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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _______.
Commission File Number: 000-32743
TELLIUM, INC.
-----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 22-3509099
------------------------------- ----------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2 Crescent Place
Oceanport, New Jersey 07757-0901
-------------------------------------------------
(Address of Principal Executive Offices)(Zip Code)
(732) 923-4100
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of March 31, 2002, there were 112,536,672 shares outstanding of the
registrant's common stock, par value $0.001.
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TELLIUM, INC.
INDEX
PART I. FINANCIAL INFORMATION
Page No.
----------
Item 1. Condensed Consolidated Financial Statements: .................................. 3
Condensed Consolidated Balance Sheets ....................................... 3
Condensed Consolidated Statements of Operations ............................. 4
Condensed Consolidated Statement of Changes in Stockholders' Equity ......... 5
Condensed Consolidated Statements of Cash Flows ............................. 6
Notes to Condensed Consolidated Financial Statements ........................ 7
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................... 9
Item 3 Quantitative and Qualitative Disclosures About Market Risk .................. 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................................. 22
Item 2. Changes in Securities and Use of Proceeds ..................................... 22
Item 3. Defaults Upon Senior Securities ............................................... 22
Item 4. Submission of Matters to a Vote of Security Holders ........................... 22
Item 5. Other Information ............................................................. 22
Item 6. Exhibits and Reports on Form 8-K .............................................. 22
Signatures .................................................................... 23
2
TELLIUM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, March 31,
2001 2002
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................................................. $ 218,708,074 $ 208,817,595
Accounts receivable .................................................................... 23,923,631 48,371,723
Inventories ............................................................................ 52,398,123 40,389,545
Prepaid expenses and other current assets .............................................. 8,107,916 6,057,913
--------------- ---------------
Total current assets .................................................................. 303,137,744 303,636,776
PROPERTY AND EQUIPMENT--Net .............................................................. 65,085,402 62,298,064
INTANGIBLE ASSETS--Net ................................................................... 60,200,000 56,150,000
GOODWILL--Net ............................................................................ 58,433,967 58,433,967
DEFERRED WARRANT COST .................................................................... 65,704,572 58,348,717
OTHER ASSETS ............................................................................. 1,276,847 949,336
--------------- ---------------
TOTAL ASSETS ............................................................................. $ 553,838,532 $ 539,816,860
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable ................................................................. $ 9,683,821 $ 10,837,907
Accrued expenses and other current liabilities ......................................... 39,777,417 39,025,178
Current portion of notes payable ....................................................... 601,847 425,112
Current portion of capital lease obligations ........................................... 95,612 88,294
Bank line of credit .................................................................... 8,000,000 8,000,000
--------------- ---------------
Total current liabilities ............................................................. 58,158,697 58,376,491
LONG-TERM PORTION OF NOTES PAYABLE ....................................................... 583,399 540,000
LONG-TERM PORTION OF CAPITAL LEASE OBLIGATIONS ........................................... 124,513 106,746
OTHER LONG-TERM LIABILITIES .............................................................. 233,335 272,059
--------------- ---------------
Total liabilities ..................................................................... 59,099,944 59,295,296
--------------- ---------------
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value, 25,000,000 shares authorized as of
December 31, 2001 and March 31, 2002, 0 issued and outstanding as of
December 31, 2001 and March 31, 2002 .................................................. - -
Common stock, $0.001 par value, 900,000,000 shares authorized,
114,495,282 and 114,986,673 issued as of December 31, 2001 and March 31, 2002, and
112,446,449 and 112,536,672 outstanding as of December 31, 2001 and March 31, 2002 .... 114,496 114,987
Additional paid-in capital ............................................................. 1,043,900,812 1,037,867,721
Notes receivable ....................................................................... (33,513,935) (30,843,597)
Accumulated deficit .................................................................... (367,137,978) (395,654,897)
Deferred employee compensation ......................................................... (144,495,721) (124,626,689)
Common stock in treasury, at cost, 2,048,833 and 2,450,001 shares as of
December 31, 2001 and March 31, 2002 .................................................. (4,129,086) (6,335,961)
--------------- ---------------
Total stockholders' equity ............................................................ 494,738,588 480,521,564
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................................... $ 553,838,532 $ 539,816,860
=============== ===============
See notes to condensed consolidated financial statements.
3
TELLIUM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
2001 2002
----------------------------------
REVENUE $ 15,635,401 $ 54,059,575
Non-cash charges related to equity issuances ................................. 4,789,653 7,355,855
----------------------------------
REVENUE, net of non-cash charges related to equity
issuances .................................................................. 10,845,748 46,703,720
COST OF REVENUE .............................................................. 10,727,114 31,246,213
----------------------------------
Gross profit ................................................................. 118,634 15,457,507
----------------------------------
OPERATING EXPENSES:
Research and development, excluding stock based
compensation ............................................................... 16,647,363 13,965,524
Sales and marketing, excluding stock based
compensation ............................................................... 7,671,789 7,155,520
General and administrative, excluding stock based
compensation ............................................................... 5,815,076 7,618,836
Amortization of intangible assets and goodwill ............................... 7,916,790 4,050,000
Stock-based compensation expense ............................................. 14,557,153 11,986,839
----------------------------------
Total operating expenses ..................................................... 52,608,171 44,776,719
----------------------------------
OPERATING LOSS ............................................................... (52,489,537) (29,319,212)
----------------------------------
OTHER INCOME (EXPENSE):
Other expense - net .......................................................... (19,687) (55,669)
Interest income .............................................................. 2,808,823 1,178,933
Interest expense ............................................................. (112,359) (320,971)
----------------------------------
Total other income ........................................................... 2,676,777 802,293
----------------------------------
NET LOSS ..................................................................... $ (49,812,760) $ (28,516,919)
==================================
BASIC AND DILUTED LOSS PER SHARE ............................................. $ (3.20) $ (0.27)
==================================
BASIC AND DILUTED WEIGHTED AVERAGE
SHARES OUTSTANDING ......................................................... 15,554,871 106,911,374
==================================
STOCK-BASED COMPENSATION EXPENSE
Cost of revenue .............................................................. $ 1,365,028 $ 1,453,144
Research and development ..................................................... 9,488,501 7,519,619
Sales and marketing .......................................................... 2,527,626 2,934,838
General and administrative ................................................... 2,541,026 1,532,382
----------------------------------
$ 15,922,181 $ 13,439,983
==================================
See notes to condensed consolidated financial statements.
4
TELLIUM, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Additional
Common Stock Treasury Stock Paid-in
------------ --------------
Shares Amount Shares Amount Capital
---------------------------------------------------------------------------
JANUARY 1, 2002 ................................ 114,495,282 $ 114,496 2,048,833 $ (4,129,086) $ 1,043,900,812
Exercise of stock options and warrants ......... 491,391 491 -- -- 283,068
Forfeiture of unvested stock options ........... -- -- -- -- (6,675,143)
Warrant and option cost ........................ -- -- -- -- 358,984
Amortization of deferred compensation .......... -- -- -- -- --
Repurchase of restricted stock ................. -- -- 401,168 (2,206,875) --
Net loss ....................................... -- -- -- -- --
---------------------------------------------------------------------------
MARCH 31, 2002 ................................. 114,986,673 $ 114,987 2,450,001 $ (6,335,961) $ 1,037,867,721
===========================================================================
Accumulated Deferred Notes Stockholders'
Deficit Compensation Receivable Equity
------------------------------------------------------------------
JANUARY 1, 2002 ................................ $ (367,137,978) $ (144,495,721) $ (33,513,935) $ 494,738,588
Exercise of stock options and warrants ......... -- -- -- 283,559
Forfeiture of unvested stock options ........... -- 6,675,143 -- --
Warrant and option cost ........................ -- -- -- 358,984
Amortization of deferred compensation .......... -- 13,193,889 -- 13,193,889
Repurchase of restricted stock ................. -- -- 2,670,338 463,463
Net loss ....................................... (28,516,919) -- -- (28,516,919)
------------------------------------------------------------------
MARCH 31, 2002 ................................. $ (395,654,897) $ (124,626,689) $ (30,843,597) $ 480,521,564
==================================================================
See notes to condensed consolidated financial statements.
5
TELLIUM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
----------------------------------
2001 2002
----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................... $ (49,812,760) $ (28,516,919)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities: ...........................................
Depreciation and amortization ........................................... 10,193,570 9,572,311
Provision for doubtful accounts ......................................... (33,000) (156,000)
Amortization of deferred compensation expense ........................... 14,244,523 13,193,889
Amortization of deferred warrant cost ................................... 4,789,653 7,355,855
Warrant and option cost related to third
parties ................................................................. 1,672,636 246,094
Changes in assets and liabilities:
Decrease in due from stockholder ........................................ - 463,463
Decrease (increase) in accounts receivable .............................. 4,302,979 (24,448,092)
Decrease (increase) in inventories ...................................... (38,241,486) 12,008,578
Decrease in prepaid expenses and other current assets ................... 6,731,366 2,206,003
Decrease (increase) in other assets ..................................... (57,833) 327,511
Increase in accounts payable ............................................ 14,465,921 1,154,086
Increase (decrease) in accrued expenses
and other current liabilities ........................................ 40,909,231 (752,239)
Increase in other long-term liabilities ................................. 37,567 38,724
----------------------------------
Net cash provided by (used in) operating
activities .......................................................... 9,202,367 (7,306,736)
----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ......................................... (30,178,505) (2,622,083)
----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt and line of credit
borrowings .............................................................. (153,681) (220,134)
Principal payments on capital lease obligations ............................ (488,688) (25,085)
Issuance of common stock ................................................... 269,162 283,559
----------------------------------
Net cash (used in) provided by financing
activities .......................................................... (373,207) 38,340
----------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS .................................... (21,349,345) (9,890,479)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................... 188,175,444 218,708,074
----------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD
$ 166,826,099 $ 208,817,595
==================================
SUPPLEMENTAL DISCLOSURE OF CASHFLOW INFORMATION
Cash paid for interest .................................................... $ 112,359 $ 164,128
==================================
See notes to condensed consolidated financial statements.
6
TELLIUM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
We design, develop and market high-speed, high-capacity, intelligent
optical switching solutions that enable network service providers to quickly and
cost-effectively deliver new high-speed services.
The accompanying, unaudited condensed consolidated financial statements
included herein for Tellium have been prepared by us pursuant to the rules and
regulations of the Securities and Exchange Commission. In our opinion, the
condensed consolidated financial statements included in this
report reflect all normal recurring adjustments which we consider necessary for
the fair presentation of the results of operations for the interim periods
covered and of our financial position at the date of the interim balance sheet.
Certain information and footnote disclosures normally included in the annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. However, we believe that the disclosures are adequate to understand
the information presented. The operating results for interim periods are not
necessarily indicative of the operating results to be expected for the entire
year. These statements should be read in conjunction with the financial
statements and related footnotes for the year ended December 31, 2001, included
in our Annual Report on Form 10-K filed with the Securities and Exchange
Commission on April 1, 2002.
2. RECENT FINANCIAL ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets". As indicated in our Form 10-K for the year ended
December 31, 2001, we implemented SFAS No. 142 as of January 1, 2002, as
required. SFAS No. 142 changes the accounting for goodwill and indefinite lived
intangible assets from an amortization method to an impairment-only approach.
Amortization of goodwill, including goodwill recorded in past business
combinations and indefinite lived intangible assets, ceased upon adoption of
this statement; however, impairment reviews may result in future periodic write
downs. Identifiable intangible assets continue to be amortized over their useful
lives and reviewed for impairment in accordance with SFAS No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of".
The following table presents the impact of SFAS No. 142 on net loss and
net loss per share for the three months ended March 31, 2002 and the impact of
SFAS No. 142 as if it had been in effect for the three months ended March 31,
2001.
Three Months Ended March 31,
-----------------------------------
2001 2002
-----------------------------------
Reported net loss ............................... $ (49,812,760) $ (28,516,919)
Add back: Goodwill amortization ................. 3,866,890 -
-----------------------------------
Adjusted net loss ............................... $ (45,945,870) $ (28,516,919)
Basic and diluted earnings per share:
Reported net loss ............................. $ (3.20) $ (0.27)
Goodwill amortization ......................... $ 0.25 -
Adjusted net loss ............................. $ (2.95) $ (0.27)
We will complete the first step of the transitional goodwill impairment
test during the three months ended June 30, 2002.
In August 2001, FASB issued SFAS No. 143 "Accounting for Asset
Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations and cost associated with the retirement of tangible
long-lived assets. We are required to implement SFAS No. 143 for fiscal years
beginning after June 15, 2002 and have not yet determined the impact that this
statement will have on our results of operations or financial position.
3. NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss for the
period by the weighted average number of common shares outstanding during the
period. Weighted average common shares outstanding for purposes of computing
basic net loss per share excludes the unvested portion of founders stock and
restricted stock. Outstanding shares of founders and restricted stock excluded
from the basic weighted average shares calculation because they were not yet
vested were 11,529,376 and 4,693,872 for three months ended March 31, 2001 and
2002, respectively. Diluted net loss per share is computed by dividing the net
loss for the
7
period by the weighted average number of common and potentially dilutive common
shares outstanding during the period, if dilutive. Potentially dilutive common
shares are composed of the incremental common shares issuable upon the
conversion of preferred stock and the exercise of stock options and warrants,
using the treasury stock method. Due to our net loss the effect of potentially
dilutive common shares is anti-dilutive, therefore, basic and diluted net loss
per share are the same. For the three months ended March 31, 2001 and 2002,
potentially dilutive shares of 78,423,992 and 3,723,142, respectively, were
excluded from the diluted weighted average shares outstanding calculation.
4. INVENTORIES
Inventories consist of the following:
December 31, 2001 March 31, 2002
-----------------------------------------
Raw materials .......................................... $20,242,766 $10,190,037
Work-in-process ........................................ 21,743,663 14,371,985
Finished goods ......................................... 10,411,694 15,827,523
-----------------------------------------
$52,398,123 $40,389,545
=========================================
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31, 2001 March 31, 2002
-----------------------------------------
Equipment .............................................. $ 46,576,810 $ 55,138,714
Furniture and fixtures ................................. 6,463,144 6,295,731
Acquired software ...................................... 9,747,235 10,172,081
Leasehold improvements ................................. 15,716,203 15,698,378
Construction in progress ............................... 6,518,764 447,535
-----------------------------------------
85,022,156 87,752,439
Less accumulated depreciation and amortization ......... 19,936,754 25,454,375
-----------------------------------------
Property, plant and equipment--Net ..................... $ 65,085,402 $ 62,298,064
=========================================
6. INTANGIBLE ASSETS
Intangible assets consist of the following:
December 31, 2001 March 31, 2002
-----------------------------------------
Licenses ............................................... $45,000,000 $45,000,000
Core Technology ........................................ 36,000,000 36,000,000
-----------------------------------------
81,000,000 81,000,000
Less accumulated amortization .......................... 20,800,000 24,850,000
-----------------------------------------
$60,200,000 $56,150,000
=========================================
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the
following:
December 31, 2001 March 31, 2002
-----------------------------------------
Accrued professional fees .............................. $ 754,129 $ 198,628
Accrued compensation and related expenses .............. 12,762,549 16,777,614
Accrued taxes .......................................... 1,175,895 650,158
Deferred revenue ....................................... 14,549,053 6,255,039
Warranty reserve ....................................... 8,466,615 10,902,294
Other .................................................. 2,069,176 4,241,445
-----------------------------------------
$ 39,777,417 $ 39,025,178
=========================================
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis addresses the financial condition
of Tellium, Inc. and its subsidiaries as of March 31, 2002 compared with
December 31, 2001, and our results of operations for the three months ended
March 31, 2002 compared with the same period last year. You should read this
discussion and analysis along with our unaudited condensed consolidated
financial statements and the notes to those statements included elsewhere in
this report, and in conjunction with our Annual Report on Form 10-K filed with
the Securities and Exchange Commission on April 1, 2002.
Certain statements and information included in this Form 10-Q are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements express our intentions,
strategies or predictions for the future. Actual results may differ from our
predictions. For more information regarding forward-looking statements, please
see "Cautionary Statement Regarding Forward-Looking Statements" below.
Overview
We design, develop and market high-speed, high-capacity, intelligent
optical switching solutions that enable network service providers to quickly
and cost-effectively deliver new high-speed services. Our product line consists
of several hardware products and related software tools.
We have purchase contracts with the following three customers: Cable &
Wireless, Dynegy Connect, an affiliate of Dynegy Global Communications, and
Qwest. Under the terms of its contract, Cable & Wireless has a minimum purchase
commitment of $350 million for the worldwide deployment of our products,
including the Aurora Optical Switch, the StarNet Wavelength Management System
and the StarNet Operating System. Cable & Wireless has conducted laboratory
testing of the Aurora Optical Switch. Including prior purchases, we expect
Dynegy Connect will purchase approximately $250 million of products under our
contract, although it has no obligation to do so. However, under the terms of
this contract, Dynegy Connect is required to purchase its full requirements for
optical switches from us until November 1, 2003. Our Aurora 32 optical switch,
StarNet Wavelength Management System, StarNet Design Tools and StarNet Operating
System have been in service in the Dynegy Connect network since April 2000.
Dynegy Connect conducted laboratory testing on the Aurora Optical Switch during
the fourth quarter of 2000. We commenced commercial shipment to Dynegy Connect
of the Aurora Optical Switch during the first quarter of 2001 and of the Aurora
128 in the second quarter of 2001. We have a five-year contract with Qwest, a
multinational provider of voice, data and network services. Under the terms of
this contract, Qwest has agreed to purchase approximately $400 million of our
products (including prior purchases) over the term of the contract, as amended
on December 31, 2001, including the Aurora Optical Switch, the StarNet
Wavelength Management System, the Aurora Full-Spectrum and the StarNet Operating
System. Qwest began conducting laboratory testing of the Aurora Optical Switch
in the fourth quarter of 2000, and we commenced commercial shipment under this
contract during the first quarter of 2001.
Since our inception, we have incurred significant losses and as of
March 31, 2002, we had an accumulated deficit of approximately $395.7 million.
We have not achieved profitability on a quarterly or an annual basis and
anticipate that we will continue to incur net losses for the foreseeable future.
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Revenue
For the three months ended March 31, 2002, we recognized gross revenue
before non-cash charges related to equity issuances of approximately $54.1
million, which represents an increase of $38.5 million over gross revenue before
non-cash charges related to equity issuances of approximately $15.6 million for
the three months ended March 31, 2001. The increase is due to increased sales to
our existing customers. Non-cash charges related to warrant issuances to
customers totaled approximately $7.4 million for the three months ended March
31, 2002, compared to approximately $4.8 million for the same period in 2001.
The increase in non-cash charges is due to higher revenue levels from the
customers for which these charges apply. We expect to generate revenues from a
limited number of customers for the foreseeable future.
Cost of Revenue
For the three months ended March 31, 2002, our cost of revenue totaled
approximately $31.2 million, which represents an increase of $20.5 million over
cost of revenue of approximately $10.7 million for the three months ended March
31, 2001. The increase was directly related to the corresponding increase in
revenue and includes increased material costs of approximately $17.1 million,
increased personnel costs of approximately $2.5 million and increased overhead
costs of approximately $0.9
9
million. Cost of revenue includes amortization of stock-based compensation of
approximately $1.5 million for the three months ended March 31, 2002 and
approximately $1.4 million for the three months ended March 31, 2001. Gross
margins improved in the three months ended March 31, 2002 from the same period
in 2001 primarily as a result of the scale up of revenues and improved
production efficiencies. We expect our cost of revenue to increase in absolute
dollars as our revenue increases.
Research and Development Expense
For the three months ended March 31, 2002, we incurred research and
development expense of approximately $14.0 million, which represents a decrease
of $2.6 million from research and development expense of approximately $16.6
million for the three months ended March 31, 2001. The decrease is attributed
primarily to prototype and consulting expenses, which decreased in total by
approximately $3.9 million, and was partly offset by an increase in research and
development personnel costs of approximately $1.0 million. We expect to continue
to fund significant levels of research and development.
Sales and Marketing Expense
For the three months ended March 31, 2002, we incurred sales and
marketing expense of approximately $7.2 million, which represents a decrease of
$0.5 million from sales and marketing expense of approximately $7.7 million for
the three months ended March 31, 2001. The decrease resulted primarily from
lower sales and marketing personnel expense, which was partly offset by
increased expenses for advertising and promotion. We expect to continue to
incur significant sales and marketing expense in future periods as we enhance
our sales and marketing operations.
General and Administrative Expense
For the three months ended March 31, 2002, we incurred general and
administrative expense of approximately $7.6 million, which represents an
increase of $1.8 million over general and administrative expense of
approximately $5.8 million for the three months ended March 31, 2001. The
increase was primarily the result of higher facility expenses, increased
insurance premiums and depreciation. We expect to incur general and
administrative expense in future periods at levels consistent with spending
levels in this period.
Amortization of Intangible Assets and Goodwill
For the three months ended March 31, 2002, we incurred amortization
expense of approximately $4.1 million, which represents a decrease of $3.8
million from amortization expense of approximately $7.9 million for the three
months ended March 31, 2001. These amounts include approximately $4.1 million in
each period of amortization of identifiable intangible assets relating to our
acquisition of Astarte Fiber Networks, Inc. and an intellectual property license
from AT&T Corp. in 2000, both of which are amortized over an estimated useful
life of 5 years. Amortization of goodwill related solely to our acquisition of
Astarte in 2000 totaled $0 for the three months ended March 31, 2002, compared
to approximately $3.8 million for the three months ended March 31, 2001. The
decrease in amortization expense occurred because, effective January 1, 2002, we
ceased recording additional amortization expense for goodwill related to Astarte
in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets". However,
impairment reviews may result in future periodic write downs. We expect
amortization expense for intangible assets to be approximately $16.3 million for
the year 2002, based on the identifiable intangible assets we carried on our
balance sheet at March 31, 2001.
Stock-Based Compensation Expense
For the three months ended March 31, 2002, we recorded stock-based
compensation expense of approximately $12.0 million, which represents a decrease
of $2.6 million from stock-based compensation expense of approximately $14.6 for
the three months ended March 31, 2001. The decrease occurred because stock-based
compensation expense in the three months ended March 31, 2001 included charges
related to the issuance and vesting of options, and there was no corresponding
expense in the three months ended March 31, 2002.
Interest Income, Net
For the three months ended March 31, 2002, we recorded interest income,
net of interest expense, of approximately $0.9 million, which represents a
decrease of $1.8 million from interest income, net of interest expense, of
approximately $2.7 million for the three months ended March 31, 2001. Net
interest income consists of interest earned on our cash and cash equivalent
10
balances, offset by interest expense related to outstanding borrowings. The
decrease in our interest income for this period is primarily attributable to
lower interest rates for the three months ended March 31, 2002 as compared to
the same period in 2001.
Income Taxes
We recorded no income tax provision or benefit for the three months
ended March 31, 2002 and 2001, due to our operating loss position and the
uncertainty of our ability to realize our deferred income tax assets, including
our net operating loss carry forwards.
Liquidity and Capital Resources
We finance our operations primarily through sales of our capital stock
and cash flows from operations. As of March 31, 2002, our cash and cash
equivalents totaled approximately $208.8 million and our working capital totaled
approximately $245.3 million.
Cash used in operating activities for the three months ended March 31,
2002 was approximately $7.3 million. Cash provided by operating activities for
the three months ended March 31, 2001 was approximately $9.2 million. The
decrease in cash flows from operating activities in the first three months of
2002 resulted primarily from increased accounts receivable, whereas cash flows
from operating activities for the same period in 2001 included advanced payments
of approximately $37.5 million received in excess of revenue recognized for
products shipped but not accepted.
Cash used in investing activities for the three months ended March 31,
2002 and 2001 was approximately $2.6 million and approximately $30.2 million,
respectively. The decrease in net cash used for investing activities reflects
primarily the result of decreased capital requirements in the first three months
of 2002, whereas the same period in 2001 included purchases of property and
equipment related to the buildout of our new facilities.
Cash provided by financing activities for the three months ended March
31, 2002 was approximately $38,000. Cash used in financing activities was
approximately $373,000 for the three months ended March 31, 2001. Cash provided
by (or used in) financing activities included cash received upon the exercise of
stock options of approximately $284,000 during the three months ended March 31,
2002 and approximately $269,000 during the three months ended March 31, 2001.
In November 1999, we entered into a lease line of credit with Comdisco,
Inc. that allows us to finance up to $4.0 million of equipment purchases. The
line bears an interest rate of 7.5% and expires in November 2002. As of
December 31, 2001 and March 31, 2002 we had not drawn any amount under this
agreement.
During the year ended December 31, 2000, we entered into a $10.0
million line of credit with Commerce Bank. The line of credit bears interest at
6.75% and expires on June 30, 2002. On each of December 31, 2001 and March 31,
2002, approximately $8.0 million was outstanding under this line of credit.
Management expects to renew this line before it expires and keep it in place
throughout 2002.
We have not entered into any agreements for derivative financial
instruments, have no obligations to provide vendor financing to our customers
and have no obligations other than recorded on our balance sheet, except for our
operating lease agreements described in Note 12 to our consolidated financial
statements included in our Annual Report on Form 10-K filed with the Securities
and Exchange Commission on April 1, 2002.
We expect to use our available cash, our line of credit facilities and
cash anticipated to be available from future operations, to fund operating
losses and for working capital and other general corporate purposes, and believe
that these sources will be sufficient for the next 12 months. We may also use a
portion of our available cash to acquire or invest in businesses, technologies
or products that are complementary to our business. We have not determined the
amounts we plan to spend on any of the uses described above or the timing of
these expenditures.
Our cash flows may be affected by our ability to manufacture and sell
our products. We currently have a limited number of customers that provide
substantially all of our revenues, and the loss of any of these customers would
decrease our cash flows. Changes in the timing and extent of the sale of our
products will also affect our cash flows. In addition, our expenses have
exceeded, and in the foreseeable future are expected to exceed, our revenue. Our
future liquidity and capital requirements will depend upon numerous factors,
including expansion of operations, product development and sales and marketing.
Also, we may need additional capital to fund cash acquisitions of complementary
businesses and technologies. If capital requirements vary materially from those
currently planned, we may require additional financing sooner than anticipated.
Any additional equity
11
financing may be dilutive to our stockholders and debt financing, if available,
may involve restrictive covenants with respect to dividends, raising capital and
other financial and operational matters that could restrict our operations.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements and information included in this Form 10-Q are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements express our intentions,
strategies or predictions for the future. Actual results may differ from our
predictions. We consider all statements regarding anticipated or future matters,
including without limitation the following, to be forward-looking statements:
. our expected future revenue growth, liquidity, cash flows and expenses,
including research and development, sales and marketing and general and
administrative expense;
. planned increases in spending in research and development;
. our plans to continue to incur significant sales and marketing
expenses in future periods as we enhance our sales and marketing
operations;
. our expectation that general and administrative spending will remain
consistent with spending levels in the three months ended
March 31, 2002;
. our plan to renew our line of credit; and
. any statements using forward-looking words, such as "anticipate",
"believe", "could", "estimate", "intend", "may", "should", "will",
"would", "projects", "expects", plans", or other similar words.
These forward-looking statements involve known and unknown risks and
uncertainties that may cause actual results to be materially different from the
results expressed or implied by the forward-looking statements. The
forward-looking statements in this Form 10-Q are only made as of the date of
this report, and we undertake no obligation to publicly update such
forward-looking statements to reflect subsequent events or circumstances.
Shareholders, potential investors and other readers are urged to consider
carefully the following factors, among others, in evaluating the forward-looking
statements:
RISK FACTORS
Risks Related to Our Business and Financial Results
We have incurred significant losses to date and expect to continue to incur
losses in the future, which may cause our stock price to decline.
We have incurred significant losses to date and expect to continue to
incur losses in the future. We had net losses of approximately $211.0 million
for the year ended December 31, 2001 and approximately $28.5 million for the
three months ended March 31, 2002. As of March 31, 2002, we had an accumulated
deficit of approximately $395.7 million. We have large fixed expenses and expect
to continue to incur significant manufacturing, research and development, sales
and marketing, administrative and other expenses in connection with the ongoing
development and expansion of our business. We expect these operating expenses to
increase as we increase our spending in order to develop and grow our business.
In order to become profitable, we will need to generate and sustain higher
revenue. If we do not generate sufficient revenue to achieve or sustain
profitability, our stock price will likely decline.
Our limited operating history makes forecasting our future revenues and
operating results difficult, which may impair our ability to manage our business
and your ability to assess our prospects.
We began our business operations in May 1997 and shipped our first
optical switch in January 1999. We have limited meaningful historical financial
and operational data upon which we can base projected revenues and planned
operating expenses and upon which you may evaluate us and our prospects. As a
young company in the new and rapidly evolving optical switching industry, we
face risks relating to our ability to implement our business plan, including our
ability to continue to develop and upgrade our technology and our ability to
maintain and develop customer and supplier relationships. You should consider
our business and prospects in light of the heightened risks and unexpected
expenses and problems we may face as a company in an early stage of development
in our industry.
12
We expect that substantially all of our revenues will be generated from a
limited number of customers, including Cable & Wireless, Dynegy Connect and
Qwest. The termination or deterioration of our relationship with these customers
will have a significant negative impact on our revenue and cause us to continue
to incur substantial operating losses.
For the year ended December 31, 2001 and the three months ended March
31, 2002, we have derived significant revenue from sales under our contract with
Dynegy Connect and Qwest. We anticipate that a majority of our revenues for the
foreseeable future will be derived from Cable & Wireless, Dynegy Connect and
Qwest.
Although Dynegy Connect has agreed to purchase its full requirements
for optical switches from us until November 1, 2003, Dynegy Connect is not
contractually obligated to purchase future products or services from us and may
discontinue doing so at any time. Dynegy Connect is permitted to terminate the
agreement for, among other things, a breach of our material obligations under
the contract.
Under our agreement with Cable & Wireless, Cable & Wireless has made a
commitment to purchase a minimum of $350 million of our optical switches by
August 7, 2005. Our agreement with Cable & Wireless gives Cable & Wireless the
right to reduce its minimum purchase commitment from $350 million to $200
million if we do not maintain a technological edge so that there exists in the
marketplace superior technology that we have not matched. This agreement also
permits Cable & Wireless to terminate the agreement upon breach of a variety of
our obligations under the contract.
Under our agreement with Qwest, Qwest has agreed to purchase
approximately $400 million (including prior purchases) of our optical switches
over the term of the contract, subject to reaching agreement on price and
technical specifications, and on the schedule of development, production and
deployment of our Aurora Full-Spectrum switches. Under our agreement, we have
also agreed to give Qwest additional flexibility to extend or terminate the
remainder of the commitment in a variety of circumstances.
If any of these customers elects to terminate its contract with us or
if a customer fails to purchase our products for any reason, we would lose
significant revenue and incur substantial operating losses, which would
seriously harm our ability to build a successful business.
If we do not attract new customers, our revenue may not increase.
We are currently very dependent on three customers. We must expand our
customer base in order to succeed. If we are not able to attract new customers
who are willing to make significant commitments to purchase our products and
services for any reason, including if there is a downturn in their businesses,
our business will not grow and our revenue will not increase. Our customer base
and revenue will not grow if:
. customers are unwilling or slow to utilize our products;
. we experience delays or difficulties in completing the
development and introduction of our planned products or product
enhancements;
. our competitors introduce new products that are superior to our
products;
. our products do not perform as expected; or
. we do not meet our customers' delivery requirements.
In the past, we issued warrants to some customers. We may not be able
to attract new customers and expand our sales with our existing customers if we
do not provide warrants or other incentives.
If our line of optical switches or their future enhancements are not
successfully developed, they will not be accepted by our customers and our
target market, and our future revenue will not grow.
We began to focus on the marketing and the selling of optical switches
in the second quarter of 1999. Our future revenue growth depends on the
commercial success and adoption of our optical switches.
We are developing new products and enhancements to existing products.
We may not be able to develop new products or product enhancements in a timely
manner, or at all. For example, our Aurora Full-Spectrum switch depends on
advancements in optical components, including micro-electromechanical systems,
which have not yet been proven for telecommunications products. Any failure to
develop new products or product enhancements will substantially decrease market
acceptance and sales of our present and future products. Any failure to develop
new products or product enhancements could also delay purchases by
13
our customers under their contracts, or, in some cases, could cause us to be in
breach under our contracts with our customers. Even if we are able to develop
and commercially introduce new products and enhancements, these new products or
enhancements may not achieve widespread market acceptance and may not be
satisfactory to our customers. Any failure of our future products to achieve
market acceptance or be satisfactory to our customers could slow or eliminate
our revenue growth.
Due to the long and variable sales cycles for our products, our revenues and
operating results may vary significantly from quarter to quarter. As a result,
our quarterly results may be below the expectations of market analysts and
investors, causing the price of our common stock to decline.
Our sales cycle is lengthy because a customer's decision to purchase
our products involves a significant commitment of its resources and a lengthy
evaluation, testing and product qualification process. We may incur substantial
expenses and devote senior management attention to potential relationships that
may never materialize, in which event our investments will largely be lost and
we may miss other opportunities. In addition, after we enter into a contract
with a customer, the timing of purchases and deployment of our products may vary
widely and will depend on a number of factors, many of which are beyond our
control, including:
. specific network deployment plans of the customer;
. installation skills of the customer;
. size of the network deployment;
. complexity of the customer's network;
. degree of hardware and software changes required; and
. new product availability.
For example, customers with significant or complex networks usually expand their
networks in large increments on a periodic basis. Accordingly, we may receive
purchase orders for significant dollar amounts on an irregular and unpredictable
basis. The long sales cycles, as well as the placement of large orders with
short lead times on an irregular and unpredictable basis, may cause our revenues
and operating results to vary significantly and unexpectedly from quarter to
quarter. As a result, it is likely that in some future quarters our operating
results may be below the expectations of market analysts and investors, which
could cause the trading price of our common stock to decline.
We expect the average selling prices of our products to decline, which may
reduce revenues and gross margins.
Our industry has experienced a rapid erosion of average product selling
prices. Consistent with this general trend, we anticipate that the average
selling prices of our products will decline in response to a number of factors,
including:
. competitive pressures;
. increased sales discounts; and
. new product introductions by our competitors.
If we are unable to achieve sufficient cost reductions and increases in
sales volumes, this decline in average selling prices of our products will
reduce our revenues and gross margins.
We will be required to record significant non-cash charges as a result of
warrants, options and other equity issuances. These non-cash charges will
adversely affect our future operating results and investors may consider this
impact material, in which case the price of our common stock could decline.
A warrant held by affiliates of Dynegy Connect allows them to purchase
5,226,000 shares of our common stock at $3.05 per share. The warrant becomes
exercisable based on a schedule of milestones. If the milestones are not reached
by March 31, 2005, the remaining unexercised shares subject to the warrant will
become exercisable. In connection with the warrant, we record and will continue
to record deferred warrant expenses as a reduction of revenue. These deferred
warrant expenses increase as we realize revenue from our contract with Dynegy
Connect.
As part of our agreement with Qwest, we issued three warrants to a
wholly-owned subsidiary of Qwest to purchase 2,375,000 shares of our common
stock at an exercise price of $14.00 per share. The 2,375,000 shares subject to
the warrants were vested when we issued the warrants. One of the warrants is
exercisable as to 1,000,000 shares. On December 20, 2001, in connection with the
Qwest contract amendment, we cancelled warrants for 1,375,000 shares of common
stock and recorded approximately $19.2 million as an offset to gross revenue.
The fair market value of the remaining issued warrant, approximately
14
$17.3 million, will be recorded as a reduction of revenue as we realize revenue
from the Qwest procurement contract.
We will incur significant additional non-cash charges as a result of
our acquisition of Astarte and our acquisition of an intellectual property
license from AT&T. The goodwill and intangible assets associated with the
Astarte acquisition are approximately $113.3 million. The identifiable
intangible asset associated with the acquisition of the AT&T license is
approximately $45.0 million. Amortization of goodwill ceased on January 1, 2002
upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets", and
goodwill is now subject to periodic impairment reviews in accordance with SFAS
No. 142. As of March 31, 2002, we had recorded goodwill, net of accumulated
amortization, of approximately $58.4 million.
In addition, we have recorded deferred compensation expense and have
begun to amortize non-cash charges to earnings as a result of options and other
equity awards granted to employees and non-employee directors at prices deemed
to be below fair market value on the dates of grant. Our future operating
results will reflect the continued amortization of those charges over the
vesting period of these options and awards. At March 31, 2002, we had recorded
deferred compensation expense of approximately $124.6 million, which will be
amortized to compensation expense through 2005.
All of the non-cash charges referred to above will negatively impact
future operating results. It is possible that some investors might consider the
impact on operating results to be material, which could result in a decline in
the price of our common stock.
Economic Recession or Downturns Could Harm Our Operating Results.
Our customers may be susceptible to economic slowdowns or recessions
and could lead to a decrease in revenue. The terrorist attacks of September 11,
2001 on New York City and Washington, D.C., and the continuing acts and threats
of terrorism are having an adverse effect on the U.S. economy and could possibly
induce or accelerate the advent of a more severe economic recession. Our
government's political, social, military and economic policies and policy
changes as a result of these circumstances could have consequences that we
cannot predict, including causing further weakness in the economy. As a result
of these events our customers and potential customers have reduced or slowed the
rate of their capital expenditures. The long-term impact of these events on our
business, including on the industry section in which we focus and our customers
and prospective customers, is uncertain. Our operating results and financial
condition consequently could be materially and adversely affected in ways we
cannot foresee.
We Have Experienced and Expect to Continue to Experience Volatility in Our Stock
Price Which Makes an Investment in Our Stock More Risky and Litigation More
Likely.
The market price of our common stock has fluctuated significantly in
the past and may fluctuate significantly in the future in response to a number
of factors, some of which are beyond our control, including: changes in
financial estimates by securities analysts; changes in market valuations of
communications and Internet infrastructure-related companies; announcements, by
us or our competitors, of new products or of significant acquisitions, strategic
partnerships or joint ventures; volume fluctuations, which are particularly
common among highly volatile securities of Internet-related companies; and
volatility of stock markets, particularly the Nasdaq National Market on which
our common stock is listed. Following periods of volatility in the market price
of a company's securities, securities class action litigation has often been
instituted against that company. We are currently not named in securities class
action lawsuits. Any future litigation, if instituted, could result in
substantial costs and a diversion of management's attention.
Insiders have substantial control over us and could limit your ability to
influence the outcome of key transactions, including changes of control.
Our directors, executive officers and principal stockholders and
entities affiliated with them own approximately 31% of the outstanding shares of
our common stock. As a result, these stockholders, if acting together, may
influence matters requiring approval by our stockholders, including the election
of directors and the approval of mergers or other business combination
transactions. These stockholders or their affiliates may acquire additional
equity in the future. The concentration of ownership may also have the effect of
delaying, preventing or deterring a change of control of our company, could
deprive our stockholders of an opportunity to receive a premium for their common
stock as part of a sale of our company and might ultimately affect the market
price of our common stock.
15
Risks Related to Our Products
Our products may have errors or defects that we find only after full deployment,
or problems may arise from the use of our products in conjunction with other
vendors' products, which could, among other things, make us lose customers and
revenues.
Our products are complex and are designed to be deployed in large and
complex networks. Our products can only be fully tested when completely deployed
in these networks with high amounts of traffic. Networking products frequently
contain undetected software or hardware errors when first introduced or as new
versions are released. Our customers may discover errors or defects in our
software or hardware, or our products may not operate as expected after they
have used them extensively in their networks. In addition, service providers
typically use our products in conjunction with products from other vendors. As a
result, if problems occur, it may be difficult to identify the source of the
problem.
If we are unable to fix any defects or errors or other problems arise,
we could:
. lose revenues;
. lose existing customers;
. fail to attract new customers and achieve market acceptance;
. divert development resources;
. increase service and repair, warranty and insurance costs; and
. be subjected to legal actions for damages by our customers.
If our products do not operate within our customers' networks, installations
will be delayed or cancelled, reducing our revenues, or we may have to modify
some of our product designs. Product modifications could increase our expenses
and reduce the margins on our products.
Our customers require that our products be designed to operate within
their existing networks, each of which may have different specifications. Our
customers' networks contain multiple generations of products that have been
added over time as these networks have grown and evolved. If our products do not
operate within our customers' networks, installations could be delayed and
orders for our products could be cancelled, causing our revenues to decline. The
requirement that we modify product designs in order to achieve a sale may result
in a longer sales cycle, increased research and development expense and reduced
margins on our products.
If our products do not meet industry standards that may emerge, or if some
industry standards are not ultimately adopted, we will not gain market
acceptance and our revenues will not grow.
Our success depends, in part, on both the adoption of industry
standards for new technologies in our market and our products' compliance with
industry standards. To date, no industry standards have been adopted related to
some functions of our products. The absence of industry standards may prevent
market acceptance of our products if potential customers delay purchases of new
equipment until standards are adopted. In addition, in developing our products,
we have made, and will continue to make, assumptions about the industry
standards that may be adopted by our competitors and existing and potential
customers. If the standards adopted are different from those, which we have
chosen to support, customers may not choose our products, and our sales and
related revenues will be significantly reduced.
If we do not establish and increase our market share in the intensively
competitive optical networking market, we will experience, among other things,
reduced revenues and gross margins.
If we do not compete successfully in the intensely competitive market
for public telecommunications network equipment, we may lose any advantage that
we might have by being the first to market with an optical switch prior to
achieving significant market penetration. In addition to losing any competitive
advantage, we may also:
. not be able to obtain or retain customers;
. experience price reductions for our products;
. experience order cancellations;
. experience increased expenses; and
. experience reduced gross margins.
16
Many of our competitors, in comparison to us, have:
. longer operating histories;
. greater name recognition;
. larger customer bases; and
. significantly greater financial, technical, sales, marketing,
manufacturing and other resources.
These competitors may be able to reduce our market share by adopting
more aggressive pricing policies than we can or by developing products that gain
wider market acceptance than our products.
Risks Related to the Expansion of Our Business
If the optical switching market does not develop as we expect, our operating
results will be negatively affected and our stock price could decline.
The market for optical switching is new and rapidly evolving. Optical
switching may not be widely adopted as a method by which service providers
address their data capacity requirements. In addition, most service providers
have made substantial investments in their current network and are typically
reluctant to adopt new and unproven technologies. They may elect to remain with
their current network design or to adopt a new design, like ours, in limited
stages or over extended periods of time. A decision by a customer to purchase
our product involves a significant capital investment. We will need to convince
service providers of the benefits of our products for future network upgrades,
and if we are unable to do so, a viable market for our products may not develop
or be sustainable. If the market for optical switching does not develop, or
develops more slowly than we expect, our operating results will be below our
expectations and the price of our stock could decline.
If we are not successful in rapidly developing new and enhanced products that
respond to customer requirements and technological changes, customers will not
buy our products and we could lose revenue.
The market for optical switching is characterized by rapidly changing
technologies, frequent new product introductions and evolving customer and
industry standards. We may be unable to anticipate or respond quickly or
effectively to rapid technological changes. Also, we may experience design,
manufacturing, marketing and other difficulties that could delay or prevent our
development and introduction of new products and enhancements. In addition, if
our competitors introduce products based on new or alternative technologies, our
existing and future products could become obsolete and our sales could decrease.
Our customers require some product features and capabilities that our
current products do not have. If we fail to develop or enhance our products or
to offer services that satisfy evolving customer demands, we will not be able to
satisfy our existing customers' requirements or increase demand for our
products. If this happens, we will lose customers and breach our existing
contracts with our customers, our operating results will be negatively impacted
and the price of our stock could decline.
If we do not expand our sales, marketing and distribution channels, we may be
unable to increase market awareness and sales of our products, which may prevent
us from increasing our sales and achieving and maintaining profitability.
Our products require a sophisticated sales and marketing effort
targeted towards a limited number of key individuals within our current and
prospective customers' organizations. Our success will depend, in part, on our
ability to develop and manage these relationships. We continue to build our
direct sales and marketing force and plan to hire additional sales and marketing
personnel and consulting engineers. Competition for these individuals is intense
because there is a limited number of people available with the necessary
technical skills and understanding of the optical switching market. In addition,
we believe that our success will depend on our ability to establish successful
relationships with various distribution partners. If we are unable to expand our
sales, marketing and distribution operations, we may not be able to effectively
market and sell our products, which may prevent us from increasing our sales and
achieving and maintaining profitability.
If we do not expand our customer service and support organization, we may be
unable to increase our sales.
We currently have a small customer service and support organization and
will need to increase our staff to support new and existing customers. Our
products are complex and our customers need highly-trained customer service and
support personnel to be available at all hours. We are likely to have difficulty
hiring customer service and support personnel because of the limited
17
number of people available with the necessary technical skills. If we are unable
to expand our customer service and support organization and rapidly train these
personnel, we may not be able to increase our sales, which could cause the price
of our stock to decline.
Our failure to manage our growth, improve existing processes and implement new
systems could result in lost sales or disruptions to our business.
We have expanded our operations rapidly since our inception in May
1997. Our growth has placed, and we anticipate that our growth will continue to
place, a significant strain on our management systems and resources. Our ability
to successfully sell our products and implement our business plan in a rapidly
evolving market requires an effective planning and management process. From
March 31, 2001 to March 31, 2002, the number of our employees increased from 493
to 534. We expect that we will need to continue to refine and expand our
financial, managerial and manufacturing controls and reporting systems. If we
are unable to implement adequate control systems in an efficient and timely
manner, our operations could be adversely affected and our growth could be
impaired, which could cause the price of our stock to decline.
If we are not able to hire and retain qualified personnel, or if we lose key
personnel, we may be unable to compete or grow our business.
We believe our future success will also depend, in large part, on our
ability to identify, attract and retain sufficient numbers of highly-skilled
employees, particularly qualified sales and engineering personnel. We may not
succeed in identifying, attracting and retaining these personnel. Further,
competitors and other entities may attempt to recruit our employees. If we are
unable to hire and retain adequate staffing levels, we may not be able to
increase sales of our products, which could cause the price of our stock to
decline.
Our future success depends to a significant degree on the skills and
efforts of Harry J. Carr, our Chief Executive Officer and Chairman of the Board,
Krishna Bala, our Chief Technology Officer, and other key executive officers and
members of our senior management. These employees have critical industry
experience and relationships that we rely on to implement our business plan. We
currently do not have "key person" life insurance policies covering any of our
employees. If we lose the services of Mr. Carr, Dr. Bala or one or more of our
other key executive officers and senior management members, we may not be able
to grow our business as we expect, and our ability to compete could be harmed,
causing our stock price to decline.
If we become subject to unfair hiring claims, we could incur substantial costs
in defending ourselves.
We may become subject to claims from companies in our industry whose
employees accept positions with us that we have engaged in unfair hiring
practices or inappropriately taken or benefited from confidential or proprietary
information. These claims may result in material litigation or judgments against
us. We could incur substantial costs in defending ourselves or our employees
against these claims, regardless of the merits of the claims. In addition,
defending ourselves from these claims could divert the attention of our
management away from our core business, which could cause our financial
performance to suffer.
We do not have significant experience in international markets and may have
unexpected costs and difficulties in developing international revenues.
We are expanding the marketing and sales of our products
internationally. This expansion will require significant management attention
and financial resources to successfully develop international sales and support
channels. We will face risks and challenges that we do not have to address in
our U.S. operations, including:
. currency fluctuations and exchange control regulations;
. changes in regulatory requirements in international markets;
. expenses associated with developing and customizing our products
for foreign countries;
. reduced protection for intellectual property rights; and
. compliance with international technical and regulatory standards
that differ from domestic standards.
If we do not successfully overcome these risks and challenges, our
international business will not achieve the revenue or profits that we expect.
18
We may not be able to obtain additional capital to fund our existing and future
operations.
At March 31, 2002, we had approximately $208.8 million in cash and cash
equivalents. We believe that our available cash, our line of credit facilities
and cash anticipated to be available from future operations, will enable us to
meet our working capital requirements for the next 12 months. The development
and marketing of new products, however, and the expansion of our direct sales
operation and associated customer support organization will require a
significant commitment of resources. As a result, we may need to raise
substantial additional capital. We may not be able to obtain additional capital
at all, or upon acceptable terms. If we are unable to obtain additional capital
on acceptable terms, we may be required to reduce the scope of our planned
product development and marketing and sales efforts. To the extent that we raise
additional capital through the sale of equity or convertible debt securities,
the issuance of additional securities could result in dilution to our existing
stockholders. If additional funds are raised through the issuance of debt
securities, their terms could impose additional restrictions on our operations.
If we make acquisitions, our stockholders could be diluted and we could assume
additional contingent liabilities. In addition, if we fail to successfully
integrate or manage the acquisitions we make, our business would be disrupted
and we could lose sales.
We may, as we did with the acquisition of Astarte, consider investments
in complementary businesses, products or technologies. In the event of any
future acquisitions, we could:
. issue stock that would dilute our current stockholders'
percentage ownership;
. incur debt that will give rise to interest charges and may impose
material restrictions on the manner in which we operate our
business;
. assume liabilities;
. incur amortization expenses related intangible assets; or
. incur large and immediate write-offs.
We also face numerous risks, including the following, in operating and
integrating any acquired business:
. problems combining the acquired operations, technologies or
products;
. diversion of management's time and attention from our core
business;
. adverse effects on existing business relationships with suppliers
and customers;
. risks associated with entering markets in which we have no or
limited prior experience; and
. potential loss of key employees, particularly those of acquired
companies.
We may not be able to successfully integrate businesses, products,
technologies or personnel that we might acquire in the future. If we fail to do
so, we could experience lost sales or disruptions to our business.
The communications industry is subject to government regulations. These
regulations could negatively affect our growth and reduce our revenues.
Our products and our customers' products are subject to Federal
Communications Commission rules and regulations. Current and future Federal
Communications Commission rules and regulations affecting communications
services or our customers' businesses or products could negatively affect our
business. In addition, international regulatory standards could impair our
ability to develop products for international service providers in the future.
We may not obtain or maintain all of the regulatory approvals that may, in the
future, be required to operate our business. Our inability to obtain these
approvals, as well as any delays caused by our compliance and our customers'
compliance with regulatory requirements could result in postponements or
cancellations of our product orders, which would significantly reduce our
revenues.
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Risks Related to Our Product Manufacturing
If we fail to predict our manufacturing and component requirements accurately,
we could incur additional costs or experience manufacturing delays, which could
harm our customer relationships.
We provide forecasts of our demand to our contract manufacturers and
component vendors up to six months prior to scheduled delivery of products to
our customers. In addition, lead times for materials and components that we
order are long and depend on factors such as the procedures of, or contract
terms with, a specific supplier and demand for each component at a given time.
If we overestimate our requirements, we may have excess inventory, which could
increase our costs and harm our relationship with our contract manufacturers and
component vendors due to unexpectedly reduced future orders. If we underestimate
our requirements, we may have an inadequate inventory of components and optical
assemblies, which could interrupt manufacturing of our products, result in
delays in shipments to our customers and damage our customer relationships.
Some of the optical components used in our products may be difficult to obtain.
This could inhibit our ability to manufacture our products and we could lose
revenue and market share.
Our industry has previously experienced shortages of optical components
and may again in the future. For some of these components, there previously were
long waiting periods between placement of an order and receipt of the
components. If such shortages should reoccur, component suppliers could impose
allocations that limit the number of components they supply to a given customer
in a specified time period. These suppliers could choose to increase allocations
to larger, more established companies, which could reduce our allocations and
harm our ability to manufacture our products. If we are not able to manufacture
and ship our products on a timely basis, we could lose revenue, our reputation
could be harmed and customers may find our competitors' products more
attractive.
Any disruption in our manufacturing relationships may cause us to fail to meet
our customers' demands, damage our customer relationships and cause us to lose
revenue.
We rely on a small number of contract manufacturers to manufacture our
products in accordance with our specifications and to fill orders on a timely
basis. Our contract manufacturers may not always have sufficient quantities of
inventory available to fill our orders or may not allocate their internal
resources to fill these orders on a timely basis.
We currently do not have long-term contracts with any of our
manufacturers. As a result, our contract manufacturers are not obligated to
supply products to us for any specific period, in any specific quantity or at
any specific price, except as may be provided in a particular purchase order. If
for any reason these manufacturers were to stop satisfying our needs without
providing us with sufficient warning to procure an alternate source, our ability
to sell our products could be harmed. In addition, any failure by our contract
manufacturers to supply us with our products on a timely basis could result in
late deliveries. Our inability to meet our delivery deadlines could adversely
affect our customer relationships and, in some instances, result in termination
of these relationships or potentially subject us to litigation. Qualifying a new
contract manufacturer and commencing volume production is expensive and
time-consuming and could significantly interrupt the supply of our products. If
we are required or choose to change contract manufacturers, we may damage our
customer relationships and lose revenue.
We purchase several of our key components from single or limited sources. If we
are unable to obtain these components on a timely basis, we will not be able to
meet our customers' product delivery requirements, which could harm our
reputation and decrease our sales.
We purchase several key components from single or, in some cases,
limited sources. We do not have long-term supply contracts for these components.
If any of our sole or limited source suppliers experience capacity constraints,
work stoppages or any other reduction or disruption in output, they may not be
able or may choose not to meet our delivery schedules. Also, our suppliers may:
. enter into exclusive arrangements with our competitors;
. be acquired by our competitors;
. stop selling their products or components to us at commercially
reasonable prices;
. refuse to sell their products or components to us at any price;
or
. be unable to obtain or have difficulty obtaining components for
their products from their suppliers.
If supply for these key components is disrupted, we may be unable to
manufacture and deliver our products to our
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customers on a timely basis, which could result in lost or delayed revenue, harm
to our reputation, increased manufacturing costs and exposure to claims by our
customers. Even if alternate suppliers are available to us, we may have
difficulty identifying them in a timely manner, we may incur significant
additional expense and we may experience difficulties or delays in manufacturing
our products. Any failure to meet our customers' delivery requirements could
harm our reputation and decrease our sales.
Our ability to compete could be jeopardized and our business plan seriously
compromised if we are unable to protect from third-party challenges the
development and maintenance of the proprietary aspects of the optical switching
products and technology we design.
Our products utilize a variety of proprietary rights that are critical
to our competitive position. Because the technology and intellectual property
associated with our optical switching products are evolving and rapidly
changing, our current intellectual property rights may not adequately protect us
in the future. We rely on a combination of patent, copyright, trademark and
trade secret laws and contractual restrictions to protect the intellectual
property utilized in our products. For example, we enter into confidentiality or
license agreements with our employees, consultants, corporate partners and
customers and control access to, and distribution of, our software,
documentation and other proprietary information. Despite our efforts to protect
our proprietary rights, unauthorized parties may attempt to copy or otherwise
obtain and use our products or technology. Also, it is possible that no patents
or trademarks will be issued from our currently pending or future patent or
trademark applications. Because legal standards relating to the validity,
enforceability and scope of protection of patent and intellectual property
rights in new technologies are uncertain and still evolving, the future
viability or value of our intellectual property rights is uncertain. Moreover,
effective patent, trademark, copyright and trade secret protection may not be
available in some countries in which we distribute or may anticipate
distributing our products. Furthermore, our competitors may independently
develop similar technologies that limit the value of our intellectual property
or design around patents issued to us. If competitors are able to use our
technology, our competitive edge would be reduced or eliminated.
If necessary licenses of third-party technology are not available to us or are
very expensive, our products could become obsolete and our business seriously
harmed because we could have to limit or cease the development of some of our
products.
We currently license technology from several companies that is
integrated into our products. We may occasionally be required to license
additional technology from third parties or expand the scope of current licenses
to sell or develop our products. Existing and future third-party licenses may
not be available to us on commercially reasonable terms, if at all. The loss of
our current technology licenses or our inability to expand or obtain any
third-party license required to sell or develop our products could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost or limit or cease the sale or development of certain products or
services. If these events occur, we may not be able to increase our sales and
our revenue could decline.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
We have not entered into contracts for derivative financial
instruments. We have assessed our vulnerability to market risks, including
interest rate risk associated with financial instruments included in cash and
cash equivalents and foreign currency risk. Due to the short-term nature of our
investments and other investment policies and procedures, we have determined
that the risks associated with interest rate fluctuations related to these
financial instruments are not material to our business. Additionally, as all
sales contracts are denominated in U.S. dollars and our European subsidiaries
are not significant in size compared to the consolidated company, we have
determined that foreign currency risk is not material to our business.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not aware of any pending legal proceedings against
us that, individually or in the aggregate, would have a
material adverse effect on our business, results of
operations or financial condition.
Item 2. Changes in Securities and Use of Proceeds
(a) Changes in Securities
On February 4, 2002, we issued 306,754 shares of common
stock to Telstra Holdings Pty Limited, an affiliate of
Dynegy Connect, upon the cashless exercise of a warrant to
purchase 731,640 shares of our common stock based on an
exercise price of $3.05 per share. The issuance of these
shares was exempt from registration pursuant to Section
4(2) of the Securities Act of 1933.
(b) Use of Proceeds
On May 17, 2001 in connection with our initial public
offering, a Registration Statement on Form S-1 (No.
333-46362) was declared effective by the Securities and
Exchange Commission. The net proceeds of our initial
public offering were approximately $139.5 million. The
proceeds of this offering were invested in short-term,
interest-bearing, investment-grade securities. We expect
to use the net proceeds from this offering primarily to
fund operating losses and for working capital and other
general corporate purposes, including increased
expenditures for research and development and sales and
marketing, to implement our business strategies. We may
also use a portion of the net proceeds from our initial
public offering to acquire or invest in businesses,
technologies or products that are complementary to our
business.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
On February 1, 2002, we filed a report on Form 8-K
announcing our financial results for the quarter and
fiscal year ended December 31, 2001.
On May 1, 2002, we filed a report on Form 8-K announcing
our financial results for the quarter ended March 31,
2002.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TELLIUM, INC.
Dated: May 15, 2002 /s/ Harry J. Carr
--------------------------------------------
Harry J. Carr
Chairman of the Board and
Chief Executive Officer
Dated: May 15, 2002 /s/ Michael J. Losch
--------------------------------------------
Michael J. Losch
Chief Financial Officer
(Principal Financial and Accounting Officer)
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