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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO _____________
Commission File Number: 000-26485
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PARADYNE NETWORKS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 75-2658219
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8545 126TH AVENUE NORTH, LARGO, FLORIDA 33773
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(Address, including zip code, of principal
executive offices, including zip code)
(727) 530-2000
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(Registrant's telephone number, including area code)
None
--------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
The number of shares outstanding of the Registrant's Common Stock as
of October 31, 2000 was 32,555,736.
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PARADYNE NETWORKS, INC.
FOR THE PERIOD ENDED SEPTEMBER 30, 2000
INDEX
<TABLE>
<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Condensed Consolidated Balance Sheets at September 30, 2000
and December 31, 1999 1
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2000
and September 30, 1999 2
Condensed Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 2000 and
September 30, 1999 3
Notes to Condensed Consolidated Financial Statements 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
ITEM 3. Quantitative and Qualitative Disclosures about Market
Risk 10
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings 11
ITEM 2. Changes in Securities and Use of Proceeds 11
ITEM 5. Other Information 11
ITEM 6. Exhibits and Reports on Form 8-K 12
SIGNATURES 12
</TABLE>
<PAGE> 3
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
UNAUDITED
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 26,581 $ 62,885
Accounts receivable less allowance for doubtful accounts of $4,585 and $4,022 29,028 29,548
at September 30, 2000 and December 31, 1999, respectively
Income tax receivables 7,500 2,010
Inventories (Note 2) 46,858 13,252
Prepaid expenses and other current assets 2,740 3,201
--------- ---------
Total current assets 112,707 110,896
Property, plant and equipment, less accumulated depreciation of $22,823 and 20,419 17,297
$15,502 at September 30, 2000 and December 31, 1999, respectively
Other assets 9,278 2,292
--------- ---------
Total assets $ 142,404 $ 130,485
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 28,120 $ 8,367
Current portion of debt 490 434
Payroll & benefit related liabilities 9,038 7,887
Other current liabilities 20,073 7,857
--------- ---------
Total current liabilities 57,721 24,545
Long term debt 287 256
--------- ---------
Total liabilities 58,008 24,801
Stockholders' equity:
Preferred stock, par value $.001; 5,000,000 shares authorized, none issued
or outstanding
Common stock, par value $.001; 60,000,000 shares authorized, 31,675,224 and
30,835,511 shares issued and outstanding as of September 30, 2000 and
December 31, 1999, respectively 32 31
Additional paid-in capital 103,458 93,487
Retained (deficit) earnings (17,232) 14,528
Other equity adjustments (1,862) (2,362)
--------- ---------
Total stockholders' equity 84,396 105,684
--------- ---------
Total liabilities and stockholders' equity $ 142,404 $ 130,485
========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
1
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PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ---------------------------
2000 1999 2000 1999
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Sales $ 54,960 $ 56,749 $ 192,700 $ 159,882
Services 716 897 2,804 1,788
Royalties 40 100 290 2,918
-------- -------- --------- ---------
Total Revenues 55,716 57,746 195,794 164,588
Cost of sales:
Cost of sales (excluding provision for excess
inventory and loss on purchase commitment) 36,048 31,592 118,130 91,657
Provisions for excess inventory and loss on
purchase commitment 34,931 34,931
-------- -------- --------- ---------
Total cost of sales 70,979 31,592 153,061 91,657
-------- -------- --------- ---------
Gross margin (15,263) 26,154 42,733 72,931
Operating expenses:
Research and development 10,262 9,068 30,285 26,903
Selling, general & administrative 12,151 13,932 46,192 41,590
Amortization of intangible assets and
deferred stock compensation 437 1,254 889 1,394
-------- -------- --------- ---------
Total operating expenses 22,850 24,254 77,366 69,887
-------- -------- --------- ---------
Operating income (loss) (38,113) 1,900 (34,633) 3,044
Other (income) expenses:
Interest, net (432) (375) (2,049) 317
Other, net 119 (143) (206) (2,684)
-------- -------- --------- ---------
Income (loss) before provision for income tax (37,800) 2,418 (32,378) 5,411
Provision (benefit) for income tax (2,298) 551 (617) 1,786
-------- -------- --------- ---------
Net income (loss) $(35,502) $ 1,867 $ (31,761) $ 3,625
======== ======== ========= =========
Weighted average number of common shares outstanding
Basic 31,661 30,666 31,506 27,638
Diluted 31,661 32,494 31,506 29,466
Earnings per common share
Basic $ (1.12) $ 0.06 $ (1.01) $ 0.13
Diluted $ (1.12) $ 0.06 $ (1.01) $ 0.12
Consolidated Statements of Comprehensive Income
Net income (loss) (35,502) 1,867 (31,761) 3,625
Translation adjustments 16 (55) 26 439
-------- -------- --------- ---------
Comprehensive income $(35,486) $ 1,812 $ (31,735) $ 4,064
======== ======== ========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
2
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PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (31,761) $ 3,625
Adjustments to reconcile net income (loss) to cash provided by (used in)
operating activities:
Loss on purchase commitment 11,378
Reserve for Inventory write-off 23,553
Increase in allowance for bad debts 563 676
Depreciation & Amortization (includes intangible asset and 6,237 5,747
deferred stock compensation of $1,043 and $1,848 respectively)
(Increase) decrease in assets
Receivables (723) 7,812
Inventories (52,598) (2,234)
Other Assets (3,030) (276)
Increase (decrease) in Liabilities --
Accounts Payable 8,774 (3,828)
Payroll Related (470) 639
Other Current Liabilities 11,836 (101)
--------- ---------
Net cash provided by (used in) operating activities (26,241) 12,060
--------- ---------
Cash flows provided by (used in) investing activities
Cash used to acquire net assets (7,596)
Capital (Expenditures)/Retirements (7,381) (3,507)
Proceeds from sale of Property, Plant and Equipment 3 26
--------- ---------
Net cash (used in) investing activities (14,974) (3,481)
--------- ---------
Cash flows provided by (used in ) financing activities
Net proceeds from stock transactions 4,830 65,765
Borrowings/Repayment of line of credit & other short term obligations (17) (16,067)
Borrowings under other debt obligations 534 388
Repayments under other debt obligations (462) (379)
--------- ---------
Net cash provided by financing activities 4,885 49,707
--------- ---------
Effect of foreign exchange rate changes on cash 26 439
--------- ---------
Net increase (decrease) in cash and cash equivalents (36,304) 58,725
--------- ---------
Cash and cash equivalents at beginning of period 62,885 2,356
--------- ---------
Cash and cash equivalents at end of period $ 26,581 $ 61,081
========= =========
Supplemental disclosure of cash flow information:
Non-cash transactions
Stock issued for notes $ (635) $ 1,135
========= =========
Recoverable taxes related to stock option exercises $ 5,291 $ --
========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
3
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PARADYNE NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND BASIS OF PRESENTATION:
Paradyne Networks, Inc. (the "Company") designs, manufactures, and
markets data communications and networking products for network service
providers and business customers. The Company's products enable business
customers to efficiently access wide area network services and allow network
service providers to provide customers with high-speed services for data, voice,
video and multimedia applications.
The accompanying unaudited consolidated financial statements include
the results of the Company and its wholly-owned subsidiaries: Paradyne
Corporation; Paradyne Canada Ltd.; Paradyne International Ltd.; Paradyne
Worldwide Corp. (formerly Paradyne Far East Corporation); Ark Electronic
Products Inc.; Paradyne GmbH; Paradyne Finance Corporation; and Paradyne
International Sales Ltd. Intercompany accounts and transactions have been
eliminated in consolidation.
The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. However, in the opinion of
management, such statements reflect all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of interim period
results. These financial statements should be read in conjunction with the
December 31, 1999 audited financial statements and notes thereto included in the
Company's Annual Report on Form 10-K as filed with the Securities and Exchange
Commission on March 27, 2000.
The results of operations for the interim periods are not necessarily
indicative of results to be expected for the entire year or for other future
interim periods.
2. INVENTORY:
Inventories at September 30, 2000 and December 31, 1999 are summarized
as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw Materials $ 29,993 $ 10,603
Work In Process 4,704 1,198
Finished Goods 12,161 1,451
--------- ---------
46,858 13,252
========= =========
</TABLE>
In September 2000, the Company recorded a provision for the writedown
of inventory in the amount of $23,553 and a loss due to non-cancelable purchase
commitments in the amount of $11,378. These charges were required because a few
network service provider customers changed their plans for rolling out DSL
services resulting in a significant reduction in demand.
4
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3. EARNINGS PER SHARE:
The following table summarizes (in thousands, except per share data)
the weighted average shares outstanding for basic and diluted earnings per share
for the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ---------------------------
2000 1999 2000 1999
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
Net Income (loss) $(35,502) $ 1,867 $ (31,761) $ 3,625
Weighted average number of common shares outstanding
Basic 31,661 30,666 31,506 27,638
Dilutive effect of stock options -- 1,828 -- 1,828
-------- -------- --------- ---------
Diluted 31,661 32,494 31,506 29,466
-------- -------- --------- ---------
Earnings per common share:
Basic $ (1.12) $ 0.06 $ (1.01) $ 0.13
Dilutive effect of stock options $ -- $ -- $ -- $ (0.01)
-------- -------- --------- ---------
Diluted $ (1.12) $ 0.06 $ (1.01) $ 0.12
-------- -------- --------- ---------
</TABLE>
4. ACQUISITION:
On April 14, 2000, the Company acquired substantially all of the
assets of Control Resources Corporation (CRC) of Fair Lawn, NJ, a wholly owned
subsidiary of P-Com, Inc. The accompanying Unaudited Condensed Consolidated
Financial Statements include the results of operations for the acquired CRC
business for the period April 15, 2000 through September 30, 2000. CRC is a
developer and manufacturer of broadband network access and service level
management systems. Under the terms of the agreement, the purchase price
(excluding contingent consideration) was $7.6 million consisting of $3.1 million
in cash and a note for $4.5 million, payable in cash or common stock. The full
amount of the note was paid off in cash on September 15, 2000. The seller will
also be due contingent consideration in the amount of $1.5 million in January
2001 because 2000 sales of products generated by the CRC business were on track
to exceed the 2000 target, as of the end of October 2000. This contingent
consideration will be accounted for as additional goodwill. The Company also
granted options to purchase 207,000 shares of its common stock at a discount to
CRC employees for future employment services to the Company. The acquisition has
been accounted for under the purchase method of accounting, which will result in
the recognition of approximately $7.6 million in intangible assets (after adding
the $1.5 million contingent consideration), to be amortized over five years on a
straight-line basis.
The following unaudited pro-forma summary presents the consolidated
results of operations of the Company as if the acquisition had occurred at the
beginning of the periods presented herein. This presentation is for
informational purposes only and does not purport to be indicative of what would
have occurred had the acquisitions been made as of these dates or of results
which may occur in the future.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
------------- -------------
<S> <C> <C>
Revenue $ 199,150,000 $ 169,590,000
Net Income (32,402,000) 1,363,000
Diluted Earnings Per Share $ (1.02) $ 0.05
</TABLE>
5
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5. INCOME TAXES:
The Company has currently projected a net operating loss for the year
2000 for income tax purposes of approximately $19 million, mainly resulting from
the exercise of stock options. This operating loss will first be carried back to
prior years, with any remaining amount being carried forward. As of September
30, 2000, the Company has a $14.8 million deferred tax asset, principally
resulting from the large write-down of inventory and the loss due to
non-cancelable purchase commitments. Due to the uncertainty of its ultimate
realization, the Company has established a valuation reserve of $14.8 million
against the net deferred tax asset as of September 30, 2000.
6. ACCOUNTING RECLASSIFICATION:
During the third quarter the Company made an accounting
reclassification related to the Company's marketing development fund agreement
with Rhythms Net Connections Inc., a major customer. Expenditures in the amount
of $6.7 million were reclassified as contra-revenue instead of being classified
as SG&A expenses. The Company made this reclassification because with the
currently available information it was not clear that Rhythms would use these
funds in such a way as to warrant presentation as marketing expenses. It appears
to be more conservative to classify these expenditures as contra-revenue rather
than marketing expenses due to the uncertainty in the final result.
7. SUBSEQUENT EVENTS:
Securities Litigation
In October 2000, following the Company's September 28, 2000 press
release regarding contemplated third quarter results, several securities class
action suits (collectively, the "Securities Actions") were filed against
Paradyne and certain of its executive officers and its Chairman of the Board of
Directors ("Defendants"). The suits allege that the Defendants, during the
period September 28,1999 through September 28, 2000, fraudulently or recklessly
inflated the market price of Paradyne's stock by erroneously reporting that
Paradyne was performing well, that product demand was solid and that inventories
were properly stated. The Securities Actions seek damages in an unspecified
amount for the alleged inflated stock price during the class period. The Company
believes the claims are without merit and intends to vigorously defend them, but
the outcome cannot be predicted. Paradyne has engaged the law firm of Holland
and Knight, LLP as its legal counsel in this litigation.
Broad-Based Stock Plan
On November 1, 2000, Paradyne's Board of Directors adopted the 2000
Broad-Based Stock Plan (the "2000 Plan"), under which Paradyne is able to grant
nonstatutory stock options, stock bonuses and rights to purchase restricted
stock to eligible participants. No more than 40% of the total shares granted
under the plan shall be granted to officers and directors. The total number of
shares of Paradyne common stock that may be issued under the 2000 Plan is
4,000,000 shares. The Board of Directors of Paradyne adopted the 2000 Plan in
order to retain the services of persons who are now employees or directors of,
or consultants to, Paradyne; to secure and retain the services of new employees,
directors and consultants; and to provide incentives for such persons to exert
maximum efforts for the success of Paradyne and its affiliates.
On November 2, 2000, options to purchase approximately 3,612,000 shares
of Paradyne common stock were granted to employees under the 2000 Plan. Each of
these stock options has an exercise price equal to $3.625 per share, and vest in
accordance with the terms of the applicable stock option agreement.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and other sections of this Form 10-Q contains
forward-looking statements that involve risks and uncertainties. These forward
looking statements are made pursuant to the "safe-harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and are made based on
management's current expectations or beliefs as well as assumptions made by, and
information currently available to management. All statements regarding future
events, our future financial performance and operating results, our business
strategy and our financing plans are forward-looking statements. In many cases,
you can identify forward-looking statements by terminology, such as "may,"
"will," "should," "expects," "intends," "plans," "anticipates,"
6
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"believes," "estimates," "predicts," "potential," or "continue," or the negative
of such terms and other comparable terminology. These statements are only
predictions. Known and unknown risks, uncertainties and other factors could
cause our actual results to differ materially from those projected in the
forward-looking statements.
OVERVIEW
We are a leading developer, manufacturer and distributor of broadband
and narrowband network access products for network service providers ("NSPs")
and business customers. We offer solutions that enable business class, service
level managed, high-speed connectivity over the existing telephone network
infrastructure and provide for cost-effective access speeds of up to 45 MBPS. We
market and sell our products worldwide to NSPs and business customers through a
multi-tier distribution system that includes direct sales, strategic partner
sales, NSP sales and traditional distributor or value added reseller ("VAR")
sales. We estimate that direct and indirect sales to, and services performed
for, Lucent Technologies accounted for approximately 23% of our total revenues
for the first nine months of 2000 versus 29% for the first nine months of 1999.
Sales to Rhythms Net Connections Inc., an NSP, accounted for approximately 15%
of our total revenue during the first nine months of 2000 versus 28% for the
same period in 1999. Sales to Dreamline, Inc., also an NSP and a new customer
for 2000, accounted for approximately 13% of our total revenue during the first
nine months of 2000. A loss or a significant reduction or delay in sales to any
of our major customers could materially and adversely affect our business,
financial condition and results of operation.
We generally recognize revenue from equipment sales upon shipment.
Estimated sales returns based on historical experience by product are recorded
at the time the product revenue is recognized. Charges for warranty work are
included in cost of equipment sales. Revenue from services, which consists
mainly of repair of out-of-warranty products, is recognized when the services
are performed and all substantial contractual obligations have been satisfied.
License and royalty revenues are recognized when we have completed delivery of
technical specifications and performed substantially all required services under
the related agreement.
The information contained in this Form 10-Q is not a complete
description of our business or the risks associated with an investment in us.
Readers are referred to documents filed by Paradyne with the Securities and
Exchange Commission, specifically our 1999 Form 10-K, which identify important
risk factors that could cause actual results to differ from those contained in
the forward-looking statements, some of which include: the uncertainty of
litigation, including putative shareholder class actions; the uncertain
acceptance of new telecommunications services based on DSL; the timing and
amount of, or cancellation or rescheduling of, orders of Paradyne's products to
existing and new customers; inability to sustain revenue growth or
profitability; dependence on sales of access products to Lucent Technologies;
rapid technological change could render our products obsolete; we are
substantially dependent on NSPs, who may reduce or discontinue their purchase of
products or services at any time; our dependence on only a few major customers
for a substantial portion of our revenues exposes us to financial risks; we
compete in highly competitive markets and competition could harm our ability to
sell products and services; if we are unable to attract and retain key personnel
and a skilled workforce, we may not be able to sustain or grow our business; our
dependence on development relationships could threaten our ability to sell
products; our reliance on international sales may make us susceptible to global
economic factors, foreign tax law issues and currency fluctuations; our reliance
on distributors and resellers; and our dependence on sole and single source
suppliers which exposes us to potential supply interruption.
QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO QUARTER AND NINE
MONTHS ENDED SEPTEMBER 30, 1999
REVENUES. Total revenues decreased $2.0 million, or 4%, to $55.7 million for the
quarter ended September 30, 2000 from $57.7 million for the same period in 1999.
This decrease primarily results from a decrease in both narrowband and broadband
product sales. Although our revenue only dropped slightly from the prior year,
it decreased significantly from expected levels. A few of our NSP customers
purchased significantly lower amounts of equipment than expected primarily due
to changes in their business strategy or due to a reduction in available funds
from the capital investment markets. Additionally, we made an accounting
reclassification of $6.7 million related to co-marketing funds with a major
customer, which resulted in a reduction in broadband revenue and an offsetting
reduction in expense. The customer will utilize the co-marketing funds for a
variety of programs. Because we cannot be sure what expenditures the customer
will make, we cannot be sure the reimbursement will be classified as marketing
expense versus contra-revenue. To be conservative, we have adjusted our
accounting for this expenditure by treating it as contra-revenue. (For a further
discussion of this accounting reclassification, see Note 6 of the Notes to
Condensed Consolidated Financial Statements in this Form 10-Q.) As a percentage
of total revenues, equipment sales were 98.6% of total revenues for the quarter
ended September 30, 2000 and 98.3% of total revenues for the same period in
1999. Total revenues for the nine months ended September 30, 2000 increased
$31.2 million, or 19%, to $195.8 million from $164.6 million for the first nine
months of 1999. This increase is mostly attributable to significant increases in
the sale of our broadband access products to new and existing customers. Most of
this increase occurred in the first six months of the year as a few of our new
customers purchased significant amounts of broadband product during the first
six months of 2000 but significantly decreased their purchases in the third
quarter of 2000. Equipment
7
<PAGE> 10
sales were 98.4% of total revenues for the nine months ended September 30, 2000
compared to 97.1% for the same period in 1999. This percentage increase was
mostly due to lower royalty income during the first nine months of 2000 than the
first nine months of 1999. The first nine months of 1999 included a one-time
royalty fee from Globespan related to termination of an existing agreement and a
one-time license fee from a third party for intellectual property relating to
narrowband technology.
GROSS MARGIN. Gross margin decreased $41.4 million, or 158%, to a negative
margin of $15.3 million for the three months ended September 30, 2000 from a
positive margin of $26.1 million for the three months ended September 30, 1999
and decreased $30.2 million, or 41%, to $42.7 million for the nine months ended
September 30, 2000 from $72.9 million for the nine months ended September 30,
1999. Several factors contributed to these decreases in gross margin. First, we
recorded a large provision for excess inventory and loss on non-cancelable
purchase commitments in the total amount of $34.9 million because a few of our
NSP customers recently communicated to us that they would be purchasing
significantly reduced levels of Paradyne equipment than they had previously
forecasted because they had significantly changed their plans for rolling out
DSL services. Secondly, as mentioned above, we made an accounting
reclassification of $6.7 million, which resulted in a reduction of broadband
revenue and marketing expenses. Gross margin as a percentage of total revenues
decreased to a negative 27.4% for the three months ended September 30, 2000 from
45.3% in the same period of 1999 primarily as a result of the provision for
excess inventory, the loss on non-cancelable purchase commitments and the
accounting reclassification already mentioned. For the nine months ended
September 30, 2000, gross margin as a percentage of total revenues decreased to
21.8% from 44.3% in the same period of 1999 because of the same factors
contributing to the decrease for the quarter and also because the nine months
ended September 30, 1999 included a one-time royalty fee from Globespan related
to the termination of an existing agreement and a one-time license fee from a
third party for intellectual property relating to narrowband technology which
did not reoccur during the first nine months of 2000. Additionally, our
competitively priced broadband products comprised a much higher percentage of
our equipment sales in the first nine months of 2000 compared to the same period
in 1999. Partially offsetting the above transactions and improving gross margin
as a percentage of revenue for the first nine months of 2000 versus 1999, was an
increase in service revenue from the repair of products for one of our major
customers.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased
$1.2 million, or 13%, to $10.3 million for the three months ended September 30,
2000 from $9.1 million for the same period in 1999. For the nine months ended
September 30, 2000, research and development expenses increased $3.4 million, or
13%, to $30.3 million compared to $26.9 million for the same period in 1999.
These increases resulted primarily from costs associated with the hiring of
additional research and development personnel. The effects of these increases
were partially offset by a decrease in professional fees related to engineering
contractors. Much of the increase in research and development personnel expense
was attributable to the April 14, 2000 acquisition of substantially all the
assets of Control Resources Corporation (CRC) from P-Com, Inc. For the three
months ended September 30, 2000, research and development expense as a
percentage of total revenues, increased to 18.4% from 15.7% in the same period
of 1999. This increase results principally from an overall increase in research
and development expenses. For the nine months ended September 30, 2000, research
and development expense as a percentage of total revenues decreased to 15.5%
from 16.3% for the same period of 1999. This decrease is primarily attributable
to the 19% increase in revenue during the nine months ended September 30, 2000.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES. SG&A expenses decreased
$1.8 million, or 13%, to $12.1 million for the three months ended September 30,
2000 from $13.9 million for the three months ended September 30, 1999 and
increased $4.6 million, or 11%, to $46.2 million for the nine months ended
September 30, 2000 from $41.6 million for the nine months ended September 30,
1999. Most of the decrease for the three months ended September 30, 2000 was due
to a decrease in advertising expenses (primarily attributable to an accounting
reclassification of expenditures related to joint advertising with a major
customer) from SG&A expense to contra-revenue (see "Revenue" under Management's
Discussion and Analysis of Financial Condition and Results of Operations in this
Form 10-Q for further information) in addition to a decrease in expenses related
to consignment of equipment to customers, offset in part by increases in
facilities expenses and corporate administrative expenses. The increase in
expenses for the nine months ended September 30, 2000 mostly result from
increases in advertising expense, increases in facilities and travel related
expenses and increases in corporate administrative expenses, offset in part by
decreases in expenses related to consignment of equipment to customers. SG&A
expense as a percentage of total revenue declined from 24.1% for the three
months ended September 30, 1999 to 21.8% for the three months ended September
30, 2000 and from 25.3% for the nine months ended September 30, 1999 to 23.6%
for the nine months ended September 30, 2000. The decrease for the quarter was
primarily attributable to reduced SG&A expenses resulting from the $6.7 million
accounting reclassification to contra revenue, while the decrease for the nine
months ended September 30, 2000 was primarily attributable to the 19% increase
in total revenue.
AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED STOCK COMPENSATION. The
amortization of intangible assets and deferred stock compensation decreased from
$1.3 million for the three months ended September 30, 1999 to $437,000 for the
three months ended September 30, 2000 and decreased from $1.4 million for the
nine months ended September 30, 1999 to $889,000 for the same period in 2000.
The amortization of intangible assets is attributable to goodwill and acquired
work force that resulted from the purchase of substantially all of the assets of
CRC from P-Com in the second quarter of 2000. The amortization of deferred
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stock compensation is related to the granting of stock options to key employees
at prices deemed to be below fair market value for financial reporting purposes.
The decreases in amortization for both the three and nine months ended September
30, 2000 result from a large decrease in the amortization of deferred stock
compensation offset in part by an increase in amortization of intangible assets.
INTEREST AND OTHER (INCOME) EXPENSE, NET. Interest and other (income) expense,
net, decreased by $200,000 from $500,000 of income for the three months ended
September 30, 1999 to $300,000 of income for the three months ended September
30, 2000 and decreased by $100,000 from $2.4 million of income for the nine
months ended September 30, 1999 to $2.3 million of income for the same period in
2000. Interest and other (income) expense, net, is related to interest on notes
payable and borrowings under lines of credit, interest on short term
investments, foreign exchange gains and losses, and technology sales. These
increases in income and decreases in expense were primarily attributable to an
increase in interest income resulting from the investment of proceeds from the
initial public offering (IPO) and a decrease in interest expense due to the
retirement of debt using IPO proceeds, offset in part by a reduction in the
amount of income received from the sale of patents.
PROVISION (BENEFIT) FOR INCOME TAXES. Benefit for income taxes increased by $2.8
million to $2.3 million of benefit for the three months ended September 30,
2000, from $500,000 of provision for the same period in 1999 and increased by
$2.4 million to $600,000 of benefit for the nine months ended September 30,
2000, from $1.8 million of provision for the same period in 1999. The effective
tax rate used during the first nine months of 1999 was 33%. Because of the loss
incurred during the quarter ended September 30, 2000 which will result in a loss
for the year 2000, the income tax provisions recorded in prior quarters were
reversed. Additionally, we reversed the net deferred tax liability on our books
resulting in a tax benefit for the nine months ended September 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operations for the nine months ended September 30,
2000 totaled $26.2 million. Adjusting net income for non-cash impacting items,
including a $23.6 million reserve for inventory write off and an $11.4 million
loss on purchase commitments, as well as depreciation, amortization and
allowance for bad debts, results in a positive cash flow of $10 million. Also
contributing to cash provided from operations were increases in accounts payable
totaling $8.8 million and other current liabilities totaling $11.8 million
primarily as a result of the timing of material receipts from vendors and
increased co-marketing expenditures. Decreases to cash from operating activities
offsetting the above contributions were principally driven by a $52.6 million
increase in inventory. The increase in inventory reflects management's decision
to carry higher stocking levels. This decision was made as a result of several
factors including: long lead time for purchasing raw materials, industry wide
shortages of raw materials needed to build Paradyne products, introduction of
several new Paradyne products in the first nine months of 2000, and customer
demand for shorter intervals of time between receiving orders and shipping the
product. Much of this inventory has been reserved for in the $23.6 million
inventory write off discussed above, reflecting the fact that a few network
service provider customers have communicated to us that they will not be
deploying the amount of equipment that they had previously forecasted.
Net cash used in investing activities for the nine months ended
September, 2000 totaled $15 million. On April 14, 2000 Paradyne purchased
substantially all the assets of CRC, a developer and manufacturer of broadband
network access and service level management systems, for $7.6 million, of which
$3.1 million was paid in cash. A note, payable in cash or common stock,
totaling $4.5 million was issued for the remainder of the purchase price. This
note was paid in cash on September 15, 2000. It is also expected that the
seller will be due contingent consideration of $1.5 million in January of 2001
because 2000 sales of products generated by the CRC business were on track to
exceed the 2000 target, as of the end of October 2000. Capital expenditures in
support of operations for the nine months ended September 30, 2000 totaled $7.4
million. We anticipate that capital requirements for the remainder of the year
2000 will be in the $2.0 million to $3.0 million range.
In June 2000, Paradyne and four financial institutions entered into a
credit agreement under which we and each of the financial institutions agreed to
provide funds to one of our major customers. We entered into this credit
agreement in order to develop further our relationship with this valuable
customer. Our portion of the credit agreement commitment is $25 million, carries
market interest rates that are indexed off the prime/LIBOR rates, and is fully
secured by virtually all of the customer's assets. Additionally, the customer
paid us a commitment fee in the amount of $750,000. The customer must initially
use any borrowings made under the credit agreement primarily to buy
telecommunications equipment, although it is not obligated to buy this equipment
from Paradyne. As of October 31, 2000, the customer has not made any borrowings
from us, however, we believe that the customer will make borrowings from us in
the fourth quarter of 2000 of between $2 million and $3 million dollars. We
cannot assure you that this customer will not borrow more money under the credit
agreement. It is our intent to pursue assignment of our commitment under the
credit agreement to other financial institutions. Our success in assigning our
commitment will depend on the availability of adequate sources of funding within
the credit market.
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Net cash provided by financing activities totaled $4.9 million and
resulted primarily from the exercise of stock options during the quarter.
We had $26.6 million of cash and cash equivalents at September 30, 2000
representing a decrease of $36.3 million from $62.9 million at December 31,1999.
Working capital decreased $31.4 million from $86.4 million at December 31, 1999
to $55.0 million at September 30, 2000.
Effective January 1, 2000, we extended our revolving line of credit
facility with Bank of America until January 31, 2001, voluntarily reduced the
facility to $30.0 million and reduced the unused line fee to 0.25% per annum.
There were no borrowings under this facility during the first nine months of
2000.
In connection with our efforts to obtain major new accounts we are
often required to make commitments to purchase inventory prior to having
approved purchase orders with customers due to the long lead times required for
certain parts. These commitments can impact cash flow until the purchase order
is approved, orders shipped, and cash collected. We can offer no assurance that
we will be successful in obtaining sufficient purchase orders, shipments and
collections in all cases, which could result in an increase in inventory levels
and negatively impact cash flow in a particular quarter or quarters.
Our line of credit facility with Bank of America will expire on January
31, 2001. Subject to our ability to renegotiate a new line of credit with the
bank or to extend the existing line of credit, and subject to currently unknown
cash needs that may arise in the future, we believe that our cash and cash
equivalents, together with cash flows from operations and borrowings under the
Bank of America line of credit facility, will be sufficient to meet our working
capital needs for the next 12 months. If we are unable to renegotiate or extend
the existing line of credit with Bank of America, we believe that there are
other financing sources available to us on commercially reasonable terms,
including credit facilities with other lenders.
RECENT TRENDS AND DEVELOPMENTS
Recently, there have been decreases in spending on networking equipment
among smaller communications companies including competitive local exchange
carriers ("CLECs"). Some companies are beginning to change their build-out
strategies amid increased competition and, some companies are experiencing
decreases in funds available from the capital investment markets. Principally
because of the reduced level of spending, in late September 2000 we lowered our
forecast for revenue over the next several quarters.
YEAR 2000 ISSUES
In 1996 we identified the Year 2000 problem as a potential risk to our
operations. As a result, we developed a comprehensive multi-year plan to make
our internal computer software and hardware systems Year 2000 compliant. Our
Year 2000 compliance plan was comprised of 3 phases: an assessment phase; an
implementation phase; and a testing phase. This plan, initiated in the first
quarter of fiscal 1997, has been completed by us and, to date, we have incurred
expenses related to Year 2000 readiness of approximately $3.7 million.
We have been successful in transitioning our computer systems and
equipment to the Year 2000. Although we believe that we have implemented a
comprehensive plan for addressing the Year 2000 problem, we cannot be certain
that these Year 2000 compliance efforts will be completely successful for the
remainder of the year 2000 and beyond. Nonetheless, we have not experienced, and
we do not anticipate, any significant problems related to the transition to the
Year 2000. Furthermore, we do not anticipate any significant expenditure in the
future related to Year 2000 compliance.
INFLATION
Because of the relatively low levels of inflation experienced in 1999
and 2000 to date, inflation did not have a significant effect on our results in
such periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in investing in or trading market risk sensitive
instruments. We also do not purchase, for investing, hedging, or for purposes
"other than trading," instruments that are likely to expose us to market risk,
whether interest rate, foreign currency exchange, commodity price or equity
price risk, except as noted in the following paragraph. We have not entered into
any forward or futures contracts, purchased any options or entered into any
interest rate swaps. Additionally, we do not currently
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engage in foreign currency hedging transactions to manage exposure for
transactions denominated in currencies other than U.S. dollars.
If we were to borrow from our revolving line of credit facility with
Bank of America, we would be exposed to changes in interest rates. We are also
exposed to changes in interest rates from investments in some held-to-maturity
securities. Under our current policies, we do not use interest rate derivative
instruments to manage exposure to interest rate changes.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Following Paradyne's September 28, 2000 press release regarding contemplated
third quarter results, several securities class action suits (collectively, the
"Securities Actions") against Paradyne; Andrew May, Paradyne's Chief Executive
Officer and President; Patrick Murphy, Paradyne's Chief Financial Officer and
Senior Vice President; and Thomas Epley, Paradyne's Chairman of the Board
(collectively, the "Defendants") were filed in October 2000 in the United States
District Court for the Middle District of Florida, Tampa Division. Plaintiffs
include the following stockholders: Steven Barrios, Hayes Ho, Jacob Turner,
Robert Preston, Ron Walker, Jerold B. Hoffman and Amy K. Hoffman. The Securities
Actions allege violations by the Defendants of the securities anti-fraud
provisions of the federal securities laws, specifically Section 10(b) of the
Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder. The Securities Actions further allege that the individual defendants
May, Murphy and Epley are liable under Section 20(a) of the Securities Exchange
Act as "control persons of Paradyne". The plaintiffs purport to represent a
class of investors during a purported class period of September 28, 1999 through
September 28, 2000 and allege, in effect, that the Defendants during that time,
through material misrepresentations and omissions, fraudulently or recklessly
inflated the market price of Paradyne's stock by allegedly erroneously reporting
that Paradyne was performing well, that its inventories were properly stated,
and that its customer base and product demand were solid. The Securities Actions
seek damages under the fraud-on-the-market theory in an unspecified amount for
the purported class for the alleged inflated amount of the stock price during
the class period. The Defendants believe the claims are without merit and intend
to vigorously defend them, although they cannot predict the outcome. Paradyne
has engaged the law firm of Holland and Knight, LLP as its legal counsel in this
litigation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Our Registration Statement on Form S-1 (Registration No. 333-76385) was
declared effective on July 15, 1999 and our initial public offering commenced on
July 16, 1999. We received net proceeds of approximately $62,240,000 after
deducting estimated underwriting discounts, commissions, and offering expenses.
As of September 30, 2000, we had used approximately $42,700,000 of the net
proceeds to repay all the outstanding indebtedness from revolving line of credit
facility with Bank of America, to pay for certain capital expenditures, for
working capital, and to fund the acquisition of CRC. We intend to use the
remainder of the net proceeds for general corporate purposes, including working
capital and additional capital expenditures.
ITEM 5. OTHER INFORMATION
On November 1, 2000, Paradyne's Board of Directors adopted the 2000
Broad-Based Stock Plan (the "2000 Plan"), under which Paradyne is able to grant
nonstatutory stock options, stock bonuses and rights to purchase restricted
stock to eligible participants. The total number of shares of Paradyne common
stock that may be issued under the 2000 Plan is 4,000,000 shares. The Board of
Directors of Paradyne adopted the 2000 Plan in order to retain the services of
persons who are now employees or directors of, or consultants to, Paradyne; to
secure and retain the services of new employees, directors and consultants; and
to provide incentives for such persons to exert maximum efforts for the success
of Paradyne and its affiliates. No more than 40% of the total shares subject to
stock awards granted under the 2000 Plan may be granted to officers or directors
of Paradyne.
As a result of a decline in the market price of Paradyne's common stock
since the date of grant of certain options under the Paradyne Networks, Inc.
Amended and Restated 1996 Equity Incentive Plan (the "1996 Plan"), many
outstanding options are exercisable at prices that far exceed the current market
price of Paradyne's common stock, thereby substantially
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impairing the effectiveness of such options as performance incentives.
Accordingly, consistent with Paradyne's philosophy of using equity incentives to
motivate and retain management and employees, Paradyne's Board of Directors and
certain of its committees decided to grant additional options priced at the
current fair market value of Paradyne's common stock. In November 2000, prior to
the date of this Form 10-Q, options to purchase approximately 594,000 shares of
Paradyne common stock were granted to employees under the 1996 Plan, and
approximately 3,612,000 shares of Paradyne common stock were granted to
employees under the 2000 Plan. Each of these stock options has an exercise price
equal to $3.625 per share, and vest in accordance with the terms of the
applicable stock option agreement.
A copy of the 2000 Plan is included as Exhibit 10.1 to this Form 10-Q.
The foregoing description of the 2000 Plan does not purport to be complete and
is qualified in its entirety by reference to the 2000 Plan, which is hereby
incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM-K
(A) EXHIBITS
<TABLE>
<CAPTION>
ITEM DESCRIPTION
---- -----------
<S> <C>
10.1 Paradyne Networks, Inc. 2000 Broad-Based Stock Plan
10.2 Credit Agreement among Connectsouth Holdings, Inc.,
Connectsouth Communications, Inc. and the Lenders Party
Hereto, First Union Investors, Inc., Bank of America, N.A.,
and Morgan Stanley Senior Funding, Inc.
27.1 Financial Data Schedule (for SEC use only)
</TABLE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Paradyne Networks, Inc.
Date: November 8, 2000 /s/ Andrew S. May
------------------------------------
Andrew S. May
Chief Executive
Officer, and Director
/s/ Patrick M. Murphy
------------------------------------
Patrick M. Murphy
Senior Vice President,
Chief Financial Officer,
Corporate Secretary and Treasurer
(Principal Financial and Accounting
Officer)
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