<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000.
OR
[__] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number: 0-30757
_______________
Sunrise Telecom Incorporated
(Exact name of Registrant as specified in its charter)
_______________
Delaware 77-0291197
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
22 Great Oaks Blvd., San Jose, California 95119
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 363-8000
_______________
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ ] No [X]
As of August 4, 2000, there were 49,862,829 shares of the Registrant's Common
Stock outstanding, par value $0.001.
1
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SUNRISE TELECOM INCORPORATED
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
PART I. Financial Information Number
--------------------- -----
<S> <C> <C>
Item 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2000
and December 31, 1999................................................ 3
Condensed Consolidated Statements of Operations for the three and six
month periods ended June 30, 2000 and 1999........................... 4
Condensed Consolidated Statements of Cash Flows for the six month
periods ended June 30, 2000 and 1999................................. 5
Notes to Condensed Consolidated Financial Statements................. 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. 9
Item 3 Quantitative and Qualitative Disclosures about Market Risk........... 23
PART II. Other Information
-----------------
Item 1 Legal Proceedings.................................................... 24
Item 2 Changes in Securities................................................ 24
Item 3 Defaults Upon Senior Securities...................................... 24
Item 4 Submission of Matters to a Vote of Security Holders.................. 24
Item 5 Other Information.................................................... 24
Item 6 Exhibits and Reports on Form 8-K..................................... 24
Signatures........................................................................... 25
</TABLE>
2
<PAGE>
PART I. Financial Information
<TABLE>
<CAPTION>
ITEM 1.
SUNRISE TELECOM INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
June 30, December 31,
2000 1999
---------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,513 $ 8,615
Accounts receivable, net of allowance for doubtful
accounts of $356 and $252, respectively 18,341 9,524
Inventories 13,562 7,612
Prepaid expenses and other assets 1,489 214
Deferred tax assets 3,261 2,050
---------------- ---------------
Total current assets 38,166 28,015
Property and equipment, net 6,653 4,417
Minority investment 887 646
Intangible assets, net of accumulated amortization of
$1,194 and $222, respectively. 12,480 2,324
Deferred tax assets 198 -
Other assets 2,908 2,864
---------------- ---------------
Total assets $ 61,292 $ 38,266
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,980 $ 1,701
Current portion of notes payable 4,283 219
Other accrued expenses 8,321 6,841
Income taxes payable 3,152 2,814
Deferred revenue 470 411
---------------- ---------------
Total current liabilities 21,206 11,986
---------------- ---------------
Deferred tax liability - 171
Notes payable, less current portion 848 638
Stockholders' equity:
Common stock 46 45
Additional paid-in capital 16,012 3,915
Deferred stock-based compensation (7,708) (2,065)
Retained earnings 30,924 23,576
Accumulated other comprehensive loss (36) -
---------------- ---------------
Total stockholders' equity 39,238 25,471
---------------- ---------------
Total liabilities and stockholders' equity $ 61,292 $ 38,266
================ ===============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
SUNRISE TELECOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
2000 1999 2000 1999
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Net sales $ 27,485 $ 16,410 $ 47,276 $ 24,500
Cost of sales 7,982 4,001 13,570 6,282
-------- -------- -------- ---------
Gross profit 19,503 12,409 33,706 18,218
-------- -------- -------- ---------
Operating expenses:
Research and development 4,484 2,813 7,838 4,519
Selling and marketing 5,376 4,157 10,454 6,287
General and administrative 2,311 1,040 3,748 1,562
-------- -------- -------- ---------
Total operating expenses 12,171 8,010 22,040 12,368
-------- -------- -------- ---------
Income from operations 7,332 4,399 11,666 5,850
Other income (expense), net (141) 39 (3) 110
-------- -------- -------- ---------
Income before income taxes 7,191 4,438 11,663 5,960
Income taxes 2,616 1,404 4,315 1,880
-------- -------- -------- ---------
Net income $ 4,575 $ 3,034 $ 7,348 $ 4,080
======== ======== ======== =========
Earnings per share:
Basic $ 0.10 $ 0.07 $ 0.16 $ 0.09
======== ======== ======== =========
Diluted $ 0.10 $ 0.07 $ 0.16 $ 0.09
======== ======== ======== =========
Shares used in per share computation:
Basic 45,451 44,551 45,255 44,546
======== ======== ======== =========
Diluted 47,638 45,606 47,207 45,561
======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
SUNRISE TELECOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 7,348 $ 4,080
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,749 531
Amortization of deferred stock-based compensation 857 31
Loss on the sale of property and equipment 36 -
Deferred income taxes (1,598) -
Change in operating assets and liabilities (net of acquisition balances):
Accounts receivable (8,127) (2,950)
Inventories (5,698) (3,137)
Prepaid expenses and other assets (1,184) (80)
Other accrued expenses 4,079 4,311
Deferred revenue 59 (46)
Income taxes payable 288 651
--------- ---------
Net cash provided by (used in) operating activities (2,191) 3,391
--------- ---------
Cash flows used in investing activities:
Capital expenditures (2,878) (800)
Purchase of long-term investment (241) -
Acquisitions, net of cash acquired (4,716) -
--------- ---------
Net cash used in investing activities (7,835) (800)
--------- ---------
Cash flows provided by (used in) financing activities:
Proceeds from short-term borrowings 2,890 -
Payments on notes payable (528) -
Repurchase of common stock - (202)
Cash dividends - (223)
Proceeds from exercise of stock options 598 71
--------- ---------
Net cash provided by (used in) financing activities 2,960 (354)
--------- ---------
Effect of exchange rate changes on cash (36) -
--------- ---------
Net increase (decrease) in cash and cash equivalents (7,102) 2,237
Cash and cash equivalents at the beginning of the period 8,615 5,030
--------- ---------
Cash and cash equivalents at the end of the period $ 1,513 $ 7,267
========= =========
Supplemental cash flow disclosures:
Cash paid during the period:
Interest $ 75 $ -
--------- ---------
Income taxes $ 3,686 $ 972
========= =========
Noncash investing and financing activities:
Promissory note issued in connection with acquisition $ 1,000 $ -
========= =========
Stock issued in acquisition $ 5,000 $ -
========= =========
Deferred stock-based compensation $ 6,500 $ 371
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
SUNRISE TELECOM INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
Sunrise Telecom Incorporated and subsidiaries (the Company) was originally
incorporated as Sunrise Telecom, Inc. in California in October 1991. In July
2000, the Company reincorporated in Delaware and changed its name to Sunrise
Telecom Incorporated (see Note 9. Capital Stock). The Company manufactures and
markets service verification equipment to pre-qualify, verify and diagnose
telecommunications and Internet networks. The Company markets and distributes
its products via a worldwide network of manufacturers, sales representatives,
distributors, and a direct sales force throughout six continents. The Company
has wholly owned subsidiaries in Norcross, Georgia; Taipei, Taiwan; Modena,
Italy; a representative liaison office in Beijing, China; a sales office in
Tokyo, Japan; and a foreign sales corporation in Barbados.
These condensed financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission and include
the accounts of the Company and its wholly owned subsidiaries. All significant
intercompany transactions have been eliminated in consolidation. Certain
information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted pursuant to such rules and
regulations. While in the opinion of the Company, the unaudited financial
statements reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the financial position at
June 30, 2000 and the operating results and cash flows for the three and six-
month periods ended June 30, 2000 and 1999, these financial statements and
notes should be read in conjunction with the Company's audited financial
statements and notes thereto, included in the Company's Registration Statement
on Form S-1 filed with the Securities and Exchange Commission. The condensed
balance sheet at December 31, 1999 has been derived from audited financial
statements as of that date.
The results of operations for the three and six-month periods ended June
30, 2000 and 1999 are not necessarily indicative of results that may be
expected for any other interim period or for the full fiscal year ending
December 31, 2000.
(2) Revenue Recognition
Revenue is recognized when earned. The Company recognizes revenue from
product sales upon shipment, assuming collectibility of the resulting
receivable is probable. Revenue from services and support provided under the
Company's extended warranty programs is deferred and recognized on a straight-
line basis over the period of the contract. Deferred revenue represents
amounts received from customers in respect of the extended warranty program in
advance of services and support to be provided. Provisions are recorded at the
time of sale for estimated product returns, standard warranty and customer
support.
(3) Earnings Per Share
Basic earnings per share (EPS) is computed using the weighted-average
number of common shares outstanding during the period. Diluted EPS is computed
using the weighted-average number of common and dilutive common equivalent
shares outstanding during the period. Dilutive common equivalent shares
consist of common stock issued in the Pro.Tel acquisition and common stock
issuable upon exercise of stock options using the treasury stock method.
The following is a reconciliation of the shares used in the computation of
basic and diluted EPS (in thousands):
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
<S> <C> <C> <C> <C> <C>
2000 1999 2000 1999
------- ------- ------- -------
Basic EPS- weighted-average number of common
shares outstanding................................. 45,451 44,551 45,255 44,546
Effect of dilutive common equivalent shares:
Stock options outstanding........................... 2,020 1,055 1,702 1,015
Stock issued in acquisition subject to put
arrangement....................................... 167 - 250 -
------- ------- ------- -------
Diluted EPS- weighted-average number of common
shares outstanding 47,638 45,606 47,207 45,561
======== ======== ======== ========
</TABLE>
6
<PAGE>
(4) Other Comprehensive Income
Comprehensive income comprises net income and other comprehensive income.
Other comprehensive income includes certain changes in equity of the Company
that are excluded from net income, including foreign currency translation
adjustments. The following table presents the calculation of comprehensive
income as required by SFAS No. 130. The components of comprehensive income,
net of tax, are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
<S> <C> <C> <C> <C>
2000 1999 2000 1999
------ ------ ------ ------
Net income............................................... $4,575 $3,034 $7,348 $4,080
Cumulative translation adjustment........................ (24) - (36) -
------ ------ ------ ------
Total comprehensive income............................... $4,551 $3,034 $7,312 $4,080
====== ====== ====== ======
</TABLE>
(5) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Interments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards, requiring that every
derivative instrument be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133, as recently amended, is
effective for fiscal years beginning after June 30, 2000. Management believes
the adoption of SFAS No. 133 will not have a material effect on the Company's
financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements." The
staff accounting bulletin, as amended, is effective no later than the fourth
quarter of 2000. The Company is in the process of determining the impact that
adoption will have on its consolidated financial statements.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions
involving Stock Compensation - - an Interpretation of Accounting Principles
Board Option No. 25." FIN 44 clarifies the application of APB Opinion No. 25.
FIN 44 is effective July 1, 2000. Management believes the adoption of FIN 44
will not have a material effect on the Company's financial position or results
of operations.
(6) Financial Statement Details
Inventories
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--------------------- --------------------
<S> <C> <C>
Raw materials.................................................... $ 8,448 $2,553
Work-in-process.................................................. 3,853 2,704
Finished goods................................................... 1,261 2,355
-------------------- -------------------
$13,562 $7,612
==================== ===================
</TABLE>
7
<PAGE>
(7) Minority Investment
During 1998, the Company acquired 1,666,667 shares (approximately 16.4%)
of the common stock of Top Union Electronics (Top Union), a Taiwan R.O.C.
corporation, for a purchase price of $606,612. Top Union is a subcontractor
manufacturer utilized by the Company for the manufacture of certain products.
During 1999 and 2000, the Company invested an additional $39,000 and $241,000,
respectively, in Top Union as part of two of three external rounds of third-
party financing obtained by Top Union. This investment by the Company was less
than 16.4% of the total financing raised by Top Union and, thus, diluted the
Company's ownership of Top Union to 13.7%. The Company accounts for this
investment using the cost method of accounting. The Company evaluates the fair
value of its investment based on the valuation associated with third party
external rounds of financing. To date no impairment charges have been
recognized.
(8) Notes Payable and Line of Credit
The Company has a $9,000,000 revolving line of credit with a financial
institution that expires on May 1, 2001, bearing interest at the bank's prime
rate less 0.25% (9.25% as of June 30, 2000). The agreement, which is
collateralized by the receivables and inventories of the Company, contains
certain financial covenants and restrictions. As of June 30, 2000, the balance
outstanding under the line of credit was $2.9 million. In addition, on June 30,
2000, the Company issued a short-term note payable in the amount of $1.0 million
in connection with an acquisition and repaid $400,000 in August 2000, with the
remainder due in monthly installments of $100,000 per month beginning in
November 2000 through April 2001.
(9) Capital Stock
Recapitalization
On April 5, 2000, the Company's Board of Directors approved the
reincorporation of the Company into Delaware and the authorization of
175,000,000 shares of $0.001 par value per share common stock and 10,000,000
shares of $0.001 par value preferred stock. The Company's stockholders approved
the reincorporation on April 22, 2000. The reincorporation became effective
before completion of the Company's initial public offering in July 2000.
(10) Acquisitions
The following summary prepared on an unaudited pro forma basis
reflects the condensed consolidated results of operations for the year ended
December 31, 1999 and the six month period ended June 30, 2000, assuming Hukk
and Pro.Tel had been acquired at the beginning of the periods presented (in
thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended Six Months
December 31, Ended
1999 June 30, 2000
---- -------------
<S> <C> <C>
Net revenues....................................................... $63,716 $47,520
Net income......................................................... $ 7,885 $ 6,788
Basic net income per share......................................... $ 0.17 $ 0.15
Shares used in pro forma per share computation..................... 45,317 45,505
</TABLE>
(11) Segment Information
SFAS No. 131, Disclosure About Segments of an Enterprise and Related
Information, establishes standards for the manner in which public companies
report information about operating segments, products, services, geographic
areas, and major customers in annual and interim financial statements. The
method of determining what information to report is based on the way that
management organizes the operating segments within the enterprise for making
operating decisions and assessing financial performance.
The Company's chief operating decision-maker is considered to be the
Company's Chief Executive Officer (CEO). The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
revenue by geographic region for purposes of making operating decisions and
assessing financial performance. The consolidated financial information reviewed
by the CEO is the same as the information presented in the accompanying
condensed consolidated statements of operations. In addition, as the Company's
assets are primarily located in its corporate offices in the United States and
not allocated to any specific segment, the Company does not produce reports for
or measure the performance of its segments based on any asset-based metrics.
Therefore, the Company operates in a single operating segment; the design,
manufacture, and sale of digital test equipment for telecommunications,
transmission, and signaling applications.
Revenue information regarding operations in the different geographic
regions is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
<S> <C> <C> <C> <C>
2000 1999 2000 1999
---- ---- ---- ----
Revenues:
North America.......................................... $21,613 $14,205 $37,368 $19,840
Europe................................................. 2,792 822 4,711 1,770
Asia/Pacific........................................... 1,978 1,226 3,548 2,487
Latin America.......................................... 1,102 157 1,649 403
------- ------- ------- -------
$27,485 $16,410 $47,276 $24,500
======= ======= ======= =======
</TABLE>
Revenue information by product category is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
<S> <C> <C> <C> <C>
2000 1999 2000 1999
---- ---- ---- ----
Digital subscriber line............................... $21,919 $16,410 $39,861 $24,500
Cable TV.............................................. 965 - 975 -
Fiber optics.......................................... 3,679 - 4,963 -
Signaling............................................. 922 - 1,477 -
------- ------- ------- -------
$27,485 $16,410 $47,276 $24,500
======= ======= ======= =======
</TABLE>
(12) Subsequent Events
Completion of Initial Public Offering
In July 2000, the Company completed its initial public offering of 4.6
million shares at $15 per share, including 600,000 over-allotment shares, of
which 782,572 shares were sold by selling stockholders. Net proceeds to the
Company from the offering after underwriter's fees and expenses of
approximately $5.2 million totaled approximately $52.1 million.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to the other information in this report, certain statements in
the following Management's Discussion and Analysis of Financial Condition and
Results of Operation (MD&A) are forward-looking statements. When used in this
report, the word "expects," "anticipates," "estimates," and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to risks and uncertainties that could cause actual results to differ materially
from those projected. Such risks and uncertainties are set forth below under
"Factors Affecting Future Operating Results." The following discussion should be
read in conjunction with the Condensed Consolidated Financial Statements and
notes thereto included elsewhere in this report.
Overview
We manufacture and market service verification equipment to pre-qualify,
verify and diagnose telecommunications and Internet networks. We design our
products to maximize technicians' effectiveness in the field and to provide
realistic network simulations for equipment manufacturers to test their
products. Our customers include incumbent local exchange carriers, competitive
local exchange carriers, and other service providers, network infrastructure
suppliers and installers throughout North America, Latin America, Europe and the
Asia/Pacific region.
Sources of Net Sales
We sell our products predominantly to large telecommunications service
providers. These prospective customers generally commit significant resources to
an evaluation of our and our competitors' products and require each vendor to
expend substantial time, effort and money educating the prospective customer
about the value of the proposed solutions. Delays associated with potential
customers' internal approval and contracting procedures, procurement practices,
testing and acceptance processes are common and may cause potential sales to be
delayed or foregone. As a result of these and related factors, the sales cycle
of new products for large customers typically ranges from six to 24 months.
Substantially all of our sales are made on the basis of purchase orders rather
than long-term agreements or requirements contracts. As a result, we commit
resources to the development and production of products without having received
advance or long-term purchase commitments from customers.
To date, a significant portion of our net sales has resulted from a small
number of relatively large orders from a limited number of customers. In the
first half of 2000 and 1999, we sold approximately $13.0 million and $10.5
million, respectively, of our products to affiliates of SBC Communications,
which represented approximately 28% and 43%, respectively, of our net sales.
Additionally, in the first half of 2000, approximately $4.9 million or 10% of
our net sales were generated from an OEM product sold to Solectron, a new
customer who integrates this product into the Stinger DSLAM that it manufactures
for Lucent Technologies. We anticipate that our operating results for any given
period will continue to be dependent to a significant extent on large purchase
orders, which can be delayed or cancelled by our customers without penalty. In
addition, we anticipate that our operating results for a given period will
continue to be dependent on a small number of customers.
Currently, competition in the telecommunications equipment market is intense
and is characterized by declining prices due to increased competition, new
products and increasing unit volumes. Due to competition and potential pricing
pressures from large customers in the future, we expect that the average selling
price and gross margins for our products will decline over time. If we fail to
reduce our production costs accordingly, our gross margins will correspondingly
decline. See "Factors Affecting Future Operating Results--Competition and --
Risks of the Telecommunications Industry."
During the last three years, a substantial portion of our net sales were
derived from customers located outside of the United States, and we believe that
continued growth will require expansion of our sales in international markets.
Currently, we maintain a procurement support and manufacturing facility in
Taipei, Taiwan, a representative liaison office in Beijing, China, a foreign
sales corporation in Barbados and manufacturing, research and development and
sales facilities in Modena, Italy, a sales office in Tokyo, Japan and expect to
establish additional international sales and other offices in the future. Prior
to our acquisition of Pro.Tel, international sales have been denominated solely
in U.S. dollars and, accordingly, we have not historically been exposed to
fluctuations in non-U.S. currency exchange rates related to these sales
activities. Since our acquisition of Pro.Tel in February 2000, we now have a
small amount of sales denominated in Euro and have begun to use derivative
instruments to hedge our foreign exchange risks. To date, foreign exchange
risks from these sales have not been material to our operations. We have also
been exposed to fluctuations in non-U.S. currency exchange rates related to our
procurement
9
<PAGE>
activities in Taiwan. In the future, we expect that a growing portion of
international sales may be denominated in currencies other than U.S. dollars,
thereby exposing us to gains and losses on non-U.S. currency transactions. We
may choose to limit such exposure by entering into various hedging strategies.
See "Factors Affecting Future Operating Results--Risks Relating to Our Business
--Risks of International Operations."
We recognize product sales upon shipment to customers. We offer a three-year
warranty covering parts and labor on our DSL and fiber optic products sold in
the United States and a one-year warranty covering parts and labor for those
products sold overseas with a two-year extended warranty option at time of sale.
Our cable TV and signaling products are covered by a one-year warranty. Sales of
extended warranties are deferred and recognized over the extended warranty term,
which is generally two years. We charge estimated warranty costs to cost of
sales when the related sales are recognized. We recognize revenue for out-of-
warranty repair when we ship the repaired product.
Cost of Sales
Our cost of sales, net of non-cash compensation expense, consist primarily of:
. direct material costs of product components, manuals, product
documentation and product accessories sold;
. production wages, taxes and benefits;
. production allocated occupancy costs;
. warranty costs;
. the costs of board level assembly by third party contract
manufacturers; and
. scrapped material used in the production process.
Our industry is characterized by limited supply chains and long lead times for
materials and components we use in the manufacture of our products. If we
underestimate our requirements, we may have inadequate inventory, resulting in
additional costs to our products to expedite delivery of certain long lead time
components. An increase in the cost of components could result in lower margins.
Additionally, these long lead times have in the past, and may in the future,
cause us to attempt to mitigate these lead times by purchasing larger quantities
of some parts, increasing our investment in inventory and the risk of the parts'
obsolescence. Any subsequent write-off of inventory could also result in lower
margins. See "Factors Affecting Future Operating Results--Risks Relating to Our
Business--Dependence on Sole and Single Source Suppliers".
We recognize direct cost of sales as we ship product. We expense scrapped
materials, wages, taxes, benefits and allocated occupancy costs as incurred.
Operating Costs
We classify our operating expenses into three general operational
categories: sales and marketing, research and development and general and
administrative. Our operating expenses also include stock-based compensation and
amortization of goodwill and other intangible assets. We classify all charges to
the sales and marketing, research and development and general and administrative
expense categories based on the nature of the expenditures. Although each of
these three categories includes expenses that are unique to the category type,
there are commonly recurring expenditures that are typically included in these
categories, such as salaries, amortization of stock-based compensation, employee
benefits, travel and entertainment costs, allocated communication, rent and
facilities costs and third party professional service fees. The sales and
marketing category of operating expenses also includes expenditures specific to
the sales and marketing group, such as those relating to commissions, public
relations and advertising, trade shows and marketing materials.
10
<PAGE>
We allocate the total cost of overhead and facilities to each of the
functional areas that use overhead and facilities based upon the facilities
square footage used by each of these areas. These allocated charges include
facility rent and utilities for the corporate office, communications charges and
depreciation expense for office furniture and equipment.
In the first half of 2000, we recorded amortization of deferred compensation
expense of $857,000 related to the grant of options to purchase our common
stock at exercise prices subsequently deemed to be below fair market value.
Total compensation expense related to options granted in 1999 and the first
quarter of 2000 will be amortized on a straight-line basis to the departments in
which the employees received these below market option grants over the
respective four-year vesting periods of the options. In the first half of 2000
and 1999, we allocated amortization of deferred stock-based compensation expense
of $114,000 and $3,000, respectively, to cost of sales, $347,000 and $18,000,
respectively, to research and development expense, $254,000 and $7,000,
respectively, to sales and marketing expense and $142,000 and $3,000,
respectively, to general and administrative expense. At June 30, 2000,
$7,708,000 of deferred compensation expense remained to be amortized at a rate
not exceeding $549,000 per quarter.
Acquisitions
Recently, we purchased two companies, Hukk Engineering ("Hukk") and Pro.Tel.
S.r.l. ("Pro.Tel"). In July 1999, we acquired Hukk Engineering, a manufacturer
of digital cable testing equipment. We accounted for the Hukk Engineering
acquisition as a purchase and recorded goodwill and other intangibles of
approximately $2.5 million to be amortized on a straight-line basis over the
next five years. In February 2000, we acquired Pro.Tel, an Italian manufacturer
of distributed network signaling analysis equipment, and its U.S. affiliate and
the assets of an unrelated U.S. distributor. We accounted for the Pro.Tel
acquisition as a purchase and recorded goodwill and other intangibles of
approximately $9.4 million to be amortized on a straight-line basis over the
next two to five years, based on the expected life of the underlying assets. In
addition, we recorded stock-based compensation for stock options granted to
employees of Pro.Tel in the first quarter of 2000 in the amount of $6.5 million
to be amortized on a straight-line basis over their four year vesting period. We
believe that acquisitions and joint ventures may be an important part of our
growth and competitive strategy. "Factors Affecting Future Operating Results--
Risks Relating to Our Business--Acquisitions."
Results of Operations
Comparison of Quarters Ended June 30, 1999 and 2000
Net Sales. Net sales increased approximately 67% from $16.4 million in the
second quarter of 1999 to $27.5 million in the same period in 2000. Sales of our
DSL products accounted for approximately $5.5 million of the net sales increase,
our new fiber optics products accounted for approximately $3.7 million of the
net sales increase, our new cable TV products accounted for approximately $1.0
million and our new signaling products accounted for approximately $922,000 of
the net sales increase.
Sales to customers in North America, Europe, Asia and Latin America were $21.6
million, $2.8 million, $2.0 million and $1.1 million in the second quarter of
2000, respectively, and $14.2 million, $822,000, $1.2 million and $157,000 in
the second quarter of 1999, respectively. The increase in North American sales
is primarily due to sales of our new customized Copper Loop Test Head for Lucent
Technologies' Stinger DSLAM, which totaled approximately $4.6 million in the
second quarter of 2000. Additionally, sales of new fiber optics products
accounted for approximately $3.3 million of the increase in North American
sales. International sales increased from approximately $2.6 million or 16% in
the second quarter of 1999 to approximately $6.4 million, or 23% in the same
period in 2000. The increase in international sales is primarily due to
increased sales of our DSL product line and our expanded international
operations.
Cost of Sales. Cost of sales consists primarily of direct material, warranty
and personnel costs related to the manufacturing of our products and allocated
overhead. Cost of sales increased approximately 100% from $4.0 million in the
second quarter of 1999 to $8.0 million in the same period in 2000. The increase
in absolute dollars is primarily due to the increase in net sales. Cost of sales
represented approximately 24% and 29% of net sales in the second quarter of 1999
and 2000, respectively. The increase as a percentage of net sales resulted
primarily from a higher sales volume of light chassis DSL products which have
lower average selling prices than full chassis DSL products and the introduction
of our new fiber optics and cable TV product lines which generated lower gross
margins.
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Research and Development. Research and development expenses consist
primarily of the costs of payroll and benefits for engineers, equipment and
consulting services. Research and development expenses increased approximately
59% from $2.8 million in the second quarter of 1999 to $4.5 million in the same
period in 2000. The increase in absolute dollars was primarily due to costs
associated with increased staffing dedicated to research and development
activities. These research and development expenses represented approximately
17% of net sales during the second quarter of 1999 and approximately 16% in the
same period in 2000. The decrease as a percentage of net sales in 2000 was
primarily attributable to increased product sales relative to research and
development expenditures. We expect that research and development expenses will
increase in absolute dollars for the foreseeable future as we intend to continue
to invest in product development.
Sales and Marketing. Sales and marketing expenses consist primarily of
manufacturers' representatives and direct sales commissions, personnel, travel
and facilities expenses related to sales and marketing, and trade show and
advertising expenses. Sales and marketing expenses increased approximately 29%
from $4.2 million in the second quarter of 1999 to $5.4 million in the same
period in 2000. The increase in absolute dollars in 2000 was primarily related
to increased staffing to support expanded product offerings and increased
marketing and promotional activities. These sales and marketing expenses
represented approximately 25% of net sales in the second quarter of 1999 and
approximately 20% in the same period in 2000. The decrease as a percentage of
net sales during the second quarter of 2000 was primarily due to our sales
growth outpacing our ability to add infrastructure to support a larger
organization which led to lower occupancy and salary and related expenses as a
percentage of sales. We expect that sales and marketing expenses will increase
in absolute dollars for the foreseeable future as we intend to continue to
invest in our sales and marketing capabilities.
General and Administrative. General and administrative expenses consist
primarily of personnel, facilities and other costs of our finance and
administrative departments as well as legal and accounting expenses. General and
administrative expenses increased approximately 122% from $1.0 million in the
second quarter of 1999 to $2.3 million in the same period in 2000. These general
and administrative expenses represented approximately 6% and 8% of net sales in
the second quarter of 1999 and 2000, respectively. The increase in both absolute
dollars and as a percentage of net sales was primarily related to increased
staffing and related costs associated with the growth of our business,
amortization of goodwill and other intangible assets related to recent business
acquisitions and deferred compensation amortization. We anticipate that general
and administrative expenses will continue to increase in absolute dollars for
the foreseeable future as we accommodate our growth, add related infrastructure
and incur expenses related to being a public company.
Other Income (Expense), Net. Other income (expense), net represents
primarily interest earned on cash balances net of interest expense on notes
payable and short-term borrowings under our line of credit. Other income
(expense), net decreased from $39,000 in the second quarter of 1999 to
($141,000) in the same period in 2000. The decrease resulted from interest
expense incurred on notes payable related to our recent acquisitions of Hukk and
Pro.Tel and from borrowings under our line of credit.
Income Taxes. Income taxes consist of federal, state and international
income taxes. We recorded income tax expense of $1.4 million in the second
quarter of 1999 and $2.6 million in the same period in 2000. Our effective
income tax rates were 32% in the second quarter of 1999 and 37% for the same
period in 2000. The effective income tax rate was higher in 2000 than in 1999
primarily due to higher levels of income, charges from non-cash amortization of
goodwill and deferred stock-based compensation, and an increased concentration
of sales in local jurisdictions with higher tax rates.
Comparison of Six Months Ended June 30, 2000 and 1999
Net Sales. Net sales increased approximately 93% from $24.5 million in the
first half of 1999 to $47.3 million in the same period in 2000. Sales of our DSL
products accounted for approximately $15.4 million of the net sales increase,
our new fiber optics products accounted for approximately $5.0 million of the
net sales increase, our new cable TV products accounted for approximately $1.0
million and our new signaling products accounted for approximately $1.5 million
of the net sales increase.
Sales to customers in North America, Europe, Asia and Latin America were $37.4
million, $4.7 million, $3.5 million and $1.6 million in the first half of 2000,
respectively, and $19.8 million, $1.8 million, $2.5 million and $403,000 in the
first half of 1999, respectively. The strong increase in North American sales is
primarily due to sales of our DSL products which accounted for approximately
$11.1 million of the increase, in part due to sales of our
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<PAGE>
new customized Copper Loop Test Head for Lucent Technologies' Stinger DSLAM,
which totaled approximately $4.9 million in the first half of 2000. Sales to SBC
Communications affiliates increased from $10.5 million or 43% of total net sales
in the first half of 1999 to $13.0 million or 28% of total net sales for the
same period in 2000, primarily due to increased purchases of our DSL products.
Additionally, sales of new fiber optics, cable TV and signaling products
accounted for approximately $4.3 million, $1.0 million, and $1.2 million,
respectively, of the increase in North American sales. International sales
increased from approximately $5.4 million or 22% in the first half of 1999 to
approximately $10.7 million, or 23% in the same period in 2000. The increase in
international sales is primarily due to increased sales of our DSL product line
and our expanded international operations.
Cost of Sales. Cost of sales increased approximately 116% from $6.3 million in
the first half of 1999 to $13.6 million in the same period in 2000. The increase
in absolute dollars is primarily due to the increase in net sales. Cost of sales
represented approximately 26% and 29% of net sales in the first half of 1999 and
2000, respectively. The increase as a percentage of net sales resulted primarily
from a higher sales volume of light chassis DSL products which have lower
average selling prices than full chassis DSL products and the introduction of
our new fiber optics and cable TV product lines which generated lower gross
margins.
Research and Development. Research and development expenses increased
approximately 73% from $4.5 million in the first half of 1999 to $7.8 million in
the same period in 2000. The increase in absolute dollars was primarily due to
costs associated with increased staffing dedicated to research and development
activities. These research and development expenses represented approximately
18% of net sales during the first half of 1999 and approximately 17% in the same
period in 2000. The decrease as a percentage of net sales in 2000 was primarily
attributable to increased product sales relative to research and development
expenditures.
Sales and Marketing. Sales and marketing expenses increased approximately 66%
from $6.3 million in the first half of 1999 to $10.5 million in the same period
in 2000. The increase in absolute dollars in 2000 was primarily related to
increased staffing to support expanded product offerings and increased marketing
and promotional activities. These sales and marketing expenses represented
approximately 26% of net sales in the first half of 1999 and approximately 22%
in the same period in 2000. The decrease as a percentage of net sales during the
first half of 2000 was primarily due to our sales growth outpacing our ability
to add infrastructure to support a larger organization which led to lower
occupancy and salary and related expenses as a percentage of sales. We expect
that sales and marketing expenses will increase in absolute dollars for the
foreseeable future as we intend to continue to invest in our sales and marketing
capabilities.
General and Administrative. General and administrative expenses increased
approximately 140% from $1.6 million in the first half of 1999 to $3.7 million
in the same period in 2000. These general and administrative expenses
represented approximately 6% and 8% of net sales in the first half of 1999 and
2000, respectively. The increase in both absolute dollars and as a percentage of
net sales was primarily related to increased staffing and related costs
associated with the growth of our business, amortization of goodwill and other
intangible assets related to recent business acquisitions and deferred
compensation amortization.
Other Income (Expense), Net. Other income (expense), net decreased from
$110,000 in the first half of 1999 to ($3,000) in the same period in 2000. The
decrease resulted from interest expense incurred on notes payable related to our
recent acquisitions of Hukk and Pro.Tel and from borrowings under our line of
credit.
Income Taxes. We recorded income tax expense of $1.9 million in the first half
of 1999 and $4.3 million in the same period in 2000. Our effective income tax
rates were 32% in the first half of 1999 and 37% for the same period in 2000.
Seasonality
We believe that our sales are seasonal in nature with the largest portion of
quarterly sales tied to the buying patterns of our customers which usually
increase during the last calendar quarter of the year as customers spend the
unused portion of their yearly budget. As a result, our first quarter sales tend
to decrease from the prior quarter.
Liquidity and Capital Resources
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Historically, we have financed our operations and satisfied our capital
expenditure requirements primarily through cash flow from operations and
borrowings under our line of credit. As of December 31, 1999 and June 30, 2000,
we had working capital of $16.0 million and $17.0 million, respectively, and
cash and cash equivalents of $8.6 million and $1.5 million, respectively.
During the six months ended June 30, 2000, we used $2.2 million in operating
activities as compared to the same period in 1999 when we generated $3.4
million. Operating cash flows decreased during the first half of 2000, as
compared with the same period in the prior year as a result of increases in
accounts receivable, increases in inventory required to meet our expected future
sales targets, increases in prepaid expenses and other assets related to our
initial public offering, and decreases in accrued compensation and related
benefits and deferred income taxes. These uses of cash were partially offset by
increased levels of income from operations, increased non-cash charges for
depreciation and amortization and amortization of deferred stock-based
compensation, and an increase in accounts and commissions payable.
Cash used in investing activities was $7.8 million and $800,000 for the six
months ended June 30, 2000 and 1999, respectively. For the first half of 2000,
cash used in investing activities included $4.7 million for acquisitions, $2.9
million for capital expenditures and $241,000 for the purchase of a long-term
investment. For the same period in 1999, cash used in investing activities
totaled $800,000 for capital expenditures. Cash used for capital expenditures
increased in the first half of 2000 primarily as a result of purchases of
general office equipment to support our growth, research and development
laboratory equipment and demonstration equipment required for the introduction
of new products and an increase in the number of our distribution channels. We
believe that capital expenditures in 2000 will include approximately $15.0
million relating to the construction of our new facility in San Jose,
California, which we are building to accommodate our need for an increase in
manufacturing capacity and employees, and approximately $5.0 million for
equipment, furniture and fixtures relating to the new facility. In addition, due
to anticipated growth in our operations and the increased capacity afforded by
our new facility, we believe that capital expenditures for the acquisition of
property and equipment relating to our ongoing business activities will increase
to a total of approximately $5.0 million in 2000.
During the six months ended June 30, 2000, we generated $3.0 million in
financing activities as compared to the same period in 1999 where we used
$354,000. For the six months ended June 30, 2000, cash provided by financing
activities included net proceeds from short-term borrowings of $2.9 million and
$598,000 received from the exercise of stock options, partially offset by
$528,000 used for repayments of notes payable. Our use of cash in financing
activities for the same period in 1999 was primarily related to the repurchase
of $202,000 of our common stock and cash dividends of $223,000, offset by
proceeds of $71,000 from the exercise of stock options.
Currently, we have a line of credit from Bank of America, N.A. for up to $9.0
million in borrowings at the bank's prime rate less 0.25% and expires on May 1,
2001. At December 31, 1999 and June 30, 2000, balances outstanding under the
line of credit were zero and $2.9 million, respectively. Borrowings under the
line of credit are secured by our inventory and accounts receivable. The
agreement governing the line of credit contains covenants, which we were in
compliance with at December 31, 1999 and for which we obtained a waiver at June
30, 2000, that, among other things:
. requires us to maintain various financial covenants, including
profitability and current ratios;
. limits capital expenditures;
. restricts the payment of dividends on our common stock to dividends
payable in common stock and to $1.0 million payable in any one fiscal year;
and
. restricts our ability to redeem our common stock beyond 20% of our
net income for the prior fiscal year.
In July 2000, we completed our initial public offering of 4.6 million
shares at $15 per share, including 600,000 over-allotment shares, of which
782,572 shares were sold by selling stockholders. Net proceeds to us from the
offering after underwriter's fees and expenses of approximately $5.2 million
totaled approximately $52.1 million.
We believe that the net proceeds received by us from our initial public
offering, together with current cash balances, cash flows from operations and
available borrowings under our line of credit will be sufficient to meet our
anticipated cash needs for working capital, capital expenditures and other
activities for at least the next 12 months.
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After that, if current sources are not sufficient to meet our needs, we may seek
additional equity or debt financing. In addition, any material acquisition of
complementary businesses, products or technologies or material joint venture
could require us to obtain additional equity or debt financing. We cannot assure
you that such additional financing would be available on acceptable terms, if at
all.
Factors Affecting Future Operating Results
Quarterly Fluctuations--Because our quarterly operating results have fluctuated
significantly in the past and are likely to fluctuate significantly in the
future, our stock price may decline and may be volatile.
In the past, we have experienced significant fluctuations in our quarterly
results due to a number of factors beyond our control. In the future, we expect
that our quarterly operating results may fluctuate significantly and will be
difficult to predict given the nature of our business. Many factors could cause
our operating results to fluctuate from quarter to quarter in the future,
including the following:
. the size and timing of orders from our customers, in each case
exacerbated by the lengthy and unpredictable buying patterns of our
customers, and our ability to ship these orders on a timely basis;
. the degree to which our customers have allocated and spent their yearly
budgets, which has, in some cases, resulted in higher net sales in our
fourth quarter;
. the uneven pace of technology innovation, the development of products
responding to these technology innovations by us and our competitors and
customer acceptance of these products and innovations;
. the varied degree of price, product and technology competition, which
has been buffeted by the rapid changes in the telecommunications industry
and our customers' and competitors' responses to these changes;
. the relative percentages of our products sold domestically and
internationally; and
. the mix of the products we sell and the varied margins associated with
these products.
. The factors listed above may affect our business and stock price in
several ways, including the following:
. Given the high fixed costs relating to overhead, research and
development, advertising and marketing, among others, if our net sales are
below our expectations in any quarter, the negative effect may be magnified
by our inability to adjust spending in a timely manner.
. As a result of the above, our stock price may decline and may be
volatile, particularly if public market analysts and investors perceive
these factors to exist, whether or not that perception is accurate.
. Finally, the above factors, taken together may make it more difficult
for us to issue additional equity in the future or raise debt financing to
fund future acquisitions and accelerate growth.
Customer Concentration--A limited number of customers account for a high
percentage of our net sales, and any adverse factor affecting these customers
or our relationship with these customers could cause our net sales to
decrease.
Our customer base is highly concentrated, and a relatively small number of
companies have accounted for a large percentage of our net sales. Net sales from
our top five customers in the United States represented approximately 16% of net
sales in 1997, 16% in 1998 and 49% in 1999 and 46% in the first half of 2000.
Our largest customers over this period have been affiliates of SBC
Communications Inc., which include Pacific Bell Telephone Company, Southwestern
Bell Telephone Company, Ameritech Corporation, Nevada Bell and Southern New
England Telephone and which in total accounted for approximately 41% of net
sales in fiscal 1999 and 28% in the first half of 2000. Additionally, sales to a
new customer in 2000, Solectron, a contract manufacturer for Lucent
Technologies' Stinger DSLAM, represented approximately 10% of sales in the first
half of 2000. No customer is presently obligated to purchase a specific amount
of products or to provide us with binding forecasts of purchases for any period.
We expect that we will continue to depend upon SBC Communications' affiliates
and other major customers for a substantial portion of our net sales in future
periods. We cannot guarantee that our future net sales,
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including those from SBC Communications' affiliates, will be comparable to our
fiscal 1999 net sales. The loss of a major customer or the reduction, delay or
cancellation of orders from one or more of our significant customers could cause
our net sales and, therefore, profits to decline. In addition, many of our
customers are able to exert substantial negotiating leverage over us. As a
result, they may cause us to lower our prices and negotiate other forms and
provisions that may negatively affect our business and profits.
Dependence on DSL--Substantially all of our sales have been from our DSL
products. If the market for DSL services does not continue to grow as we
anticipate, our net sales could decline.
In 1999 and the first half of 2000, sales of our DSL products represented
approximately 98% and 84% of our net sales, respectively. Currently, our DSL
products are primarily used by a limited number of incumbent local exchange
carriers, including the regional Bell operating companies, and competitive local
exchange carriers, who offer DSL services. A competitive local exchange carrier
is a company that, following the Telecommunications Act of 1996, is authorized
to compete in a local communications services market. These parties, and other
Internet service providers and users, are continuously evaluating alternative
high-speed data access technologies, including cable modems, fiber optics,
wireless technology and satellite technologies, and may at any time adopt these
competing technologies. These competing technologies may ultimately prove to be
superior to DSL services and reduce or eliminate the demand for our DSL
products.
In addition, the availability and quality of DSL service may be impaired by
technical limitations and problems of the existing copper wire network on which
DSL service runs, such as:
. the distance of end users from the central office of the incumbent local
exchange carrier, which is typically limited to between 12,000 and 18,000
feet;
. the quality and degree of interference with the copper wire network;
. the configuration of the copper wire network, which may degrade or
prevent DSL service;
. the ability of DSL networks and operational support systems of service
providers to connect and manage a substantial number of online end users at
high speeds, while achieving reliable and high quality service; and
. the vulnerability of the copper wire network to physical damage from
natural disasters and other unanticipated telecommunications failures and
problems.
Accordingly, our future success is substantially dependent upon whether DSL
technology gains widespread market acceptance by these companies, end users of
their services and other Internet service providers and users.
To date, our customers have deployed DSL equipment, including our products, in
substantially larger volumes than their current subscriber count. The inability
of our current or future customers to acquire and retain subscribers as planned,
or to respond to competition for their services or reduced demand for their
services, could cause them to reduce or eliminate their DSL deployment plans. If
our customers are forced to reduce or eliminate their DSL deployment plans, our
sales to them will decline.
Use of Field Technicians--If service providers reduce their use of field
technicians and successfully implement a self-service installation model,
demand for our products could decrease.
To ensure quality service, our major service provider customers, including SBC
Communications, historically sent a technician who uses our product into the
field to verify service for installations. However, SBC Communications has
recently announced plans to encourage their customers to install their own DSL
service. U.S. West and Bell Atlantic already encourage customers to install DSL
themselves. By encouraging customers to install DSL themselves, these phone
companies intend to reduce their expenses and expedite installation for their
customers. To encourage self-installation, these companies offer financial
incentives. Additionally, SBC Communications has created a subsidiary, Advanced
Solutions, Inc., to provide installation services which further reduces the need
for the local telephone company technician to carry a test set that can emulate
both a DSL modem and find DSL physical layers problems. If SBC Communications
and other service providers successfully implement these plans or choose to send
technicians into the field only after a problem has been reported, or if
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alternative methods of verification become available, such as remote
verification, the need for field technicians and the need for our products could
decrease.
Sales Implementation Cycles--The length and unpredictability of the sales and
implementation cycles for our products makes it difficult to forecast
quarterly revenues.
Sales of our products often entail an extended decision-making process on the
part of prospective customers. We frequently experience delays following initial
contact with a prospective customer and expend substantial funds and management
effort pursuing these sales. Our ability to forecast the timing and amount of
specific sales is therefore limited. As a result, the uneven buying patterns of
our customers may cause fluctuations in our quarterly operating results, which
could cause our stock price to decline.
Other sources of delays that lead to long sales cycles, or even a sales loss,
include: potential customers' internal approval and contracting procedures,
procurement practices, and testing and acceptance processes. As a result, the
sales cycle for larger deployment of selected products typically ranges from six
to 24 months for new deployment of selected product sales, and up to six months
for occasional large selected product sales. The deferral or loss of one or more
significant sales could significantly affect operating results in a particular
quarter, especially if there are significant sales and marketing expenses
associated with the deferred or lost sales.
Product Enhancements--If we are unable to enhance our existing products and
successfully manage the development of new products, our future success may be
threatened.
The market for our products is characterized by rapid technological advances,
changes in customer requirements and preferences, evolving industry and
customer-specific protocol standards and frequent new product enhancements and
introductions. Our existing products and our products currently under
development could be rendered obsolete by the introduction of products for
telecommunications networks involving competing technologies, by the evolution
of alternative technologies or new industry protocol standards and by rival
products introduced by our competitors. These market conditions are made more
complex and challenging by the high degree to which the telecommunications
industry is fragmented.
We believe our future success will depend, in part, upon our ability, on a
timely and cost-effective basis, to continue to:
. anticipate and respond to varied and rapidly changing customer
preferences and requirements, a process made more challenging by our
customers' buying patterns;
. anticipate and develop new products and solutions for networks based on
emerging technologies, such as the asynchronous transfer mode protocol that
packs digital information into cells to be routed across a network, and
Internet telephony, which comprises voice, video, image and data across the
Internet, that are likely to be characterized by continuing technological
developments, evolving industry standards and changing customer
requirements;
. invest in research and development to enhance our existing products and
to introduce new verification and diagnostic products for the
telecommunications, Internet, cable network and other markets; and
. support our products by investing in effective advertising, marketing
and customer support.
We cannot assure you that we will accomplish these objectives, and our failure
to do so could have a material adverse impact on our market share, business and
financial results.
Potential Product Liability--Our products are complex, and our failure to detect
errors and defects may subject us to costly repairs, product returns under
warranty and product liability litigation.
Our products are complex and may contain undetected defects or errors when
first introduced or as enhancements are released. These errors may occur despite
our testing and may not be discovered until after a product has been shipped and
used by our customers. This risk is compounded by the fact that we offer over 20
products, with multiple hardware and software modifications, which makes it more
difficult to ensure high standards
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of quality control in our manufacturing process. The existence of these errors
or defects could result in costly repairs and/or returns of products under
warranty and, more generally, in delayed market acceptance of the product or
damage to our reputation and business.
In addition, the terms of our customer agreements and purchase orders, which
provide us with protection against unwarranted claims of product defect and
error, may not protect us adequately from unwarranted claims against us, unfair
verdicts if a claim were to go to trial, settlement of these kinds of claims or
future regulation or laws regarding our products. Our defense against these
claims in the future, regardless of their merit, could result in substantial
expense to us, diversion of management time and attention, damage to our
business reputation and hurt our ability to retain existing customers or attract
new customers.
Managing Growth--We may have difficulties managing our expanding operations,
which could reduce our chances of maintaining our profitability.
We have recently experienced rapid growth in revenues and in our business
generally that has placed, and we expect will continue to place, a significant
strain on our management and operations. For example, our revenues have
increased from $28.5 million in 1998 to $61.5 million in 1999, our number of
employees has increased from 118 at December 31, 1998 to 295 at June 30, 2000,
and we have made two important acquisitions, that of Hukk Engineering and
Pro.Tel. As a result of our historical and expected growth, we face several
risks, including:
. the need to improve our operational, financial, management,
informational and control systems;
. the need to hire, train and retain highly skilled personnel in a market
where there are already severe shortages of these kinds of personnel, as we
discuss below; and
. the possibility that our management's attention will be diverted from
running our business to the needs of managing a public company.
We cannot assure you that we will be able to manage this growth profitably.
Competition--Competition could reduce our market share and decrease our net
sales.
The market for our products is fragmented and intensely competitive both in
and outside the United States, and is subject to rapid technological change,
evolving industry standards, regulatory developments and varied and changing
customer preferences and requirements. We compete with a number of United States
and international suppliers that vary in size and in the scope and breadth of
the products and services offered. The following table sets forth our principal
competitors in each of our product categories.
<TABLE>
<CAPTION>
Product Category Principal Competitors
---------------- ---------------------
<S> <C>
Digital Subscriber Line Acterna Corporation (formerly TTC, a division of Dynatech
Corporation) and Agilent Technologies, Inc.
Fiber Optics SONET/SDH Digital Lightwave, Inc., Acterna Corporation (formerly TTC, a
division of Dynatech Corporation) and Agilent Technologies, Inc.
Cable TV Acterna Corporation (formerly Dynatech Corporation,
formerly Wavetek Wandel Golterman, Inc. prior to their merger
with Dynatech Corporation on May 23, 2000) and Agilent
Technologies, Inc.
Signaling Inet Technologies, Inc. and GN Nettest
</TABLE>
Many of these competitors have longer operating histories, larger installed
customer bases, longer relationships with customers, wider name recognition and
product offerings and greater financial, technical, marketing, customer service
and other resources than we do.
We expect that, as our industry and market evolves, new competitors or
alliances among competitors with existing and new technologies could emerge and
acquire significant market share. We anticipate that competition in
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our market will increase and we will face greater threats to our market share,
price pressure on our products and the likelihood that, over time, our
profitability may decrease. In addition, it is difficult to assess accurately
the market share of our products or of Sunrise overall because of the high
degree of fragmentation in the market for DSL service verification equipment, in
particular, and for high-speed data access technology, in general. As a result,
it may be difficult for us to forecast accurately trends in the market, which of
our products will be the most competitive over the longer term and, thus, what
is the best use of our human and other form of capital. We cannot assure you
that we will be able to compete effectively.
Need for New Personnel--If we cannot hire and train the R&D, manufacturing,
sales, and marketing personnel we need to support our anticipated growth, our
plans for continued expansion will be hampered.
Our business requires engineers, technicians and other highly trained and
experienced personnel. In particular, since our products require a sophisticated
selling effort targeted at several key people within our prospective customers'
organizations, we have a special need for experienced sales personnel as well as
specialized engineers. In addition, the complexity of our products and the
difficulty of configuring and maintaining them require highly trained customer
service and support personnel. If we continue to grow, we will need to hire a
significant number of engineering, sales, marketing and customer service and
support personnel in the future, in and outside the United States. Given that
competition for such persons is intense, especially in the San Francisco Bay
Area, we may not be successful in attracting and retaining these individuals.
Our failure to hire, train and keep these kinds of employees could impair our
ability to grow profitably. In addition, if we do hire new personnel, the
addition of significant numbers of new personnel will require us to incur
significant start-up expenses, including procurement of office space and
equipment, initial training costs, and may result in low productivity rates of
these new personnel. These start-up expenses may adversely affect our future
operating results.
Reliance On Non-U.S. Workers--If U.S. immigration policies prevent us from
hiring or retaining the workers we need, our growth may be limited.
In the past we have filled a significant portion of our new personnel needs,
particularly for our engineers, with non-U.S. citizens holding temporary work
visas that allow these persons to work in the United States for a limited period
of time. We rely on these non-U.S. workers because of the shortage of engineers,
technicians and other highly skilled and experienced workers in the
telecommunications industry in the United States, in general, and in the San
Francisco Bay Area, in particular. Regulations of the Immigration and
Naturalization Service permit non-U.S. workers a limited number of extensions
for their visas and also set quotas regarding the number of non-U.S. workers
U.S. companies may hire. As a result, we face the risk that a portion of our
existing employees may not be able to continue to work for us, thereby
disrupting our operations, and that we may not be able to hire the number of
engineers, technicians and other highly skilled and experienced workers that we
need to grow our business. Furthermore, changes in these regulations could
exacerbate these risks.
Dependence on Key Employees--If one or more of our senior managers were to
leave, we could experience difficulties in replacing them and our operating
results could suffer.
Our success depends to a significant extent upon the continued service and
performance of a relatively small number of key senior management, technical,
sales and marketing personnel. The loss of any of our three founders, Paul Ker-
Chin Chang, Paul A. Marshall and Robert C. Pfeiffer, in particular, would likely
harm our business. None of these individuals is bound by an employment agreement
with us, and we do not carry key man life insurance on them. In addition,
competition for senior level personnel with telecommunications knowledge and
experience is intense. If any of our senior managers were to leave Sunrise, we
would need to devote substantial resources and management attention to replace
them. As a result, management attention may be diverted from managing our
business and we may need to pay higher compensation to replace these employees.
Risks of International Operations--Our plan to expand sales in international
markets could lead to higher operating expenses and may subject us to
unpredictable regulatory and political systems.
Sales to customers located outside of the United States represented 46% of our
net sales in 1997, 42% in 1998, 20% in 1999 and 23% in the first half of 2000,
and we expect international revenues to continue to account for a significant
percentage of net sales for the foreseeable future. In addition, an important
part of our strategy calls for
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further expansion into international markets. As a result, we will face various
risks relating to our international operations, including:
. potentially higher operating expenses, resulting from the establishment
of international offices, the hiring of additional personnel and the
localization and marketing of products for particular countries'
technologies;
. the need to establish relationships with government-owned or subsidized
telecommunications providers as well as additional distributors;
. fluctuations in foreign currency exchange rates and the risks of using
hedging strategies to minimize our exposure to these fluctuations, which
have been heightened by our recent acquisition of Pro.Tel, whose revenues
have been and are likely to continue to be in Italian lira; and
. potentially adverse tax consequences related to acquisitions and
operations, including the ability to claim goodwill deductions and a
foreign tax credit against U.S. federal income taxes, especially since
Italy has a higher tax rate.
We cannot assure you that one or more of these factors will not materially and
adversely affect our ability to expand into international markets, our revenues
and profits.
In addition, since the last six months of 1997, the Asia/Pacific region has
experienced instability in many of its economies and significant devaluations in
local currencies. Approximately 20% of our sales in 1998, 9% of our sales in
1999 and 8% of our sales in the first half of 2000 were derived from customers
located in this region. These instabilities may continue or worsen, which could
have a materially adverse effect on our results of operations. If international
revenues are not adequate to offset the additional expense of expanding
international operations, our future growth and profitability could suffer.
Dependence on Sole and Single Source Suppliers--Because we depend on a limited
number of suppliers and some sole and single source suppliers that are not
contractually bound in the long-term, our future supply of product components
is uncertain. This could lead to manufacturing difficulties.
In our manufacturing process, we purchase many key products, such as
microprocessors, bus interface chips, optical components and oscillators, from a
single source or sole supplier and we license certain software from third
parties. We rely exclusively on third-party subcontractors to manufacture some
sub-assemblies, and we have retained, from time to time, third party design
services in the development of our products. We do not have long-term supply
agreements with these vendors. In general, we make advance purchases of some
products and components to ensure an adequate supply, particularly for products
that require lead times of up to six months to manufacture. In the past, we have
experienced supply problems as a result of financial or operational difficulties
of our suppliers, shortages, discontinuations resulting from component
obsolescence or other shortages or allocations of supplies. Our reliance on
these third parties involves a number of risks, including:
. the unavailability of critical products and components on a timely
basis, on commercially reasonable terms or at all;
. if products or software licenses were to become unavailable, the need to
qualify new or alternative products or develop or license new software for
our use and/or to reconfigure our products and manufacturing process, each
of which could be lengthy and expensive;
. the likelihood that, if these products are not available, we would
suffer an interruption in the manufacture and shipment of our products
until the products or alternatives become available;
. reduced control over product quality and cost, risks exacerbated by the
need to respond, at times, to unanticipated changes and increases in
customer orders; and
. the unavailability of, or interruption in, access to some process
technologies.
In addition, the purchase of these components on a sole source basis subjects us
to risks of price increases and potential quality assurance problems. This
dependence magnifies the risk that we may not be able to ship our
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products on a timely basis to satisfy customers' orders. We cannot assure you
that one or more of these factors will not cause delays or reductions in product
shipments or increases in product costs, which in turn could have a material
adverse effect on our business.
Manufacturing Capacity--If demand for our products exceeds our manufacturing
capacity, our revenues may suffer.
Demand for our products has put increased pressure on our manufacturing
capacity. If we are not able to increase our manufacturing capacity in the time
necessary to meet demand, if we experience difficulty in obtaining parts or
components needed for manufacturing, or if demand exceeds our expectations, we
may experience insufficient manufacturing capacity. If our manufacturing
capacity does not keep pace with product demand, we will not be able to fulfill
orders in a timely manner which in turn could have a material adverse effect on
our revenues and on our overall business.
Acquisitions--We have acquired two companies and intend to pursue further
acquisitions in the future. These activities involve numerous risks, including
the use of cash, amortization of goodwill and the diversion of management
attention.
Recently, we acquired two companies, Hukk Engineering in July 1999, and
Pro.Tel in February 2000. As a result of these acquisitions, we face numerous
risks, including:
. integrating the existing management, sales force, technicians and other
personnel into one existing culture and business;
. combining manufacturing, administrative and management information and
other control systems into our corresponding systems;
. developing and implementing an integrated business strategy from what
had been previously three independent companies; and
. developing compatible or complementary products and technologies from
previously independent operations. For Hukk Engineering, this means
addressing the convergence of telephony and cable products.
The risks stated above will be made more difficult because Hukk Engineering is
located in Norcross, Georgia and Pro.Tel is located in Modena, Italy and
Springfield, Virginia. In addition, if we make future acquisitions, these risks
will be exacerbated by the need to integrate additional operations at a time
when we may not have fully integrated Hukk Engineering and Pro.Tel.
If we pursue further acquisitions, we will face similar risks as those above
and additional risks, including:
. the diversion of our management's attention and the expense of
identifying and pursuing suitable acquisition candidates, whether or not
consummated;
. negotiating and closing these transactions;
. the potential need to fund these acquisitions by dilutive issuances of
equity securities and by incurring debt; and
. the potential negative effect on our financial statements from the
increase in goodwill and other intangibles, the write-off of research and
development costs and the high cost and expenses of completing
acquisitions.
We cannot assure you that we will locate suitable acquisition candidates or
that, if we do, we will be able to acquire them and then integrate them
successfully and efficiently into our business.
Risks of the Telecommunications Industry--We face several risks regarding the
telecommunications industry, including the possible effects of its rapid and
unpredictable growth, the possible effects of consolidation among our
principal customers and the risk that deregulation will slow.
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Since the passage of the Telecommunication Act of 1996, the telecommunications
industry has experienced rapid growth. This has and will likely continue to lead
to great innovations in technology, intense competition, short product life
cycles and, to some extent, regulatory uncertainty in and outside the United
States. The course of the development of the telecommunications industry is,
however, difficult to predict. As a result, companies who operate in this
industry have a difficult time forecasting future trends and developments and
the acceptance of competing technologies. One possible effect of this
uncertainty is that there may be, in the future, a delay or a reduction in these
companies' investment in their business and purchase of related equipment, such
as our products, and a reduction in their and our access to capital. Moreover,
in the short-term, deregulation may result in a delay or a reduction in the
procurement cycle because of the general uncertainty involved with the
transition period of businesses.
The telecommunications industry has been experiencing consolidation among its
primary participants, such as incumbent local exchange carriers and competitive
local exchange carriers, several of whom are our primary customers. For example,
in recent years, SBC acquired Pacific Bell and Ameritech, both of which were
customers of ours. Continued consolidation may cause delay or cause cancellation
of orders for our products. In addition, the consolidation of our customers will
likely provide them with greater negotiating leverage with us and may lead them
to pressure us to lower the prices of our products.
Because the market for our products has grown with the deregulation of
portions of the telecommunications industry, we face the risk that these trends
may slow or may be reversed. For example, in the United States, there is
litigation pending that challenges the validity of the Telecommunications Act of
1996 and the local telephone competition rules adopted by the Federal
Communications Commission to implement that act. If deregulation in
international markets and in the United States were to slow or to take an
unanticipated course, the telecommunications industry might suffer the following
effects:
. greater consolidation of providers of high-speed access technologies,
which may not favor the development of DSL technology and which might
provide these companies with greater negotiating leverage regarding the
prices and other terms of the DSL products and services they purchase;
. uncertainty regarding judicial and administrative proceedings, which may
affect the pace at which investment and deregulation continue to occur;
. a general slowdown in economic activity relating to the
telecommunications industry and a consequent multiplier effect on the
general economy;
. reduced investment in the telecommunications industry in general and in
DSL technology in particular due to increased uncertainty regarding the
future of the industry and this technology; and
. delay in purchase orders of service verification equipment, such as our
products, if they were to reduce their investment in new high-speed access
technologies.
Intellectual Property Risks--Policing any unauthorized use of our intellectual
property by third parties and defending any intellectual property infringement
claims against us could be expensive and disrupt our business.
Our intellectual property and proprietary technology is an important part of
our business, and we depend on the development and use of various forms of
intellectual property and proprietary technology. As a result, we are subject to
several related risks, including the risks of unauthorized use of our
intellectual property and the costs of protecting our intellectual property.
Much of our intellectual property and proprietary technology is not protected
by patents. If unauthorized persons were to copy, obtain or otherwise
misappropriate our intellectual property or proprietary technology without our
approval, the value of our investment in research and development would decline,
our reputation and brand could be diminished and we would likely suffer a
decline in revenue. We believe these risks, which are present in any business in
which intellectual property and proprietary technology play an important role,
are exacerbated by the difficulty in finding unauthorized use of intellectual
property in our business, the increasing incidence of patent infringement in our
industry in general and the difficulty of enforcing intellectual property rights
in some foreign countries.
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In addition, litigation has in the past been, and may in the future be,
necessary to enforce our intellectual property rights. This kind of litigation
is time-consuming and expensive to prosecute or resolve, and results in
substantial diversion of management resources. We cannot assure you that we will
be successful in that litigation, that our intellectual property rights will be
held valid and enforceable in any litigation or that we will otherwise be able
to protect our intellectual property and proprietary technology.
Concentration of Control--Our executive officers and directors retain
significant control over us, which allows them to decide the outcome of
matters submitted to stockholders for approval. This influence may not be
beneficial to all stockholders.
Mr. Chang, Mr. Marshall and Mr. Pfeiffer beneficially own approximately 26%,
24% and 13% of our outstanding shares of common stock. Consequently, these three
individuals, acting together, are able to control the election of our directors
and the approval of significant corporate transactions that must be submitted to
a vote of stockholders. In addition, Mr. Chang, Mr. Marshall and Mr. Pfeiffer
constitute three of the six members of the board of directors and have
significant influence in directing the actions taken by the directors. The
interests of these persons may conflict with your interests as stockholders, and
the actions they take or approve may be contrary to those desired by other
stockholders. This concentration of ownership and control of the management and
affairs of our company may also have the effect of delaying or preventing a
change in control of our company that stockholders may consider desirable.
Anti-takeover Provisions--Anti-takeover provisions in our charter documents
could prevent or delay a change of control, and as a result, negatively impact
our stockholders.
Some provisions of our certificate of incorporation and bylaws may have the
effect of discouraging, delaying or preventing a change in control of our
company or unsolicited acquisition proposals that you, as a stockholder, may
consider favorable. These provisions provide for:
. authorizing the issuance of "blank check" preferred stock;
. a classified board of directors with staggered, three-year terms;
. prohibiting cumulative voting in the election of directors;
. requiring super-majority voting to effect certain amendments to our
certificate of incorporation and by-laws;
. limiting the persons who may call special meetings of stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election to the
board of directors or for proposing matters that can be acted upon at
stockholders meetings.
Some provisions of Delaware law and our stock incentive plans may also have the
effect of discouraging, delaying or preventing a change in control of our
company or unsolicited acquisition proposals. These provisions also could limit
the price that some investors might be willing to pay in the future for shares
of our common stock.
ITEM 3. Qualitative and Quantitative Disclosure about Market Risk
We sell our products in North America, Asia, Latin America and Europe. As a
result, our financial results could be affected by factors such as changes in
foreign currency exchange rates. Prior to our acquisition of Pro.Tel,
international sales have been denominated solely in U.S. dollars and,
accordingly, we have not historically been exposed to fluctuations in non-U.S.
currency exchange rates related to these sales activities. Since our acquisition
of Pro.Tel in February 2000, we now have a small amount of sales denominated in
Euro and have begun to use derivative instruments to hedge our foreign exchange
risks. To date, foreign exchange risks from these sales have not been material
to our operations. Our interest income is sensitive to changes in the general
level of U.S. interest rates, particularly since the majority of our investments
are in money market accounts. Due to the nature of our investments, we
anticipate no material market risk exposure.
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PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS.
In September 1999, the United States District Court for the Northern
District of California entered final judgment against Electrodata, Inc. stating
that it had literally infringed our U.S. Patent No. 5,619,489, entitled Handheld
Communications Tester. The court also entered judgment against Electrodata that
the patent claims at issue were valid and the patent was enforceable.
Electrodata has filed a notice of appeal with the United States Court of Appeals
for the Federal Circuit. The parties have briefed the issues, and the Federal
Circuit will most likely hear oral argument in Fall 2000. We do not believe
that the outcome of this appeal will materially impact our business.
ITEM 2. CHANGES IN SECURITIES and USE OF PROCEEDS.
From April 1 through June 30, 2000, we issued approximately 166,449 shares
of our common stock to employees pursuant to exercises of stock options (with an
average exercise price of $1.37 per share) under our 1993 stock option plan.
These issuances were deemed exempt from registration under Section 5 of the
Securities Act of 1933 in reliance upon Rule 701 thereunder.
Our registration statement (Registration No. 333-32070) under the
Securities Act of 1933, as amended, for our initial public offering became
effective on July 12, 2000. A total of 4,600,000 shares of common stock were
registered and 3,817,428 shares of our common stock were sold to an underwriting
syndicate. Chase H&Q, CIBC World Markets and U.S. Bancorp Piper Jaffray were
the managing underwriters of the offering. An additional 782,572 shares of
common stock were sold on behalf of selling stockholders as part of the same
offering. All shares were sold to the public at a price of $15.00 per share. In
connection with the offering, we paid approximately $4.0 million in underwriting
discounts and commissions to the underwriters. Offering proceeds, net of
aggregate expenses to us of approximately $1.2 million, were approximately $52.1
million. We intend to use the net proceeds of the offering for working capital
and general corporate purposes, including the construction of our new facility,
repayment of notes payable and amounts drawn under our line of credit, and
capital expenditures made in the ordinary course of our business. We may also
apply a portion of the proceeds of the offering to acquire businesses or
products and technologies that are complementary to our business and product
offerings.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the annual meeting of stockholders held on April 22, 2000, stockholders
holding an aggregate of 42,097,656 shares of our common stock approved our
reincorporation from California to Delaware, which became effective in July
2000. At the same meeting, stockholders holding an aggregate of 42,097,656
shares of our common stock also ratified the appointment of KPMG LLP as our
independent auditors for the 2000 fiscal year.
ITEM 5. OTHER INFORMATION. None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) (a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on form 8-K filed during the three-month period
ended June 30, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SUNRISE TELECOM INCORPORATED
(Registrant)
Date: August 14, 2000
By: /s/ Paul Ker-Chin Chang
-----------------------
Paul Ker-Chin Chang
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Peter L. Eidelman
---------------------
Peter L. Eidelman
Chief Financial Officer
(Principal Accounting Officer)
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EXHIBIT INDEX
Exhibit No.
-----------
27.1 Financial Data Schedule.
26
