UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JANUARY 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-30362
CROSSROADS SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2846643
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8300 NORTH MOPAC EXPRESSWAY
AUSTIN, TEXAS 78759
(Address of Registrant's principal executive offices, including zip code.)
(512) 349-0300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
As of March 1, 2003 Registrant had outstanding 24,840,408 shares of
common stock, par value $0.001 per share.
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED JANUARY 31, 2003
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of October 31, 2002 and
January 31, 2003 ............................................................. 1
Condensed Consolidated Statements of Operations for the three months
ended January 31, 2002 and 2003 .............................................. 2
Condensed Consolidated Statements of Cash Flows for the three months
ended January 31, 2002 and 2003 .............................................. 3
Notes to Condensed Consolidated Financial Statements ........................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................................ 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 36
Item 4. Controls and Procedures ........................................................ 36
PART II OTHER INFORMATION
Item 1. Legal Proceedings .............................................................. 37
Item 2. Changes in Securities and Use of Proceeds ...................................... 38
Item 3. Defaults Upon Senior Securities ................................................ 38
Item 4. Submission of Matters to a Vote of Security Holders ............................ 38
Item 5. Other Information .............................................................. 38
Item 6. Exhibits and Reports on Form 8-K ............................................... 38
SIGNATURES ............................................................................... 39
</Table>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2002 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 14,723 $ 16,597
Short-term investments ....................................................... 19,588 15,603
------------ ------------
Total cash, cash equivalents and short-term investments ................. 34,311 32,200
Accounts receivable, net of allowance for doubtful
accounts of $277 and $229, respectively .................................... 5,721 5,363
Inventories, net ............................................................. 2,767 2,605
Prepaids and other current assets ............................................ 956 1,528
------------ ------------
Total current assets .................................................... 43,755 41,696
Notes receivable from related party, net ........................................... 63 65
Property and equipment, net ........................................................ 6,106 5,365
Intangibles, net ................................................................... 173 --
Other assets ....................................................................... 362 362
------------ ------------
Total assets ............................................................ $ 50,459 $ 47,488
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................. $ 4,165 $ 3,964
Accrued expenses ............................................................. 3,393 3,559
Accrued warranty costs ....................................................... 615 787
Deferred revenue ............................................................. 727 640
------------ ------------
Total current liabilities ............................................... 8,900 8,950
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
25,870,508 and 24,859,408 shares issued and outstanding, respectively ...... 26 25
Additional paid-in capital ................................................... 183,253 183,147
Deferred stock-based compensation ............................................ (311) (774)
Notes receivable from stockholders ........................................... (126) --
Accumulated deficit .......................................................... (141,024) (143,601)
Treasury stock at cost (469,237 and 469,237 shares, respectively) ............ (259) (259)
------------ ------------
Total stockholders' equity .............................................. 41,559 38,538
------------ ------------
Total liabilities and stockholders' equity .............................. $ 50,459 $ 47,488
============ ============
</Table>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
1
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
------------------------------
2002 2003
------------ ------------
Revenue:
Product .................................................... $ 9,034 $ 9,561
Other ...................................................... 163 111
------------ ------------
Total revenue ................................. 9,197 9,672
Cost of revenue (including stock-based compensation expense
of $24 and $12, respectively) ............................ 5,876 6,429
------------ ------------
Gross profit .................................................... 3,321 3,243
------------ ------------
Operating expenses:
Sales and marketing (including stock-based compensation
expense of $189 and $77, respectively) ................... 2,310 1,025
Research and development (including stock-based
compensation expense of $79 and $94, respectively) ....... 5,184 3,139
General and administrative (including stock-based
compensation expense of $955 and $309, respectively) ..... 2,469 1,644
Amortization of intangibles ................................ 70 173
------------ ------------
Total operating expenses ...................... 10,033 5,981
------------ ------------
Loss from operations ............................................ (6,712) (2,738)
Other income, net .......................................... 318 161
------------ ------------
Net loss ........................................................ $ (6,394) $ (2,577)
============ ============
Basic and diluted net loss per share ............................ $ (0.23) $ (0.10)
============ ============
Shares used in computing basic and
diluted net loss per share ................................. 27,274,904 25,087,407
============ ============
</Table>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
------------------------------
2002 2003
------------ ------------
Cash flows from operating activities:
Net loss ................................................. $ (6,394) $ (2,577)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation ........................................... 1,711 1,031
Amortization of intangibles ............................ 70 173
Stock-based compensation ............................... 1,247 492
Provision for doubtful accounts receivable ............. (111) (48)
Provision for excess and obsolete inventories .......... (169) 100
Changes in assets and liabilities:
Accounts receivable .................................... (712) 406
Inventories ............................................ (30) 62
Prepaids and other current assets ...................... 49 (572)
Accounts payable ....................................... (1,274) (201)
Accrued expenses and other ............................. (1,128) 251
------------ ------------
Net cash used in operating activities ................. (6,741) (883)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment ....................... (1,116) (291)
Purchase of held-to-maturity investments ................. (9,000) (3,025)
Maturity of held-to-maturity investments ................. -- 7,010
Payment of note receivable from related party ............ 47 126
------------ ------------
Net cash provided by (used in) investing activities ... (10,069) 3,820
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock ................... 326 44
Purchase of common stock under open market
stock purchase program .................................. -- (1,107)
------------ ------------
Net cash provided by (used in) financing activities ... 326 (1,063)
------------ ------------
Net increase (decrease) in cash and cash equivalents ....... (16,484) 1,874
Cash and cash equivalents, beginning of period ............. 43,686 14,723
------------ ------------
Cash and cash equivalents, end of period ................... $ 27,202 $ 16,597
============ ============
</Table>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
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, value-added resellers, or VARs, system integrators and storage
service providers. The Company is organized and operates as one business
segment.
The accompanying financial data as of January 31, 2003, and for the
three-month periods ended January 31, 2002 and 2003, have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission (the "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, 2002,
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 January 31, 2003, results of operations for the three-month
periods ended January 31, 2002 and 2003, and cash flows for the three-month
periods ended January 31, 2002 and 2003, have been made. The results of
operations for the three months ended January 31, 2003 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 condensed 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 condensed consolidated financial statements and the reported amounts of
revenue and expenses during the reporting periods. Estimates are used for, but
not limited to, the useful lives of property and equipment, allowances for
doubtful accounts and product returns, inventory and warranty reserves,
impairment charges, facilities lease losses and other charges, accrued
liabilities and other reserves and contingencies. 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, cash on deposit and all
highly liquid investments with original maturities at the date of purchase less
than three months. Cash equivalents consist primarily of cash deposited in money
market accounts and high-grade auction rate securities. Cash equivalents totaled
$14.7 million and $16.6 million at October 31, 2002 and January 31, 2003,
respectively. In conjunction with entering into a lease agreement for its
headquarters in April 2000, the Company signed an unconditional, irrevocable
letter of credit with a bank for $250,000, which is secured by a $3.0 million
line of credit. 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 U.S. government agency debt,
municipal debt instruments, corporate obligations and certificates of deposit
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. As of October 31, 2002
4
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
and January 31, 2003, the fair value and amortized cost of short-term
investments were approximately $19.6 million and $15.6 million, respectively.
Fair Value of Financial Instruments
The fair values of the Company's cash equivalents, accounts receivable,
accounts payable and accrued expenses approximate their carrying values due to
their short maturities.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using standard cost, which approximates the first-in, first-out method.
Provisions, when required, are made to reduce excess and obsolete inventories to
their estimated net realizable values.
Inventories consist of the following (in thousands):
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2002 2003
------------ ------------
Raw materials .......................................... $ 2,089 $ 1,905
Work-in-process ........................................ -- 298
Finished goods ......................................... 1,667 1,491
------------ ------------
3,756 3,694
Less: Allowance for excess and obsolete inventory .... (989) (1,089)
------------ ------------
$ 2,767 $ 2,605
============ ============
</Table>
Property and Equipment
The Company's property and equipment are stated at cost and depreciated
using the straight-line method over the estimated useful lives of the respective
assets, generally one to three years for equipment and five years for furniture
and fixtures. Leasehold improvements are amortized on a straight-line basis over
the shorter of the estimated useful life of the related asset or the remaining
life of the lease. Upon retirement or disposition of assets, the cost and
related accumulated depreciation are removed from the accounts, and the related
gains or losses are reflected in operations.
Property and equipment consist of the following (in thousands):
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2002 2003
------------ ------------
Equipment ............................................. $ 16,534 $ 16,795
Furniture and fixtures ................................ 1,367 1,396
Leasehold improvements ................................ 707 707
------------ ------------
18,608 18,898
Less: Accumulated depreciation and amortization ..... (12,502) (13,533)
------------ ------------
$ 6,106 $ 5,365
============ ============
</Table>
5
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2002 2003
------------ ------------
Facility lease abandonment - restructuring ............ $ 1,957 $ 1,829
Employee separation and other costs - restructuring ... 326 190
Vacation .............................................. 305 254
Marketing development funds ........................... 251 228
Payroll related ....................................... 214 365
Property, state and franchise taxes ................... 144 24
Other ................................................. 196 669
------------ ------------
$ 3,393 $ 3,559
============ ============
</Table>
Revenue Recognition
Product revenue is generally recognized when persuasive evidence of an
arrangement exists, delivery has occurred, price is fixed or determinable, and
collectibility is probable and the risk of loss has passed to the OEM. Revenue
from product sales to customers that do not have rights of return, including
product sales to original equipment manufacturers and certain distributors, VARs
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 revenue
as of October 31, 2002 and January 31, 2003 were approximately $727,000 and
$640,000, respectively.
Concentrations
Financial instruments that potentially expose the Company to concentrations
of credit risk consist primarily of cash and cash equivalents, short-term
investments and accounts receivable. The Company invests only in high credit
quality short-term instruments and limits the amount of credit exposure to any
one entity.
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. Revenue is concentrated with several major
customers. The loss of a major customer, a change of suppliers or significant
technological change in the industry could affect operating results adversely.
The Company had trade accounts receivable from four customers, which comprised
approximately 58% and 69% of total trade accounts receivable at October 31, 2002
and January 31, 2003, 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 business is concentrated in the storage area networking
industry, which has been impacted by unfavorable economic conditions and reduced
information technology, or 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. 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.
Additionally, the Company relies on a limited number of contract
manufacturers to provide manufacturing services for its products. The inability
of any contract manufacturer or supplier to fulfill supply requirements could
materially impact future operating results.
6
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The percentage of sales to significant customers was as follows:
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
------------------------------
2002 2003
------------ ------------
Compaq* ............................................... 3.0% --*
StorageTek ............................................ 34.5% 20.8%
Hewlett Packard* ...................................... 36.6% --*
Hewlett Packard (including Compaq)* ................... --* 63.2%
</Table>
* In May 2002, Hewlett-Packard completed its acquisition of Compaq. These
percentages reflect sales to Hewlett-Packard and Compaq prior to the merger and
sales to the combined company after the merger.
The level of sales to any customer may vary from quarter to quarter.
However, the Company expects that significant customer concentration, in
particular to our two major customers, will continue for the foreseeable future.
The loss of either of these customers, or a decrease in the level of sales to
either of these customers, could have a material adverse impact on the Company's
financial condition or results of operations.
Comprehensive Income
The Company reports comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income". This standard defines comprehensive income as
the changes in equity of an enterprise except those resulting from stockholders'
transactions. Accordingly, comprehensive income (loss) includes certain changes
in equity that are excluded from net income (loss). The Company has had no items
of other comprehensive loss for the three months ended, January 31, 2002 and
2003, and accordingly, comprehensive loss for all periods presented approximated
net loss.
3. BUSINESS RESTRUCTURING EXPENSES AND ASSET IMPAIRMENT
In May 2002, the Company's board of directors approved and the Company
subsequently completed a restructuring plan to reduce its workforce by
approximately 25 percent, or 40 people (primarily in the sales, marketing and
general and administrative areas), to scale down its infrastructure and to
consolidate operations. In connection with the restructuring, Brian R. Smith,
the Company's 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.
As a result of this restructuring plan, the Company recorded $3.7 million in
business restructuring expenses and a $1.2 million impairment of assets charge.
Components of business restructuring expenses, asset impairments and the
remaining restructuring accruals as of January 31, 2003 are as follows (in
thousands):
<Table>
<Caption>
EMPLOYEE
FACILITY LEASE ASSET SEPARATION AND
ABANDONMENT IMPAIRMENTS OTHER COSTS TOTAL
---------------- ---------------- ---------------- ----------------
Effect of restructuring
plan and impact to accrued
liabilities ............................ $ 2,114 $ 1,208 $ 1,552 $ 4,874
Cash activity .......................... (285) -- (1,186) (1,471)
Non-cash activity ...................... -- (1,208) (176) (1,384)
---------------- ---------------- ---------------- ----------------
Balance as of January 31, 2003 ......... $ 1,829 $ -- $ 190 $ 2,019
================ ================ ================ ================
</Table>
As of January 31, 2003, remaining cash expenditures resulting from the
restructuring are estimated to be $2.0 million and relate primarily to facility
lease abandonment losses. Excluding facility lease abandonment losses, the
Company estimates that these costs should be substantially incurred within one
year of the restructuring. The Company has substantially completed our
restructuring efforts initiated in conjunction with the restructuring
7
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
announcement made during fiscal 2002; however, there can be no assurance future
restructuring efforts will not be necessary.
4. LINE OF CREDIT
As of January 2003, the Company carried a 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
matured on February 1, 2003, and the Company is in the process of negotiating an
extension for this line of credit. As of January 31, 2003, there were no
borrowings outstanding under this revolving line of credit.
5. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facility and certain equipment under various operating
lease agreements expiring in 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 $250,000, which is secured by the
$3.0 million line of credit. Future minimum lease payments under all
non-cancelable operating leases as of January 31, 2003 were $6.6 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 January 31, 2003, the Company had a facility lease losses reserve,
related to future facilities lease commitments of $1.8 million (see Note 3) of
space vacated as part of the Company's restructuring plan.
Product Warranties
It is the Company's policy to repair or replace products that have been
authorized for repair or replacement by the Company's customers. The Company
maintains a reserve for the estimated costs of such repairs or replacements and
adjusts the reserve based on historical sales volumes as well as actual costs
incurred. Activity in the reserve for product returns during the three months
ended January 31, 2003 was as follows (in thousands):
<Table>
<Caption>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
-------------- -------------- -------------- --------------
Warranty Reserve ...... $ 615 $ 179 $ (7) $ 787
============== ============== ============== ==============
</Table>
LEGAL PROCEEDINGS
Intellectual Property Litigation
On March 31, 2000, the Company 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 appealed the judgment against it, contending that the '972 patent is
invalid and not infringed. The Federal Circuit Court of Appeals recently
affirmed the lower court ruling that Crossroads' patent was valid and willfully
infringed by
8
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Chaparral, which must stop shipping all products that contain the
Crossroads technology and pay Crossroads a royalty for prior shipments.
On April 14, 2000, the Company 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 the year ended October 31, 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 us 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. On November 22, 2002, the court
granted the Company's motion for summary judgment. On February 26, 2003, the
plaintiffs filed a notice of appeal. The plaintiffs are seeking unspecified
amounts of compensatory damages, interest and costs, including legal fees. The
Company denies the allegations in the complaint and intends to defend itself
vigorously. 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.
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.
Other
From time to time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. Management believes that,
other than the matters described above, there are no claims or actions pending
or threatened against the Company, the ultimate disposition of which would have
a material impact on the Company's financial position, results of operations or
cash flows. 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 in the normal course
of business.
6. STOCKHOLDERS' EQUITY
DEFERRED STOCK BASED COMPENSATION
In connection with the grant of stock options to our employees and directors
since fiscal 1998, we have recorded deferred compensation aggregating
approximately $23.6 million as of January 31, 2003. Deferred compensation
9
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
represents, for accounting purposes, the difference between the deemed fair
value of the common stock underlying these options and their exercise price on
the date of grant. The difference has been recorded as deferred stock-based
compensation and is being amortized over the vesting period of the applicable
options, typically four years. Of the total deferred compensation amount,
approximately $22.8 million has been amortized, forfeited or cancelled as of
January 31, 2003.
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
-----------------------------
2002 2003
------------ ------------
Cost of revenue ........................ $ 24 $ 12
Sales and marketing .................... 189 77
Research and development ............... 79 94
General and administrative ............. 955 309
------------ ------------
Total stock-based compensation ....... $ 1,247 $ 492
============ ============
</Table>
The Company expects to amortize the remaining amounts of deferred
stock-based compensation as of January 31, 2003 in the periods indicated (in
thousands):
<Table>
<Caption>
YEAR ENDED OCTOBER 31,
----------------------------------------------
2003 2004 2005 TOTAL
------------ ------------ ------------ ------------
Cost of revenue .......................... $ 14 $ 2 $ -- $ 16
Sales and marketing ...................... 87 28 1 116
Research and development ................. 188 44 -- 232
General and administrative ............... 314 95 1 410
------------ ------------ ------------ ------------
Total stock-based compensation ......... $ 603 $ 169 $ 2 $ 774
============ ============ ============ ============
</Table>
As of January 31, 2003, the Company has one stock-based employee
compensation plan, which is described more fully in Note 8 of our Annual Report
on Form 10-K. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation", to stock-based employee compensation (in thousands):
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
------------------------------
2002 2003
------------ ------------
Net loss, as reported .......................................................... $ (6,394) $ (2,577)
Stock-based employee compensation expense
included in reported net income, net of related tax effects ................ 1,247 492
Stock-based employee compensation expense
determined under fair value based method for all awards, net of related
tax effects ................................................................ 3,056 4,048
Pro forma net loss ............................................................. $ (8,203) $ (6,133)
Net loss per share:
Basic and diluted - as reported ............................................ $ (0.23) $ (0.10)
Basic and diluted - pro forma .............................................. $ (0.30) $ (0.24)
</Table>
STOCK OPTION EXCHANGE PROGRAM
On February 10, 2003, we completed a stock option exchange program offered
to all eligible option holders. Under the exchange offer, eligible employees and
non-employee members of our board of directors had the opportunity to tender for
cancellation certain eligible stock options in exchange for new options to be
granted at least six months and one day after the cancellation of the tendered
options. The number of shares subject to each new option was based on the
exercise price of the exchanged option. If the exercise price per share of a
returned option
10
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
was $3.99 or less, the number of shares that will be subject to the new option
will be determined by dividing the number of shares subject to the returned
option by 3. If the exercise price per shares of a returned option was at least
$4.00 but not more than $49.99, the number of shares that will be subject to the
new option will be determined by dividing the number of shares subject to the
returned option by 4. If the exercise price per share of a returned option was
$50.00 or more, the number of shares that will be subject to the new option will
be determined by dividing the number of shares subject to the returned option by
5.
We accepted approximately 498,806 options for cancellation and exchange
which equals approximately 10.7% of the total number of options eligible for
exchange. While our executive officers and members of our board of directors
were eligible to participate in the exchange program, none of them elected to
participate in the program. We currently expect to grant approximately 124,709
new options, taking into consideration employee terminations since the
cancellation date. The exercise price per share of the new options will be equal
to the fair market value of our common stock on the new grant date, which is
expected to be on or promptly after August 12, 2003. We do not expect to record
any compensation expense as a result of the exchange program.
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 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 5,889,571 and
6,146,772 for the three months ended January 31, 2002 and 2003, respectively.
8. RECENT ACCOUNTING PRONOUNCEMENTS
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. Since the
Company's last restructuring effort in the second quarter of fiscal 2002, there
have been no further restructuring efforts. Moreover, the Company has
experienced no adverse affects by adopting the provisions of SFAS No. 146.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are
11
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
effective for any guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements of interim or
annual periods ending after December 15, 2002. The adoption of FIN 45 has not
had a material effect on the Company's financial position, results of
operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure".SFAS No. 148 amends SFAS No. 123
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for fiscal years beginning after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002. The Company continues to account for employee stock based compensation
using APB No. 25 and currently follows the disclosure provisions of SFAS No.
123. The Company does not expect the adoption of SFAS No. 148 to have a material
effect on our financial position, results of operations, or cash flows.
9. 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 accrued interest at 7% per year and compounded semi-annually. 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. In January 2003, the Company
collected approximately $128,000 in principal and interest upon the retirement
of the Company's former chief financial officer. As of January 31, 2003, there
were no outstanding loans to officers.
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 was due in one
lump sum on July 1, 2002. The terms on this note are in the process of being
extended and the balance is approximately $65,000 as of January 31, 2003.
10. SUBSEQUENT EVENTS
In March 2002, we entered into an exclusive reseller business relationship
with Luminex Software, Inc. Provided that Luminex met specified minimum purchase
thresholds, Luminex had the option to purchase the assets of our Oregon
subsidiary and intellectual property related to the mainframe products,
including the right to manufacture those products. Luminex met these minimum
purchase thresholds and the sale of the Oregon business was recently completed
in February 2003.
In March 2003, the Company signed an agreement to sublease a portion of its
abandoned facilities. The anticipated rent payments from this sublease are
approximately $540,000 through January 2006.
12
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 a leading provider of enterprise data routing solutions for open
system storage area networks, or SANs, based on our market share of storage
routers shipped. By using our storage routers to serve as the interconnect
between SANs and the other devices in a computer network, organizations are able
to more effectively and efficiently store, manage and ensure the integrity and
availability of their data. Specifically, when used in SANs our storage routers:
o decrease congestion in the transfer of data within a network;
o reduce the time required to back up and restore data;
o improve utilization of storage resources; and
o preserve and enhance existing server and storage system
investments.
Our mission is to be the company customers trust to link business with
information, regardless of technology or location. Our objective is to maintain
our position as the leading provider of storage routing solutions as storage,
server, and network technologies and markets continue to grow and evolve. The
key elements of our strategy are to:
o solve customer storage issues;
o grow our current market position and expand into adjacent
markets; and
o increase our market leadership by continual investment in
intellectual property.
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 SANs. We also sell our storage routers through companies that distribute,
resell or integrate our storage routers as part of a complete SAN solution.
A significant portion of our revenue is concentrated among a small number of
OEM customers, and the merger of Hewlett-Packard and Compaq in May 2002 has
resulted in additional concentration. For the three months ended January 31,
2002 and 2003, two customers (StorageTek and Hewlett-Packard) and two customers
(StorageTek and Hewlett-Packard including Compaq), represented 71% and 84% of
our total revenue, respectively. For the three months ended January 31, 2002 and
2003, our distribution channel, consisting of our distributors, VARs and Systems
Integrators, accounted for 12% and 6% of our total revenue, respectively. The
level of sales to any single customer may vary and the loss of either of our two
significant customers, or a decrease in the level of sales to either of our
significant customers, particularly Hewlett-Packard (including Compaq), would
seriously harm our financial condition and results of operations. Fluctuations
in revenue have resulted from, among other things, product and customer
transitions, OEM qualification and testing and reduced IT spending rates. We
expect that a significant portion of our future revenue will continue to come
from sales of products to a relatively small number of customers.
13
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 50% and 20% of our product revenue during the three months ended
January 31, 2002 and 2003, respectively. This decrease was partially offset by
increased sales of our fourth and fifth generation products, which accounted for
approximately 4% and 36% of our product revenue during the three months ended
January 31, 2002 and 2003, respectively. We anticipate that sales of our older
products will continue to decrease as we successfully transition our customers
to our newer product platforms. Additionally, 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 37% and
35% of our product revenue during the three months ended January 31, 2002 and
2003, respectively.
RECENT EVENTS
On February 10, 2003, we completed a stock option exchange program offered
to all eligible option holders. Under the exchange offer, eligible employees and
non-employee members of our board of directors had the opportunity to tender for
cancellation certain eligible stock options in exchange for new options to be
granted at least six months and one day after the cancellation of the tendered
options. The number of shares subject to each new option was based on the
exercise price of the exchanged option. If the exercise price per share of a
returned option was $3.99 or less, the number of shares that will be subject to
the new option will be determined by dividing the number of shares subject to
the returned option by 3. If the exercise price per shares of a returned option
was at least $4.00 but not more than $49.99, the number of shares that will be
subject to the new option will be determined by dividing the number of shares
subject to the returned option by 4. If the exercise price per share of a
returned option was $50.00 or more, the number of shares that will be subject to
the new option will be determined by dividing the number of shares subject to
the returned option by 5.
We accepted approximately 498,806 options for cancellation and exchange
which equals approximately 10.7% of the total number of options eligible for
exchange. While our executive officers and members of our board of directors
were eligible to participate in the exchange program, none of them elected to
participate in the program. We currently expect to grant approximately 124,709
new options, taking into consideration employee terminations since the
cancellation date. The exercise price per share of the new options will be equal
to the fair market value of our common stock on the new grant date, which is
expected to be on or promptly after August 12, 2003. We do not expect to record
any compensation expense as a result of the exchange program.
In January 2003, Andrea C. Wenholz was named vice president and chief
financial officer of Crossroads. She has 15 years of financial management
experience, including expertise in implementing financial systems and controls
and managing mergers and acquisitions. Prior to joining Crossroads, Mrs. Wenholz
served as chief financial officer of Chicory Systems where she successfully
oversaw the sale of Chicory Systems to Parthus Technologies plc. She then served
as the Controller of U.S. Operations at Parthus, which eventually became Parthus
Ceva, following its merger with Ceva. Other financial management roles she has
served are, Business Unit Controller with Cisco Systems and Controller at
Netspeed. Mrs. Wenholz is a C.P.A. who started her career in public accounting
at KPMG and holds a Bachelors of Business Administration from Texas A&M
University.
In December 2002, Crossroads launched the Crossroads ServerAttach SA40, the
first appliance to connect SCSI servers to networked storage. With ServerAttach,
Crossroads leveraged its existing tape attach technology to allow attachment of
servers into fibre channel architectures or SANs. The ServerAttach products are
targeted at mid-range to enterprise servers like the AS/400, RS/6000, HP 9000,
and the Dec Alpha or enterprise versions of UNIX. We believe that there is a
large installed base of these servers that run critical enterprise applications
which represents a significant opportunity for us with OEMs, storage solution
companies, value-added resellers and end users. Our ServerAttach products are a
natural extension of our core technology to a broader market and potential
customer base while requiring only a modest incremental investment.
In November 2002, we amended our existing licensing agreement with
Hewlett-Packard. Pursuant to this amendment we will outsource the manufacturing
of our embedded routers to Hewlett-Packard, who will manufacture the hardware
and license the software from us for its current line of embedded solutions. As
a result, we will not have to carry the inventory and overhead costs of the
hardware, and we will receive a royalty for the software, which will result in
les revenue. However, even though revenue will be less in the
14
future, our arrangement will have a positive impact on per unit gross margin.
We believe this agreement will allow us to leverage the strengths of both
companies which are Hewlett-Packard's economies of scale in manufacturing and
systems integration expertise and our software, value-added applications and
intellectual property. We are currently working under the new agreement and plan
to transition the manufacturing of our embedded solutions during our fiscal
second quarter 2003.
In May 2002, we launched the industry's first low-cost two-gigabit fibre
channel storage router, the Crossroads 6000, which is targeted at the small to
mid-sized 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. During 2002, we successfully transitioned our major OEM
customers, including StorageTek and Hewlett-Packard (including Compaq) to the
10000 and 6000 product platforms.
In May 2002, our board of directors approved, and we completed, a
restructuring plan to reduce our workforce by approximately 25%, or 40 people
(primarily in the sales, marketing and general and administrative areas), to
scale down our infrastructure and 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. In fiscal 2002, we
recorded $3.7 million in business restructuring expenses and a $1.2 million
impairment of assets charge. We have substantially completed our restructuring
plan and are not currently planning any further restructuring efforts; however,
there can be no assurance future restructuring efforts will not be necessary.
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 was the exclusive reseller of our mainframe products. The
agreement expanded an already existing customer relationship and included a
license to the hardware, software and firmware designs of our mainframe
products. In February 2003, after Luminex met specified minimum purchase
thresholds, Luminex purchased the assets and intellectual property related to
the mainframe products, including the right to manufacture those products, for a
nominal amount.
In January 2002, we expanded our product line with the launch of our fifth
generation product line -- the Crossroads 10000 Multi-Protocol Storage Router
for enterprise environments. The 10000 is a fully redundant, modular storage
router that performs protocol and storage management functions between storage
devices and the network. It provides multi-protocol connectivity and management
of SCSI and fibre channel storage devices into fibre channel, with the
capability for future iSCSI application in storage networks. We have seen recent
price strength in the 10000 line because of its software capabilities and we
have also been able to realize manufacturing savings.
PATENT PORTFOLIO
We have 14 patents issued with 87 patents pending worldwide. 31 patent
applications are pending in the United States Patent and Trademark Office with
respect to our technology. An additional 51 patent applications are pending
internationally (11 in the European Patent Office, ten in Canada, ten in Japan,
seven in Australia, five in Hong Kong, four in Indonesia and 4 in China). We
also have five international patent applications pending under the Patent
Cooperation Treaty. However, none of our patents, including patents that may be
issued in the future, may adequately protect our technology from infringement or
prevent others from claiming that our technology infringes that of third
parties. Failure to adequately protect our intellectual property could
materially harm our business. In addition, our competitors may independently
develop similar or superior technology.
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,
contending that the `972 patent is invalid and was not infringed. In February
2003, the Federal Circuit Court of Appeals affirmed the lower court ruling that
the `972 patent was valid and willfully infringed by Chaparral. During fiscal
2002, we were awarded an additional patent, the `035 patent, which is an
extension of our `972 patent for access controls that are vital to network
storage environments.
15
STOCKHOLDERS' EQUITY
DEFERRED STOCK BASED COMPENSATION
In connection with the grant of stock options to our employees and directors
since fiscal 1998, we have recorded deferred compensation aggregating
approximately $23.6 million as of January 31, 2003. Deferred compensation
represents, for accounting purposes, the difference between the deemed fair
value of the common stock underlying these options and their exercise price on
the date of grant. The difference has been recorded as deferred stock-based
compensation and is being amortized over the vesting period of the applicable
options, typically four years. Of the total deferred compensation amount,
approximately $22.8 million has been amortized, forfeited or cancelled as of
January 31, 2003.
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
-----------------------------
2002 2003
------------ ------------
Cost of revenue ........................... $ 24 $ 12
Sales and marketing ....................... 189 77
Research and development .................. 79 94
General and administrative ................ 955 309
------------ ------------
Total stock-based compensation .......... $ 1,247 $ 492
============ ============
</Table>
We expect to amortize the remaining amounts of deferred stock-based
compensation as of January 31, 2003 in the periods indicated (in thousands):
<Table>
<Caption>
YEAR ENDED OCTOBER 31,
----------------------------------------------
2003 2004 2005 TOTAL
------------ ------------ ------------ ------------
Cost of revenue .......................... $ 14 $ 2 $ -- $ 16
Sales and marketing ...................... 87 28 1 116
Research and development ................. 188 44 -- 232
General and administrative ............... 314 95 1 410
------------ ------------ ------------ ------------
Total stock-based compensation ......... $ 603 $ 169 $ 2 $ 774
============ ============ ============ ============
</Table>
STOCK OPTION EXCHANGE PROGRAM
On February 10, 2003, we completed a stock option exchange program in which
we accepted for exchange and canceled 498,806 options to purchase common stock
and expect to grant approximately 124,709 new options on or shortly after August
12, 2003. See Note 6 to the condensed consolidated financial statements for
additional information.
BUSINESS RESTRUCTURING EXPENSES AND ASSET IMPAIRMENT
In May 2002, our board of directors approved and the company subsequently
completed a restructuring plan to reduce its workforce by approximately 25
percent, or 40 people (primarily in the sales, marketing and general and
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.
As a result of this restructuring plan, we recorded $3.7 million in business
restructuring expenses and a $1.2 million impairment of assets charge.
Components of business restructuring expenses, asset impairments and the
remaining restructuring accruals as of January 31, 2003 are as follows (in
thousands):
16
<Table>
<Caption>
EMPLOYEE
FACILITY LEASE ASSET SEPARATION AND
ABANDONMENT IMPAIRMENTS OTHER COSTS TOTAL
---------------- ---------------- ---------------- ----------------
Effect of restructuring
plan and impact to accrued
liabilities ....................... $ 2,114 $ 1,208 $ 1,552 $ 4,874
Cash activity ..................... (285) -- (1,186) (1,471)
Non-cash activity ................. -- (1,208) (176) (1,384)
---------------- ---------------- ---------------- ----------------
Balance as of January 31, 2003 .... $ 1,829 $ -- $ 190 $ 2,019
================ ================ ================ ================
</Table>
As of January 31, 2003, remaining cash expenditures resulting from the
restructuring are estimated to be $2.0 million and relate primarily to facility
lease abandonment losses. Excluding facility lease abandonment losses, we
estimate that these costs will be substantially incurred within one year of the
restructuring. We have substantially completed our restructuring efforts
initiated in conjunction with the restructuring announcement made during fiscal
2002; however, there can be no assurance future restructuring efforts will not
be necessary.
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, revenue 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:
o Revenue recognition;
o Warranty obligations;
o Excess and obsolete inventories;
o Allowance for doubtful accounts; and
o Facility lease abandonment losses.
Revenue recognition. With respect to sales of our products to OEMs, we
recognize product revenue when persuasive evidence of an arrangement exists,
delivery has occurred, price is fixed or determinable, collectibility is
probable and risk of loss has passed to the OEM. Product sales to distributors,
VARs and system integrators who do not have return rights are recognized upon
reported sell-through to end-users. To the extent that we sell products to
distributors, VARs 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
revenue as of January 31, 2003 was approximately $640,000. 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
17
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:
o historical collection experience;
o a customer's current credit-worthiness;
o customer concentrations;
o age of the receivable balance, both individually and in the
aggregate; and
o 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 abandonment losses. We vacated excess leased facilities as a
result of the restructuring plan we initiated during fiscal 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 fiscal
2002, approximately $1.8 million relates to the base rent and fixed operating
expenses of the vacated space through the lease term, which ends April 15, 2006.
NET OPERATING LOSS CARRYFORWARDS
Since our inception on 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 January 31,
2003, we had an accumulated deficit of approximately $143.6 million. As of
January 31, 2003, we had approximately $71.8 million of net operating loss
carryforwards for federal income tax purposes. 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 our 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 manage our investment 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 in the foreseeable future. We will require
increases in revenue before we achieve and sustain profitability; and we cannot
assure that such increases in revenue will result in profitability.
18
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 6 to Notes to
Condensed Consolidated Financial Statements.
<Table>
<Caption>
THREE MONTHS ENDED
JANUARY 31,
-------------------------------
2002 2003
------------ ------------
Revenue:
Product revenue ................ 98.2% 98.9%
Other revenue .................. 1.8 1.1
------------ ------------
Total revenue ............... 100.0 100.0
Cost of revenue ................... 63.9 66.5
------------ ------------
Gross profit ...................... 36.1 33.5
Operating expenses:
Sales and marketing ............ 25.1 10.6
Research and development ....... 56.4 32.5
General and administrative ..... 26.8 17.0
Amortization of intangibles .... 0.8 1.8
------------ ------------
Total operating expenses .... 109.1 61.9
------------ ------------
Loss from operations .............. (73.0) (28.4)
Other income, net ................. 3.5 1.7
------------ ------------
Net loss .......................... (69.5)% (26.7)%
============ ============
</Table>
COMPARISON OF THREE MONTHS ENDED JANUARY 31, 2002 AND 2003
Total revenue. Total revenue increased 5.2% from $9.2 million for the three
months ended January 31, 2002 to $9.7 million for the three months ended January
31, 2003.
The level of sales to any single customer may vary and the loss of either of
our significant OEM customers, or a decrease in the level of sales to either of
our significant OEM customers, could seriously harm our financial condition and
results of operations. We expect to continue to experience significant customer
concentration in sales to key OEM accounts for the foreseeable future. During
the three months ended January 31, 2003, this concentration was evidenced by
volume from our top three customers representing 87.3% of our total revenue, of
which Hewlett-Packard (including Compaq) and StorageTek each individually
accounted for 63.2% and 20.8% of our revenue, respectively. In addition,
Hewlett-Packard and Compaq, two of our three largest OEM customers, merged in
May 2002, which could result in a disruption in our sales to these two
customers.
In recent quarters, unfavorable economic conditions and reduced information
technology, or IT, spending rates in the United States, Europe, and Asia have
lead to a decline in our growth rates compared to historical trends. We are
unable to predict when IT spending rates will return to historical levels, if at
all.
Our post-sales obligations are generally limited to product warranties with
a duration of 12 to 39 months following the sale of our products. Warranty
costs, sales returns, and other allowances are accrued based on experience when
the related product revenue is recognized. Service revenue is recognized over
the service period.
Product revenue. Product revenue increased 5.8% from $9.0 million for the
three months ended January 31, 2002 to $9.6 million for the three months ended
January 31, 2003. The increase in product revenue was attributable to strong
sales of our fifth generation products to Hewlett-Packard (including Compaq).
During the three months ended January 31, 2002 and 2003, sales to
Hewlett-Packard (including Compaq) were $3.6 million and $6.1 million,
respectively. The large increase in sales to Hewlett-Packard (including Compaq)
was primarily offset by decreased sales to StorageTek primarily due to a large
sales volume for the three months ended January 31, 2002 of our older line of
embedded products. During the three months ended January 31, 2002 and 2003,
sales to StorageTek were $3.2 million and $2.0 million, respectively. However,
StorageTek has successfully transitioned to our newer line of products and is
expected to continue to be a 10% customer.
19
In November 2002, we amended our existing licensing agreement with
Hewlett-Packard. Pursuant to this amendment we will outsource the manufacturing
of our embedded routers to Hewlett-Packard, who will manufacture the hardware
and license the software from us for its current line of embedded solutions. As
a result, we will not have to carry the inventory and overhead costs of the
hardware, and we will receive a royalty for the software, which will result in
less revenue. However, even though revenue will be less in the future, our
arrangement will have a positive impact on per unit gross margin. We believe
this agreement will allow us to leverage the strengths of both companies which
are Hewlett-Packard's economies of scale in manufacturing and systems
integration expertise and our software, value-added applications and
intellectual property. We are currently working under the new agreement and plan
to transition the manufacturing of our embedded solutions during our fiscal
second quarter 2003.
Other revenue. Other revenue includes sales of maintenance contracts,
consulting fees and fees received from the licensing of other intellectual
property. Other revenue decreased 31.9% from approximately $163,000 for the
three months ended January 31, 2002 to approximately $111,000 for the three
months ended January 31, 2003. The decrease in other revenue was primarily
related to approximately $60,000 in royalty and other revenue associated with
granting a license in the comparable period of 2002 to use certain technology
which was acquired by us from Polaris.
Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue increased 9.4% from $5.9
million for the three months ended January 31, 2002 to $6.4 million for the
three months ended January 31, 2003. Stock based compensation was $24,000 and
$12,000 for the three months ended January 31, 2002 and 2003, respectively. The
increase in cost of revenue was primarily due to increases in unit sales volume
and a corresponding increase in manufacturing costs. Gross profit decreased 2.3%
from $3.3 million for the three months ended January 31, 2002 to $3.2 million
for the three months ended January 31, 2003. Gross profit margin decreased from
36.1% for the three months ended January 31, 2002 to 33.5% for the three months
ended January 31, 2003. This decrease in gross margin was primarily due to a
lower margin product mix resulting from sales of our embedded routers during
three months ended January 31, 2003. The decrease was also due to lower margin
OEM product sales and the overall product mix.
Under the terms of the amended agreement with Hewlett-Pakard, we will
continue to manufacture our box-based 4x50, 6000 and 10000 products for
Hewlett-Packard, as well as for our other OEMs for whom we will also continue to
manufacture our Crossroads branded solutions. We have seen recent price strength
in the 10000 line and we have also realized manufacturing savings. Both of these
factors should have a positive impact on gross margins.
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 decreased 55.6% from $2.3 million for the three
months ended January 31, 2002 to $1.0 million for the three months ended January
31, 2003. Stock based compensation was $189,000 and $77,000 for the three months
ended January 31, 2002 and 2003, respectively. The decrease in sales and
marketing expenses was primarily due to our restructuring efforts during fiscal
2002, which resulted in approximately $753,000 of decreased compensation
expense. Sales and marketing personnel totaled 23 at January 31, 2002 and 14 at
January 31, 2003. This reduction in force combined with improved expense
management efforts resulted in decreased corporate overhead allocations, travel
and tradeshow expenditures. As a percentage of total revenue, sales and
marketing expenses decreased from 25.1% for the three months ended January 31,
2002 to 10.6% for the three months ended January 31, 2003. We anticipate that
sales and marketing expenses may fluctuate as a percentage of total revenue, due
to our ongoing sales and marketing efforts that is intended to broaden awareness
of the benefits of our existing and recently introduced products.
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 decreased 39.5% from $5.2 million for the three months ended January
31, 2002 to $3.1 million for the three months ended January 31, 2003. Stock
based compensation was $79,000 and $94,000 for the three months ended January
31, 2002 and 2003, respectively. The decrease in research and development
expenses was primarily
20
due to our restructuring efforts during fiscal 2002, which resulted in
approximately $609,000 of decreased compensation expense, decreased prototyping
costs of approximately $685,000 and decreased corporate overhead allocations of
approximately $385,000. Research and development personnel totaled 93 at January
31, 2002 and 67 at January 31, 2003. As a percentage of total revenue, research
and development expenses decreased from 56.4% for the three months ended January
31, 2002 to 32.5% for the three months ended January 31, 2003. We anticipate
that research and development expenses may fluctuate as a percentage of total
revenue, due to our ongoing development of 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 decreased 33.4% from $2.5
million for the three months ended January 31, 2002 to $1.6 million for the
three months ended January 31, 2003. Stock based compensation was $955,000 and
$309,000 for the three months ended January 31, 2002 and 2003, respectively. The
decrease in general and administrative expenses was primarily due to our
restructuring efforts in fiscal 2002, which resulted in approximately $646,000
of decreased stock based compensation charges and approximately $133,000 of
decreased compensation expense. General and administrative personnel totaled 30
at January 31, 2002 and 19 at January 31, 2003. As a percentage of total
revenue, general and administrative expenses decreased from 26.8% for the three
months ended January 31, 2002 to 17.0% for the three months ended January 31,
2003. We anticipate that general and administrative expenses may increase
slightly due to increased directors and officers insurance costs and increased
costs associated with compliance of the additional reporting and other
obligations imposed by the Sarbanes-Oxley Act of 2002 and related legislation
and regulatory changes.
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 $318,000 and $161,000 for the three months ended January
31, 2002 and 2003, respectively, representing 3.5% and 1.7% of total revenue,
respectively. The decrease in other income, net was primarily due to decreased
cash, cash equivalent and short-term investment balances and lower interest
rates as a result of weakening macro-economic conditions.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents selected financial statistics and information
related to our liquidity and capital resources (dollars in thousands):
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2002 2003
------------ ------------
Cash and cash equivalents ............................. $ 14,723 $ 16,597
Short-term investments ................................ $ 19,588 $ 15,603
Working capital ....................................... $ 34,855 $ 32,746
Current ratio ......................................... 4.9:1 4.6:1
Days of sales outstanding - for the quarter ended ..... 64 51
</Table>
Our principal sources of liquidity at January 31, 2003 consisted of $16.6
million in cash and cash equivalents and $15.6 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
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. The line of credit matured on
February 1, 2003 and we are currently in the process of negotiating an extension
for this line of credit. As of January 31, 2003, there were no borrowings
outstanding under the revolving line of credit and no term loans outstanding.
21
As of January 31, 2003, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
Cash utilized by operating activities was $6.7 million for the three months
ended January 31, 2002 as compared to $883,000 for the three months ended
January 31, 2003. This decrease in net cash utilized was primarily due to a
significant reduction in net loss for the three months ended January 31, 2003 as
compared to the three months ended January 31, 2002. In addition, there was a
decrease in accounts receivable and increases in accrued expenses during the
three months ended January 31, 2003.
Cash utilized by investing activities was $10.1 million for the three months
ended January 31, 2002 as compared to $3.8 million provided by investing
activities for the three months ended January 31, 2003. The increase in net cash
provided reflects maturities of held-to-maturity investments, net of purchases,
of approximately $4.0 million during the three months ended January 31, 2003,
compared to the purchase of held-to-maturity investments of approximately $9.0
million during the three months ended January 31, 2002. Capital expenditures
were $1.1 million and $290,000 for the three months ended January 31, 2002 and
2003, respectively. These capital 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 ongoing
research and development in developing our technologies and expanding our
product offerings. We anticipate additional capital expenditures through fiscal
2003, primarily to support our ongoing product development efforts.
Cash provided by financing activities was $326,000 for the three months
ended January 31, 2002 as compared to $1.1 million utilized for the three months
ended January 31, 2003. The increased utilization of net cash reflects the
purchase of Crossroads shares through our open market stock purchase program of
approximately $1.1 million during the three months ended January 31, 2003. 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, 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.
STOCKHOLDER RIGHTS PLAN
On August 21, 2002, our board of directors approved, adopted and entered
into a Stockholder 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
us, nor were we aware of any such efforts at the time of adoption.
The rights 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 us.
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 us without
offering a fair price to all of our stockholders.
Under the rights 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
22
announces a tender or exchange offer that would result in the acquisition of 15
percent or more of our common stock while the 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 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 our board prior to attempting a takeover. The rights will
expire on September 3, 2012.
STOCK BONUS INCENTIVE PROGRAM
During fiscal 2002, we entered into agreements with some of our employees to
issue up to 259,788 shares of restricted common stock at no cost to the
employees, resulting in deferred stock-based compensation of approximately $1.2
million. During the three months ended January 31, 2003, we entered into
agreements with some of our employees to issue up to 1,253,786 shares of
restricted common stock at no cost to the employees, per share, resulting in
deferred stock-based compensation of approximately $768,000. This deferred
stock-based compensation is being amortized to expense as the restrictions on
the shares of common stock lapse. The restrictions generally lapse in individual
tranches over a two-year period, assuming continued employment of the recipient.
However, the lapsing of these restrictions may be accelerated in accordance with
the original agreements if the recipient meets certain predefined individual
performance objectives and/or the Crossroads accomplishes specific predefined
entity wide goals.
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 May
2002, the board of directors authorized the extension of our stock repurchase
program by approving a program to repurchase up to an additional $5.0 million
worth of our common stock in the open market pursuant to which we repurchased
1,714,465 shares of our common stock for an aggregate purchase of $1.7 million
from May 2002 through October 31, 2002. In October 2002, the board of directors
authorized the further extension of our stock repurchase program through the end
of 2003, pursuant to which we repurchased 1,065,500 shares of our common stock
for an aggregate purchase of $1.1 million from November 2002 through January 31,
2003. As of January 31, 2003, we had repurchased an aggregate of 3,441,265
shares of our common stock for an aggregate purchase price of $4.9 million.
Under the repurchase program, 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.
CONTRACTUAL CASH OBLIGATIONS AND COMMITMENTS
We lease office space and equipment under long-term operating lease
agreements that expire on various dates through April 15, 2006. In April 2000,
we relocated our headquarters in accordance with an agreement to lease
approximately 63,548 square feet of general office, laboratory, and
administrative space in Austin, Texas. The term of the lease agreement is six
years, from April 1, 2000 through April 15, 2006, and represents a lease
commitment of $1.9 million per year through the lease term. In conjunction with
entering into the lease agreement, we signed an unconditional, irrevocable
letter of credit with a bank for $250,000, which is secured by a $3.0 million
line of credit.
23
The following summarizes our contractual cash obligations as of January 31,
2003 (in thousands):
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------
FISCAL FISCAL FISCAL FISCAL
TOTAL 2003 2004 2005 2006 BEYOND
-------- -------- -------- -------- -------- --------
Operating leases ......................... $ 6,648 $ 1,615 $ 2,163 $ 1,916 $ 954 $ --
======== ======== ======== ======== ======== ========
(Total contractual cash obligations)
</Table>
RECENT ACCOUNTING PRONOUNCEMENTS
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. Since our last
restructuring effort in the second quarter of fiscal 2002, there have been no
further restructuring efforts. Moreover, we have experienced no adverse affects
by adopting the provisions of SFAS No. 146.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN 45 has not had a material effect on our financial
position, results of operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for fiscal years beginning after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002. We continue to account for employee stock based compensation using APB No.
25 and currently follow the disclosure provisions of SFAS No. 123. We do not
expect the adoption of SFAS No. 148 to have a material effect on our financial
position, results of operations, or cash flows.
24
ADDITIONAL 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 in every fiscal quarter since fiscal
1996 and expect to continue to incur losses in the future. As of January 31,
2003, we had an accumulated deficit of $143.6 million. We cannot be certain that
we will be able to generate sufficient revenue to achieve profitability or
become cash flow positive. Although we engaged in a restructuring plan in 2002
pursuant to which we significantly reduced our expense structure, we still
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. 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, the current weak economic
environment which has resulted in decreased corporate IT spending and other
factors that are beyond our control, reduces our ability to accurately forecast
our quarterly and annual revenue. 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 changes in general economic conditions and specific economic
conditions in the computer, storage, and networking
industries. In particular, continuing economic uncertainty has
resulted in a general reduction in IT spending. This reduction
in IT spending has lead to a decline in our growth rates
compared to historical trends;
25
o the timing of orders from, and product integration by, our
customers, particularly our OEMs, and the tendency of these
customers to change their order requirements frequently with
little or no advance notice to us;
o the rate of adoption of SANs 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;
o the rate at which new markets emerge for products we are
currently developing;
o the successful launch and customer acceptance of our new
ServerAttach family of products;
o disruptions or downturns in general economic activity
resulting from terrorist activity and armed conflict;
o increases in prices of components used in the manufacture of
our products; and
o variations in the mix of our products sold and the mix of
distribution channels through which they are sold.
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 businesses fluctuates with general economic and
business conditions, continued soft demand for storage area network products
caused by a weakening economy and budgetary constraints have resulted in
decreased revenue. 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 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 revenue.
THE STORAGE TECHNOLOGY MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL EVOLUTION,
AND OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW PRODUCTS.
The market for our products is characterized by rapidly changing technology
and evolving industry standards and is highly competitive with respect to timely
innovation. At this time, the storage technology market is particularly subject
to change with the emergence of fibre channel and iSCSI protocols and other new
storage technologies and solutions. The introduction of new products embodying
new or alternative technology or the emergence of new industry standards could
render our existing products obsolete or unmarketable. Our future success will
depend in part on our ability to anticipate changes in technology, to gain
access to such technology for incorporation into our
26
products and to develop new and enhanced products on a timely and cost-effective
basis. Risks inherent in the development and introduction of new products
include:
o delay in our initial shipment of new products;
o the difficulty in forecasting customer demand accurately;
o our inability to expand production capacity fast enough to
meet customer demand;
o the possibility that new products may cannibalize our current
products;
o competitors' responses to our introduction of new products;
and
o the desire by customers to evaluate new products for longer
periods of time before making a purchase decision.
In addition, we must be able to maintain the compatibility of our products
with future device technologies, and we must rely on producers of new device
technologies to achieve and sustain market acceptance of those technologies.
Development schedules for high-technology products are subject to uncertainty,
and we may not meet our product development schedules.If we are unable, for
technological or other reasons, to develop products in a timely manner or if the
products or product enhancements that we develop do not achieve market
acceptance, our business will be harmed.
FAILURE TO MANAGE OUR BUSINESS EFFECTIVELY COULD SERIOUSLY HARM OUR BUSINESS,
FINANCIAL CONDITION, AND PROSPECTS.
Our ability to successfully implement our business plan, develop and offer
products, and manage our business in a rapidly evolving market requires a
comprehensive and effective planning and management process. We continue to
change the scope of our operations, including managing our headcount
appropriately. Changes in our business, headcount, organizational structure and
relationships with customers and other third parties has placed, and will
continue to place, a significant strain on our management systems and resources.
Our failure to continue to improve upon our operational, managerial, and
financial controls, reporting systems, and procedures, and our failure to
continue to train and manage our work force, could seriously harm our business
and financial results.
OUR COMMON STOCK IS CURRENTLY TRADING ABOVE $1.00 PER SHARE. HOWEVER, IF THE
CLOSING BID PRICE OF OUR COMMON STOCK WERE TO FALL BELOW $1.00 PER SHARE FOR
MORE THAN 30 CONSECUTIVE TRADING DAYS, OUR STOCK COULD AGAIN BE AT RISK OF BEING
DELISTED FROM THE NASDAQ NATIONAL MARKET.
In December 2002, Nasdaq sent us a notice that we were to be delisted from
the Nasdaq National Market for failure to maintain the $1.00 minimum bid price
requirement for listing on the Nasdaq National Market. While we were awaiting
our hearing with Nasdaq to appeal our delisting, the closing bid price of our
common stock remained above $1.00 for twelve consecutive trading days and we
received a notice from Nasdaq that our hearing was cancelled and that we would
remain on the Nasdaq National Market.
While we avoided the threat of being delisted, in the event that the closing
bid price of our stock were to fall below $1.00 for 30 consecutive trading days,
we would again be in danger of having our stock delisted from the Nasdaq
National Market. Delisting could make our stock more difficult to trade, reduce
the trading volume of our stock and further depress our stock price. In
addition, delisting or the threat of delisting could impair our ability to raise
funds in the capital markets, which could materially impact our business,
results of operations and financial condition.
27
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. On November 22, 2002, the court granted our motion
for summary judgment, concluding that the plaintiffs failed to demonstrate an
essential element to their claim of securities fraud. On February 26, 2003, the
plaintiffs filed a notice of appeal to the Fifth Circuit Court of Appeals. The
plaintiffs are seeking unspecified amounts of compensatory damages, interest and
costs, including legal fees. The litigation is still 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 5 to Notes to Condensed
Consolidated Financial Statements.
On November 21, 2001, a derivative state action was filed in the 261st
District Court of Travis County, Texas on behalf of Crossroads by James Robke
and named several of our officers and directors as defendants. The 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. Our inability to prevail in this action could have
a material adverse effect on our future business, financial condition and
results of operations. See Note 5 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 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 would be likely to purchase our products 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,
particularly in the current economic environment. 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, VARs, 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, VARs, 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.
28
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 a limited number of principal products within our storage
router product family that we sell in commercial quantities. 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 routers
which were released in 2002 and our ServerAttach family of products, which we
released in December 2002. While we have recently begun to receive revenue from
the sale of our 6000, 8000 and 10000 storage routers, their market acceptance
remains uncertain. During the three months ended January 31, 2002 and 2003,
sales of our 6000, 8000 and 10000 storage routers accounted for approximately 4%
and 36% of our product revenue, respectively. If any of these four product lines
do not achieve sufficient market acceptance, our future growth prospects could
be seriously harmed. 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.
Factors that may affect the market acceptance of our products, some of which
are beyond our control, include the following:
o growth of the SAN market;
o changing requirements of customers within the SAN market;
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, VAR, 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 2000, 2001, 2002, and the three months ended January 31, 2003,
approximately 77%, 70%, 78% and 93% of our total revenue, respectively, was
derived from six customers. In fiscal 2002, Hewlett-Packard (including sales to
Compaq and to the combined company) and StorageTek represented 51% and 24% of
our total revenue, respectively. For the three months ended January 31, 2003,
Hewlett-Packard (including Compaq) and StorageTek represented 63% and 21% of our
total revenue, respectively. In May 2002, the merger between Hewlett-Packard and
Compaq was consummated which significantly increased our customer concentration.
If we experience any adverse effect of the acquisition of Compaq by
Hewlett-Packard, including the risks due to the increase in customer
concentration or any change in product focus or strategy which adversely affects
anticipated revenue or margins or our overall relationship with the newly
combined company, 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
29
anticipation of sales to them. If we are unsuccessful or delayed in qualifying
any products with an OEM, such failure or delay would preclude or delay sales of
that product to the OEM, which may impede our ability to grow our business.
DEMAND FOR OUR PRODUCTS DEPENDS SIGNIFICANTLY UPON THE NEED TO INTERCONNECT
SCSI-BASED TAPE STORAGE SYSTEMS WITH FIBRE CHANNEL SANS, AND WE EXPECT TO FACE
COMPETITION FROM MANUFACTURERS OF TAPE STORAGE SYSTEMS THAT INCORPORATE FIBRE
CHANNEL INTERFACES INTO THEIR PRODUCTS.
In traditional computer networks, system backup is accomplished by
transferring data from applications and databases over the servers used in the
network to tape drives or other media where the data is safely stored. Tape
storage devices generally rely on a SCSI connection to interface with the
network in receiving and transmitting data. Our routers enable these SCSI-based
storage devices to interface with the fibre channel-based components of the SAN.
Because our routers allow communication between SCSI storage devices and a fibre
channel SAN, organizations are able to 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 I/O 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 I/O
bottlenecks, such as iSCSI. A number of large companies in the computer hardware
and software industries are actively involved in the development of new
technologies and standards that we expect to incorporate 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.
UNCERTAINTIES INVOLVING SALES AND DEMAND FORECASTS FOR OUR PRODUCTS COULD
NEGATIVELY AFFECT OUR BUSINESS.
We have limited ability to forecast the demand for our products. In
preparing sales and demand forecasts, we rely largely on input from our
distribution partners. If our distribution partners are unable to accurately
forecast demand, or we fail to effectively communicate with our distribution
partners about end-user demand or other time sensitive information, sales and
demand forecasts may not reflect the most accurate, up-to-date information.
Because we make business decisions based on our sales and demand forecasts, if
these forecasts are inaccurate, our business and financial results could be
negatively impacted. Furthermore, we may not be able to identify these forecast
differences until late in our fiscal quarter. Consequently, we may not be able
to make adjustments to our business model without negatively impacting our
business and results of operations.
30
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 a limited number of contract manufacturers, primarily Solectron,
to assemble the printed circuit board for our current shipping programs,
including our 4x50, 6000, 8000 and 10000. We generally place orders for products
with Solectron 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 Solectron 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. Solectron 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.
WE HAVE ENGAGED IN RESTRUCTURING EFFORTS IN 2002 WHICH HAVE REDUCED OUR SALES
AND MARKETING ORGANIZATION FROM 37 EMPLOYEES TO 14 EMPLOYEES, A REDUCTION OF
65%. THIS REDUCTION IN OUR SALES AND MARKETING FORCE MAY DECREASE OUR ABILITY TO
AGGRESSIVELY TARGET NEW MARKETS.
In May 2002, we had a reduction in force which impacted our sales and
marketing organization significantly. While we feel that our sales and marketing
organization is sufficient to support our current products and customer base,
the current size of our sales and marketing organization may prohibit us from
actively pursuing new markets or opportunities. For example, we believe that
enhancing our sales and marketing efforts will be key to our ability to achieve
widespread customer penetration for our Server Attach product line, which is
critical to our future growth prospects.
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 have recently introduced new products and product enhancements, which
requires that we coordinate our efforts with those of our component suppliers
and our contract manufacturers to rapidly achieve volume production. In
addition, we are in the process of transitioning the manufacture of our embedded
router products to Hewlett-Packard. If we should fail to effectively manage our
relationships with our component suppliers, our contract manufacturers and other
manufacturers of our products 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
31
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 ADIC through their acquisition of Pathlight in
2001, ATTO and Chaparral Network Storage. 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. While we do not currently face significant competition for our
ServerAttach products, we anticipate we will see increased competition as this
market develops.
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 Crossroads. As a result, these
competitors may have greater credibility with our existing and potential
customers. They also may be able to adopt more aggressive pricing policies and
devote greater resources to the development, promotion and sale of their
products than we can to ours, which would allow them to respond more quickly
than us to new or emerging technologies or changes in customer requirements. In
addition, some of our current and potential competitors have already established
supplier or joint development relationships with decision makers at our current
or potential customers. These competitors may be able to leverage their existing
relationships to discourage these customers from purchasing products from us or
to persuade them to replace our products with their products. Increased
competition could decrease our prices, reduce our sales, lower our margins, or
decrease our market share. These and other competitive pressures may prevent us
from competing successfully against current or future competitors, and may
materially harm our business.
WE HAVE LICENSED OUR 4200 AND 4X50 STORAGE ROUTER TECHNOLOGY TO A KEY CUSTOMER,
WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.
We have licensed our 4200 and 4x50 storage router technology to
Hewlett-Packard. Hewlett-Packard currently manufactures the 4200 product under
its name and pays us a royalty. Hewlett-Packard has vastly greater resources and
distribution capabilities than we do, and therefore, it could establish market
acceptance in a relatively short time frame for any competitive products that it
may introduce, which, in turn, would reduce demand for our products from
Hewlett-Packard and could reduce demand for our products from other customers.
32
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 routers to embedded routers, 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, VARs 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.
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. 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, would harm our business. Additionally, our
inability to attract or retain qualified personnel in the future or any 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
33
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:
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.
34
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
approximately 30% of the total voting power of our company, as of January 31,
2003. 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. Our ongoing open
market stock repurchase program has also increased the control our affiliates
have over us. 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. Further, in August 2002, our Board of Directors approved, adopted
and entered into a Stockholder Rights Plan which also may have the effect of
discouraging, delaying or preventing an acquisition which stockholders otherwise
may desire to support.
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, since February 1, 2002, the market price
of our common stock as quoted on the NASDAQ National Market System fluctuated
between $0.38 and $6.07. Although our stock price is currently over $1.00, our
stock price was recently below $1.00 for an extended period, which caused us
additional challenges, such as the risk of being delisted from the Nasdaq
National Market. In the event the price of our common stock were to fall below
$1.00 per share for an extended period, we would again face the challenge of
being delisted from the Nasdaq National Market. 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.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information related to quantitative and qualitative disclosure regarding
market risk is set forth in Management's Discussion and Analysis of financial
Condition and Results of Operations and the risk factors under Item 2 above.
Such information is incorporated by reference herein.
ITEM 4. CONTROLS AND PROCEDURES.
We performed an evaluation under the supervision and with the participation
of our management, including our Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934). Based on that evaluation, our management,
including our CEO and CFO, concluded that our disclosure controls and procedures
were effective as of January 31, 2003 to ensure that information required to be
disclosed by us in the reports filed or submitted by us under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. There have been no significant changes
in our internal controls or other factors that could significantly affect
internal controls subsequent to January 31, 2003.
36
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. alleging that Chaparral has infringed one of our 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, we were awarded damages with a royalty amount of 5% for Chaparral's
router product line and 3% for their RAID product line. Chaparral appealed the
judgment against it, contending that the '972 patent is invalid and not
infringed. The Federal Circuit Court of Appeals recently affirmed the lower
court ruling that our patent was valid and willfully infringed by Chaparral.
On April 14, 2000, we filed a lawsuit against Pathlight Technology, Inc.
alleging that Pathlight has infringed one of our patents with their SAN Data
Gateway Router. Pathlight was subsequently acquired by ADIC on May 11, 2001. In
June 2001, ADIC paid 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 the year ended October 31, 2001. In connection with
the settlement of the lawsuit, we granted ADIC a non-exclusive license under the
'972 patent.
On May 19, 2000, Chaparral filed a counter-suit against us alleging tortious
interference with prospective business relations. We moved to have this matter
dismissed, which the judge ordered, with prejudice, in April 2001.
Securities Class Action Litigation
We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. The plaintiffs in the actions purport to represent
purchasers of our common stock during various periods ranging from January 25,
2000 through August 24, 2000. On November 22, 2002, the court granted our motion
for summary judgment. On February 26, 2003, the plaintiffs filed a notice of
appeal. The plaintiffs are seeking unspecified amounts of compensatory damages,
interest and costs, including legal fees. We deny the allegations in the
complaint and will continue to defend ourselves vigorously. 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.
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.
37
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended January 31, 2003, we issued an aggregate of
3,000 shares of our common stock to one employee pursuant to exercises of stock
options that were granted to him prior to October 19, 1999, the date of our
initial public offering, each with an exercise price of $0.233 per share. These
issuances were deemed exempt from registration under Section 5 of the Securities
Act of 1933 in reliance upon Rule 701 thereunder and appropriate legends were
affixed to the share certificates issued in each such transaction.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
10.1* Employment Agreement dated as of January 6, 2003 by and
between Registrant and Andrea Wenholz (filed as Amendment
10.12 to Registrant's Annual Report on Form 10-K for the
fiscal year ended October 31, 2002 and incorporated herein by
reference)
10.2* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated November 4, 2002 from Registrant to Robert C.
Sims (filed as Amendment 10.14 to Registrant's Annual Report
on Form 10-K for the fiscal year ended October 31, 2002 and
incorporated herein by reference)
10.3* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated November 20, 2002 from Registrant to Brian R.
Smith (filed as Amendment 10.15 to Registrant's Annual Report
on Form 10-K for the fiscal year ended October 31, 2002 and
incorporated herein by reference)
10.4* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated January 6, 2003 from Registrant to Andrea
Wenholz (filed as Amendment 10.16 to Registrant's Annual
Report on Form 10-K for the fiscal year ended October 31, 2002
and incorporated herein by reference)
10.5 Letter dated December 18, 2002 from Registrant to Andrea
Wenholz with the agreement effective January 6, 2003
10.6 Letter Agreement dated January 3, 2003 from Registrant to
Reagan Y. Sakai
10.7 Employment Agreement dated January 6, 2003 by and between
Registrant and Andrea Wenholz
99.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
* Incorporated herein by reference to the indicated filing.
(b) Reports on Form 8-K
Crossroads did not file any current reports on Form 8-K during the
fiscal quarter ended January 31, 2003. After January 31, 2003, we
filed the following current report on Form 8-K:
o We filed a Form 8-K dated February 12, 2003 announcing that
our board of directors appointed KPMG LLP to serve as our
independent public accountants and dismissed our former
independent public accountants, PricewaterhouseCoopers LLP.
The change will become effective upon the completion by
PricewaterhouseCoopers LLP of its review of our financial
statements for the fiscal quarter ended January 31, 2003.
38
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.
March 17, 2003 /s/ Brian R. Smith
- -------------- ------------------------------------------
(Date) Brian R. Smith
Chief Executive Officer
(Principal Executive Officer)
March 17, 2003 /s/ Andrea C. Wenholz
- -------------- ------------------------------------------
(Date) Andrea C. Wenholz
Chief Financial Officer
(Principal Financial and Accounting Officer)
39
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Brian R. Smith, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Crossroads Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a 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 this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons fulfilling the equivalent
function):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003
/s/ Brian R. Smith
--------------------------------------------
Brian R. Smith
Chairman of the Board, President and
Chief Executive Officer
40
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Andrea C. Wenholz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Crossroads Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a 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 this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and have:
a. Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons fulfilling the equivalent
function):
a. All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003
/s/ Andrea C. Wenholz
--------------------------------------------
Andrea C. Wenholz
Vice President and Chief Financial Officer
41
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1* Employment Agreement dated as of January 6, 2003 by and
between Registrant and Andrea Wenholz (filed as Amendment
10.12 to Registrant's Annual Report on Form 10-K for the
fiscal year ended October 31, 2002 and incorporated herein by
reference)
10.2* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated November 4, 2002 from Registrant to Robert C.
Sims (filed as Amendment 10.14 to Registrant's Annual Report
on Form 10-K for the fiscal year ended October 31, 2002 and
incorporated herein by reference)
10.3* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated November 20, 2002 from Registrant to Brian R.
Smith (filed as Amendment 10.15 to Registrant's Annual Report
on Form 10-K for the fiscal year ended October 31, 2002 and
incorporated herein by reference)
10.4* Fiscal Year 2003 Stock Bonus Incentive Program Letter
Agreement dated January 6, 2003 from Registrant to Andrea
Wenholz (filed as Amendment 10.16 to Registrant's Annual
Report on Form 10-K for the fiscal year ended October 31, 2002
and incorporated herein by reference)
10.5 Letter dated December 18, 2002 from Registrant to Andrea
Wenholz with the agreement effective January 6, 2003.
10.6 Letter Agreement dated January 3, 2003 from Registrant to
Reagan Y. Sakai
10.7 Employment Agreement dated January 6, 2003 by and between
Registrant and Andrea Wenholz
99.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
</Table>
* Incorporated herein by reference to the indicated filing.