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 APRIL 30, 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:
CROSSROADS SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2846643
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8300 NORTH MOPAC EXPRESSWAY
AUSTIN, TEXAS 78759
(Address of principal executive offices) (Zip Code)
(512) 349-0300
(Registrant's telephone number, including area code)
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 June 13, 2002, Registrant had outstanding 27,395,555 shares of common
stock, par value $0.001 per share.
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of October 31, 2001 and
April 30, 2002................................................... 3
Condensed Consolidated Statements of Operations for the three
months and six months ended April 30, 2001 and 2002.............. 4
Condensed Consolidated Statements of Cash Flows for the six
months ended April 30, 2001 and 2002............................. 5
Notes to Condensed Consolidated Financial Statements............... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 29
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 30
Item 2. Changes in Securities and Use of Proceeds.......................... 31
Item 3. Defaults Upon Senior Securities.................................... 31
Item 4. Submission of Matters to a Vote of Security Holders................ 31
Item 5. Other Information.................................................. 31
Item 6. Exhibits and Reports on Form 8-K................................... 31
SIGNATURES................................................................... 32
</Table>
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
OCTOBER 31, APRIL 30,
2001 2002
----------- ---------
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 43,686 $ 10,613
Short-term investments ........................................................ 10,000 31,288
--------- ---------
Total cash, cash equivalents and short-term investments .................. 53,686 41,901
Accounts receivable, net of allowance for doubtful
accounts of $388 and $256, respectively .................................... 3,768 4,823
Inventories, net .............................................................. 3,080 2,953
Prepaids and other current assets ............................................. 1,894 1,685
--------- ---------
Total current assets ..................................................... 62,428 51,362
Notes receivable from related party, net ............................................ 244 179
Property and equipment, net ......................................................... 11,021 9,275
Intangibles, net .................................................................... 997 858
Other assets ........................................................................ 713 704
--------- ---------
Total assets ............................................................. $ 75,403 $ 62,378
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .............................................................. $ 7,070 $ 4,889
Accrued expenses .............................................................. 2,744 1,679
Accrued warranty costs ........................................................ 597 822
Deferred revenue .............................................................. 746 699
--------- ---------
Total current liabilities ................................................ 11,157 8,089
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
27,542,664 and 27,473,435 shares issued and outstanding, respectively ....... 28 27
Additional paid-in capital .................................................... 184,042 185,106
Deferred stock-based compensation ............................................. (3,914) (3,056)
Notes receivable from stockholders ............................................ (118) (122)
Accumulated deficit ........................................................... (115,535) (127,408)
Treasury stock at cost (467,794 and 468,262 shares, respectively) ............. (257) (258)
--------- ---------
Total stockholders' equity ............................................... 64,246 54,289
--------- ---------
Total liabilities and stockholders' equity ............................... $ 75,403 $ 62,378
========= =========
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
--------------------------- ---------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenue:
Product revenue ................................................. $ 9,885 $ 8,963 $ 19,709 $ 17,997
Other revenue ................................................... 329 101 479 264
------------ ------------ ------------ ------------
Total revenue ................................................ 10,214 9,064 20,188 18,261
Cost of revenue (including stock-based compensation expense
of $33, $23, $72 and $47, respectively) .......................... 6,137 5,985 11,013 11,861
------------ ------------ ------------ ------------
Gross profit ......................................................... 4,077 3,079 9,175 6,400
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing (including stock-based compensation
expense of $87, $102, $135 and $291, respectively) ............ 4,426 1,673 8,494 3,983
Research and development (including stock-based
compensation expense of $82, $96, $347 and $175,
respectively) ................................................. 4,062 4,573 8,364 9,757
General and administrative (including stock-based
compensation expense of $1,951, $765, $4,173 and $1,720,
respectively) ................................................. 4,335 2,473 9,051 4,942
Amortization of intangibles ..................................... 3,596 70 7,192 140
------------ ------------ ------------ ------------
Total operating expenses ..................................... 16,419 8,789 33,101 18,822
------------ ------------ ------------ ------------
Loss from operations ................................................. (12,342) (5,710) (23,926) (12,422)
Other income, net ............................................ 724 231 1,698 549
------------ ------------ ------------ ------------
Net loss before cumulative effect of accounting change ............... (11,618) (5,479) (22,228) (11,873)
Cumulative effect of accounting change ............................... -- -- (130) --
------------ ------------ ------------ ------------
Net loss ............................................................. $ (11,618) $ (5,479) $ (22,358) $ (11,873)
============ ============ ============ ============
Basic and diluted net loss per share:
Before cumulative effect of accounting change ................... $ (0.42) $ (0.20) $ (0.81) $ (0.44)
Cumulative effect of accounting change .......................... -- -- (0.01) --
------------ ------------ ------------ ------------
Basic and diluted net loss per share ......................... $ (0.42) $ (0.20) $ (0.82) $ (0.44)
============ ============ ============ ============
Shares used in computing basic and
diluted net loss per share ...................................... 27,403,579 27,269,731 27,343,204 27,272,360
============ ============ ============ ============
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
SIX MONTHS ENDED
APRIL 30,
----------------------
2001 2002
-------- --------
Cash flows from operating activities:
Net loss .............................................. $(22,358) $(11,873)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation ....................................... 2,359 3,208
Amortization of intangibles ........................ 7,192 140
Stock-based compensation ........................... 4,727 2,233
Provision for doubtful accounts receivable ......... 127 (132)
Provision for excess and obsolete inventories ...... 404 474
Changes in assets and liabilities:
Accounts receivable ................................ 330 (923)
Inventories ........................................ (477) (347)
Prepaids and other current assets .................. 481 209
Accounts payable ................................... 1,857 (2,181)
Accrued expenses ................................... (428) (1,065)
Accrued warranty costs ............................. 124 225
Deferred revenue and other ......................... (262) (41)
-------- --------
Net cash used in operating activities .............. (5,924) (10,073)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment .................... (3,233) (1,462)
Purchase of held-to-maturity investments .............. (1,967) (21,288)
Maturity of held-to-maturity investments .............. 17,591 --
Payment of note receivable from related party ......... 89 63
Other assets .......................................... 6 --
-------- --------
Net cash provided by (used in) investing
activities ....................................... 12,486 (22,687)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock ................ 426 356
Purchase of treasury stock ............................ (23) --
Purchase of common stock under open market
stock purchase program ............................. -- (669)
-------- --------
Net cash provided by (used in) financing
activities ....................................... 403 (313)
-------- --------
Net increase (decrease) in cash and cash equivalents ..... 6,965 (33,073)
Cash and cash equivalents, beginning of period ........... 42,447 43,686
-------- --------
Cash and cash equivalents, end of period ................. $ 49,412 $ 10,613
======== ========
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of Crossroads Systems, Inc. ("Crossroads" or the "Company") and its
wholly-owned subsidiaries. Headquartered in Austin, Texas, Crossroads, a
Delaware corporation, is a leading global provider of connectivity for storage
networking solutions. Crossroads sells its products and services primarily to
leading storage system and server original equipment manufacturers,
distributors, resellers, system integrators and storage service providers. The
Company is organized and operates as one business segment. All inter-company
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 year ended October
31, 2001, included in our Annual Report on Form 10-K.
The results of operations for the three months and six months ended April
30, 2002 are not necessarily indicative of results that may be expected for any
other interim period or for the full year.
2. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.
Inventories consist of the following (in thousands):
<Table>
<Caption>
OCTOBER 31, APRIL 30,
2001 2002
----------- ---------
Raw materials ................................................... $ 3,692 $ 3,164
Work-in-process ................................................. -- 3
Finished goods .................................................. 1,168 1,092
------- -------
4,860 4,259
Less: Allowance for excess and obsolete inventory ...... (1,780) (1,306)
------- -------
$ 3,080 $ 2,953
======= =======
</Table>
3. PROPERTY AND EQUIPMENT
The Company's property and equipment are stated at cost and depreciated
using the straight-line method over the estimated useful lives of the respective
assets, generally one to three years for equipment and five years for furniture
and fixtures. Leasehold improvements are amortized on a straight-line basis over
the shorter of the estimated useful life of the related asset or the remaining
life of the lease. Upon retirement or disposition of assets, the cost and
related accumulated depreciation are removed from the accounts, and the related
gains or losses are reflected in operations.
Property and equipment consist of the following (in thousands):
<Table>
<Caption>
OCTOBER 31, APRIL 30,
2001 2002
----------- ---------
Equipment .................................................. $ 17,509 $ 18,750
Furniture and fixtures ..................................... 1,878 1,891
Leasehold improvements ..................................... 906 906
-------- --------
20,293 21,547
-------- --------
Less: accumulated depreciation and amortization ... (9,272) (12,272)
-------- --------
$ 11,021 $ 9,275
======== ========
</Table>
6
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. CONCENTRATIONS
The Company's sales are primarily concentrated in the United States and are
primarily derived from sales to original equipment manufacturers in the computer
storage and server industry. The Company had trade accounts receivable from four
customers, which comprised approximately 36% and 58% of total trade accounts
receivable at October 31, 2001 and April 30, 2002, respectively. The Company
performs credit evaluations of its customers and generally does not require
collateral on accounts receivable balances and provides allowances for potential
credit losses and product sales returns.
The Company's products are concentrated in the storage area network industry
that is highly competitive and subject to rapid technological change. The
Company's supplier arrangement for the production of certain vital components of
its storage routers is concentrated with a small number of key suppliers.
Revenue is concentrated with several major customers. The loss of a major
customer, a change of suppliers or significant technological change in the
industry could affect operating results adversely.
The percentage of sales to significant customers was as follows:
<Table>
<Caption>
THREE MONTHS ENDED
APRIL 30,
-------------------
2001 2002
----- -----
Customer A........................... 3.1% 17.7%
Customer B........................... 19.0% 32.6%
Customer C........................... 18.4% 0.0%
Customer D........................... 19.0% 23.5%
</Table>
The level of sales to any customer may vary from quarter to quarter.
However, we expect that significant customer concentration will continue for the
foreseeable future. The loss of any one of these customers, or a decrease in the
level of sales to any one of these customers, could have a material adverse
impact on the Company's financial condition or results of operations. During
April 2001, Advanced Digital Information Corporation ("ADIC"), Customer C above,
transitioned out of the Company's router products upon consummation of its
acquisition of Pathlight Technology, Inc. ("Pathlight"), which was subsequently
completed on May 11, 2001. Sales to ADIC were approximately $1.9 million and $0
during the three months ended April 30, 2001 and 2002, respectively. In April
2001, we decided to write off inventory specifically related to ADIC resulting
in a charge of approximately $47,000.
5. LINE OF CREDIT
In January 2002, the Company extended its existing line of credit with its
bank. The committed revolving line provides for an advance of up to $3.0 million
with a borrowing base of 80% of eligible accounts receivable. The line of credit
matures on February 1, 2003. As of April 30, 2002, there were no borrowings
outstanding under this revolving line of credit.
6. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
Intellectual Property Litigation
On March 31, 2000, Crossroads filed a lawsuit against Chaparral Network
Storage, Inc. ("Chaparral") alleging that Chaparral has infringed one of its
patents (5,941,972, hereinafter "972 patent") with some of their products. In
September 2001, the jury found that the '972 patent was valid and that all of
Chaparral's RAID and router products that contained LUN Zoning had infringed all
claims of the Crossroads '972 patent. The federal judge in this matter issued a
permanent injunction against Chaparral from manufacturing any RAID or router
product that contained LUN Zoning or access controls and assessed punitive
damages. As a result, the Company was awarded damages with a royalty amount of
5% for Chaparral's router product line and 3% for their RAID product line.
Chaparral has appealed the judgment against it, contending that the '972 patent
is invalid and not infringed. Crossroads intends to vigorously defend the
appeal.
7
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On April 14, 2000, Crossroads filed a lawsuit against Pathlight Technology,
Inc. alleging that Pathlight has infringed one of its patents with their SAN
Data Gateway Router. Pathlight was subsequently acquired by ADIC on May 11,
2001. In June 2001, ADIC paid the Company $15.0 million in connection with the
settlement of this lawsuit, this payment was recognized as contra operating
expense in the statement of operations for fiscal 2001. In connection with the
settlement of the lawsuit, the Company granted ADIC a non-exclusive license
under the '972 patent.
On May 19, 2000, Chaparral filed a counter-suit against Crossroads alleging
tortuous interference with prospective business relations. The Company moved to
have this matter dismissed, which the judge ordered, with prejudice in April
2001.
Securities Class Action Litigation
The Company and several of its officers and directors were named as
defendants in several class action lawsuits filed in the United States District
Court for the Western District of Texas. The plaintiffs in the actions purport
to represent purchasers of our common stock during various periods ranging from
January 25, 2000 through August 24, 2000. The Court consolidated the actions and
appointed a lead plaintiff under the Private Securities Litigation Reform Act of
1995. The amended consolidated complaint was filed in February 2001 and the
Company filed a motion to dismiss, which was denied. The plaintiffs are seeking
unspecified amounts of compensatory damages, interests and costs, including
legal fees. The Company denies the allegations in the complaint and intends to
defend itself vigorously. The class action lawsuit is still at an early stage.
Consequently, it is not possible at this time to predict whether the Company
will incur any liability or to estimate the damages, or the range of damages, if
any, that the Company might incur in connection with this lawsuit. The inability
of the Company to prevail in this action could have a material adverse effect on
the Company's future business, financial condition and results of operations.
Derivative State Action
On November 21, 2001, a derivative state action was filed in the 261st
District Court of Travis County, Texas on behalf of Crossroads by James Robke
and named several of its officers and directors as defendants. The derivative
state action is based upon the same general set of facts and circumstances
outlined above in connection with the purported securities class action
litigation. The derivative state action alleges that certain of the individual
defendants sold shares while in possession of material inside information in
purported breach of their fiduciary duties to Crossroads. The derivative state
action also alleges waste of corporate assets. On January 28, 2002, the Company
filed an answer and general denial to the derivative state action, and special
exceptions based on plaintiff's failure to make a pre-suit demand on the
Company's board of directors. The Company believes the allegations in the
derivative state action are without merit and intends to defend itself
vigorously. The derivative state action is still at an early stage.
Consequently, it is not possible at this time to predict whether the Company
will incur any liability or to estimate the damages, or the range of damages, if
any, that the Company might incur in connection with this action. The inability
of the Company to prevail in this action could have a material adverse effect on
the Company's future business, financial condition and results of operations.
Other
If the Company reduces or cancels production orders with its third party
contract manufacturer, the Company may be required to reimburse its contract
manufacturer for materials purchased on its behalf.
7. STOCK-BASED COMPENSATION
In connection with the grant of certain stock options to our employees and
directors, the Company recorded deferred compensation aggregating $20.8 million
as of April 30, 2002, representing the difference between the deemed fair value
of the common stock underlying these options and their exercise price at the
date of grant. Such amount is presented as a reduction of stockholders' equity
and is being amortized over the vesting period of the applicable individual
options, generally four years. Deferred compensation expense is decreased in the
period of forfeiture for any accrued but unvested compensation arising from the
early termination of an option holder's services. Of the total deferred
compensation amount, approximately $17.7 million has been amortized or cancelled
as of April 30, 2002.
8
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company allocates stock-based compensation to specific line items within
the statement of operations based on the classification of the employees who
received the benefit.
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
------------------- -------------------
2001 2002 2001 2002
------ ------ ------ ------
Cost of revenue .................................. $ 33 $ 23 $ 72 $ 47
Sales and marketing .............................. 87 102 135 291
Research and development ......................... 82 96 347 175
General and administrative ....................... 1,951 765 4,173 1,720
------ ------ ------ ------
Total stock-based compensation .... $2,153 $ 986 $4,727 $2,233
====== ====== ====== ======
</Table>
We expect to amortize the remaining amounts of deferred stock-based
compensation as of April 30, 2002 in the periods indicated (in thousands):
<Table>
<Caption>
YEAR ENDED OCTOBER 31,
---------------------------------------------
2002 2003 2004 TOTAL
------ ------ ------ ------
Cost of revenue ............................. $ 37 $ 21 $ -- $ 58
Sales and marketing ......................... 198 139 5 342
Research and development .................... 174 102 2 278
General and administrative .................. 1,177 1,102 99 2,378
------ ------ ------ ------
Total stock-based compensation ...... $1,586 $1,364 $ 106 $3,056
====== ====== ====== ======
</Table>
8. NET LOSS PER SHARE
In accordance with SFAS No. 128, "Earnings Per Share," ("SFAS No. 128")
basic earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period, less shares subject to repurchase. Diluted earnings per share is
computed by giving effect to all dilutive potential common shares that were
outstanding during the period. Basic 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 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 4,784,653 and
5,711,149 for the six months ended April 30, 2001 and 2002, respectively.
9. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 is effective for all
fiscal quarters of fiscal years beginning after December 15, 1999. Effective
November 1, 2000, the Company adopted SAB No. 101. The adoption of SAB No. 101
resulted in a change in method of revenue recognition for certain product
shipments due to the specified shipping terms for these shipments. The
cumulative effect of this accounting change was approximately $130,000, which
has been included in net loss for the three months ended January 31, 2001. Prior
period financial statements have not been restated to apply SAB No. 101
retroactively.
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations," which requires that all business
combinations be accounted for under the purchase method and defines the criteria
for identifying intangible assets for recognition apart from goodwill. SFAS No.
141 applies to business combinations initiated after June 30, 2001 and all
business combinations accounted for using the purchase method for which the
acquisition date is July 1, 2001 or later. The Company has not initiated any
business combinations subsequent to June 30, 2001; therefore, the adoption of
SFAS No. 141 did not have a material impact on the Company's financial position
or results of operations.
9
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which changes how goodwill and other intangible assets are accounted
for subsequent to their initial recognition. Under this standard, goodwill and
other intangibles assets having indefinite useful lives are no longer amortized,
but are subjected to periodic assessments of impairment. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001. Effective November
1, 2001, the Company early adopted SFAS No. 142. The Company currently does not
have any goodwill; therefore, the adoption of SFAS No. 142 did not have a
material impact on the Company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Impairment of Long-lived
Assets," which supercedes SFAS No. 121, "Accounting for the Impairment of
long-lived Assets and for long-lived Assets to be disposed of". SFAS No. 144
retains the requirements of SFAS No. 121 to (a) recognize an impairment loss if
the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and (b) measure an impairment loss as the difference
between the carrying amount and the fair value of the asset. SFAS No. 144
removes goodwill from its scope. SFAS No. 144 is applicable to financial
statements issued for fiscal years beginning after December 15, 2001, or for the
Company's fiscal year ended October 31, 2003. The adoption of SFAS No. 144 is
not expected to have a material impact on the Company's financial position or
results of operations.
In May 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4,44,
and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002."
This Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. SFAS No. 145 is effective for financial statements issued for fiscal
years beginning after May 15, 2002, the adoption of which is not expected to
have a material impact on the Company's financial position or results of
operations.
10. RELATED PARTY TRANSACTIONS
Notes Receivable
During May 1999, the Company's board of directors approved the acceptance of
full recourse notes in the amount of approximately $442,000 from certain of the
Company's officers as consideration for the exercise of 1,014,999 options. The
notes accrue interest at 7% per year, compounded semi-annually and principal and
accrued interest is due in one lump sum in 2003. In March 2000, the Company
repurchased 232,500 unvested shares for approximately $123,000 and subsequently
collected $114,000 in principal and interest upon the retirement of the
Company's former president and chief operating officer. In June 2000, the
Company repurchased 88,125 unvested shares for approximately $52,000 and
collected approximately $59,000 in principal and interest upon the retirement of
the Company's former vice-president of sales. In January 2001, the Company
repurchased 13,594 unvested shares for approximately $9,000 and collected
approximately $16,000 in principal and interest upon the retirement of the
Company's former vice-president of engineering. The balance of these full
recourse notes was approximately $122,000 as of April 30, 2002.
In October 1999, the Company loaned an officer of the Company $100,000 for
personal reasons, not equity related, in exchange for a full recourse promissory
note due in full, with accrued interest, in 6 years or upon the date in which
the officer ceases to remain in service. The note accrues interest at 7% per
year, compounded annually and principal and accrued interest is due in one lump
sum on December 31, 2006. The balance on this note was approximately $119,000 as
of April 30, 2002.
In July 2000, the Company loaned an employee of the Company $50,000 for
personal reasons, not equity related, in exchange for a full recourse promissory
note due in full, with accrued interest, in 2 years or upon the date in which
the employee ceases to remain in service. The note accrues interest at 10.5% per
year, compounded semi-annually and principal and accrued interest is due in one
lump sum on July 1, 2002. The balance on this note was approximately $60,000 as
of April 30, 2002.
In April 2001, the Company loaned an officer of the Company $45,000 for
personal reasons, not equity related, in exchange for a full recourse promissory
note due in full, with accrued interest, in 6 months or upon the date in which
the officer ceases to remain in service. The note accrues interest at 7.5% per
year, compounded semi-annually and principal and accrued interest is due in one
lump
10
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
sum on October 16, 2001. During the three months ended January 31, 2002, the
Company collected the balance of approximately $47,000 due under this note.
In May 2001, the Company loaned an employee of the Company $25,000 for
personal reasons, not equity related, in exchange for a full recourse promissory
note due in full, with accrued interest, in 18 months or upon the date in which
the employee ceases to remain in service. The note accrues interest at 7.5% per
year, compounded semi-annually and principal and accrued interest is due in one
lump sum on November 14, 2002. During the three months ended April 30, 2002, the
Company collected the balance of approximately $26,000 due under this note.
11. SUBSEQUENT EVENTS
In May 2002, the Company announced that Brian R. Smith, the Company's
founder and chairman, will return as chief executive officer and president,
replacing Larry Sanders effective immediately. Robert C. Sims, formerly vice
president of engineering and operations, has been named chief operating officer
and will also assume management of sales and marketing. Reagan Y. Sakai remains
chief financial officer and will assume other management responsibilities. In
addition, Crossroads reduced its workforce by approximately 25 percent, or 40
people, primarily in the sales, marketing and general and administrative areas.
In the fiscal third quarter, the Company expects to record a one-time charge of
approximately $1.5 million with respect to severance payments and other related
expenses. The Company also may incur certain additional one-time charges during
the fiscal third quarter with respect to facilities consolidation and impairment
of fixed assets, if any, which are undetermined at this time.
In June 2002, the Company announced that the Company's board of directors
approved an extension of the Company's stock repurchase program by approving a
program to repurchase up to $5 million worth of its common stock. The program is
expected to continue for a period not to exceed six months, unless extended by
the Company's board of directors.
11
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.
OVERVIEW
We are the leading provider of enterprise data routing solutions for open
system storage area networks, based on our market share of storage routers
shipped. By using our storage routers to serve as the interconnect between
storage area networks, or 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. Specifically, when used in
storage area networks our storage routers decrease congestion in the transfer of
data within a network, reduce the time required to back up data, improve
utilization of storage resources, and preserve and enhance existing server and
storage system investments.
Our mission is to be the company customers trust to link business with
information regardless of technology or location. Our objective is to maintain
our position as the leading provider of storage routing solutions as storage,
server, and network technologies and markets continue to grow and evolve. The
key elements of our strategy are to 1) be a customer centric, market driven
company, 2) to leverage our market position and core competencies to expand and
diversify our product offerings and 3) to maintain our market leadership by
continuing to invest in intellectual property and interoperability.
We have developed or acquired extensive expertise in several different
input-output (I/O) and networking protocols, including small computer system
interface (SCSI), Fibre Channel, Enterprise Systems Connection (ESCON),
Ethernet, Transmission Control Protocol/Internet Protocol (TCP/IP),
Internet-based SCSI protocol (iSCSI) and InfiniBand. We provide our products in
a variety of configurations including both stand-alone box and library-embedded
router form factors with varying port counts. We have applied our expertise in
these protocols to develop solutions for leading server and storage system
providers such as ACAL, ADIC, ATL, Bell Micro, Compaq, Cranel, Datalink, Dell,
Fujitsu-Siemens, Groupe Bull, Hewlett-Packard, Hitachi Data Systems, IBM,
McDATA, sanrise, StorageTek, Sun Microsystems, Tech Data and Unisys which enable
customers to connect to the information that they require to run their
businesses, regardless of the technology or location.
In August 2001, we announced that we had re-engaged Compaq as a customer,
which had decided to introduce a competitive product in fiscal 2000. Under the
new agreement, Crossroads and Compaq will develop a range of solutions for
protecting data in networked storage environments with first shipments scheduled
in April 2002.
In August 2001, we expanded our product line with the launch of our fourth
generation product line -- the Crossroads 8000 storage router and management
software. The 8000 is the first in a new line of multi-protocol enabled routers
designed to connect storage devices into Fibre Channel and iSCSI storage
networks, and InfiniBand fabrics. One element of the 8000 is the Crossroads
Visual Manager software. This software increases the intelligence in the SAN and
reduces the cost of storage management.
In January 2002, we expanded our product line with the launch of our fifth
generation product line -- the Crossroads 10000 enterprise storage router. The
10000 is a fully redundant, modular storage router that performs protocol and
storage management functions between storage devices and the network. It will
provide multi-protocol connectivity and management of SCSI and Fibre Channel
storage devices into Fibre Channel, iSCSI and InfiniBand storage networks.
In April 2002, we began shipping the first of our Crossroads 10000 network
storage routers for SAN data protection to Compaq Computer Corp., now part of
Hewlett-Packard. Compaq is shipping storage routers for SAN data protection that
increases the reliability, flexibility and performance of tape backup in
networked storage environments through technologies such as server-free backup
and multi-protocol connectivity.
In May 2002, Adaptec, Inc. became the first RAID company to license the
Crossroads `972 patent, which provides access controls vital to networked
storage systems. Adaptec will add this technology to RAID controllers that ship
with its DuraStor(TM) 7220SS, a
12
Fibre Channel-to-SCSI storage subsystem. Specifically, the technology enables
Adaptec's RAID cards to protect data in shared storage from unauthorized access
and overwrites by multiple hosts.
During fiscal 2001, we succeeded in two important lawsuits that demonstrated
our ability to protect important aspects of our intellectual property portfolio.
In June, Pathlight Technology, a wholly owned subsidiary of Advanced Digital
Information Corp., admitted both the validity and infringement of one of our
patents (5,941,972, hereinafter "`972 patent") in a $15 million settlement. In
September, a jury and judge validated that same patent against Chaparral Network
Storage Corporation, while extending the patent's application to all RAID and
router products using Access Controls or LUN zoning, awarding us damages and
punitive damages. To date, we have sold our products primarily to original
equipment manufacturers, or OEMs, of servers and storage systems. These computer
equipment manufacturers sell our storage routers to end-user organizations for
use in their storage area networks. We also sell our storage routers through
companies that distribute, resell or integrate our storage routers as part of a
complete SAN solution. A few OEM customers historically have accounted for a
substantial portion of our revenue. During fiscal 2001, sales to Hewlett-Packard
accounted for 26.4% of our total revenue and sales to StorageTek accounted for
22.8%. During the six months ended April 30, 2002, sales to Hewlett-Packard and
StorageTek respectively accounted for 30.1% and 33.5% of our total revenue.
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. During April 2001, ADIC transitioned out of our router products upon
consummation of its acquisition of Pathlight Technology, Inc., which was
subsequently completed on May 11, 2001. In April 2001, we decided to write off
inventory specifically related to ADIC resulting in a charge of approximately
$47,000. Other 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.
We expect to continue to experience significant customer concentration in
sales to key OEM accounts for the foreseeable future. With respect to sales of
our products to OEMs, we recognize product revenue when products are shipped and
risk of loss has passed 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 the related
cost of revenue associated with such sales and recognize these amounts when that
customer sells our products to its customers. At April 30, 2002, our deferred
revenue totaled approximately $699,000. 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.
In March 2000, we consummated our acquisition of Polaris Communications,
Inc. Polaris was a leading developer and marketer of System 390, or S/390,
mainframe communication interfaces and systems delivering increased connectivity
and bandwidth options to enterprise data centers, focusing on high-speed
connections between open-systems and mainframes. During the third quarter of
fiscal 2001, in response to deteriorating macroeconomic conditions and the
resulting decline in demand and product revenue, we reassessed our product
strategy, initiated a market sizing exercise on our core business and examined
our expense structure in an attempt to realign our business plan to achieve
profitability. The strategic review triggered a reduction in force and an
impairment evaluation of the intangible assets related to the Polaris
acquisition because of indications that the carrying amounts might not be
recoverable based on the expected undiscounted cash flows from the Polaris
business unit. Based on a valuation prepared by an independent third-party
appraisal company, we recorded a write-down of these intangible assets totaling
$25.0 million.
In March 2002, we announced that we have entered into an exclusive reseller
business relationship with Luminex Software, Inc. Under the terms of the
agreement, Luminex will be the exclusive reseller of our mainframe products. The
agreement expands an already existing customer relationship and includes a
license to the hardware, software and firmware designs of our mainframe
products. At the end of the agreement, provided that Luminex meets specified
minimum purchase thresholds, Luminex will have the option to purchase the assets
and intellectual property related to the mainframe products, including the right
to manufacture those products. Luminex has a seven-year history of working with
us as an OEM and shares a similar customer and OEM base. Luminex has hired the
entire Crossroads-Oregon engineering and marketing team, and will operate the
business from its current location in Beaverton, Oregon. With our product line,
Luminex will now provide focused software and hardware development for the Data
Center and Enterprise class of customer. Effective immediately, all
Crossroads-Oregon customers will now be supported by Luminex.
In connection with the grant of stock options to our employees and
directors, we recorded deferred compensation aggregating approximately $20.8
million as of April 30, 2002. Deferred compensation represents, for accounting
purposes, the difference between the deemed fair value of the common stock
underlying these options and their exercise price on 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, typically four
years. Of the total deferred compensation amount, approximately $17.7 million
has been amortized as of April 30, 2002.
13
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
------------------- -------------------
2001 2002 2001 2002
------ ------ ------ ------
Cost of revenue ....................................... $ 33 $ 23 $ 72 $ 47
Sales and marketing ................................... 87 102 135 291
Research and development .............................. 82 96 347 175
General and administrative ............................ 1,951 765 4,173 1,720
------ ------ ------ ------
Total stock-based compensation ......... $2,153 $ 986 $4,727 $2,233
====== ====== ====== ======
</Table>
We expect to amortize the remaining amounts of deferred stock-based
compensation as of April 30, 2002 in the periods indicated (in thousands):
<Table>
<Caption>
YEAR ENDED OCTOBER 31,
---------------------------------------------
2002 2003 2004 TOTAL
------ ------ ------ ------
Cost of revenue ............................. $ 37 $ 21 $ -- $ 58
Sales and marketing ......................... 198 139 5 342
Research and development .................... 174 102 2 278
General and administrative .................. 1,177 1,102 99 2,378
------ ------ ------ ------
Total stock-based compensation ...... $1,586 $1,364 $ 106 $3,056
====== ====== ====== ======
</Table>
In fiscal 2000, we purchased shares of Series A preferred stock of
Banderacom Corporation (formerly known as INH Semiconductor Corporation) for
$99,999. In fiscal 2001, we purchased shares of Series B preferred stock of
Banderacom Corporation for $192,000. Banderacom is a fabless semiconductor
company focused on supplying InfiniBand semiconductor devices used to increase
the bandwidth, scalability, and reliability, of computer, networking, storage,
and server system products.
We have ten patents issued, two allowed and twenty-four patent applications
pending in the United States Patent and Trademark Office with respect to our
technology. We have forty-nine pending international patent applications (eleven
in the European Patent Office, ten in Canada, ten in Japan, seven in Australia,
three in Hong Kong, four in Indonesia and four in China). We also have eleven
international patent applications pending under the Patent Cooperation Treaty.
However, none of our patents, including patents that may be issued in the
future, may adequately protect our technology from infringement or prevent
others from claiming that our technology infringes that of third parties.
Failure to adequately protect our intellectual property could materially harm
our business. In addition, our competitors may independently develop similar or
superior technology.
We have incurred significant operating losses in every fiscal quarter and
annual period since November 1, 1995 and our accumulated deficit was $127.4
million at April 30, 2002. As of April 30, 2002, we had approximately $64.1
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. Under the Tax Reform Act of 1986,
the amount of and the benefit from net operating losses that can be carried
forward may be impaired in certain circumstances. Events that may cause changes
in the Company's tax carryovers include, but are not limited to, a cumulative
ownership change of more than 50% over a three-year period.
14
RESULTS OF OPERATIONS
The following table sets forth our consolidated financial data for the
periods indicated expressed as a percentage of our total revenue, including the
aforementioned allocation of stock-based compensation, for all periods
presented. See Item 1, Financial Statements (Unaudited) - Note 7 to Notes to
Condensed Consolidated Financial Statements.
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
--------------------- ---------------------
2001 2002 2001 2002
------ ------ ------ ------
Revenue:
Product revenue ............................... 96.8% 98.9% 97.6% 98.6%
Other revenue ................................. 3.2 1.1 2.4 1.4
------ ------ ------ ------
Total revenue ........................... 100.0 100.0 100.0 100.0
Cost of revenue ...................................... 60.1 66.0 54.5 65.0
------ ------ ------ ------
Gross profit ......................................... 39.9 34.0 45.5 35.0
Operating expenses:
Sales and marketing ........................... 43.3 18.5 42.1 21.8
Research and development ...................... 39.8 50.4 41.4 53.4
General and administrative .................... 42.4 27.3 44.9 27.1
Amortization of intangibles ................... 35.2 0.8 35.6 0.8
------ ------ ------ ------
Total operating expenses ................ 160.7 97.0 164.0 103.1
------ ------ ------ ------
Loss from operations ................................. (120.8) (63.0) (118.5) (68.1)
Other income, net .................................... 7.1 2.6 8.4 3.1
------ ------ ------ ------
Net loss before cumulative effect of acct change ..... (113.7) (60.4) (110.1) (65.0)
Cumulative effect of accounting change ............... -- -- (0.6) --
------ ------ ------ ------
Net loss ............................................. (113.7)% (60.4)% (110.7)% (65.0)%
====== ====== ====== ======
</Table>
COMPARISON OF THREE MONTHS ENDED APRIL 30, 2001 AND 2002
Total revenue. Total revenue decreased 11.3% from $10.2 million for the
three months ended April 30, 2001 to $9.1 million for the three months ended
April 30, 2002.
Product revenue. Product revenue decreased 9.3% from $9.9 million for the
three months ended April 30, 2001 to $9.0 million for the three months ended
April 30, 2002. The decrease was primarily due to the loss of one of our larger
OEM customers, ADIC, which accounted for close to $1.9 million in revenue during
the three months ended April 30, 2001 and no revenue for the three months ended
April 30, 2002. This decrease was partially offset by increased sales to Compaq
of 411% from $314,000 during the three months ended April 30, 2001 to $1.6
million during the three months ended April 30, 2002 as we began shipping the
first of our Crossroads 10000 network storage routers for SAN data protection to
Compaq, now part of Hewlett-Packard. Product sales have shifted to our fourth
and fifth generation of products, the 6000, 8000 and the 10000, and to our
embedded line of products. Sales of our 4100's, 4200's and 4x50 line of products
accounted for approximately 85.9% and 54.2% of our product revenue during the
three months ended April 30, 2001 and 2002, respectively. This decrease was
offset by increased sales of our fourth and fifth generation products, which
accounted for none and approximately 20.1% of our product revenue during the
three months ended April 30, 2001 and 2002, respectively. As storage networking
continues to mature as an industry, we have seen a trend towards simplification
of networking components and management. The impact of this trend on our
business has been the push for, and subsequent ramp up of embedded routers being
shipped with tape libraries. Sales of our embedded products accounted for
approximately 2.6% and 13.8% of our product revenue during the three months
ended April 30, 2001 and 2002, respectively.
15
Other revenue. Other revenue includes sales of maintenance contracts,
consulting fees and fees received from the licensing of other intellectual
property. Other revenue decreased 69.2% from approximately $329,000 for the
three months ended April 30, 2001 to approximately $101,000 for the three months
ended April 30, 2002. During the three months ended April 30, 2002, we
recognized approximately $58,000 of technical service and support revenue,
$20,000 of royalties and approximately $23,000 in other revenue associated with
granting a license to use certain technology acquired from Polaris.
Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue, net of stock-based
compensation of $33,000 and $23,000 during the three months ended April 30, 2001
and 2002, respectively, decreased 2.3% from $6.1 million for the three months
ended April 30, 2001 to $6.0 million for the three months ended April 30, 2002.
Gross profit, net of stock-based compensation, decreased 24.5% from $4.1 million
for the three months ended April 30, 2001 to $3.1 million for the three months
ended April 30, 2002. Gross profit margin, net of stock-based compensation,
decreased from 40.2% for the three months ended April 30, 2001 to 34.2% for the
three months ended April 30, 2002. This decrease in gross margin was primarily
due to a lower margin product mix resulting from the shift to our embedded
routers during fiscal 2002. These embedded routers are lower cost than the
stand-alone box routers and this lower cost is passed on to our OEM customers.
In addition, we shipped 35 free seed units and 85 at cost units as part of our
agreement with Compaq regarding their initial stocking order of our 10000
product, which accounted for approximately 2.5% of the decrease in our gross
margin during the three months ended April 30, 2002. The decrease was also due
to lower margin OEM product sales and the overall product mix.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs, other promotional activities and stock-based compensation.
Sales and marketing expenses, net of stock-based compensation of $87,000 and
$102,000 during the three months ended April 30, 2001 and 2002, respectively,
decreased 63.8% from $4.4 million for the three months ended April 30, 2001 to
$1.6 million for the three months ended April 30, 2002. This decrease in sales
and marketing expenses for the three months ended April 30, 2002 was primarily
due to the reduction in sales and marketing personnel resulting in approximately
$1.7 million of decreased compensation expense and approximately $63,000 of
decreased travel and entertainment expenses. Sales and marketing personnel
decreased from 71 at April 30, 2001 to 21 at April 30, 2002. In addition, this
decrease was also attributable to decreased depreciation and corporate overhead
allocations of approximately $389,000, decreased consulting fees of
approximately $231,000 and decreased prototype expenses of $108,000. As a
percentage of total revenue, sales and marketing expenses decreased from 43.3%
for the three months ended April 30, 2001 to 18.5% for the three months ended
April 30, 2002. We anticipate that sales and marketing expenses may fluctuate as
a percentage of total revenue, due to the reduction of our sales and marketing
expenses, which is intended to enable us to meet our goal of achieving cash flow
break-even by the end of this fiscal year.
Research and development. Research and development expenses consist
primarily of salaries and other personnel-related costs, product development,
prototyping expenses and stock-based compensation. Research and development
expenses, net of stock-based compensation of $82,000 and $96,000 during the
three months ended April 30, 2001 and 2002, respectively, increased 12.5% from
$4.0 million for the three months ended April 30, 2001 to $4.5 million for the
three months ended April 30, 2002. This increase in research and development
expenses was primarily due to approximately $86,000 of increased compensation
expense and approximately $188,000 of increased depreciation expense related to
increased capital spending required to support our ongoing quality efforts and
the interoperability testing of our products. Research and development personnel
totaled 79 at April 30, 2001 and 77 at April 30, 2002. As a percentage of total
revenue, research and development expenses increased from 39.8% for the three
months ended April 30, 2001 to 50.4% for the three months ended April 30, 2002.
We anticipate that research and development expenses may fluctuate as a
percentage of total revenue, due to our ongoing efforts 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 and executive departments, as well as legal and
accounting expenses, insurance costs and stock-based compensation. General and
administrative expenses, net of stock-based compensation of $1.95 million and
$765,000 during the three months ended April 30, 2001 and 2002, respectively,
decreased 28.4% from $2.4 million for the three months ended April 30, 2001 to
$1.7 million for the three months ended April 30, 2002. This decrease in general
and administrative expenses was primarily due to the reduction of administrative
personnel resulting in approximately $399,000 of decreased compensation expense
and decreased legal costs associated with patent infringement lawsuits of
approximately $273,000. General and administrative personnel totaled 46 at April
30, 2001 and 30 at April 30, 2002. As a percentage of total revenue, general and
administrative expenses decreased from 42.4% for the three months ended April
30, 2001 to 27.3% for the three months ended April 30, 2002.
16
COMPARISON OF SIX MONTHS ENDED APRIL 30, 2001 AND 2002
Revenue. Total revenue decreased 9.5% from $20.2 million for the six
months ended April 30, 2001 to $18.3 million for the six months ended April 30,
2002.
Product revenue. Product revenue decreased 8.7% from $19.7 million for
the six months ended April 30, 2001 to $18.0 million for the six months ended
April 30, 2002. The decrease was primarily due to the loss of one of our larger
OEM customers, ADIC, which accounted for approximately $1.9 million in revenue
during the six months ended April 30, 2001 and no revenue for the six months
ended April 30, 2002. As a percentage of total revenue, product revenue
increased from 97.6% for the six months ended April 30, 2001 to 98.6% for the
six months ended April 30, 2002. A significant portion of our product revenue is
generated from sales of the Crossroads 4x50 line of high-performance intelligent
routers that enable companies to realize the benefits of managing their mission
critical data using applications such as server-free backup and LAN-free backup
while protecting the investments made in their current enterprise systems. Sales
of our 4x50 product accounted for approximately 60.3% and 49.2% of our product
revenue during the six months ended April 30, 2001 and 2002, respectively. This
decrease was offset by increased sales of our fourth and fifth generation
products, which accounted for none and approximately 12.0% of our product
revenue during the six months ended April 30, 2001 and 2002, respectively. As
storage networking continues to mature as an industry, we have seen a trend
towards simplification of networking components and management. The impact of
this trend on our business has been the push for, and subsequent ramp of
embedded routers being shipped with tape libraries. Sales of our embedded
products accounted for approximately 1.3% and 25.3% of our product revenue
during the six months ended April 30, 2001 and 2002, respectively.
Other revenue. Other revenue includes sales of maintenance contracts,
consulting fees and fees received from the licensing of other intellectual
property. Other revenue decreased 44.8% from $479,000 for the six months ended
April 30, 2001 to $264,000 for the six months ended April 30, 2002. The decrease
was due to the license of our 4X50 technology of $200,000 from Hewlett-Packard
during the six months ended April 30, 2001.
Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue, net of stock-based
compensation of $72,000 and $47,000 during the six months ended April 30, 2001
and 2002, respectively, increased 8.0% from $10.9 million for the six months
ended April 30, 2001 to $11.8 million for the six months ended April 30, 2002.
Gross profit, net of stock-based compensation, decreased 30.3% from $9.2 million
for the six months ended April 30, 2001 to $6.4 for the six months ended April
30, 2002. Gross profit margin, net of stock-based compensation, decreased from
45.8% for the six months ended April 30, 2001 to 35.3% for the six months ended
April 30, 2002. This decrease in gross margin was primarily due to a lower
margin product mix resulting from the shift to our embedded routers during
fiscal 2002. These embedded routers are lower cost than the stand-alone box
routers and this lower cost is passed on to our OEM customers. The decrease was
also due to lower margin OEM product sales and the overall product mix.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs, other promotional activities and stock-based compensation.
Sales and marketing expenses, net of stock-based compensation of $135,000 and
$291,000 during the six months ended April 30, 2001 and 2002, respectively,
decreased 55.8% from $8.4 million for the six months ended April 30, 2001 to
$3.7 million for the six months ended April 30, 2002. This decrease in sales and
marketing expenses for the six months ended April 30, 2002 was primarily due to
a reduction in sales and marketing personnel from 71 at April 30, 2001 to 21 at
April 30, 2002. The reduction in personnel resulted in a decrease of
compensation expense of approximately $2.5 million. In addition, the reduction
in personnel contributed to the decrease of corporate allocated expenses of
approximately $738,000, decreased professional expenses of approximately
$375,000, decreased equipment/prototype expenses of approximately $177,000,
decreased depreciation expenses of approximately $80,000 and decreased tradeshow
expenses of approximately $51,000. As a percentage of total revenue, sales and
marketing expenses decreased from 42.1% for the six months ended April 30, 2001
to 21.8% for the six months ended April 30, 2002. We anticipate that sales and
marketing may fluctuate as a percentage of total revenue, due to the reduction
of our sales and marketing expenses, which is intended to enable us to meet our
goal of achieving cash flow break-even by the end of this fiscal year.
Research and development. Research and development expenses consist
primarily of salaries and other personnel-related costs, product development,
prototyping expenses and stock-based compensation. Research and development
expenses, net of stock-based compensation of $347,000 and $175,000 during the
six months ended April 30, 2001 and 2002, respectively, increased 19.5% from
$8.0 million for the six months ended April 30, 2001 to $9.6 million for the six
months ended April 30, 2002. This increase in research and development expenses
was primarily due to a change in corporate expense allocation methodology, which
resulted in an increase of approximately $750,000. In addition, in an effort to
retain talented personnel, compensation expenses increased approximately
$390,000 and depreciation expense increased $396,000 as a result of additional
capital expenditures. Research and development personnel totaled
17
79 at April 30, 2001 and 77 at April 30, 2002. As a percentage of total revenue,
research and development expenses increased from 41.4% for the six months ended
April 30, 2001 to 53.4% for the six months ended April 30, 2002. 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, insurance costs and stock-based
compensation. General and administrative expenses, net of stock-based
compensation of $4.2 million and $1.7 million during the six months ended April
30, 2001 and 2002, respectively, decreased 33.9% from $4.9 million for the six
months ended April 30, 2001 to $3.2 million for the six months ended April 30,
2002. This decrease in general and administrative expenses was primarily due to
decreased professional fees associated with patent infringement lawsuits of
approximately $1.0 million and the reduction of administrative personnel
compensation charges of approximately $634,000 as a result of staff
efficiencies. General and administrative personnel totaled 46 at April 30, 2001
and 30 at April 30, 2002. As a percentage of total revenue, general and
administrative expenses decreased from 44.9% for the six months ended April 30,
2001 to 27.1% for the six months ended April 30, 2002. We anticipate that
general and administrative expenses will continue to decrease in absolute
dollars for the foreseeable future as we manage costs. However, if our revenue
continues to decrease, general and administrative expenses could increase 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
approximately $724,000 and $231,000 for the three months ended April 30, 2001
and 2002, respectively, representing 7.1% and 2.5% of total revenue,
respectively. The decrease in other income, net was primarily due to decreased
interest income on short-term investments resulting from weakening macroeconomic
conditions and, thus, lower yields on our investments.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity at April 30, 2002 consisted of $10.6
million in cash and cash equivalents and $31.3 million in short-term
investments.
In February 2000, we entered into a $1.0 million letter of credit in
connection with the lease requirements of our new facility. In January 2002, we
extended our existing line of credit with Silicon Valley Bank. The committed
revolving line is an advance of up to $3.0 million with a borrowing base of 80%
of eligible accounts receivable. The line of credit matures on February 1, 2003.
The line of credit contains 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. As of
April 30, 2002, there were no borrowings outstanding under the revolving line of
credit and no term loans outstanding.
As of April 30, 2002, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As such, we are not exposed to
any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
Cash utilized by operating activities was $5.9 million for the six months
ended April 30, 2001 as compared to $10.1 million for the six months ended April
30, 2002. The increase in net cash utilized reflects increases in accounts
receivable and decreases in accounts payable and accrued expenses of
approximately $4.2 million.
Cash provided by investing activities was $12.5 million for the six months
ended April 30, 2001 as compared to $22.7 million utilized by investing
activities for the six months ended April 30, 2002. The increase in net cash
utilized reflects the purchase of held-to-maturity investments of approximately
$21.3 million during the six months ended April 30, 2002 compared to the
maturity of held-to-maturity investments, net of purchases, of approximately
$15.6 million during the six months ended April 30, 2001. Capital expenditures
were $3.2 million and $1.5 million for the six months ended April 30, 2001 and
2002, respectively. 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 continued research and
development efforts. We anticipate additional capital expenditures through
fiscal 2002 of at least $500,000.
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Cash provided by financing activities was $403,000 for the six months ended
April 30, 2001 as compared to $313,000 utilized for the six months ended April
30, 2002. The increase in net cash utilized reflects the purchase of Crossroads
shares through our open market stock purchase program of approximately $669,000
during the six months ended April 30, 2002. 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 (equipment loan).
We believe our existing cash balances and our credit facilities will be
sufficient to meet our capital requirements beyond 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, the timing of introductions of new products and
enhancements to existing products, and market acceptance of our products.
Additionally, we may enter into acquisitions or strategic arrangements in the
future that 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.
STOCK REPURCHASE PROGRAM
In September 2001, our board of directors authorized the repurchase of up
to $5.0 million of our common stock in the open market pursuant to which we
repurchased 661,300 shares of our common stock for an aggregate of $2.1 million
through April 30, 2002. In June 2002, the board of directors authorized the
extension of our stock repurchase program by approving a program to repurchase
up to $5 million worth of our common stock. The program is effective
immediately, and is expected to continue for a period not to exceed six months
unless extended by our board. Under the plan, the stock will be purchased in the
open market or privately negotiated transactions from time to time in compliance
with the SEC's Rule 10b-18, subject to market conditions, applicable legal
requirements and other factors. The timing and amounts of any purchases will be
as determined by our management from time to time or may be suspended at any
time without prior notice, depending on market conditions and other factors they
deem relevant. The timing and size of any future stock repurchases are subject
to market conditions, stock prices, cash position and other cash requirements.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of our financial condition and results
of operations are based upon our condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to customer programs and incentives, product
returns, bad debts, inventories, intangible assets, warranty obligations,
restructuring and contingencies and litigation. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Our critical accounting policies are as follows:
o Revenue recognition
o Warranty obligations
o Excess and obsolete inventories
Revenue recognition. With respect to sales of our products to OEMs, we
recognize product revenue when products are shipped and risk of loss has passed
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 the related cost of revenue
associated with such sales and recognize these amounts when that customer sells
our products to its customers. Deferred revenues as of April 30, 2002 were
approximately $699,000. As described above, management judgments and estimates
must be made and used in connection with the revenue recognized in any
accounting period. Material differences may result in the amount and timing of
our revenue for any period if our management made different judgments or
utilized different estimates.
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Warranty obligations. We provide for the estimated cost of product
warranties at the time revenue is recognized. These estimates are developed
based on historical information. While we engage in extensive product quality
programs and processes, including actively monitoring and evaluating the quality
of our component suppliers, our warranty obligation is affected by product
failure rates, material usage and service delivery costs incurred in correcting
a product failure. Should actual product failure rates, material usage or
service delivery costs differ from management's estimates, revisions to the
estimated warranty liability would be required.
Excess and obsolete inventories. We write down our inventories for estimated
obsolescence or unmarketable inventory based on the difference between the cost
of inventories and the estimated market value based upon assumptions about
future demand and market conditions. If actual demand and/or market conditions
are less favorable than those projected by management, additional inventory
write-downs may be required.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 is effective for all
fiscal quarters of fiscal years beginning after December 15, 1999. Effective
November 1, 2000, we adopted SAB No. 101. The adoption of SAB No. 101 resulted
in a change in method of revenue recognition for certain product shipments due
to the specified shipping terms for these shipments. The cumulative effect of
this accounting change was approximately $130,000, which has been included in
net loss for the three months ended April 30, 2001. Prior period financial
statements have not been restated to apply SAB No. 101 retroactively.
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations," which requires that all business
combinations be accounted for under the purchase method and defines the criteria
for identifying intangible assets for recognition apart from goodwill. SFAS No.
141 applies to business combinations initiated after June 30, 2001 and all
business combinations accounted for using the purchase method for which the
acquisition date is July 1, 2001 or later. We have not initiated any business
combinations subsequent to June 30, 2001; therefore, the adoption of SFAS No.
141 did not have a material impact on our financial position or results of
operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which changes how goodwill and other intangible assets are accounted
for subsequent to their initial recognition. Under this standard, goodwill and
other intangibles assets having indefinite useful lives are no longer amortized,
but are subjected to periodic assessments of impairment. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001. Effective November
1, 2001, we early adopted SFAS No. 142. We currently do not have any goodwill;
therefore, the adoption of SFAS No. 142 did not have a material impact on our
financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Impairment of long-lived
Assets," which supercedes SFAS No. 121, "Accounting for the Impairment of
long-lived Assets and for long-lived Assets to be disposed of". SFAS No. 144
retains the requirements of SFAS No. 121 to (a) recognize an impairment loss
only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and (b) measure an impairment loss as the difference
between the carrying amount and the fair value of the asset. SFAS No. 144
removes goodwill from its scope. SFAS No. 144 is applicable to financial
statements issued for fiscal years beginning after December 15, 2001, or for our
fiscal year ended October 31, 2003. The adoption of SFAS No. 144 is not expected
to have a material impact on our financial position or results of operations.
In May 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4,44,
and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002."
This Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. SFAS No. 145 is effective for financial statements issued for fiscal
years beginning after May 15, 2002, the adoption of which is not expected to
have a material impact on our financial position or results of operations.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the other information in this Form 10-Q, the following
factors should be considered in evaluating Crossroads and our business. These
factors include, but are not limited to the potential for significant losses to
continue; our inability to accurately predict revenue and budget for expenses
for future periods; fluctuations in revenue and operating results; class action
securities litigation; overall market performance; limited product lines;
limited number of OEM customers; lengthy OEM product qualification process;
competition; delays in research and development; inventory risks; the loss of
our primary contract manufacturers; risks of delay or poor execution from a
variety of sources; inventory risks; limited resources; pricing; dependence upon
key personnel; product liability claims; the inability to protect our
intellectual property rights; concentration of ownership; volatility of stock
price; and the impact on our results or operations due to changes in accounting
standards, including the implementation of SAB NO. 101 with respect to revenue
recognition. The discussion below addresses some of these factors. Additional
risks and uncertainties that we are unaware of or that we currently deem
immaterial also may become important factors that affect us.
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 fiscal
1996 and expect to continue to incur losses in the future. As of April 30, 2002,
we had an accumulated deficit of $127.4 million. We cannot be certain that we
will be able to sustain growth rates that we will need to realize sufficient
revenue to achieve profitability. We also expect to incur significant sales and
marketing, research and development and general and administrative expenses and,
as a result, we expect to continue to incur losses. Our inability to realize the
benefit of the new agreement with Compaq Computer Corporation and the
uncertainty regarding the relationship with Compaq, now a subsidiary of
Hewlett-Packard, may result in less than expected revenue which could affect our
ability to ever 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 AND SHIFTING 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 five years and, thus, we
have only a limited 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 that 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 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 results 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 OEMs, and the tendency of these
customers to change their 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;
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o the 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 emerges 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.
AN ADVERSE DECISION IN THE VARIOUS SECURITIES CLASS ACTION AND DERIVATIVE
LAWSUITS FILED AGAINST US MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND
FINANCIAL PERFORMANCE.
We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. The plaintiffs in the actions purport to represent
purchasers of our common stock during various periods ranging from January 25,
2000 through August 24, 2000. The Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. The
amended consolidated complaint was filed in February 2001 and we filed a motion
to dismiss, which was denied. The litigation is at an early stage and it is not
possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, that we might incur in connection
with such actions. An adverse judgment may have a material adverse effect on our
business and financial performance. See Note 6 to Notes to Condensed
Consolidated Financial Statements.
On November 21, 2001, a derivative state action was filed in the 261st
District Court of Travis County, Texas on behalf of Crossroads by James Robke
and named several of our officers and directors as defendants. The securities
litigation is based upon the same general set of facts and circumstances
outlined above in connection with the purported shareholder class actions. The
derivative state action alleges that certain of the individual defendants sold
shares while in possession of material inside information in purported breach of
their fiduciary duties to Crossroads. The derivative state action also alleges
waste of corporate assets. On January 28, 2002, we filed an answer and general
denial to the derivative state action, and special exceptions based on
plaintiff's failure to make a pre-suit demand on our board of directors. We
believe the allegations in the derivative state action are also without merit
and intend to defend ourselves vigorously. An adverse judgment may have a
material adverse effect on our business and financial performance. See Note 6 to
Notes to Condensed Consolidated Financial Statements.
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
relatively new, it is difficult to predict its potential size or future growth
rate. Substantially all of 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, storage service providers 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, storage system
providers and end-user organizations;
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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 and 4200 products have accounted for the vast majority of our product
revenue to date. To reduce our dependence on these products, we must
successfully develop and introduce to market new products and product
enhancements in a timely manner. On September 1, 2000, we began notifying our
customers that our 4100 product was at its "end of life." Customers who
purchased the 4100 product are continuing to migrate to our next generation of
products that we refer to as the 4x50 product line. While we are continuing to
sell our 4100 product, sales of our 4x50 product accounted for approximately
67.6% and 51.2% of our product revenue during the three months ended April 30,
2001 and 2002, respectively. Our future growth and competitiveness will depend
greatly on the market acceptance of our newly introduced product lines,
including the 6000, 8000 and 10000 storage router. We have just began to receive
revenues from the sale of our 6000, 8000 and 10000 storage routers. However,
their market acceptance remains uncertain. Sales of our 6000, 8000 and 10000
storage routers accounted for none and approximately 20.1% of our product
revenue during the three months ended April 30, 2001 and 2002, respectively. If
either of these two products do not achieve sufficient market acceptance, our
future growth prospects will be seriously affected. Moreover, even if we are
able to develop and commercially introduce new products and enhancements, these
new products or enhancements may not achieve market acceptance that 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, system integrator and storage
system provider customers.
WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF OUR REVENUE.
THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY CUSTOMERS WOULD
SIGNIFICANTLY REDUCE OUR REVENUE AND WOULD SUBSTANTIALLY HARM OUR FUTURE RESULTS
OF OPERATIONS.
In fiscal 1999, 2000, 2001 and the six months ended April 30, 2002,
approximately 84.6%, 68.2%, 61.4% and 73.9% of our revenue, respectively, was
derived from six customers. In fiscal 2001, Hewlett-Packard and StorageTek
represented 26.4% and 22.8% of our total revenue, respectively. During the six
months ended April 30, 2002, Hewlett-Packard and StorageTek represented 30.1%
and 33.5% of our total revenue, respectively. During fiscal 2001, ADIC
transitioned out of our router products upon consummation of its acquisition of
Pathlight Technology. In addition, in May 2002, the merger between
Hewlett-Packard and Compaq was consummated. If we experience any adverse effect
of the acquisition of Compaq by Hewlett-Packard, including the risks due to an
increase in customer concentration, and any change in product focus or strategy
which adversely affects anticipated revenues or margins or our overall
relationship with the newly combined companies or if we are unable to replace
the revenue lost due to ADIC's transition away from our line of storage routers,
our results of operations and future prospects will suffer.
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. In August 2001, we announced that we had
re-engaged Compaq as a customer, which had decided to introduce a competitive
product in fiscal 2000. Under the new agreement, Crossroads and Compaq will
develop a range of solutions for protecting data in networked storage
environments with first delivery shipments scheduled in April 2002. 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.
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OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS THAT 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 an 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 affect 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 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 and risk of loss has passed to the OEM. As
a result, we incur inventory and manufacturing costs in advance of anticipated
revenue. Because demand for our
24
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.
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.
During fiscal 2001, we received our last shipments from XeTel Corporation, a
contract manufacturer; and we have engaged another contract manufacturer,
Solectron, to assemble the printed circuit board for our current shipping
programs, including our 4x50, 6000, 8000, 10000 and embedded router family of
products. We generally place orders for products with our contract manufacturer
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 our contract manufacturer 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. Our contract manufacturer has not provided assurance to
us that adequate capacity will be available to us within the time required to
meet additional demand for our products.
OUR PLANS TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS TO MARKET REQUIRE
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 manufacturers to rapidly achieve volume production. If we should
fail to effectively manage our relationships with our component suppliers and
our contract manufacturers, or if any of our suppliers or our manufacturers
experience delays, disruptions, capacity constraints or quality control problems
in their 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 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 revenue 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 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 that 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 Network Storage and Nishan
Systems. In addition, during 2001, ADIC, one of our OEM customers, acquired
Pathlight Technology whose products are competitive with our 4100 and 4x50
product lines. As a result, ADIC transitioned out of our router products. In
addition, other OEM customers could develop products or technologies internally,
or by entering into strategic relationships with or acquiring other existing SAN
product providers that would replace their need for our products and would
become
25
a source of competition. We expect to face competition in the future from OEMs,
including our customers and potential customers, LAN router manufacturers,
storage system industry suppliers, including manufacturers and vendors of other
SAN products or entire SAN systems, and innovative start-up companies. For
example, manufacturers of Fibre Channel hubs or switches could seek to include
router functionality within their SAN products that 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. This could
introduce additional competition in our markets, especially if one of our OEMs
begins to manufacture our higher end storage routers.
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 AND 4X50 STORAGE ROUTER TECHNOLOGY TO A KEY CUSTOMER,
WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.
We have licensed our 4200 and 4x50 storage router technology to
Hewlett-Packard. Hewlett-Packard currently manufactures the 4200 product under
its name and pays us a royalty. Hewlett-Packard has vastly greater resources and
distribution capabilities than we do, and therefore, 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.
WE EXPECT UNIT PRICES OF OUR PRODUCTS TO DECREASE OVER TIME, AND IF WE CANNOT
INCREASE OUR SALES VOLUMES OUR REVENUE WILL DECLINE.
As storage networking continues to mature as an industry, we have seen a
trend towards simplification of networking components and management. The impact
of this trend on our business has been the push for, and subsequent ramp of
embedded routers being shipped with tape libraries. These embedded routers are
lower cost than the stand-alone box routers and this lower cost is passed on to
our OEM customers. As our mix shifts from box to embedded, we will see a
reduction in average price per unit and revenue will decline if volume does not
increase. Additionally, 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, with the actual
discount determined according to the 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 generally have
been partially 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. 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.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS
THAT COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUE.
Networking products such as ours may 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
26
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 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. We do not have employment contracts with any of our key
personnel. 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.
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. 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
against us could force us to take specific actions, including:
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. This
would 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;
27
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.
INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER OUR COMPANY AND COULD
DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL.
Our executive officers and directors, and their affiliates, beneficially own
a significant portion of the total voting power of our company. 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 us on terms that 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 that 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.
28
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.
THE ISSUANCE BY THE SEC OF AN ACCOUNTING BULLETIN RELATED TO REVENUE
RECOGNITION, SAB NO. 101, MAY HAVE A MATERIAL ADVERSE IMPACT ON OUR FINANCIAL
PERFORMANCE.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No. 101,
"Revenue Recognition in Financial Statements." SAB No. 101 summarizes the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. Effective November 1, 2000, we adopted SAB
No. 101. While SAB No. 101 will not affect the fundamental aspects of our
operations as measured by product shipments and cash flows, implementation of
SAB No. 101 will affect our reported results of operations. It is possible that
SAB No. 101 will result in increased fluctuations in our quarterly operating
results and increase the likelihood that we may fail to meet the expectations of
securities analysts for any period. The adoption of SAB No. 101 resulted in a
change in method of revenue recognition for certain product shipments due to the
specified shipping terms for these shipments. The cumulative effect of this
accounting change was approximately $130,000, which has been included in net
income for the year ended October 31, 2001. Prior period financial statements
have not been restated to apply SAB No. 101 retroactively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information concerning market risk is contained on Pages 31 and 32 of our 2001
Annual Report on Form 10-K and is incorporated herein by reference to the annual
report.
29
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Intellectual Property Litigation
On March 31, 2000, we filed a lawsuit against Chaparral Network Storage,
Inc. ("Chaparral") alleging that Chaparral has infringed one of our patents
(5,941,972, hereinafter "972 patent") with some of their products. In September
2001, the jury found that the '972 patent was valid and that all of Chaparral's
RAID and router products that contained LUN Zoning had infringed all claims of
our '972 patent. The federal judge in this matter issued a permanent injunction
against Chaparral from manufacturing any RAID or router product that contained
LUN Zoning or access controls and assessed punitive damages. As a result, we
were awarded damages with a royalty amount of 5% for Chaparral's router product
line and 3% for their RAID product line. Chaparral has appealed the judgment
against it, contending that the '972 patent is invalid and not infringed. We
intend to vigorously defend the appeal.
On April 14, 2000, we filed a lawsuit against Pathlight Technology, Inc.
alleging that Pathlight has infringed one of our patents with their SAN Data
Gateway Router. Pathlight was subsequently acquired by ADIC on May 11, 2001. In
June 2001, ADIC paid us $15.0 million in connection with the settlement of this
lawsuit, this payment was recognized as contra operating expense in the
statement of operations for fiscal 2001. In connection with the settlement of
the lawsuit, we granted ADIC a non-exclusive license under the '972 patent.
On May 19, 2000, Chaparral filed a counter-suit against us alleging tortuous
interference with prospective business relations. We moved to have this matter
dismissed, which the judge ordered, with prejudice in April 2001.
Securities Class Action Litigation
We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. The plaintiffs in the actions purport to represent
purchasers of our common stock during various periods ranging from January 25,
2000 through August 24, 2000. The Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. The
amended consolidated complaint was filed in February 2001 and we filed a motion
to dismiss, which was denied. The plaintiffs are seeking unspecified amounts of
compensatory damages, interests and costs, including legal fees. We deny the
allegations in the complaint and intend to defend ourselves vigorously. The
class action lawsuit is still at an early stage. Consequently, it is not
possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, if any, that we might incur in
connection with this lawsuit. Our inability to prevail in this action could have
a material adverse effect on our future business, financial condition and
results of operations.
Derivative State Action
On November 21, 2001, a derivative state action was filed in the 261st
District Court of Travis County, Texas on behalf of Crossroads by James Robke
and named several of our officers and directors as defendants. The derivative
state action is based upon the same general set of facts and circumstances
outlined above in connection with the purported securities class action
litigation. The derivative state action alleges that certain of the individual
defendants sold shares while in possession of material inside information in
purported breach of their fiduciary duties to Crossroads. The derivative state
action also alleges waste of corporate assets. On January 28, 2002, we filed an
answer and general denial to the derivative state action, and special exceptions
based on plaintiff's failure to make a pre-suit demand on our board of
directors. We believe the allegations in the derivative state action are without
merit and intend to defend ourselves vigorously. The derivative state action is
still at an early stage. Consequently, it is not possible at this time to
predict whether we will incur any liability or to estimate the damages, or the
range of damages, if any, that we might incur in connection with this action.
Our inability to prevail in this action could have a material adverse effect on
our future business, financial condition and results of operations.
30
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the fiscal quarter ended April 30, 2002, we issued an aggregate
of 2,906 shares of our common stock to employees pursuant to exercises of stock
options that were granted prior to October 19, 1999, the date of our initial
public offering, with exercise prices ranging from $0.50 to $1.00 per share.
These issuances were deemed exempt from registration under Section 5 of the
Securities Act of 1933 in reliance upon Rule 701 thereunder and appropriate
legends were affixed to the share certificates issued in each such transaction.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our annual meeting of stockholders held on March 1, 2002, our
stockholders voted on the following matters:
(1) The election of two Class I directors to serve until our 2005
annual meeting or until his or her successor has been elected and qualified. The
nominees of the board of directors were elected by the following vote:
<Table>
<Caption>
In Favor Withheld
David L. Riegel 23,295,720 137,088
Brian R. Smith 22,713,380 719,428
</Table>
(2) The approval of an amendment to our 1999 Stock Incentive Plan to
increase the number of shares of our common stock authorized to be issued under
the plan by 1,000,000 shares and to amend the plan to increase the number of
shares for which any one person can receive options, separately exercisable
stock appreciation rights and direct stock issuances in the aggregate in any one
calendar year from 500,000 shares to 1,000,000 shares. This amendment was
approved by a vote of 20,666,938 shares in favor, 2,742,461 shares opposed and
23,409 shares abstaining.
(3) The approval of the appointment of PricewaterhouseCoopers LLP as
independent auditors for the fiscal year ending October 31, 2002. The
appointment was approved by a vote of 23,373,063 shares in favor, 54,585 shares
opposed and 5,160 shares abstaining.
ITEM 5. OTHER INFORMATION
In May 2002, we announced that Brian R. Smith, our founder and chairman
of the board, returned as chief executive officer and president, replacing Larry
Sanders. Robert C. Sims, formerly vice president of engineering and operations,
was named chief operating officer and assumed management of sales and marketing.
Reagan Y. Sakai remained chief financial officer and assumed other management
responsibilities. In addition, we reduced our workforce by approximately 25
percent, or 40 people, primarily in the sales, marketing and general and
administrative areas. In the fiscal third quarter, we expect to record a
one-time charge of approximately $1.5 million with respect to severance payments
and other related expenses. We also may incur certain additional one-time
charges during the fiscal third quarter with respect to facilities consolidation
and impairment of fixed assets, if any, which are undetermined at this time.
In June 2002, we announced that our board of directors approved an
extension of our stock repurchase program by approving a program to repurchase
up to $5 million worth of our common stock. The program is expected to continue
for a period not to exceed six months, unless extended by our board of
directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
None.
(b) Reports on Form 8-K
Crossroads did not file any current reports on Form 8-K during the
three months ended April 30, 2002.
31
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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.
June 14, 2002 /s/ Brian R. Smith
------------- --------------------------------------------
(Date) Brian R. Smith
Chief Executive Officer
(Principal Executive Officer)
June 14, 2002 /s/ Reagan Y. Sakai
------------- --------------------------------------------
(Date) Reagan Y. Sakai
Chief Financial Officer
(Principal Financial and Accounting Officer)
32