or redesign
those products that use the technology. In addition, claims asserting that our
products infringe or may infringe the proprietary rights of others may force us
to enter into royalty or licensing agreements, which may not be available on
terms acceptable to us, if at all.
Although we are not currently aware of any material intellectual property
claims against us, we may be party to litigation in the future. We cannot
assure you that we would prevail in any such actions, given their complex
technical issues and inherent uncertainties.
Risks Related to Our Product Manufacturing
We depend on Solectron to manufacture substantially all of our products, and
any delay or interruption in manufacturing by this contract manufacturer would
result in delayed or reduced shipments to our customers and would harm our
business.
We currently outsource substantially all of our manufacturing to Solectron
Corporation. We do not have internal manufacturing capabilities. Our reliance
on Solectron involves a number of risks, including lack of adequate capacity,
unavailability of, or interruptions in access to, process technologies and
reduced control over component availability, delivery schedules, manufacturing
yields and costs. Solectron may not acquire or generate sufficient quantities
of inventory available to fill our orders, or may be unwilling to allocate its
internal resources to fill our orders on a timely basis. If Solectron is unable
or unwilling to continue manufacturing our products in required volumes and at
high quality levels, we will have to identify, qualify and select acceptable
alternative manufacturers, which could be a time-consuming process. It is
possible that an alternate source may not be available to us or be in a
position to satisfy our production requirements at acceptable prices and
quality.
11
<PAGE>
If we are required or choose to change our contract manufacturer, our revenue
may decline and our customer relationships may be damaged. Any significant
interruption in manufacturing would reduce our supply of products to our
customers and harm our business.
If we fail to accurately predict our component or manufacturing requirements,
we could incur additional costs or experience manufacturing delays.
We currently provide forecasts of our demand to Solectron and our component
suppliers months prior to scheduled delivery of products to our customers. Lead
times for the materials and components that we order vary significantly and
depend on numerous factors, including the specific supplier, contract terms and
demand for a component at a given time. If we overestimate our component
requirements, Solectron may purchase excess inventory. For the parts that are
unique to our products, we could be required to pay for these excess parts and
recognize related inventory write-down costs. If we underestimate our
requirements, Solectron may have an inadequate inventory, which could interrupt
the manufacturing of our products and result in delays in shipments and
revenue, or could cause us to purchase materials and components from third
parties at higher costs decreasing our margins and increasing our operating
losses.
We depend on sole or limited source suppliers for several key components. If we
are unable to obtain these components on a timely basis, we will be unable to
meet our customers' product delivery requirements, which would harm our
business.
We currently purchase several key components from single or limited sources.
For some of these components, there can be waiting periods of six months or
more between placement of an order and receipt of the components. If any of our
sole or limited source suppliers experiences capacity constraints, work
stoppages or any other reduction or disruption in output, it may be unable to
meet our delivery schedule. We currently do not have long-term supply contracts
for many of our key components. Our suppliers may enter into exclusive
arrangements with our competitors, be acquired by our competitors, stop selling
their products or components to us at commercially reasonable prices, refuse to
sell their products or components to us at any price or be unable to obtain or
have difficulty obtaining components for their products from their suppliers.
We may be unable to develop alternative sources for these components. Even if
alternate suppliers are available to us, identifying and qualifying them could
be difficult and time consuming. If we do not receive critical components from
our suppliers in a timely manner, we will be unable to manufacture our products
in a timely manner and would, therefore, be unable to meet our customers'
product delivery requirements. Any failure to meet a customer's delivery
requirements could harm our reputation and decrease our sales, which would harm
our business, financial condition and results of operations.
Our headquarters and certain suppliers are all located in Northern California
where natural disasters may occur and harm our facilities and key personnel,
which would render us unable to provide services to our customers.
Our corporate headquarters, research and development center, product testing
facilities and many of our suppliers are located in Northern California, which
has historically been vulnerable to natural disasters, such as earthquakes,
fires and floods. The occurrence of a natural disaster might disrupt the local
economy and pose physical risks to our employees and our property. We do not
presently have redundant, multiple site capacity in the event of a natural
disaster. Accordingly, in the event of a disaster affecting our operations, our
business would suffer.
12
<PAGE>
Risks Related to the Expansion of Our Business
Competition for qualified personnel in the network equipment and communications
industries is intense and if we are not successful in attracting and retaining
these personnel, our business could be harmed.
We believe our future success will depend in large part upon our ability to
identify, attract and retain highly skilled managerial, engineering, sales and
marketing and finance personnel. Competition for qualified personnel in our
industry and in the San Francisco Bay Area in particular, as well as other
areas in which we recruit is extremely intense and is characterized by
escalating salaries and equity-based compensation, which may increase our
operating expenses, dilute our stockholders' percentage ownership or impair our
ability to recruit qualified candidates. Further, competitors and other
entities may attempt to recruit our employees or claim that we have improperly
recruited employees from them. If we are unable to hire or retain any of these
required personnel and expand our corporate infrastructure, we may not be able
to increase sales of our products, which would seriously harm our business,
financial condition and results of operations.
Our business will suffer if we fail to properly manage our growth and
continually improve our internal controls and systems.
We have expanded our operations rapidly since our inception. The number of
our employees has grown from eight as of September 30, 1999 to approximately
490 as of September 30, 2000. We continue to substantially increase the scope
of our operations and the number of our employees. We plan to increase
significantly our operating expenses to broaden our customer support
capabilities, develop new distribution channels, expand our sales and marketing
operations and fund greater levels of research and development. We also plan to
expand our general and administrative capabilities to address the increased
reporting and other administrative demands which will result from us becoming a
publicly-held company after this offering and the increasing size of our
business. Our growth has placed, and will continue to place, a significant
strain on our management and resources. Our ability to successfully offer our
products and implement our business plan in a rapidly evolving market requires
an effective planning and management process. To manage our growth properly, we
must:
. hire, train, manage and retain qualified personnel, including engineers
and research and development personnel;
. carefully manage and expand our manufacturing relationships and related
controls and reporting systems;
. effectively manage multiple relationships with our customers, suppliers
and other third parties;
. implement additional operational controls, reporting and financial
systems and procedures; and
. successfully integrate employees of acquired companies.
Failure to do any of the above in an efficient and timely manner could
seriously harm our business, financial condition and results of operations.
Any strategic acquisitions or investments we make could disrupt our business
and seriously harm our financial condition.
We may, from time to time, consider acquisitions of, or investments in,
complementary companies, products or technologies to supplement our internal
growth. Since inception, we have acquired four companies, and we are likely to
acquire additional businesses, products or technologies in the future. We may
encounter difficulties identifying and acquiring suitable candidates on
reasonable terms.
If we do complete future acquisitions, we could:
. issue stock that would dilute our current stockholders' percentage
ownership;
. incur substantial debt;
13
<PAGE>
. assume contingent liabilities;
. incur amortization expenses related to goodwill and other intangible
assets; or
. incur large and immediate write-offs.
Any strategic acquisitions or investments that we make in the future will
involve numerous risks, including:
. problems combining the acquired operations, technologies or products;
. unanticipated costs;
. diversion of management's time and attention from our existing 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 acquired
companies.
We do not know whether we will be able to successfully integrate the
businesses, products, technologies or personnel that we might acquire in the
future or that any strategic investments we make will meet our financial or
other investment objectives. Any failure to do so could seriously harm our
business, financial condition and results of operations.
We may need additional capital to fund our existing and future operations. If
we are unable to obtain additional capital, we may be required to reduce the
scope of our planned product development and marketing and sales efforts, which
would harm our business, financial condition and results of operations.
We expect that development and marketing of new products and the expansion
of our direct sales operation and associated support personnel will require a
significant commitment of resources. We may incur significant operating losses
or expend significant amounts of capital if:
. the market for our products develops more slowly than anticipated;
. we fail to establish market share or generate revenue at anticipated
levels;
. our capital expenditure forecasts change or prove inaccurate; or
. we fail to respond to unforeseen challenges or take advantage of
unanticipated opportunities.
As a result, we may need to raise substantial additional capital. To the
extent that we raise additional capital through the sale of equity or equity-
linked debt securities, our then-existing stockholders would be diluted. If
additional funds are raised through the issuance of debt securities, the terms
of such debt could impose financial or other restrictions on our operations.
Additional capital, if required, may not be available on acceptable terms, or
at all. If we are unable to obtain additional capital, we may be required to
reduce the scope of our planned product development and sales and marketing
efforts, which would harm our business, financial condition and results of
operations.
Risks Related to This Offering
We will have broad discretion in how we use the proceeds of this offering, and
we may not use these proceeds effectively.
Our management will have considerable discretion in the application of the
net proceeds of this offering. You will not have the opportunity, as part of
your investment decision, to assess whether the proceeds are being used
appropriately. We currently intend to use the net proceeds for working capital,
general corporate purposes,
14
<PAGE>
including strategic acquisitions and investments, and repayment of debt. We
have not yet finalized the amount of net proceeds to be used specifically for
each of these purposes. The net proceeds may be used for corporate purposes
that do not lead to our profitability or increase our market value.
Insiders will continue to have substantial control over us after this offering
and could limit your ability to influence the outcome of key transactions,
including our sale to another company.
We anticipate that our executive officers, directors and entities affiliated
with them will, in the aggregate, beneficially own approximately % of our
outstanding common stock following the completion of this offering. These
stockholders, if acting together, will be able to influence significantly all
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions. Circumstances may arise in which the interests of these
stockholders could conflict with the interests of our other stockholders. These
stockholders could delay or prevent a change in control of our company even if
such a transaction would be beneficial to our other stockholders.
Our charter documents and Delaware law could discourage takeover attempts that
stockholders may consider favorable.
Our certificate of incorporation and our bylaws to be effective on the
closing of this offering contain provisions that could make it more difficult
for a third party to acquire us, even if doing so would be beneficial to our
stockholders. These provisions include:
. authorizing the issuance of shares of highly dilutive preferred stock;
. prohibiting cumulative voting in the election of directors;
. prohibiting stockholders from calling stockholders meetings; and
. prohibiting stockholder action by written consent.
In addition, Section 203 of the Delaware General Corporation Law prohibits
us from engaging in a business combination with any of our interested
stockholders for three years after such stockholder became an interested
stockholder unless certain specified conditions are met.
For information regarding these and other provisions, please see
"Description of Capital Stock."
We cannot assure you that a market will develop for our common stock or what
the market price of our common stock will be.
Before this offering there was no public trading market for our common
stock, and we cannot assure you that one will develop or be sustained after
this offering. The initial public offering price for our common stock will be
determined through our negotiations with the underwriters and may not bear any
relationship to the market price at which our common stock will trade after
this offering or to any other established criteria of our value. We cannot
predict the prices at which our common stock will trade at any time in the
future.
The trading price of our common stock is likely to be volatile. The stock
market in general, and the equity markets for technology companies in
particular, has experienced extreme volatility. This volatility has often been
unrelated to the operating performance of particular companies. Volatility in
the market price of our common stock may prevent investors from being able to
sell their common stock at or above the initial public offering price.
In addition, in the past, securities class action litigation has often been
brought against companies after periods of decline in the market price of their
securities. Due to the potential volatility of our stock price, we may be the
target of securities litigation in the future. Securities litigation could
result in substantial costs and divert management's attention and resources
from our business. We could also incur significant damages as a result of such
litigation.
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<PAGE>
If a significant number of shares become available for sale and are sold in a
short period of time, the market price of our common stock could decline.
Our current stockholders hold a substantial amount of our common stock. They
will be subject to agreements with the underwriters or us that restrict their
ability to transfer their stock for 180 days from the date of this prospectus.
After these agreements expire, a substantial number of shares will be eligible
for sale in the public market. If after this offering our stockholders sell
substantial amounts of our common stock in the public market within a short
time period, the market price of our common stock could fall. In addition, the
sale of a substantial number of shares by our stockholders could impair our
ability to raise capital through the sale of additional stock. For a detailed
discussion of the shares eligible for future sale, please see "Shares Eligible
for Future Sale."
As a new investor, you will incur substantial dilution as a result of this
offering and future equity issuances.
The initial public offering price will be substantially higher than the pro
forma net tangible book value per share of our outstanding common stock. As a
result, investors purchasing common stock in this offering will incur immediate
dilution of $ per share. This dilution is due in large part to earlier
investors in our company having paid substantially less than the initial public
offering price when they purchased their shares. The exercise of outstanding
options and warrants and future equity issuances, including any additional
shares issued in connection with acquisitions, will result in further dilution
to investors.
We do not plan to pay dividends in the foreseeable future.
We do not anticipate paying cash dividends to our stockholders in the
foreseeable future. Accordingly, investors must rely on sales of their common
stock after price appreciation, which may never occur, as the only way to
realize on their investment. Investors seeking cash dividends should not
purchase our common stock.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Prospectus Summary," "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Result of Operations" and "Business," contains forward-looking statements.
These statements relate to future events or our future financial performance,
and involve known and unknown risks, uncertainties and other factors that may
cause our actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance
or achievements expressed or implied by these forward-looking statements. These
risks and other factors include those listed under "Risk Factors" and elsewhere
in this prospectus. In some cases, you can identify forward-looking statements
by terminology such as "may," "will," "should," "expects," "intends," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," "continue" or
the negative of these terms or other comparable terminology. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements.
16
<PAGE>
USE OF PROCEEDS
Our net proceeds from the sale of shares of common stock in this
offering are estimated to be $ million, based on an assumed initial public
offering price of $ per share, after deducting estimated underwriting
discounts and commissions and estimated offering expenses payable by us.
The principal purposes of this offering are to obtain additional working
capital for general corporate purposes, including strategic acquisitions and
investments, to establish a public market for our common stock, and to increase
our visibility in the industry and facilitate future access to public capital
markets. We also intend to use the net proceeds of this offering to fund
operating losses and expand sales and marketing and research and product
development activities. A portion of the net proceeds may also be used for the
acquisition of businesses, products and technologies that are complementary to
ours. Currently, we have no agreements or commitments for acquisitions of any
businesses, products or technologies. Pending these uses, we will invest the
net proceeds of this offering in short-term and investment grade securities.
We intend to use a portion of the net proceeds of this offering to repay in
full outstanding indebtedness to Credit Suisse First Boston, New York Branch,
of approximately $47.5 million as of September 30, 2000. This indebtedness was
incurred in December 1999 in connection with our acquisition of Premisys
Communications, Inc. and accrues interest at the current Eurodollar rate plus
1% per annum. As of September 30, 2000, the loan was accruing interest at a
rate of 9.5% per annum. The loan matures in November 2004 and must be repaid in
full from the proceeds of this offering.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We do
not anticipate paying any cash dividends on our capital stock in the
foreseeable future. We currently intend to retain all available funds and any
future earnings to fund the development and growth of our business.
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<PAGE>
CAPITALIZATION
The table below sets forth the following information as of September 30,
2000:
. our actual capitalization;
. our pro forma capitalization to give effect to the conversion of all
outstanding shares of preferred stock into shares of common stock; and
. our pro forma as adjusted capitalization to give effect to our receipt
of the proceeds from our sale of shares of common stock in this
offering at an assumed initial public offering price of $ per share,
after deducting estimated underwriting discounts and commissions,
estimated offering expenses payable by us and estimated amounts for
repayment of a senior secured term loan.
This information should be read in conjunction with our consolidated
financial statements and the notes to those consolidated financial statements
appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of September 30, 2000
---------------------------------
Pro Forma
Actual Pro Forma As Adjusted
--------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Long term debt, less current portion......... $ 39,375 $ 39,375 $
Redeemable convertible preferred stock:
Series A-1 through A-12, $0.001 par value;
actual--125,000 shares authorized, 125,000
shares issued and outstanding; pro forma--
125,000 shares authorized, no shares
issued or outstanding; pro forma as
adjusted--no shares authorized, issued or
outstanding............................... 383,114 --
Stockholders' equity (deficit):
Preferred stock, $0.001 par value; actual
and pro forma--no shares authorized,
issued or outstanding; pro forma as
adjusted--50,000 shares authorized, no
shares issued or outstanding.............. -- --
Common stock, $0.001 par value; actual--
300,000 shares authorized, 92,629 shares
issued and outstanding; pro forma 300,000
shares authorized, 217,629 shares issued
and outstanding; pro forma as adjusted--
500,000 shares authorized, shares
issued and outstanding.................... 93 218
Additional paid-in capital................. 124,834 507,823
Notes receivable from stockholders......... (2,130) (2,130)
Deferred stock compensation................ (78,518) (78,518)
Accumulated other comprehensive loss....... (22) (22)
Accumulated deficit........................ (157,735) (157,735)
--------- --------- ----
Total stockholders' equity (deficit)..... (113,478) 269,636
--------- --------- ----
Total capitalization................... $ 309,011 $ 309,011 $
========= ========= ====
</TABLE>
The foregoing excludes:
. 7,850,318 shares of common stock issuable upon exercise of outstanding
options at a weighted average exercise price of $2.73 per share;
. 100,000, 15,000 and 30,000 shares of common stock issuable to the City
of Oakland, Solectron Corporation and Broadband Infrastructure Group
Corporation, respectively, upon exercise of outstanding warrants at a
combined weighted average exercise price of $4.77 per share;
. 24,732,642 shares of common stock issuable upon exercise of options
available for grant under our 1999 Stock Option Plan; and
. 500,000 shares of common stock available for issuance under our 2000
Employee Stock Purchase Plan which will be effective upon the closing of
this offering.
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<PAGE>
DILUTION
Our pro forma net tangible book value (deficit) as of September 30, 2000
was approximately $ million or approximately $ per share of common stock.
Pro forma net tangible book value (deficit) per share represents the amount of
our total tangible assets less total liabilities, divided by the number of
shares of common stock outstanding. After giving effect to the sale of
shares of common stock offered by us in this offering at an assumed initial
public offering price of $ per share and our receipt of the proceeds after
deducting the estimated underwriting discounts and commissions and the
estimated offering expenses payable by us, our pro forma net tangible book
value, as adjusted, as of September 30, 2000, would have been approximately
$ or approximately $ per share of common stock. This represents an
immediate increase in pro forma net tangible book value of $ per share to
our existing stockholders and an immediate dilution in pro forma net tangible
book value of $ per share to new investors of common stock in this
offering. If the initial public offering price is higher or lower, the
dilution to new investors will be greater or less, respectively. The following
table summarizes this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................. $
Pro forma net tangible book value (deficit) per share as of
September 30, 2000............................................ $( )
Increase per share attributable to this offering...............
-----
Pro forma net tangible book value per share after this offering..
----
Dilution per share to new investors.............................. $
====
</TABLE>
The following table summarizes on a pro forma basis, as of September 30,
2000, the differences between our existing stockholders and new investors with
respect to the number of shares of common stock issued by us, the total
consideration paid and the average price per share paid:
<TABLE>
<CAPTION>
Total
Shares Issued Consideration
----------------- ----------------- Average Price
Number Percentage Amount Percentage Per Share
------ ---------- ------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... % $ % $
New investors..............
----- --- ----- ---
Total.................... % $ %
===== === ===== ===
</TABLE>
The foregoing excludes:
. 7,850,318 shares of common stock issuable upon exercise of outstanding
options at a weighted average exercise price of $2.73 per share;
. 100,000, 15,000 and 30,000 shares of common stock issuable to the City
of Oakland, Solectron Corporation and Broadband Infrastructure Group
Corporation, respectively, upon exercise of outstanding warrants at a
combined weighted average exercise price of $4.77 per share;
. 24,732,642 shares of common stock issuable upon exercise of options
available for grant under our 1999 Stock Option Plan; and
. 500,000 shares of common stock available for issuance under our 2000
Employee Stock Purchase Plan which will be effective upon the closing of
this offering.
To the extent outstanding options or warrants are exercised, there will be
further dilution to new investors.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the consolidated financial statements, the notes to those
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
prospectus. The consolidated statements of operations data for the period from
September 1, 1999 (inception) through December 31, 1999 and the nine months
ended September 30, 2000 and the consolidated balance sheet data as of December
31, 1999 and September 30, 2000 set forth below are derived from our
consolidated financial statements which have been audited by KPMG LLP,
independent certified public accountants, and are included elsewhere in this
prospectus. Our historical results are not necessarily indicative of results to
be expected for any future period.
<TABLE>
<CAPTION>
Period from
September 1, 1999 Nine months
(inception) through ended
December 31, 1999 September 30, 2000
------------------- ------------------
(in thousands, except per share data)
<S> <C> <C>
Consolidated Statements of Operations
Data:
Net revenue............................. $ -- $ 60,511
Cost of revenue (excluding $0 and $3,159
of stock based compensation for the
period ended December 31, 1999 and the
nine months ended September 30, 2000).. -- 33,937
--------- ----------
Gross profit............................ -- 26,574
Operating expenses:
Research and product development
(excluding $1,890 and $16,265 of stock
based compensation for the period
ended December 31, 1999 and the nine
months ended September 30, 2000)...... 4,016 60,888
Sales and marketing (excluding $512 and
$6,068 of stock based compensation for
the period ended December 31, 1999 and
the nine months ended September 30,
2000)................................. 226 23,364
General and administrative (excluding
$489 and $7,478 of stock based
compensation for the period ended
December 31, 1999 and the nine months
ended September 30, 2000)............. 1,321 10,009
Write-off of in-process research and
development........................... 21,320 439
Stock based compensation............... 2,891 32,970
Amortization of intangibles............ 147 28,073
--------- ----------
Total operating expenses.............. 29,921 155,743
--------- ----------
Operating loss.......................... (29,921) (129,169)
Interest expense, net................... (104) (466)
--------- ----------
Net loss before income tax benefit...... (30,025) (129,635)
Income tax benefit...................... -- (1,925)
--------- ----------
Net loss................................ $ (30,025) $ (127,710)
--------- ----------
Accretion on preferred stock............ (195) (1,968)
--------- ----------
Net loss applicable to common
stockholders........................... $ (30,220) $ (129,678)
========= ==========
Basic and diluted net loss per share
applicable to common stockholders...... $ (0.40) $ (1.73)
========= ==========
Weighted average shares outstanding used
to compute basic and diluted net loss
per share applicable to common
stockholders........................... 75,000 75,034
========= ==========
Pro forma basic and diluted net loss per
share (unaudited)...................... $ (0.15) $ (0.64)
========= ==========
Weighted average shares outstanding used
to compute pro forma basic and diluted
net loss per share (unaudited)......... 200,000 200,034
========= ==========
<CAPTION>
As of As of
December 31, 1999 September 30, 2000
------------------- ------------------
(in thousands)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents............... $ 73,916 $ 124,735
Short-term investments.................. 4,005 18,152
Working capital......................... 53,023 134,527
Total assets............................ 282,073 392,722
Long term debt, less current portion.... 45,000 39,375
Redeemable convertible preferred stock.. 186,371 383,114
Total stockholders' deficit............. (26,887) (113,478)
</TABLE>
See note 11 of our consolidated financial statements for determination of
shares used in computing basic and diluted net loss per share applicable to
common stockholders and unaudited pro forma basic and diluted net loss per
share data.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following commentary should be read in conjunction with the consolidated
financial statements and the notes to those consolidated financial statements
appearing elsewhere in this prospectus. This discussion contains forward-
looking statements that involve risks and uncertainties. Our actual results may
differ materially from those anticipated in these forward-looking statements as
a result of many factors, including but not limited to those set forth under
"Risk Factors" and elsewhere in this prospectus.
Overview
We have developed a hardware and software architecture designed to redefine
the way network service providers deliver communication services to their
subscribers. Our Single Line Multi-Service, or SLMS, architecture is designed
to extend the speed, reliability and cost-efficiencies currently achieved in
the core of the communications network through the local loop to business and
consumer subscribers. Our SLMS products are both protocol and media agnostic,
supporting voice, video, data and entertainment services under a common
management and provisioning system. We have designed our SLMS products to
interoperate with different types of equipment already deployed in service
provider networks, to allow for efficient and seamless installation and to
enable flexibility in designing and deploying networks. We formulated our SLMS
architecture for both incumbent and competitive service providers, including
domestic and foreign public telephone companies and operators of copper, fiber,
coaxial and wireless networks. All of the products, services and subscribers in
an SLMS network are managed by the Zhone Management System, or ZMS, which
provides a single network and subscriber management system to allow network
service providers, as well as their subscribers, to instantly and easily
provision and upgrade their networks and services. In addition, ZMS is capable
of interfacing with and managing other vendors' equipment already deployed in
service providers' networks. We also sell our IMACS products, which we acquired
as a result of our purchase of Premisys Communications, Inc.
Our operating activities to date have consisted primarily of research and
development, product design, development and testing. During this period, we
also staffed and trained our administrative, marketing and sales personnel and
began sales and marketing activities.
We are developing products through a combination of internal development and
acquisition of technologies and companies. In November 1999, we acquired CAG
Technologies, Inc., a leader in system development and manufacturing, supplying
electronic sub-systems and assemblies to the communications industry worldwide.
In December 1999, we acquired Premisys Communications, Inc., a designer,
manufacturer, and marketer of integrated digital access products for
communications service providers. In February 2000, we acquired Roundview,
Inc., an engineering firm dedicated to developing project-oriented software for
Internet networking technologies, and OptaPhone Systems, Inc., a provider of
cost-effective wireless, short-haul and last mile solutions for public,
private, and government networks.
To date, we have generated substantially all of our revenue from sales of
our IMACS products. We only recently began generating revenue from the sale of
our SLMS products. For the nine months ended September 30, 2000, sales of our
IMACS and SLMS products accounted for approximately 86% and 14% of our net
revenue, respectively. We expect that SLMS product sales will account for an
increasing portion of our revenue in the future.
For the nine months ended September 30, 2000, sales to Motorola and Paradyne
Corporation, which resells our products to AT&T and Lucent Technologies,
accounted for approximately 47% of our revenue. We anticipate that our
operating results for future periods will continue to be dependent on a small
number of customers. In addition, we anticipate that our operating results for
future periods will continue to be dependent to a significant extent on large
purchase orders, which can be delayed or cancelled by our customers without
penalty.
21
<PAGE>
We recognize revenue from the sale of our products, under normal credit
terms or sales-type leases, net of estimated sales returns and allowances at
the time of shipment of product. Revenue is deferred if there are significant
post-delivery obligations or collection is not considered probable at the time
of sale. When significant post-delivery obligations exist, revenue is deferred
until such obligations are fulfilled. Revenue from service obligations and
operating leases is recognized ratably over the period of the obligation or
lease. We make sales to product distributors which are generally given
privileges to return a portion of inventory. We recognize revenue from sales to
distributors when the products have been sold by the distributors. We accrue
for warranty costs, sales returns and other allowances at the time of shipment
based on our experience.
Our cost of revenue consists primarily of amounts paid to third-party
contract manufacturers, manufacturing start-up expenses, personnel and related
costs. We outsource substantially all of our product and printed circuit board
assembly to contract manufacturers. Manufacturing and engineering documentation
controls are performed at our Oakland, California facility. We currently use
Solectron Corporation to manufacture and assemble substantially all of our
products. We also rely on single or limited source suppliers to manufacture key
components of our products. A significant portion of our cost of revenues is
related to these outsourcing arrangements.
Our products' gross margins vary depending on customer-requested
configurations. Our actual mix of products sold will depend significantly on
the amount of orders from new and existing customers, and the stage of their
network deployment. As a result, our gross margin may fluctuate significantly
from period to period. In general, our gross margin will primarily be affected
by the following factors:
. demand for our products and services;
. changes in our pricing policies;
. mix of products and product configurations sold;
. mix of sales channels through which our products and services are sold;
. volume of manufacturing and its effect on manufacturing and component
costs; and
. availability and fluctuating costs of our key components.
Research and product development expenses consist primarily of salaries and
related personnel costs, prototype costs, consulting costs, licensed technology
costs, recruiting costs and other costs related to the design, development,
testing and enhancement of our products. We also incur significant expenses in
connection with the purchase of equipment used to test our products as well as
the use of our products for internal design and learning purposes. We expense
our research and product development costs as they are incurred. Several
components of our research and product development efforts require significant
expenditures, the timing of which may cause significant quarterly variations in
our expenses. We believe that continued investment in research and product
development is critical to attain our strategic product development objectives
and to meet changing customer requirements and technological advances. We
expect that research and product development expenses will increase as we
develop and test our SLMS products.
Sales and marketing expenses consist primarily of salaries, commissions and
the related personnel costs of sales and marketing personnel, promotions,
travel and other marketing expenses and recruiting expenses. We expect that
sales and marketing expenses will increase in the future as we 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.
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, human resources, information
technology and administrative personnel, as well as recruiting, professional
fees, insurance and other general corporate expenses. We expect general and
administrative expenses to increase as we add personnel and incur additional
costs related to the growth of our business and operation as a public company.
22
<PAGE>
In connection with our acquisitions, we allocated and expensed a portion of
the purchase price to acquired in-process research and development. A portion
of the purchase price for the in-process research and development charges
related to the acquisitions of CAG Technologies, Inc. and Premisys
Communications in 1999 was expensed immediately since the technological
feasibility of the research and development projects had not yet been achieved
and were believed to have no alternative future use. The purchase price was
allocated to acquired assets and liabilities on the basis of their estimated
fair values, which resulted in expensing approximately $1.0 million and $20.3
million of the purchase price to in-process research and development for
CAG Technologies and Premisys Communications, respectively. Intangible assets
were identified through on-site interviews, review of data and discussions with
management concerning the acquired assets, technologies in development, costs
necessary to complete the purchased in-process research and development,
historical financial performance, estimates of future performance, market
potential and the assumptions underlying these estimates.
We used the "income approach" for the valuation analysis of acquired, core
developed, in-process research and development and tradenames. This approach
focuses on the income-producing capability of the asset and was obtained
through review of data, analysis of relevant market sizes, growth factors and
expected trends in technology. The steps followed in applying this approach
included estimating the costs to develop the purchased in-process research and
development into commercially viable products, estimating the resulting net
cash flows from such projects and discounting the net cash flows back to their
present values using a rate of return consistent with the relative risk levels.
We used the "cost approach" for the valuation analysis of each acquired work
force. This approach is based on the theory that a prudent investor would pay
no more than the cost of constructing a similar asset of like utility at prices
applicable at the time of appraisal. The cost approach does not capture the
full value of an income-producing asset, and since value is driven by the
income generating ability of the technology employed, this approach was not
utilized to value any acquired technology.
At the time of its purchase, Premisys Communications was in the process of
developing a family of broadband products that connect the communication co-
location center with the core network fiber ring backbone. At the time of the
acquisition, we estimated that, on average, 70% of the development effort had
been completed. Research and development costs incurred to complete in-process
research and development projects in connection with the Premisys
Communications acquisition were approximately $2.7 million. The first shipments
of products to customers incorporating acquired in-process research and
development projects commenced in the quarter ended March 31, 2000.
The resulting net cash flows from the Premisys Communications projects were
based on our estimates of product revenues, cost of goods sold, operating
expenses, research and development costs and income taxes from such projects.
The revenue projections used to value the in-process technology were based on
estimates of relevant market sizes and growth factors, expected trends in
technology and the nature and expected timing of new product introductions by
us and our competitors. The rate used in discounting the net cash flows was
approximately 24%. This discount rate, which is higher than our cost of
capital, reflects the uncertainties surrounding the successful development of
technology. The efforts required to develop the in-process research and
development of Premisys Communications into commercially viable products
principally relate to the completion of planning, designing, prototyping and
testing functions that are necessary to establish that the software produced
will meet its design specifications, including technical performance, features
and function requirements.
If these projects do not continue to be successfully developed, our revenue
and profitability may be adversely affected in future periods. Additionally,
the value of other intangible assets acquired may become impaired. Results will
also be subject to uncertain market events and risks that are beyond our
control, such as trends in technology, government regulations, market size and
growth and future product introduction by competitors. We believe that the
assumptions used in this valuation reasonably estimate the future benefits.
There can be no assurance that actual results in future periods will not
deviate from current estimates.
23
<PAGE>
From September 1, 1999 (inception) through September 30, 2000, we recorded
total deferred stock compensation of approximately $111.8 million, representing
the difference between the deemed value of our common stock for accounting
purposes and the exercise price of the options at their date of grant. As of
September 30, 2000, deferred stock compensation, net of amortization, was $78.5
million. Options granted are typically subject to a four-year vesting period.
Stock issuances from exercise of stock options prior to vesting are generally
subject to our right to repurchase the stock, which lapses over a four-year
period. We are amortizing the deferred stock compensation using an accelerated
method over the vesting periods of the applicable options, or repurchase
periods for the exercised options, generally over four years.
From September 1, 1999 (inception) through September 30, 2000, we recorded
total goodwill and intangibles of $164.2 million related to our acquisitions.
We are amortizing these intangibles over a period of three to five years.
Quarterly Results of Operations
The following table sets forth, for the periods presented, data from our
consolidated statements of operations, both in absolute dollar amounts and as a
percentage of net revenue. The consolidated statements of operations data for
the period from September 1, 1999 (inception) through December 31, 1999 and for
the quarters ended March 31, 2000, June 30, 2000 and September 30, 2000 are
derived from our audited consolidated financial statements that are included
elsewhere in the prospectus. This information should be read in conjunction
with the consolidated financial statements and the notes thereto included
elsewhere in this prospectus. The operating results in any quarter are not
necessarily indicative of the results that may be expected for any future
period. We have incurred net losses in each quarter since inception, and we
expect to continue to incur losses for the foreseeable future.
<TABLE>
<CAPTION>
Period from Quarter ended
September 1, 1999 ---------------------------------
(inception) through March June 30, September 30,
December 31, 1999 31, 2000 2000 2000
------------------- -------- -------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Consolidated Statements of Operations Data:
Net revenue.................................. $ -- $ 18,278 $ 19,421 $ 22,812
Cost of revenue(1)........................... -- 10,402 10,668 12,867
-------- -------- -------- --------
Gross profit................................. -- 7,876 8,753 9,945
Operating expenses:
Research and product development(2)........ 4,016 14,715 25,727 20,446
Sales and marketing(3)..................... 226 5,206 8,209 9,949
General and administrative(4).............. 1,321 3,259 3,255 3,495
Write-off of in-process research and
development............................... 21,320 439 -- --
Stock based compensation................... 2,891 5,299 8,980 18,691
Amortization of intangibles................ 147 9,372 9,327 9,374
-------- -------- -------- --------
Total operating expenses................. 29,921 38,290 55,498 61,955
Operating loss............................... (29,921) (30,414) (46,745) (52,010)
Interest income (expense), net............... (104) (332) (658) 524
-------- -------- -------- --------
Net loss before income tax benefit........... (30,025) (30,746) (47,403) (51,486)
Income tax benefit........................... -- (1,925) -- --
-------- -------- -------- --------
Net loss..................................... $(30,025) $(28,821) $(47,403) $(51,486)
======== ======== ======== ========
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
Quarter ended
--------------------------------
March 31, June 30, September 30,
2000 2000 2000
--------- -------- -------------
<S> <C> <C> <C>
As a Percentage of Net Revenue:
Net revenue................................... 100 % 100 % 100 %
Cost of revenue............................... 57 55 56
---- ---- ----
Gross profit.................................. 43 45 44
Operating expenses:
Research and product development............ 81 132 90
Sales and marketing......................... 28 42 44
General and administrative.................. 18 17 15
Write-off of in-process research and
development................................ 2 -- --
Stock based compensation.................... 29 46 82
Amortization of intangibles................. 51 48 41
---- ---- ----
Total operating expenses.................. 209 285 272
Operating loss................................ (166) (240) (228)
Interest income (expense), net................ (2) (3) 2
---- ---- ----
Net loss before income tax benefit............ (168) (243) (226)
Income tax benefit............................ 10 -- --
---- ---- ----
Net loss...................................... (158)% (243)% (226)%
==== ==== ====
</TABLE>
--------
(1) Excluding $0, $473, $896 and $1,790 of stock based compensation for the
period from September 1, 1999 (inception) through December 31, 1999 and the
quarters ended March 31, 2000, June 30, 2000 and September 30, 2000,
respectively.
(2) Excluding $1,890, $2,651, $4,420 and $9,194 of stock based compensation for
the period from September 1, 1999 (inception) through December 31, 1999 and
the quarters ended March 31, 2000, June 30, 2000 and September 30, 2000,
respectively.
(3) Excluding $512, $991, $1,683 and $3,394 of stock based compensation for the
period from September 1, 1999 (inception) through December 31, 1999 and the
quarters ended March 31, 2000, June 30, 2000 and September 30, 2000,
respectively.
(4) Excluding $489, $1,184, $1,981 and $4,313 of stock based compensation for
the period from September 1, 1999 (inception) through December 31, 1999 and
the quarters ended March 31, 2000, June 30, 2000 and September 30, 2000,
respectively.
Net Revenue. We began generating revenue in the quarter ended March 31,
2000. Net revenue for the quarters ended March 31, 2000, June 30, 2000 and
September 30, 2000 was approximately $0.8 million, $2.3 million and $5.1
million, respectively, for our SLMS products and approximately $17.5 million,
$17.1 million and $17.7 million, respectively, for our IMACS products. The
increase in net revenue from the quarter ended March 31, 2000 to the quarter
ended June 30, 2000 attributable to our SLMS product line was primarily due to
the first full quarter of SLMS product availability. The increase in net
revenue from the quarter ended June 30, 2000 to the quarter ended September 30,
2000 was primarily due to new SLMS product introductions and increased demand
for our SLMS products. We expect that sales of our SLMS products will account
for substantially all of our revenue growth in the foreseeable future. The
limited growth in net revenue attributable to our IMACS products was primarily
due to our allocation of limited resources to our IMACS products. We do not
expect sales of our IMACS products to comprise a significant portion of our
revenue growth in the foreseeable future.
Cost of Revenue. Cost of revenue for the quarter ended March 31, 2000 was
approximately $10.4 million, or 57% of net revenue, compared to approximately
$10.7 million, or 55% of net revenue, for the quarter ended June 30, 2000 and
$12.9 million, or 56% of net revenue, for the quarter ended September 30, 2000.
These costs included adding manufacturing personnel, establishing final product
testing capabilities and
25
<PAGE>
establishing operations with outside contract manufacturers, as well as high
per unit costs due to low initial volumes of our products. This decrease in
cost of revenue as a percentage of total revenue was primarily due to higher
unit volume sales in the quarters ended June 30, 2000 and September 30, 2000
compared to the quarter ended March 31, 2000. We expect that our cost of
revenue will vary as a percentage of net revenue depending on the mix and
average selling prices of products sold.
Research and Product Development Expenses. Research and product development
expenses for the period from September 1, 1999 (inception) through December 31,
1999 and the quarters ended March 31, 2000, June 30, 2000 and September 30,
2000 were approximately $4.0 million, $14.7 million, $25.7 million and $20.4
million, respectively. The increase from the quarter ended March 31, 2000 to
the quarter ended June 30, 2000 was primarily due to additional personnel
costs, licensed technology and other costs related to the design, development,
testing and enhancement of our products. The decrease from the quarter ended
June 30, 2000 to the quarter ended September 30, 2000 was primarily due to
lower licensed technology costs as a result of fewer licenses being executed
compared to the quarter ended June 30, 2000. We will continue to invest in
research and product development to attain our strategic product development
objectives. As a result, we expect our research and product development
expenses to increase in the future.
Sales and Marketing Expenses. Sales and marketing expenses for the period
from September 1, 1999 (inception) through December 31, 1999 and the quarters
ended March 31, 2000, June 30, 2000 and September 30, 2000 were approximately
$0.2 million, $5.2 million, $8.2 million and $9.9 million, respectively. This
increase was primarily attributable to our expanded efforts to sell and market
our SLMS products, including increased costs related to the hiring of
additional sales and systems engineers, product marketing, and key management
personnel as well as increased advertising, trade shows and public relations
costs, commission expenses and demonstration equipment costs. We expect sales
and marketing expenses to significantly increase in future periods as we
continue to expand our domestic and international sales and marketing efforts.
General and Administrative Expenses. General and administrative expenses for
the period from September 1, 1999 (inception) through December 31, 1999 and the
quarters ended March 31, 2000, June 30, 2000 and September 30, 2000 were
approximately $1.3 million, $3.3 million, $3.3 million and $3.5 million,
respectively. This increase was primarily due to the hiring of additional
general and administrative personnel necessary to support and scale our
operations and increased legal and accounting expenses. We expect our general
and administrative expenses to increase in future periods as we hire additional
personnel required to support the expansion of our business and operations as a
public company.
Stock Based Compensation Expenses. Stock based compensation expenses totaled
approximately $2.9 million, $5.3 million, $9.0 million and $18.7 million for
the period from September 1, 1999 (inception) through December 31, 1999 and the
quarters ended March 31, 2000, June 30, 2000 and September 30, 2000,
respectively. As of September 30, 2000, we have deferred approximately $78.5
million of stock based compensation, which will be recognized as stock
compensation expense over the next four years. In addition, we expect to issue
stock options in the future, for which additional stock compensation expense
may be recognized.
Amortization of Intangibles. Amortization of intangibles for the period from
September 1, 1999 (inception) through December 31, 1999 and the quarters ended
March 31, 2000, June 30, 2000 and September 30, 2000 were approximately $0.1
million, $9.4 million, $9.3 million and $9.4 million, respectively. This
increase was primarily due to the amortization of goodwill resulting from our
acquisition of Premisys Communications in December 1999.
Interest Income (Expense), Net. Our net interest income (expense) for the
period from September 1, 1999 (inception) through December 31, 1999 and the
quarters ended March 31, 2000, June 30, 2000 and September 30, 2000 was
approximately $(0.1 million), $(0.3 million), $(0.7 million) and $0.5 million,
respectively. Our net interest income (expense) consists of interest paid on an
outstanding term loan partially offset by interest earned on our cash, cash
equivalents, short-term investments and restricted cash.
26
<PAGE>
Income Tax Benefit. We recognized a deferred tax benefit of approximately
$1.9 million for the nine months ended September 30, 2000. We have provided a
valuation allowance to the extent gross deferred tax assets exceed deferred tax
liabilities.
Liquidity and Capital Resources
We have financed our operations to date primarily through private sales of
our capital stock and borrowings under long-term debt agreements for the
purchase of Premisys Communications.
In November 1999, we issued 125,000,000 shares of Series A redeemable
convertible preferred stock to investors in exchange for a maximum capital
commitment of $500.0 million. As of September 30, 2000, we had received capital
contributions of $400.0 million. We were required to collateralize the
borrowings on our long-term debt agreement with $60.0 million of the remaining
unused capital commitments. The remaining $40.0 million in available capital
commitments may be drawn prior to completion of this offering. Any unused
portion of the capital commitment expires upon completion of this offering.
From September 1, 1999 (inception) through September 30, 2000, net cash used
in operating activities was approximately $64.5 million. From September 1, 1999
(inception) through December 31, 1999, we generated approximately $17.5 million
in cash from our operating activities. For the nine months ended September 30,
2000, we used approximately $82.0 million in cash for operating activities
primarily due to our net loss of approximately $127.7 million for the nine
months ended September 30, 2000 partially offset by non-cash charges of
approximately $64.9 million for the nine months ended September 30, 2000.
From September 1, 1999 (inception) through September 30, 2000, net cash used
in investing activities was approximately $249.5 million. From September 1,
1999 (inception) through December 31, 1999, we used approximately $183.6
million in cash for investing activities primarily due to the acquisition of
Premisys Communications in December 1999. For the nine months ended September
30, 2000, we used approximately $65.9 million in cash for investing activities
primarily due to the purchase of manufacturing and test equipment, information
systems equipment, office equipment, restricted cash equivalents and short-term
investments.
From September 1, 1999 (inception) through September 30, 2000, net cash
provided by financing activities was approximately $438.7 million. From
September 1, 1999 (inception) through December 31, 1999, we generated
approximately $240.0 million in cash from financing activities primarily due to
our private equity financing and the credit facility obtained in connection
with our acquisition of Premisys Communications. During the nine months ended
September 30, 2000, we generated approximately $198.7 million from financing
activities primarily due to cash received pursuant to capital commitments in
connection with our private equity financing.
Our principal source of liquidity is cash, cash equivalents and short-term
investments of approximately $142.9 million at September 30, 2000. We believe
the cash, cash equivalents and short-term investments will be sufficient to
meet cash and investment requirements for at least the next twelve months.
In November 1999, a wholly-owned subsidiary of our company borrowed $125.0
million from a related party financial institution, $50.0 million of which was
under a senior secured term loan facility, in connection with our acquisition
of Premisys Communications. We repaid $75.0 million of this debt in December
1999. Borrowings under the term loan accrue interest at the current Eurodollar
rate plus 1% per annum. Borrowings on the loan are repayable in $2.5 million
quarterly installments from September 30, 2000 through December 31, 2000, $1.9
million quarterly installments from March 31, 2001 through December 31, 2001,
and $3.1 million quarterly installments from March 31, 2002 through November
30, 2004. Under the term of the loan agreement, the loan must be repaid from
the proceeds of (1) this offering, (2) an offering of debt or (3) a sale or
disposition of assets. The loan agreement restricts the subsidiary's ability to
make distributions. The loan agreement also contains financial covenants. We
were in compliance with these covenants at September 30, 2000.
27
<PAGE>
In August 2000, we entered into a $70.0 million five-year operating lease
for our office headquarters, research and product development and manufacturing
facilities in Oakland, California. The monthly payments are based on the London
Interbank Offer Rate and are based on the lease amount of up to $70.0 million
on the date of occupancy of the individual buildings. Our lease payments will
be approximately $5.0 million annually. The lease payments are scheduled to
begin upon completion and full occupancy of the individual buildings, which we
expect to occur by March 2001. At the end of the lease, we have the option to
purchase the land and buildings for approximately $70.0 million or to renew the
lease for two successive periods of one year each. The guaranteed residual
payment on the lease is approximately $59.5 million.
The lease requires that we maintain a specific level of restricted cash to
serve as collateral. Our restricted investment balance as of September 30, 2000
was $23.7 million and is recorded in other assets on our consolidated balance
sheet. The lease also requires that we maintain specific levels of earnings
before interest, taxation, depreciation, amortization, rent and other financial
ratios. We were in compliance with these covenants at September 30, 2000. We
are currently in discussions with the lessor to amend financial covenants in
the lease. If these covenants are not amended, we may not be in compliance with
them beginning in the quarter ended December 31, 2000. The lessor's remedies
for breach of these covenants include terminating our right to possession of
the properties and recovery of any unpaid rent plus any rental loss for the
remainder of the term, or continuing the lease in place and increasing rentals
to reflect a rate of prime plus 2%.
Increasingly, as a result of the financial demands of major network
deployments, service providers are looking to their suppliers for financing
assistance. From time to time we may provide or commit to extend credit or
credit support to our customers. This financing may include extending credit to
customers or guaranteeing the indebtedness of customers to third parties.
Depending upon market conditions, we may seek to factor these arrangements to
financial institutions and investors to free up our capital and reduce the
amount of our financial commitments for such arrangements. Our ability to
provide customer financing is limited and depends upon a number of factors,
including our capital structure and level of our available credit and our
ability to factor commitments. Any extension of financing to our customers will
limit the capital that we have available for other uses.
Disclosures about Market Risk
We do not use derivative financial instruments. We do not hold financial
instruments for trading or speculative purposes. Our financial instruments have
short maturities and therefore are not subject to significant interest rate
risk. We generally place our marketable security investments in high credit
quality instruments, primarily U.S. Government obligations and corporate
obligations with contractual maturities of less than one year. Our financial
liabilities that are subject to interest rate risk are our senior secured term
loan which accrues interest at a current Eurodollar rate plus 1% per annum. We
do not expect any material loss from our marketable security investments and
therefore believe that our potential interest rate exposure is not material.
We currently have product development activities in Canada and sales
operations throughout Europe, Asia and Latin America. We record expenses for
our subsidiaries in local currency. Accordingly, our operating results are also
exposed to changes in exchange rates between the U.S. dollar and those
currencies. While to date, our results have not materially been affected by any
changes in currency exchange rates, devaluation of the U.S. dollar against
these currencies would adversely affect our operating results.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," or FAS 133. FAS 133, as amended,
establishes accounting and reporting standards for derivative instruments and
for hedging activities and is effective for all years beginning after June 15,
2000. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133
until fiscal years beginning after June 15, 2000. We are studying the impact
that FAS 133 will have on our financial statements.
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In December 1999, the SEC issued Staff Accounting Bulleting No. 101, or SAB
101. SAB 101 summarized certain of the SEC Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
SAB No. 101B was issued June 26, 2000, which allows registrants until the
fourth quarter of years beginning after December 15, 1999 to implement SAB 101.
SAB 101, as amended, and any resulting change in accounting principles that a
registrant would have to report, is effective no later than our fiscal quarter
ending December 31, 2000. In October 2000, the SEC issued SAB 101 "Frequently
Asked Questions and Answers," which gives further guidance on SAB 101. We are
studying the impact, if any, that SAB 101 will have on our financial
statements.
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BUSINESS
Business Overview
Zhone Technologies, Inc. is a new breed of network equipment vendor. We have
developed a hardware and software architecture designed to redefine the way
network service providers deliver communication services to their subscribers.
Our Single Line Multi-Service, or SLMS, architecture is designed to extend the
speed, reliability and cost-efficiencies currently achieved in the core of the
communications network through the local loop to business and consumer
subscribers. SLMS products are both protocol and media agnostic, supporting
voice, video, data and entertainment services under a common management and
provisioning system. We have designed our SLMS products to interoperate with
different types of equipment already deployed in service providers' networks,
to allow for efficient and seamless installation, and to enable flexibility in
designing and deploying networks. These products enable operators of copper,
fiber, coaxial and wireless networks to migrate from existing network
infrastructure to high-bandwidth, multi-service platforms. All of the products,
services and subscribers in an SLMS network are managed by our Zhone Management
System, or ZMS, which provides a single network and subscriber management
system to allow network service providers, as well as their subscribers, to
instantly and easily provision and upgrade their networks and services. In
addition, ZMS is capable of interfacing with and managing other vendors'
equipment already deployed in service providers' networks.
We began operations in September 1999 and immediately applied our
significant capital and experience in identifying and integrating companies to
complete several strategic acquisitions. These acquisitions have brought us
incremental technologies and research and product development personnel. We are
building a 300,000 square foot headquarters in Oakland, California, and
currently operate six additional development centers across the United States
and Canada. We are building the infrastructure, employee base, technological
breadth and market presence to provide a comprehensive solution to problems
associated with the delivery of high bandwidth communications services from
service providers to subscribers.
Industry Background
Increasing Demand For Bandwidth
The rapid growth of business and consumer Internet use, the advent of e-
commerce, interactive television, video conferencing and telecommuting, and the
large increase in web content have resulted in levels of communications traffic
that severely tax the capacity of today's networks. To meet the increasing
demand for faster and more reliable communications services, equipment vendors
and service providers have made significant investments in research,
development and deployment of fiber optic technologies to increase bandwidth
and improve efficiency in the core of the network. However, bandwidth between
the fiber optic core at the network operators' central equipment sites and
their subscribers' premises remains severely constrained. This segment of the
network, commonly referred to as the "local loop" or the "access network," is
generally comprised of copper-pair, coaxial cable, wireless or fiber
infrastructure. The Yankee Group estimates that approximately 90% of today's
communications over the local loop between business and consumer subscriber
locations and service providers still occurs on 56 kilobits per second or
slower modem lines. In contrast, communications in the core of the network
travel at speeds of up to 10 gigabits per second.
Increasing Competition to Deliver Communications Services
The Telecommunications Act of 1996, combined with the increased demand for
bandwidth and the introduction of new broadband technologies, have changed the
competitive dynamics of access networks. Incumbent service providers, which
previously had no competition or compelling reason to deploy new broadband
services and cannibalize their profitable legacy high speed communications
service offerings, are being threatened by a proliferation of new service
providers, including competitive local exchange carriers, or CLECs, inter-
exchange carriers, or IXCs, and cable companies, that are deploying new
technologies and
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services. To remain competitive and acquire new subscribers, large national
service providers are partnering with CLECs and Internet service providers, or
ISPs, and buying cable and telephone networks at increasingly higher costs per
subscriber.
Historically, service providers generated the majority of their revenue by
offering subscribers a single service, such as voice, and consequently designed
their access networks to support single service delivery. However, competitive
pressures have forced many service providers to offer additional services, such
as video and high-speed Internet access. Subscribers are demanding increased
reliability, faster service provisioning, higher data speeds and improved
security, all at lower costs. To meet the demands for multiple services, many
service providers are acquiring or building parallel access networks to deliver
new or additional services to their subscribers. However, these parallel access
networks are costly to deploy and maintain.
In an effort to reduce the complexity and inefficiencies of parallel access
networks, communications equipment providers have introduced systems that
deliver two services over a single line, a concept we refer to as single line
dual-service. The single line dual-service technologies currently being
deployed most broadly include: (1) analog voice and DSL over the traditional
telephony copper wire infrastructure and (2) video and broadband data access
over the coaxial cable infrastructure. In addition, a limited number of network
service providers have tested and deployed expensive, complex networks
consisting of discrete technologies from multiple vendors to deliver additional
voice, data and video communications services to subscribers.
[Graphic of a network from the subscriber premise through a co-location
center and a data center to a network service provider's central office showing
the several elements of communications equipment required to deliver telephone,
high-speed Internet access and video services.]
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Increasing Complexity of Today's Access Networks
Single line dual-service solutions generally require multiple, costly pieces
of equipment to be deployed in service providers' networks. Deploying and
operating these multi-vendor or multiple overlay access networks presents a
number of challenges for network service providers, including very high capital
and operating costs. Each individual element in the access network requires a
unique provisioning and management system, and none of the elements are
designed to interoperate with the rest of the components in the network. In
many cases, a request for a new service, such as an additional voice line or
higher-speed Internet connection, requires separate provisioning steps for the
new service across each element of a multi-vendor network. These elements, in
turn, must interface with service providers' operating and billing systems,
which have their own proprietary interfaces. The complexity of the task
increases with each new hardware and management system incorporated, and it is
not uncommon for carriers to staff a new team of highly trained technical
specialists to manage and maintain each new platform. In the end, a carrier can
spend millions of dollars and thousands of worker-hours integrating multi-
vendor solutions. At best, the result is a complex collection of multiple
element management and provisioning systems that prevent service providers from
quickly delivering even a single service to subscribers in a timely and cost-
effective way. In addition, implementing access networks consisting of network
equipment from multiple vendors places significant interoperability,
reliability and feasibility testing burdens on service providers and requires
the management of procurement from multiple suppliers. The deployment and
operation of expanded service offerings must not jeopardize the delivery of, or
the revenue derived from, a service provider's principal service offering, such
as toll quality voice service or broadcast cable service.
The complexity of today's access networks has resulted in a significant
increase in the time and expense service providers incur deploying, operating,
and provisioning new services. At the same time, there has been a dramatic
increase in subscriber demand for enhanced communications services, such as
multiple phone, fax and high-speed Internet connections. Many subscribers still
have limited access to these enhanced communications services. Even when
enhanced communications services are available, the services are characterized
by significant uncertainty and delays in delivery, as well as quality and
reliability problems. Moreover, there is limited flexibility to continue to add
new communications services due to the limited availability of multiple access
lines per subscriber.
Most of today's subscribers have limited or no access to high speed
communications services even though most access networks reaching homes and
businesses today are capable of delivering integrated voice, data and video
traffic in a high-bandwidth, cost-effective manner. This is due in part to the
scale and complexity of the access network infrastructure. This complexity has
resulted from equipment vendors introducing products that address only a narrow
set of service providers' needs. Current solutions do not provide a
comprehensive, architectural approach for delivering high-bandwidth, enhanced
communications services over access networks. Service providers are demanding
solutions that consolidate delivery of voice, data and video services across
any access media, allowing service providers to reduce costs and compete more
effectively. Such solutions must leverage existing hardware and network
infrastructure, provide for ease of management and operations and enable
service provider and subscriber provisioning on demand.
The Zhone Solution
We were founded to offer network service providers a new, comprehensive
architectural approach to deploying access networks. Our SLMS architecture is
both protocol and media agnostic, capable of delivering and managing bundled
voice, data, video and entertainment services across copper, fiber, coaxial
cable and wireless-based networks. Our products are designed to facilitate
interoperability with different types of equipment already deployed in service
providers' networks to allow for efficient and seamless installation and
flexibility in designing and deploying access networks. All of the products,
services and subscribers in an SLMS network are managed and operated through
our ZMS, giving network service providers, as well as their subscribers, the
ability to instantly and easily provision and upgrade their communications
services.
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[Graphic of a network from the customer premise through a co-location center
and a data center to a network service provider's central office showing
Zhone's SLMS products delivering voice, data and video services across copper,
fiber coaxial cable or wireless-based networks.]
Our SLMS architecture and products enable service providers to offer
business and residential subscribers simple, direct access to a wide range of
services, including traditional voice, fax, broadband Internet access,
broadcast video/television and entertainment over any access media. Our SLMS
products enable both incumbent and competitive service providers to deliver
customized packages of services to any subscriber using the existing local loop
infrastructure. We have designed our SLMS products to integrate seamlessly into
existing networks, allowing incumbent service providers to leverage their
investments in existing circuit switch equipment and copper plants. Incumbent
service providers will be able to use our SLMS products to respond to pressures
from competitive service providers by rapidly offering multiple services with a
single management system and without the need for overlay access network
infrastructure. For competitive service providers, SLMS products offer direct,
high-speed access to large numbers of subscribers without requiring new
investments in local loop infrastructure.
Our current SLMS products include the Sechtor Universal Voice Gateway, the
Arca-Dacs Digital Cross Connect, the Z-Plex Multiplexor and the Broadband
Access Node, or BAN. Each of these products can be centrally provisioned and
managed by ZMS. These products are designed to enable our customers to
consolidate the local loop infrastructure and to migrate from existing network
infrastructures to high-bandwidth multi-service platforms by:
Enabling bundled voice, data, video and entertainment services over any
protocol and any medium. Our SLMS products are designed to enable service
providers to efficiently and cost-effectively provide their subscribers with a
broad range of voice, data, video and entertainment services, including high
speed Internet access, local dial tone, long distance voice, frame relay access
and voice and data virtual private networks, or VPNs. Our products will enable
service providers to deliver these services over copper pair, coaxial cable,
wireless or fiber using high speed transmission technologies, such as DSL, T1,
E1, NxT1, DS3, LMDS or OCx.
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As a result, service providers will be able to reduce their total network costs
by eliminating large numbers of network components, each designed to support
only a single service. In addition, service providers will be better able to
differentiate themselves by offering their subscribers tailored services and a
single point of contact, which will ultimately help increase service providers'
revenue and reduce their subscriber turnover.
Leveraging service providers' existing access network infrastructure. All of
our SLMS products are designed to be compatible with existing devices within
service providers' current networks. Interoperability ensures that existing
service providers can upgrade their multi-vendor networks over time to leverage
the capital they have already invested in traditional network equipment and
copper, coaxial and fiber cabling. In addition, ZMS is designed to interoperate
with network service providers' current operating support system, or OSS, as
well as their current subscriber management, billing, diagnostic and alarming
software.
Providing for ease of management and operations. ZMS is a client/server
solution designed with the scalability and reliability to manage a broad array
of services for delivery to millions of subscribers through thousands of
devices. ZMS supports the SLMS architecture, making the entire access network
appear as one unified element to the network service provider. It will allow
service providers to deliver and manage their entire range of components,
subscribers and services through a unified web-based interface from a remote
location, and supports customer provisioning, fault processing, accounting and
performance management. Together, ZMS and our other SLMS products will allow
service providers to provide for seamless integration into their existing OSS
environments.
Enabling provisioning on demand. The combination of our SLMS architecture
and ZMS is designed to enable service providers to deploy services to their
customers more quickly than is currently possible using a traditional
collection of access products. The SLMS architecture will enable rapid
deployment of new services because service providers will provision new
services from their network operations centers rather than through a technician
sent to a subscriber location; subscribers will access the new services by
simply selecting software options. The ZMS web-based interface will enable
service providers and their subscribers to quickly provision new services, such
as additional voice lines, advanced calling features and higher speed data
services.
The Zhone Strategy
Our objective is to be a leading provider of communication equipment that
consolidates the last mile infrastructure. We are designing our products to
enable service providers to migrate from existing network infrastructure to
high bandwidth, multi-service platforms. Key elements of our strategy include:
Expanding our infrastructure to meet service provider needs. To offer an
architecture as broad as SLMS to a wide variety of network service providers,
we have scaled our organization very quickly. As of September 30, 2000, we
employed approximately 490 people, including a senior management team with
significant experience in the communications industry and in building,
acquiring and integrating technology companies. We have built a facility that
allows us to test our products in a communications laboratory with the capacity
comparable to a network supporting approximately 240,000 subscribers, with
hundreds of access infrastructure products from multiple vendors. In addition,
we operate six additional development centers across the United States and
Canada to support the continued development of technology required by our
customers. We have established three sales organizations to support large,
global service providers, emerging service providers and international service
providers. We will continue to invest aggressively in our infrastructure and
hire qualified personnel, as well as expand our current and future development,
testing laboratory and sales and support sites.
Continuing the advancement and introduction of our SLMS products. Our SLMS
architecture is the core of our product development strategy. The design
criteria for SLMS products include carrier-class reliability, multi-protocol
and service support and ease of provisioning. We will continue to introduce
SLMS products that offer the configurations and feature sets that our customers
demand. In addition, we have introduced products that adhere to the standards,
protocols and interfaces dictated by international standards bodies and service
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providers. To ensure rapid development of our SLMS architecture and products,
we have established engineering teams responsible for each critical aspect of
our architecture and products. We will continue to leverage our expertise in
both voice and data technologies to enhance the SLMS architecture, supporting
new services, protocols and technologies as they emerge. To further this
objective, we will continue investing in research and development efforts to
extend the SLMS architecture and introduce new SLMS products.
Pursuing strategic acquisitions and relationships. We have grown through a
combination of strategic hiring and the acquisition of companies with relevant
technologies and skilled personnel, including CAG Technologies, Inc., Premisys
Communications, Inc., Roundview, Inc. and OptaPhone Systems, Inc. Our senior
management has extensive experience in identifying, executing and integrating
strategic acquisitions, both at Zhone and at previous companies. We intend to
pursue additional strategic acquisitions and relationships with companies that
have innovative technologies and products, highly skilled personnel, market
presence, and customer relationships and distribution channels that complement
our strategy. We will also endeavor to obtain third-party technology licenses,
distribution partnerships and manufacturing relationships to enhance our
product offerings and accelerate our time-to-market.
Delivering full customer solutions. In addition to delivering hardware and
software product solutions, we provide our customers with pre-sales and post-
sales support, education and professional services to enable our customers to
more efficiently deploy and manage their networks. We provide our customers
with application notes, business planning, web-based and phone-based
troubleshooting assistance and installation guides. Our support programs
provide a comprehensive portfolio of support tools and resources that enable
our customers to effectively sell to, support and expand their subscriber base
using our products and solutions. As of September 30, 2000, our customer
support organization had 27 full-time network support engineers, and we will
grow this organization to continue to offer current and future customers 24-
hour service, seven days a week.
SLMS Products
Our SLMS architecture provides the framework around which we are designing
and developing high speed, protocol and media agnostic communications software
and equipment for the local loop. Our SLMS products span three distinct areas:
Network and Subscriber Management. ZMS is designed to allow service
providers not only to deploy and manage all the devices in their access
networks, but also to rapidly deliver and bill for new services, increase
revenue through additional service offerings and faster deployments and reduce
operating costs through efficiencies in personnel and operations. ZMS supports
tactical provisioning, billing, subscriber management, configuration,
operational center management, diagnostics, alarming and customer network
management. ZMS eliminates multiple management layers, allowing service
providers to more efficiently operate networks, rapidly provision new services
and smoothly integrate SLMS products with existing OSSs.
<TABLE>
<CAPTION>
Product Specifications and Functions Benefits Status
------- ---------------------------------------- ------------------------------------------- ------------
<S> <C> <C> <C>
ZMS . Distributed client/server architecture . One management system for the local loop Beta Testing
. Runs in a Unix or Windows environment . End-to-end subscriber management
. Standard protocols such as SNMP and . Scalable and reliable architecture
FTP, all FCAPS and relevant subscriber . Rapid provisioning
information stored in Oracle database . Simplified OSS integration
. Scalable management platform
. Flexible access to management information
</TABLE>
Broadband Aggregation and Transport Systems. These products leverage
existing infrastructure to aggregate, concentrate and optimize communications
traffic from copper, coaxial, wireless and fiber networks. These products are
deployed in central offices, remote offices, points of presence, curbsides,
data and co-location centers and large enterprises.
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<TABLE>
<CAPTION>
Products Specifications and Functions Benefits Status
-------- ------------------------------------------ -------------------------------------------------------- ------------
<S> <C> <C> <C>
SECHTOR 300 . Uses standard GR-303 signaling to . Enables voice over any TDM network Shipping
concentrate voice traffic . Concentrates voice traffic using GR-303
. Integrates traditional 3.1.0 digital . Reduces backhaul costs by optimizing
cross connect functionality at the bandwidth utilization for voice
edge of the network . Simplifies network management and metallic test access
. Leverages existing voice infrastructures
. Delivers carrier-class reliability
ARCA-DACS 100 . Grooms DS3, DS1s and DS0s to allow . Optimizes the access network Shipping
for more efficient use of backhaul . Allows carriers to leverage existing infrastructure
SONET transport, multiplexors, . Effective, efficient, economical
3.1.0 DACS ports and switch ports . 3.1.0 digital cross-connect at the network edge
. Integrated DS0 level grooming
. Network management simplicity and metallic test access
. Carrier-class reliability
. International digital cross-connect capability
BAN . Integrates multiple access components . Ties the local loop network to the network core Beta Testing
in a single chassis . Aggregates copper, coaxial and fiber media
. Digital Subscriber Loop Access . Flexible, scalable integrated design
Multiplexor (DSLAM) . Carrier-class redundancy with innovative fault
. Digital Loop Carrier for traditional tolerant architecture
TDM voice and access service (DLC) . End-to-end provisioning and management of
. ATM edge switching and IP routing all subscriber services
. Voice gateway (VoIP and VoATM)
with GR-303 / V5.2
. Subscriber and Network Management
System
Access Systems. Our access products offer a cost-effective solution for
combining analog voice and data services onto a single platform. These products
deliver data interface connectivity for Internet routers and frame relay access
devices.
<CAPTION>
Products Specifications and Functions Benefits Status
-------- ------------------------------------------ -------------------------------------------------------- ------------
<S> <C> <C> <C>
Z-PLEX 10 . Supports T1 WAN access trunks and . Multi-service voice and data access solution Shipping
24 analog line-side voice POTS combined . Common service delivery platform
with a high speed V.35 data port . Easily installed in any location
. Delivers data interface connectivity for . Service guarantees to customers
Internet routers and frame relay access . Low profile measures on rack unit
devices . Remote provisioning and maintenance
. Supports 24 POTS ports or a mixture of . Simple installation and configuration
16 FXS+8 FXO ports . Remote management
</TABLE>
Future SLMS Products and Product Enhancements
The Multi-Access Loop Carrier. The Multi-Access Loop Carrier, or MALC, will
terminate high speed and traditional interfaces. The MALC is being designed to
integrate traditional basic and enhanced voice, data, and video services. The
MALC will offer three critical benefits for service provider deployments: (1)
it will reside anywhere the local loop terminates: curbside on a traditional
digital loop carrier footprint and power distribution model; at a cable head-
end; in the basement of a building; or in a central office or virtual central
office, (2) it will terminate all classes of access network infrastructure,
including legacy telecommunications lines: analog, digital, voice-centric and
data-centric lines, and (3) it will consolidate all services, independent of
protocol or media, into a common format, and channel all of the services onto a
single, high-speed fiber optic or wireless interface for delivery to the BAN.
Z-Edge IADS. We are developing a complete line of Integrated Access Devices,
or IADs, that will allow our service provider customers to better target their
business and consumer subscribers. IADs use existing wiring infrastructure
within a residence or business to provide service for existing telephones,
cable TVs and high-bandwidth Internet access. Our IADs will offer service
providers a range of products and configurations to
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enable them to better manage their available bandwidth to meet their individual
service requirements. The Z-Edge IAD will support all voice, data, video and
entertainment services delivered over a common line, and will be suitable for
both business and consumer subscribers.
Wireless and Cable Interface. We are developing wireless and cable
interfaces for an SLMS product that will allow service providers to transmit
all voice, data, video and entertainment services over wireless and cable
infrastructures. The BAN will use industry standard interfaces, including
DOCSIS 1.1, Packet Cable and SNMP interfaces for communication to existing
cable plants and common equipment.
IMACS Products
Our IMACS products, which we acquired as a result of our purchase of
Premisys Communications, enable service providers to offer subscribers access
to both traditional and new and emerging services and technologies. Service
providers can use our IMACS products to provide Plain Old Telephone Services,
or POTS, analog private lines and Digital Data Services, or DDS, as well as
Frame Relay, ATM and ISDN or a combination of traditional and advanced
services. The structure of the IMACS products supports circuit, packet and cell
switching in a single platform. The IMACS products contain built-in network
diagnostic and troubleshooting tools, and conform to international requirements
for interfaces, emissions, power, safety and quality in a standards based
architecture designed to manage diverse regulatory requirements.
Technology
Voice and Data Expertise. We have built an engineering team with research,
development and design expertise in both voice and data communications. This
has allowed us to develop products that capitalize on the convergence of the
previously separate voice and data networks. For instance, our New Jersey
research team has expertise in embedded system design focused on voice
protocols for signaling Digital Signal Processors, or DSPs, voice payload
switching and voice over IP. In addition, our Minnesota team has expertise in
data communications development. Our SLMS architecture is built to interoperate
in networks supporting packet, cell and circuit technologies. In addition, we
have designed our SLMS architecture to support new services, protocols and
technologies as they emerge.
Network Management System Expertise. As networks have become larger and more
complex in terms of both size and installed base of equipment, they have become
increasingly difficult to manage and maintain. We designed ZMS, our network
management system, with the scalability and reliability necessary to run an
SLMS-based network and the flexibility to allow our products to interoperate in
a network with equipment from multiple vendors. As a result, ZMS allows our
service provider customers to easily transition to SLMS products, as well as to
upgrade their current network management systems to more quickly and cost-
effectively provision services for both their new and existing subscriber
bases. ZMS is a client/server based system for installing, provisioning and
operating converged access networks, integrating with an existing OSS to
provide full operational and business management. ZMS supports the SLMS
architecture, making the entire access network appear to the network service
provider as one unified element.
Acquired Technologies. We recognize the need to acquire complementary
technologies to help us augment engineering resources necessary to respond
directly to service providers' needs. To date, we have completed four
acquisitions, each of which provides us with technical personnel and technology
expertise in the following areas:
. CAG Technologies, Inc.--hardware-based communications subsystems,
assemblies and product development infrastructure.
. Premisys Communications, Inc.--platforms that integrate access to voice,
data, video and entertainment services.
. Roundview, Inc.--software and packet-centric expertise.
. OptaPhone Systems, Inc.--point-to-point and point-to-multipoint wireless
access solutions.
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Test Methodologies. A key component of our SLMS architecture has been, and
will continue to be, interoperability testing and certification with a variety
of products that reside in networks in which we will deploy our products. We
have built a testing facility to conduct extensive interoperability trials with
equipment from other vendors. In addition, we are testing ZMS with other
vendors' equipment to allow these service providers to transition the
management and service of their networks to our ZMS.
Customers
Historically, sales of our IMACS products have been primarily to CLECs,
ILECs and IXCs. For sales of our SLMS products, we are targeting CLECs, ILECs,
IXCs, MSOs, foreign telephone companies and other communications service
providers.
For the nine months ended September 30, 2000, sales to Motorola and Paradyne
Corporation, which resells our products to AT&T and Lucent Technologies,
accounted for approximately 47% of our revenue. No other customers accounted
for more than 10% of our total revenue for that same period.
Research and Development
We have made, and will continue to make, substantial investments in research
and development. Research and product development expenses were approximately
$4.0 million for the period from September 1 through December 31, 1999, and
were approximately $60.9 million for the nine months ended September 30, 2000.
As of September 30, 2000, we had approximately 264 employees engaged in product
development, quality assurance and documentation.
We conduct the majority of our research and development in Oakland,
California. We have built a facility that allows us to test our products in a
communications laboratory with the capacity comparable to a network supporting
approximately 240,000 subscribers. We also have focused engineering teams
staffed at development centers located in the following cities: Lowell,
Massachusetts; Brooklyn Center, Minnesota; Eatontown, New Jersey; Ottawa,
Canada; and Westlake Village and Rohnert Park, California.
Our current plans for research and development include:
. continuing to refine the SLMS architecture;
. introducing new products under our SLMS architecture; and
. creating effective interfaces and protocols for international markets.
Sales and Marketing
We currently focus our sales efforts in three areas:
. Carrier Sales. Our Carrier Sales organization focuses on large global
communications service providers. Our strategy is to target these
service providers with our direct sales force and support them with a
separate engineering organization to meet their needs as they deploy
SLMS networks on a global basis.
. Emerging Carrier Sales. Our Emerging Carrier Sales team concentrates on
traditional and emerging CLECs as well as cable and wireless service
providers. This organization is also responsible for managing our
distribution and original equipment manufacturer, or OEM, partnerships.
. International Sales. Our International Sales organization targets
foreign based service providers and is staffed with individuals with
specific experience dealing with service providers in their designated
international territories.
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Our marketing team works with our sales teams by identifying and sizing
target markets for our products, creating awareness of our company and
products, generating contacts and leads within these targeted markets and
performing outbound education and public relations.
Our IMACS products are sold primarily through OEM and reseller channels.
While we will continue to support the IMACS product line to serve our
customers' needs, we do not intend to increase the level of sales and marketing
resources dedicated to the IMACS products.
Manufacturing
We outsource substantially all of our product manufacture and assembly to
third party contractors. In particular, we rely heavily on our contractual
relationship with Solectron for the manufacture and assembly of key components
of our network equipment. Under our agreement with Solectron, Solectron has the
option to acquire manufacturing assets, i.e., equipment and inventory, from us
or third parties that we may acquire. If Solectron acquires such manufacturing
assets, Solectron will, on a case-by-case basis and as mutually agreed by
Solectron and us, use these manufacturing assets to supply us with products and
services. We have established our contract manufacturing relationship with
Solectron based on its quality assurance, timely delivery, and strength in
volume manufacturing of our products. Using a contract manufacturer allows us
to reduce our capital expenditures, achieve purchasing economies of scale and
reduce inventory warehousing. Our design engineers interact regularly with
Solectron to help them quickly generate product components meeting our exacting
technical requirements.
We also complement our contract manufacturing relationships with our in-
house capabilities for final assembly and testing of our products. Our internal
manufacturing expertise is focused on product design for testability, design
for manufacturability and the transfer of products from development to
manufacturing. We also configure, package, and ship our products from our own
facilities after a series of inspections, reliability tests and quality control
measures. Our manufacturing engineers design and build all of our testing
stations, establish quality standards and protocols and develop test procedures
to assure the reliability and quality of our products. Our manufacturing
engineers work closely with our design engineers to ensure manufacturability
and feasibility of our products and to ensure that manufacturing and testing
processes evolve as our technologies evolve. Additionally, our manufacturing
engineers interface with our contract manufacturers to ensure that outsourced
manufacturing processes and products will integrate easily and cost-effectively
with our in-house manufacturing systems.
In the future, we may expand our existing contract manufacturing
relationships or establish new contract manufacturing relationships.
Furthermore, we may expand our current manufacturing facilities or secure new
manufacturing facilities to meet our anticipated manufacturing requirements.
Customer Service And Support
Our technical support services enable our service provider customers to
effectively sell to, support and expand their subscriber base. We offer free
lifetime web support, standard one-year warranties for our products, and the
opportunity to upgrade to enhanced services, critical network support and
extended warranty protection. We provide our customers with pre-sales and post-
sales support, education and professional services that enable them to deploy
and manage their networks more efficiently. We offer our customers application
notes, business planning, and installation guides, as well as web-based and
phone-based troubleshooting assistance. Furthermore, our customer service
personnel works closely with our design and manufacturing engineers to ensure
that customer feedback is integrated into our research, development and
production strategies.
As of September 30, 2000, our customer support organization had 27 full-time
employees. We are continuing to build this organization to offer current and
future customers 24 hour service, seven days a week. As our customer service
team grows, we will enhance our ability to tailor customer support services to
suit the
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unique needs of particular customers. As our product lines expand and as
technology evolves, we will strengthen and diversify our customer support
services.
Competition
Competition in the communications equipment market is intense. We are aware
of many companies in related markets that address particular aspects of the
features and functions that our products will provide. Currently, our primary
competitors include large equipment companies, such as Cisco Systems, Lucent
Technologies and Nortel Networks. We also may face competition from other large
communications companies that enter our market in the future. In addition, a
number of new public and private companies have announced plans for new
products to address the same network needs that our products address.
Many of our competitors have longer operating histories, greater name
recognition, larger customer bases and greater financial, technical, sales and
marketing resources than we do and may be able to undertake more extensive
marketing efforts, adopt more aggressive pricing policies and provide more
vendor financing than we can. Moreover, our competitors may foresee the course
of market developments more accurately than we do and could develop new
technologies that compete with our products or render our products obsolete.
Due to the rapidly evolving markets in which we compete, additional competitors
with significant market presence and financial resources may enter our markets,
further intensifying competition.
In our markets, competitive factors include:
. performance;
. reliability and scalability;
. ease of installation and use;
. interoperability with existing products;
. upgradability;
. price;
. technical support and customer service; and
. brand recognition.
While we believe we are successfully handling each of these competitive
factors, we expect to face intense competition in our markets. There can be no
assurance that we will be able to compete successfully with our current or
future competitors, or that competitive pressures will not materially and
adversely affect our business, financial condition and results of operations.
Intellectual Property
Our success and ability to compete are dependent on our ability to develop
and maintain the proprietary aspects of our technology. We rely on a
combination of trademark, copyright and trade secret laws, employee and third-
party nondisclosure agreements and licensing arrangements to protect our
intellectual property. However, these legal protections afford only limited
protection for our intellectual property.
We have incorporated third-party licensed technology into our current
products. From time to time, we may be required to license additional
technology from third parties to develop new products or product enhancements.
Third-party licenses may not be available or continue to be available to us on
commercially reasonable terms. The inability to maintain or re-license any
third-party licenses required in our current products, or to obtain any new
third-party licenses to develop new products and product enhancements could
require us to obtain substitute technology of lower quality or performance
standards or at greater cost, and delay or prevent us from making these
products or enhancements.
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We have filed trademark applications for "ARCADACS," "BAN," "SLMS," "ZEDGE,"
"ZPLEX" and the Zhone logo and we intend to file additional trademark
applications to support Zhone branding and marketing efforts.
Employees
As of September 30, 2000, we employed approximately 490 full-time employees,
including 72 in sales and marketing, 51 in manufacturing, 264 in engineering,
76 in finance and administration and 27 in customer support and professional
services. None of our employees is represented by collective bargaining
agreements, and we believe that our relations with our employees are good.
Facilities
The following table shows, as of September 30, 2000, each of our facilities,
its function, location and size and lease term:
<TABLE>
<CAPTION>
Function Location Sq. Feet Lease Term
-------- -------- -------- ----------
<S> <C> <C> <C>
Executive offices and Oakland, California 90,000(1) August 2005
research and (under construction)
development
Research and development Oakland, California 20,544 December 2001
Research and development Rohnert Park, California 14,568 November 2000
Research and development Westlake Village, California 12,882 June 2005
Research and development Lowell, Massachusetts 11,808 December 2004
Research and development Brooklyn Center, Minnesota 7,436 May 2005
Research and development Eatontown, New Jersey 10,665 June 2005
Research and development Ottawa, Ontario 10,818 January 2001
Sales Hoffman Estates, Illinois 9,700 October 2005
Sales Milan, Italy 5,000 August 2005
Sales Wanchai, Hong Kong 4,400 December 2003
</TABLE>
--------
(1) We currently occupy 90,000 square feet of commercial space. We plan to
build and use an aggregate of 300,000 square feet of commercial space.
We also have other offices, which are used primarily for sales and support
purposes. We are presently expanding our main facilities in Oakland,
California, and we believe that, when completed, our facilities will be
adequate for our purposes. All of our facilities are leased.
Legal Proceedings
We are currently not a party to any material legal proceedings.
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MANAGEMENT
Executive Officers, Directors and Key Employees
Our executive officers, directors and certain key employees, as of September
30, 2000, are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Executive Officers and
Directors
Mory Ejabat................... 50 Chief Executive Officer and Chairman of the
Board of Directors
Jeanette Symons............... 37 Chief Technology Officer and Vice
President, Engineering
Gary A. Wetsel................ 54 Chief Financial Officer and Vice President,
Finance
James G. Coulter(2)........... 40 Director
Robert K. Dahl(1)............. 59 Director
James H. Greene, Jr.(2)....... 50 Director
C. Richard Kramlich(2)........ 65 Director
John Marren(1)................ 37 Director
Alex Navab, Jr.(1)............ 34 Director
John W. Sidgmore.............. 49 Director
Dan C. Stanzione.............. 55 Director
Key Employees
Roger W. Boyce................ 45 Vice President and General Manager, Gateway
Systems
David F. Colicchio............ 49 Vice President, Global Service and Support
Michael A. Graves............. 54 Chief Information Officer and Vice
President
Marty D. Hahnfeld............. 33 Vice President, Emerging Carrier Sales
James R. Hindmarch............ 57 Vice President, Operations
Allan L. Jennings............. 49 Vice President and General Manager,
Management Systems and Software
David M. Markowitz............ 41 Associate Vice President, Marketing
David P. Misunas.............. 49 Vice President and General Manager, Access
Products
Patrick J. Nichols............ 53 Vice President and General Manager,
Wireless Systems Division
Dave Robison.................. 35 Vice President, International Sales and
Business Development
Bruce M. Ruberg............... 44 Corporate Controller and Vice President
Michael W. Scheck............. 43 Vice President, Carrier Sales
Gary Zieses................... 50 Vice President, Human Resources
</TABLE>
--------
(1) Member of the audit committee.
(2) Member of the compensation committee.
Mory Ejabat is a co-founder of our company and has served as our Chairman of
the Board of Directors and Chief Executive Officer since our inception. Prior
to co-founding our company, from June 1995 to June 1999, Mr. Ejabat was
President and Chief Executive Officer of Ascend Communications, Inc., a
provider of telecommunications equipment which was acquired by Lucent
Technologies, Inc. in June 1999. Previously, Mr. Ejabat held various senior
management positions with Ascend from September 1990 to June 1995, including
Executive Vice President and Vice President, Operations. Mr. Ejabat holds a
B.S. in Industrial Engineering and an M.S. in Systems Engineering from
California State University at Northridge and an M.B.A. from Pepperdine
University.
Jeanette Symons is a co-founder of our company and has served as our Chief
Technical Officer and Vice President, Engineering since our inception. Prior to
co-founding our company, Ms. Symons was Chief Technical Officer and Executive
Vice President of Ascend Communications, Inc., which Ms. Symons co-founded,
from January 1989 to June 1999. Before co-founding Ascend, Ms. Symons was a
software engineer at Hayes Microcomputer, a modem manufacturer, where she
developed and managed its ISDN program. Ms. Symons holds a B.S. in Systems
Engineering from the University of California at Los Angeles.
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Gary A. Wetsel has served as our Chief Financial Officer and Vice President,
Finance since February 2000. Prior to joining us, Mr. Wetsel served as
President and Chief Executive Officer of WarpSpeed Communications, a provider
of telecommunications software, from February 1998 to February 2000. From
November 1996 to February 1998, Mr. Wetsel was Executive Vice President and
Chief Operating Officer of Wyse Technology, a computer terminal provider. From
July 1996 to November 1996, Mr. Wetsel was a consultant. From November 1994 to
June 1996, Mr. Wetsel was employed by Borland International, a provider of
computer software, as Senior Vice President and Chief Financial Officer, and
was later appointed President, Chief Executive Officer and director. Mr. Wetsel
holds a B.S. in Accounting and Finance from Bentley College and is a certified
public accountant.
James G. Coulter has served as a director of our company since November
1999. Since January 1993, Mr. Coulter has been a founding partner of Texas
Pacific Group, an investment firm. Since 1992, Mr. Coulter has also served as a
principal of Air Partners, L.P. and a partner and director of Colony Advisors,
Inc. Mr. Coulter also serves as a director of Beringer Wine Estates, Globespan,
Inc., Northwest Airlines, Inc. and Oxford Health Plans, Inc. Mr. Coulter holds
a B.A. in Engineering Sciences from Dartmouth College and an M.B.A. from
Stanford University.
Robert K. Dahl has served as a director of our company since our inception.
Since January 1998, Mr. Dahl has served as a partner of Riviera Ventures LLP, a
private investment firm. Previously, Mr. Dahl held various senior management
positions with Ascend Communications, Inc., including Executive Vice President
from October 1997 to January 1998 and Chief Financial Officer from January 1994
to October 1997. Mr. Dahl also serves as a director of Bank of Alameda,
Northpoint Communications Group, Inc. and Momentum Business Applications, Inc.
Mr. Dahl holds a B.S. in Finance from the University of California at Berkeley.
James H. Greene, Jr. has served as a director of our company since November
1999. Mr. Greene is a General Partner of KKR Associates, L.P., or KKR
Associates, and was a General Partner of Kohlberg Kravis Roberts & Co., or KKR,
from January 1993 until January 1996 when he became a member of the limited
liability company which serves as the general partner of KKR. Mr. Greene also
serves as a director of Accuride Corporation, Birch Telecom, Inc., CAIS
Internet, Inc., Intermedia Communications, Inc., Owens-Illinois, Inc. and
Safeway Inc. Mr. Greene holds a B.S. in Economics from the University of
Pennsylvania.
C. Richard Kramlich has served as a director of our company since November
1999. Since June 1978, Mr. Kramlich has been a general partner of New
Enterprise Associates, a venture capital firm. Mr. Kramlich also serves as a
director of Juniper Networks, Com21, Inc., Chalone, Inc., Silicon Graphics,
Inc. and Lumisys Incorporated. Mr. Kramlich holds a B.S. in History from
Northwestern University and an M.B.A. from Harvard University.
John Marren has served as a director of our company since May 2000. Since
April 2000, Mr. Marren has been a partner of Texas Pacific Group. From 1996 to
April 2000, Mr. Marren served as a Managing Director at Morgan Stanley Dean
Witter, an investment banking company. Mr. Marren also serves as a director of
Globespan, Inc. and ON Semiconductor Corp. Mr. Marren holds a B.S. in
Electrical Engineering from the University of California, Santa Barbara.
Alex Navab, Jr. has served as a director of our company since November 1999.
Mr. Navab has been a director of KKR since 1999, and an executive of KKR and a
limited partner of KKR Associates since 1993. Mr. Navab also serves as a
director of Birch Telecom, Inc., Borden, Inc., CAIS Internet, Inc., Intermedia
Communications, Inc., KSL Recreation Group, Inc. and Regal Cinemas, Inc. Mr.
Navab holds a B.A. from Columbia University and an M.B.A. from Harvard
University.
John W. Sidgmore has served as a director of our company since September
1999. Since December 1996, Mr. Sidgmore has served as Vice Chairman of
WorldCom, Inc., a telecommunications company. Since June 1994, Mr. Sidgmore has
served as Vice Chairman of UUNET Technologies Incorporated, an Internet
services
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<PAGE>
provider which is a subsidiary of WorldCom, Inc. Mr. Sidgmore also serves as a
director of WorldCom, Inc. and MicroStrategy Inc. Mr. Sidgmore holds a B.A. in
Economics from the State University of New York.
Dan C. Stanzione has served as a director of our company since February
2000. Since April 1996, Dr. Stanzione has been President Emeritus and Chief
Operating Officer of Bell Laboratories at Lucent Technologies, Inc., a provider
of telecommunications equipment. From December 1972 to April 1996,
Dr. Stanzione held various positions with AT&T, a telecommunications company.
Dr. Stanzione also serves as a director of Quest Diagnostics. Dr. Stanzione
holds a B.S. in Electrical Engineering, an M.S. in Environmental Engineering
and a Ph.D. in Electrical and Computer Engineering from Clemson University.
Roger W. Boyce has served as our Vice President and General Manager, Gateway
Systems since February 2000. From December 1995 to December 1999, Mr. Boyce was
Vice President and General Manager, WAN Systems Business Unit with Ascend
Communications, Inc. Mr. Boyce holds a B.S. in Industrial Technology from
Montclair University and an M.S. in Technology Management from the Stevens
Institute of Technology.
David F. Colicchio has served as our Vice President, Global Service and
Support since December 1999. From June 1999 to December 1999, Mr. Colicchio was
Vice President, Worldwide Services Operations of the NetCare Professional
Services Division at Lucent Technologies, Inc. Previously, Mr. Colicchio held
various senior management positions with Ascend Communications, Inc., including
Vice President, Customer Support Business Unit from July 1997 to June 1999 and
Vice President, Customer Satisfaction and TQM from July 1995 to June 1997. Mr.
Colicchio holds a B.S. in Biomedical Engineering and an M.S. in Electrophysics
and Solid-State Electronics from the Rensselaer Polytechnic Institute.
Michael A. Graves has served as our Chief Information Officer and Vice
President since April 2000. Prior to joining us, Mr. Graves was the Chief
Information Officer and Corporate Vice President of Applied Materials, Inc., a
provider of semiconductor manufacturing equipment, from December 1997 to April
2000. From March 1995 to December 1997, Mr. Graves was the Chief Information
Officer and Vice President of Silicon Graphics, Inc., a provider of high
performance computers. Mr. Graves holds a B.S. in Education from the University
of North Texas.
Marty D. Hahnfeld has served as our Vice President, Emerging Carrier Sales
since October 1999. Prior to joining us, Mr. Hahnfeld was Area Vice President
at Ascend Communications, Inc. from October 1995 to September 1999. From
January 1994 to October 1995, Mr. Hahnfeld was Director of Strategic Accounts
at ADC Telecommunications, a provider of telecommunications equipment.
James R. Hindmarch has served as our Vice President, Operations since August
2000. Prior to joining us, Mr. Hindmarch served as Executive Vice President,
Operations and Information Systems at Ascend Communications, Inc. from August
1997 to August 2000. From August 1996 to August 1997, Mr. Hindmarch was
Executive Vice President, Operations and Information Systems for CIDCO
Incorporated, a provider of telecommunications equipment. From September 1994
to August 1996, Mr. Hindmarch served as Senior Vice President, Operations and
Information Systems at Plantronics, Inc., a provider of telecommunications
equipment. Mr. Hindmarch holds a B.S. in Industrial Management from San Jose
State University.
Allan L. Jennings has served as our Vice President and General Manager,
Management Systems and Software since November 1999. Prior to joining us, Mr.
Jennings was Vice President, Core Systems Engineering at Ascend Communications,
Inc. from July 1998 to October 1999. From July 1996 to July 1999, Mr. Jennings
was President and General Manager of Netlink Corporation, a subsidiary of
Cabletron, Inc., a provider of wide area networking equipment. Previously, Mr.
Jennings was General Manager of the Mobile Computing Group at Digital Equipment
Corp., a provider of computer equipment. Mr. Jennings holds a B.S. in
Electrical Engineering from the University of Utah.
David M. Markowitz has served as our Associate Vice President, Marketing
since July 2000. From January 2000 to July 2000, Mr. Markowitz was our Director
of Marketing. Prior to joining us, Mr. Markowitz was Vice
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<PAGE>
President, Marketing at Lucent Technologies, Inc. from August 1999 to January
2000. From October 1995 to July 1999, Mr. Markowitz held various product
management and marketing positions at Ascend Communications, Inc. Mr. Markowitz
received a B.S. with a concentration in physics from Columbia University and an
M.S. in Geophysics from the Colorado School of Mines.
David P. Misunas has served as our Vice President and General Manager of
Access Products since December 1999. From October 1999 to December 1999, Mr.
Misunas served as our Vice President, Business Development. From July 1999 to
October 1999, Mr. Misunas was Vice President, Market Development in the Core
Switching Division of Lucent Technologies, Inc. From August 1997 to July 1999,
Mr. Misunas was Vice President and General Manager in the Voice and Carrier
Signaling Division at Ascend Communications, Inc. From August 1995 to August
1997, Mr. Misunas was Vice President, Product Development at MICOM
Communications Corp., a provider of telecommunications equipment which is a
division of Nortel Networks Corporation. Mr. Misunas holds a B.S. in Electrical
Engineering and an M.S. in Electrical Engineering and Computer Science from the
Massachusetts Institute of Technology.
Patrick J. Nichols has served as our Vice President and General Manager,
Wireless Systems Division since February 2000. From July 1997 to February 2000,
Mr. Nichols was Chief Executive Officer and President of OptaPhone Systems,
Inc., a provider of local loop telephony systems and products. From June 1996
to July 1997, Mr. Nichols was a principal of Hultquist Capital, an investment
banking firm. From November 1994 to June 1996, Mr. Nichols served as Chief
Financial Officer of Noller Communications, Inc., a provider of wireless
telecommunications systems which is a subsidiary of Bakie Telecommunications of
Indonesia. Mr. Nichols holds a B.S. in Marketing from San Jose State University
and an M.B.A. with an emphasis in finance from Santa Clara University.
Dave Robison has served as our Vice President, International Sales and
Business Development since December 1999. From December 1994 to December 1999,
Mr. Robison held various management positions at Ascend Communications, Inc.,
including Vice President Emerging Carrier Sales and Business Development, Vice
President NSP Business (Domestic) and Director of ISP Sales.
Bruce M. Ruberg has served as our Corporate Controller and Vice President
since September 1999. Prior to joining us, Mr. Ruberg was the Controller for
the Access Division of Lucent Technologies from June 1999 through August 1999.
Mr. Ruberg was Assistant Controller of Ascend Communications, Inc. from April
1996 through June 1999. Previously, Mr. Ruberg held the position of Corporate
Controller of Farallon Computing, Inc. from February 1991 through March 1996.
Mr. Ruberg holds a B.S. in Accounting from the University of Illinois.
Michael W. Scheck has served as our Vice President, Carrier Sales since
April 2000. From February 2000 to March 2000, Mr. Scheck served as a consultant
to us. From January 1996 to April 2000, Mr. Scheck was Vice President, Sales at
Ascend Communications, Inc. Mr. Scheck received a B.S. in Marketing from
California State University at Chico.
Gary Zieses has served as our Vice President, Human Resources since February
2000. Prior to joining us, Mr. Zieses was Vice President, Human Resources at
Ascend Communications, Inc. from May 1998 to February 2000. From January 1996
to May 1998, Mr. Zieses was Vice President, Human Resources at Charles Schwab,
a provider of financial services. Mr. Zieses holds a B.S. in Economics from
George Mason University.
Board Composition
Our board of directors currently consists of nine members. All directors are
elected to hold office until their successors have been elected and qualified
or until their earlier death, resignation, disqualification or removal.
There are no familial relationships among any of our directors, executive
officers or key employees.
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<PAGE>
Board Committees
Our board of directors has an audit committee and a compensation committee.
Audit committee. The audit committee of our board of directors recommends
the appointment of our independent auditors, reviews our internal accounting
procedures and financial statements and consults with and reviews the services
provided by our independent auditors, including the results and scope of their
audit. The audit committee currently consists of Messrs. Dahl, Marren and
Navab.
Compensation committee. The compensation committee of our board of directors
reviews and recommends to the board the compensation and benefits of all of our
executive officers, administers our stock option plans and establishes and
reviews general policies relating to compensation and benefits of our
employees. The compensation committee currently consists of Messrs. Coulter,
Greene and Kramlich.
Compensation Committee Interlocks and Insider Participation
None of the members of our compensation committee has at any time been one
of our officers or employees. None of our executive officers currently serves,
or in the past year has served, as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving on our board of directors or compensation committee. Prior to the
creation of our compensation committee, all compensation decisions were made by
our full board of directors and Mr. Ejabat did not participate in discussions
with respect to his own compensation.
Director Compensation
Our directors do not receive any cash compensation for their services as
directors or members of committees of the board of directors but are reimbursed
for their reasonable expenses incurred in attending meetings of the board of
directors. Our directors are eligible to participate in our 1999 Stock Option
Plan and employee-directors will be able to participate in our 2000 Employee
Stock Purchase Plan.
In December 1999, we granted Mr. Sidgmore options to purchase 200,000 shares
of common stock at an exercise price of $0.10 per share that vest over four
years. In February 2000, we granted each of Messrs. Greene and Navab options to
purchase 25,000 shares of common stock at an exercise price of $0.10 per share
that vest over four years. In February 2000, we granted Mr. Stanzione options
to purchase 150,000 shares of common stock at an exercise price of $0.10 per
share that vest over four years.
In February 2000, we granted NEA Development Corporation, an entity
affiliated with Mr. Kramlich, an option to purchase 75,000 shares of common
stock at an exercise price of $0.10 per share that vests over four years. We
also granted TPG Genpar II, L.P., an entity affiliated with Messrs. Coulter and
Marren, an option to purchase 50,000 shares of common stock at an exercise
price of $0.10 per share that vests over four years.
All of the options that have been issued to our directors or their
affiliates are immediately exercisable. However, if exercised, the underlying
shares are subject to a right of repurchase by us at the original exercise
price per share. In the case of Messrs. Sidgmore and Stanzione, this right of
repurchase lapses with respect to 25% of the total number of shares upon
completion of twelve months of service from the initial vesting date and with
respect to the balance of the shares in equal monthly installments over the
following three years. In the case of Messrs. Greene and Navab, NEA Development
Corporation and TPG Genpar II, L.P., the underlying shares are subject to a
right of repurchase by us at the original exercise price per share which lapses
at the rate of 1/48th of the total number of shares on a monthly basis.
Upon a change in control of our company, our right to repurchase any shares
issued to Messrs. Sidgmore, Greene, Navab and Stanzione upon the exercise of
their options will lapse, and none of these shares will be
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<PAGE>
subject to repurchase by us. In addition, our right to repurchase any shares
issued to NEA Development Corporation and TPG Genpar II, L.P. upon the exercise
of their options will fully lapse upon a change in control.
Executive Compensation
In the fiscal year ended December 31, 1999, we paid our Chief Executive
Officer no salary or bonus. Our Chief Executive Officer is sometimes referred
to as the "named executive officer" elsewhere in this prospectus. None of our
other executive officers were paid a combined salary and bonus in excess of
$100,000 for the fiscal year ended December 31, 1999. Beginning on January 1,
2000, our Chief Executive Officer and Chief Technology Officer became entitled
to receive an annual salary of $350,000 and $250,000, respectively. Beginning
February 2000, our Chief Financial Officer became entitled to receive an annual
salary of $250,000. In addition, these executives may be entitled to receive an
annual bonus at the discretion of our board of directors
Option Grants, Aggregated Option Exercises in Last Fiscal Year and Fiscal Year
End Option Values
There were no option grants to our named executive officer during the fiscal
year ended December 31, 1999. Consequently, there were no option exercises by
our named executive officer in the last fiscal year and no options outstanding
as of the fiscal year ended December 31, 1999.
On February 8, 2000, we granted Mr. Wetsel, our Chief Financial Officer and
Vice President, Finance, an option to purchase 300,000 shares of our common
stock at an exercise price of $0.10 per share. On September 1, 2000, we granted
Mr. Wetsel an option to purchase an additional 75,000 shares of our common
stock at an exercise price of $4.00 per share. Mr. Wetsel's option grants,
together with option grants made to our key employees, were granted under our
1999 Stock Option Plan. The options are immediately exercisable. However, if
exercised, the underlying shares are subject to a right of repurchase at cost
in our favor which lapses with respect to 25% of the total number of shares
upon completion of twelve months of service from the initial vesting date and
with respect to the balance of the shares in equal monthly installments over
the following three years. All outstanding options were granted at the fair
market value of our common stock, as determined by the board of directors on
the date of grant.
Employment Contracts and Change of Control Arrangements
We routinely deliver written offer letters containing provisions on salary,
bonuses, benefits and stock option grants to prospective members of management
and other employees. Our 1999 Stock Option Plan provides that, in the event of
a change in our control, each outstanding option must be assumed or an
equivalent option substituted by the acquiring corporation, or the option will
terminate and cease to be outstanding effective as of the date of the change in
control.
On October 20, 1999, we entered into an employment agreement with Mory
Ejabat. The employment agreement provides that Mr. Ejabat will receive an
annual salary to be determined by the board of directors on an annual basis,
which amount is currently $350,000, and, at the discretion of the board of
directors, an annual bonus. The employment agreement contains limited non-
compete and non-solicitation provisions, which are in effect until the date
that is nine months after the expiration of the term of the agreement. Under
the terms of the employment agreement, in the event we terminate Mr. Ejabat's
employment for any reason other than cause, or in the event there is good
reason for Mr. Ejabat to resign, Mr. Ejabat will be entitled to receive a
severance payment equal to the salary that he would have received if he had
remained employed through October 20, 2003. Mr. Ejabat's 40,000,000 shares are
subject to a right of repurchase which lapses monthly, in equal installments
from and after July 1, 1999 and ending in June 30, 2003. Our right of
repurchase lapses with respect to 50% of Mr. Ejabat's unvested shares upon Mr.
Ejabat's death or disability. In addition, our right of repurchase lapses with
respect to all of Mr. Ejabat's shares upon either a change of control of our
company, our termination of Mr. Ejabat's employment for a reason other than
cause, death, or disability, or Mr. Ejabat's resignation from employment for
good reason.
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<PAGE>
On October 20, 1999, we entered into an employment agreement with Jeanette
Symons. The employment agreement provides that Ms. Symons will receive an
annual salary to be determined by the board of directors on an annual basis,
which amount is currently $250,000, and, at the discretion of the board of
directors, an annual bonus. The employment agreement contains limited non-
compete and non-solicitation provisions, which are in effect until the date
that is nine months after the expiration of the term of the agreement. Under
the terms of the employment agreement, in the event we terminate Ms. Symons'
employment for a reason other than cause, or in the event there is good reason
for Ms. Symons to resign, Ms. Symons will be entitled to receive a severance
payment equal to the salary that she would have received if she had remained
employed through October 20, 2003. Ms. Symons' 32,500,000 shares are subject to
a right of repurchase which lapses monthly in equal installments from and after
July 1, 1999 and ending on June 30, 2003. Our right of repurchase lapses with
respect to 50% of Ms. Symons' unvested shares upon Ms. Symons' death or
disability. In addition, our right of repurchase lapses with respect to all of
Ms. Symons' shares upon either a change of control of our company, our
termination of Ms. Symons' employment for a reason other than cause, death, or
disability, or Ms. Symons' resignation from employment for good reason.
For information regarding the effect of a change in control on options
granted to our directors and their affiliates, see "Management--Director
Compensation."
Stock Plans
1999 Stock Option Plan
Our 1999 Stock Option Plan was approved by our board of directors and by our
stockholders in November 1999. In October 2000, our board of directors amended
the plan, subject to stockholder approval prior to the completion of this
offering, to increase the number of shares of common stock reserved for
issuance under the plan from 50.0 million shares to 60.0 million shares. The
share reserve will automatically be increased on January 1, 2002 and each
January 1 thereafter by an amount equal to the lesser of 13,000,000 shares per
year, 5% of our outstanding common stock on the last day of the preceding
fiscal year or such lesser number of shares as determined by our board of
directors. The plan provides for the grant of incentive stock options, within
the meaning of Section 422 of the Internal Revenue Code, to employees and for
grants of nonstatutory stock options to employees, including officers, non-
employee directors and consultants.
The compensation committee of our board of directors currently administers
the plan. Subject to the provisions of the plan, the board or its committee has
the authority to select the persons to whom options are granted and determine
the terms of each option, including:
. the number of shares of common stock covered by the option;
. when the option becomes exercisable;
. the per share option exercise price, which in the case of incentive
stock options must be at least equal to the fair market value of a share
of common stock on the grant date or 110% of such fair market value for
incentive stock options granted to 10% stockholders, and, in the case of
nonstatutory stock options, must be at least 85% of the fair market
value of a share of common stock on the grant date; and
. the duration of the option, which for incentive stock options may not
exceed ten years, or, with respect to incentive stock options granted to
10% stockholders, five years.
All options granted under the plan are immediately exercisable but remain
subject to repurchase by us at the original exercise price paid per share if
the option holder ceases service with us before vesting in the shares. Options
granted under the plan generally vest 25% upon completion of twelve months of
service from the initial vesting date and the balance vests in equal monthly
installments over the following three years, although our board of directors or
a committee thereof may specify a different vesting schedule for a particular
grant. In addition, our board of directors or a committee thereof has the
authority under the plan to grant options which will immediately vest, in full
or in part, upon a change in control of our company. Options
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<PAGE>
granted under the plan are non-transferable other than by will or the laws of
descent and distribution; provided, however that our board of directors or a
committee thereof may provide that nonstatutory stock options are transferable
for estate planning purposes, subject to applicable law.
In the event of a change in control of our company, the acquiring or
successor corporation may either assume the outstanding options granted under
the plan or substitute for outstanding options equivalent options for the
acquiring or successor corporation's stock. All options expire if they are not
assumed, substituted or exercised prior to a change of control.
As of September 30, 2000, 17,602,040 shares, net of shares repurchased by
us, have been issued upon the exercise of options, options to purchase a total
of 7,665,318 shares at a weighted average exercise price of $2.80 per share
were outstanding and 24,732,642 shares were available for future option grants.
Options Granted Outside of 1999 Stock Option Plan
From time to time, we have granted and may continue to grant nonstatutory
stock options outside of our 1999 Stock Option Plan to individuals and entities
that have provided or will provide services to us pursuant to separate stock
option agreements. These agreements generally provide that the options are
immediately exercisable. The options granted under these agreements generally
vest 25% upon completion of twelve months from the initial vesting date and the
balance vests in equal monthly installments over the following three years,
although the board or its committee may specify a different vesting schedule
for a particular grant. Upon a change in control of our company, outstanding
options granted under some of these agreements will fully vest. All options
granted outside of our 1999 Stock Option Plan were granted at the fair market
value of our common stock, as determined by the board of directors on the date
of grant.
As of September 30, 2000, 24,933 shares, net of shares repurchased by us,
have been issued upon the exercise of options granted outside of our 1999 Stock
Option Plan. In addition, options to purchase a total of 185,000 shares at a
weighted average exercise price of $0.12 per share were outstanding.
2000 Employee Stock Purchase Plan
Our 2000 Employee Stock Purchase Plan was adopted by the board in October
2000 and remains subject to stockholder approval prior to the completion of
this offering. The plan will become effective immediately upon the completion
of this offering. We have reserved a total of 500,000 shares of common stock
for issuance under the plan, none of which will be issued as of the completion
of this offering. The share reserve will automatically be increased on January
1, 2002 and on each January 1 thereafter until and including January 1, 2011,
by an amount equal to the lesser of 2,750,000 shares per year, one percent of
our outstanding common stock on the last day of the immediately preceding
fiscal year, or such lesser number of shares as determined by our board of
directors.
The plan is intended to qualify under Section 423 of the Internal Revenue
Code. The plan will be administered by our compensation committee. Our
employees, including officers and employee-directors, or employees of any
parent or subsidiary designated by the board for participation in the plan, are
eligible to participate in the plan if they are customarily employed for more
than 20 hours per week and more than five months per year. Eligible employees
may begin participating at the start of any offering period.
The first offering period will run for approximately 12 months and will be
divided into two consecutive purchase periods of approximately six months. The
first offering period commences on the date of this prospectus, and will
terminate on the last day of January 2002. Subsequent offering periods will
generally have a duration of approximately 12 months. Offering periods after
the initial offering period will commence on the first day of February and
August of each year. The board may change the dates or duration of one or more
offering periods, but no offering may exceed 27 months.
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<PAGE>
The plan permits eligible employees to purchase our common stock through
payroll deductions, or through cash payments for the first offer period, at a
price no less than 85% of the lower of the fair market value of the common
stock on (1) the first day of the offering period, or (2) the purchase date.
Participants generally may not purchase more than 1,000 shares on a purchase
date or stock having a value greater than $25,000 in any calendar year as
measured at the beginning of the offering period. In the event of a change in
control of our company, the board may accelerate the purchase date of the then
current offering period to a date prior to the change in control, unless the
acquiring or successor corporation assumes or replaces the purchase rights
outstanding. Our board of directors may amend or terminate the plan at any
time.
401(k) Plan
In January 2000, we adopted a retirement savings and investment plan, or
401(k) plan, covering our eligible full-time employees located in the United
States. The 401(k) plan is intended to qualify under Section 401(k) of the
Internal Revenue Code of 1986, as amended, so that contributions to the 401(k)
plan by employees are not taxable to employees until withdrawn from the 401(k)
plan. Pursuant to the 401(k) plan, participating employees may elect to reduce
their current compensation by up to the lesser of 15% of their annual
compensation or the statutorily prescribed annual limit ($10,500 in 2000), and
to have the amount of the reduction contributed to the 401(k) plan. The 401(k)
plan permits discretionary matching and profit sharing contributions by our
company. To date, we have not made any contributions to the 401(k) plan on
behalf of any of our employees.
Limitation of Liability and Indemnification of Officers and Directors
As permitted by the Delaware General Corporation Law, we have adopted
provisions in our certificate of incorporation and bylaws that limit or
eliminate the personal liability of our directors for a breach of their
fiduciary duty of care as a director. The duty of care generally requires that,
when acting on behalf of the corporation, directors exercise an informed
business judgment based on all material information reasonably available to
them. Consequently, a director will not be personally liable to us or our
stockholders for monetary damages or breach of fiduciary duty as a director,
except for liability for:
. any breach of the director's duty of loyalty to us or our stockholders;
. any act or omission not in good faith or that involve intentional
misconduct or a knowing violation of law;
. any act related to unlawful stock repurchases, redemptions or other
distributions or payment of dividends; or
. any transaction from which the director derived an improper personal
benefit.
These limitations of liability do not affect the availability of equitable
remedies such as injunctive relief or rescission. Our certificate of
incorporation also authorizes us to indemnify our officers, directors and other
agents to the full extent permitted under Delaware law.
As permitted by the Delaware General Corporation Law, our bylaws provide
that:
. we are required to indemnify our directors and officers to the fullest
extent permitted by the Delaware General Corporation Law, subject to
limited exceptions;
. we are required to indemnify our other employees to the extent that we
indemnify our officers and directors, unless otherwise required by law,
our certificate of incorporation, bylaws or agreements;
. we are required to advance expenses, as incurred, to our directors and
officers in connection with a legal proceeding to the fullest extent
permitted by the Delaware General Corporation Law, subject to limited
exceptions; and
. the rights provided in our bylaws are not exclusive.
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We intend to enter into separate indemnification agreements with each of our
directors and officers which may be broader than the specific indemnification
provisions contained in the Delaware General Corporation Law. These
indemnification agreements may require us, among other things, to indemnify our
officers and directors against liabilities that may arise by reason of their
status or service as directors or officers, other than liabilities arising from
willful misconduct. These indemnification agreements also may require us to
advance any expenses incurred by the directors or officers as a result of any
proceeding against them as to which they could be indemnified and to obtain
directors' and officers' insurance if available on reasonable terms.
At present, there is no pending litigation or proceeding involving any of
our directors, officers, employees or agents in which indemnification by us is
sought, nor are we aware of any threatened litigation or proceeding that may
result in a claim for indemnification.
We have purchased a policy of directors' and officers' liability insurance
that insures our directors and officers against the cost of defense, settlement
or payment of a judgment in some circumstances.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Since our inception in September 1999, there has not been, nor is there
currently planned, any transaction or series of similar transactions to which
we were or are a party in which the amount involved exceeds $60,000 and in
which any director, executive officer or holder of more than 5% of our capital
stock or any member of their immediate families had or will have a direct or
indirect material interest other than agreements which are described under the
caption "Management" and the transactions described below.
Issuance of Common Stock
In June 1999, we sold to Mory Ejabat, as the sole trustee of the Morteza
Ejabat Trust Under Declaration of Trust Dated May 18, 1998, 40,000,000 shares
of common stock for $0.001 per share. You should read "Management--Employment
Contracts and Change of Control Arrangements" for more information regarding
the vesting of these shares.
In June 1999, we sold to Jeanette Symons, as the sole trustee of the Symons
Living Trust Dated March 15, 1995, 32,500,000 shares of common stock for $0.001
per share. You should read "Management--Employment Contracts and Change of
Control Arrangements" for more information regarding the vesting of these
shares.
In June 1999, we sold to Robert K. Dahl, as the sole trustee of the Dahl
Family Trust Dated October 31, 1989 and Amended May 3, 1990, 2,500,000 shares
of common stock for $0.001 per share. Effective October 20, 1999, we entered
into a director services agreement with Robert Dahl. Under the terms of the
director services agreement and the agreements entered into by Mr. Dahl in
connection with our preferred stock financing discussed below, our right to
repurchase Mr. Dahl's common stock will lapse with respect to 50% of Mr. Dahl's
unvested shares in the event Mr. Dahl's services as a director cease due to his
death or disability. In addition, our right of repurchase will lapse with
respect to all of Mr. Dahl's shares in the event Mr. Dahl's services as a
director involuntarily cease for a reason other than cause, death or
disability, Mr. Dahl resigns from our board for good reason, or there is a
change of control of our company.
In November 1999, Mr. Ejabat, Ms. Symons and Mr. Dahl exchanged all of their
shares of our common stock for membership interests in multiple limited
liability companies established in connection with our issuance of preferred
stock as described below.
Issuance of Preferred Stock and Zhone LLC Structure
In November 1999, we completed a private placement of twelve separate but
substantially similar series of redeemable convertible Series A preferred stock
constituting 125,000,000 shares of preferred stock in the aggregate. In this
private placement, investors committed to invest up to $500 million, or $4.00
per share of preferred stock. The twelve series of Series A preferred stock, or
Series A-1 through Series A-12 preferred stock, were issued to twelve limited
liability companies which were created for the sole purpose of completing the
financing. To date, investors have contributed 80% or $400 million of their
aggregate $500 million capital commitment, or $3.20 per share of preferred
stock. Immediately prior to the closing of this offering, all outstanding
shares of our Series A-1 through A-12 preferred stock will convert
automatically into an equal number of shares of common stock.
The Zhone LLC structure was implemented to restrict the ability of our
founders to realize profits from the sale of their shares until such time as
our Series A preferred stock investors realize a specified rate of return on
their capital investment. Each LLC was created to hold the investment of one or
more investors and 75,000,000 shares of common stock owned by Mr. Ejabat, Ms.
Symons and Mr. Dahl which they acquired from us in June 1999. The LLCs are
governed by 12 essentially identical LLC operating agreements.
Capital Commitments. The investors committed to pay in to the LLCs up to
$500 million in the aggregate in exchange for Class A membership interests in
the LLCs. In turn, the LLCs agreed to acquire
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125,000,000 shares of Series A preferred stock from us at a purchase price of
up to $4.00 per share. The investors' initial capital contribution to the LLCs
was $.80 per share of Series A preferred and to date they have invested an
additional $2.40 per share of Series A preferred for a total capital
contribution to the LLCs to date of $400 million, or $3.20 per share of Series
A preferred. The investors must make additional capital contributions to the
LLCs when and if our Board of Directors elects to make a capital call on the
LLCs. The investors' capital commitments cease upon the earlier of the
completion of this offering, October 31, 2001 or our voluntary or involuntary
liquidation, dissolution or winding up. In the event an investor fails to make
its required capital contribution following a capital call, the investor may,
among other possible seriously adverse consequences, lose a significant
percentage of its investment in the LLC and therefore, indirectly in us.
LLC Membership Interests. Investors making capital contributions to an LLC
received Class A membership interests in return. The cash invested was used by
the LLC to acquire shares of Series A preferred stock from us. In addition, Mr.
Ejabat, Ms. Symons and Mr. Dahl each contributed all of their shares of common
stock to the LLCs in exchange for Class B membership interests in the LLC.
These shares of common stock were contributed in proportion to the capital
committed to each LLC by the investor or investors in that LLC based on a ratio
of a five shares of Series A preferred stock for every three shares of common
stock. For example, in Zhone Investors I, L.L.C., (1) the investors committed
up to $155,000,000 of capital to the LLC representing 38,750,000 shares of
Series A preferred stock and (2) Mr. Ejabat, Ms. Symons and Mr. Dahl
contributed an aggregate of 23,250,000 shares of common stock to the LLC.
Management of the LLCs; Restrictions on Disposition of Shares. Each LLC is
managed by a manager appointed by one or more investors in the LLC. The manager
must take all actions related to the voting and disposition of Series A
preferred stock, and the shares of common stock into which such shares will
automatically convert upon the completion of this offering, at the direction of
the investor in that LLC. In addition, the manager must take all actions
related to the voting and disposition of shares of common stock at the
direction of Mr. Ejabat, Ms. Symons and Mr. Dahl. A manager of an LLC may not
dispose of any shares of common stock held by the LLC that are not otherwise
vested in accordance with the purchase agreements entered into between Mr.
Ejabat, Ms. Symons and Mr. Dahl and each LLC. Further, a manager may not make
any disposition of common shares held by an LLC attributable to Mr. Ejabat, Ms.
Symons and Mr. Dahl to the extent this disposition would result in the
percentage of such common stock disposed of by an LLC exceeding the percentage
of Series A preferred stock, or shares of common stock issued upon conversion
of the Series A preferred stock, disposed of at any given time. The purpose of
this restriction is to ensure that Mr. Ejabat, Ms. Symons and Mr. Dahl are not
able to dispose of a greater percentage of their holdings than the investors.
Rate of Return Protection. The LLC operating agreements are structured so
that the investors have the right to obtain a minimum return on their capital
contributions before the common stockholders will be able to keep all of the
proceeds from the sale of their shares. Restrictions on the common stockholders
may include the inability to dispose of shares prior to the disposition of
shares held by the LLCs attributed to the investors' investment and the
possibility that the common stockholders may not be entitled to receive in full
the proceeds of a disposition by an LLC of shares of common stock attributable
to them. In addition, in connection with a distribution of shares to the
investors and the common stockholders by an LLC following a transaction which
results in a change of control of our company or the sale of substantially all
of our assets to an unaffiliated party, the assets of each LLC will be
distributed in accordance with a distribution hierarchy which provides the
investors with a specified rate of return in preference to the common
stockholders. While there is a possibility that the right to receive the
proceeds of one or more sales of common stock by the LLCs may shift back and
possibly forth between the investors and the common stockholders, under no
circumstances can any contractual component of the LLC structure result in the
issuance of equity securities to any of the parties which would be dilutive to
persons acquiring shares in this offering.
Termination of the LLCs. The LLCs will be terminated and the assets of the
LLCs will be distributed to the investors and the common stockholders in
accordance with the distribution hierarchy set forth in each LLC's operating
agreement in the event of a voluntary or involuntary liquidation of the LLC, or
a change of control transaction or sale of substantially all of our assets. In
addition, the LLCs will be automatically
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dissolved on October 28, 2011 or at such time as the closing price of our
common stock as indicated on the NASDAQ National Market exceeds during any 60
calendar days in any 90 calendar period following the expiration of the lock-up
agreements entered into between the investors and our underwriters of this
offering equals or exceeds the greater of:
(a) the sum of the each investors per share capital contributions plus the
greater of 100% of such per share capital contribution or an amount
equal to a 30% cumulative annual return on such per share capital
contribution, compounded annually, or
(b) 400% of the aggregate per share capital contributions of the investor.
For example, assuming an aggregate capital commitment of $400 million, or $3.20
per share, is contributed to us, and the closing price of our common stock
equals or exceeds $12.80 per share at all times for the sixty day period
following the expiration of the lock-up agreements, then all of the LLCs will
terminate in accordance with section (b) above at the end of this sixty day
period. The termination of the LLCs and the distribution of the assets of the
LLCs will not result in any dilution to the persons acquiring shares of common
stock in this offering.
Our officers, directors and 5% stockholders beneficially acquired shares of
our Series A preferred stock as follows:
<TABLE>
<CAPTION>
Number of Shares Series of
Executive Officers, Directors and 5% Stockholders of Preferred Stock Preferred Stock
------------------------------------------------- ------------------ ---------------
<S> <C> <C>
Mory Ejabat................................................... 2,500,000 Series A-6
Jeanette Symons............................................... 2,500,000 Series A-6
Robert K. Dahl................................................ 250,000 Series A-6
John W. Sidgmore.............................................. 25,000 Series A-6
Dan C. Stanzione.............................................. 50,000 Series A-6
Entities affiliated with Texas Pacific Group, Inc. ........... 38,750,000 Series A-1
Entities affiliated with Kohlberg Kravis Roberts & Co. ....... 37,500,000 Series A-2
Entities affiliated with New Enterprise Associates............ 13,750,000 Series A-3
California Public Employees Retirement System................. 12,500,000 Series A-4
</TABLE>
Loans From Executive Officers
In connection with our acquisition of Premisys Communications, Inc., we
obtained loans in December 1999 from Mr. Ejabat and Ms. Symons in the principal
amounts of approximately $10.0 million and $3.4 million, respectively. The loan
from Mr. Ejabat accrued interest at a rate of approximately 5.9% per annum, and
the loan from Ms. Symons accrued interest at the rate of approximately 4.8% per
annum. The loan from Mr. Ejabat was paid in full in December 1999, and the loan
from Ms. Symons was paid in full in January 2000.
Acquisition of Roundview, Inc.
On February 1, 2000, we acquired substantially all of the assets of
Roundview, Inc. for $250,000. Ms. Symons was a principal stockholder of
Roundview.
Rights Agreement
We have entered into a registration rights agreement with Mr. Ejabat, Ms.
Symons, Mr. Dahl and our Series A preferred stockholders, which provides those
stockholders rights to require us to register their shares of our capital
stock. Please see "Description of Capital Stock--Registration Rights" for more
information regarding this agreement.
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Business Relationships with Directors and Executive Officers
All of the transactions described above were approved by disinterested
directors of the board of directors. As a result, we believe those transactions
were made on terms no less favorable to us that could have been obtained from
unaffiliated third parties. We intend that all future transactions and loans
between us and our officers, directors and principal stockholders and their
affiliates, will be approved by a majority of the board of directors. In
addition, we intend that all of these future transactions will take place on
terms no less favorable to us than could be obtained from unaffiliated third
parties.
Indemnification Agreements
We have entered or intend to enter into indemnification agreements with each
of our directors and executive officers. These agreements will require us to
indemnify these individuals to the fullest extent permitted by the Delaware
General Corporation Law.
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PRINCIPAL STOCKHOLDERS
The following table presents information concerning the beneficial ownership
of the shares of our common stock as of September 30, 2000, by:
. each person we know to be the beneficial owner of 5% of more of our
outstanding shares of common stock;
. each of our executive officers;
. each of our directors; and
. all of the executive officers and directors as a group.
The information set forth in the table gives effect to the conversion of all
of our preferred stock.
Beneficial ownership is determined under the rules of the Securities and
Exchange Commission and generally includes voting or investment power over
securities. Except in cases where community property laws apply or as indicated
in the footnotes to this table, we believe that each stockholder identified in
the table possesses sole voting and investment power over all shares of common
stock shown as beneficially owned by the stockholder. Percentage of beneficial
ownership is based on 217,628,973 shares of common stock outstanding as of
September 30, 2000, and shares of common stock outstanding after the
completion of this offering. Shares of common stock subject to options that are
currently exercisable or exercisable within 60 days of September 30, 2000, are
considered outstanding and beneficially owned by the person holding the options
for the purpose of computing the percentage ownership of that person but are
not treated as outstanding for the purpose of computing the percentage
ownership of any other person. Unless indicated below, the address of each
individual listed below is 7001 Oakport Street @ Zhone Way, Oakland, California
94621. For more information regarding our ownership structure and in particular
the limited liability companies which hold most of our outstanding shares, see
"Certain Relationships and Related Party Transactions--Issuance of Preferred
Stock and the Zhone LLC Structure."
<TABLE>
<CAPTION>
Percentage of Shares
Number of Outstanding
Shares ----------------------
Beneficially Prior to the After the
Name and Address of Beneficial Owner Owned Offering Offering
------------------------------------ ------------ ------------ ---------
<S> <C> <C> <C>
Executive Officers and Directors:
Mory Ejabat(1)............................ 42,394,792 19.5% %
Jeanette Symons(2)........................ 34,894,792 16.0
Gary A. Wetsel(3)......................... 375,000 *
James G. Coulter(4)....................... 38,800,000 17.8
301 Commerce St., Ste. 3300
Fort Worth, Texas 76102
Robert K. Dahl(5)......................... 2,737,500 1.3
James H. Greene, Jr.(6)................... 37,525,000 17.2
9 West 57th St., Ste. 4200
New York, NY 10019
C. Richard Kramlich(7).................... 13,825,000 6.4
1119 St. Paul St.
Baltimore, MD 21202
John Marren............................... -- --
301 Commerce St., Ste. 3300
Fort Worth, Texas 76102
Alex Navab, Jr.(8)........................ 37,525,000 17.2
9 West 57th St., Ste. 4200
New York, NY 10019
John W. Sidgmore(9)....................... 225,000 *
3060 Williams Dr., 6th Floor
Fairfax, VA 22301
Dan C. Stanzione(10)...................... 200,000 *
3008 Southeast Southview Dr.
Stuart, FL 34996
All executive officers and directors as a 171,002,084 78.6
group (11 persons)(11)...................
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Percentage of Shares
Number of Outstanding
Shares ----------------------
Beneficially Prior to the After the
Name and Address of Beneficial Owner Owned Offering Offering
------------------------------------ ------------ ------------ ---------
<S> <C> <C> <C>
Other 5% Stockholders:
Entities affiliated with Texas Pacific 38,750,000 17.8% %
Group, Inc.(12)...........................
301 Commerce St., Ste. 3300
Fort Worth, Texas 76102
Entities affiliated with Kohlberg Kravis 37,500,000 17.2
Roberts & Co.(13).........................
9 West 57th St., Ste. 4200
New York, NY 10019
Entities affiliated with New Enterprise 13,825,000 6.4
Associates(14)............................
1119 St. Paul St.
Baltimore, MD 21202
California Public Employees Retirement 12,500,000 5.7
System(15)................................
c/o Pacific Corporate International,
c/o Pacific Corporate Group
1200 Prospect St.
La Jolla, CA 92037
</TABLE>
--------
* Less than 1% of the total shares.
(1) Consists of (i) 940,000 shares held by Ejabat Ventures, L.L.C. through
Zhone Investors FF, L.L.C. and (ii) 41,454,792 shares held by Mory Ejabat,
as the sole trustee of the Morteza Ejabat Trust Under Declaration of Trust
dated May 18, 1998, as follows: (a) 12,400,000 shares held through Zhone
Investors I, L.L.C.; (b) 12,000,000 shares held through Zhone Investors
II, L.L.C.; (c) 4,400,000 shares held through Zhone Investors III, L.L.C.;
(d) 4,000,000 shares held through Zhone Investors IV, L.L.C.;
(e) 2,000,000 shares held through Zhone Investors V, L.L.C.; (f) 3,972,792
shares held through Zhone Investors FF, L.L.C., of which 2,500,000 shares
relate to Mr. Ejabat's $10,000,000 capital commitment to Zhone Investors
FF, L.L.C.; (g) 800,000 shares held through Zhone Investors VII, L.L.C.;
(h) 344,000 shares held through Zhone Investors VIII, L.L.C.; (i) 560,000
shares held through Zhone Investors IX, L.L.C.; (j) 338,000 shares held
through Zhone Investors X, L.L.C.; (k) 320,000 shares held through Zhone
Investors XI, L.L.C.; and (l) 320,000 shares held through Zhone Investors
XII, L.L.C.
(2) Consists of (i) 710,000 shares held by Symons Ventures, L.L.C. through
Zhone Investors FF, L.L.C. and (ii) 34,184,792 shares held by Jeanette
Symons, as the sole trustee of the Symons Living Trust dated March 15,
1995, as follows: (a) 10,075,000 shares held through Zhone Investors I,
L.L.C.; (b) 9,750,000 shares held through Zhone Investors II, L.L.C.; (c)
3,575,000 shares held through Zhone Investors III, L.L.C.; (d) 3,250,000
shares held through Zhone Investors IV, L.L.C.; (e) 1,625,000 shares held
through Zhone Investors V, L.L.C.; (f) 3,730,667 shares held through Zhone
Investors FF, L.L.C., of which 2,500,000 shares relate to Ms. Symons'
$10,000,000 capital commitment to Zhone Investors FF, L.L.C.; (g) 650,000
shares held through Zhone Investors VII, L.L.C.; (h) 279,500 shares held
through Zhone Investors VIII, L.L.C.; (i) 455,000 shares held through
Zhone Investors IX, L.L.C.; (j) 274,625 shares held through Zhone
Investors X, L.L.C.; (k) 260,000 shares held through Zhone Investors XI,
L.L.C.; and (l) 260,000 shares held through Zhone Investors XII, L.L.C.
(3) Consists of 375,000 shares issued to Gary Wetsel upon the exercise of
immediately exercisable options, all of which are subject to our right of
repurchase.
(4) Consists of (i) 38,750,000 shares held by TPG Zhone, L.L.C. through Zhone
Investors I, L.L.C. and (ii) 50,000 shares issuable upon the exercise of
immediately exercisable options granted to TPG Genpar II, L.P., which is
the general partner of TPG Partners II, L.P., which is the managing member
of TPG Zhone, L.L.C. Mr. Coulter is one of the founders of Texas Pacific
Group and a shareholder and director of TPG Advisors II, Inc., which is
the general partner of TPG Genpar II, L.P. Mr. Coulter disclaims
beneficial ownership in all of such shares, except to the extent of his
proportionate interest therein.
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(5) Consists of 2,737,500 shares held by Robert K. Dahl, as Trustee of the
Dahl Family Trust Dated October 31, 1989 as amended May 3, 1990 as
follows: (a) 775,000 shares held through Zhone Investors I, L.L.C.; (b)
750,000 shares held through Zhone Investors II, L.L.C.; (c) 275,000 shares
held through Zhone Investors III, L.L.C.; (d) 250,000 shares held through
Zhone Investors IV, L.L.C.; (e) 125,000 shares held through Zhone
Investors V, L.L.C.; (f) 394,875 shares held through Zhone Investors FF,
L.L.C., of which 237,500 shares relate to Mr. Dahl's $1,000,000 capital
commitment to Zhone Investors FF, L.L.C.; (g) 50,000 shares held through
Zhone Investors VII, L.L.C.; (h) 21,500 shares held through Zhone
Investors VIII, L.L.C.; (i) 35,000 shares held through Zhone Investors IX,
L.L.C.; (j) 21,125 shares held through Zhone Investors X, L.L.C.; (k)
20,000 shares held through Zhone Investors XI, L.L.C.; and (l) 20,000
shares held through Zhone Investors XII, L.L.C.
(6) Consists of (a) 25,000 shares issuable upon the exercise of immediately
exercisable options granted to Mr. Greene, and (b) 37,500,000 shares held
by KKR-ZT, L.L.C. through Zhone Investors II, L.L.C., an entity affiliated
with Kohlberg Kravis Roberts & Co. Mr. Greene is a member of the general
partner of Kohlberg Kravis Roberts & Co., which is affiliated with KKR
1996 Fund L.P., which is the manager of KKR-ZT, L.L.C., which is the
manager of Zhone Investors II, L.L.C. Mr. Greene disclaims beneficial
ownership in the shares held by KKR-ZT, L.L.C. through Zhone Investors II,
L.L.C., except to the extent of his proportionate interest therein.
(7) Consists of (a) 6,250,000 shares held by New Enterprise Associates VIII,
L.P. through Zhone Investors III, L.L.C., 7,500,000 shares held by New
Enterprise Associates 9, L.P. through Zhone Investors III, L.L.C. and (c)
75,000 shares issuable upon the exercise of immediately exercisable
options granted to NEA Development Corporation, each of which is an entity
affiliated with New Enterprise Associates. Mr. Kramlich is a general
partner of New Enterprise Associates. Mr. Kramlich disclaims beneficial
ownership in such shares, except to the extent of his proportionate
interest therein.
(8) Consists of (a) 25,000 shares issuable upon the exercise of immediately
exercisable options granted to Mr. Navab, and (b) 37,500,000 shares held
by KKR-ZT, L.L.C. through Zhone Investors II, L.L.C., each of which is an
entity affiliated with Kohlberg Kravis Roberts & Co. Mr. Navab is an
employee of Kohlberg Kravis Roberts & Co., which is affiliated with KKR
1996 Fund L.P., which is the manager of KKR-ZT, L.L.C., which is the
manager of Zhone Investors II, L.L.C. Mr. Navab disclaims beneficial
ownership in the shares held by KKR-ZT, L.L.C. through Zhone Investors II,
L.L.C., except to the extent of his proportionate interest therein.
(9) Consists of 200,000 shares held by Mr. Sidgmore and 25,000 shares held
through Zhone Investors FF, L.L.C.
(10) Consists of 150,000 shares held by Mr. Stanzione and 50,000 shares held
through Zhone Investors FF, L.L.C.
(11) Includes all information set forth in footnotes 1 through 10 above.
(12) Consists of 38,750,000 shares held by TPG Zhone, L.L.C. through Zhone
Investors I, L.L.C., which is an entity affiliated with Texas Pacific
Group, Inc.
(13) Consists of 37,500,000 shares held by KKR-ZT, L.L.C. through Zhone
Investors II, L.L.C., which is an entity affiliated with Kohlberg Kravis
Roberts & Co.
(14) Consists of (a) 6,250,000 shares held by New Enterprise Associates VIII,
L.P. through Zhone Investors III, L.L.C., 7,500,000 shares held by New
Enterprise Associates 9, L.P. through Zhone Investors III, L.L.C. and (c)
75,000 shares issuable upon the exercise of immediately exercisable
options granted to NEA Development Corporation, each of which is an entity
affiliated with New Enterprise Associates.
(15) Consists of 12,500,000 shares held by Zhone Investors IV, L.L.C., an
entity affiliated with the California Public Employees Retirement System.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, our authorized capital stock will consist
of 500,000,000 shares of common stock, $0.001 par value per share, and
50,000,000 shares of preferred stock, $0.001 par value per share.
The following is a summary of the rights of our common stock and preferred
stock. This summary is not complete. For more detailed information, please see
our certificate of incorporation which is filed as an exhibit to the
registration statement of which this prospectus is a part.
Common Stock
As of September 30, 2000, and assuming the conversion of all outstanding
preferred stock into common stock upon the closing of this offering, there were
217,628,973 shares of common stock outstanding held by 447 stockholders and
options outstanding to purchase 7,665,318 shares of common stock under the 1999
Stock Option Plan and other options outstanding to purchase 185,000 shares of
common stock.
Dividend Rights. Subject to preferences that may apply to shares of
preferred stock outstanding at the time, the holders of outstanding shares of
common stock are entitled to receive dividends out of assets legally available
at the times and in the amounts as our board of directors may from time to time
determine.
Voting Rights. Each common stockholder is entitled to one vote for each
share of common stock held on all matters submitted to a vote of stockholders.
Cumulative voting for the election of directors is not provided for in our
certificate of incorporation, which means that the holders of a majority of the
shares voted can elect all of the directors then standing for election.
No Preemptive or Similar Rights. Our common stock is not entitled to
preemptive rights and is not subject to conversion or redemption.
Right to Receive Liquidation Distributions. Upon our liquidation,
dissolution or winding-up, the assets legally available for distribution to our
stockholders are distributable ratably among the holders of our common stock
and any participating preferred stock outstanding at that time after payment of
liquidation preferences, if any, on any outstanding preferred stock and payment
of other claims of creditors. Each outstanding share of common stock is, and
all shares of common stock to be outstanding upon completion of this offering
will be, fully paid and nonassessable.
Preferred Stock
Upon the closing of this offering, each outstanding share of our Series A
preferred stock outstanding will be converted into one share of common stock.
See note 7 to our financial statements for a description of the preferred
stock.
Following the offering, we will be authorized, subject to the limits imposed
by the Delaware General Corporation Law, to issue 50,000,000 shares of
preferred stock in one or more series, to establish from time to time the
number of shares to be included in each series, to fix the rights, preferences
and privileges of the shares of each wholly unissued series and any of its
qualifications, limitations, restrictions. Our board of directors can also
increase or decrease the number of shares of any series, but not below the
number of shares of that series then outstanding, without any further vote or
action by our stockholders.
Our board of directors may authorize the issuance of preferred stock with
voting or conversion rights that could adversely affect the voting power or
other rights of our common stockholders. The issuance of preferred stock, while
providing flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of delaying, deferring or preventing
our change in control and may cause the market price of our common stock to
decline or impair the voting and other rights of the holders of our common
stock. We have no current plans to issue any shares of preferred stock.
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<PAGE>
Warrants
On January 20, 2000, we issued a warrant to the City of Oakland to purchase
100,000 shares of common stock at an exercise price per share of $4.00. This
warrant may be exercised at any time prior to January 20, 2010.
On March 13, 2000, we issued a warrant to Solectron Corporation to purchase
15,000 shares of common stock at an exercise price per share of $0.40. This
warrant may be exercised at any time prior to March 13, 2005.
On September 5, 2000, we issued a warrant to Broadband Infrastructure Group
Corporation to purchase 30,000 shares of common stock at an exercise price per
share of $9.50. This warrant may be exercised at any time prior to September 5,
2005.
Registration Rights
Mory Ejabat, Jeanette Symons, Robert K. Dahl and the holders of
approximately 125,000,000 shares of preferred stock have the right to require
us to register their shares with the Securities and Exchange Commission so that
those shares may be publicly resold or to include their shares in any
registration statement we file.
Demand Registration Rights
. At any time six months after the closing of this offering the holders of
at least 20% of the shares having registration rights (excluding the
shares held by Mory Ejabat, Jeanette Symons and Robert Dahl attributable
to the shares purchased by them in June 1999) have the right to demand
that we file a registration statement so long as the aggregate amount of
securities to be sold under the registration statement exceeds $5.0
million.
. If we are eligible to file a registration statement on Form S-3, the
holders of at least 20% of the shares having registration rights have
the right to demand that we file a registration statement on Form S-3.
Piggyback Registration Rights
If we register any securities for public sale, stockholders with
registration rights will have the right to include their shares in the
registration statement. The underwriters of any underwritten offering will have
the right to limit the number of shares having registration rights to be
included in the registration statement, but not below 30% of the total number
of shares included in the registration statement, except for this offering in
which the underwriters have excluded any sales by existing investors.
Expenses of Registration
We will pay all expenses relating to any demand or piggyback registration.
However, we will not pay for the expenses of any demand registration if the
request is subsequently withdrawn by the holders of a majority of the shares
having registration rights, subject to very limited exceptions.
Expiration of Registration Rights
The registration rights described above will expire seven years after this
offering is completed. The registration rights will terminate earlier for a
particular stockholder if that holder can resell all of its securities in a
three-month period under Rule 144 of the Securities Act (without reference to
Rule 144(k)) and we are subject to the reporting requirements of the Securities
Exchange Act of 1934, or Exchange Act.
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<PAGE>
Antitakeover Effects of Delaware Law and Provisions of Our Certificate of
Incorporation and Bylaws
Delaware Takeover Statute
We are subject to Section 203 of the Delaware General Corporation Law. This
statute regulating corporate takeovers prohibits a Delaware corporation from
engaging in any business combination with any interested stockholder for three
years following the date that the stockholder became an "interested
stockholder," unless:
. prior to the date of the transaction, the board of directors of the
corporation approved either the business combination or the transaction
which resulted in the stockholder becoming an interested stockholder;
. the interested stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced, excluding
for purposes of determining the number of shares outstanding (a) shares
owned by persons who are directors and also officers, and (b) shares
owned by employee stock plans in which employee participants do not have
the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or
. on or subsequent to the date of the transaction, the business
combination is approved by the board and authorized at an annual or
special meeting of stockholders, and not by written consent, by the
affirmative vote of at least 66 2/3% of the outstanding voting stock
which is not owned by the interested stockholder.
Section 203 defines a "business combination" to include:
. any merger or consolidation involving the corporation and the interested
stockholder;
. any sale, transfer, pledge or other disposition involving the interested
stockholder of 10% or more of the assets of the corporation;
. subject to exceptions, any transaction that results in the issuance or
transfer by the corporation of any stock of the corporation to the
interested stockholder; or
. the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
In general, Section 203 defines an interested stockholder as any entity or
person beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by the entity or person.
Certificate of Incorporation and Bylaw Provisions
Provisions of our certificate of incorporation and bylaws which will become
effective upon the closing of this offering may have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, control of our company. These provisions could
cause the price of our common stock to decrease. Some of these provisions allow
us to issue preferred stock without any vote or further action by the
stockholders, eliminate the right of stockholders to act by written consent
without a meeting and eliminate cumulative voting in the election of directors.
These provisions may make it more difficult for stockholders to take specific
corporate actions and could have the effect of delaying or preventing a change
in our control. The amendment of any of these provisions would require approval
by holders of at least two-thirds of the outstanding common stock.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock, and there can be no assurance that a significant public market for the
common stock will develop or be sustained after this offering. Future sales of
substantial amounts of common stock, including shares issued upon exercise of
outstanding options and warrants, in the public market following this offering
could adversely affect market prices prevailing from time to time and could
impair our ability to raise capital through the sale of our equity securities.
Sales of substantial amounts of our common stock in the public market after the
restrictions lapse could adversely affect the prevailing market price and our
ability to raise equity capital in the future.
Upon completion of this offering and based on shares outstanding at
September 30, 2000, we will have outstanding shares of common
stock. Of these shares, all the shares sold in this offering, plus any shares
issued upon exercise of the underwriters' over-allotment option, will be freely
tradable without restriction under the Securities Act, unless purchased by our
"affiliates" as that term is defined in Rule 144 under the Securities Act.
The remaining shares of common stock outstanding are
"restricted securities" within the meaning of Rule 144 under the Securities
Act. Restricted securities may be sold in the public market only if registered
or if they qualify for an exemption from registration under Rules 144, 144(k)
or 701 promulgated under the Securities Act, which are summarized below.
Our directors, officers and stockholders have entered into lock-up
agreements with the underwriters of this offering generally providing that they
will not offer, sell, contract to sell or grant any option to purchase or
otherwise dispose of our shares of common stock or any securities exercisable
for or convertible into our common stock owned by them prior to this offering
for a period of 180 days after the effective date of the registration statement
filed pursuant to this offering without the prior written consent of Credit
Suisse First Boston Corporation. As a result of these contractual restrictions,
notwithstanding possible earlier eligibility for sale under the provisions of
Rules 144, 144(k) and 701, shares subject to lock-up agreements may not be sold
until such agreements expire or are waived by Credit Suisse First Boston
Corporation. Based on shares outstanding as of September 30, 2000, taking into
account the lock-up agreements, and assuming Credit Suisse First Boston
Corporation does not release stockholders from these agreements prior to the
expiration of the 180 day lock-up period, the following shares will be eligible
for sale in the public market at the following times:
. beginning on the effective date of the registration statement, the
shares sold in this offering will be immediately available for
sale in the public market;
. beginning 180 days after the date of this prospectus, approximately
additional shares will become eligible for sale under Rule
144 or 701, subject to volume restrictions as described below; and
. the remainder of the restricted securities will be eligible for sale
from time to time thereafter, subject in some cases to compliance with
Rule 144.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned restricted
shares for at least one year, including the holding period of any prior owner
except an affiliate, would be entitled to sell within any three-month period a
number of shares that does not exceed the greater of:
. 1% of the number of shares of common stock then outstanding, which will
equal approximately shares immediately after this offering; or
. the average weekly trading volume of our common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale.
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<PAGE>
Sales under Rule 144 are also subject to certain manner of sale provisions
and notice requirements and to the availability of current public information
about us. Under Rule 144(k), a person who is not deemed to have been an
affiliate of the company at any time during the three months preceding a sale,
and who has beneficially owned the shares proposed to be sold for at least two
years, including the holding period of any prior owner except an affiliate, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
Rule 701, as currently in effect, permits resales of shares in reliance upon
Rule 144 but without compliance with certain restrictions, including the
holding period requirement, of Rule 144. Any of our employees, officers,
directors, or consultant who purchased shares under a written compensatory plan
or contract may be entitled to rely on the resale provisions of Rule 701. Rule
701 permits affiliates to sell their Rule 701 shares under Rule 144 without
complying with the holding period requirements of Rule 144. Rule 701 further
provides that non-affiliates may sell such shares in reliance on Rule 144
without having to comply with the holding period, public information, volume
limitation or notice provisions of Rule 144. All holders of Rule 701 shares are
required to wait until 90 days after the date of this prospectus before selling
such shares. However, all Rule 701 shares are subject to lock-up agreements and
will only become eligible for sale at the earlier of the expiration of the 180-
day lock-up agreements or no sooner than 90 days after the offering upon
obtaining the prior written consent of Credit Suisse First Boston Corporation.
Within 90 days following the effectiveness of this offering, we intend to
file a registration statement on Form S-8 registering approximately
shares of common stock subject to outstanding options or reserved for future
issuance under our 1999 stock option plan and our 2000 employee stock purchase
plan, based on shares and options outstanding as of September 30, 2000. As of
September 30, 2000, options to purchase a total of 7,665,318 shares were
outstanding and 24,732,642 additional shares were reserved for future issuance
under our 1999 stock option plan. Upon the filing of the registration statement
on Form S-8, common stock issued upon exercise of outstanding options which are
not subject to our right of repurchase or which are issued under our 2000
employee stock purchase plan, other than common stock issued to our affiliates,
will be available for immediate resale in the open market. Also beginning six
months after the date of this offering, holders of approximately 200,000,000
restricted shares will be entitled to certain registration rights. See
"Description of Capital Stock--Registration Rights" on page 60 for more
information regarding these rights. Registration of such shares under the
Securities Act would result in such shares becoming freely tradable without
restriction under the Securities Act, except for shares purchased by
affiliates, immediately upon the effectiveness of such registration.
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<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 2000, we have agreed to sell to the underwriters
named below, for whom Credit Suisse First Boston Corporation, Lehman Brothers
Inc., UBS Warburg LLC, Thomas Weisel Partners LLC and U.S. Bancorp Piper
Jaffray Inc., are acting as representatives, the following respective numbers
of shares of common stock:
<TABLE>
<CAPTION>
Number
of
Underwriters Shares
------------ ------
<S> <C>
Credit Suisse First Boston Corporation...............................
Lehman Brothers Inc..................................................
UBS Warburg LLC......................................................
Thomas Weisel Partners LLC...........................................
U.S. Bancorp Piper Jaffray Inc.......................................
----
Total..............................................................
====
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering, other than those
shares covered by the over-allotment option described below. The underwriting
agreement also provides that if an underwriter defaults, the purchase
commitments of non-defaulting underwriters may be increased or the offering may
be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to additional shares at the initial public offering price less
the underwriting discounts and commissions. The option may be exercised only to
cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $ per share. The underwriters
and selling group members may allow a discount of $ per share on sales to
other broker/dealers. After the initial public offering, the public offering
price and concession and discount to broker/ dealers may be changed by the
representatives.
The following table summarizes the compensation and estimated expenses we
will pay:
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting Discounts
and Commissions paid by
us..................... $ $ $ $
Expenses payable by us.. $ $ $ $
</TABLE>
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
We intend to use more than 10% of the net proceeds from the sale of the
common stock to repay indebtedness owed by us to Credit Suisse First Boston,
New York Branch, the banking affiliate of Credit Suisse First Boston
Corporation. Accordingly, the offering is being made in compliance with the
requirements of Rule 2710(c)(8) of the National Association of Securities
Dealers, Inc. Conduct Rules. This rule provides generally that if more than 10%
of the net proceeds from the sale of stock, not including underwriting
compensation, is paid to the underwriters or their affiliates, the initial
public offering price of the stock may not be higher than that recommended by a
"qualified independent underwriter" meeting certain standards. Accordingly,
Lehman Brothers, Inc. is assuming the responsibilities of acting as the
qualified independent
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underwriter in pricing the offering and conducting due diligence. The initial
public offering price of the shares of common stock is no higher than the price
recommended by Lehman Brothers, Inc.
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act relating
to, any shares of our common stock or securities convertible into or
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any such offer, sale, pledge, disposition or
filing, without the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus, except
issuances pursuant to the exercise of employee stock options outstanding on the
date hereof.
All of our executive officers, directors and stockholders have agreed that
they will not offer, sell, contract to sell, pledge or otherwise dispose of,
directly or indirectly, any shares of our common stock or securities
convertible into or exchangeable or exercisable for any shares of our common
stock, enter into a transaction which would have the same effect, or enter into
any swap, hedge or other arrangement that transfers, in whole or in part, any
of the economic consequences of ownership of our common stock, whether any of
these transactions are to be settled by delivery of our common stock or other
securities, in cash or otherwise, or publicly disclose the intention to make
any offer, sale, pledge or disposition, or to enter into any transaction, swap,
hedge or other arrangement, without, in each case, the prior written consent of
Credit Suisse First Boston Corporation for a period of 180 days after the date
of this prospectus.
The underwriters have reserved for sale, at the initial public offering
price, up to shares of common stock for vendors, customers and other
people and entities with whom we maintain business relationships who have
expressed an interest in purchasing common stock in this offering. The number
of shares available for sale to the general public in this offering will be
reduced to the extent these persons purchase the reserved shares. Any reserved
shares not purchased will be offered by the underwriters to the general public
on the same terms as the other shares.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act or contribute to payments which the underwriters may be required
to make in that respect.
We will apply to list the shares of common stock on The Nasdaq Stock
Market's National Market under the symbol "ZHON."
Prior to this offering, there has been no public market for our common
stock. The initial public offering price will be determined by negotiation
between us and the representatives. The principal factors to be considered in
determining the public offering price include:
. the information set forth in this prospectus and otherwise available to
the underwriters;
. the history and the prospects for the industry in which we will compete;
. the ability of our management;
. the prospects for our future earnings;
. the present state of our development and our current financial
condition;
. the general condition of the securities markets at the time of this
offering; and
. the recent market prices of, and the demand for, publicly-traded common
stock of generally comparable companies.
We offer no assurances that the initial public offering price will
correspond to the price at which the common stock will trade in the public
market following the offering or that an active trading market for the common
stock will develop and continue after the offering.
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In connection with the offering, the underwriters may engage in stabilizing
transactions, over-allotment transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act.
. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
. Over-allotment involves sales by the underwriters of shares in excess of
the number of shares the underwriters are obligated to purchase, which
creates a syndicate short position. The short position may be either a
covered short position or a naked short position. In a covered short
position, the number of shares over-allotted by the underwriters is not
greater than the number of shares that they may purchase in the over-
allotment option. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
option. The underwriters may close out any short position by either
exercising their over-allotment option and/or purchasing shares in the
open market.
. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open
market as compared to the price at which they may purchase shares
through the over-allotment option. If the underwriters sell more shares
than could be covered by the over-allotment option, a naked short
position, the position can only be closed out by buying shares in the
open market. A naked short position is more likely to be created if the
underwriters are concerned that there could be downward pressure on the
price of the shares in the open market after pricing that could
adversely affect investors who purchase in the offering.
. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of our
common stock or preventing or retarding a decline in the market price of the
common stock. As a result, the price of the common stock may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on The Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
A prospectus in electronic format may be made available on the websites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters
for sale to their online brokerage account holders. Internet distributions will
be allocated by the underwriters that will make internet distributions on the
same basis as other allocations.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker/dealer in December 1998. Since
December 1998, Thomas Weisel Partners has acted as a lead or co-manager on
numerous offerings of equity securities that have been completed. Thomas Weisel
Partners does not have any material relationship with us or any of our
officers, directors or other controlling persons, except with respect to its
contractual relationship with us pursuant to the underwriting agreement entered
into in connection with this offering.
Credit Suisse First Boston Corporation has provided investment banking and
financial advisory services to our company for which it has received customary
fees. In addition, Credit Suisse First Boston Venture Fund I, L.P., an
affiliate of Credit Suisse First Boston Corporation, beneficially owns
1,000,000 shares of our Series A redeemable convertible preferred stock. For
additional information regarding our Series A redeemable convertible preferred
stock financing, please see "Certain Relationships and Related Party
Transactions--Issuance of Preferred Stock and Zhone LLC Structure." All shares
of our Series A redeemable convertible
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preferred stock will be automatically converted into shares of our common stock
immediately prior to the closing of this offering.
We are in compliance with the terms of our loan from Credit Suisse First
Boston, New York Branch. The decision of Credit Suisse First Boston Corporation
to distribute our common stock was made independent of Credit Suisse First
Boston, New York Branch and Credit Suisse First Boston Venture Fund I, L.P.,
which affiliates had no involvement in determining whether or when to
distribute our common stock under this offering or the terms of this offering.
Credit Suisse First Boston Corporation will not receive any benefit from this
offering other than its portion of the underwriting fee as paid by us.
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NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are made. Any resale of the common stock in Canada must
be made under applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made in accordance
with available statutory exemptions or under a discretionary exemption granted
by the applicable Canadian securities regulatory authority. Purchasers are
advised to seek legal advice prior to any resale of the common stock.
Representations of Purchasers
By purchasing common stock in Canada and accepting a purchase confirmation,
a purchaser is representing to us and the dealer from whom the purchase
confirmation is received that:
. the purchaser is entitled under applicable provincial securities laws to
purchase the common stock without the benefit of a prospectus qualified
under the securities laws;
. where required by law, that the purchaser is purchasing as principal and
not as agent; and
. the purchaser has reviewed the text above under Resale Restrictions.
Rights of Action (Ontario Purchasers)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities laws. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or such persons. All or a substantial portion of the assets of
the issuer and such persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or such persons
in Canada or to enforce a judgment obtained in Canadian courts against such
issuer or persons outside of Canada.
Notice to British Columbia Residents
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that the purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser in this offering. This report must be
in the form attached to British Columbia Securities Commission Blanket Order
BOR #95/17, a copy of which may be obtained from us. Only one report must be
filed for common stock acquired on the same date and under the same prospectus
exemption.
Taxation and Eligibility for Investment
Canadian purchasers of common stock should consult with their own legal and
tax advisors with respect to the tax consequences of an investment in the
common stock in their particular circumstances and about the eligibility of the
common stock for investment by the purchaser under relevant Canadian
legislation.
68
<PAGE>
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Gray Cary Ware & Freidenrich LLP, Palo Alto, California. Various legal
matters relating to the offering will be passed upon for the underwriters by
Latham & Watkins, Menlo Park, California. As of September 30, 2000, persons and
entities affiliated with Gary Cary Ware & Freidenrich LLP beneficially owned
50,000 shares of our preferred stock, all of which will convert to common stock
immediately prior to the closing of this offering.
CHANGE IN ACCOUNTANTS
Ernst & Young LLP served as our independent auditors until their dismissal
effective August 22, 2000. There were no disagreements between Ernst & Young
LLP and us on any matters of accounting principles or practices, financial
statement disclosure or auditing scope or procedure that if not resolved to the
satisfaction of Ernst & Young LLP, would have caused Ernst & Young LLP to make
reference to the subject matter of these disagreements.
Effective August 2000, we engaged KPMG LLP as our principal accountants to
audit our financial statements. We did not consult with KPMG LLP on any
accounting or financial reporting matters in the period before their
appointment. The change in accountants was approved by our board of directors.
EXPERTS
The consolidated financial statements and schedule of Zhone Technologies,
Inc. and subsidiaries as of December 31, 1999 and September 30, 2000, for the
period from September 1, 1999 (inception) to December 31, 1999 and for the nine
months ended September 30, 2000 have been included herein and in the
registration statement in reliance on the reports of KPMG LLP, independent
certified public accountants appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
The financial statements of Premisys Communications, Inc. as of June 30,
1999, 1998 and 1997 and for each of the years in the period ended June 30, 1999
included in this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act that registers the shares of our common stock to be sold in this
offering. The registration statement, including the attached exhibits and
schedules, contain additional relevant information about us and our capital
stock. The rules and regulations of the SEC allow us to omit various
information included in the registration statement from this document.
In addition, upon completion of this offering, we will become subject to the
reporting and information requirements of the Exchange Act and, as a result,
will file periodic reports, proxy statements and other information with the
SEC. You may read and copy this information at the public reference room of the
SEC at 450 Fifth Street, N.W., Room 1024, Washington, DC 20549. You may also
obtain copies of this information by mail from the public reference section of
the SEC, 450 Fifth St., N.W. Room 1024, Washington, DC 20549, at prescribed
rates. You may obtain information on the operation of the public reference
rooms by calling the SEC at 1 (800) SEC-0330.
The SEC also maintains an internet website that contains reports, proxy
statements and other information about issuers, like us who file electronically
with the SEC. The address of that website is http://www.sec.gov.
We intend to furnish our stockholders with annual reports containing audited
financial statements, and make available to our stockholders quarterly reports
for the first three quarters of each fiscal year containing unaudited interim
financial information.
69
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Zhone Technologies, Inc. Consolidated Financial Statements
Report of Independent Auditors............................................ F-2
Consolidated Balance Sheets............................................... F-3
Consolidated Statements of Operations..................................... F-4
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Deficit.................................................... F-5
Consolidated Statements of Cash Flows..................................... F-6
Notes to Consolidated Financial Statements................................ F-7
Premisys Communications, Inc. Consolidated Financial Statements
Report of Independent Accountants......................................... F-23
Consolidated Balance Sheet................................................ F-24
Consolidated Income Statement............................................. F-25
Consolidated Statement of Stockholders' Equity............................ F-26
Consolidated Statement of Cash Flows...................................... F-27
Notes to Consolidated Financial Statements................................ F-28
Unaudited Pro Forma Combined Condensed Statement of Operations............ F-39
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Zhone Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Zhone
Technologies, Inc. and subsidiaries as of December 31, 1999 and September 30,
2000, and the related consolidated statements of operations, redeemable
convertible preferred stock and stockholders' deficit and cash flows for the
periods from September 1, 1999 (inception) through December 31, 1999 and for
the nine months ended September 30, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Zhone
Technologies, Inc. and subsidiaries as of December 31, 1999 and September 30,
2000 and the results of their operations, and their cash flows for the periods
from September 1, 1999 (inception) through December 31, 1999 and the nine
months ended September 30, 2000, in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Mountain View, California
October 16, 2000
F-2
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 73,916 $ 124,735
Short-term investments........................... 4,005 18,152
Accounts receivable, net of allowances for sales
returns and doubtful accounts of $4,535 and
$6,350, respectively............................ 5,846 10,461
Inventories...................................... 7,854 29,353
Prepaid expenses and other current assets........ 4,012 4,853
Deferred taxes................................... 16,500 15,235
-------- ---------
Total current assets........................... 112,133 202,789
Property and equipment, net........................ 7,944 26,640
Goodwill and other intangibles, net................ 161,688 136,025
Other assets....................................... 308 27,268
-------- ---------
Total assets................................... $282,073 $ 392,722
======== =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable................................. $ 16,660 $ 23,897
Payable to officer............................... 3,364 --
Accrued acquisition costs........................ 22,422 3,861
Current portion of senior secured term loan...... 5,000 8,125
Accrued and other liabilities.................... 11,664 32,379
-------- ---------
Total current liabilities...................... 59,110 68,262
Senior, secured term loan, less current portion.... 45,000 39,375
Deferred taxes..................................... 18,425 15,235
Other long-term liabilities........................ 54 214
-------- ---------
Total liabilities.............................. 122,589 123,086
-------- ---------
Series A redeemable convertible preferred stock,
$0.001 par value, 125,000 shares authorized;
125,000 shares issued and outstanding; liquidation
value of $200,000 and $400,000 at December 31,
1999 and September 30, 2000, respectively......... 186,371 383,114
Stockholders' deficit:
Common stock, $0.001 par value, 300,000 shares
authorized; 79,320 and 92,629 shares issued and
outstanding at December 31, 1999 and
September 30, 2000, respectively................ 79 93
Additional paid-in capital....................... 19,440 124,834
Notes receivable from stockholders............... -- (2,130)
Deferred stock compensation...................... (16,381) (78,518)
Accumulated other comprehensive loss............. -- (22)
Accumulated deficit.............................. (30,025) (157,735)
-------- ---------
Total stockholders' deficit.................... (26,887) (113,478)
-------- ---------
Total liabilities, redeemable convertible
preferred stock and stockholders' deficit..... $282,073 $ 392,722
======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Period from
September 1, 1999 Nine months
(inception) through ended
December 31, 1999 September 30, 2000
------------------- -------------------
<S> <C> <C>
Net revenue............................................... $ -- $ 60,511
Cost of revenue (excluding $0 and $3,159 of stock based
compensation for the period ended December 31, 1999 and
the nine months ended September 30, 2000)................ -- 33,937
-------- ---------
Gross profit.............................................. -- 26,574
Operating expenses:
Research and product development (excluding $1,890 and
$16,265 of stock based compensation for the period
ended December 31, 1999 and the nine months ended
September 30, 2000).................................... 4,016 60,888
Sales and marketing (excluding $512 and $6,068 of stock
based compensation for the period ended December 31,
1999 and the nine months ended September 30, 2000)..... 226 23,364
General and administrative (excluding $489 and $7,478 of
stock based compensation for the period ended December
31, 1999 and the nine months ended September 30, 2000). 1,321 10,009
Write-off of in-process research and development........ 21,320 439
Stock based compensation................................ 2,891 32,970
Amortization of intangibles............................. 147 28,073
-------- ---------
Total operating expenses.............................. 29,921 155,743
-------- ---------
Operating loss........................................ (29,921) (129,169)
Interest expense, net..................................... (104) (466)
-------- ---------
Net loss before income tax benefit........................ (30,025) (129,635)
Income tax benefit........................................ -- (1,925)
-------- ---------
Net loss.................................................. $(30,025) $(127,710)
-------- ---------
Accretion on preferred stock.............................. (195) (1,968)
-------- ---------
Net loss applicable to common stockholders................ $(30,220) $(129,678)
======== =========
Basic and diluted net loss per share applicable to common
stockholders............................................. $ (0.40) $ (1.73)
======== =========
Weighted average shares outstanding used to compute basic
and diluted net loss per share applicable to common
stockholders............................................. 75,000 75,034
======== =========
Pro forma basic and diluted net loss per share
(unaudited).............................................. $ (0.15) $ (0.64)
======== =========
Weighted average shares outstanding used to compute pro
forma basic and diluted net loss per share (unaudited)... 200,000 200,034
======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
(in thousands)
<TABLE>
<CAPTION>
Series A
Redeemable
Convertible
----------------
Preferred Stock Common Stock
---------------- -------------------------
Notes Accumulated
Additional Receivable Deferred Other Total
paid in from Stock Comprehensive Accumulated Stockholders'
Shares Amount Shares Amount capital Stockholders Compensation Loss Deficit Deficit
------- -------- ------ ------ ---------- ------------ ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of
common stock for
cash............ -- $ -- 75,000 $ 75 $ (65) $ -- $ -- $ -- $ -- $ 10
Exercise of
stock options... -- -- 4,320 4 428 -- -- -- -- 432
Issuance of
Series A
redeemable
convertible
preferred stock
(net of issuance
costs of
$13,824)........ 125,000 186,176 -- -- -- -- -- -- -- --
Accretion on
preferred stock. -- 195 -- -- (195) -- -- -- -- (195)
Deferred
compensation
related to stock
option grants... -- -- -- -- 19,272 -- (19,207) -- -- 65
Amortization of
deferred
compensation
related to stock
option grants... -- -- -- -- -- -- 2,826 -- -- 2,826
Net loss........ -- -- -- -- -- -- -- -- (30,025) (30,025)
------- -------- ------ ---- -------- ------- -------- ----- --------- ---------
Balances at
December 31,
1999............ 125,000 $186,371 79,320 $ 79 $ 19,440 $ -- $(16,381) $ -- $ (30,025) $ (26,887)
------- -------- ------ ---- -------- ------- -------- ----- --------- ---------
Exercise of
stock options
for cash and
notes........... -- -- 14,566 15 12,176 (2,130) -- -- -- 10,061
Repurchase of
unvested common
stock........... -- -- (1,259) (1) (221) -- -- -- -- (222)
Capital draw
from convertible
preferred stock
(net of issuance
costs of
$5,025)......... -- 194,775 -- -- -- -- -- -- -- --
Accretion on
preferred stock. -- 1,968 -- -- (1,968) -- -- -- -- (1,968)
Deferred
compensation
related to stock
option grants... -- -- -- -- 95,107 -- (92,562) -- -- 2,545
Amortization of
deferred
compensation
related to stock
option grants... -- -- -- -- -- -- 30,425 -- -- 30,425
Issuance of
warrants........ -- -- -- -- 300 -- -- -- -- 300
Issuance of
common stock.... -- -- 2 -- -- -- -- -- -- --
Net loss........ -- -- -- -- -- -- -- -- (127,710) (127,710)
Foreign currency
translation
adjustment...... -- -- -- -- -- -- -- (22) -- (22)
------ ---------
Comprehensive
loss............ -- -- -- -- -- -- -- -- -- (127,732)
------- -------- ------ ---- -------- ------- -------- ----- --------- ---------
Balances at
September 30,
2000............ 125,000 $383,114 92,629 $ 93 $124,834 $(2,130) $(78,518) $ (22) $(157,735) $(113,478)
======= ======== ====== ==== ======== ======= ======== ===== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Period from
September 1, 1999 Nine months
(inception) through ended
December 31, September 30,
1999 2000
------------------- -------------
<S> <C> <C>
Operating activities
Net loss.................................... $ (30,025) $(127,710)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization............... 318 33,391
Stock based compensation.................... 2,891 32,970
Write-off of in-process research and
development................................ 21,320 439
Deferred income taxes....................... -- (1,925)
Net changes in operating assets and
liabilities, net of acquisitions:
Accounts receivable........................ -- (4,301)
Inventories................................ -- (21,908)
Prepaid expenses and other current assets.. (248) (2,931)
Other assets............................... (6) (2,137)
Accounts payable........................... 13,374 6,922
Income taxes............................... -- 3,029
Accrued liabilities........................ 9,922 2,161
--------- ---------
Net cash provided by (used in) operating
activities............................... 17,546 (82,000)
Investing activities
Acquisition of subsidiaries, net of cash
acquired................................... (181,936) (2,318)
Purchase of property and equipment.......... (1,677) (24,609)
Purchase of other investments............... -- (1,100)
Purchase of short-term investments.......... -- (14,147)
Purchase of restricted cash equivalents..... -- (23,708)
--------- ---------
Net cash used in investing activities..... (183,613) (65,882)
Financing activities
Proceeds from issuance of senior secured
term loan.................................. 125,000 --
Proceeds from issuance of Series A
redeemable convertible preferred stock,
net of issuance costs...................... 186,176 194,775
Proceeds from issuance of common stock and
warrants, net of repurchases............... 442 10,139
Repayment of debt........................... (75,000) (2,826)
Proceeds (repayment) of loan from officer... 3,365 (3,365)
--------- ---------
Net cash provided by financing activities. 239,983 198,723
Effect of exchange rate changes on cash...... -- (22)
--------- ---------
Net increase in cash and cash equivalents.... 73,916 50,819
Cash and cash equivalents at
inception/beginning of period............... -- 73,916
--------- ---------
Cash and cash equivalents at end of period... $ 73,916 $ 124,735
========= =========
Supplemental disclosure of noncash investing
and financing activities
Capital lease obligations incurred.......... $ -- $ 69
========= =========
Deferred compensation related to stock
option grants.............................. $ 19,207 $ 92,562
========= =========
Cash paid during the period for taxes........ $ -- $ 152
========= =========
Cash paid during the period for interest..... $ 565 $ 2,377
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Description of Business
Zhone Technologies, Inc. is a new breed of network equipment vendor. The
Company has developed a hardware and software architecture designed to redefine
the way network service providers deliver communication services to their
subscribers. The Company's Single Line Multi-Service architecture is designed
to extend the speed, reliability and cost-efficiencies currently achieved in
the core of the communications network through the local loop to business and
consumer subscribers. The Company's SLMS products are both protocol and media
agnostic, supporting voice, video, data and entertainment services under a
common management and provisioning system. The Company was incorporated under
the laws of the state of Delaware in June 1999. The Company began operations in
September 1999, and is headquartered in Oakland, California.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ materially from those estimates.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all cash and highly liquid investments purchased with
an original maturity of less than three months at the date of purchase to be
cash equivalents. Short-term investments include securities with original
maturities greater than three months and less than one year. Short-term
investments, consisting principally of debt securities of domestic
municipalities and corporations, have been classified as available-for-sale.
Under this classification the investments are reported at fair value, with
unrealized gains and losses excluded from results of operations and reported as
a separate component of stockholders' deficit. As of December 31, 1999 and
September 30, 2000, such unrealized gains and losses were not significant.
Realized gains and losses and declines in value judged to be other than
temporary are included in results of operations. Gains and losses from the sale
of securities are based on the specific identification method.
Fair Value of Financial Instruments
The carrying amount of the Company's financial instruments, which includes
cash, cash equivalents, short term investments, accounts receivable, accounts
payable, accrued liabilities and debt obligations approximate their fair values
at December 31, 1999 and September 30, 2000.
Concentrations of Credit Risk and Credit Risk Evaluations
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. Cash and cash equivalents
consist principally of demand deposit and money market accounts, commercial
paper and debt
F-7
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
securities of domestic municipalities with strong credit ratings. Short-term
investments consist primarily of debt securities of domestic municipalities and
corporations with strong credit ratings. Cash and cash equivalents and short-
term investments are held with various domestic financial institutions with
high credit standing. The Company has not experienced any significant losses on
its cash and cash equivalents or short-term investments. The Company conducts
business with companies in various industries primarily in the United States.
The Company performs ongoing credit evaluations of its customers and generally
does not require collateral. Allowances are maintained for potential credit
issues, and such losses to date have been within management's expectations. For
the nine months ended September 30, 2000, the Company had sales to two
customers which individually represented 24% and 23% of net revenues. At
December 31, 1999, the Company had receivable balances from one customer
representing 16% of accounts receivable. At September 30, 2000 the Company had
receivable balances from four customers individually representing 12%, 13%, 15%
and 18% of accounts receivable, respectively.
Revenue Recognition
The Company generally recognizes product revenue upon shipment of product,
under normal credit terms or under sales type leases, net of estimated sales
returns and allowances at time of shipment. Revenue is deferred if there are
significant post-delivery obligations or collection is not considered probable
at the time of sale. When significant post-delivery obligations exist, revenue
is deferred until such obligations are fulfilled. Revenue from service
obligations and operating leases is recognized ratably over the period of the
obligation or lease. The Company makes certain sales to product distributors.
These customers are generally given privileges to return a portion of
inventory. The Company recognizes revenues to distributors when the products
have been sold by the distributors. The Company accrues for warranty costs,
sales returns, and other allowances at the time of shipment based on historical
experience. Revenues from transactions involving the Company's software
applications products is accounted for in accordance with Statement of Position
(SOP) 97-2, "Software Revenue Recognition," as amended by SOP 98-9, "Software
Revenue Recognition with Respect to Certain Arrangements." Accordingly, the
Company recognizes revenue from licenses of software application products
provided that a purchase order has been received, the software and related
documentation have been shipped, collection of the resulting receivable is
deemed probable, and the fee is fixed or determinable. To date, revenue from
software transactions and sales type leases has not been significant.
Inventories
Inventories are stated at the lower of cost or market, cost being determined
using the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over two to five years. Leasehold improvements are
amortized over the shorter of their economic life or the remaining lease term.
Intangible Assets
Intangible assets consist primarily of purchased technology, assembled
workforce and goodwill and are amortized on a straight line basis over three to
five years. Amortization expense was $0.1 million and $28.1 million for the
period from September 1, 1999 (inception) to December 31, 1999 and the nine
months ended September 30, 2000, respectively.
F-8
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Long-Lived Assets
The Company evaluates long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets is
measured by a comparison of the carrying amount of an asset to future net
undiscounted cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the asset exceeds its fair value.
Software Development Costs
Development costs related to software incorporated in the Company's products
incurred subsequent to the establishment of technological feasibility are
capitalized and amortized over the estimated lives of the related products.
Technological feasibility is established upon completion of a working model. To
date, costs incurred subsequent to the establishment of technological
feasibility and before general product release have not been significant, and
all software development costs have been charged to product development expense
in the accompanying consolidated statements of operations.
Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in financial statements. SFAS 130 requires
classification of other comprehensive income in a financial statement and
display of other comprehensive income separately from retained earnings and
additional paid-in capital. As of September 30, 2000, other comprehensive
income relates to foreign currency translations adjustments.
Foreign Currency Translation
For each of the Company's foreign subsidiaries, the functional currency is
its local currency. Assets and liabilities of foreign operations are translated
into U.S. dollars using current exchange rates, and revenues and expenses are
translated into U.S. dollars using average exchange rates. The effects of
foreign currency translations adjustments are deferred and included as a
component of accumulated other comprehensive loss in stockholders' deficit.
Foreign currency transaction gains and losses are a result of the effect of
exchange rate changes on transactions denominated in currencies other than the
functional currency. To date foreign currency transaction gains (losses) have
not been significant.
Advertising Expense
The Company expenses advertising costs at such time as advertisements are
published or broadcast. Advertising costs for the period from September 1, 1999
to December 31,1999 were not significant. Advertising costs included in sales
and marketing expense are approximately $0.3 million for the nine months ended
September 30, 2000.
Accounting for Stock-Based Compensation
The Company has elected to account for employee stock options using the
intrinsic value method, in accordance with APB No. 25, "Accounting for Stock
Issued to Employees" and complies with the disclosure requirements of Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock
F-9
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Based Compensation." Under APB No. 25, compensation cost, if any, is recognized
over the respective vesting period based on the difference, on the date of
grant, between fair value of the Company's common stock and the grant price.
The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123. In March 2000, the FASB issued FASB Interpretation
No. 44 ("FIN No. 44"), "Accounting for Certain Transactions Involving Stock
Compensation: An Interpretation of APB No. 25." The Company has adopted the
provisions of FIN No. 44, and such adoption did not materially impact the
Company's results of operations.
Income Taxes
The Company uses the asset and liability method to account for income taxes.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax basis of assets and
liabilities. Deferred tax assets and liabilities are measured using enacted tax
rates and laws that will be in effect when the differences are expected to
reverse. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized.
Net Loss per Common Share
Basic net loss per share is computed by dividing the net loss applicable to
common stockholders for the period by the weighted average number of shares of
common stock outstanding during the period. The calculation of diluted net loss
per share gives effect to common stock equivalents; however, potential common
shares are excluded if their effect is antidilutive. Potential common shares
are composed of common stock subject to repurchase rights and incremental
shares of common stock issuable upon the exercise of stock options and warrants
and upon conversion of Series A Redeemable Convertible Preferred stock.
Unaudited Pro Forma Net Loss per Share
Unaudited pro forma net loss per share for the period ended December 31,
1999 and for the nine months ended September 30, 2000, is computed by dividing
the net loss for the period by the weighted average number of shares of common
stock outstanding, including the pro forma effects of the automatic conversion
of the Company's redeemable convertible preferred stock into shares of the
Company's common stock effective at the time of the Company's initial public
offering as if such conversion occurred on September 1, 1999 or at the date of
original issuance, if later.
Segment Information
In 1999, the Company adopted the provisions of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for the way companies report information about operating
segments in interim and annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company determined that it has operated within one
discrete reportable business segment since inception. Substantially all assets
of the Company are located in the United States. Net revenue from sales in
North America was $57.3 million or 95% of total revenue for the nine months
ended September 30, 2000. Net revenue from sales to other regions, including
Europe, Middle East, Africa, Asia and Latin America, was $3.2 million or 5% of
total revenue.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). FAS 133, as amended, establishes
accounting and reporting standards for derivative instruments and for hedging
activities and is effective for all years beginning after June 15, 2000. In
July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities--Deferral of the Effective Date of FASB
F-10
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133
until fiscal years beginning after June 15, 2000. The Company is studying the
impact that FAS 133 will have on the Company's financial statements.
In December 1999, the SEC issued Staff Accounting Bulleting ("SAB") No. 101.
The SAB summarized certain of the SEC Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
SAB No. 101B was issued June 26, 2000 which allows registrants until the fourth
quarter of years beginning after December 15, 1999 to implement SAB No. 101.
SAB No. 101 as amended and any resulting change in accounting principle that a
registrant would have to report, is effective no later than the Company's
fiscal quarter ending December 31, 2000. In October 2000, the SEC issued SAB
101, "Frequently Asked Questions and Answers," which gives further guidance on
SAB 101. The company is studying the impact that SAB 101 will have on the
company's financial statements, if any.
2. Cash, Cash Equivalents and Short-Term Investments
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
(in thousands)
<S> <C> <C>
Cash and cash equivalents
Cash............................................ $ 3,160 $ 31,874
Municipal securities............................ -- 8,767
Money market funds.............................. 70,756 10,984
Repurchase agreements........................... -- 29,178
Commercial paper................................ -- 43,932
------- --------
Cash and cash equivalents......................... $73,916 $124,735
======= ========
Short-term investments--available for sale
Commercial paper................................ $ -- $ 17,072
Municipal bonds................................. 4,005 1,080
------- --------
Short-term investments............................ $ 4,005 $ 18,152
======= ========
</TABLE>
3. Business Combination
During the period from September 1, 1999 (inception) through December 31,
1999, the Company made two acquisitions described in the paragraphs that
follow, each of which has been accounted for as a purchase. The consolidated
financial statements include the operating results of each business from the
date of acquisition.
Purchased In-Process Research and Development
The amounts allocated to purchased research and development were determined
through established valuation techniques used in the high technology
telecommunications industry and were expensed upon acquisition, because
technological feasibility had not been established and no future alternative
uses existed. The values assigned to purchased in-process research and
development were determined by identifying the on-going research projects for
which technological feasibility had not been achieved and assessing the state
of completion of the research and development effort. The state of completion
was determined by estimating the costs and time incurred to date relative to
those costs and time to be incurred to develop the purchased in-process
research and development into commercially viable products, estimating the
resulting net cash flows only from the percentage of research and development
efforts complete at the date of acquisition, and
F-11
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
discounting the net cash flows back to their present value. The discount rate
included a factor that took into account the uncertainty surrounding the
successful development of the purchased in-process technology projects.
Purchased Technology
To determine the values of purchased technology, the expected future cash
flows of the existing developed technologies were discounted taking into
account the characteristics and applications of the product, the size of
existing markets, growth rates of existing and future markets as well as an
evaluation of past and anticipated product lifecycles.
Acquired Workforce
To determine the values of the acquired workforce, employees were identified
who would require significant cost to replace and train. Then each employee's
partially burdened cost (salary, benefits, facilities), the cost to train the
employee, and the recruiting costs (locating, interviewing, and hiring) were
estimated. These costs were then aggregated and tax-affected to estimate the
value of the assembled workforce.
Amounts allocated to purchased technology, acquired workforce, goodwill and
other intangible assets for the business acquisitions that follow are being
amortized on a straight-line basis over periods of three to five years which
represents their estimated useful economic life.
CAG Technologies
In November 1999, the Company acquired CAG Technologies ("CAG") in exchange
for total consideration of approximately $8.8 million, consisting of $6.6
million in cash, approximately $2.1 million in liabilities assumed and
approximately $0.1 million in acquisition costs. CAG developed
telecommunication subsystems and assemblies. The purchase consideration of the
acquired assets and assumed liabilities were allocated based on fair values as
follows (in thousands):
<TABLE>
<S> <C>
Purchased in-process research and development charged directly to
operations......................................................... $1,012
Net assets acquired................................................. 378
Purchased technology................................................ 4,708
Acquired workforce.................................................. 546
Goodwill............................................................ 2,190
------
Total purchase consideration...................................... $8,834
======
</TABLE>
Premisys Communications, Inc.
In December 1999, the Company acquired Premisys Communications, Inc.
("Premisys") in exchange for total consideration of approximately $295.8
million, consisting of $248.3 million in cash, assumed liabilities of $35.1
million, and approximately $12.4 million in acquisition costs. Premisys
manufactured voice, data and video customer premises equipment. The purchase
consideration of the acquired assets and assumed liabilities were allocated
based on fair values as follows (in thousands):
<TABLE>
<S> <C>
Purchased in-process research and development charged directly
to operations.................................................... $ 20,308
Net assets acquired............................................... 120,984
Purchased technology.............................................. 35,642
Acquired workforce................................................ 3,628
Goodwill and other................................................ 115,232
--------
Total purchase consideration.................................... $295,794
========
</TABLE>
F-12
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Other Acquisitions
In February 2000, the Company made two other acquisitions of all of the
assets of technology based companies for total purchase consideration of $2.5
million in cash. The total purchase price was allocated to the assets acquired
based on estimated fair values.
At December 31, 1999, accrued liabilities related to these acquisitions
totaled $22.4 million. These included compensation related liabilities of $3.3
million, direct transaction costs of $3.6 million, facility costs of
$2.5 million, assumed obligations of $8.7 million and other liabilities of $4.3
million. At September 30, 2000, accrued liabilities related to these
acquisitions totaled $3.9 million. These included facility costs of
$0.2 million, compensation related liabilities of $0.2 million, direct
transaction costs of $0.1 million, assumed obligations of $2.9 million and
other liabilities of $0.5 million.
The following table reflects the unaudited pro forma combined results of
operations of the Company on the basis that the acquisitions of CAG and
Premisys had taken place on September 1, 1999. The impact of the other
acquisitions was not material to the combined results of operations of the
Company for the nine months ended September 30, 2000.
<TABLE>
<CAPTION>
Period from
September 1, 1999
(inception)
through
December 31, 1999
--------------------
(in thousands except
per share data)
<S> <C>
Net revenue............................................ $ 16,102
========
Net loss............................................... $(47,712)
========
Net loss per share--basic and diluted.................. $ (0.64)
========
Number of shares used in computation--basic and
diluted............................................... 75,000
========
</TABLE>
The pro forma financial information is not necessarily indicative of the
operating results that would have occurred had the acquisitions been
consummated as of September 1, 1999, nor are they necessarily indicative of
future operating results.
F-13
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Balance Sheet Detail
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
-------------- --------------
(in thousands) (in thousands)
<S> <C> <C>
Inventories:
Raw materials............................... $1,931 $17,563
Work-in-process............................. 1,668 8,229
Finished goods.............................. 4,255 3,561
------ -------
$7,854 $29,353
====== =======
Property and equipment:
Machinery and equipment..................... $2,639 $14,773
Computers and acquired software............. 3,372 11,648
Furniture and fixtures...................... 1,115 3,271
Leasehold improvements...................... 989 1,567
Equipment under operating lease............. -- 409
------ -------
8,115 31,668
Less accumulated depreciation and
amortization................................. (171) (5,028)
------ -------
$7,944 $26,640
====== =======
</TABLE>
Depreciation and amortization expense associated with property and equipment
amounted to $0.2 million and $5.3 million for the period from September 1, 1999
(inception) to December 31, 1999 and the nine months ended September 30, 2000,
respectively.
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
-------------- --------------
(in thousands) (in thousands)
<S> <C> <C>
Goodwill and other intangibles:
Purchased technology......................... $ 40,350 $ 42,170
Acquired workforce........................... 4,174 4,653
Tradename.................................... 1,522 1,522
Goodwill..................................... 115,789 115,900
-------- --------
161,835 164,245
Less accumulated amortization.................. (147) (28,220)
-------- --------
$161,688 $136,025
======== ========
Accrued liabilities:
Accrued contract manufacturing costs......... $ -- $ 9,673
Warranty..................................... 3,817 3,236
Personnel costs.............................. 2,305 5,457
Taxes payable................................ -- 1,013
Deferred revenue............................. 696 4,543
Other........................................ 4,846 8,457
-------- --------
$ 11,664 $ 32,379
======== ========
</TABLE>
5. Debt
In connection with the acquisition of Premisys, a wholly owned subsidiary of
the Company borrowed $125.0 million from a related party financial institution,
$75.0 million of which was repaid in December 1999 and $50.0 million of which
was under a senior secured term loan facility. Borrowings under the secured
loan accrue interest at the current Eurodollar rate plus 1% per annum.
Borrowings on the loan are payable in
F-14
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$2.5 million quarterly installments from September 30, 2000 through December
31, 2000, $1.9 million quarterly installments from March 31, 2001 through
December 31, 2001 and $3.1 million quarterly installments from March 31, 2002
through November 2004. The loan must be repaid from the proceeds of (i) a
public offering of shares of the Company's common stock, (ii) an offering of
debt by the Company or, (iii) a sale or disposition of the Company's assets.
The loan agreement restricts the ability of that subsidiary to make
distributions. The loan agreement also contains certain financial covenants
which the Company is in compliance with at September 30, 2000.
6. Income Taxes
There have been no provisions for U.S. federal or state income taxes for
the period from September 1, 1999 (inception) to December 31, 1999. The
Company recognized a deferred tax benefit of $1.9 million for the nine months
ended September 30, 2000.
A reconciliation of the expected tax benefit to the actual tax benefit is
as follows (amounts in thousands):
<TABLE>
<CAPTION>
Period from
September 1, 1999
(inception) through Nine months ended
December 31, 1999 September 30, 2000
---------------------- ----------------------
% of % of
Amount pre tax loss Amount pre tax loss
-------- ------------ -------- ------------
<S> <C> <C> <C> <C>
Expected tax benefit at statutory
(35%) rate...................... $(10,509) (35.0)% $(45,372) (35.0)%
State taxes, net of federal
benefit......................... (1,710) (5.7) (7,449) (5.7)
Increases in (decrease to) tax
resulting from:
Acquired in process research
and development............... 7,462 24.8 179 0.1
Stock based compensation....... 1,012 3.4 12,098 9.3
Goodwill amortization.......... 51 0.2 7,074 5.5
NOL and costs capitalized for
tax purposes.................. 1,657 5.5 1,743 1.3
Valuation allowance............ -- -- 29,904 23.1
Other.......................... 2,037 6.8 (102) (0.1)
-------- ----- -------- -----
Actual tax benefit and
effective tax rate.......... $ -- -- % $ (1,925) (1.5)%
======== ===== ======== =====
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and income tax purposes. Significant components of the Company's deferred tax
assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
(in thousands)
<S> <C> <C>
Deferred tax assets:
Product and revenue related reserves........... $ 12,111 $ 10,145
Net operating loss and tax credit
carryforwards................................. 829 25,220
Purchased technology........................... 1,821 7,636
Other.......................................... 1,739 2,138
-------- --------
Gross deferred tax assets...................... 16,500 45,139
Less valuation allowance....................... -- (29,904)
-------- --------
Total deferred tax assets.................... 16,500 15,235
Deferred tax liabilities:
Other identified intangibles................... (18,425) (15,235)
-------- --------
Net deferred tax liabilities................. $ (1,925) $ --
======== ========
</TABLE>
F-15
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the nine months ended September 30, 2000, the net change in the
valuation allowance was an increase of $29.9 million.
As of September 30, 2000, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $61.7 million and
$30.9 million which expire in 2020 and 2005, respectively.
Utilization of the Company's net operating loss carryforwards may be subject
to substantial annual limitation due to the ownership change limitations
provided by the Internal Revenue Code and similar state provisions. Such an
annual limitation could result in the expiration of the net operating loss
carryforwards before utilization.
7. Series A Redeemable Convertible Preferred Stock
On November 1, 1999, the Company issued 125.0 million shares of Series A
redeemable convertible preferred stock to an investor group in exchange for a
maximum available capital commitment of $500.0 million (the "Capital
Commitment"). The purchase price per share is variable and is based on total
actual capital contributions received by the Company at any point in time,
divided by the 125.0 million shares of Series A redeemable convertible
preferred stock. If the full Capital Commitment of $500.0 million is received,
the maximum purchase price per share will be $4.00.
In addition, in connection with the $50.0 million Premisys acquisition
senior secured term loan, the Company was required to collateralize the loan
with capital commitments from the $500.0 million Capital Commitment equal to
120% of the principal amount of the loan. This reduces the amount that can
otherwise be called by the Company under the Capital Commitment. As of December
31, 1999 and September 30, 2000, the note was collateralized with $60.0 million
in capital commitments.
As of December 31, 1999 and September 30, 2000, the Company has received
cash capital contributions of $200.0 million and $400.0 million, respectively,
and the $60.0 million collateralized note commitment, which equates to a
purchase price per share of $2.08 and $3.68, respectively. The difference
between the balance sheet carrying value of $186.4 million at December 31, 1999
and $383.1 million at September 30, 2000 represents issue costs. The carrying
value is being accreted to the redemption value by charges against
stockholders' equity over the period to redemption.
Subject to certain antidilutive provisions, each share of Series A
redeemable convertible preferred stock is convertible at the option of the
holder into the same number of shares of common stock. The Series A redeemable
convertible preferred stock will be automatically converted into common stock
in the event of an affirmative election of the holders of at least a majority
of the outstanding shares of redeemable convertible preferred stock, voting as
separate classes, or a public offering, with gross proceeds of at least $100.0
million and a per share offering price of at least twice the price per share of
the then outstanding redeemable convertible preferred stock ($4.16 as of
December 31, 1999 and $7.36 as of September 30, 2000). The Series A redeemable
convertible preferred stock votes with the common stock on an as-if-converted
basis on all matters submitted for approval by the Company's stockholders.
Dividends will be paid in amount per share of Series A preferred stock (on an
as-if converted basis) equal to dividends paid on the common stock, if and when
declared by the Board of Directors.
Upon any liquidation, dissolution or winding up of the Company, each holder
of Series A redeemable convertible preferred stock shall be entitled to receive
an amount in cash equal to the greater of (i) the purchase price per share plus
any accrued and unpaid dividends thereon, or (ii) the amount such holder would
have received in such liquidation on an as-if-converted basis. Any assets
remaining for distribution shall be distributed to the holders of common stock.
At, or any time after, November 1, 2004, 2005 and 2006, the Company will be
required to redeem in three annual installments, that number of shares of
redeemable
F-16
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
convertible preferred stock equal to not less than 33.3%, 66.7% and 100%,
respectively. Subject to certain antidilutive provisions, the redemption price
equals the original issuance price per share.
8. Stockholders' Deficit
Common Stock
At inception, the Company issued to its founders 10.0 million shares of its
common stock at $0.001. In October 1999, the Company's Board of Directors
approved amendments to the Company's Articles of Incorporation to increase the
number of authorized shares of common stock to 300.0 million and approved a
7.5-for-1 stock split of all issued and outstanding common stock. All share
amounts in the accompanying consolidated financial statements have been
restated to reflect the stock split.
Warrants
In January 2000, in connection with the operating lease for the Company's
new headquarters (see Note 10), the Company issued an immediately exercisable
warrant to purchase up to 100,000 shares of the Company's common stock at an
exercise price of $4.00 per share. The warrant expires in January 2010. The
fair value of the warrant was $300,000 and is included in additional paid-in
capital.
Stock Option Plans
Under the Company's 1999 Stock Option Plan (the "Plan"), 50.0 million shares
of common stock are reserved for the issuance of incentive stock options
("ISO's") and nonqualified stock options ("NSO's") to certain directors,
employees and consultants of the Company. In October 2000, the Company's board
of directors amended the plan, subject to stockholder approval prior to the
completion of this offering, to increase the number of shares of common stock
reserved for issuance under the plan from 50.0 million shares to 60.0 million
shares. The share reserve will automatically be increased on January 1, 2002
and each January 1 thereafter by an amount equal to the lesser of 13.0 million
shares per year, 5% of the Company's outstanding common stock on the last day
of the preceding fiscal year or such lesser number of shares as determined by
the Company's board of directors. The ISO's may be granted at a price per share
not less than the fair market value at the date of grant. NSO's shall not be
granted for less than eighty-five percent (85%) of the fair market value of the
share of common stock on the effective date of grant of the option;
additionally, no options granted to a ten percent owner shall have an exercise
price per share less than one hundred ten percent (110%) of the fair market
value of a share of common stock on the date of grant of the option. Options
granted under the Plan are immediately exercisable or vest over a four-year
period and expire ten years after the date of grant. Shares issued upon option
exercise are subject to a repurchase option at the original exercise price paid
per share and generally lapse over a four-year period from the date of grant.
As of December 31, 1999, 4,320,355 shares were subject to repurchase and no
options were vested. As of September 30, 2000, 17,299,873 shares were subject
to repurchase and 333,767 options were vested.
The Company granted 10,000 and 206,600 options outside of the 1999 stock
option plan as of December 31, 1999 and September 30, 2000, respectively. These
agreements generally provide that the options are immediately exercisable. The
options granted under these agreements generally vest 25% upon completion of
twelve months from the initial vesting date and the balance vests in equal
monthly installments over the following three years, although the board or its
committee may specify a different vesting schedule for a particular grant. Upon
a change in control of our company, outstanding options granted under some of
these agreements will fully vest. All options granted outside of our 1999 Stock
Option Plan were granted at the fair market value of our common stock, as
determined by the board of directors on the date of grant.
Our 2000 Employee Stock Purchase Plan was adopted by the board in October
2000 and remains subject to stockholder approval prior to the completion of
this offering. The plan will become effective immediately upon the completion
of this offering. We have reserved a total of 500,000 shares of common stock
for issuance
F-17
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
under the plan, none of which have been issued as of the completion of this
offering. The share reserve will automatically be increased on January 1, 2002
and on each January 1 thereafter until and including January 1, 2011, by an
amount equal to the lesser of 2,750,000 shares per year, one percent of our
outstanding common stock on the last day of the immediately preceding fiscal
year, or such lesser number of shares as determined by the board of directors.
A summary of the stock option activity for the period from September 1, 1999
(inception) through September 30, 2000 is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Options Exercise Price
----------- --------------
<S> <C> <C>
Granted.......................................... 9,901,500 $0.10
Canceled......................................... (36,000) 0.10
Exercised........................................ (4,320,355) 0.10
-----------
Outstanding at December 31, 1999................. 5,545,145 $0.10
Granted.......................................... 18,258,533 $1.83
Canceled......................................... (1,387,650) 0.17
Exercised........................................ (14,565,710) 0.84
-----------
Outstanding at September 30, 2000................ 7,850,318 $2.73
===========
</TABLE>
Stock Based Compensation
In connection with stock options granted to employees to purchase common
stock, the company recorded a deferred charge for stock-based compensation of
$19.2 million for the period from September 1, 1999 (inception) to December 31,
1999 and $92.6 million for the nine months ended September 30, 2000. Such
amounts represent, for employee stock options, the difference at the grant date
between the exercise price of each stock option granted and the fair value of
the underlying common stock. The deferred charges for employee options are
being amortized to expense using an accelerated method in accordance with
Financial Interpretation No. 28 over the vesting periods of the applicable
options, or repurchase periods for the exercised options, generally over four
years. Amortization of deferred stock-based compensation expense was $2.8
million for the period from September 1, 1999 (inception) to December 31, 1999
and $30.4 million for the nine months ended September 30, 2000.
During the period from September 1, 1999 (inception) to December 31, 1999
and the nine months ended September 30, 2000, the Company issued options to
consultants totaling 170,000 and 604,200, respectively. The options are
immediately exercisable and expire ten years from the date of grant. Certain
options are subject to a vesting period of generally four years. The Company
values these options using the Black-Scholes option pricing model. The Company
recorded stock-based compensation expense of approximately $0.1 million and
$2.6 million for the periods ended December 31, 1999 and the nine months ended
September 30, 2000, respectively. The underlying shares of common stock
associated with the options subject to vesting are revalued at each balance
sheet date to reflect their current fair value. The following assumptions were
used in determining the fair value of the options for the period from September
1, 1999 (inception) to December 31, 1999 and the nine months ended September
30, 2000: contractual life of ten years, risk-free interest rate of 5.84% and
6.13%, respectively, volatility of 85% and expected dividend yield of 0%.
Pro Forma Disclosures on the Effects of Stock-Based Compensation
The weighted-average fair value at grant date of options granted during the
period from September 1, 1999 (inception) through December 31, 1999 was $2.00
per share, and the weighted-average remaining contractual
F-18
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
life of options outstanding at December 31, 1999 was 10 years. The weighted-
average fair value at grant date of options granted for the nine months ended
September 30, 2000 was $5.90 per share, and the weighted- average remaining
contractual life of options outstanding at September 30, 2000 was 9.8 years.
Pro forma information regarding the results of operations has been estimated
using the minimum value option pricing model which does not consider stock
price volatility. Because the Company does not have actively traded equity
securities, volatility is not considered in determining the fair value of
stock-based awards to employees.
For the period from September 1, 1999 (inception) through December 31, 1999
and the nine months ended September 30, 2000, the fair value of the Company's
stock-based awards to employees was estimated using the following weighted
average assumptions: expected life of option of 4 years, risk-free interest
rate of 5.84% and 6.13% respectively, and expected dividend yield of 0%.
Pro Forma Net Loss
Had stock-based compensation cost for the options been determined based on
the fair value at the grant dates using the minimum value method, the Company's
net loss would have been as follows (in thousands):
<TABLE>
<CAPTION>
Period from
September 1, 1999 Nine months
(inception) through ended
December 31, 1999 September 30, 2000
------------------- ------------------
<S> <C> <C>
Net loss applicable to common
stockholders:
As reported....................... $(30,220) $(129,678)
======== =========
Pro forma......................... $(30,249) $(130,504)
======== =========
Earnings per share applicable to
common stockholders
As reported basic and diluted..... $ (0.40) $ (1.73)
Pro forma basic and diluted....... $ (0.40) $ (1.74)
</TABLE>
Shares Reserved for Future Issuance
As of September 30, 2000, the Company had the following shares reserved for
future issuance:
<TABLE>
<S> <C>
Stock options outstanding....................................... 7,850,318
Stock options available for future issuance under the 1999 stock
option plan.................................................... 24,732,642
Other shares.................................................... 145,067
Outstanding redeemable convertible preferred stock.............. 125,000,000
-----------
157,728,027
===========
</TABLE>
401(k) Plan
In January 2000, the Company adopted a 401(k) plan for its employees whereby
currently eligible employees may contribute up to a specified percentage of
their earnings, on a pre-tax basis, subject to the maximum amount permitted by
the Internal Revenue Code. Under the 401(k) plan, the Company may make
discretionary contributions. The Company made no contributions to the plan for
the nine months ended September 30, 2000.
F-19
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Related Party Transactions
The Company borrowed $13.4 million from the founders in December 1999 of
which $10.0 million was repaid with accrued interest in December 1999. The
remaining $3.4 million was repaid with accrued interest in January 2000. In
connection with the Premisys acquisition, the Company borrowed $125.0 million
from a related party financial institution (See note 5).
10. Commitments and Contingencies
The Company has entered into operating and capital leases for certain office
space and equipment, some of which contain renewal options. Capital lease
obligations for equipment represent the present value of future lease payments
under the agreements. The Company has options to purchase the leased assets at
the end of the lease terms.
Future minimum lease payments under all noncancelable operating and capital
leases with terms in excess of one year are as follows:
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
(in thousands)
<S> <C> <C>
Years ending December 31,
2000....................................................... $ 2,131 $ 3
2001....................................................... 8,116 15
2002....................................................... 7,765 15
2003....................................................... 7,798 14
2004....................................................... 7,267 12
Thereafter................................................. 64,403 --
------- ----
Total minimum lease payments............................. $97,480 59
=======
Less interest.............................................. (7)
----
Present value of minimum lease payments.................... 52
Less current portion of capital lease obligations.......... (12)
----
Capital lease obligations, less current portion............ $ 40
====
</TABLE>
Rent expense under operating leases totaled $48,000 during the period from
September 1, 1999 (inception) through December 31, 1999 and $3.3 million for
the nine months ended September 30, 2000.
Property and equipment at December 31, 1999 and September 30, 2000 include
assets acquired under capitalized leases of $126,000 and $72,000, with related
accumulated amortization of $54,000 and $18,000.
Included within the operating lease commitments above is a $70 million five-
year operating lease for office headquarters, research and product development,
and manufacturing facilities in Oakland, California, entered into in August
2000. The monthly payments are based on the London Interbank Offer Rate and on
the lease amount of up to $70.0 million on the date of occupancy of the
individual buildings. Annual lease payments will be approximately $5.0 million.
The monthly lease payments are scheduled to begin upon completion and full
occupancy of the individual buildings, which is expected to occur by March
2001. At the end of the lease, the Company has the option to purchase the land
and buildings at approximately $70 million, or renew the lease for an
additional 5 years. The guaranteed residual payment on the lease is
approximately $59.5 million. As part of the agreement the Company must also
comply with certain financial covenants, including specific levels of earnings
before interest, taxation, depreciation, amortization, rent and other financial
ratios.
F-20
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of September 30, 2000, the Company was in compliance with these
covenants. The Company is in discussions with the lessor to amend financial
covenants. If such covenants are not amended, the Company may not be in
compliance with these covenants beginning in the fourth quarter of 2000. The
lessor's remedies for breach of such covenants include terminating our right to
possession of the properties and recovery of any unpaid rent plus any rental
loss for the remainder of the term or continuing the lease in place and
increasing rentals to reflect a rate of prime plus 2%.
The Company is required to maintain a specific level of restricted cash to
serve as collateral for these leases. The restricted cash balance as of
September 30, 2000 was $23.7 million and is recorded in other assets on the
balance sheet.
The Company depends on sole source and limited source suppliers for several
key components and contract manufacturing. If the Company were unable to obtain
these components on a timely basis, the Company would be unable to meet its
customers product delivery requirements, which could adversely impact operating
results.
The Company is subject to various legal proceedings, claims, and litigation
arising in the ordinary course of business. The Company's management does not
expect that the ultimate cost to resolve these matters will have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
11. Net Loss Per Share
The following table sets forth the computation of basic, diluted and pro
forma net loss per share:
<TABLE>
<CAPTION>
Nine months
September 1, 1999 ended
(inception) through September 30,
December 31, 1999 2000
------------------- -------------
(In thousands,
except per share data)
<S> <C> <C>
Historical Presentation
Numerator:
Net loss............................................. $(30,025) $(127,710)
Accretion of preferred stock......................... (195) (1,968)
-------- ---------
Net loss applicable to common stockholders......... $(30,220) $(129,678)
======== =========
Denominator:
Weighted-average common shares outstanding........... 75,864 86,912
Adjustment for common shares issued subject to
repurchase.......................................... (864) (11,878)
-------- ---------
Denominator for basic calculation.................. 75,000 75,034
======== =========
Basic and Diluted net loss per share applicable to
common shareholders................................... $ (0.40) $ (1.73)
======== =========
Pro forma Presentation (unaudited)
Numerator:
Net loss............................................. $(30,025) $(127,710)
======== =========
Denominator:
Denominator for basic calculation.................... 75,000 75,034
Pro forma conversion of securities................... 125,000 125,000
-------- ---------
Denominator for pro forma disclosure................. 200,000 200,034
======== =========
Pro forma basic and diluted net loss per share..... $ (0.15) $ (0.64)
======== =========
</TABLE>
F-21
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table sets forth common stock equivalents (potential common
stock) that are not included in the diluted net loss per share calculation
above because their effect would be antidilutive for the periods indicated:
<TABLE>
<CAPTION>
Nine months
September 1, 1999 ended
(inception) through September 30,
December 31, 1999 2000
------------------- -------------
(in thousands)
<S> <C> <C>
Weighted average common stock equivalents:
Preferred stock......................... 125,000 125,000
Common shares issued subject to
repurchase............................. 864 11,878
Warrants................................ -- 145
Outstanding stock options granted....... 5,545 7,850
------- -------
131,409 144,873
======= =======
</TABLE>
F-22
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Premisys Communications, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Premisys
Communications, Inc. and its subsidiaries at June 30, 1998 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended June 30, 1999, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
July 22, 1999 except for Note 6, which is as of September 10, 1999.
F-23
<PAGE>
PREMISYS COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
<TABLE>
<CAPTION>
June 30,
-----------------
1998 1999
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 31,006 $ 3,982
Short-term investments.................................... 74,975 80,452
Accounts receivable, net.................................. 12,208 8,459
Inventories............................................... 3,859 15,231
Deferred tax assets....................................... 7,355 7,895
Prepaid expenses and other assets......................... 657 1,368
-------- --------
Total current assets.................................... 130,060 117,387
Property and equipment, net................................. 8,392 9,053
Other assets................................................ 305 184
-------- --------
$138,757 $126,624
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 6,969 $ 5,759
Accrued liabilities....................................... 10,277 10,020
Income taxes payable...................................... 735 1,015
-------- --------
Total current liabilities............................... 17,981 16,794
-------- --------
Commitments (Note 9)
Put warrant obligations..................................... -- 10,625
-------- --------
Stockholders' equity:
Preferred stock, $0.01 par value, 2,000 shares authorized;
no shares issued or outstanding.......................... -- --
Common stock, $0.01 par value, 100,000 shares authorized;
25,974 and 26,478 shares issued and outstanding.......... 260 265
Additional paid-in capital................................ 85,230 78,336
Treasury stock............................................ -- (22,303)
Retained earnings......................................... 35,286 42,907
-------- --------
Total stockholders' equity.............................. 120,776 99,205
-------- --------
$138,757 $126,624
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE>
PREMISYS COMMUNICATIONS, INC.
CONSOLIDATED INCOME STATEMENT
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three months
ended September
Year ended June 30, 30,
------------------------ ---------------
1997 1998 1999 1998 1999
------- -------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenues............................. $78,358 $102,298 $92,423 $25,011 $21,676
Cost of revenues..................... 27,262 35,586 36,660 8,388 9,802
------- -------- ------- ------- -------
Gross profit......................... 51,096 66,712 55,763 16,623 11,874
------- -------- ------- ------- -------
Operating expenses:
Research and development........... 10,519 16,205 19,823 4,748 5,911
Acquired in-process technology..... 4,000 4,431 -- -- --
Selling, general and
administrative.................... 21,364 27,705 28,305 6,493 5,922
------- -------- ------- ------- -------
Total operating expenses......... 35,883 48,341 48,128 11,241 11,833
------- -------- ------- ------- -------
Income from operations............... 15,213 18,371 7,635 5,382 41
Interest and other income, net....... 2,641 3,399 3,573 988 719
------- -------- ------- ------- -------
Income before income taxes........... 17,854 21,770 11,208 6,370 760
Provision for income taxes........... 6,963 8,055 3,587 2,357 243
------- -------- ------- ------- -------
Net income....................... $10,891 $ 13,715 $ 7,621 $ 4,013 $ 517
======= ======== ======= ======= =======
Net income per share
Basic.............................. $ 0.44 $ 0.54 $ 0.31 $ 0.15 $ 0.02
======= ======== ======= ======= =======
Diluted............................ $ 0.41 $ 0.50 $ 0.30 $ 0.15 $ 0.02
======= ======== ======= ======= =======
Shares used in computing net income
per share
Basic.............................. 24,722 25,569 24,600 25,910 24,165
======= ======== ======= ======= =======
Diluted............................ 26,498 27,495 25,384 27,025 24,820
======= ======== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE>
PREMISYS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Stock Additional
------------- Paid-In Treasury Retained
Shares Amount Capital Stock Earnings
------ ------ ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance, June 30, 1996............. 24,399 $244 $ 66,656 $ -- $10,680
Shares issued under Employee Stock
Purchase Plan..................... 46 -- 1,109 -- --
Exercise of options................ 746 8 2,776 -- --
Tax benefit of exercised stock
options........................... -- -- 4,453 -- --
Net income for fiscal 1997......... -- -- -- -- 10,891
------ ---- -------- -------- -------
Balance, June 30, 1997............. 25,191 252 74,994 -- 21,571
Shares issued under Employee Stock
Purchase Plan..................... 52 -- 919 -- --
Exercise of options................ 731 8 3,213 -- --
Tax benefit of exercised stock
options........................... -- -- 6,104 -- --
Net income for fiscal 1998......... -- -- -- -- 13,715
------ ---- -------- -------- -------
Balance, June 30, 1998............. 25,974 260 85,230 -- 35,286
Shares issued under Employee Stock
Purchase Plan..................... 94 1 1,052 -- --
Exercise of options................ 410 4 2,318 -- --
Tax benefit of exercised stock
options........................... -- -- 1,123 -- --
Put warrant obligations............ -- -- (10,625) -- --
Cost to dissolve part of put
warrant obligations............... (762) --
Repurchase of common stock......... -- -- -- (22,303) --
Net income for fiscal 1999......... -- -- -- -- 7,621
------ ---- -------- -------- -------
Balance, June 30, 1999............. 26,478 $265 $ 78,336 $(22,303) $42,907
====== ==== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
PREMISYS COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three months ended
Year ended June 30, September 30,
---------------------------- --------------------
1997 1998 1999 1998 1999
-------- -------- -------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income.................................. $ 10,891 $ 13,715 $ 7,621 $ 4,013 $ 517
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation.............................. 1,347 2,194 3,565 678 1,083
Deferred tax assets....................... (4,292) (148) (540) -- --
Changes in assets and liabilities:
Accounts receivable......................... 8,609 (4,550) 3,749 (2,490) (3,692)
Inventories................................. (4,554) 4,916 (11,372) (2,719) 4,730
Prepaid expenses and other assets........... (3,235) 2,831 (590) 336 54
Accounts payable............................ 1,506 2,213 (1,210) 276 (2,249)
Accrued liabilities......................... (459) 4,769 (257) (873) (776)
Income taxes payable........................ (580) 735 280 2,340 234
-------- -------- -------- --------- --------
Net cash provided by operating activities. 9,233 26,675 1,246 1,561 (99)
-------- -------- -------- --------- --------
Cash flows from investing activities:
Purchase of property and equipment.......... (5,091) (4,142) (4,226) (750) (1,065)
Purchase of short-term investments.......... (5,498) (30,674) (5,477) (10,173) 6,810
-------- -------- -------- --------- --------
Net cash used in investing activities..... (10,589) (34,816) (9,703) (10,923) 5,745
-------- -------- -------- --------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net. 3,893 4,140 3,375 1,317 485
Tax benefit of exercised stock options...... 4,453 6,104 1,123 -- --
Cost to dissolve part of put warrant
obligations................................ -- -- (762) -- (3,698)
Repurchase of common stock.................. -- -- (22,303) (8,941) --
Proceeds (repayment) of long-term debt...... (125) (20) -- -- --
-------- -------- -------- --------- --------
Net cash provided by financing activities. 8,221 10,224 (18,567) (7,624) (3,213)
-------- -------- -------- --------- --------
Net increase in cash...................... 6,865 2,083 (27,024) (16,986) 2,433
Cash and cash equivalents at beginning of
period....................................... 22,058 28,923 31,006 31,006 3,982
-------- -------- -------- --------- --------
Cash and cash equivalents at end of period.... $ 28,923 $ 31,006 $ 3,982 $ 14,020 $ 6,415
======== ======== ======== ========= ========
Supplemental disclosures:
Cash paid for income taxes.................. $ 10,644 $ 63 $ 1,918 -- --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All interim information related to the period ended September 30, 1999 is
unaudited)
NOTE 1--The Company and Summary of Significant Accounting Policies
The Company
Premisys Communications, Inc. and its subsidiaries, (together, the
"Company"), design, manufacture and market integrated digital access products
for telecommunications service providers. The Company's products assist
domestic and international public carriers in building, expanding and managing
their worldwide telecommunications networks for their business customers.
Summary of Significant Accounting Policies
Management Estimates and Assumptions
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of Premisys
Communications, Inc. and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated. The U.S. dollar is
the functional currency of Premisys Asia, Premisys Canada and Premisys Europe.
Exchange gains and losses resulting from transactions denominated in currencies
other than U.S. dollars are included in net income. To date, the resulting
gains and losses have not been material.
Unaudited Interim Financial Information
The unaudited interim consolidated financial statements of the Company for
the three months ended September 30, 1998 and 1999 included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and note
disclosures normally included in the consolidated financial statements prepared
in accordance with generally accepted accounting principles have been condensed
or omitted pursuant to such rules and regulations relating to the interim
financial statements. In the opinion of management, the accompanying unaudited
interim financial statements reflect all adjustments, consisting of normal
recurring adjustments except as otherwise noted, necessary to present fairly
the financial position of the Company as of September 30, 1998 and 1999 and the
results of its operations and its cash flows for the three months ended
September 30, 1998 and 1999.
Cash, Cash Equivalents and Short-Term Investments
Cash and cash equivalents include cash, money market funds and certain
municipal securities with a maturity of three months or less when purchased.
All of the Company's short-term investments, consisting principally of
municipal securities, have been classified as available-for-sale. Under this
classification the investments are reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity. At June 30, 1998 and 1999, such unrealized gains and
losses were not significant.
Inventories
Inventories are stated at the lower of cost or market, cost being determined
using the first-in, first-out (FIFO) method.
F-28
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost, and depreciation is computed
using the straight-line method over their estimated useful lives, which range
from two years for computer equipment and purchased software to five years for
machinery and equipment and furniture and fixtures. Leasehold improvements are
amortized using the straight-line method based upon the shorter of the
estimated useful lives (all of which are currently five years) or the remaining
lease term.
Revenue Recognition
The Company recognizes revenue upon shipment of product to customers
provided no significant obligations remain and collectibility is probable.
Certain distributors have sales agreements allowing limited rights to return
product without penalties. In such cases the Company recognizes revenue upon
sales of the product by the distributor to its customers.
Software Development Costs
Software development costs incurred prior to the establishment of
technological feasibility are expensed as incurred. Software development costs
incurred subsequent to the establishment of technological feasibility will be
capitalized, if material. To date, all software development costs incurred
subsequent to the establishment of technological feasibility have been
immaterial, and therefore no software development costs have been capitalized.
Warranty Expense
Upon product shipment, the Company provides for the estimated cost that may
be incurred under its various product warranties.
Net Income Per Share
Basic net income per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted net income per share gives effect to all dilutive
potential common shares outstanding during a period. In computing diluted net
income per share, the average stock price for the period is used in determining
the number of shares assumed to be purchased under the treasury stock method
from exercise of stock options.
Fiscal Year
The Company uses a 52/53 week accounting year that ends on the Friday
closest to June 30. For purposes of financial statement presentation, each
fiscal year is considered to have ended on June 30.
Comprehensive Income
Comprehensive income is defined as the change in equity of a company during
a period from transactions and other events and circumstances excluding
transactions resulting from investment by owners and distribution to owners.
For the years ended June 30, 1997, 1998 and 1999, the comprehensive income of
the Company did not differ significantly from the net income.
F-29
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Derivative instruments and hedging activities
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities and
is effective for all fiscal years beginning after June 15, 2000. The Company
does not expect the adoption of SFAS 133 to have a material impact on its
results of operations.
NOTE 2--Balance Sheet Components
<TABLE>
<CAPTION>
June 30,
----------------
1998 1999
------- -------
(in thousands)
<S> <C> <C>
Accounts receivable:
Trade accounts receivable................................ $12,408 $ 8,621
Less: allowance for doubtful accounts.................... (200) (162)
------- -------
$12,208 $ 8,459
======= =======
Inventories:
Raw materials............................................ $ 582 $ 1,376
Work-in-process.......................................... 676 1,476
Finished goods........................................... 2,601 12,379
------- -------
$ 3,859 $15,231
======= =======
Property and equipment:
Machinery and equipment.................................. $ 4,355 $ 5,691
Computers and purchased software......................... 4,931 7,263
Furniture and fixtures................................... 2,074 2,406
Leasehold improvements................................... 2,402 2,628
------- -------
13,762 17,988
Less: accumulated depreciation........................... (5,370) (8,935)
------- -------
$ 8,392 $ 9,053
======= =======
Accrued liabilities:
Employee compensation.................................... $ 3,960 $ 2,792
Warranty................................................. 3,842 4,475
Other.................................................... 2,475 2,753
------- -------
$10,277 $10,020
======= =======
</TABLE>
NOTE 3--Acquired Research and Development In-Process
In the quarter ended March 31, 1997, the Company executed a technology
license agreement with Positron. The Company licensed certain SONET and SDH
based technologies for use in its future products, including the Q-155, which
was announced in June 1997 and began shipping in the quarter ended March 31,
1999. The licensed technology includes the right to modify and manufacture
products which are based on Positron's OSIRIS-155Mb/s SONET/SDH products. The
licensed technology also includes the right to use and manufacture Positron
proprietary application-specific integrated circuits (ASICs), and training and
integration assistance on all design materials.
F-30
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company paid Positron $4 million of license fees over three years. Also,
Positron is to be paid a royalty on the Company's products utilizing the
licensed technology up to a maximum of $4 million. The Company expensed the $4
million of license fees as acquired research and development in process in the
quarter ended March 31, 1997. Payments of license fees to Positron in fiscal
1997, 1998 and 1999 totaled $2.0 million, $1.0 million and $1.0 million,
respectively.
In the quarter ended March 31, 1998, the Company announced the execution of
a technology license agreement with SNT. SNT's technologies will provide the
Company with a non-blocking switching core expandable to 11.6 Gbs, ATM
interfaces to OC-3 and OC-12, 10/100MB Ethernet/Fast Ethernet interfaces, and
related software. The Company intends to use these technologies to develop
broadband ATM and IP multiservice platforms.
The Company is paid a total of $4.4 million for licensing SNT technologies
and related software. The Company expensed these fees as acquired research and
development in-process in the March 31, 1998 quarter. The Company also received
options to license future releases of SNT software for additional fees. To date
the Company has not purchased any additional software releases from SNT.
NOTE 4--Income Taxes
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Year ended June 30,
-----------------------
1997 1998 1999
------- ------ ------
(in thousands)
<S> <C> <C> <C>
Current:
Federal........................................... $ 9,058 $6,230 $3,000
State............................................. 2,138 1,891 1,043
Foreign........................................... 59 82 84
------- ------ ------
11,255 8,203 4,127
Deferred:
Federal........................................... (3,467) (216) (442)
State............................................. (825) 68 (98)
------- ------ ------
(4,292) (148) (540)
------- ------ ------
$ 6,963 $8,055 $3,587
======= ====== ======
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences
between carrying amounts of assets and liabilities for financial reporting and
income tax purposes. Significant components of the Company's deferred tax
assets are as follows:
<TABLE>
<CAPTION>
June 30,
-------------
1998 1999
------ ------
(in
thousands)
<S> <C> <C>
Financial accruals not yet deductible......................... $5,265 $6,683
Capitalized purchased technology.............................. 2,076 1,212
Capitalized research and development expenses................. 14 0
------ ------
$7,355 $7,895
====== ======
</TABLE>
F-31
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the income tax provisions computed at the United States
federal statutory rate to the effective tax rate is as follows:
<TABLE>
<CAPTION>
Year ended June
30,
-------------------
1997 1998 1999
---- ---- -----
<S> <C> <C> <C>
Federal statutory rate...................................... 35.0 % 35.0 % 35.0 %
State taxes, net of federal benefit......................... 6.1 6.1 5.8
Tax exempt interest income.................................. (4.8) (5.0) (10.3)
Other....................................................... 2.7 0.9 1.5
---- ---- -----
Effective tax rate.......................................... 39.0 % 37.0 % 32.0 %
==== ==== =====
</TABLE>
NOTE 5--Net Income Per Share
Following is a presentation of the Basic and Diluted EPS computations for
the periods presented below:
<TABLE>
<CAPTION>
Per Share
Income Shares Amount
------- ------ ---------
(in thousands)
<S> <C> <C> <C>
Year ended June 30, 1997
Earnings per share of common stock--basic................... $10,891 24,722 $0.44
Effect of dilutive securities:
Stock options............................................. -- 1,776
------- ------ -----
Earnings per share of common stock--diluted................. $10,891 26,498 $0.41
======= ====== =====
Year ended June 30, 1998
Earnings per share of common stock--basic................... $13,715 25,569 $0.54
Effect of dilutive securities:
Stock options............................................. -- 1,926
------- ------ -----
Earnings per share of common stock--diluted................. $13,715 27,495 $0.50
======= ====== =====
Year ended June 30, 1999
Earnings per share of common stock--basic................... $ 7,621 24,600 $0.31
Effect of dilutive securities:
Stock options............................................. -- 784
------- ------ -----
Earnings per share of common stock--diluted................. $ 7,621 25,384 $0.30
======= ====== =====
</TABLE>
NOTE 6--Put Warrants
As of September 17, 1998, pursuant to the authorized stock repurchase
program, the Company sold 2.0 million put warrants and purchased 1.5 million
call options. On January 26, 1999, the Company paid $762,000 to dissolve the
obligation for 1.0 million put warrants and 0.75 million call options that were
to expire on January 29, 1999. On September 10, 1999, the Company paid $3.7
million to dissolve the remaining 1.0 million put warrants and 0.75 million
call options which were to expire on September 15, 1999.
NOTE 7--Stockholders Equity and Benefit Plans
Repurchase of stock
On August 31, 1998, the Company's Board of Directors authorized the
repurchase, at management's discretion, of up to 4.0 million shares of the
Company's Common Stock at market prices not to exceed $14.00
F-32
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
per share and as market and business conditions warrant. As of June 30, 1999,
the Company had repurchased for cash 2.4 million shares at market prices
ranging from $6.69 to $10.94 per share.
Stockholder rights plan
On September 17, 1998, the Company's Board of Directors ("Board") adopted a
Stockholder Rights Plan ("Plan") designated to protect the long-term value of
the Company for its stockholders during any future unsolicited acquisition
attempt. Pursuant to the Plan, the Board declared a dividend of one preferred
share right ("Right") for each share of the Company's Common Stock outstanding
on October 5, 1998. Each Right becomes exercisable to purchase one one-
hundredth (1/100) of a share of Series A Junior Participating Preferred Stock
at an exercise price of $80.00. The Rights will expire on September 18, 2008.
The Company may redeem the Rights at a price of $0.001 per Right.
Stock Option Plans
In March 1992, the Company adopted a Stock Option Plan (the "1992 Option
Plan"). The 1992 Option Plan provides for the granting of incentive stock
options and nonqualified stock options to employees at prices not less than the
fair market value and not less than 85% of the fair market value of the
Company's Common Stock, respectively, on the date of grant. While previously
issued options remain outstanding under the 1992 Option Plan, the Company can
no longer issue new options out of the 1992 Option Plan.
On November 16, 1994, the Company's Board of Directors approved the 1994
Stock Option Plan (the "1994 Option Plan"). Under the terms of the 1994 Option
Plan, 6,460,000 shares of the Company's Common Stock are reserved for issuance
at exercise prices not less than the fair value of the Company's Common Stock
at the date of grant. The incentive and nonqualified stock options have ten-
year terms, and vest over a period determined by the Board of Directors, but
not to exceed five years. Options granted to date have vesting terms of four
years. The 1994 Option Plan will terminate ten years after its adoption unless
terminated earlier by the Board of Directors.
In February 1995, the Company's Board of Directors adopted, and the
Company's stockholders approved, the 1995 Directors Stock Option Plan
("Directors Plan"), which provides for the automatic grant of options to
purchase shares of Common Stock to non-employee directors of the Company
("Eligible Directors"). The maximum number of shares of Common Stock that may
be issued pursuant to options granted under the Directors Plan is 240,000.
Pursuant to the terms of the Directors Plan, each Eligible Director who becomes
a member of the Board and who has not otherwise received options in connection
with his Board service will automatically be granted an option to purchase
24,000 shares of Common Stock on the date the Eligible Director first joins the
board. Each Eligible Director will automatically be granted an additional
option for 6,000 shares of Common Stock annually. Each Grant will vest as to
25% of the shares per year thereafter, so long as the non-employee director
remains a member of the Board. Options granted under the Directors Plan expire
ten years from the date of grant. The exercise price of options under the
Directors Plan must be equal to the fair market value of the Company's Common
Stock on the date of grant. The Directors Plan will terminate in February 2005,
unless sooner terminated by the Board.
On March 19, 1997 the Compensation Committee of the Board of Directors
approved offering employees the right to amend outstanding stock options
granted under the Company's 1994 Stock Option Plan. The amended stock options
have an exercise price equal to the closing price of the Company's Common Stock
on April 23, 1997 and a new vesting schedule beginning on the same date with a
duration equal to that of the original option. Corporate officers were excluded
from this option repricing offer. Employees elected to amend options for
approximately 1,051,000 shares; the new exercise price was $8.1875 per share.
In the summary table below, these options are included in shares granted and
shares canceled in fiscal 1997.
F-33
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of transactions relating to all of the Company's option plans is
as follows:
<TABLE>
<CAPTION>
Options Outstanding
--------------------
Weighted
Options Average
Available Exercise
for Grant Shares Price
---------- ---------- --------
<S> <C> <C> <C>
Balance at June 30, 1996................... 2,797,761 2,909,458 $10.61
Options granted............................ (3,401,647) 3,401,647 $16.35
Options canceled........................... 1,457,105 (1,457,105) $27.33
Options exercised.......................... -- (746,089) $ 3.80
---------- ---------- ------
Balance at June 30, 1997................... 853,219 4,107,911 $10.67
Additional shares authorized, December
1997...................................... 1,200,000 -- --
Options granted............................ (1,761,550) 1,761,550 $24.07
Options canceled........................... 484,970 (484,970) $12.03
Options exercised.......................... -- (731,276) $ 4.41
---------- ---------- ------
Balance at June 30, 1998................... 776,639 4,653,215 $16.58
Additional shares authorized, December
1998...................................... 1,260,000 -- --
Options granted............................ (3,011,894) 3,011,894 $10.20
Options canceled........................... 2,065,529 (2,065,529) $20.84
Options exercised.......................... -- (409,708) $ 5.67
---------- ---------- ------
Balance at June 30, 1999................... 1,090,274 5,189,872 $12.10
========== ========== ======
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options as of June 30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------ --------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (in years) Price Exercisable Price
------------- ----------- --------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.10-$7.13 1,091,662 7.90 $ 5.46 475,354 $ 3.40
$7.19-$8.56 985,692 7.76 $ 8.14 418,368 $ 8.10
$8.69-$9.19 1,147,813 9.06 $ 9.00 257,921 $ 9.00
$9.25-$17.25 824,688 9.24 $12.71 92,391 $12.08
$17.88-$51.00 1,140,017 8.50 $24.55 472,294 $25.29
--------- ---------
$0.10-$51.00 5,189,872 8.48 $12.10 1,716,328 $11.88
========= =========
</TABLE>
Stock Purchase Plan
In February 1995, the Company's Board of Directors approved the 1995
Employee Stock Purchase Plan (the "Stock Purchase Plan"). Under the terms of
the Stock Purchase Plan, all employees of the Company may contribute, through
payroll deductions, up to 10% of their annual compensation toward the purchase
of the Company's Common Stock. The Company has reserved 400,000 shares for
issuance under the Stock Purchase Plan. The purchase price per share is 85% of
the lesser of (a) the fair market value of the Common Stock on the first day of
the offering period, as defined, or (b) the fair market value of the Common
Stock on the last day of the offering period, as defined. The Stock Purchase
Plan will terminate ten years after its adoption unless terminated earlier by
the Board of Directors.
F-34
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma net income and earnings per share
Pro forma information regarding net income and earnings per share is
required by SFAS 123. This information is required to be determined as if the
Company had accounted for its employee stock options, including shares issued
under the Stock Purchase Plan (collectively the "options") granted subsequent
to June 30, 1995, under the fair value method of that statement. The fair value
of options granted in fiscal 1997, 1998 and 1999 reported below have been
estimated at the date of grant using a Black-Scholes option pricing model. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of publicly traded options that have no vesting restrictions and are
fully transferable.
Had stock-based compensation cost for the options been determined based on
the fair value at the grant dates using the Black-Scholes model as prescribed
by SFAS 123, the Company's Results of Operations for the years ended June 30,
1997, 1998 and 1999 would have been as follows:
<TABLE>
<CAPTION>
Year ended June 30,
----------------------
1997 1998 1999
------- ------- ------
(in thousands except
per share data)
<S> <C> <C> <C>
Net income/(loss):
As reported....................................... $10,891 $13,715 $7,621
Pro forma......................................... $ 2,371 $ 3,474 $ (107)
Earnings per share--basic:
As reported....................................... $ 0.44 $ 0.54 $ 0.31
Pro forma......................................... $ 0.10 $ 0.14 $ 0.00
Earnings per share--diluted:
As reported....................................... $ 0.41 $ 0.50 $ 0.30
Pro forma......................................... $ 0.09 $ 0.13 $ 0.00
</TABLE>
The pro forma effect on net income and earnings per share for fiscal 1997,
1998 and fiscal 1999 is not representative of the pro forma effect on net
income in future years because it does not take into consideration pro forma
compensation expense related to grants made prior to fiscal 1996.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes model with the following weighted average assumptions:
<TABLE>
<CAPTION>
Year ended
June 30,
----------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Stock option plans:
Expected dividend yield.................................. 0.0% 0.0% 0.0%
Expected stock price volatility.......................... 65.0% 65.0% 65.0%
Risk free interest rate.................................. 6.4% 5.6% 5.7%
Expected life of options (years)......................... 3.09 3.57 3.04
Stock purchase plan:
Expected dividend yield.................................. 0.0% 0.0% 0.0%
Expected stock price volatility.......................... 65.0% 65.0% 65.0%
Risk free interest rate.................................. 5.4% 5.3% 4.9%
Expected life of options (years)......................... 0.50 0.50 0.50
</TABLE>
F-35
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The weighted average estimated grant date fair value, as defined by SFAS
123, for options granted under stock option plans during fiscal 1997, 1998 and
1999 was $7.51, $11.18 and $10.20 per share, respectively. The weighted average
estimated grant date fair value, as defined by SFAS 123, for purchase rights
granted under the Stock Purchase Plan during fiscal 1997, 1998 and 1999 was
$7.46, $5.75 and $5.29 per share, respectively.
401(k) Plan
The Company adopted a 401(k) plan for its employees whereby currently
eligible employees may contribute up to 15% of their earnings, on a pre-tax
basis, subject to the maximum amount permitted by the Internal Revenue Code.
Under the 401(k) plan, the Company may make contributions at the discretion of
the Board of Directors. During fiscal 1997, 1998 and 1999, the Company matched
employee contributions up to $800 per contributor per plan year.
NOTE 7--Segment Information and International Operations
The Company operates in one business segment, providing telecommunications
access equipment.
The following is a summary of the Company's operations:
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------
1997 1998 1999
------- -------- -------
(in thousands)
<S> <C> <C> <C>
Revenues from third party customers:
United States.................................. $72,679 $ 97,358 $89,554
Asia........................................... 3,452 2,996 873
Europe......................................... 355 954 717
Latin America.................................. 1,872 990 1,279
------- -------- -------
$78,358 $102,298 $92,423
======= ======== =======
Income (loss) from operations:
United States.................................. $15,114 $ 18,060 $ 9,949
Asia........................................... 1,025 1,216 (829)
Europe......................................... (1,706) (796) (1,586)
Latin America.................................. 780 (109) 101
------- -------- -------
$15,213 $ 18,371 $ 7,635
======= ======== =======
</TABLE>
<TABLE>
<CAPTION>
June 30,
-----------------
1998 1999
-------- --------
(in thousands)
<S> <C> <C>
Identifiable assets:
United States............................................ $137,104 $123,950
Asia..................................................... 307 385
Canada................................................... 646 1,533
Europe................................................... 683 453
Latin America............................................ 17 303
-------- --------
$138,757 $126,624
======== ========
</TABLE>
The Company derived 7%, 5% and 3% of its revenues from direct sales to
international customers in fiscal 1997, 1998 and 1999, respectively.
F-36
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 8--Concentration of Sales and Credit Risk
The following table summarizes the percentage of revenues accounted for by
the Company's significant customers:
<TABLE>
<CAPTION>
Year ended June 30,
------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Paradyne............................................ 30% 15% 29%
ALS(1).............................................. (a) (a) 13%
Motorola............................................ 15% 11% 13%
ADC Telecommunications.............................. 12% 29% (a)
DSC................................................. 10% (a) (a)
</TABLE>
--------
(a) Amounts not provided as revenues for the period were less than 10% of
the total.
(1) AT&T Local Services ("ALS") was formerly known as Teleport
Communications Group ("Teleport").
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
short-term investments, municipal securities and trade accounts receivable. The
Company's investment policy limits the amount of credit exposure to any one
financial institution or commercial issuer. The Company has not experienced any
material losses on its investments.
The Company generally extends 30-day credit terms to its customers, which is
consistent with industry business practices. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral from its customers. The Company maintains an allowance
for doubtful accounts receivable based upon the expected collectibility of all
accounts receivable. The Company has not experienced any material write-offs of
uncollectible accounts receivable.
NOTE 9--Commitments
The Company's principal offices are located in two facilities, totaling
118,281 square feet, leased by the Company in Fremont, California. The leases
on these facilities, which are classified as non-cancelable operating leases,
expire on various dates through December 31, 2005. In addition, the Company
leases a facility, totaling 29,840 square feet, in Fremont, California that it
subleases to a third party under a three year sublease that commenced in April
1999. The lease on this facility, which is classified as a non-cancelable
operating lease, expires in December 2005. The Company also leases facilities
in other locations. The leases on these facilities, which are classified as
non-cancelable operating leases, expire on various dates through December 31,
2005.
Future minimum lease payments under all noncancelable operating leases are
as follows:
<TABLE>
<CAPTION>
Year Ending June 30, (in thousands)
-------------------- --------------
<S> <C>
2000.......................................................... $ 2,192
2001.......................................................... 2,157
2002.......................................................... 2,144
2003.......................................................... 2,167
2004.......................................................... 2,104
Thereafter.................................................... 1,184
-------
Total minimum payments...................................... $11,948
=======
</TABLE>
F-37
<PAGE>
PREMISYS COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Rent expense under facility leases totaled $941,000, $1,365,000 and
$2,350,000 during fiscal 1997, 1998 and 1999, respectively.
In addition, the Company leases certain equipment under long-term lease
agreements that are classified as capital leases. These capital leases expire
at various dates through 2001. Property and equipment at June 30, 1998 and
1999 include assets acquired under capitalized leases of $351,000 and
$172,000, with related accumulated amortization of $272,000 and $70,000,
respectively. Future minimum payments under capitalized leases are not
material.
NOTE 10--Subsequent Events
Effective July 2, 1999, Peter Hauser resigned. Mr. Hauser was the Company's
Senior Vice-President of International Sales.
Effective August 16, 1999, Carol H. Sharer was appointed to serve on the
Company's Board of Directors.
Effective July, 1999, Lip-Bu Tan and Marino Polestra resigned from the
Company's Board of Directors.
NOTE 11--Sale of Business (Unaudited)
On December 22, 1999, Zhone Technologies, Inc. acquired all of the issued
and outstanding shares of the Company's common stock, at which time the
Company became a wholly owned subsidiary of Zhone Technologies, Inc.
F-38
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
The following unaudited pro forma combined condensed statement of operations
is presented for illustrative purposes only and is not necessarily indicative
of the combined results of operations for future periods or the results of
operations that actually would have been realized had Zhone Technologies, Inc.
and Premisys Communications, Inc. been a combined company during the specified
periods. The unaudited pro forma combined condensed statement of operations,
including the related notes, is qualified in its entirety by reference to, and
should be read in conjunctions with, the historical financial statements and
related notes thereto of Zhone Technologies, Inc. and Premisys Communications,
Inc., included elsewhere in this prospectus. On December 22, 1999, Zhone
Technologies, Inc. acquired Premisys Communications, Inc. The following
unaudited pro forma combined condensed statement of operations gives effect to
the acquisition of Premisys Communications, Inc. by Zhone Technologies, Inc.
using the purchase method of accounting as if Premisys Communications, Inc. had
been acquired on July 1, 1999. The unaudited pro forma combined condensed
statement of operations is based on the historical financial statements of
Zhone Technologies, Inc. and Premisys Communications, Inc.
The unaudited pro forma combined condensed statement of operations combines
Zhone Technologies, Inc., audited consolidated statement of operations for
period from September 1, 1999 (inception) through December 31, 1999 with
Premisys Communications, Inc.'s consolidated statement of operations for the
period from July 1, 1999 through December 22, 1999.
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
Six months ended December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Historical Historical
Zhone Premisys
Technologies, Communications, Pro Forma Pro Forma
Inc. Inc. Adjustments Combined
------------- --------------- ----------- ---------
<S> <C> <C> <C> <C>
Revenues................................. $ -- $ 29,903 $ -- $ 29,903
Cost of revenues......................... -- 18,935 -- 18,935
-------- -------- -------- --------
Gross profit............................. -- 10,968 -- 10,968
Operating expense:
Research and product development....... 4,016 11,732 -- 15,748
Selling, general and administrative.... 1,547 14,290 -- 15,837
Write-off of in-process research and
development........................... 21,320 -- (20,308)(1) 1,012
Stock based compensation............... 2,891 2,891
Amortization of intangibles............ 147 17,472 (2) 17,619
-------- -------- -------- --------
Total operating expenses................. 29,921 26,022 (2,836) 53,107
-------- -------- -------- --------
Income (loss) from operations............ (29,921) (15,054) 2,836 (42,139)
Interest and other income, net........... (104) 551 -- 447
-------- -------- -------- --------
Income (loss) before income taxes........ (30,025) (14,503) 2,836 (41,692)
Provision for income taxes............... -- 2,688 (2,097)(3) 591
-------- -------- -------- --------
Net income (loss)........................ $(30,025) $(17,191) $ 4,933 $(42,283)
======== ======== ======== ========
Basic and diluted net loss per share..... $ (0.40) $ (0.56)
======== ========
Shares used in computation............... 75,000 75,000
======== ========
</TABLE>
F-39
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
The following adjustments have been reflected in the unaudited pro forma
combined condensed statement of operations:
(1) Adjustment to reverse the value of purchased in-process research and
development as this is a non-recurring charge associated with the
acquisition of Premisys;
(2) Adjustment to record additional amortization of goodwill, purchased
technology and other intangible assets for the six month period ended
December 31, 1999. Goodwill, purchased technology and other intangible
assets are being amortized over three to five years; and
(3) Adjustment for the estimated tax effect of the pro forma adjustments
at an estimated tax rate of 35% and assumes no tax benefit for the write-
off of in-process research and development and the amortization of
goodwill.
F-40
<PAGE>
[Zhone LOGO]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth all costs and expenses, other than the
underwriting discounts and commissions payable by the Registrant in connection
with the sale and distribution of the common stock being registered. All
amounts shown are estimates except for the Securities and Exchange Commission
registration fee, the NASD filing fee and the Nasdaq National Market
application fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee................. $91,080
NASD filing fee..................................................... 30,500
Nasdaq National Market application fee.............................. *
Blue sky qualification fees and expenses............................ 5,000
Printing and engraving expenses..................................... *
Legal fees and expenses............................................. *
Accounting fees and expenses........................................ *
Director and officer liability insurance............................ *
Transfer agent and registrar fees................................... *
Miscellaneous expenses.............................................. *
-------
Total........................................................... $ *
=======
</TABLE>
--------
* To be completed by amendment.
Item 14. Indemnification of Directors and Officers.
Section 102 of the Delaware General Law, or DGCL, as amended, allows a
corporation to eliminate the personal liability of directors of a corporation
to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, except where the director breached his duty of
loyalty, failed to act in good faith, engaged in intentional misconduct or
knowingly violated a law, authorized the payment of a dividend or approved a
stock repurchase in violation of Delaware corporate law or obtained an improper
personal benefit.
Section 145 of the DGCL provides, among other things, that we may indemnify
any person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding (other than an
action by or in the right of Zhone Technologies, Inc.) by reason of the fact
that the person is or was a director, officer, agent, or employee of Zhone
Technologies, Inc., or is or was serving at our request as a director, officer,
agent or employee of another corporation, partnership, joint venture, trust or
other enterprise against expenses, including attorneys' fees, judgments, fines
and amounts paid in settlement actually and reasonably incurred by the person
in connection with such action, suit or proceeding. The power to indemnify
applies (a) if such person is successful on the merits or otherwise in defense
of any action, suit or proceeding, or (b) if such person acting in good faith
and in a manner he reasonably believed to be in the best interest, or not
opposed to the best interest, of Zhone Technologies, Inc., and with respect to
any criminal action or proceeding had no reasonable cause to believe his
conduct was unlawful. The power to indemnify applies to actions brought by or
in the right of Zhone Technologies, Inc. as well but only to the extent of
defense expenses (including attorneys' fees but excluding amounts paid in
settlement) actually and reasonably incurred and not to any satisfaction of
judgment or settlement of the claim itself, and with the further limitation
that in such actions no indemnification shall be made in the event of any
adjudication of liability to Zhone Technologies, Inc., unless the court
believes that in light of all the circumstances indemnification should apply.
Section 174 of the DGCL provides, among other things, that a director, who
willfully or negligently approves of an unlawful payment of dividends or an
unlawful stock purchase or redemption, may be held liable for such actions. A
director who was either absent when the unlawful actions were approved or
dissented at the
II-1
<PAGE>
time, may avoid liability by causing his or her dissent to such actions to be
entered in the books containing minutes of the meetings of the board of
directors at the time such action occurred or immediately after such absent
director receives notice of the unlawful acts.
Our Certificate of Incorporation (Exhibit 3.1 hereto) and Bylaws (Exhibit
3.3 hereto) provide that we shall indemnify our directors, officers, employees
and agents to the maximum extent permitted by Delaware Law, including in
circumstances in which indemnification is otherwise discretionary under
Delaware Law. In addition, we intend to enter into separate indemnification
agreements (Exhibit 10.1 hereto) with our directors and officers which would
require us, among other things, to indemnify them against certain liabilities
which may arise by reason of their status or service (other than liabilities
arising from willful misconduct of a culpable nature). We also intend to
maintain director and officer liability insurance, if available on reasonable
terms. These indemnification provisions and the indemnification agreements may
be sufficiently broad to permit indemnification of our officers and directors
for liabilities (including reimbursement of expenses incurred) arising under
the Securities Act of 1933, as amended (the "Securities Act").
The Underwriting Agreement (Exhibit 1.1) hereto provides for indemnification
by the Underwriters of us and our officers and directors for certain
liabilities, including matters arising under the Securities Act.
Item 15. Recent Sales of Unregistered Securities.
(a) Since our inception, we have issued and sold the following unregistered
securities:
1. From inception through September 30, 2000, we granted options to purchase an
aggregate of 27,943,433 shares of common stock under our 1999 Stock Option
Plan, of which 18,854,465 have been exercised and 1,423,650 have been
canceled. Of the shares issued upon the exercise of these options, 1,252,425
were subsequently repurchased by us. From inception through September 30,
2000, we issued options outside of our 1999 Stock Option Plan to purchase an
aggregate of 216,000 shares of common stock, of which 31,600 have been
exercised. Of the shares issued upon the exercise of these options,
6,667 were subsequently repurchased by us.
2. In June 1999, we sold 75,000,000 shares of common stock for $0.001 per share
for a total purchase price of $75,000.
3. In November 1999, we sold the following preferred stock: (a) 38,750,000
shares of series A-1 preferred stock to certain investors in exchange for a
capital commitment of up to $155,000,000 or $4.00 per share, (b) 37,500,000
shares of series A-2 preferred stock to certain investors in exchange for a
capital commitment of up to $150,000,000 or $4.00 per share, (c) 13,750,000
shares of series A-3 preferred stock to certain investors in exchange for a
capital commitment of up to $55,000,000 or $4.00 per share, (d) 12,500,000
shares of series A-4 preferred stock to certain investors in exchange for a
capital commitment of up to $50,000,000 or $4.00 per share, (e) 6,250,000
shares of series A-5 preferred stock to certain investors in exchange for a
capital commitment of up to $25,000,000 or $4.00 per share, (f) 7,868,750
shares of series A-6 preferred stock to certain investors in exchange for a
capital commitment of up to $31,475,000 or $4.00 per share, (g) 2,500,000
shares of series A-7 preferred stock to certain investors in exchange for a
capital commitment of up to $10,000,000 or $4.00 per share, (h) 1,075,000
shares of series A-8 preferred stock to certain investors in exchange for a
capital commitment of up to $4,300,000 or $4.00 per share, (i) 1,750,000
shares of series A-9 preferred stock to certain investors in exchange for a
capital commitment of up to $7,000,000 or $4.00 per share, (j) 1,056,250
shares of series A-10 preferred stock to certain investors in exchange for a
capital commitment of up to $4,225,000 or $4.00 per share, (k) 1,000,000
shares of series A-11 preferred stock to certain investors in exchange for a
capital commitment of up to $4,000,000 or $4.00 per share, and (l) 1,000,000
shares of series A-12 preferred stock to certain investors in exchange for a
capital commitment of up to $4,000,000 or $4.00 per share.
4. In January 2000, in connection with a purchase of real property, we issued
to the City of Oakland a warrant to purchase 100,000 shares of common stock,
at an exercise price of $4.00 per share for an aggregate exercise price of
$400,000.
II-2
<PAGE>
5. In March 2000, in connection with the outsourcing of our manufacturing
operations, we issued to Solectron Corporation, a warrant to purchase
15,000 shares of common stock, at an exercise price of $0.40 per share for
an aggregate exercise price of $6,000.
6. In February 2000, we sold 2,000 shares of common stock to Dennis Shepherd
in consideration for services rendered.
7. In September 2000, in connection with a purchase agreement for our
products, we issued to Broadband Infrastructure Group Corporation a warrant
to purchase 30,000 shares of common stock at an exercise price of $9.50 per
share.
There were no underwriters employed in connection with any of the
transactions set forth in this Item 15.
The issuances described in Item 15(a)(1) and Item 15(a)(2) were deemed
exempt from registration under the Securities Act in reliance on Section 4(2)
or Rule 701 promulgated thereunder as transactions pursuant to compensatory
benefit plans and contracts relating to compensation. The issuances described
in Items 15(a)(2) through 15(a)(6) were deemed exempt from registration under
the Securities Act in reliance on Section 4(2) of the Securities Act as
transactions by an issuer not involving a public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates and other instruments issued in such transactions.
All recipients either received adequate information about us or had access,
through employment or other relationships, to such information.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement
2.1 Agreement and Plan of Merger, dated as of October 20, 1999, by and
among Registrant, Zhone Acquisition Corp. and Premisys Communications,
Inc.
2.2 Agreement and Plan of Reorganization, dated as of November 15, 1999,
by and among Registrant, CAG Acquisition Corporation, CAG
Technologies, Inc. and Fred Ackourey
2.3 Asset Purchase Agreement, dated as of February 1, 2000, by and among
Registrant, Roundview, Inc., Jeannette Symons, Edward Stockwell and
Lori Brown
2.4 Agreement and Plan of Reorganization, dated as of February 8, 2000, by
and among Registrant, Opt Acquisition Corporation and OptaPhone
Systems, Inc.
3.1 Amended and Restated Certificate of Incorporation
3.2* Form of Amended and Restated Certificate of Incorporation to be
effective upon the closing of this offering
3.3 Amended and Restated By-laws
3.4* Form of Amended and Restated Bylaws to be effective upon the closing
of this offering
4.1* Specimen stock certificate
4.2 Rights Agreement dated November 1, 1999
5.1* Opinion of Gray Cary Ware & Freidenrich LLP
10.1 Form of Indemnification Agreement by and between Registrant and
Registrant's directors and officers
10.2* 1999 Stock Option Plan, as amended
10.3* 2000 Employee Stock Purchase Plan
10.4 Employment Agreement, dated as of October 20, 1999, by and between
Registrant and Mory Ejabat, Registrant's Chairman and Chief Executive
Officer
10.5 Employment Agreement, dated as of October 20, 1999, by and between
Registrant and Jeanette Symons, Registrant's Chief Technology Officer
and Vice President, Engineering
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.6 Director Services Agreement by and between Registrant and Robert K.
Dahl
10.7 Form of Amended and Restated LLC Operating Agreement for Zhone
Investors I, LLC through Zhone Investors V, LLC and Zhone Investors
VII, LLC through Zhone Investors XII, LLC
10.8 Operating Agreement of Zhone Investors FF, LLC
10.9 Form of Amended and Restated Series A-1 through A-12 Preferred Stock
Purchase Agreement
10.10 Form of Class B Member Interest Purchase Agreement
10.11 Strategic Alliance Agreement, dated as of March 13, 2000, by and
between Registrant and Solectron Corporation
10.12 Form of Asset Purchase Agreement by and between Registrant and
Solectron Corporation
10.13 Supply Agreement, dated as of March 13, 2000, by and between
Registrant and Solectron Corporation
10.14 Credit Agreement, dated as of November 29, 1999, by and between
Premisys Systems, LLC and Credit Suisse First Boston Corporation
10.15 Lease Agreement (Improvements Buildings 1 & 2) dated August 1, 2000,
by and between Registrant and BNP Leasing Corporation
10.16 Lease Agreement (Improvements Building 3) dated August 1, 2000, by and
between Registrant and BNP Leasing Corporation
10.17 Lease Agreement (Land) dated August 1, 2000, by and between Registrant
and BNP Leasing Corporation
10.18 Purchase Agreement (Improvements Buildings 1 & 2) dated August 1,
2000, by and between Registrant and BNP Leasing Corporation
10.19 Purchase Agreement (Improvements Building 3) dated August 1, 2000, by
and between Registrant and BNP Leasing Corporation
10.20 Purchase Agreement (Land) dated August 1, 2000, by and between
Registrant and BNP Leasing Corporation
10.21 Warrant to purchase up to 15,000 shares of common stock granted to
Solectron Corporation
10.22 Warrant to purchase up to 100,000 shares of common stock granted to
the City of Oakland
10.23 Warrant to purchase up to 30,000 shares of common stock granted to
Broadband Infrastructure Group Corporation
17.1* Letter from Ernst & Young, LLP regarding change in certifying
accountant
21.1 List of Subsidiaries of the Registrant
23.1 Consent of KPMG LLP, independent auditors
23.2 Consent of PricewaterhouseCoopers LLP, independent auditors
23.3* Consent of Gray Cary Ware & Freidenrich LLP (included in Exhibit 5.1)
24.1 Power of Attorney (included on signature page)
27.1 Financial Data Schedule
</TABLE>
--------
* To be filed by amendment.
(b) Financial Statement Schedules.
Independent Auditors' Report on Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
Item 17. Undertakings
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
II-4
<PAGE>
Insofar as indemnification by the Registrant for liabilities arising under
the Securities Act may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions referenced in Item 14 of
this Registration Statement or otherwise, the Registrant has been advised that
in the opinion of the Commission such indemnification is against public policy
as expressed in the Securities Act, and is therefore unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer,
or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered
hereunder, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective; and
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at the time shall be
deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Oakland, State of California, on
October 19, 2000.
ZHONE TECHNOLOGIES, INC.
/s/ Mory Ejabat
By: _________________________________
Mory Ejabat
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Mory Ejabat and Gary A. Wetsel, and each
of them acting individually, as his true and lawful attorneys-in-fact and
agents, each with full power of substitution, for him in any and all
capacities, to sign any and all amendments to this Registration Statement
(including post-effective amendments or any abbreviated registration statement
and any amendments thereto filed pursuant to Rule 462(b) increasing the number
of securities for which registration is sought), and to file the same, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, with full power of each to act alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully for all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said attorneys-in-
fact and agents, or his or their substitute or substitutes, may lawfully do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Mory Ejabat Chief Executive Officer October 19, 2000
______________________________________ and Chairman of the Board
Mory Ejabat (Principal Executive
Officer)
/s/ Gary A. Wetsel Chief Financial Officer October 19, 2000
______________________________________ (Principal Financial and
Gary A. Wetsel Accounting Officer)
/s/ Robert K. Dahl Director October 19, 2000
______________________________________
Robert K. Dahl
/s/ James Coulter Director October 19, 2000
______________________________________
James Coulter
/s/ John Marren Director October 19, 2000
______________________________________
John Marren
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ James Greene, Jr. Director October 19, 2000
______________________________________
James Greene, Jr.
/s/ Alex Navab, Jr. Director October 19, 2000
______________________________________
Alex Navab, Jr.
/s/ C. Richard Kramlich Director October 19, 2000
______________________________________
C. Richard Kramlich
/s/ John W. Sidgmore Director October 19, 2000
______________________________________
John W. Sidgmore
/s/ Dan C. Stanzione Director October 19, 2000
______________________________________
Dan C. Stanzione
</TABLE>
II-7
<PAGE>
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors
Zhone Technologies, Inc.:
Under date of October 16, 2000, we reported on the consolidated balance
sheets of Zhone Technologies, Inc. and subsidiaries as of December 31, 1999 and
September 30, 2000, and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders' deficit and cash flows
for the periods from September 1, 1999 (inception) through December 31, 1999
and the nine months ended September 30, 2000, included in the prospectus. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule in the registration statement. This financial statement schedule is
the responsibility of the Company's management. Our responsibility is to
express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
KPMG LLP
Mountain View, California
October 16, 2000
S-1
<PAGE>
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance at Balance at
Beginning Charged to End of
Description of period Operations Deductions Other(1) Period
----------- ---------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
Period ended December 31,
1999 allowance for sales
returns and doubtful
accounts................. $ -- -- -- 4,535 4,535
Period ended December 31,
1999 warranty reserve.... $ -- -- -- 3,817 3,817
Period ended September 30,
2000 allowance for sales
returns and doubtful
accounts................. $4,535 5,426 (3,611) -- 6,350
Period ended September 30,
2000 warranty reserve.... $3,817 383 (964) -- 3,236
</TABLE>
--------
(1) Balance related to the acquisition of Premisys Communications, Inc.
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement
2.1 Agreement and Plan of Merger, dated as of October 20, 1999, by and
among Registrant, Zhone Acquisition Corp. and Premisys Communications,
Inc.
2.2 Agreement and Plan of Reorganization, dated as of November 15, 1999,
by and among Registrant, CAG Acquisition Corporation, CAG
Technologies, Inc. and Fred Ackourey
2.3 Asset Purchase Agreement, dated as of February 1, 2000, by and among
Registrant, Roundview, Inc., Jeannette Symons, Edward Stockwell and
Lori Brown
2.4 Agreement and Plan of Reorganization, dated as of February 8, 2000, by
and among Registrant, Opt Acquisition Corporation and OptaPhone
Systems, Inc.
3.1 Amended and Restated Certificate of Incorporation
3.2* Form of Amended and Restated Certificate of Incorporation to be
effective upon the closing of this offering
3.3 Amended and Restated By-laws
3.4* Form of Amended and Restated Bylaws to be effective upon the closing
of this offering
4.1* Specimen stock certificate
4.2 Rights Agreement dated November 1, 1999
5.1* Opinion of Gray Cary Ware & Freidenrich LLP
10.1 Form of Indemnification Agreement by and between Registrant and
Registrant's directors and officers
10.2* 1999 Stock Option Plan, as amended
10.3* 2000 Employee Stock Purchase Plan
10.4 Employment Agreement, dated as of October 20, 1999, by and between
Registrant and Mory Ejabat, Registrant's Chairman and Chief Executive
Officer
10.5 Employment Agreement, dated as of October 20, 1999, by and between
Registrant and Jeanette Symons, Registrant's Chief Technology Officer
and Vice President, Engineering
10.6 Director Services Agreement by and between Registrant and Robert K.
Dahl
10.7 Form of Amended and Restated LLC Operating Agreement for Zhone
Investors I, LLC through Zhone Investors V, LLC and Zhone Investors
VII, LLC through Zhone Investors XII, LLC
10.8 Operating Agreement of Zhone Investors FF, LLC
10.9 Form of Amended and Restated Series A-1 through A-12 Preferred Stock
Purchase Agreement
10.10 Form of Class B Member Interest Purchase Agreement
10.11 Strategic Alliance Agreement, dated as of March 13, 2000, by and
between Registrant and Solectron Corporation
10.12 Form of Asset Purchase Agreement by and between Registrant and
Solectron Corporation
10.13 Supply Agreement, dated as of March 13, 2000, by and between
Registrant and Solectron Corporation
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.14 Credit Agreement, dated as of November 29, 1999, by and between
Premisys Systems, LLC and Credit Suisse First Boston Corporation
10.15 Lease Agreement (Improvements Buildings 1 & 2) dated August 1, 2000,
by and between Registrant and BNP Leasing Corporation
10.16 Lease Agreement (Improvements Building 3) dated August 1, 2000, by and
between Registrant and BNP Leasing Corporation
10.17 Lease Agreement (Land) dated August 1, 2000, by and between Registrant
and BNP Leasing Corporation
10.18 Purchase Agreement (Improvements Buildings 1 & 2) dated August 1,
2000, by and between Registrant and BNP Leasing Corporation
10.19 Purchase Agreement (Improvements Building 3) dated August 1, 2000, by
and between Registrant and BNP Leasing Corporation
10.20 Purchase Agreement (Land) dated August 1, 2000, by and between
Registrant and BNP Leasing Corporation
10.21 Warrant to purchase up to 15,000 shares of common stock granted to
Solectron Corporation
10.22 Warrant to purchase up to 100,000 shares of common stock granted to
the City of Oakland
10.23 Warrant to purchase up to 30,000 shares of common stock granted to
Broadband Infrastructure Group Corporation
17.1* Letter from Ernst & Young, LLP regarding change in certifying
accountant
21.1 List of Subsidiaries of the Registrant
23.1 Consent of KPMG LLP, independent auditors
23.2 Consent of PricewaterhouseCoopers LLP, independent auditors
23.3* Consent of Gray Cary Ware & Freidenrich LLP (included in Exhibit 5.1)
24.1 Power of Attorney (included on signature page)
27.1 Financial Data Schedule
</TABLE>
--------
* To be filed by amendment.
