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UNITED STATES
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 JANUARY 31, 2000
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number:
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CROSSROADS SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 74-2846643
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
9390 RESEARCH BOULEVARD, SUITE II-300
AUSTIN, TEXAS 78759
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(Address of principal executive offices) (Zip Code)
(512) 349-0300
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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. [X] Yes [ ] No
As of March 1, 2000, Registrant had outstanding 26,609,923 shares of
common stock, par value $0.001 per share.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
TABLE OF CONTENTS
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of October 31, 1999 and
January 31, 2000............................................................................ 3
Condensed Consolidated Statements of Operations for the Three Months
Ended January 31, 1999 and 2000............................. ............................... 4
Condensed Consolidated Statement of Changes in Stockholders' Equity for the
Three Months Ended January 31, 2000......................................................... 5
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended January 31, 1999 and 2000...................................................... 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...................................... 25
PART II OTHER INFORMATION
Item 2. Changes in Securities........................................................................... 26
Item 6. Exhibits and Reports on Form 8-K................................................................ 26
SIGNATURES ................................................................................................. 27
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
OCTOBER 31, JANUARY 31,
1999 2000
----------- -----------
Current assets:
Cash and cash equivalents ............................................... $ 61,320 $ 60,072
Short-term investments .................................................. 19,500 14,091
Accounts receivable, net of allowance for doubtful
accounts of $95 and $130, respectively ............................... 3,654 6,549
Inventories ............................................................. 3,278 2,779
Prepaids and other current assets ....................................... 933 1,315
--------- ---------
Total current assets ............................................ 88,685 84,806
Note receivable from related party, net ................................... 154 150
Property and equipment, net ............................................... 2,273 3,575
Other assets .............................................................. 618 479
--------- ---------
Total assets .................................................... $ 91,730 $ 89,010
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................ $ 3,328 $ 2,710
Accrued expenses ........................................................ 735 1,129
Accrued warranty costs .................................................. 309 408
Deferred revenue ........................................................ 117 171
Current portion of long-term debt ....................................... 1,031 --
--------- ---------
Total current liabilities ....................................... 5,520 4,418
Long-term debt, net of current portion .................................... 1,325 --
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares
authorized, respectively, 26,549,919 and 26,590,821
shares issued and outstanding, respectively ........................... 27 27
Additional paid-in capital .............................................. 102,461 102,409
Deferred stock-based compensation ....................................... (3,718) (3,030)
Notes receivable from stockholders ...................................... (463) (469)
Accumulated deficit ..................................................... (13,420) (14,343)
Treasury stock at cost (22,500 shares) .................................. (2) (2)
--------- ---------
Total stockholders' equity
84,885 84,592
--------- ---------
Total liabilities and stockholders' equity ...................... $ 91,730 $ 89,010
========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED
JANUARY 31,
----------------------------
1999 2000
------------ ------------
Revenue:
Product revenue ..................... $ 3,160 $ 8,692
Other revenue ....................... 60 101
------------ ------------
Total revenue ............... 3,220 8,793
Cost of revenue ....................... 1,807 4,638
------------ ------------
Gross profit .......................... 1,413 4,155
------------ ------------
Operating expenses:
Sales and marketing ................. 770 2,212
Research and development ............ 838 1,984
General and administrative .......... 436 1,317
Amortization of stock-based
compensation ....................... 49 688
------------ ------------
Total operating expenses .... 2,093 6,201
------------ ------------
Loss from operations .................. (680) (2,046)
Other income (expense):
Interest income ..................... 47 1,161
Interest expense .................... (22) (29)
Other income (expense) .............. 8 (9)
------------ ------------
Other income, net ................ 33 1,123
------------ ------------
Net loss .............................. (647) (923)
Accretion on redeemable
convertible preferred stock ......... (71) --
------------ ------------
Net loss attributable to common
stock ............................... $ (718) $ (923)
============ ============
Basic and diluted net loss per
share ............................... $ (0.11) $ (0.04)
============ ============
Shares used in computing basic
and diluted net loss per share ...... 6,456,513 25,629,217
============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTES
COMMON STOCK ADDITIONAL DEFERRED RECEIVABLE TOTAL
----------------------- PAID-IN STOCK-BASED FROM ACCUMULATED TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS DEFICIT STOCK EQUITY
------------ --------- ---------- ------------- ------------- ---------- --------- ------------
Balance at October 31, 1999 .. 26,549,919 $ 27 $ 102,461 $ (3,718) $ (463) $ (13,420) $ (2) $ 84,885
Issuance of common stock ... 40,902 -- 43 -- -- -- -- 43
Stock-based compensation ... -- -- -- 688 -- -- -- 688
Accrued interest on notes
receivable from
stockholders ............ -- -- -- -- (6) -- -- (6)
Registration of stock option
plan .................... -- -- (95) -- -- -- -- (95)
Net loss ................... -- -- -- -- -- (923) -- (923)
---------- ----- ---------- -------- ------- ---------- ------ --------
Balance at January 31, 2000 .. 26,590,821 $ 27 $ 102,409 $ (3,030) $ (469) $ (14,343) $ (2) $ 84,592
========== ===== ========== ======== ======= ========== ======= ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED JANUARY 31,
------------------------------
1999 2000
------------ -------------
Cash flows from operating activities:
Net loss ................................... $ (647) $ (923)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization ........... 196 412
Amortization of stock-based
compensation .......................... 49 688
Provision for doubtful accounts .........
receivable ............................ 5 44
Amortization of note receivable
from related party .................... -- 4
Changes in assets and liabilities:
Accounts receivable ................... (1,173) (2,939)
Inventories ........................... 120 499
Prepaids and other assets ............. (90) (382)
Accounts payable ...................... 361 (618)
Accrued expenses ...................... 75 394
Accrued warranty costs ................ 26 99
Deferred revenue and other ............ -- 48
------------ -------------
Net cash used in operating
activities ...................... (1,078) (2,674)
------------ -------------
Cash flows from investing activities:
Purchase of property and equipment ......... (266) (1,714)
Purchase of held-to-maturity investments.... -- (7,591)
Maturity of held-to-maturity investments.... 649 13,000
Other assets ............................... 141 139
------------ -------------
Net cash provided by investing
activities ...................... 524 3,834
------------ -------------
Cash flows from financing activities:
Proceeds from issuance of common stock ..... 19 43
Registration of stock option plan .......... -- (95)
Borrowings under long-term debt
agreements .............................. 200 --
Repayment of long-term indebtedness ........ (90) (2,356)
------------ -------------
Net cash provided by (used in)
financing activities ............ 129 (2,408)
------------ -------------
Net decrease in cash and cash equivalents.... (425) (1,248)
Cash and cash equivalents, beginning of
period ..................................... 1,695 61,320
------------ -------------
Cash and cash equivalents, end of period ..... $ 1,270 $ 60,072
============ ==============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of Crossroads Systems, Inc. and its wholly-owned subsidiary. All
intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited interim condensed consolidated financial statements
reflect all adjustments (consisting only of normal recurring entries) which, in
the opinion of our management, are necessary for a fair presentation of the
results for the interim periods presented. 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 the Securities and Exchange Commission's rules and regulations.
These financial statements should be read in conjunction with the audited
financial statements and related notes for the three-year period ended October
31, 1999, included in our Annual Report on Form 10-K.
The results of operations for the three months ended January 31, 2000 are not
necessarily indicative of results that may be expected for any other interim
period or for the full year.
2. NET LOSS PER SHARE
Our net loss per share per share is calculated in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share". This method
requires calculation of both earnings per share and earnings per share, assuming
dilution. Earnings per share excludes the dilutive effect of common stock
equivalents such as stock options, while earnings per share, assuming dilution
includes such dilutive effects. Future weighted-average shares outstanding
calculations will be impacted by the following factors: (i) the ongoing issuance
of common stock associated with stock option exercises; (ii) the issuance of
common shares associated with our employee stock purchase program; (iii) any
fluctuations in our stock price, which could cause changes in the number of
common stock equivalents included in the earnings per share, assuming dilution
computation; and (iv) the issuance of common stock to effect business
combinations should we enter into such transactions.
The Company has excluded all redeemable convertible preferred stock, up until
the date of their conversion, and all outstanding stock options from the
calculation of diluted net loss per share because all such securities are
antidilutive for all periods presented. The total number of common stock
equivalents excluded from the calculations of diluted net loss per common share
were 13,589,064 and 2,301,130 for the three months ended January 31, 1999 and
2000, respectively.
3. INVENTORIES
Inventories consist of the following:
OCTOBER 31, JANUARY 31,
1999 2000
------------- ------------
Raw materials ............................................... $2,247 $1,628
Work in process ............................................. -- 79
Finished goods .............................................. 1,031 1,072
------------- ------------
$3,278 $2,779
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4. SUBSEQUENT EVENTS
Agreement and Plan of Merger and Reorganization with Polaris Communications,
Inc.
On February 3, 2000, we entered into an Agreement and Plan of Merger and
Reorganization with Polaris Communications, Inc. ("Polaris"). The agreement sets
forth the terms and conditions of our proposed acquisition of Polaris by means
of a merger of a wholly-owned subsidiary of Crossroads with and into Polaris
after which Polaris would become a wholly-owned subsidiary of Crossroads.
Pursuant to the agreement, we will acquire all of the outstanding common stock
of Polaris in exchange for 450,000 shares of our common stock. This acquisition
will be accounted for as a purchase. The completion of this transaction is
subject to the satisfaction of a number of conditions, including approval by the
shareholders of Polaris and the completion of a fairness hearing under Oregon
law.
Early Release for 20 Percent of Lock-up Shares
On February 22, 2000, we announced that the underwriters for Crossroads' initial
public offering agreed to release approximately 3.8 million shares subject to
lock-up agreements due to expire April 16, 2000. This release was for 20 percent
of all of the shares currently subject to lock-up agreements and was effective
with the opening of trading on February 25, 2000. This partial release of the
underwriters' lock-up has no effect on various resale restrictions under
applicable securities laws and regulations that apply to certain stockholders.
Appointment of New President and Chief Operating Officer
On March 1, 2000, we announced that Larry Sanders has been named president and
chief operating officer. He succeeds Jim Moore, who retired effective March 3,
2000. We expect to record additional compensation charges for the quarter ending
April 30, 2000 and thereafter resulting from this transition.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This report contains forward-looking statements, within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, that involve risks and uncertainties, such as statements concerning:
growth and future operating results; developments in our markets and strategic
focus; new products and product enhancements; potential acquisitions and the
integration of acquired businesses, products and technologies; strategic
relationships; and future economic, business and regulatory conditions. Such
forward-looking statements are generally accompanied by words such as "plan,"
"estimate," "expect," "believe," "should," "would," "could," "anticipate," "may"
or other words that convey uncertainty of future events or outcomes. These
forward-looking statements and other statements made elsewhere in this report
are made in reliance on the Private Securities Litigation Reform Act of 1995.
The section below entitled "Factors That May Affect Future Results" sets forth
certain factors that could cause our actual future results to differ materially
from these statements.
OVERVIEW
We are the leading provider of storage routers for storage area
networks, based on our market share of storage routers shipped. Storage routers
are computer equipment that organizations use to connect servers and storage
systems together in a storage area network, or SAN. A SAN is a high speed
computer network that facilitates data transfers among servers and storage
systems using high performance data communications that follow the
industry-accepted rules and conventions, which are commonly referred to as
computer protocols. By using our storage routers to serve as the interconnect
between SANs and the other devices in a computer network, organizations are able
to more effectively and efficiently store, manage and ensure the integrity and
availability of their data.
Our company was originally formed in 1995 as Infinity Commstor, LLC, a
Texas limited liability company. In 1996, Infinity Commstor was merged into a
newly formed Delaware corporation, which became Crossroads Systems, Inc., with
operations conducted through a wholly-owned Texas corporation subsidiary. Since
mid-1996, our operating activities have related primarily to increasing our
research and development capabilities, designing, developing and marketing our
storage routers, staffing our administrative, marketing and sales organizations
and establishing relationships with OEMs and distributors, resellers and system
integrators. We began shipping our first product, the Crossroads 4100 storage
router, to OEMs for their evaluation in July 1997. Prior to that time, our
revenue was derived principally from consulting services related to the
implementation of Fibre Channel components and from the sale of a software
developer's kit used to deploy Fibre Channel systems.
In the past we have experienced fluctuation in the timing of orders
from our OEM customers, and we expect to continue to experience these
fluctuations in the future. These fluctuations have resulted from, among other
things, OEM customers placing initial orders for our products for purposes of
qualification and testing. As a result, we may report an increase in sales or a
commencement of sales of a product in a quarter that will not be followed by
similar sales in subsequent quarters as OEMs conduct qualification and testing.
A key element of our growth strategy is to expand our sales channels.
To this end, we have established relationships with a number of distributors,
resellers and system integrators. Although we anticipate that revenue derived
from sales to distributors, resellers and system integrators will increase as a
percentage of our total revenue in future periods, we expect to continue to
experience significant customer concentration in sales to key OEM accounts for
the foreseeable future.
Although we negotiate the prices for our products on an individual
basis with each of our OEM customers, many of our current agreements with our
OEM customers include provisions that require reductions in the sales price for
our products over time. We believe that this practice is common within our
industry. To date, our agreements with OEM customers, including our largest
customers, provide for quarterly reductions in pricing on a product-by-product
basis ranging from 8% to 15% annually, with the actual discount determined
according to the
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volume potential expected from the customer, the OEM's customer base, the
credibility the OEM may bring to our solution, additional technology the OEM may
help us incorporate with our product and other Crossroads products the OEM
supports. Notwithstanding, the decreases in our average selling prices of our
older products has been offset by higher average selling prices for our newer
products, as well as sales to distributors, resellers and system integrators
where price decreases are not generally required. Nonetheless, we could
experience declines in our average unit selling prices for our products in the
future, especially if our newer products do not receive broad market acceptance
or if our efforts to increase sales to distributors, resellers and system
integrators are not successful. In addition, declines in our average selling
prices may be more pronounced should we encounter significant pricing pressures
from increased competition within the storage router market.
With respect to sales of our products to OEMs, we recognize product
revenue when products are shipped to the OEM. Product sales to distributors,
resellers and system integrators who do not have return rights are recognized at
the time of shipment. To the extent that we sell products to distributors,
resellers and system integrators that have rights of return, we defer revenue
and cost of revenue associated with such sales and recognize these amounts when
that customer sells our products to its customers. At January 31, 2000, our
deferred revenue totaled $171,000. We provide a repair or replace warranty of
between 15 and 39 months following the sale of our products, and we provide a
reserve for warranty costs when the related product revenue is recognized.
To date, we have outsourced substantially all of our manufacturing
requirements to XeTel Corporation, a contract manufacturer, and a significant
portion of our cost of revenue historically has consisted of payments to that
manufacturer. In September 1999, we transitioned the final assembly and test
portion of our manufacturing process from Xetel to an in-house facility.
Beginning in September 1999, we have incurred and expect to continue to incur
monthly charges of $61,500 related to rent, payroll and other operating expenses
due to this transition. During the transition period, our manufacturing costs
increased, and our gross profit decreased, as we incurred costs of final
assembly and test performed both by us and our contract manufacturer. We believe
that bringing final assembly and test operations in-house has allowed us to
reduce our total manufacturing costs on a per unit basis and provides us with
greater flexibility to respond to changes in customer demand. As the needs of
our customers continue to evolve, we plan to reassess our manufacturing
requirements on a periodic basis and effect appropriate changes to our
manufacturing processes.
In connection with the grant of stock options to our employees and
directors, we recorded deferred compensation during fiscal 1998 and 1999
aggregating approximately $5.0 million. Deferred compensation represents, for
accounting purposes, the difference between the deemed fair value of the common
stock underlying these options and their exercise price at the date of grant.
The difference has been recorded as deferred stock-based compensation and is
being amortized over the vesting period of the applicable options, generally
four years. Of the total deferred compensation amount, approximately $1.9
million has been amortized as of January 31, 2000. The amortization of deferred
compensation is recorded as an operating expense. We currently expect to
amortize the remaining amounts of deferred compensation as of January 31, 2000
in the periods indicated:
February 1, 2000 to October 31, 2000............... $1,575,000
November 1, 2000 to October 31, 2001............... 950,000
November 1, 2001 to October 31, 2000............... 425,000
November 1, 2002 to July 31, 2003.................. 80,000
----------
$3,030,000
==========
We have incurred significant operating losses in every fiscal quarter
and annual period since November 1, 1995 and our accumulated deficit was $14.3
million at January 31, 2000. Moreover, we anticipate that we will continue to
incur net losses on both a quarterly and annual basis for the foreseeable
future, in part due to our plans to devote substantial resources to expand our
sales and marketing and research and development activities.
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As of January 31, 2000, we had approximately $10.6 million of federal
net operating loss carryforwards. These net operating loss carryforwards begin
to expire in 2011. We have not recognized any benefit from the future use of
loss carryforwards for these periods or for any other periods since inception
due to uncertainties regarding the realization of deferred tax assets based on
our taxable earnings history.
RESULTS OF OPERATIONS
The following table sets forth our consolidated financial data for the
periods indicated expressed as a percentage of our total revenue.
THREE MONTHS ENDED JANUARY
31,
---------------------------
1999 2000
------------ ------------
Revenue:
Product revenue ........................ 98.1% 98.8%
Other revenue .......................... 1.9 1.2
------------ ------------
Total revenue .................. 100.0 100.0
Cost of revenue .......................... 56.1 52.7
------------ ------------
Gross profit ............................. 43.9 47.3
------------ ------------
Operating expenses:
Sales and marketing .................... 23.9 25.2
Research and development ............... 26.0 22.6
General and administrative ............. 13.6 15.0
Amortization of stock-based compensation 1.5 7.8
------------ ------------
Total operating expenses ....... 65.0 70.6
------------ ------------
Loss from operations ..................... (21.1) (23.3)
Other income, net ........................ 1.0 12.8
------------ ------------
Net loss..................................
(20.1)% (10.5)%
============ ============
COMPARISON OF FISCAL QUARTERS ENDED JANUARY 31, 1999 AND 2000
Revenue. Our total revenue increased 173% from $3.2 million for the
quarter ended January 31, 1999 to $8.8 million for the quarter ended January 31,
2000.
Product revenue. Product revenue increased 175% from $3.2 million for
the quarter ended January 31, 1999 to $8.7 million for the quarter ended January
31, 2000. As a percentage of total revenue, product revenue increased from 98.1%
for the quarter ended January 31, 1999 to 98.8% for the quarter ended January
31, 2000. The increases in product revenue resulted from increased sales of our
storage router product family.
Other revenue. Other revenue includes sales of licenses for a software
developer's kit, consulting fees and fees received from the licensing of other
intellectual property. Other revenue increased 68% from $60,000 for the quarter
ended January 31, 1999 to $101,000 for the quarter ended January 31, 2000. The
increase for the quarter ended January 31, 2000 was due to the license of a
product design for $40,000 in that period. We do not anticipate significant
other revenue in the future.
Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead and
warranty costs. Cost of revenue increased 157% from $1.8 million for the quarter
ended January 31, 1999 to $4.6 million for the quarter ended January 31, 2000.
These increases were primarily due to increases in unit sales volume and a
corresponding increase in costs related to manufacturing. Gross profit increased
194% from $1.4 million for the quarter ended January 31, 1999 to $4.2 million
for the quarter ended
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January 31, 2000. The increase was primarily due to increased product revenue in
each of these periods. Gross profit increased from 43.9% for the quarter ended
January 31, 1999 to 47.3% for the quarter ended January 31, 2000. The increase
in gross profit resulted from favorable customer and product mix in addition to
the benefits of moving our final assembly and test to an in-house facility.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs and other promotional activities. Sales and marketing
expenses increased 187% from $770,000 for the quarter ended January 31, 1999 to
$2.2 million for the quarter ended January 31, 2000. The increase in sales and
marketing expenses for the quarter ended January 31, 2000 was primarily due to
the hiring of additional sales and marketing personnel resulting in
approximately $700,000 of increased compensation expense, including increased
commissions commensurate with greater sales. Sales and marketing personnel
totaled 15 at January 31, 1999 and 48 at January 31, 2000. As a percentage of
total revenue, sales and marketing expenses increased from 24% for the quarter
ended January 31, 1999 to 25% for the quarter ended January 31, 2000. We
anticipate that sales and marketing expenses will continue to increase in
absolute dollars and may fluctuate as a percentage of total revenue, due to the
planned expansion of our sales and marketing efforts and increased marketing
activity that is intended to broaden awareness of the benefits of our products.
Research and development. Research and development expenses consist
primarily of salaries and other personnel-related costs, product development and
prototyping expenses. Research and development expenses increased 137% from
$838,000 for the quarter ended January 31, 1999 to $2.0 million for the quarter
ended January 31, 2000. The increase in research and development expenses was
primarily due to the hiring of additional research and development personnel
resulting in approximately $600,000 of increased compensation expense, increased
prototyping costs of approximately $150,000 related to the development of our
4x50 product line and approximately $200,000 of increased depreciation expense.
Research and development personnel totaled 25 at January 31, 1999 and 60 at
January 31, 2000. As a percentage of total revenue, research and development
expenses decreased from 26% for the quarter ended January 31, 1999 to 23% for
the quarter ended January 31, 2000. The decrease for the quarter ended January
31, 2000 was primarily due to substantially higher revenue in the quarter ended
January 31, 2000. We expect that research and development expenses will continue
to increase in absolute dollars and will fluctuate as a percentage of our total
revenue, due to the importance of research and development in developing our
technologies and expanding our product offerings.
General and administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs, facilities and other
costs of our administrative, executive and information technology departments,
as well as legal and accounting expenses and insurance costs. General and
administrative expenses increased 202% from $436,000 for the quarter ended
January 31, 1999 to $1.3 million for the quarter ended January 31, 2000. The
increase in general and administrative expenses was primarily due to the hiring
of administrative personnel resulting in approximately $400,000 of increased
compensation expense for the quarter ended January 31, 2000 which were necessary
to manage and support the growth in our business as a public company. General
and administrative personnel totaled 11 at January 31, 1999 and 30 at January
31, 2000. As a percentage of total revenue, general and administrative expenses
increased from 14% for the quarter ended January 31, 1999 to 15% for the quarter
ended January 31, 2000. We anticipate that general and administrative expenses
will continue to increase in absolute dollars for the foreseeable future as we
accommodate growth, add related infrastructure and incur expenses related to
being a public company. However, if our revenue continues to increase, general
and administrative expenses should decrease as a percentage of total revenue.
OTHER INCOME, NET
Other income, net consists primarily of interest income on short-term
investments partially offset by interest expense. Other income, net was $33,000
and $1.1 million in the quarters ended January 31, 1999 and 2000, respectively,
representing 1% and 13% of total revenues, respectively. The increase in other
income, net was primarily due to increased cash, cash equivalents and short-term
investment balances resulting from the proceeds from our initial public offering
in October 1999.
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LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity at January 31, 2000 consisted of
$60.1 million in cash and cash equivalents, $14.1 million in short-term
investments and our bank credit facility. The credit facility, as amended and
restated in September 1999, includes a revolving line of credit providing
borrowings up to the lesser of (a) $2.5 million or (b) 80% of eligible accounts
receivable plus 25% of eligible inventories; and an equipment loan agreement
providing for financing up to $1.9 million. Borrowings under the revolving line
of credit bear interest at the bank's prime rate, which was 8.25% at January 31,
2000, and are secured by our accounts receivable and inventories. Term loan
financing available to us under the equipment loan agreement bears interest at
the bank's prime rate plus 0.5%, is secured by the related capital equipment and
is payable through June 30, 2003. The line of credit and the equipment loan
agreement expire in August 2000. The line of credit and equipment loan agreement
contain provisions that prohibit the payment of cash dividends and require the
maintenance of specified levels of tangible net worth and certain financial
performance covenants measured on a monthly basis. In February 2000, we entered
into a $1.0 million letter of credit in connection with the lease requirements
of our new facility. As of January 31, 2000, there were no borrowings
outstanding under the revolving line of credit and no term loans outstanding.
Our bank credit facility requires that we comply with the following
financial covenants:
o a quick ratio of at least 1.50-to-1.00 ("quick ratio" being
defined as the ratio of our consolidated, unrestricted cash; cash
equivalents; net billed accounts receivable; and investments with
maturities of fewer than twelve months to our current
liabilities);
o a debt-to-tangible net worth ratio of not more than 1.00-to-1.00;
and
o a liquidity coverage-to-debt service ratio of not less than
1.50-to-1.00 ("liquidity coverage" being defined as cash plus 80%
of accounts receivable eligible for borrowings).
Additionally, the credit facility requires that we operate at a profit in each
fiscal quarter; however, we are allowed a loss which may not exceed $2.9 million
in each of the fiscal quarters ending October 31, 1999, January 31, 2000 and
April 30, 2000; $2.3 million in the fiscal quarter ending July 31, 2000; and
$1.5 million in the fiscal quarter ending October 31, 2000. During December
1999, we paid all outstanding obligations under our bank credit facility.
Cash utilized by operating activities was $1.1 million for the quarter
ended January 31, 1999 as compared to $2.7 million for the quarter ended January
31, 2000. The increases in net cash utilized reflected increased losses from
operations, working capital required to fund the expansion of our operations and
increases in accounts receivable.
Cash provided by investing activities was $524,000 for the quarter
ended January 31, 1999 as compared to $3.8 million for the quarter ended January
31, 2000. The increases in net cash utilized reflected the maturity of
held-to-maturity investments, net of purchases, of $5.4 million, reduced by
capital expenditures during the period. Capital expenditures were $266,000 for
the quarter ended January 31, 1999 and $1.7 million for the quarter ended
January 31, 2000. These expenditures reflect our investments in computer
equipment and software, test equipment, software development tools and leasehold
improvements, all of which were required to support our business expansion. We
anticipate capital expenditures through fiscal 2000 of at least $9.7 million to
fund our purchase of a new enterprise resource planning system; leasehold
improvements; costs associated with the transition to an in-house facility of
the final assembly and test portions of our manufacturing process, including
modification to our facilities and test and other manufacturing equipment; and
equipment and software to support our projected growth in personnel.
Cash provided by financing activities was $129,000 for the quarter
ended January 31, 1999 as compared to cash utilized by financing activities of
$2.4 million for the quarter ended January 31, 2000. The increase in cash
utilized reflected the
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payment of our existing debt of $2.4 million in December 1999. We have funded
our operations to date primarily through sales of preferred stock and our
initial public offering, resulting in aggregate gross proceeds to us of $98.2
million (which amount includes the $12.0 million of proceeds received from the
private placement of our Series E preferred stock in August 1999), product sales
and, to a lesser extent, bank debt.
We believe the net proceeds we received from our initial public
offering, together with our existing cash balances, the net proceeds from the
sale of our Series E preferred stock and our credit facilities, will be
sufficient to meet our capital requirements through at least the next 12 months.
However, we could be required, or could elect, to seek additional funding prior
to that time. Our future capital requirements will depend on many factors,
including the rate of revenue growth, the timing and extent of spending to
support product development efforts and expansion of sales and marketing
activities, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. In February 2000, we
entered into an agreement to acquire Polaris Communications, Inc. (see page 6)
and we may enter into additional acquisitions or strategic arrangements in the
future which also could require us to seek additional equity or debt financing.
We cannot assure you that additional equity or debt financing, if required, will
be available to us on acceptable terms, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivatives and Hedging Activities," which establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. We do not currently engage or plan to engage in derivative
instruments or hedging activities.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. The application of SAB No. 101
did not have a material impact on the financial statements of the Company.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
Numerous factors may affect our business and future operating results.
These factors include, but are not limited to the potential for significant
losses to continue; our ability to accurately forecast our revenues;
fluctuations in revenue and operating results; overall market performance;
limited product lines; limited number of OEM customers; competition; delays in
research and development; inventory risks; the inability to expand our
distribution channels; the loss of our primary contract manufacturer; risks of
delay or poor execution from a variety of sources; inventory risks; limited
resources; pricing; dependence upon key personnel; international operations;
product liability claims; potential future acquisitions; residual Year 2000
issues; concentration of ownership; and volatility of stock price. The
discussion below addresses some of these factors. For a more thorough discussion
of these and other factors that may affect our business and future results, see
the discussion under the caption "Additional Factors That May Affect Future
Results" in our Annual Report on Form 10-K dated January 31, 2000.
WE HAVE INCURRED SIGNIFICANT LOSSES, WE EXPECT FUTURE LOSSES, AND WE MAY NEVER
BECOME PROFITABLE.
We have incurred significant losses in every fiscal quarter since the
end of fiscal 1996 and expect to continue to incur losses in the future. As of
January 31, 2000, we had an accumulated deficit of $14.3 million. Although our
revenue has grown in recent quarters, we cannot be certain that we will be able
to sustain these growth rates or that we will realize sufficient revenue to
achieve profitability. We also expect to incur significant product development,
sales and marketing and administrative expenses and, as a result, we expect to
continue to incur losses. We will need to generate significant revenue to
achieve profitability. Moreover, even if we do achieve profitability, we may not
be able to sustain or increase profitability.
DUE TO OUR LIMITED OPERATING HISTORY AND THE UNCERTAIN DEVELOPMENT OF THE
STORAGE AREA NETWORK MARKET, WE MAY HAVE DIFFICULTY ACCURATELY PREDICTING
REVENUE FOR FUTURE PERIODS AND APPROPRIATELY BUDGETING FOR EXPENSES.
We have generated product revenue for approximately three years and,
thus, we have only a short history from which to predict future revenue. This
limited operating experience, combined with the rapidly evolving nature of the
storage area network market in which we sell our products and other factors
which are beyond our control, reduces our ability to accurately forecast our
quarterly and annual revenue. However, we use our forecasted revenue to
establish our expense budget. Most of our expenses are fixed in the short term
or incurred in advance of anticipated revenue. As a result, we may not be able
to decrease our expenses in a timely manner to offset any shortfall of revenue.
We are currently expanding our staffing and increasing our expense levels in
anticipation of future revenue growth. If our revenue does not increase as
anticipated, significant losses could result due to our higher expense levels.
WE HAVE EXPERIENCED AND EXPECT TO CONTINUE TO EXPERIENCE SIGNIFICANT
PERIOD-TO-PERIOD FLUCTUATIONS IN OUR REVENUE AND OPERATING RESULTS, WHICH MAY
RESULT IN VOLATILITY IN OUR STOCK PRICE.
We have experienced and expect to continue to experience significant
period-to-period fluctuations in our revenue and operating results due to a
number of factors, and any such variations and factors may cause our stock price
to fluctuate. Accordingly, you should not rely on the results of any past
quarterly or annual periods as an indication of our future performance.
It is likely that in some future period our operating result will be
below the expectations of public market analysts or investors. If this occurs,
our stock price may drop, perhaps significantly.
A number of factors may particularly contribute to fluctuations in our
revenue and operating results, including:
o the timing of orders from, and product integration by, our
customers, particularly our original equipment manufacturer, or
OEM, customers, and the tendency of these customers to change
their
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order requirements frequently with little or no advance notice to
us;
o the rate of adoption of storage area networks as an alternative
to existing data storage and management systems;
o the ongoing need for storage routing products in storage area
network architectures;
o deferrals of customer orders in anticipation of new products,
services or product enhancements from us or our competitors or
from other providers of storage area network products; and
o the rate at which new markets emerge for products we are
currently developing.
In addition, potential and existing OEM customers often place initial
orders for our products for purposes of qualification and testing. As a result,
we may report an increase in sales or a commencement of sales of a product in a
quarter that will not be followed by similar sales in subsequent quarters as
OEMs conduct qualification and testing. This order pattern has in the past and
could in the future lead to fluctuations in quarterly revenue and gross profits.
OUR BUSINESS IS DEPENDENT ON THE STORAGE AREA NETWORK MARKET WHICH IS NEW AND
UNPREDICTABLE, AND IF THIS MARKET DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE,
OUR BUSINESS WILL SUFFER.
Fibre Channel-based storage area networks, or SANs, were first deployed
in 1997. As a result, the market for SANs and related storage router products
has only recently begun to develop and is rapidly evolving. Because this market
is new, it is difficult to predict its potential size or future growth rate. Our
products are used exclusively in SANs and, therefore, our business is dependent
on the SAN market. Accordingly, the widespread adoption of SANs for use in
organizations' computing systems is critical to our future success. Most of the
organizations that potentially may purchase our products from our customers have
invested substantial resources in their existing computing and data storage
systems and, as a result, may be reluctant or slow to adopt a new approach like
SANs. SANs are often implemented in connection with the deployment of new
storage systems and servers. Therefore, our future success is also substantially
dependent on the market for new storage systems and servers. Furthermore, the
ability of the different components used in a SAN to function effectively, or
interoperate, with each other when placed in a computing system has not yet been
achieved on a widespread basis. Until greater interoperability is achieved,
customers may be reluctant to deploy SANs. Our success in generating revenue in
the emerging SAN market will depend on, among other things, our ability to:
o educate potential OEM customers, distributors, resellers, system
integrators and end-user organizations about the benefits of SANs
and storage router technology, including, in particular, the
ability to use storage routers with SANs to improve system backup
and recovery processes;
o maintain and enhance our relationships with OEM customers,
distributors, resellers, system integrators and end-user
organizations;
o predict and base our products on standards which ultimately
become industry standards; and
o achieve interoperability between our products and other SAN
components from diverse vendors.
WE HAVE LIMITED PRODUCT OFFERINGS AND OUR SUCCESS DEPENDS ON OUR ABILITY TO
DEVELOP IN A TIMELY MANNER NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET
ACCEPTANCE.
We currently have only three principal products within our storage
router product family that we sell in commercial quantities. In particular,
sales of our 4100 product have accounted for the vast majority of our product
revenue to date. To reduce our dependence on the 4100 product, we must
successfully develop and introduce to market new products and product
enhancements in a timely manner. Even if we are able to develop and commercially
introduce new products and enhancements, these new products or enhancements may
not achieve
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market acceptance which could reduce our revenue.
Factors that may affect the market acceptance of our products, some of
which are beyond our control, include the following:
o growth of, and changing requirements of customers within, the SAN
and storage router markets;
o performance, quality, price and total cost of ownership of our
products;
o availability, performance, quality and price of competing
products and technologies;
o our customer service and support capabilities and responsiveness;
and
o successful development of our relationships with existing and
potential OEM, distributor, reseller and system integrator
customers.
WE DEPEND ON A LIMITED NUMBER OF OEM CUSTOMERS FOR THE VAST MAJORITY OF OUR
REVENUE, AND THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY OEM
CUSTOMER WOULD SIGNIFICANTLY REDUCE OUR REVENUE.
In fiscal 1998, 1999 and the three months ended January 31, 2000,
approximately 90%, 85% and 84% of our revenue, respectively, was derived from
six OEM customers. Furthermore, during fiscal 1998, our four largest customers
- -- ADIC, Compaq, Hewlett-Packard and StorageTek -- accounted for 25%, 20%, 16%
and 14% of our total revenue, respectively. In fiscal 1999, revenue from Compaq
and StorageTek represented 36% and 36% of our total revenue, respectively.
During the three month period ended January 31, 2000, Compaq and StorageTek
represented 33% and 43% or our total revenue, respectively. We rely on OEMs as a
primary distribution channel as they are able to sell our products to a large
number of end-user organizations, which enables us to achieve broad market
penetration, with limited sales, marketing and customer service and support
resources from us. Our operating results in the foreseeable future will continue
to depend on sales to a relatively small number of OEM customers. Therefore, the
loss of any of our key OEM customers, or a significant reduction in sales to any
one of them, would significantly reduce our revenue.
OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS WHICH DOES NOT ASSURE PRODUCT SALES.
Prior to offering our products for sale, our OEM customers require that
each of our products undergo an extensive qualification process, which involves
interoperability testing of our product in the OEM's system as well as rigorous
reliability testing. This qualification process may continue for a year or
longer. However, qualification of a product by an OEM does not assure any sales
of the product to the OEM. Despite this uncertainty, we devote substantial
resources, including sales, marketing and management efforts, toward qualifying
our products with OEMs in anticipation of sales to them. If we are unsuccessful
or delayed in qualifying any products with an OEM, such failure or delay would
preclude or delay sales of that product to the OEM, which may impede our ability
to grow our business.
DEMAND FOR OUR PRODUCTS DEPENDS SIGNIFICANTLY UPON THE NEED TO INTERCONNECT
SCSI-BASED TAPE STORAGE SYSTEMS WITH FIBRE CHANNEL SANS, AND WE EXPECT TO FACE
COMPETITION FROM MANUFACTURERS OF TAPE STORAGE SYSTEMS THAT INCORPORATE FIBRE
CHANNEL INTERFACES INTO THEIR PRODUCTS.
In traditional computer networks, system backup is accomplished by
transferring data from applications and databases over the servers used in the
network to tape drives or other media where the data is safely stored. Tape
storage devices generally rely on a SCSI connection to interface with the
network in receiving and transmitting data. Our routers enable these SCSI-based
storage devices to interface with the Fibre Channel-based components of the SAN.
Because our routers allow communication between SCSI storage devices and a Fibre
Channel SAN, organizations are able to effect their backup processes over the
SAN rather than through the computer network, enabling the servers of the
network to remain available for other computing purposes. We currently derive
the
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majority of our revenue from sales of storage routers that are used to connect
SCSI-based tape storage systems with SANs. The introduction of tape storage
systems that incorporate Fibre Channel interfaces would enable tape storage
devices to communicate directly with SANs, without using storage routers. We are
aware that a number of manufacturers of storage systems, including several of
our current customers, are developing tape storage systems with embedded Fibre
Channel interfaces, with products expected to be introduced to market in the
near future. If these or other manufacturers are successful in introducing Fibre
Channel-based storage systems, demand for our storage router products would be
materially reduced and our revenue would decline.
OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON UTILIZING EMERGING
TECHNOLOGIES AND STANDARDS, AND ANY DELAY OR ABANDONMENT OF EFFORTS TO DEVELOP
THESE TECHNOLOGIES OR STANDARDS BY INDUSTRY PARTICIPANTS, OR FAILURE OF THESE
TECHNOLOGIES OR STANDARDS TO ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR
COMPETITIVE POSITION.
Our products are intended to complement other SAN products to improve
the performance of computer networks by addressing the input/output bottlenecks
that have emerged between the storage systems and the servers within a computing
system. We have devoted and expect to continue to devote significant resources
to developing products based on emerging technologies and standards that reduce
input/output bottlenecks. A number of large companies in the computer hardware
and software industries are actively involved in the development of new
technologies and standards that are expected to be incorporated in our new
products. Should any of these companies delay or abandon their efforts to
develop commercially available products based on these new technologies and
standards, our research and development efforts with respect to such
technologies and standards likely would have no appreciable value. In addition,
if we do not correctly anticipate new technologies and standards, or if our
products based on these new technologies and standards fail to achieve market
acceptance, our competitors may be better able to address market demand than
would we. Furthermore, if markets for these new technologies and standards
develop later than we anticipate, or do not develop at all, demand for our
products that are currently in development would suffer, resulting in less
revenue for these products than we currently anticipate.
WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE MANUFACTURE
PRODUCTS IN ADVANCE OF BINDING COMMITMENTS FROM OUR CUSTOMERS TO PURCHASE OUR
PRODUCTS.
In order to assure availability of our products for some of our largest
OEM customers, we manufacture products in advance of purchase orders from these
customers based on forecasts provided by them. However, these forecasts do not
represent binding purchase commitments and we do not recognize revenue for such
products until the product is shipped to the OEM. As a result, we incur
inventory and manufacturing costs in advance of anticipated revenue. Because
demand for our products may not materialize, this product delivery method
subjects us to increased risks of high inventory carrying costs and increased
obsolescence and may increase our operating costs.
FAILURE TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS COULD IMPEDE OUR FUTURE GROWTH.
The future growth of our business will depend in part on our ability to
expand our existing relationships with distributors, resellers and system
integrators, develop additional channels for the distribution and sale of our
products and manage these relationships. As part of our growth strategy, we
intend to expand our relationships with distributors, resellers and system
integrators. The inability to successfully execute this strategy could impede
our future growth.
THE LOSS OF OUR PRIMARY CONTRACT MANUFACTURER, OR THE FAILURE TO FORECAST DEMAND
ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR PRIMARY
CONTRACT MANUFACTURER SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY TO
MANUFACTURE AND SELL OUR PRODUCTS.
To date, we have relied on a third-party manufacturer, XeTel
Corporation, to manufacture substantially all of our products on a purchase
order basis. We do not have a long-term supply contract with XeTel and,
therefore, XeTel is not obligated to manufacture products for us for any
specific period, or in any specific quantity, except as
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may be provided in a particular purchase order. Although we believe that other
providers of manufacturing services can adequately address our needs, we expect
that it would take approximately three months to transition the performance of
these services from XeTel to a new manufacturer. We generally place orders for
products with XeTel approximately four months prior to the anticipated delivery
date, with order volumes based on forecasts of demand from our customers.
Accordingly, if we inaccurately forecast demand for our products, we may be
unable to obtain adequate manufacturing capacity from XeTel to meet our
customers' delivery requirements, or we may accumulate excess inventories. We
have on occasion in the past been unable to adequately respond to unexpected
increases in customer purchase orders, and therefore were unable to benefit from
this incremental demand. XeTel has not provided assurances to us that adequate
capacity will be available to us within the time required to meet additional
demand for our products. Recently, we have engaged another contract
manufacturer, Solectron, to make our 4x50 family of products. We believe that
this will enable us to reduce our reliance on XeTel. Our contract with XeTel can
be terminated be either party with 90 days advance written notice.
OUR PLANS TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS TO MARKET REQUIRES
COORDINATION ACROSS OUR SUPPLIERS AND MANUFACTURERS, WHICH EXPOSES US TO RISKS
OF DELAY OR POOR EXECUTION FROM A VARIETY OF SOURCES.
We plan to introduce new products and product enhancements, which will
require that we coordinate our efforts with those of our component suppliers and
our contract manufacturer to rapidly achieve volume production. If we should
fail to effectively manage our relationships with our component suppliers and
our contract manufacturer, or if any of our suppliers or our manufacturer
experiences delays, disruptions, capacity constraints or quality control
problems in its manufacturing operations, our ability to ship products to our
customers could be delayed, and our competitive position and reputation could be
harmed. Qualifying a new component supplier or contract manufacturer and
commencing volume production can be expensive and time consuming. If we are
required to change or choose to change suppliers, we may lose revenue and damage
our customer relationships.
WE HAVE TRANSITIONED THE FINAL ASSEMBLY AND TEST PORTION OF OUR MANUFACTURING
PROCESS TO AN IN-HOUSE FACILITY, WHICH HAS INCREASED OUR FIXED COSTS AND EXPOSED
US TO INCREASED INVENTORY RISKS.
In September 1999, we transitioned our final assembly and product test
operations in-house. Our contract manufacturer previously performed these
activities for us. Although we have personnel with prior experience in managing
assembly and test operations, we have not previously assembled our products, and
we may encounter difficulties and delays in establishing, maintaining or
expanding our internal assembly and test capabilities. Our assembly and test
operations also will require us to increase the number of our full-time and
part-time employees, purchase additional equipment and maintain larger
facilities, all of which will increase our fixed costs. If demand for our
products does not support the effective utilization of these employees and
additional facilities and equipment, we may not realize any benefit from
replacing our contract manufacturer with internal final assembly and testing.
Furthermore, internal final assembly and test operations requires us to manage
and maintain the components used in our products at our facilities. A
significant portion of this inventory will be useful only in the final assembly
of our products. Any decrease in demand for our products could result in a
substantial part of this inventory becoming excess, obsolete or otherwise
unusable. If our internal final assembly and test operations are underused or
mismanaged, we may incur significant costs that could adversely affect our
operating results.
WE DEPEND ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY
COMPONENTS, AND IF WE ARE UNABLE TO BUY THESE COMPONENTS ON A TIMELY BASIS, OUR
DELAYED ABILITY TO DELIVER OUR PRODUCTS TO OUR CUSTOMERS MAY RESULT IN REDUCED
REVENUE AND LOST SALES.
We currently purchase Fibre Channel application specific integrated
circuits and other key components for our products from sole or limited sources.
To date, most of our component purchases have been made in relatively small
volumes. As a result, if our suppliers receive excess demand for their products,
we likely will receive a low priority for order fulfillment as large volume
customers will use our suppliers' available capacity. If we are delayed in
acquiring components for our products, the manufacture and shipment of our
products will also be delayed, which will reduce our revenues and may result in
lost sales. We generally use a rolling six-month forecast of our future product
sales to determine our component requirements. Lead times for ordering materials
and components vary
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significantly and depend on factors such as specific supplier requirements,
contract terms and current market demand for such components. If we overestimate
our component requirements, we may have excess inventory which would increase
our costs. If we underestimate our component requirements, we may have
inadequate inventory which would delay our manufacturing and render us unable to
deliver products to customers on a scheduled delivery date. We also may
experience shortages of certain components from time to time, which also could
delay our manufacturing. Manufacturing delays could negatively impact our
ability to sell our products and damage our customer relationships.
COMPETITION WITHIN OUR MARKETS MAY REDUCE SALES OF OUR PRODUCTS AND REDUCE OUR
MARKET SHARE.
The market for SAN products generally, and storage routers in
particular, is increasingly competitive. We anticipate that the market for our
products will continually evolve and will be subject to rapid technological
change. We currently face competition from ATTO, Chaparral, Pathlight and, to
some extent, Computer Network Technologies. In addition, our OEM customers could
develop products or technologies internally that would replace their need for
our products and would become a source of competition. We expect to face
competition in the future from storage system industry suppliers, including
manufacturers and vendors of other SAN products or entire SAN systems, as well
as innovative start-up companies. For example, manufacturers of Fibre Channel
hubs or switches could seek to include router functionality within their SAN
products which would obviate the need for our storage routers. As the market for
SAN products grows, we also may face competition from traditional networking
companies and other manufacturers of networking products. These networking
companies may enter the storage router market by introducing their own products
or by entering into strategic relationships with or acquiring other existing SAN
product providers.
WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF OUR
CURRENT AND POTENTIAL COMPETITORS.
Some of our current and potential competitors have longer operating
histories, significantly greater resources, broader name recognition and a
larger installed base of customers than we have. As a result, these competitors
may have greater credibility with our existing and potential customers. They
also may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than us to new or
emerging technologies or changes in customer requirements. In addition, some of
our current and potential competitors have already established supplier or joint
development relationships with decision makers at our current or potential
customers. These competitors may be able to leverage their existing
relationships to discourage these customers from purchasing products from us or
to persuade them to replace our products with their products. Increased
competition could decrease our prices, reduce our sales, lower our margins, or
decrease our market share. These and other competitive pressures may prevent us
from competing successfully against current or future competitors, and may
materially harm our business.
WE HAVE LICENSED OUR 4200 STORAGE ROUTER TECHNOLOGY TO A STOCKHOLDER THAT IS
ALSO A KEY CUSTOMER, WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.
We have licensed our 4200 storage router technology to Hewlett-Packard.
Hewlett-Packard is a stockholder of our company and a key customer. While
Hewlett-Packard has not introduced to market any products competitive to ours
that use the licensed technology, it could potentially do so in the future.
Because Hewlett-Packard has vastly greater resources and distribution
capabilities than Crossroads, it could establish market acceptance in a
relatively short time frame for any competitive products that it may introduce,
which, in turn, would reduce demand for our products from Hewlett-Packard and
could reduce demand for our products from other customers.
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WE EXPECT UNIT PRICES OF OUR PRODUCTS TO DECREASE OVER TIME, AND IF WE CANNOT
INCREASE OUR SALES VOLUMES OUR REVENUE WILL DECLINE.
Many of our agreements with OEM customers provide for decreases in the
price of our products over time. In addition, we anticipate that, as products in
the SAN market become standardized and more widely available, we may need to
reduce the average unit selling price of our products in the future to respond
to competitive pricing pressures or new product introductions by our
competitors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volume, our revenue will decline.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUE.
Networking products such as ours frequently contain undetected software
or hardware errors when first introduced or as new versions are released. Our
products are complex and errors have been found in the past and may be found
from time to time in the future. In addition, our products include components
from a number of third-party vendors. We rely on the quality testing of these
vendors to ensure the adequate operation of their products. Because our products
are manufactured with a number of components supplied by various third-party
sources, should problems occur in the operation or performance of our products,
it may be difficult to identify the source. In addition, our products are
deployed within SANs from a variety of vendors. Therefore, the occurrence of
hardware and software errors, whether caused by our or another vendor's SAN
products, could adversely affect sales of our products. Furthermore, defects may
not be discovered until our products are already deployed in the SAN. These
errors also could cause us to incur significant warranty, diagnostic and repair
costs, divert the attention of our engineering personnel from our product
development efforts and cause significant customer relations and business
reputation problems. We are currently aware of a defect in a module purchased
from a component supplier that was incorporated into some of our installed
products. While we no longer include this module in new products, the existence
of this defective module in our installed product base could result in product
returns and future loss of business.
WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL AND HIRE
ADDITIONAL PERSONNEL, OUR ABILITY TO SELL OUR PRODUCTS COULD BE HARMED.
We believe our future success will depend in large part upon our
ability to attract and retain highly skilled managerial, engineering and sales
and marketing personnel. In particular, due to the relatively early stage of our
business, we believe that our future success is highly dependent on Brian R.
Smith, our co-founder, chief executive officer and chairman of the board, to
provide continuity in the execution of our growth plans. We do not have
employment contracts with any of our key personnel. We have experienced
difficulty in hiring engineers with appropriate qualifications in networking,
routing and storage technologies and we may not be successful in attracting and
retaining sufficient levels of such engineers to support our anticipated growth.
The loss of the services of any of our key employees, the inability to attract
or retain qualified personnel in the future or delays in hiring required
personnel, particularly engineers and sales personnel, could delay the
development and introduction of, and negatively impact our ability to sell, our
products.
TO MANAGE OUR GROWTH AND EXPANSION, WE PLAN TO RELOCATE TO NEW FACILITIES AND
UPGRADE AND IMPLEMENT OUR ENTERPRISE RESOURCE PLANNING SYSTEM, WHICH MAY DISRUPT
OUR BUSINESS.
Our rapid growth in personnel and operations has placed, and will
continue to place, a significant strain on our management and operational
resources, including our physical facilities and enterprise resource planning
system. We plan to continue to aggressively expand our operations to pursue
existing and potential market opportunities. We plan to relocate our
headquarters facility to a larger facility in the near future. In addition, we
have selected and are currently implementing a new enterprise resource planning
system in order to integrate manufacturing, resource planning and financial
accounting. We expect these changes to be disruptive, time-
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consuming and expensive processes. If we are unsuccessful or experience delays
in effecting these changes, our ability to effectively manage our operations may
be compromised.
WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY, WHICH WILL
SUBJECT US TO ADDITIONAL BUSINESS RISKS.
To date, a significant portion of our products that are purchased by
OEMs are shipped to their end-user customers in international markets. We intend
to open sales offices in international markets to focus on expanding our
international sales activities in Europe and the Pacific Rim region. Our planned
international sales growth will be limited if we are unable to expand our
international sales channel relationships, hire additional personnel and develop
relationships with international distributors, resellers, system integrators and
service providers. We may not be able to maintain or increase international
market demand for our products. Our international sales activities are subject
to a number of risks, including:
o increased complexity and costs of managing international
operations;
o protectionist laws and business practices that favor local
competition in some countries;
o multiple, conflicting and changing laws, regulations and tax
schemes;
o longer sales cycles;
o greater difficulty in accounts receivable collection and longer
collection periods; and
o political and economic instability.
To date, all of our sales to international customers have been
denominated in U.S. dollars. As a result, an increase in the value of the U.S.
dollar relative to foreign currencies could make our products more expensive for
our customers to purchase, thus rendering them less competitive.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE.
Our products rely on our proprietary technology, and we expect that
future technological advancements made by us will be critical to sustain market
acceptance of our products. Therefore, we believe that the protection of our
intellectual property rights is and will continue to be important to the success
of our business. We rely on a combination of patent, copyright, trademark and
trade secret laws and restrictions on disclosure to protect our intellectual
property rights. We also enter into confidentiality or license agreements with
our employees, consultants and business partners, and control access to and
distribution of our software, documentation and other proprietary information.
Despite these efforts, unauthorized parties may attempt to copy or otherwise
obtain and use our products or technology. Monitoring unauthorized use of our
products is difficult, and we cannot be certain that the steps we have taken
will prevent unauthorized use of our technology, particularly in foreign
countries where applicable laws may not protect our proprietary rights as fully
as in the United States.
OUR EFFORTS TO PROTECT OUR INTELLECTUAL PROPERTY MAY CAUSE US TO BECOME INVOLVED
IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM OUR BUSINESS.
In recent years, there has been significant litigation in the United
States involving patents, trademarks and other intellectual property rights.
Although we have not been involved in intellectual property litigation, we may
become involved in litigation in the future to protect our intellectual property
or defend allegations of infringement asserted by others. Legal proceedings
could subject us to significant liability for damages or invalidate our
intellectual property rights. Any litigation, regardless of its outcome, would
likely be time consuming and expensive to resolve and would divert management's
time and attention. Any potential intellectual property litigation also could
force us to take specific actions, including:
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o cease selling our products that use the challenged intellectual
property;
o obtain from the owner of the infringed intellectual property
right a license to sell or use the relevant technology or
trademark, which license may not be available on reasonable
terms, or at all; or
o redesign those products that use infringing intellectual property
or cease to use an infringing trademark.
ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION.
As part of our growth strategy, we intend to review opportunities to
acquire other businesses or technologies that would complement our current
products, expand the breadth of our markets or enhance our technical
capabilities. For example, in February 2000, we entered into an agreement to
acquire Polaris Communications, Inc.. Acquisitions entail a number of risks that
could materially and adversely affect our business and operating results,
including:
o problems integrating the acquired operations, technologies or
products with our existing business and products;
o diversion of management's time and attention from our core
business;
o difficulties in retaining business relationships with suppliers
and customers of the acquired company;
o risks associated with entering markets in which we lack prior
experience; and
o potential loss of key employees of the acquired company.
OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY
CUSTOMERS IN OUR MARKET.
Our products comprise only a part of a SAN. All components of a SAN
must uniformly comply with the same industry standards in order to operate
efficiently together. We depend on companies that provide other components of
the SAN to support prevailing industry standards. Many of these companies are
significantly larger and more influential in effecting industry standards than
we are. Some industry standards may not be widely adopted or implemented
uniformly, and competing standards may emerge that may be preferred by OEM
customers or end users. If larger companies do not support the same industry
standards that we do, or if competing standards emerge, our products may not
achieve market acceptance which would adversely affect our business.
RESIDUAL YEAR 2000 ISSUES MAY DISRUPT OUR OPERATIONS, SUBJECT US TO LIABILITIES
AND COSTS AND AFFECT THE TIMING OF OUR REVENUES.
The Year 2000 computer problem refers to the potential for system and
processing failures of date-related data as a result of computer controlled
systems using two digits rather than four to define the applicable year. For
example, software programs that have time-sensitive components may recognize a
date represented as "00" as the year 1900 rather than the year 2000.
Because our products are used in connection with other products,
residual Year 2000 problems affecting these products could cause our products to
fail. If residual Year 2000 problems cause the failure of any of the technology,
software or systems necessary to use our products or operate our business, we
could lose customers, suffer significant disruptions on our business, lose
revenues and incur substantial liabilities and expenses. We could also become
involved in costly litigation resulting from Year 2000 problems. This could
materially and adversely affect our business, financial condition and results of
operations.
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INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER OUR COMPANY AND COULD
DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL.
At January 31, 2000, our executive officers and directors, and their
respective affiliates, beneficially owned, in the aggregate, 12,253,175 shares
of our outstanding common stock. As a result, these stockholders will be able to
exert significant control over all matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. This concentration of voting power could delay or prevent an
acquisition of our company on terms which other stockholders may desire.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT, DELAY OR
IMPEDE A CHANGE IN CONTROL OF US AND MAY REDUCE THE MARKET PRICE OF OUR COMMON
STOCK.
Provisions of our certificate of incorporation and bylaws could have
the effect of discouraging, delaying or preventing a merger or acquisition that
a stockholder may consider favorable. We also are subject to the anti-takeover
laws of the State of Delaware which may discourage, delay or prevent someone
from acquiring or merging with us, which may adversely affect the market price
of our common stock.
OUR STOCK PRICE MAY BE VOLATILE.
The market price of our common stock has been volatile in the past and
may be volatile in the future. The market price of our common stock may be
significantly affected by the following factors:
o actual or anticipated fluctuations in our operating results;
o changes in financial estimates by securities analysts or our
failure to perform in line with such estimates;
o changes in market valuations of other technology companies,
particularly those that sell products used in SANs;
o announcements by us or our competitors of significant technical
innovations, acquisitions, strategic partnerships, joint ventures
or capital commitments;
o introduction of technologies or product enhancements that reduce
the need for storage routers;
o the loss of one or more key OEM customers; and
o departures of key personnel.
The stock market has experienced extreme volatility that often has been
unrelated to the performance of particular companies. These market fluctuations
may cause our stock price to fall regardless of our performance.
OF OUR TOTAL OUTSTANDING SHARES, 18,489,435, OR 69%, ARE RESTRICTED FROM
IMMEDIATE RESALE BUT MAY BE SOLD INTO THE MARKET IN THE NEAR FUTURE. THIS COULD
CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DROP SIGNIFICANTLY, EVEN IF OUR
BUSINESS IS DOING WELL.
At March 1, 2000, we had 26,609,923 shares of common stock outstanding.
This includes the 8,120,488 shares, which are currently freely tradeable,
including 3,807,988 shares released from lock-up restrictions on February 25,
2000 by the underwriters of our initial public offering, unless they are
purchased by our "affiliates" as such term is defined in the Securities Act. The
remaining 18,489,435 shares will become available for resale in the public
market as shown in the chart below.
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% OF TOTAL
NUMBER OF SHARES SHARES OUTSTANDING DATE OF AVAILABILITY FOR RESALE INTO THE PUBLIC MARKET
- ----------------- ------------------ ------------------------------------------------------
8,120,488 31% Immediately (except to the extent purchased by our
affiliates).
14,200,738 53% These shares will become freely tradeable on April 16,
2000 due to an agreement these stockholders have with the
underwriters of our initial public offering. However, the
underwriters can waive this restriction and allow these
stockholders to sell their shares at any time without
prior notice.
4,288,697 16% These shares are restricted securities as defined in Rule
144 of the Securities Act, and will become freely
tradeable on a date after April 16, 2000 unless they are
purchased by our affiliates.
As restrictions on resale end, the market price of our stock could drop
significantly if the holders of restricted shares sell them or are perceived by
the market as intending to sell them.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information concerning market risk is contained on Page 33 of our 1999 Annual
Report on Form 10-K and is incorporated by reference to such annual report.
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CROSSROADS SYSTEMS, INC. AND SUBSIDIARY
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
From November 1, 1999 through January 31, 2000, we issued approximately
40,902 shares of our common stock to employees pursuant to exercises of stock
options (with exercise prices ranging from $0.50 to $18.00 per share) under our
stock plans. These issuances were deemed exempt from registration under Section
5 of the Securities Act of 1933 in reliance upon Rule 701 thereunder. In
addition, the recipients of securities in each such transaction represented
their intentions to acquire the securities for investment only and not with a
view to, or for sale in connection with, any distribution thereof and
appropriate restrictive transfer legends were affixed to the share certificates
issued in each such transaction.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit Index
Exhibit Number Description
27.1 Financial Data Schedule
(b) Reports on Form 8-K
After January 31, 2000, we filed a Current Report on Form 8-K dated
February 3, 2000 (Item 5) reporting the execution of an Agreement and
Plan of Merger and Reorganization with Polaris Communications, Inc.
and the resignation of Ms. Wo Overstreet as a director of the Company.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CROSSROADS SYSTEMS, INC.
March 15, 2000 /s/ Brian R. Smith
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(Date) Brian R. Smith
Chairman of the Board and Chief Executive Officer
(Principal executive officer)
March 15, 2000 /s/ Reagan Y. Sakai
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(Date) Reagan Y. Sakai
Chief Financial Officer
(Principal finance and accounting officer)
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INDEX TO EXHIBITS
Exhibit Number Description
-------------- -----------
27.1 Financial Data Schedule
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