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 JULY 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER:
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, including zip code, of Registrant's
principal executive offices)
(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 September 13, 2002, Registrant had outstanding 26,427,154 shares of
common stock, par value $0.001 per share.
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED JULY 31, 2002
TABLE OF CONTENTS
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of October 31, 2001 and
July 31, 2002.................................................... 3
Condensed Consolidated Statements of Operations for the three
months and nine months ended July 31, 2001 and 2002................ 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended July 31, 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............................................ 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 37
Item 4. Controls and Procedures............................................ 37
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 38
Item 2. Changes in Securities and Use of Proceeds.......................... 39
Item 3. Defaults Upon Senior Securities.................................... 39
Item 4. Submission of Matters to a Vote of Security Holders................ 39
Item 5. Other Information.................................................. 39
Item 6. Exhibits and Reports on Form 8-K................................... 39
SIGNATURES................................................................... 40
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
OCTOBER 31, JULY 31,
2001 2002
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 43,686 $ 3,912
Short-term investments ................................................ 10,000 32,288
-------------- --------------
Total cash, cash equivalents and short-term investments .......... 53,686 36,200
Accounts receivable, net of allowance for doubtful
accounts of $388 and $184, respectively ............................ 3,768 4,087
Inventories, net ...................................................... 3,080 3,810
Prepaids and other current assets ..................................... 1,894 1,356
-------------- --------------
Total current assets ............................................. 62,428 45,453
Notes receivable from related party, net .................................... 244 62
Property and equipment, net ................................................. 11,021 7,022
Intangibles, net ............................................................ 997 787
Other assets ................................................................ 713 695
-------------- --------------
Total assets ..................................................... $ 75,403 $ 54,019
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................................... $ 7,070 $ 3,716
Accrued expenses ...................................................... 2,744 3,540
Accrued warranty costs ................................................ 597 515
Deferred revenue ...................................................... 746 620
-------------- --------------
Total current liabilities ........................................ 11,157 8,391
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
27,542,664 and 26,877,030 shares issued and outstanding, respectively 28 27
Additional paid-in capital ............................................ 184,042 182,147
Deferred stock-based compensation ..................................... (3,914) (526)
Notes receivable from stockholders .................................... (118) (125)
Accumulated deficit ................................................... (115,535) (135,637)
Treasury stock at cost (467,794 and 468,262 shares, respectively) ..... (257) (258)
-------------- --------------
Total stockholders' equity ....................................... 64,246 45,628
-------------- --------------
Total liabilities and stockholders' equity ....................... $ 75,403 $ 54,019
============== ==============
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)
THREE MONTHS NINE MONTHS
ENDED ENDED
JULY 31, JULY 31,
---------------------------- ----------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenue:
Product revenue ......................................... $ 7,731 $ 7,341 $ 27,441 $ 25,338
Other revenue ........................................... 699 154 1,177 418
------------ ------------ ------------ ------------
Total revenue ........................................ 8,430 7,495 28,618 25,756
Cost of revenue (including stock-based compensation expense
of $28, $20, $100 and $67, respectively) ................. 5,240 5,090 16,253 16,951
------------ ------------ ------------ ------------
Gross profit ................................................. 3,190 2,405 12,365 8,805
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing (including stock-based compensation
expense of $54, $106, $189 and $397, respectively) .... 3,751 1,090 12,245 5,073
Research and development (including stock-based
compensation expense of $52, $100, $399 and $275,
respectively) ......................................... 4,572 3,629 12,936 13,386
General and administrative (including stock-based
compensation expense of $1,145, $87, $5,318 and $1,807,
respectively) ......................................... 3,806 1,202 12,857 6,144
Amortization of intangibles ............................. 2,418 70 9,610 210
Business restructuring charges .......................... -- 3,667 -- 3,667
Impairment of assets .................................... 25,007 1,208 25,007 1,208
Litigation settlement ................................... (15,000) -- (15,000) --
------------ ------------ ------------ ------------
Total operating expenses ............................. 24,554 10,866 57,655 29,688
------------ ------------ ------------ ------------
Loss from operations ......................................... (21,364) (8,461) (45,290) (20,883)
Other income, net .................................... 582 232 2,280 781
------------ ------------ ------------ ------------
Net loss before cumulative effect of accounting change ....... (20,782) (8,229) (43,010) (20,102)
Cumulative effect of accounting change ....................... -- -- (130) --
------------ ------------ ------------ ------------
Net loss ..................................................... $ (20,782) $ (8,229) $ (43,140) $ (20,102)
============ ============ ============ ============
Basic and diluted net loss per share:
Before cumulative effect of accounting change ........... $ (0.75) $ (0.31) $ (1.56) $ (0.74)
Cumulative effect of accounting change .................. -- -- (0.01) --
------------ ------------ ------------ ------------
Basic and diluted net loss per share ................. $ (0.75) $ (0.31) $ (1.57) $ (0.74)
============ ============ ============ ============
Shares used in computing basic and
diluted net loss per share .............................. 27,535,887 26,901,218 27,408,137 27,147,287
============ ============ ============ ============
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)
NINE MONTHS ENDED
JULY 31,
-----------------------------
2001 2002
-------- --------
Cash flows from operating activities:
Net loss ............................................. $(43,140) $(20,102)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation ...................................... 3,648 4,513
Amortization of intangibles ....................... 9,610 210
Write-down of intangibles ......................... 25,007 --
Stock-based compensation .......................... 6,006 2,546
Provision for doubtful accounts receivable ........ 144 (204)
Provision for excess and obsolete inventories ..... 656 366
Non-cash restructuring charges .................... -- 2,561
Non-cash impairment losses ........................ -- 1,208
Changes in operating assets and liabilities:
Accounts receivable ................................ 1,240 (115)
Inventories ........................................ 239 (1,096)
Prepaids and other current assets .................. 498 538
Accounts payable ................................... 1,755 (3,354)
Accrued expenses ................................... (650) (1,631)
Accrued warranty costs ............................. 160 (82)
Deferred revenue and other ......................... (183) (126)
-------- --------
Net cash provided by (used in) operating activities 4,990 (14,768)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment .................. (4,981) (1,722)
Purchase of held-to-maturity investments ............ (11,967) (22,288)
Maturity of held-to-maturity investments ............ 19,558 --
Payment of note receivable from related party ....... 59 194
Other assets ........................................ (187) --
-------- --------
Net cash provided by (used in) investing activities 2,482 (23,816)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock .............. 823 439
Purchase of treasury stock .......................... (22) (1)
Purchase of common stock under open market
stock purchase program ............................. -- (1,628)
Other ............................................... (1) --
-------- --------
Net cash provided by (used in) financing activities 800 (1,190)
-------- --------
8,272 (39,774)
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period .......... 42,447 43,686
-------- --------
Cash and cash equivalents, end of period ................ $ 50,719 $ 3,912
======== ========
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. ORGANIZATION AND 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 financial data as of July 31, 2002, and for the three and
nine-month periods ended July 31, 2001 and 2002, have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission (SEC). 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.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present a fair statement of financial
position as of July 31, 2002, results of operations for the three and nine-month
periods ended July 31, 2001 and 2002, and cash flows for the nine-month periods
ended July 31, 2001 and 2002, have been made. The results of operations for the
three months and nine months ended July 31, 2002 are not necessarily indicative
of results that may be expected for any other interim period or for the full
year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of the accompanying consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates and such differences may be material to the financial statements.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and on deposit. All highly
liquid investments with maturity of three months or less when purchased are
considered to be cash equivalents. Cash equivalents consist primarily of cash
deposited in money market accounts and high-grade commercial paper. Cash
equivalents totaled $48.1 million and $3.8 million at July 31, 2001 and 2002,
respectively. While the Company's cash and cash equivalents are on deposit with
high quality FDIC insured financial institutions, at times such deposits exceed
insured limits. The Company has not experienced any losses in such accounts.
Short-Term Investments
Short-term investments consist primarily of high grade commercial paper and
corporate debt with original maturities at the date of purchase greater than
three months and less than twelve months. All short-term investments have been
classified as held to maturity and are carried at amortized cost, which
approximates fair value, due to the short period of time to maturity.
6
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):
OCTOBER 31, JULY 31,
2001 2002
----------- --------
Raw materials ....................................... $ 3,692 $ 3,339
Work-in-process ..................................... -- 149
Finished goods ...................................... 1,168 1,736
------- -------
4,860 5,224
Less: Allowance for excess and obsolete inventory.. (1,780) (1,414)
------- -------
$ 3,080 $ 3,810
======= =======
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):
OCTOBER 31, JULY 31,
2001 2002
----------- ---------
Equipment ....................................... $ 17,509 $ 17,711
Furniture and fixtures .......................... 1,878 1,365
Leasehold improvements .......................... 906 703
-------- --------
20,293 19,779
-------- --------
Less: accumulated depreciation and amortization (9,272) (12,757)
-------- --------
$ 11,021 $ 7,022
======== ========
Revenue Recognition
Product revenue is generally recognized when persuasive evidence of an
arrangement exists, delivery has occurred, fee is fixed or determinable, and
collectibility is probable. Revenue from product sales to customers that do not
have rights of return, including product sales to original equipment
manufacturers and certain distributors, resellers and system integrators, are
recognized upon shipment. Sales and cost of sales related to customers that have
rights of return are deferred and subsequently recognized upon sell-through to
end-users. The Company provides for the estimated cost to repair or replace
products under warranty and technical support costs when the related product
revenue is recognized. Deferred revenues as of July 31, 2001 and 2002 were
approximately $924,000 and $620,000, respectively.
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. 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 $130,000, which has been included in net loss for the year ended
October 31, 2001.
Investments
The Company accounts for its investment in Banderacom Corporation (formerly
INH Semiconductor Corporation) ("Banderacom") using the cost method as the
Company's investment represents less than a 20% ownership interest and the
Company is not able to exert significant influence over Banderacom. The
Company's
7
investment in Banderacom, which is included in other non-current assets, was
approximately $100,000 and $292,000 at July 31, 2001 and 2002, respectively.
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 66% of total trade accounts
receivable at October 31, 2001 and July 31, 2002, respectively. The Company
performs credit evaluations of its customers and generally does not require
collateral on accounts receivable balances. The Company has established reserves
for credit losses and sales returns and other allowances. The Company has not
experienced material credit losses in any of the periods presented.
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 have a material adverse impact on the Company's financial
condition or results of operations.
The percentage of sales to significant customers was as follows:
THREE MONTHS ENDED
JULY 31,
----------------------------
2001 2002
------- -------
Customer A........................... % 0.5 % 24.6
Customer B........................... % 30.3 % 8.9
Customer C........................... % 29.2 % 39.0
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.
The Company's business is concentrated in the storage area networking
industry, which has been impacted by unfavorable economic conditions and reduced
information technology (IT) spending rates. Accordingly, the Company's future
success depends upon the buying patterns of customers in the storage area
networking industry, their response to current and future IT investment trends,
and the continued demand by such customers for the Company's products. The
Company's continued success will depend upon its ability to enhance its existing
products and to develop and introduce, on a timely basis, new cost-effective
products and features that keep pace with technological developments and
emerging industry standards.
3. BUSINESS RESTRUCTURING EXPENSES AND ASSET IMPAIRMENT
In May 2002, the Company announced that Brian R. Smith, its founder and
chairman, has 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 also assumed management of sales and
marketing. Reagan Y. Sakai remains chief financial officer and assumes other
management responsibilities. In addition, the Company's board of directors
approved a restructuring plan to reduce its workforce by approximately 25
percent, or 40 people (primarily in the sales, marketing and general
administrative areas), to scale down its infrastructure and to consolidate
operations.
For the three and nine months ended July 31, 2002, the Company recorded
$3.7 million in restructuring charges and a $1.2 million impairment of fixed
asset charge. Components of business restructuring charges, asset impairments
and the remaining restructuring accruals as of July 31, 2002 are as follows (in
thousands):
8
EMPLOYEE
FACILITY SEPARATION
LEASE ASSET AND OTHER
LOSSES IMPAIRMENTS COSTS TOTAL
-------- ----------- ---------- --------
Effect of restructuring plan and impact $ 2,114 $ 1,208 $ 1,552 $ 4,874
to accrued liabilities ................
Cash activity ......................... (28) -- (910) (938)
Non-cash activity ..................... -- (1,208) (167) (1,375)
Balance as of July 31, 2002 ........... $ 2,086 $ -- $ 475 $ 2,561
As of July 31, 2002, remaining cash expenditures resulting from the
restructuring are estimated to be $2.6 million and relate primarily to facility
lease losses. Excluding facility lease losses, the Company estimates that these
costs will be substantially incurred within one year of the restructuring. The
Company has substantially implemented its restructuring efforts initiated in
conjunction with the restructuring announcement made during the three months
ended July 31,2002; however, there can be no assurance future restructuring
efforts will not be necessary.
Consolidation of Excess Facilities
Facility lease losses relate to lease obligations for excess office space the
Company has vacated as a result of the restructuring plan. The Company recorded
$2.1 million in restructuring expense in relation to a site consolidation during
the three and nine months ended July 31, 2002. Total lease commitments include
the remaining lease liabilities, leasehold improvements required to sublease the
vacated space and brokerage commissions. The estimated costs of vacating these
leased facilities, including estimated costs to sublease, were based on market
information and trend analysis as estimated by the Company. It is reasonably
possible that actual results could differ from these estimates in the near term,
and such differences could be material to the financial statements. Of the $2.1
million charge recorded during the three and nine months ended July 31, 2002,
approximately $1.8 million relates to the base rent and fixed operating expenses
of the vacated space through the lease term of January 31, 2006.
Asset Impairments
Asset impairments recorded pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets To Be Disposed Of", relate to the impairment of
computer equipment, software, furniture and fixtures and certain leasehold
improvements. The majority of fixed assets were impaired as a direct result of
the Company's restructuring plan, reducing its workforce by 25%, and decision to
vacate certain office space, resulting in an impairment of $836,000 during the
three and nine months ended July 31, 2002. The remaining fixed assets considered
impaired relate to IT infrastructure and unique test equipment that can no
longer be utilized based on the current product roadmap and business
environment.
Employee Separation and Other Costs
Employee separation and other costs, which include severance, related taxes,
outplacement and other benefits, payable to approximately 40 terminated
employees, totaled $1.6 million during the three and nine months ended July 31,
2002. Employee groups impacted by the restructuring efforts include personnel in
positions throughout the Company, primarily in the sales, marketing and general
administrative functions.
4. 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 July 31, 2002, there were no borrowings
outstanding under this revolving line of credit.
9
5. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facility and certain equipment under various
operating lease agreements expiring through January 2006. In conjunction with
entering into a lease agreement for its headquarters, the Company signed an
unconditional, irrevocable letter of credit with a bank for $1.0 million, which
is secured by a $1.0 million certificate of deposit. Future minimum lease
payments under all non-cancelable operating leases as of July 31, 2002 were $7.3
million. In addition to base rent on its facilities lease, many of the operating
lease agreements require that the Company pay a proportional share of the
respective facilities' operating expenses.
As of July 31, 2002, the Company had a facility lease losses reserve,
related to future facilities lease commitments of $2.1 million (see Note 3) of
space vacated as part of the Company's restructuring plan
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 the "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.
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
tortious 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.
10
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. 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.
6. 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 July 31, 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 $20.3 million has been amortized or cancelled
as of July 31, 2002.
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):
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------ ------------------------
2001 2002 2001 2002
------ ------ ------ ------
Cost of revenue ............... $ 28 $ 20 $ 100 $ 67
Sales and marketing ........... 54 106 189 397
Research and development ...... 52 100 399 275
General and administrative .... 1,145 87 5,318 1,807
------ ------ ------ ------
Total stock-based compensation $1,279 $ 313 $6,006 $2,546
====== ====== ====== ======
We expect to amortize the remaining amounts of deferred stock-based
compensation as of July 31, 2002 in the periods indicated (in thousands):
YEAR ENDED OCTOBER 31,
------------------------------------
2002 2003 2004 TOTAL
---- ---- ---- ----
Cost of revenue .......... $ 17 $ 21 $ -- $ 38
Sales and marketing ...... 35 59 2 96
Research and development . 76 92 2 170
General and administrative 87 129 6 222
---- ---- ---- ----
Total stock-based
compensation ............. $215 $301 $ 10 $526
---- ---- ---- ----
7. 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
11
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 5,564,803 and
5,698,397 for the nine months ended July 31, 2001 and 2002, respectively.
8. 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 $125,000 as of July 31, 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. During the three months ended July 31, 2002, the
Company forgave the balance of this note of approximately $120,000 due under
this note as part of a severance agreement entered into as a result of the
Company's restructuring plan.
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 $62,000 as
of July 31, 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 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.
12
9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued 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.
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.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting
for restructuring costs and supersedes previous accounting guidance, principally
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF Issue No. 94-3"). SFAS No. 146 requires that the
liability associated with exit or disposal activities be recognized when the
liability is incurred. Under EITF Issue No. 94-3, liabilities for exit costs
were recognized when a Company commits to an exit plan. SFAS No. 146 also
establishes that a liability should initially be measured and recorded at fair
value. Accordingly, SFAS No. 146 may affect the timing and amount of recognizing
restructuring costs. The Company will adopt the provisions of SFAS No. 146 for
any restructuring activities initiated after December 31, 2002.
10. SUBSEQUENT EVENTS
On August 21, 2002, the Company's Board of Directors approved, adopted and
entered into, a Stockholder Rights Plan, the "Rights Plan". The Rights Plan is
similar to plans adopted by many other companies, and was not adopted in
response to any attempt to acquire the Company, nor was the Company aware of any
such efforts at the time of adoption.
13
The Rights Plan is designed to enable the Company's stockholders to realize
the full value of their investment by providing for fair and equal treatment of
all stockholders in the event that an unsolicited attempt is made to acquire the
company. Adoption of the Rights Plan is intended to deter coercive takeover
tactics including the accumulation of shares in the open market or through
private transactions and to prevent an acquiror from gaining control of the
Company without offering a fair price to all of the Company's stockholders. The
Rights are intended to enable all stockholders to realize the long-term value of
their investment in the Company. The Rights will not prevent a takeover attempt,
but should encourage anyone seeking to acquire the Company to negotiate with the
board prior to attempting to takeover.
Under the plan, the Company declared and paid a dividend of one right for
each share of common stock held by stockholders of record as of the close of
business on September 3, 2002. Each right initially entitles stockholders to
purchase one unit of a share of the Company's preferred stock at $12 per share.
However, the rights are not immediately exercisable and will become exercisable
only upon the occurrence of certain events. If a person or group acquires or
announces a tender or exchange offer that would result in the acquisition of 15
percent or more of the Company's common stock while the stockholder rights plan
remains in place, then, unless the rights are redeemed by the Company for $0.01
per right, all rights holders except the acquirer will be entitled to acquire
the Company's common stock at a significant discount. The rights will expire on
September 3, 2012.
14
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:
- be a customer centric, market driven company,
- to leverage our market position and core competencies to expand and
diversify our product offerings, and
- 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.
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, Compaq and
StorageTek accounted for 26.4%, 1.9%, and 22.8% of our total revenue,
respectively. During the nine months ended July 31, 2002, sales to
Hewlett-Packard, Compaq and StorageTek respectively accounted for 32.7%, 14.5%
and 26.4% of our total revenue. Fluctuations in revenue 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.
15
We are headquartered in Austin, Texas, and operate satellite offices in
other U.S. cities. We had 122 employees at July 31, 2002. Due in large part to
the restructuring plan we implemented in 2002, total headcount decreased 45%
from 223 at July 31, 2001.
RECENT EVENTS
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 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. We believe the Crossroads 10000 network storage router
increases the reliability, flexibility and performance of tape backup in
networked storage environments through technologies such as LAN-free,
server-free backup and multi-protocol connectivity.
In May 2002, we launched the industry's first low-cost two-gigabit Fibre
Channel storage router, the Crossroads 6000. Targeted at the small to mid-sized
market, the Crossroads 6000 complements the Crossroads 10000, which is intended
for the enterprise market. The 6000 provides customers an alternative to
purchasing newer equipment by enabling them to continue to leverage existing
equipment, such as SCSI tape libraries.
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 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.
In May 2002, our board of directors approved a restructuring plan to reduce
our workforce by approximately 25 percent, or 40 people (primarily in the sales,
marketing and general administrative areas), to scale down our infrastructure
and to consolidate operations. In connection with this restructuring, Brian R.
Smith, our founder and chairman, has 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 also assumed
management of sales and marketing. Reagan Y. Sakai remains chief financial
officer and assumed other management responsibilities. For the three months
ended July 31, 2002, we recorded $3.7 million in restructuring charges and a
$1.2 million impairment of fixed asset charge.
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 $5.0
million worth of our common stock. As of July 31, 2002, we had repurchased
666,000 shares of our common stock for an aggregate purchase price of $960,000.
The program is expected to continue for a period not to exceed six months,
unless extended by our board of directors.
In August 2002, we announced that our board of directors adopted a
Stockholder Rights Plan in which preferred stock purchase rights will be
distributed as a dividend at the rate of one Right for each share of common
stock of the Company held by stockholders of record as of the close of business
on September 3, 2002. The Rights Plan is designed to deter coercive takeover
tactics including the accumulation of shares in the open market or through
private transactions and to prevent an acquiror from gaining control of the
Company without offering a fair price to all of the Company's stockholders. The
Rights will expire on September 3, 2012.
PATENT PORTFOLIO
We have 13 patents issued, and 24 patent applications pending in the United
States Patent and Trademark Office with respect to our technology. We have 51
pending international patent applications (11 in the European Patent Office, 10
in Canada, 10 in Japan, seven in Australia, five in Hong Kong, four in Indonesia
and four in China). We also have twelve 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
16
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.
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 $15.0 million settlement. In
September 2001, 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. In fiscal 2002, Chaparral appealed the judgment
against it, contending that the "972 patent is invalid and not infringed.
Crossroads intends to vigorously defend the appeal.
During the three months ended July 31, 2002, we were awarded an additional
patent, which is an extension of our 972 patent for access controls that are
vital to network storage environments.
BUSINESS ACQUISITION AND INVESTMENTS
In March 2000, we consummated our acquisition of Polaris Communications,
Inc. Polaris was a 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 market 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. As a result, all Crossroads-Oregon
customers are now supported by Luminex.
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. Due to the downturn in the private equity markets
generally and the performance of Banderacom in particular, we are in the process
of determining if we should take a charge related to the impairment of our
investment in Banderacom. However, we have not yet determined whether, when or
by what amount we should reduce our carrying cost for this investment.
STOCK-BASED COMPENSATION
In connection with the grant of stock options to our employees and
directors, we recorded deferred compensation aggregating approximately $20.8
million as of July 31, 2002. Deferred compensation represents, for accounting
purposes, the difference between the deemed fair value of the common stock
underlying these options and their
17
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 $20.3 million has been amortized or cancelled
as of July 31, 2002.
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------ ------------------------
2001 2002 2001 2002
------ ------ ------ ------
Cost of revenue ............... $ 28 $ 20 $ 100 $ 67
Sales and marketing ........... 54 106 189 397
Research and development ...... 52 100 399 275
General and administrative .... 1,145 87 5,318 1,807
------ ------ ------ ------
Total stock-based compensation $1,279 $ 313 $6,006 $2,546
====== ====== ====== ======
We expect to amortize the remaining amounts of deferred stock-based
compensation as of July 31, 2002 in the periods indicated (in thousands):
YEAR ENDED OCTOBER 31,
------------------------------------
2002 2003 2004 TOTAL
---- ---- ---- ----
Cost of revenue ........................ $ 17 $ 21 $ -- $ 38
Sales and marketing .................... 35 59 2 96
Research and development ............... 76 92 2 170
General and administrative ............. 87 129 6 222
---- ---- ---- ----
Total stock-based compensation ....... $215 $301 $ 10 $526
---- ---- ---- ----
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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 ongoing basis, we evaluate our
estimates, including those related to customer programs and incentives, product
returns, bad debts, inventories, intangible assets, warranty obligations,
restructuring, 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.
We believe the following critical accounting policies, among others, affect
our more significant judgments and estimates used in the preparation of our
Condensed Consolidated Financial Statements:
- Revenue recognition
- Warranty obligations
- Excess and obsolete inventories
- Estimating allowance for doubtful accounts
- Facility lease losses
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 July 31, 2002 were
approximately $620,000. 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.
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
18
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.
Allowance for Doubtful Accounts. We continuously assess the collectibility
of outstanding customer invoices and in doing such, we maintain an allowance for
estimated losses resulting from the non-collection of customer receivables. In
estimating this allowance, we consider factors such as: historical collection
experience, a customer's current credit-worthiness, customer concentrations, age
of the receivable balance, both individually and in the aggregate, and general
economic conditions that may affect a customer's ability to pay. Actual customer
collections could differ from our estimates. For example, if the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
Facility lease losses. We vacated excess leased facilities as a result of the
restructuring plan we initiated during the three months ended July 31, 2002. We
recorded an accrual of $2.1 million for the remaining lease liabilities of such
vacated properties, leasehold improvements required to sublease the vacated
space, as well as brokerage commissions. We estimated costs of vacating these
leased facilities, including estimated costs to sublease, based on market
information and trend analysis. It is reasonably possible that actual results
will differ from these estimates in the near term, and such differences could be
material to our financial statements. Of the $2.1 million charge recorded during
the three and nine months ended July 31, 2002, approximately $1.8 million
relates to the base rent and fixed operating expenses of the vacated space
through the lease term of January 31, 2006.
Since our inception in November 1, 1995, we have incurred substantial costs
to develop our technology and products, market, sell and service these products,
recruit and train personnel and build a corporate infrastructure. As a result,
we have incurred significant losses since our inception and, as of July 31,
2002, we had an accumulated deficit of approximately $135.6 million. As of July
31, 2002, we had approximately $72.1 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. We believe our success depends on the continued
development and acceptance of our products and services, the growth of our
customer base as well as the overall growth in the storage router market.
Accordingly, we intend to invest in research and development, sales, marketing,
professional services and to a lesser extent our operational and financial
systems, as necessary. Furthermore, we expect to continue to incur operating
losses and negative cash flow for the foreseeable future, and we will require
increases in revenues before we achieve and sustain profitability; however, we
cannot assure that such increases in revenue will result in profitability.
19
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 5 to Notes to
Condensed Consolidated Financial Statements.
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------- ------------------------
2001 2002 2001 2002
------ ------ ------ -----
Revenue:
Product revenue .......................... 91.7% 97.9% 95.9% 98.4%
Other revenue ............................ 8.3 2.1 4.1 1.6
------ ------ ------ -----
Total revenue ...................... 100.0 100.0 100.0 100.0
Cost of revenue ................................ 62.2 67.9 56.8 65.8
------ ------ ------ -----
Gross profit ................................... 37.8 32.1 43.2 34.2
Operating expenses:
Sales and marketing ...................... 44.5 14.6 42.8 19.7
Research and development ................. 54.2 48.4 45.2 52.0
General and administrative ............... 45.2 16.0 44.9 23.9
Amortization of intangibles .............. 28.7 0.9 33.6 0.8
Restructuring charges .................... -- 48.9 -- 14.2
Impairment of assets ..................... 296.6 16.1 87.4 4.7
Litigation settlement .................... (177.9) -- (52.4) --
------ ------ ------ -----
Total operating expenses ........... 291.3 144.9 201.5 115.3
------ ------ ------ -----
Loss from operations ........................... (253.5) (112.8) (158.3) (81.1)
Other income, net .............................. 6.9 3.0 8.0 3.0
------ ------ ------ -----
Net loss before cumulative effect of acct change (246.6) (109.8) (150.3) (78.1)
Cumulative effect of accounting change ......... -- -- (0.5) --
------ ------ ------ -----
Net loss ....................................... (246.6)% (109.8)% (150.8)% (78.1)%
------ ------ ------ -----
COMPARISON OF THREE MONTHS ENDED JULY 31, 2001 AND 2002
Total revenue. Total revenue decreased 11.1% from $8.4 million for the three
months ended July 31, 2001 to $7.5 million for the three months ended July 31,
2002.
Product revenue. Product revenue decreased 5.0% from $7.7 million for the
three months ended July 31, 2001 to $7.3 million for the three months ended July
31, 2002. The decrease was the net result of decreasing revenue from several of
our OEM customers. More specifically, revenues from StorageTek and Dell
decreased $1.9 million and $800,000, respectively. These decreases were
partially offset by increased revenues from Compaq and Hewlett-Packard of $1.8
million and $500,000, respectively. The increase in revenue from Compaq and
Hewlett-Packard are primarily attributable to the continued ramp up of our
Crossroads 10000 network storage routers for SAN data protection. Although
Hewlett-Packard completed its acquisition of Compaq in May 2002, we have not yet
consolidated the two companies into one customer for internal purposes.
On a product basis, sales have shifted to our fourth and fifth generation of
products, the 6000, 8000 and 10000, and to our embedded line of products. Sales
of our older family of products, the 4100, 4200 and 4x50 lines, accounted for
approximately 68.0% and 31.1% of our product revenue during the three months
ended July 31, 2001 and 2002, respectively. This decrease was partially offset
by increased sales of our fourth and fifth generation
20
products, which accounted for none and approximately 31.4% of our product
revenue during the three months ended July 31, 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 23.2% and 29.9% of our product revenue
during the three months ended July 31, 2001 and 2002, respectively.
A significant portion of our revenues is concentrated among a relatively
small number of OEM customers, and the merger of Hewlett-Packard and Compaq has
resulted in substantial additional concentration. For the three months ended
July 31, 2001 and 2002, three customers (StorageTek, Hewlett-Packard and Dell)
and two customers (Hewlett-Packard and Compaq) each contributed greater than 10
percent of our total revenues for combined totals of 70.0% and 63.6% of our
total revenues, respectively. For the three months ended July 31, 2001 and 2002,
our distribution channel accounted for 7.6% and 13.9% of our total revenues,
respectively. The level of sales to any single customer may vary and the loss of
any one significant customer, or a decrease in the level of sales to any one
significant customer, particularly Hewlett-Packard/Compaq, would seriously harm
our financial condition and results of operations. We expect that a significant
portion of our future revenues will continue to come from sales of products to a
relatively small number of customers.
Other revenue. Other revenue includes sales of maintenance contracts,
consulting fees and fees received from the licensing of other intellectual
property. Other revenue decreased 78.0% from approximately $699,000 for the
three months ended July 31, 2001 to approximately $154,000 for the three months
ended July 31, 2002. The decrease in other revenue was primarily related to
$610,000 in license revenue for the three months ended July 31, 2001 associated
with granting a license to use certain technology acquired from Polaris in the
comparable period last year.
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 $28,000 and $20,000 during the three months ended July 31, 2001
and 2002, respectively, decreased 2.7% from $5.2 million for the three months
ended July 31, 2001 to $5.1 million for the three months ended July 31, 2002.
Gross profit, net of stock-based compensation, decreased 24.6% from $3.2 million
for the three months ended July 31, 2001 to $2.4 million for the three months
ended July 31, 2002. Gross profit margin, net of stock-based compensation,
decreased from 38.2% for the three months ended July 31, 2001 to 32.4% for the
three months ended July 31, 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 $54,000 and
$106,000 during the three months ended July 31, 2001 and 2002, respectively,
decreased 73.4% from $3.7 million for the three months ended July 31, 2001 to
$1.0 million for the three months ended July 31, 2002. This decrease in sales
and marketing expenses for the three months ended July 31, 2002 was primarily
due to the reduction in sales and marketing personnel resulting in approximately
$1.2 million of decreased compensation expense, approximately $152,000 of
decreased travel and entertainment expenses, and approximately $129,000 of
decreased communication and moving allowance costs. Sales and marketing
personnel decreased from 60 at July 31, 2001 to 12 at July 31, 2002. In
addition, this decrease was also attributable to decreased depreciation and
corporate overhead allocations of approximately $311,000, decreased advertising
and marketing costs of approximately $156,000 and decreased equipment and
evaluation units of approximately $144,000. As a percentage of total revenue,
sales and marketing expenses decreased from 44.5% for the three months ended
July 31, 2001 to 14.6% for the three months ended July 31, 2002. We currently
anticipate that sales and marketing expenses will remain relatively constant in
terms of absolute dollars during the next quarter.
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 $52,000 and $100,000 during the
three months ended July 31, 2001 and 2002, respectively, decreased 21.9% from
$4.5 million for the three months ended July 31, 2001
21
to $3.5 million for the three months ended July 31, 2002. This decrease in
research and development expenses was primarily due to approximately $335,000 of
decreased compensation expense primarily due to personnel reductions,
approximately $374,000 of decreased professional service fees due to our efforts
to minimize 3rd party consulting/outside services and approximately $395,000 of
decreased prototype expenses due to an increased focus to reduce costs
throughout the development process. These decreases are partially offset by an
increase in depreciation of approximately $168,000, which is related to
increased capital spending required to support our ongoing quality efforts and
the interoperability testing of our products. Research and development personnel
decreased from 87 at July 31, 2001 to 66 at July 31, 2002. As a percentage of
total revenue, research and development expenses decreased from 54.2% for the
three months ended July 31, 2001 to 48.4% for the three months ended July 31,
2002. We anticipate that research and development expenses may increase 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 $1.1 million and
$87,000 during the three months ended July 31, 2001 and 2002, respectively,
decreased 58.1% from $2.7 million for the three months ended July 31, 2001 to
$1.1 million for the three months ended July 31, 2002. This decrease in general
and administrative expenses was primarily due to the reduction of administrative
personnel resulting in approximately $690,000 of decreased compensation expense
(net of one time severance charges) and decreased legal costs associated with
patent infringement lawsuits of approximately $812,000. General and
administrative personnel decreased from 40 at July 31, 2001 to 17 at July 31,
2002. As a percentage of total revenue, general and administrative expenses
decreased from 45.2% for the three months ended July 31, 2001 to 16.0% for the
three months ended July 31, 2002. We currently anticipate that general and
administrative expenses will increase due to increased D&O insurance costs and
increased costs associated with compliance with the additional reporting and
other obligations imposed by the Sarbanes-Oxley Act of 2002 and related
legislation and regulatory changes.
COMPARISON OF NINE MONTHS ENDED JULY 31, 2001 AND 2002
Revenue. Total revenue decreased 10.0% from $28.6 million for the nine
months ended July 31, 2001 to $25.8 million for the nine months ended July 31,
2002.
Product revenue. Product revenue decreased 7.7% from $27.4 million for the
nine months ended July 31, 2001 to $25.3 million for the nine months ended July
31, 2002. The decrease was partially due to the loss of one of our larger OEM
customers, ADIC, which accounted for approximately $3.0 million in revenue
during the nine months ended July 31, 2001 but no revenue for the nine months
ended July 31, 2002. This decrease was partially offset by the addition of
Luminex as an exclusive reseller, which accounted for no revenue for the nine
months ended July 31, 2001 and approximately $900,000 in revenues for the nine
months ended July 31, 2002. As a percentage of total revenue, product revenue
increased from 95.9% for the nine months ended July 31, 2001 to 98.4% for the
nine months ended July 31, 2002. A significant, but declining, 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 56.1% and 43.1% of our product revenue during the nine months
ended July 31, 2001 and 2002, respectively. This decrease was partially offset
by increased sales of our fourth and fifth generation products, the 6000, 8000
and 10000 storage routers, which accounted for none and approximately 17.6% of
our product revenue during the nine months ended July 31, 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
increase in use of, embedded routers being shipped with tape libraries. Sales of
our lower cost, lower margin embedded products accounted for approximately 7.2%
and 26.2% of our product revenue during the nine months ended July 31, 2001 and
2002, respectively.
A significant portion of our revenues is concentrated among a relatively
small number of OEM customers, and the merger of Hewlett-Packard and Compaq has
resulted in substantial additional concentration. For the nine months ended July
31, 2001 and 2002, three customers (Hewlett-Packard, Compaq and ADIC) and three
customers (StorageTek, Hewlett-Packard and Compaq) each contributed greater than
10 percent of our total revenues for
22
combined totals of 52.7% and 73.5% of our total revenues, respectively. For the
nine months ended July 31, 2001 and 2002, our distribution channel accounted for
11.5% and 11.7% of our total revenues, respectively. The level of sales to any
single customer may vary and the loss of any one significant customer, or a
decrease in the level of sales to any one significant customer, particularly
Hewlett-Packard/Compaq would seriously harm our financial condition and results
of operations. We expect that a significant portion of our future revenues will
continue to come from sales of products to a relatively small number of
customers.
Other revenue. Other revenue decreased 64.5% from $1.2 million for the nine
months ended July 31, 2001 to approximately $418,000 for the nine months ended
July 31, 2002. The decrease was primarily due to a decline in license income of
approximately $744,000.
Cost of revenue and gross profit. Cost of revenue, net of stock-based
compensation of $100,000 and $67,000 during the nine months ended July 31, 2001
and 2002, respectively, increased 4.5% from $16.2 million for the nine months
ended July 31, 2001 to $16.9 million for the nine months ended July 31, 2002.
Gross profit, net of stock-based compensation, decreased 28.8% from $12.5
million for the nine months ended July 31, 2001 to $8.9 for the nine months
ended July 31, 2002. Gross profit margin, net of stock-based compensation,
decreased from 43.6% for the nine months ended July 31, 2001 to 34.4% for the
nine months ended July 31, 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 $189,000 and
$397,000 during the nine months ended July 31, 2001 and 2002, respectively,
decreased 61.2% from $12.1 million for the nine months ended July 31, 2001 to
$4.7 million for the nine months ended July 31, 2002. This decrease in sales and
marketing expenses for the nine months ended July 31, 2002 was primarily due to
a reduction in sales and marketing personnel from 60 at July 31, 2001 to 12 at
July 31, 2002, resulting in approximately $3.6 million of decreased compensation
expense and approximately $292,000 of decreased communication and moving
allowance costs. In addition, the reduction in personnel contributed to
approximately $752,000 of decreased corporate allocated expenses, approximately
$463,000 of decreased professional fees and approximately $391,000 of decreased
equipment and evaluation units. As a percentage of total revenue, sales and
marketing expenses decreased from 42.8% for the nine months ended July 31, 2001
to 19.7% for the nine months ended July 31, 2002. We currently anticipate that
sales and marketing expenses will remain relatively constant in terms of
absolute dollars during the next quarter.
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 $399,000 and $275,000 during the
nine months ended July 31, 2001 and 2002, respectively, increased 4.6% from
$12.5 million for the nine months ended July 31, 2001 to $13.1 million for the
nine months ended July 31, 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 $1.1 million. This
increase was primarily offset by a decrease in professional services expenses of
approximately $518,000. Research and development personnel decreased from 87 at
July 31, 2001 to 66 at July 31, 2002. As a percentage of total revenue, research
and development expenses increased from 45.2% for the nine months ended July 31,
2001 to 52.0% for the nine months ended July 31, 2002. The increase in R&D
expenses reflects our continued belief that investment in R&D is a critical
factor in maintaining our competitive position . 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 $5.3 million and $1.8 million during the nine months ended July
31, 2001 and 2002, respectively, decreased 42.5% from $7.5 million for the nine
months ended July 31, 2001 to $4.3 million for the nine months ended July 31,
2002. This decrease in general and administrative expenses
23
was primarily due to decreased professional fees associated with patent
infringement lawsuits of approximately $1.8 million and the reduction of
administrative personnel compensation charges of approximately $1.4 million as a
result of staff efficiencies. General and administrative personnel totaled 40 at
July 31, 2001 and 17 at July 31, 2002. As a percentage of total revenue, general
and administrative expenses decreased from 44.9% for the nine months ended July
31, 2001 to 23.9% for the nine months ended July 31, 2002. We currently
anticipate that general and administrative expenses will increase due to
increased D&O insurance costs and increased costs associated with compliance
with the additional reporting and other obligations imposed by the
Sarbanes-Oxley Act of 2002 and related legislation and regulatory changes.
BUSINESS RESTRUCTURING EXPENSES AND ASSET IMPAIRMENT
In May 2002, our board of directors approved a restructuring plan to reduce
its workforce by approximately 25 percent, or 40 people (primarily in the sales,
marketing and general administrative areas), to scale down our infrastructure
and to consolidate operations. In connection with the restructuring, Brian R.
Smith, our founder and chairman, 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 also assumed
management of sales and marketing. Reagan Y. Sakai remains chief financial
officer and assumed other management responsibilities.
For the three and nine months ended July 31, 2002, we recorded $3.7 million
in restructuring charges and a $1.2 million impairment of fixed asset charge.
Components of business restructuring charges, asset impairments and the
remaining restructuring accruals as of July 31, 2002 are as follows (in
thousands):
FACILITY EMPLOYEE
LEASE ASSET SEPARATION AND
LOSSES IMPAIRMENTS OTHER COSTS TOTAL
------- ----- ------- -------
Effect of restructuring plan and impact $ 2,114 $ 1,208 $ 1,552 $ 4,874
to accrued liabilities ................
Cash activity ......................... (28) -- (910) (938)
Non-cash activity ..................... -- (1,208) (167) (1,375)
Balance as of July 31, 2002 ........... $ 2,086 $ -- $ 475 $ 2,561
As of July 31, 2002, remaining cash expenditures resulting from the
restructuring are estimated to be $2.6 million and relate primarily to facility
lease losses. Excluding facility lease losses, we estimate that these costs will
be substantially incurred within one year of the restructuring. We have
substantially implemented our restructuring efforts initiated in conjunction
with the restructuring announcement made during the three months ended July
31,2002; however, there can be no assurance future restructuring efforts will
not be necessary.
Consolidation of Excess Facilities
Facility lease losses relate to lease obligations for excess office space we
have vacated as a result of the restructuring plan. We recorded $2.1 million in
restructuring expense in relation to a site consolidation during the three and
nine months ended July 31, 2002. Total lease commitments include the remaining
lease liabilities, leasehold improvements required to sub-lease the vacated
space and brokerage commissions. The estimated costs of vacating these leased
facilities, including estimated costs to sublease, were based on market
information and trend analysis as estimated by management. However, we expect
actual results may differ from these estimates in the near term, and such
differences could be material to our financial statements. Of the $2.1 million
charge recorded during the three and nine months ended July 31, 2002,
approximately $1.8 million relates to the base rent and fixed operating expenses
of the vacated space through the lease term of January 31, 2006.
Asset Impairments
Asset impairments recorded pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets To Be Disposed Of", relate to the impairment of
computer equipment, software, furniture and fixtures and certain leasehold
improvements. The
24
majority of fixed assets were impaired as a direct result of our restructuring
plan, reducing our workforce by 25%, and decision to vacate certain office
space, resulting in an impairment of $836,000 during the three and nine months
ended July 31, 2002. The remaining fixed assets considered impaired relate to IT
infrastructure and unique test equipment that can no longer be utilized based on
the current product roadmap and business environment.
Employee Separation and Other Costs
Employee separation and other costs, which include severance, related taxes,
outplacement and other benefits, payable to approximately 40 terminated
employees, totaled $1.6 million during the three and nine months ended July 31,
2002. Employee groups impacted by the restructuring efforts include personnel in
positions throughout the company, primarily in the sales, marketing and general
administrative functions.
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 $2.3 million and $781,000 for the nine months ended July 31, 2001
and 2002, respectively, representing 8.0% and 3.0% 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
The following table presents selected financial statistics and information
(dollars in thousands):
OCTOBER 31, JULY 31,
2001 2002
----------- --------
Cash and cash equivalents $43,686 $ 3,912
Short-term investments $10,000 $32,288
Working capital $51,271 $37,062
Current ratio 5.6:1 5.4:1
Days of sales outstanding - for the quarter ended 40 50
Our principal sources of liquidity at July 31, 2002 consisted of $3.9
million in cash and cash equivalents and $32.3 million in short-term
investments.
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 July 31, 2002, there were no borrowings
outstanding under the revolving line of credit and no term loans outstanding.
As of July 31, 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 provided by operating activities was $5.0 million for the nine months
ended July 31, 2001 as compared to $14.8 million utilized for the nine months
ended July 31, 2002. The increase in net cash utilized is primarily due to our
net losses. The increase in net cash utilized also reflects increases in
accounts receivable and inventory and a decrease in accounts payable of
approximately $3.4 million during the nine months ended July 31, 2002. We
anticipate using net cash to fund operating activities in future periods.
Cash provided by investing activities was $2.5 million for the nine months
ended July 31, 2001 as compared to $23.8 million utilized by investing
activities for the nine months ended July 31, 2002. The increase in net cash
25
utilized reflects the purchase of held-to-maturity investments of approximately
$22.3 million during the nine months ended July 31, 2002, compared to the
maturity of held-to-maturity investments, net of purchases, of approximately
$7.6 million during the nine months ended July 31, 2001. Capital expenditures
were $5.0 million and $1.7 million for the nine months ended July 31, 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 $100,000 primarily to support our ongoing product
development efforts.
Cash provided by financing activities was $800,000 for the nine months ended
July 31, 2001 as compared to $1.2 million utilized for the nine months ended
July 31, 2002. The increase in net cash utilized reflects the purchase of
Crossroads shares through our open market stock purchase program of
approximately $1.6 million during the nine months ended July 31, 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, the amount of cash used to fund our stock
repurchase program, 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 purchase of $2.1
million during the six-month period from September 2001 to April 2002. In June
2002, the board of directors authorized the extension of our stock repurchase
program by approving a program to repurchase up to $5.0 million worth of our
common stock. As of July 31, 2002, we had repurchased 666,000 shares of our
common stock for an aggregate purchase price of $960,000. The program is
expected to continue for a period not to exceed six months, unless extended by
our board of directors. 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued 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.
26
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 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.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting
for restructuring costs and supersedes previous accounting guidance, principally
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF Issue No. 94-3"). SFAS No. 146 requires that the
liability associated with exit or disposal activities be recognized when the
liability is incurred. Under EITF Issue No. 94-3, liabilities for exit costs
were recognized when a Company commits to an exit plan. SFAS No. 146 also
establishes that a liability should initially be measured and recorded at fair
value. Accordingly, SFAS No. 146 may affect the timing and amount of recognizing
restructuring costs. We will adopt the provisions of SFAS No. 146 for any
restructuring activities initiated after December 31, 2002.
27
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 and negative cash flow, we expect future losses and negative
cash flow, and we may never become profitable or cash flow positive.
WE HAVE INCURRED SIGNIFICANT LOSSES AND NEGATIVE CASH FLOW, WE EXPECT FUTURE
LOSSES AND NEGATIVE CASH FLOW, AND WE MAY NEVER BECOME PROFITABLE OR CASH FLOW
POSITIVE.
We have incurred significant losses in every fiscal quarter since fiscal
1996 and expect to continue to incur losses in the future. As of July 31, 2002,
we had an accumulated deficit of $135.6 million. We cannot be certain that we
will be able to generate growth rates that we will need to realize sufficient
revenue to achieve profitability or become cash flow positive. 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 our relationship with Compaq Computer
Corporation and the uncertainty regarding our relationship with Compaq,
following its acquisition by Hewlett-Packard, may result in less than expected
revenue, which would affect our ability to ever achieve profitability or
positive cash flow. Moreover, even if we do achieve profitability, we may not be
able to sustain or increase profitability or cash flow.
DUE TO 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
28
notice to us;
o the rate of adoption of storage area networks as an alternative to
existing data storage and management systems;
o the ongoing need for storage routing products in storage area network
architectures;
o 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.
GLOBAL ECONOMIC CONDITIONS MAY CONTINUE TO ERODE, WHICH MIGHT NEGATIVELY IMPACT
US, AND THE PRICE OF OUR COMMON STOCK.
The macroeconomic environment and capital spending on information technology
have continued to erode, resulting in continued uncertainty in our revenue
expectations. The operating results of our business depend on the overall demand
for storage area network products. Because our sales are primarily to major
corporate customers whose business fluctuate with general economic and business
conditions, continued soft demand for storage are network products caused by a
weakening economy and budgetary constraints have resulted in decreased revenues.
We may be especially prone to this as a result of the relatively high percentage
of revenue we have historically derived from the high-tech industry, which has
been more significantly adversely impacted by the current weak economic
environment. Customers may continue to defer or reconsider purchasing products
if they continue to experience a lack of growth in their business or if the
general economy fails to significantly improve, resulting in a continued
decrease in our product revenues.
OUR COMMON STOCK HAS TRADED BELOW $1 FOR MORE THAN 30 CONSECUTIVE TRADING DAYS
AND OUR STOCK IS AT RISK OF BEING DE-LISTED FROM THE NASDAQ NATIONAL MARKET
SYSTEM.
The market price of our stock has fallen substantially during the past
eighteen months, and the closing bid price of our stock has been below $1.00 for
over 30 consecutive trading days as of the date of this filing and, therefore,
NASDAQ may begin proceedings to de-list our stock from the NASDAQ National
Market System. De-listing could make our stock more difficult to trade, reduce
the trading volume of our stock and further depress our stock price. In
addition, de-listing or the threat of de-listing could impair our ability to
raise funds in the capital markets, which could materially impact our business,
results of operations and financial condition. We are currently considering
implementing measures to allow us to remain in compliance with this and other
NASDAQ listing standards, but there can be no assurance that we will be
successful.
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.
29
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. 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;
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, 4200 and 4x50 products have accounted for the vast majority of our
product revenue to date, but sales of these older generation products are
declining rapidly. 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." During 2001, we also
notified our customers that our 4200 product was at its "end of life." Customers
who purchased the 4100 and 4200 products 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 4200 product, sales of our 4x50 product accounted for
approximately 49.4% and 29.9% of our product revenue during the three months
ended July 31, 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 begun 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
17.6% of our product revenue during the nine months ended July 31, 2001 and
2002, respectively. If either of these three products do not achieve sufficient
market acceptance, our future growth prospects will be
30
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 nine months ended July 31, 2002,
approximately 84.6%, 68.2%, 61.4% and 73.6% 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 nine
months ended July 31, 2002, Hewlett Packard and StorageTek represented 32.7% and
26.4% 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 the 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. Our operating results in the
foreseeable future will continue to depend on sales to a relatively small number
of OEM customers. Therefore, the loss of any of our key OEM customers, or a
significant reduction in sales to any one of them, would significantly reduce
our revenue.
OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS 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
31
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 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.
We rely on one 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.
32
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, 4200 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 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
33
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 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.
34
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 or key
management, particularly after we eliminated several management positions and
reallocated those responsibilities among the remaining management in connection
with our recent restructuring, 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.
As we have discussed elsewhere in this Report, we have engaged in lengthy
and costly litigation regarding our `972 patent. While we have prevailed to
date in these cases, Chaparral has appealed the judgment against it and
there can be no assurance we will prevail in this appeal. Moreover, we
cannot assure you that we would prevail in any future effort to enforce our
rights in the `972 patent.
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:
35
o problems integrating the acquired operations, technologies or products
with our existing business and products;
o diversion of management's time and attention from our core business;
o difficulties in retaining business relationships with suppliers and
customers of the acquired company;
o risks associated with entering markets in which we lack prior
experience; and
o potential loss of key employees of the acquired company.
OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY
CUSTOMERS IN OUR MARKET.
Our products comprise only a part of a SAN. All components of a SAN must
uniformly comply with the same industry standards in order to operate
efficiently together. We depend on companies that provide other components of
the SAN to support prevailing industry standards. Many of these companies are
significantly larger and more influential in effecting industry standards than
we are. Some industry standards may not be widely adopted or implemented
uniformly, and competing standards may emerge that may be preferred by OEM
customers or end users. If larger companies do not support the same industry
standards that we do, or if competing standards emerge, our products may not
achieve market acceptance which would adversely affect our business.
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.
On August 21, 2002, our Board of Directors approved, adopted and entered
into, a Stockholder Rights Plan. The Plan is similar to plans adopted by many
other companies, and was not adopted in response to any attempt to acquire us,
nor were we aware of any such efforts at the time of adoption.
The Plan is designed to enable our stockholders to realize the full value of
their investment by providing for fair and equal treatment of all stockholders
in the event that an unsolicited attempt is made to acquire the company.
Adoption of the Plan is intended to deter coercive takeover tactics including
the accumulation of shares in the open market or through private transactions
and to prevent an acquiror from gaining control of the company without offering
a fair price to all of our stockholders. The Rights will expire on September 3,
2012.
Under the plan, we declared and paid a dividend of one right for each share
of common stock held by stockholders of record as of the close of business on
September 3, 2002. Each right initially entitles stockholders to purchase one
unit of a share of our preferred stock at $12 per share. However, the rights are
not immediately exercisable and will become exercisable only upon the occurrence
of certain events. If a person or group acquires or announces a tender or
exchange offer that would result in the acquisition of 15 percent or more of our
common stock while the stockholder rights plan remains in place, then, unless
the rights are redeemed by us for $0.01 per right, all rights holders except the
acquirer will be entitled to acquire our common stock at a significant discount.
The Rights
36
are intended to enable all stockholders to realize the long-term value of their
investment in the company. The Rights will not prevent a takeover attempt, but
should encourage anyone seeking to acquire us to negotiate with the board prior
to attempting to takeover.
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. For example, during the nine months ended July 31,
2002, the market price of our common stock as quoted on the NASDAQ National
Market System has fluctuated between $6.75 and $0.57. Our stock price is
currently below $1.00, which, as discussed above, is causing us additional
challenges, including the risk of being de-listed from the NASDAQ National
Market System. The market price of our common stock may be significantly
affected by the following factors:
o actual or anticipated fluctuations in our operating results;
o changes in financial estimates by securities analysts or our failure to
perform in line with such estimates;
o changes in market valuations of other technology companies, particularly
those that sell products used in SANs;
o announcements by us or our competitors of significant technical
innovations, acquisitions, strategic partnerships, joint ventures or
capital commitments;
o introduction of technologies or product enhancements that reduce the
need for storage routers;
o the loss of one or more key OEM customers; and
o departures of key personnel.
The stock market has experienced extreme volatility that often has been
unrelated to the performance of particular companies. These market fluctuations
may cause our stock price to fall regardless of our performance.
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.
ITEM 4. CONTROLS AND PROCEDURES.
There is no disclosure regarding significant changes regarding our internal
controls because we have not conducted a formal evaluation of our internal
control procedures.
37
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.
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. 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.
38
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended July 31, 2002, we issued an aggregate of
1,875 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.
In August 2002, we announced that our board of directors adopted a
stockholder rights plan in which preferred stock purchase rights will be
distributed as a dividend at the rate of one right for each share of common
stock of the Company held by stockholders of record as of the close of business
on September 3, 2002. The rights plan is designed to deter coercive takeover
tactics including the accumulation of shares in the open market or through
private transactions and to prevent an acquirer from gaining control of the
Company without offering a fair price to all of the Company's stockholders. The
rights will expire on September 3, 2012.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
4.2 Rights Agreement, dated as of August 21, 2002, between Crossroads
Systems, Inc. and American Stock Transfer & Trust Company, which
includes the form of Certificate of Designation for the Series A junior
participating preferred stock as Exhibit A, the form of Rights
Certificate as Exhibit B and the Summary of Rights to Purchase Series A
Preferred Stock as Exhibit C, files as Exhibit 4 to the Company's
Current Report on Form 8-K dated August 21, 2002 and incorporated by
reference herein.
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Crossroads did not file any current reports on Form 8-K during the
three months ended July 31, 2002. After July 31, 2002, we filed the
following current report on Form 8-K:
o We filed a Form 8-K dated August 21, 2002 announcing that
our board of directors adopted a stockholder rights plan in
which preferred share purchase rights will be distributed as
a dividend at the rate of one right for each share of common
stock outstanding as the close of business on September 3,
2002.
39
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.
September 16, 2002 /s/ Brian R. Smith
------------------ ---------------------------------------------
(Date) Brian R. Smith
Chief Executive Officer
(Principal Executive Officer)
September 16, 2002 /s/ Reagan Y. Sakai
------------------ ---------------------------------------------
(Date) Reagan Y. Sakai
Chief Financial Officer
(Principal Financial and Accounting Officer)
40
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Crossroads Systems, Inc. (the
"Company") on Form 10-Q for the period ending July 31, 2002 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Brian
R. Smith, Chairman of the Board, President and Chief Executive Officer of the
Company, certify, pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to ss. 302
of the Sarbanes-Oxley Act of 2002, that:
(1) I have read the Report;
(2) Based on my knowledge, the Report does not contain any untrue statement
of material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by the Report; and
(3) Based on my knowledge, the financial statements, and other financial
information included in the Report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the Company as of, and for, the periods presented in the Report.
/s/ Brian R. Smith
----------------------------------------------------
Brian R. Smith
Chairman of the Board, President and Chief Executive Officer
September 16, 2002
41
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Crossroads Systems, Inc. (the
"Company") on Form 10-Q for the period ending July 31, 2002 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Reagan
Y. Sakai, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C.ss. 1350, as adopted pursuant to ss. 302 of the Sarbanes-Oxley Act of
2002, that:
(1) I have read the Report;
(2) Based on my knowledge, the Report does not contain any untrue statement
of material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by the Report; and
(3) Based on my knowledge, the financial statements, and other financial
information included in the Report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the Company as of, and for, the periods presented in the Report.
/s/ Reagan Y. Sakai
-------------------------------------------------
Reagan Y. Sakai
Vice President and Chief Financial Officer
September 16, 2002
EXHIBIT INDEX
4.2 Rights Agreement, dated as of August 21, 2002, between Crossroads
Systems, Inc. and American Stock Transfer & Trust Company, which includes
the form of Certificate of Designation for the Series A junior
participating preferred stock as Exhibit A, the form of Rights
Certificate as Exhibit B and the Summary of Rights to Purchase Series A
Preferred Stock as Exhibit C, filed as Exhibit 4 to the Company's Current
Report on Form 8-K dated August 21, 2002, and incorporated by reference
herein.
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002