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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 000-28843
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TURNSTONE SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0473640
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2220 CENTRAL EXPRESSWAY, SANTA CLARA, CALIFORNIA 95050
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(408) 907-1400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of February 28, 2001, there were 64,724,388 shares of the Registrant's
Common Stock outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the Registrant (based on the closing price for the Common
Stock on the Nasdaq National Market on February 28, 2001) was approximately
$193,668,903.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant incorporates by reference into Part III of this Form 10-K
portions of the Registrant's definitive Proxy Statement to be issued in
conjunction with the Registrant's 2001 Annual Meeting of Stockholders to be held
on May 10, 2001, which is expected to be filed not later than 120 days after the
Registrant's fiscal year ended December 31, 2000.
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TURNSTONE SYSTEMS, INC.
FORM 10-K
DECEMBER 31, 2000
TABLE OF CONTENTS
PAGE
ITEM NUMBER
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PART I
1. Business.................................................... 4
2. Properties.................................................. 26
3. Legal Proceedings........................................... 26
4. Submission of Matters to a Vote of Security Holders......... 26
4A. Executive Officers of the Registrant........................ 27
PART II
Market for Registrant's Common Equity and Related
5. Stockholder Matters......................................... 29
6. Selected Consolidated Financial Data........................ 30
Management's Discussion and Analysis of Financial Condition
7. and Results of Operations................................... 31
Quantitative and Qualitative Disclosures About Market
7A. Risk........................................................ 38
8. Financial Statements and Supplementary Data................. 40
PART III
Changes in and Disagreements with Accountants on Accounting
9. and Financial Disclosure.................................... 63
10. Directors and Executive Officers of the Registrant.......... 63
11. Executive Compensation...................................... 63
Security Ownership of Certain Beneficial Owners and
12. Management.................................................. 63
13. Certain Relationships and Related Transactions.............. 63
PART IV
Exhibits, Financial Statement Schedules and Reports on Form
14. 8-K......................................................... 63
SIGNATURES........................................................ 67
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements. These
statements relate to future events or our future financial performance. In some
cases, you can identify forward-looking statements by terminology such as "may,"
"will," "should," "except," "plan," "anticipate," "believe," "estimate,"
"predict," "potential" or "continue," the negative of such terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of the forward-looking
statements. We are under no duty to update any of the forward-looking statements
after the date of this report to conform such statements to actual results or to
changes in our expectations.
Readers are also urged to carefully review and consider the various
disclosures made by us which attempt to advise interested parties of the factors
which affect our business, including without limitation the disclosures made
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and under the caption "Business -- Risk Factors"
included herein and in our Registration Statement on Form S-1 (No. 333-45130)
filed with the Securities and Exchange Commission on September 1, 2000, and
thereafter amended.
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PART I
ITEM 1. BUSINESS
OVERVIEW
We are a leading provider of products that enable local exchange carriers
to rapidly deploy and efficiently maintain digital subscriber line, or DSL,
services. Our products enable the automation and remote control of installation,
qualification and maintenance of copper telephone lines. The Copper CrossConnect
CX100, our flagship product, enables local exchange carriers to rapidly and
efficiently deploy high speed digital services on existing copper telephone
lines. The CX100 is currently being installed in telephone company central
offices and remote terminals by communications service providers to speed their
deployment of DSL services. Our Smart Splitter SX500 platform, which was
introduced in November 2000, enables complete loop management for incumbent
local exchange carriers deploying residential DSL and voice services over the
same copper line, and for line sharing arrangements where different carriers
share the same copper line.
In the fiscal year ended December 31, 2000, we achieved a number of
significant milestones. In February 2000, we completed our initial public
offering and listing on the Nasdaq National Market. In August 2000, we acquired
Paragon Solutions Limited, a New Zealand-based telecommunications equipment
design firm with twenty-five engineers. We also continued our expansion abroad
by opening offices in Australia, Germany and the United Kingdom. During the year
we shipped more than 11,000 CX100s to more than 50 customers. Our customers
include voice and data competitive local exchange carriers located in the United
States and internationally, including Covad Communications, Lucent Technologies,
McLeodUSA, Inc., Mpower Communications (formerly MGC Communications), Qwest
Communications International Inc. (formerly U.S. West), Rhythms NetConnections,
Riodata GmbH and XO Communications (formerly Nextlink).
In the fourth quarter of 2000, however, we began to experience a high
degree of uncertainty with respect to our competitive local exchange carrier
customers. Because of their inability to obtain additional financing or generate
sufficient revenues to fund their operations, many of our customers either
reduced or discontinued the buildout of their networks and their purchases of
our products. Some of our customers also became delinquent in their payments for
our prior sales to them or filed for bankruptcy protection. The inability of our
customers to obtain financing to purchase our products and build out their
networks or to pay us for prior sales we made to them has had and is likely to
continue to have a negative impact on our business going forward.
INDUSTRY BACKGROUND
INCREASING NEED FOR HIGH SPEED ACCESS
Internet content and the number of users accessing the Internet are
expected to continue to grow rapidly. International Data Corporation projects
the number of worldwide users conducting transactions on the Internet to grow
from approximately 240 million in 1999 to more than 600 million by 2003. In
addition, content is becoming more data-intensive as websites increasingly offer
streaming video and audio, animation and software downloads. As more users
access more Internet content, the ability to connect to the Internet at high
speeds is becoming more important. To remain competitive, businesses are using
high-speed connections to access and provide information via the Internet,
conduct transactions with customers and suppliers, and communicate more
effectively with remote employees. Consumers are also increasingly accessing the
Internet to communicate, collect and publish data-intensive information, conduct
retail purchases and access online entertainment.
To meet this demand, a number of local exchange carriers are increasingly
offering high-speed Internet access and other services, often over existing
telephone lines. The existing lines that comprise the local loop extend from
telephone companies' central offices out to businesses and residences. Local
exchange carriers are taking advantage of the underutilized capacity of this
telephone network infrastructure to deliver high-speed Internet connections to
businesses and residences.
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EMERGING DSL SERVICES AND LOCAL EXCHANGE CARRIERS
A number of local exchange carriers are deploying DSL to offer high-speed,
cost-effective, access services on existing copper lines. Because DSL networks
reuse the existing copper lines extending from telephone companies' central
offices to businesses and residences, they can be less expensive to deploy than
alternative access technologies. In addition, significant portions of the cost
of a DSL network can be deferred until subscribers are added, reducing the
initial fixed cost of the network. Other advantages of DSL include the ability
to leverage more of the underutilized capacity of the telephone line, offer
multiple services on the same line and operate as a dedicated, always-on
service, not requiring subscribers to initiate a dial-up connection each time
the service is used.
Challenges to providing DSL service generally include the difficulty in
identifying, installing and determining the quality of a particular line, and
the expense of deploying and maintaining DSL service using traditional
labor-intensive procedures. The market for DSL-based services is still in a
relatively early stage of development and is rapidly evolving. Our future
success is substantially dependent upon whether DSL technology gains widespread
market acceptance by local exchange carriers, of which there are a limited
number, and by end users of their services. Our success is also dependent upon
whether we can successfully penetrate the incumbent local exchange carrier
market and whether local exchange carriers in general can obtain adequate
financing to fund the buildout of their DSL networks and the purchases of our
products. An incumbent local exchange carrier is a communications company that
held an exclusive license to offer local telephone services prior to the U.S.
Telecommunications Act of 1996 or similar legislation in other countries.
Examples include the regional Bell operating companies in the United States.
The primary alternative methods of providing high-speed Internet access
include cable modems, wireless technology and satellite technologies. Cable
modem service targets the residential market and theoretically can provide
faster download speeds than DSL, if access is provided over a line with a single
user. However, because of the cable modems' method of data transmission and
cable layout patterns, all cable modem users in a particular neighborhood share
the same bandwidth, and download speeds decrease as the number of users in that
neighborhood increases. Both wireless and satellite technologies enable users to
transmit and receive information using radio frequencies at transmission speeds
close or comparable to DSL transmission speeds. However, neither of these
technologies provides an alternative method for incumbent local exchange
carriers to make use of their existing physical infrastructure for analog voice
services. In addition, as with DSL technology, neither wireless nor satellite
technology has achieved widespread acceptance. Technology for providing
high-speed data services is rapidly evolving, however, and our success will
depend upon DSL technology remaining competitive with these and other emerging
technologies.
In the mid-to-late 1990's, various competitive dynamics prompted local
exchange carriers to target either the consumer or business market segments
using DSL technology. Cable operators, such as AT&T@Home and RoadRunner, began
delivering high-speed consumer services, prompting the incumbent local exchange
carriers to respond by accelerating their investments in DSL technologies. To
date, incumbent local exchange carriers have generally focused their DSL
deployments on the consumer segment by using versions of DSL that work in
conjunction with existing analog voice services as well as the associated line
maintenance procedures. However, these consumer-oriented versions of DSL
typically have limitations that make them unattractive for businesses. We
believe many incumbent local exchange carriers will gradually convert their
existing local loop equipment from analog to digital to deliver more competitive
business services as well as voice services in a more cost-effective manner.
Deregulation under the U.S. Telecommunications Act of 1996 and similar
legislation in other countries enabled competitive local exchange carriers to
provide competing services. It also eliminated a substantial barrier to
competitive local exchange carriers by allowing access to the incumbent local
exchange carriers' facilities in order to utilize the existing local loop
network infrastructure. Many of these competitive local exchange carriers are
new companies without a significant installed base of traditional analog voice
equipment and as a result are deploying modern DSL equipment and implementing
new telephone line maintenance procedures in the incumbent carriers' facilities.
This has enabled a number of competitive local exchange carriers to use the
local loop to offer competitively priced, high-speed services to business
customers.
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In November 1999, the Federal Communications Commission ordered that both
competitive local exchange carriers and incumbent local exchange carriers share
the same physical copper telephone line for delivering services to the customer
under an arrangement known as line sharing, by June 2000. Line sharing is
generally implemented by installing a signal splitter that offers competitive
local exchange carriers access to the higher frequency signals used to deliver
DSL services on the copper line. This arrangement leads to operational
challenges, however, because the signal splitter impairs the ability to properly
test and qualify the copper line and because competitive and incumbent local
exchange carriers require different line testing, maintenance and monitoring
capabilities. In addition, the incumbent and competitive local exchange carriers
have yet to work out many of the implementation issues relating to line sharing.
For example, it has yet to be determined whether the incumbent or the
competitive local exchange carrier will purchase, install and maintain the
signal splitter. Until these issues are resolved, we believe that implementation
of line sharing equipment will be delayed.
DSL LINE INSTALLATION AND MAINTENANCE
Competitive local exchange carriers gain access to the local loop and
deploy DSL by leasing space in an incumbent local exchange carrier's central
office, installing network equipment in this space and leasing specific copper
telephone lines to connect subscribers. Incumbent local exchange carriers must
connect copper lines as requested from the competitive local exchange carriers'
leased space to subscriber locations, a process that tends to be labor
intensive. When a competitive local exchange carrier orders a line to be
connected from their equipment to the subscriber's site, the incumbent local
exchange carrier's personnel must manually complete one or more connections.
These include connections inside the central office, at the subscriber's site
and possibly at various points throughout the local loop.
The process above varies somewhat if the DSL services are ordered directly
through the incumbent local exchange carrier or if the DSL services are deployed
in a line sharing arrangement. In these cases, the incumbent local exchange
carrier will not have to provision a new copper line if an existing line is
delivering voice services to the subscriber. However, the DSL service order must
still be processed, the copper line must still be connected to the appropriate
DSL access multiplexer, the existing circuit must be qualified for DSL services,
the carrier network must be configured and the necessary customer premises
equipment must be installed. A DSL access multiplexer receives signals from
multiple DSL connections and puts the signals on a larger, high-speed
transmission line.
DSL DEPLOYMENT CHALLENGES
Despite the new revenue opportunity DSL provides for local exchange
carriers, there are several major challenges in deploying and maintaining a new
DSL infrastructure that have slowed deployment. The challenges include:
Manual DSL Installation is Difficult, Expensive and Labor Intensive. DSL
installation requires one or more connections to the copper line in a process
that traditionally relies on manual labor and hand-held test tools. A common
problem that arises with local exchange carriers deploying DSL is human error in
installing the copper line. To ensure that the line has been correctly
connected, technicians rely on standard analog voice tools that attach to the
copper lines at any point in order to correctly identify the line. This
technique relies upon incumbent local exchange carrier voice equipment that
generates audible dial tones as well as an audible identification code
associated with a particular line. Since a competitive local exchange carrier's
DSL lines are not connected to this voice equipment, an audible dial tone is not
available. Without this line identification information, connections are often
performed incorrectly at one or more of the various points throughout the
network. Discovering and correcting these mistakes by dispatching service
personnel into the field is costly and leads to delays in establishing service.
DSL Services are Dependent on Copper Line Length and Quality. DSL operates
at higher frequencies than traditional analog voice service and is therefore
more dependent on the length and quality of the copper line and more easily
affected by electrical interference. Because various devices connected to, or
faults occurring on, the copper line can cause problems for DSL, they must be
identified in advance so that the line
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can be properly prepared for DSL service. In addition, a greater range of
frequencies must be monitored to fully qualify the line and detect electrical
interference. For local exchange carriers to efficiently maintain DSL services,
they must be able to qualify and monitor copper lines. Where DSL and voice
services are delivered over the same line or in line sharing arrangements, local
exchange carriers face additional operational challenges such as the inability
to perform comprehensive testing from certain points in the network. To date, a
significant amount of on-site labor and expensive hand-held test equipment has
been required to install, qualify, maintain and troubleshoot lines for DSL.
DSL Maintenance is Complex. Because DSL runs on the local loop, DSL
networks require local exchange carriers to deploy DSL equipment in a large
number of central offices or remote terminals in order to provide service in a
broad geographic region. Local exchange carriers must sometimes send technicians
to individual central offices to reconnect lines, to correct equipment failures
or to change subscriber services. For example, in the event of a DSL access
multiplexer failure, the local exchange carrier would need to either replace the
defective equipment or manually reconnect the subscriber lines around the
failure. These on-site service calls to the central office or remote terminals
can be costly and lead to delays in service availability. Given the ramp up in
the deployment of DSL technology and the need for guaranteed levels of service,
local exchange carriers are increasingly automating and remotely managing
activities related to DSL deployment and maintenance.
NEED FOR A PURPOSE-BUILT SOLUTION
Given the historically exclusive use of the copper local loop
infrastructure by incumbent local exchange carriers for voice traffic, most
equipment vendors have focused on the needs of the incumbent local exchange
carriers and their traditional analog voice services. These vendors have not
developed products optimized for the unique requirements of new digital
services, competitive local exchange carriers and line sharing arrangements.
Traditional systems, often based on proprietary software, are difficult and
expensive to integrate with new DSL equipment and modern operational support
systems. We believe widespread deployment of competitive DSL services requires
new infrastructure equipment with standard interfaces providing for the
automation and remote management of line installation, qualification and
maintenance that would otherwise be manually implemented.
THE TURNSTONE SOLUTION
Our products improve the efficiency of installing and managing DSL services
while delivering the high levels of reliability and scalability needed in a
large, complex network.
We believe that our CX100 product family is the first solution designed and
built specifically to enable local exchange carriers deploying DSL to automate
and remotely control the installation, qualification and maintenance of copper
telephone lines in a local loop. Our CX100 product family consists of the Copper
CrossConnect CX100 and associated modules and the CrossWorks suite of software
applications. The CX100 product family is designed specifically to enable the
rapid and efficient deployment of high-speed digital services on the existing
local loop.
Our Smart Splitter SX500 platform, which was introduced in November 2000,
enables loop management for incumbent local exchange carriers deploying
residential DSL and voice services over the same line, and for line sharing
arrangements. The SX500 offers signal splitting functionality, line testing
access at all points of the network and an open interface that can be compatible
with existing network operational support systems. Local exchange carriers can
interface the SX500 with any testing platform, including the CX100.
The CX100 and SX500 are typically deployed between one or more DSL access
multiplexers and the copper subscriber lines. Additional modules can be added
over time as subscriber count increases and as more modules are added to DSL
access multiplexers. CrossWorks can operate independently or be integrated with
a local exchange carrier's operational support system, enhancing efficiency and
scalability.
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The benefits of our solution include:
Rapid and Efficient DSL Deployment. Our products enable carriers to
remotely perform line qualification, testing and maintenance on any line
connected through the system. Accurate line qualification and testing enable
local exchange carriers to rapidly and efficiently deploy DSL services and
reduce installation and labor costs. Our products provide local exchange
carriers with critical testing capabilities, including traditional tests
performed on analog lines as well as advanced tests that are appropriate for DSL
network environments. Our customers can remotely confirm if a particular copper
line is properly connected into the central office, and whether it can support a
specific type and speed of DSL service prior to deploying field personnel for
installation at the subscriber site. Our products can also generate audible
tones on any set of lines, providing field personnel with a convenient mechanism
for ensuring lines are correctly connected during DSL installation. These
features are also useful for performing fault isolation and maintenance on DSL
subscriber lines after service is installed and operational.
Improved Network Reliability. Our products improve network reliability and
availability by providing local exchange carriers with remote service
modification and restoration capabilities, enabling local exchange carriers to
offer guaranteed levels of service. For example, in the event of a DSL access
multiplexer failure, our customers can rapidly restore services by remotely
reconnecting the affected lines around the problem, a process we call protection
switching. Carriers can also use the protection switching capability to remotely
modify a customer's service type quickly and cost effectively. The ability to
remotely modify a customer's services is useful for handling unforeseen
installation problems or responding quickly to service change requests without
the requirement for costly on-site labor.
Automated Operations. Our CrossWorks software operates in conjunction with
the CX100 to automate the collection, analysis and archiving of information
regarding subscribers, line assignments, test histories and other information.
Raw test data can be automatically gathered at programmed intervals and
analyzed, generating pass/fail notifications based on user-defined thresholds
for particular services. All of the information is automatically stored and is
available for future troubleshooting or trend analysis. CrossWorks also includes
automated network administration capabilities such as software upgrades, backups
and alarm tracking. CrossWorks may be integrated with service providers'
existing operational support systems using open, standard interfaces or operated
as a stand-alone application.
Compatible with all Services and Platforms and in Line Sharing
Arrangements. Our products are designed to be compatible with all types of local
loop services, DSL access multiplexers and in the case of the SX500, all testing
platforms. A single CX100 or SX500 may be deployed with multiple DSL access
multiplexers from a variety of vendors, including Alcatel, Cisco, Copper
Mountain, Lucent, Nokia and Paradyne. Where DSL and voice services are delivered
over the same line or in line sharing arrangements, the SX500 can be accessed by
any testing platform, including the CX100. With our solution in place, local
exchange carriers can deploy next-generation equipment to support emerging DSL
services as well as leverage existing investments in networking equipment that
support more traditional services.
STRATEGY
Our objective is to be the leading provider of products to enable local
exchange carriers to automate and remotely control the installation,
qualification and maintenance of copper telephone lines for DSL service. Key
elements of our strategy include:
Penetrate the Incumbent Local Exchange Carrier Market and New International
Markets as They Emerge. We believe our established position in the competitive
local exchange carrier market will better enable us to penetrate incumbent local
exchange carriers and local exchange carriers in other countries who will
gradually convert their installed base of analog voice equipment to more
efficient DSL equipment due to superior economics, demand for new services and
continued deregulation. We intend to continue to develop products specifically
targeted at incumbent local exchange carriers, such as our SX500 platform. We
also intend to add more features to make our solutions more attractive to
incumbent local exchange carriers and to local exchange carriers in other
countries. We plan to continue to expand our sales, marketing and support
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capabilities to meet the growing demand for high-speed access solutions and
increase our brand recognition both domestically and internationally.
Increase Penetration in the Competitive Local Exchange Carrier Market. Our
initial target customers were competitive local exchange carriers specifically
focused on offering DSL services to business users. We expect that this target
market will continue to mature as new competitive local exchange carriers
emerge, as established competitive local exchange carriers supplement their
existing services with DSL service offerings for businesses and as the market
experiences consolidation. We believe our early success with competitive local
exchange carriers such as Covad Communications, McLeodUSA, Inc., Mpower
Communications (formerly MGC Communications), Qwest Communications International
Inc. (formerly U.S. West), Rhythms NetConnections, Riodata GmbH and XO
Communications (formerly Nextlink) will better enable us to market to other
competitive local exchange carriers as they deploy DSL.
Enhance Product Offerings. We believe that our core product offerings can
be enhanced to offer better value to existing and new customers. We plan to
continue adding features and functionality to increase the utility and
applicability of our product offerings. Since our products have been deployed by
a number of our customers, we have developed an understanding of the challenges
facing these carriers. This knowledge enables us to design additional features
and capabilities into our products. We expect to invest significant development
resources in the areas of service qualifications, network management,
operational support system interfaces and manufacturing cost reductions. In
addition, we have obtained regulatory approvals and certifications so that our
products may be deployed in several European and Asian jurisdictions. We intend
to seek the necessary regulatory approvals and certifications so that our
products may be deployed widely outside of the United States.
Develop Relationships with Original Equipment Manufacturers and
Resellers. Although we primarily market our products through our direct sales
force, we believe original equipment manufacturer relationships can enhance our
market position and make us a more attractive vendor to a broader base of
customers. We have an original equipment manufacturer relationship with Lucent
Technologies, who has chosen to resell the CX100 as a co-branded system, and
with several international resellers. We expect these relationships to expand
our distribution and customer support capacity internationally as well as
satisfy the equipment financing requirements of certain customers. In the
future, we expect to develop other original equipment manufacturer and reseller
relationships in order to penetrate additional customer segments and market our
products in international markets.
Leverage Relationships with Complementary Vendors. Our products are
compatible with a variety of DSL equipment as well as analog telephone
equipment. The CX100 or SX500 may be used with multiple DSL access multiplexers
from a number of vendors, including Alcatel, Cisco, Copper Mountain, Lucent,
Nokia and Paradyne. Because our solution is complementary to DSL access
multiplexers, we believe DSL access multiplexer vendors are likely to recommend
our products to their customers. We intend to make our products an attractive
complement to all DSL access multiplexer vendors and to further encourage joint
sales and marketing activities. We are also working with vendors of hand-held
line test equipment in order to provide more sophisticated capabilities.
Outsource Manufacturing. We outsource manufacturing of our products
including material procurement, board level assembly, final assembly, test and
shipment to our customers. We use automated design, manufacturing and test
processes to minimize cycle times and improve product quality. We believe that
continuing this arrangement will lower our manufacturing costs, provide us with
more flexibility to scale our operations to meet changing demand and allow us to
focus our engineering resources on new product development and product
enhancements.
PRODUCTS
Our products are designed to be deployed in a telephone company's central
offices or remote terminals between one or more DSL access multiplexers and the
copper subscriber lines. Modules may be added over time as subscriber count
increases and as more DSL access multiplexer modules are added. With the CX100
our customers can remotely qualify and monitor copper lines as well as verify
connections to subscriber sites.
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With the SX500 our customers can implement complete loop management solutions
for delivering residential DSL and voice services over the same copper line, and
for line sharing arrangements. We also offer a suite of software modules, called
CrossWorks, which enables our customers to more efficiently control our
products, enhancing remote or automated management of the local loop. We expect
that these core technologies will serve as the basis for future generations of
products.
Copper CrossConnect CX100. The CX100 is a modular product designed for
central office and remote terminal environments and is compliant with network
equipment building standards. The base system, which depends on customer
configuration, typically consists of one CX100 chassis, one P150 module that
provides the management and control functions of the CX100 and one or more L140
modules that provide access to copper telephone lines. The base system is
installed and fully cabled in a central office or remote terminal, with
additional modules added over time as subscriber count increases and as more DSL
access multiplexer modules are added. All modules may be inserted or removed
while the system is operational and are automatically recognized and inventoried
by the system upon insertion. All modules, indicators and switches are
accessible from the front of the system, consistent with current industry
practices. The CX100 supports dual 48-volt power feeds. In the event of loss of
power, the CX100 maintains all connections with no loss of subscriber service.
The CX100 chassis is available in 19 and 23 inch configurations. The 19 inch
version supports 425 lines, and the 23 inch version supports 550 lines. The
following modules are currently available for the CX100:
- P150. The P150 module provides management and control functions for the
CX100 and has line qualification functionality and the capability of
testing lines for use of the integrated services digital network
standard. The P150 supports Ethernet, serial port or dial-up modem access
for management, as well as access for interfacing to external test gear.
- L140. The L140 module provides access to the P150 and connections for up
to 25 copper lines. Additional L140 modules may be added over time as
subscriber count increases and as more DSL access multiplexer modules are
added.
- M101. The M101 module provides a six-port Ethernet hub and four contacts
for monitoring physical alarms in central offices. This optional module
provides a convenient management connectivity solution between multiple
network products within the central office.
- M120. The M120 module provides an eight-port terminal server and modem
for remote management and monitoring of multiple network devices in
central offices.
Smart Splitter SX500. The Smart Splitter SX500 is a modular product that
incorporates signal splitting and test access for the efficient provisioning of
residential DSL and voice services over the same line and in line sharing
arrangements. The base system, which depends on customer configuration,
typically consists of one SX500 chassis, one SP50 module that provides
management and control functions and test access out to the subscriber and one
or more SL24 splitter modules that provide signal splitting functionality and
test access towards the voice switch or DSL access multiplexer. Additional
modules may be added over time as subscriber count increases. All modules may be
inserted or removed while the system is operational, and a continuous dial tone
is assured even during these module changes. The SX500 supports dual 48-volt
power feeds. In the event of loss of power, the SX500 functions as a passive
signal splitter and does not disrupt voice and DSL services. The SX500 is
available in the 19 inch configuration which supports 456 splitters, and the 23
inch version which supports 576 splitters. The following modules are currently
available for the SX500:
- SP50. The SP50 module performs system management and control for the
SX500 and enables test access for the portion of the network extending
out to the subscriber site.
- SL24. The SL24 module provides signal splitting functionality for up to
24 lines and enables test access for the portion of the network extending
towards the voice switch or the DSL access multiplexer.
CrossWorks. CrossWorks is a suite of software products that enable service
providers to automate physical management of a large volume of copper lines when
using CX100 systems. When the CX100 and the
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SX500 systems are deployed together, CrossWorks can be used to manage both
systems. CrossWorks employs a client-server architecture that offers flexible
integration with existing operational support systems. The CrossWorks server,
which performs most of the automation work, can be accessed via standard
interfaces, such as common object request broker architecture, commonly known as
CORBA, JAVA, remote method indication, commonly known as RMI, simple network
management protocol, commonly known as SNMP, or distributed component object
model, commonly known as DCOM, allowing a service provider to use its own user
interface. Alternatively, a service provider can use CrossWorks as a standalone
client-server application. With either of these approaches, CrossWorks is
designed to interface with the service provider's existing database through a
standard application programming interface. These options are designed to
provide the service provider with automated system capabilities while leveraging
its existing operational support systems infrastructure.
CUSTOMERS
For the year ended December 31, 2000, our nonexclusive original equipment
manufacturer relationship with Lucent Technologies accounted for approximately
19% of our revenues and no other customers accounted for more than 10% of our
revenues. The following is a representative list of our customers as of December
31, 2000: Covad Communications, DSL.net, McLeodUSA, Inc., Mpower Communications
(formerly MGC Communications), Qwest Communications International Inc. (formerly
U.S. West), Rhythms NetConnections, Riodata GmbH and XO Communications (formerly
Nextlink). We have no long-term contracts with any of our customers, and they
may reduce or discontinue their purchases at any time.
SALES AND MARKETING
We sell and market our products through our direct sales force, indirect
channels and through participation in affiliation programs.
Direct Sales. As of December 31, 2000, our direct sales effort in North
America was directed by 8 account managers. We also had 6 account managers based
internationally in Australia, Germany, New Zealand and the United Kingdom. Our
direct sales efforts are primarily focused on incumbent local exchange carriers
and international carriers who are beginning to deploy DSL and competitive local
exchange carriers that are financially stable. We plan to continue to expand our
direct sales organization internationally in the future. We also have 17 systems
engineers who support our account managers and work with customers' engineering
and operations personnel to improve their ability to use and integrate our
products. Direct sales accounted for approximately 81% of our revenues for the
year ended December 31, 2000.
Indirect Sales. We and Lucent Technologies, a leader in the global
telecommunications equipment market, are parties to an original equipment
manufacturer agreement. Under this agreement, we co-brand the CX100 with Lucent,
which resells the CX100 products. Lucent offers DSL access equipment and
services, including vendor financing, which facilitate the sale of our products
and services. Lucent generally provides first level support for our products to
its customers. Our agreement allows Lucent to sell our product on a worldwide,
nonexclusive basis. Under our agreement, Lucent provides monthly, nonbinding,
twelve-month forecasts of Lucent's anticipated orders. The contract contains no
minimum purchase requirements and is terminable by Lucent at any time. Products
are shipped against individual purchase orders. The agreement expires in August
2002 but may be renewed by agreement of both parties for an additional twelve
month period. We have also entered into nonexclusive, territory-based
arrangements with several international resellers. These arrangements typically
have one-year renewable terms, contain no minimum purchase requirements and are
terminable by either party at any time.
Affiliation Programs. We have worked to make our hardware products
interoperable with complementary products of other equipment providers in order
to enable us to jointly offer a more comprehensive solution for deploying DSL
services. Hardware companies with which we have affiliated with are AccessLan
Communications, Inc., ADTRAN, Inc., Alcatel Alsthom S.A., Cisco Systems, Copper
Mountain Networks, Inc., Lucent, Paradyne Corporation and Sunrise Telecom Inc.
We have also initiated the CrossWorks Back Office Network Development program
whereby we work with other leading vendors and system integrators to
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accelerate the development of next generation back office systems that enable
DSL service providers to fully automate installation, management and maintenance
of copper telephone lines. Vendors and systems integrators with which we are
currently affiliated are BusinessEdge Solutions, Cygent Inc., Cap Gemini Ernst &
Young LLP, Nightfire Software Inc., Syndesis Limited and Vitria Technology, Inc.
Our marketing organization is responsible for sales support activities,
product presentations, documentation and pricing, as well as new product and
feature definition. Our marketing organization also performs activities such as
marketing communications, joint marketing with affiliates, marketing research,
trademark administration and other support functions.
CUSTOMER SERVICE AND SUPPORT
We believe a high level of continuing service and support is critical to
our long-term success. We offer comprehensive hardware and software maintenance
and support programs for our products. The majority of our service and support
activities are related to training, troubleshooting and network management.
These services are provided by telephone, email and directly at customer
locations using personnel from our customer support group. We also offer various
training courses for our direct customers and original equipment manufacturers.
RESEARCH AND DEVELOPMENT
We have assembled a team of highly skilled engineering professionals who
are experienced at designing data networking equipment and network management
software. Our engineering personnel have expertise in a number of fields,
including digital loop carrier design, voice and data switching technology,
local loop equipment design and operations support systems. During the year
ended December 31, 2000, we spent $18.7 million on research and development. As
of December 31, 2000, we had a total of 85 employees engaged in research and
development.
We believe that our future success depends on our continued ability to
adapt to the rapidly changing local loop market, to maintain our expertise in
management of the local loop and to continue anticipating and satisfying our
customers' evolving needs. We continually review and evaluate technological and
regulatory changes affecting the local exchange carrier market and seek to offer
products and capabilities that solve customers' operational challenges and
improve their efficiency.
Through our research and development efforts, we created our CrossWorks
suite of software products that enable more efficient integration of our CX100
systems' functions into our customers' operations support systems. We believe
that our extensive experience designing and implementing high-quality network
components has enabled us to develop high-value integrated systems solutions.
We are currently investing significant resources in operational support
systems interfaces and capabilities, automated testing, new modules optimized
for specific applications and support for additional industry standards,
including international compliance testing for our products.
COMPETITION
The market for telecommunications equipment is highly competitive. A number
of companies that have traditionally produced products for analog voice networks
also sell products that compete with ours. These companies include: Harris
Corporation, Hekimian Laboratories, a division of Spirent plc, Inrange
Technologies Corporation, Lucent Technologies, Nokia Corporation, Nortel
Networks, Teradyne Corporation and Tollgrade Communications. In addition, a
number of smaller companies are expected to introduce products that will compete
with ours.
We also compete with DSL equipment providers including Lucent, Nortel,
Nokia and Alcatel, who have announced plans to incorporate competitive features
and functionality into their DSL access multiplexers. To the extent we expand
the capabilities of our products to incorporate functionality traditionally
contained in other equipment, we may also face increased competition from other
vendors.
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Remaining competitive in our markets will require a continued high level of
investment in research and development, marketing, and customer service. The
principal competitive factors in our market include:
- speed of new product introductions to market;
- depth of product functionality;
- ease of installation, integration and use;
- system reliability and performance;
- price and financing terms;
- technical support and customer service;
- size and stability of the vendor's operations; and
- compliance with government and industry standards.
Due to the rapidly evolving markets in which we compete, additional
competitors with significant market presence and financial resources, including
other large telecommunications equipment manufacturers, may enter our markets,
thereby further intensifying competition. We may not have sufficient resources
to continue to make the investments or achieve the technological advances
necessary to compete successfully. The markets for high-speed telecommunications
products are characterized by rapid technological developments, frequent
enhancements to existing products and new product introductions, changes in end
user requirements and evolving industry standards. The emerging nature of these
products and services and their rapid evolution requires us to continually
improve the performance, features and reliability of our products, particularly
in response to competitive product offerings. Current or future competitors may
foresee the course of market developments more accurately than we do and may
introduce products incorporating superior or alternative technologies that could
render our products obsolete.
Our products are primarily used in DSL-based service applications that use
copper lines. Numerous other high-speed access technologies, including cable
modems, satellite technology and wireless technologies compete with DSL-based
services. These competing technologies may ultimately prove to be superior to
DSL-based services and reduce or eliminate the demand for our products. The
properties of copper lines limit the speed and distance over which data can be
transmitted. Service levels degrade as distance from the central switching
station increases. Other competing technologies, such as wireless and cable, are
not subject to such limitations. Our products may become obsolete as a result of
the development of competing technologies that are more reliable, faster and
less expensive than DSL.
MANUFACTURING
Our manufacturing operation is entirely outsourced. We and A-Plus
Manufacturing, a division of C-MAC Industries Inc., are parties to a contract
manufacturing agreement, under which we subcontract manufacturing of our
products. A-Plus Manufacturing, located in San Jose, California, is an
established contract manufacturer with ISO 9002 and Telecordia, formerly
Bellcore, certifications. These certifications relate to the manufacturer's
compliance with industry standards for quality control procedures and
telecommunications products. This subcontracting arrangement includes material
procurement, board level assembly, final assembly, test and shipment to our
customers. We utilize automated design, manufacturing and test processes to
minimize cycle times and improve product quality. We design and implement all of
the tests that are required to meet internal and external quality standards, and
routinely monitor product quality via on-site inspections. This arrangement
provides us with the following benefits:
- we operate without substantial space dedicated to manufacturing
operations;
- we conserve a significant portion of the working capital that would be
required for funding inventory; and
- we can more easily adjust manufacturing volumes to meet changes in
demand.
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A combination of standard parts and components are used, which are
generally available from more than one vendor, and a number of key components
are purchased from sole or limited source vendors for which alternative sources
are not currently available. In most cases, there are no guaranteed supply
arrangements with these suppliers, and we or our contract manufacturer may fail
to obtain these supplies in a timely manner in the future. Delivery delays,
supply interruptions or the discontinuation of these components could result in
delays or reduction in product shipments and revenues. In addition, the purchase
of these components on a sole source basis subjects us to risks of price
increases and potential quality assurance problems.
Our contract manufacturer currently purchases key components for which
there are currently no substitutes available from approximately 8 suppliers. All
of these components are critical to the production of our products, and
competition exists with other manufacturers for these key components. While
alternative suppliers may be available, we must first identify these suppliers
and qualify them. Qualifying additional suppliers is time-consuming and
expensive. We cannot be certain that we will be able to qualify or identify
alternative suppliers in a timely fashion, or at all. In addition, our contract
manufacturer may not be able to obtain sufficient quantities of these components
from existing or future suppliers on the same or substantially the same terms as
are currently available. Consolidations involving suppliers could further reduce
the number of alternatives and affect the cost of components. An increase in the
cost of components could make our products less competitive and result in lower
margins. Financial or other difficulties faced by these suppliers or significant
changes in market demand for these components could limit the availability of
these components. Any interruption or delay in the supply of any of these
components, or an inability to obtain these components from alternate sources at
acceptable prices and within a reasonable amount of time, would adversely affect
our ability to meet scheduled product deliveries to our customers, cause us to
lose sales to existing and future customers and harm our operating results and
financial condition.
In addition, lead times for some of the materials and components we use are
very long and depend on factors such as the specific supplier, contract terms
and demand for each component at a given time. Our contract manufacturer also
may experience shortages of components from time to time, which also could delay
the manufacturing of our products. Additionally, long lead times for some
materials and components have in the past, and may in the future, cause us to
attempt to mitigate these lead times by purchasing inventories of some parts
ourselves, increasing our costs, the risk of the parts' obsolescence and the
risk of incurring supply contract cancellation fees if we overestimate our
component requirements. Limited sources of supply of, and competition with other
manufacturers for, key components may increase the price we pay to obtain these
components and lower our gross margins. If we fail to carry a sufficient
inventory of long lead time items, if lead times increase or if demand for our
products increases unexpectedly, we may have insufficient access to components
necessary to meet demand for our products on a timely basis. If demand for our
products decreases unexpectedly, which we have experienced in the past and may
experience in the future, we may have excess inventory and incur supply contract
cancellations fees.
INTELLECTUAL PROPERTY
We rely on a combination of copyright, trademark, trade secret and other
intellectual property law, nondisclosure agreements and other protective
measures to protect our intellectual property. We have filed six patent
applications to date. We attempt to protect our intellectual property rights by
limiting access to the distribution of our software, documentation and other
proprietary information. In addition, we enter into confidentiality agreements
with our employees and certain customers, vendors and strategic partners. These
steps may fail to prevent the misappropriation of our intellectual property,
particularly in foreign countries where the laws may not protect our
intellectual property as fully as in the United States. Other parties may
independently develop competing technology. Attempts may be made to copy aspects
of our products or to obtain and use information that we regard as proprietary.
Our existing and future patent applications, if any, may not be approved, any
issued patents may not protect our intellectual property, and any issued patents
may be challenged by third parties. Any failure to adequately protect our
intellectual property could result in our competitors offering similar products,
potentially resulting in loss of a competitive advantage and decreased revenues.
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We employ many types of intellectual property in the development and
manufacturing of our products. We believe that the loss of all or a substantial
portion of our intellectual property could have a material adverse effect on our
results of operations. Our intellectual property protection measures might not
be sufficient to prevent misappropriation of our technology. In addition, the
laws of many foreign countries do not protect our intellectual properties to the
same extent as the laws of the United States. From time to time, we may desire
or be required to renew or to obtain licenses from others in order to further
develop and market commercially viable products effectively. Any necessary
licenses might not be available on reasonable terms. To date, we have not been
notified that our products infringe the proprietary rights of third parties, but
in the future third parties might claim infringement by us with respect to our
current or future products. These claims and any resulting lawsuit, if
successful, could subject us to significant liability for damages and invalidate
our proprietary rights. These lawsuits, regardless of their success, would
likely be time-consuming and expensive to resolve and would divert management
time and attention. Any potential intellectual property litigation also could
force us to do one or more of the following:
- cease selling, incorporating or using products or services that
incorporate the infringed intellectual property;
- obtain from the holder of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on acceptable terms, if at all; or
- redesign those products or services that incorporate the disputed
technology.
We may in the future initiate claims or litigation against third parties
for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of competitors.
These claims could result in costly litigation and the diversion of our
technical and management personnel. As a result, our operating results could
suffer and our financial condition could be harmed.
We have registered Turnstone Systems, the Turnstone Systems logo, Copper
CrossConnect CX100 and Smart Splitter SX500 as trademarks. Each trademark, trade
name or service mark of any other company appearing in this prospectus belongs
to its holder.
EMPLOYEES
As of December 31, 2000, we had a total of 160 employees based in the
United States, 35 employees based in New Zealand and 8 employees based in
various other international jurisdictions. Of the total, 85 were engaged in
research and development, 58 were engaged in sales, marketing and customer
support, 27 were engaged in operations, and 33 were engaged in administration
and finance. None of our employees is subject to a collective bargaining
agreement and we believe that our relations with our employees are good.
RISK FACTORS
In addition to other information in this Form 10-K, the following risk
factors should be carefully considered in evaluating Turnstone and its business
because such factors currently may have a significant impact on Turnstone's
business, operating results and financial condition. As a result of the risk
factors set forth below and elsewhere in this Form 10-K, and the risks discussed
in Turnstone's other Securities and Exchange Commission filings, actual results
could differ materially from those projected in any forward-looking statements.
WE HAVE LOST MONEY IN THE PAST, ARE CURRENTLY EXPERIENCING LOSSES AND MAY NOT
ACHIEVE PROFITABILITY IN THE FUTURE, WHICH COULD CAUSE THE MARKET PRICE OF OUR
COMMON STOCK TO DECLINE.
We have experienced losses in the past and were not profitable on an
operating basis for the fourth quarter of fiscal 2000. Our stock price declined
substantially in the fourth quarter of fiscal 2000. If we do not succeed in
generating significant revenue growth, we will not be able to achieve
profitability and the market price of our common stock may decline further. We
expect to continue to incur significant product
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development, sales and marketing and administrative expenses. In particular, we
anticipate that our expenses will increase substantially in the next 12 months
as we:
- increase our sales and marketing activities, particularly by expanding
our incumbent local exchange carrier and international sales and support
organization;
- develop our technology, expand our existing product lines and add new
features to penetrate new markets; and
- develop additional infrastructure and hire additional management.
Our operating expenses are largely based on currently anticipated revenue
trends, which may not be realized, and a high percentage of our expenses are and
will continue to be fixed in the short term. We will need to generate
significant revenues to offset these expenses and achieve profitability.
OUR LIMITED OPERATING HISTORY AND THE LIMITED OPERATING HISTORY OF MANY OF OUR
CURRENT CUSTOMERS MAKE FORECASTING DIFFICULT, AND IF OUR OPERATING RESULTS ARE
BELOW EXPECTATIONS, THE PRICE OF OUR COMMON STOCK WILL DECLINE.
As a result of our limited operating history, it is difficult to forecast
accurately our revenues and operating expenses. Specifically, we began
operations in January 1998, began shipping the CX100 in the first quarter of
1999 and introduced the SX500 in November 2000. The revenue and income potential
of our products and business are unproven and the market that we are addressing
is rapidly evolving. In addition, we are experiencing limited visibility and
continued uncertainty with respect to many of our competitive local exchange
carrier customers, who also have limited operating histories and who have
recently faced financial difficulties. These financial difficulties have caused
and may continue to cause our customers to cancel or reduce their orders of our
products or to become delinquent in their payments for our prior sales to them.
If our customers continue to reduce orders for our products or become unable to
pay for products already ordered, our operating results will fall below our
expectations and the expectations of investors and market analysts, and the
price of our common stock will decline.
IF DSL TECHNOLOGY FAILS TO GAIN WIDESPREAD MARKET ACCEPTANCE, THE DEMAND FOR OUR
PRODUCTS MAY DECREASE.
If DSL technology fails to gain widespread acceptance, our revenues and
results of operations will be harmed. Our products are primarily used by local
exchange carriers who offer DSL-based services. Our future success is
substantially dependent upon whether DSL technology gains widespread market
acceptance by local exchange carriers, of which there are a limited number, and
by end users of their services. Local exchange carriers are continuously
evaluating alternative high-speed data access technologies and may at any time
adopt technologies other than DSL. Numerous other high-speed access
technologies, including cable modems, wireless technology and satellite
technologies compete with DSL-based services. Cable modem service can
theoretically provide faster download speeds than DSL. Both wireless and
satellite technologies enable users to transmit and receive information using
radio frequencies at speeds close or comparable to DSL transmission speeds.
These competing technologies may ultimately prove to be superior to DSL-based
services and reduce or eliminate the demand for our products.
IF WE FAIL TO PENETRATE THE INCUMBENT LOCAL EXCHANGE CARRIER MARKET, OUR ABILITY
TO GROW OUR BUSINESS WILL BE JEOPARDIZED.
Previously, our sales efforts have primarily been focused on competitive
local exchange carriers. We have shifted our focus to penetrating the incumbent
local exchange carrier market and face a number of new challenges, including our
inexperience selling to incumbent carriers, a very long sales cycle, competition
from established suppliers and stringent customer service and support
requirements. In addition, the incumbent carriers may be reluctant to make
additional infrastructure investments or to purchase products from a supplier
with whom they have not previously worked. If we cannot overcome these
challenges and penetrate the incumbent local exchange carrier market, our growth
will be slowed and we may not achieve profitability.
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SUBSTANTIALLY ALL OF OUR REVENUES COME FROM NEW AND EMERGING COMPETITIVE LOCAL
EXCHANGE CARRIERS, WHOSE INABILITY TO OBTAIN CAPITAL IS CAUSING THEM AND MAY
CONTINUE TO CAUSE THEM TO REDUCE OR DISCONTINUE THEIR PURCHASES OF OUR PRODUCTS.
Because our current customer base consists principally of new and emerging
businesses, we will not be able to increase our revenues if their business
models, which are largely unproven, are not successful or if their financial
conditions continue to deteriorate. To date, our customers have consisted
principally of competitive local exchange carriers. These carriers require
substantial capital for the development, construction and expansion of their
networks and the introduction of their services. Recently, many of these
carriers have had difficulty in obtaining or have been unable to obtain
financing and have either reduced or discontinued their purchase of our
products. A continued reduction in the financing available to our customers, or
the inability of our customers to obtain financing, will continue to impair our
ability to make future sales as well as to collect amounts due on sales we have
already made. In addition, we may choose to provide financing to our customers,
which will subject us to additional financial risk and may cause us to incur
additional losses. The telecommunications service provider industry has recently
experienced consolidation. The loss of a customer, through industry
consolidation or otherwise, could reduce or eliminate our sales to that
customer.
IF OUR CUSTOMERS ARE UNABLE TO ACQUIRE AND RETAIN DSL SUBSCRIBERS, THEY MAY
CURTAIL THEIR DSL DEPLOYMENT PLANS AND REDUCE THEIR PURCHASES OF OUR PRODUCTS OR
CONTINUE TO HAVE PROBLEMS PAYING FOR OUR PRODUCTS.
To date, our customers have deployed DSL equipment, including our products,
in substantially larger volumes than their current subscriber count. The
inability of our current or future customers to acquire and retain subscribers
as planned, or to respond to competition for their services or reduced demand
for their services, could cause them to reduce or eliminate their DSL deployment
plans. If our customers are forced to reduce or eliminate their DSL deployment
plans, our sales to them will decline.
Recently, because of their inability to obtain additional financing or
generate sufficient revenues to fund their operations, a number of our customers
have become delinquent in their payments for our prior sales to them. As of
December 31, 2000, eight of our customers were experiencing financial
difficulties and were not able to stay current in their payments. As a result,
during the fourth quarter of 2000 we recorded a charge to our bad debt reserve
for the receivables of these customers. We cannot assure you that we will ever
be able to collect any payments from these customers. Two of these customers,
Digital Broadband Communications, Inc. and Vectris Communications, Inc., have
filed for bankruptcy protection. With respect to them or any of our customers
that have sought or may seek bankruptcy protection in the future, the bankruptcy
court may require us to return some or all of the payments we received from them
prior to their bankruptcy filing. The inability of our customers to pay us for
prior sales we made to them has and will continue to have a negative impact on
our operating results.
OUR CUSTOMERS HAVE AND MAY CONTINUE TO MAKE AVAILABLE FOR SALE LARGE QUANTITIES
OF OUR PRODUCTS IN THE PUBLIC MARKETPLACE AT DISCOUNTED PRICES, WHICH COULD
RESULT IN LOST SALES AND LOWER GROSS MARGINS FOR US.
Recently, a number of our customers have decided to scale back or
discontinue their network buildouts or have filed for bankruptcy. As a result,
these customers have and may continue to make available for sale large
quantities of our products in the public marketplace, often at discounted
prices. If our prospective customers choose to purchase our products from these
customers instead of from us, our sales may decline. In addition, we may
experience pricing pressures as a result of the excess supply of our products in
the marketplace, which could force us to lower our average selling prices and
reduce our gross margins.
THE CX100 AND SX500 ARE CURRENTLY OUR ONLY VOLUME PRODUCT OFFERINGS, AND IF THEY
FAIL TO ACHIEVE MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO GROW OUR REVENUES.
Our future growth and a significant portion of our future revenue depend on
the success of our CX100 and SX500 platforms, which are the only two volume
products that we currently offer. Accordingly, failure of the CX100, SX500 or
future products to maintain meaningful levels of market acceptance and customer
satisfaction would limit our sales and our revenue growth. We only began
shipping the CX100 in the first
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quarter of 1999, and have not yet recognized any revenue from the SX500, which
was introduced in November 2000. Many potential customers who have evaluated the
CX100 or SX500 have not yet deployed the product in production network
environments and may choose not to deploy our current products or any of our
future products. Other potential customers may have already deployed another
technology and may therefore be unwilling to deploy the CX100 or SX500.
Even when customers do purchase and deploy our products, due to the variety
and complexity of environments in which the CX100 or SX500 is installed, the
installed product may not operate as expected. Failure of our products to
operate as expected could delay or prevent their volume deployment, which could
decrease our revenues and increase our expenses as we devote additional
development resources to improving product performance. The success and
deployment into our customers' networks of our products will also depend on
customer satisfaction with our products and numerous other factors, including:
- the realization of operating cost efficiencies for our customers when our
products are deployed and our customers' ability to quantify these
operational efficiencies;
- our successful development of systems and software that address customer
infrastructure requirements; and
- our customers' successful integration of our CrossWorks software into
their operational support systems.
WE DERIVE A MAJORITY OF OUR REVENUES FROM A SMALL NUMBER OF CUSTOMERS, AND ANY
DECREASE IN REVENUES FROM A MAJOR CUSTOMER COULD PREVENT US FROM MEETING
SECURITIES ANALYSTS' EXPECTATIONS AND CAUSE OUR STOCK PRICE TO FALL.
We began recognizing revenues from the CX100 in the quarter ended March 31,
1999. The majority of our revenues to date have been recognized from a small
number of customers. Purchases by large customers and, therefore, our revenues,
may vary significantly from quarter to quarter. The loss of any one of our major
customers or a reduction or delay in purchases of our products from any one of
these customers would cause our revenues to decline and could cause our stock
price to decline if our revenues are below analysts' expectations. Revenues from
significant customers as a percentage of our total revenues for the years ended
December 31, 2000 and 1999 were as follows:
2000 1999
------------- ----
Lucent Technologies................................... 19% 15%
Rhythms NetConnections................................ Less than 10% 41%
Network Access Solutions.............................. Less than 10% 19%
Covad Communications.................................. Less than 10% 11%
We expect that the majority of our revenues will continue to depend on
sales of our products to a small number of customers. In addition, a small
number of customers may account for substantially all of our revenues in any
particular quarter, and these customers may change from quarter to quarter. We
have no long-term contracts with any customers for the purchase of our products,
and customers may reduce or discontinue purchases at any time. Customers may
also delay or cancel purchase orders without penalty.
There are a limited number of local exchange carriers that are potential
customers, and this number may not increase in the future. Consolidation among
local exchange carriers may increase our reliance on a small number of customers
in future periods. Accordingly, our future revenues will depend significantly
upon the timing and size of future purchase orders from our largest customers.
In addition, because we are dependent on a limited number of customers, we
expect to experience volatility relating to the budgeting cycles of our
customers and the telecommunications industry in general. For example, the
telecommunications sector recently experienced a general market downturn and
many of our customers have been unable to raise the capital necessary to fund
their budgeted buildout plans, and have ceased or significantly reduced their
purchases of our products or have been unable to pay or delayed payment for
products they had previously purchased. Adverse changes in our revenues or
operating results as a result of
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these budgeting cycles or any other reduction in capital expenditures by our
large customers have substantially reduced and could continue to substantially
reduce the trading price of our common stock. Some of our customers are
significantly larger than us and are able to exert a high degree of influence
over us. They have sufficient bargaining power to demand low prices and other
terms and conditions that may negatively affect our business and results of
operations.
OUR OPERATING RESULTS MAY FLUCTUATE DUE TO SEASONAL BUYING PATTERNS OF OUR
CUSTOMERS.
Based on our limited operating history, we believe that on a relative
basis, purchases by our customers tend to be lower in the fourth calendar
quarter. Many of our customers typically establish annual plans for building out
their networks at the beginning of each calendar year. To the extent they are
completed prior to the fourth calendar quarter, some of our customers may decide
to cease or significantly reduce purchases of our products. We cannot be sure,
however, that this trend will continue or that additional patterns of
seasonality will not occur in international markets as we expand our
international operations. Additionally, our customers are affected by a number
of other business factors, including capital availability, DSL adoption rates
and competition, which could greatly alter their network buildout plans and
normal seasonal buying patterns.
THE LONG SALES CYCLE FOR OUR PRODUCTS MAY CAUSE OUR REVENUES AND OPERATING
RESULTS TO VARY SIGNIFICANTLY FROM QUARTER TO QUARTER.
Because the sales cycle for our products is long, our revenues in a given
quarter may not meet market expectations if we experience delays in customer
orders. In addition, we may have incurred substantial sales and marketing
expenses during that quarter, without offsetting revenues. As a result, delays
resulting from our lengthy sales cycle could reduce our revenues and decrease
our profits, or result in a loss. Specifically, our customers' network planning
and purchase decisions normally involve a significant commitment of resources
and a lengthy evaluation and product qualification process. The decision to
purchase our products is made as part of this network planning process, and our
sales cycle can be as long as one year or more. Throughout the sales cycle, we
often spend considerable time and resources educating and providing information
to prospective customers regarding the use and benefits of our products. Even
after making the decision to purchase our products, our customers may delay or
cancel the deployment of our products. Timing of deployment is unpredictable,
can vary widely and depends on a number of factors, many of which are beyond our
control, including:
- customers' current network deployment procedures;
- customers' level of expertise;
- status and performance of customers' other network equipment;
- degree of software development and integration necessary for the customer
to deploy our products; and
- financial and administrative resources of the customer.
INTENSE COMPETITION IN OUR INDUSTRY COULD RESULT IN OUR LOSING CUSTOMERS OR
BEING UNABLE TO ATTRACT NEW CUSTOMERS. AS A RESULT, OUR REVENUE COULD DECLINE OR
WE COULD EXPERIENCE LOSSES.
The market for telecommunications equipment is highly competitive. If we
are unable to compete effectively, our revenues could decline, our expenses
could increase, and our earnings could decrease or we could experience losses. A
number of companies produce products that compete with ours, including Harris
Corporation, Hekimian Laboratories, a division of Spirent plc, Lucent
Technologies, Nokia Corporation, Nortel Networks, Teradyne Corporation and
Tollgrade Communications. Many of our current and potential competitors have
significantly greater sales and marketing, technical, manufacturing, financial
and other resources. In addition, a number of smaller companies are expected to
produce products that compete with ours. Due to the rapidly evolving market in
which we compete, additional competitors with significant market presence and
financial resources, including other large telecommunications equipment
manufacturers, may enter that market, thereby further intensifying competition.
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We also compete with DSL equipment providers, including Alcatel, Lucent,
Nokia and Nortel, who have each announced plans to incorporate competitive
features and functionality into their DSL access multiplexers. A DSL access
multiplexer is a network device, usually located at a telephone company's
central office, that receives signals from multiple DSL connections and puts the
signal on a larger, high-speed transmission line. Lucent has announced plans to
produce DSL access multiplexer products that will include some of the same
features and functions as our CX100 product. If our current and potential
customers choose to deploy DSL access multiplexers that include features and
functions that are competitive with our products, or delay purchases of our
products to evaluate these DSL access multiplexers, our business could be
seriously harmed. To the extent we expand the capabilities of our products to
incorporate functionality traditionally contained in other equipment, we may
also face increased competition from other vendors.
WE EXPECT AVERAGE SELLING PRICES AND GROSS MARGINS OF OUR PRODUCTS TO DECREASE,
AND WE MAY NOT BE SUCCESSFUL IN REDUCING OUR COSTS OR REDESIGNING OUR PRODUCTS
TO REMAIN COMPETITIVE.
The market for telecommunications equipment is characterized by declining
prices due to increased competition, new products and increasing unit volumes.
Due to competition and potential pricing pressures from large customers in the
future, we expect that the average selling price and gross margins for our
products will decline over time. If we fail to reduce our production costs, our
gross margins will decline rapidly. We may not be successful in redesigning our
products or achieving cost reductions in a timely manner, particularly as we
introduce new products. In addition, redesign may not provide sufficient cost
reductions to allow us to remain competitive.
SOME KEY COMPONENTS IN OUR PRODUCTS COME FROM SOLE OR LIMITED SOURCES OF SUPPLY,
WHICH EXPOSES US TO POTENTIAL SUPPLY INTERRUPTIONS THAT COULD PREVENT OR DELAY
THE MANUFACTURE AND SALE OF OUR PRODUCTS AND COULD REDUCE GROSS MARGINS OF OUR
PRODUCTS.
Our contract manufacturer currently purchases a number of key components
used in the manufacture of our products from sole or limited sources of supply
for which alternative sources are not currently qualified and may not be
available. In most cases we and our contract manufacturer have no guaranteed
supply arrangement with these suppliers, and we or our contract manufacturer may
fail to obtain these supplies in a timely or cost effective manner. Financial or
other difficulties faced by these suppliers or significant changes in market
demand for, or supply of, these components could limit the availability to us of
these components. We have experienced supply delays in the past and may
experience delays in the future. Such delays could:
- significantly increase the cost of manufacturing our products and reduce
gross margins of our products;
- adversely affect our ability to meet scheduled product deliveries to our
customers; and
- cause us to lose sales to existing and future customers.
In addition, the purchase of these components on a sole source basis
subjects us to risks of price increases and potential quality assurance
problems.
Our contract manufacturer currently purchases key components for which
there are currently no substitutes available from approximately 8 suppliers. All
of these components are critical to the production of our products, and
competition exists with other manufacturers for these key components. We might
not be able to qualify or identify alternative suppliers in a timely fashion, or
at all. Consolidations involving suppliers could further reduce the number of
alternatives for us and affect the cost of components. An increase in the cost
of components could make our products less competitive and result in lower
margins.
IF WE FAIL TO ACCURATELY PREDICT OUR MANUFACTURING REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS AND EXCESS INVENTORY OR EXPERIENCE MANUFACTURING DELAYS AND A
SHORTAGE OF INVENTORY.
We have a supply contract with A-Plus Manufacturing, a division of C-MAC
Industries Inc., to build our products. We provide product demand forecasts to
A-Plus Manufacturing no less than six months prior to scheduled delivery of
products to our customers. If we overestimate our requirements, A-Plus
Manufacturing may have excess inventory, which we could be obligated to
purchase. If we underestimate our requirements,
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A-Plus Manufacturing may have inadequate inventory, which could interrupt
manufacturing of our products and result in delays in shipments and revenues, or
add additional costs to our products to expedite delivery of certain long lead
time components.
In addition, lead times for some of the materials and components used in
our products are very long and depend on factors such as the specific supplier,
contract terms and demand for each component at a given time. If we or A-Plus
Manufacturing fail to carry a sufficient inventory of long lead time items, if
lead times increase or if demand for our products increases unexpectedly, we may
have insufficient access to components necessary to meet demand for our products
on a timely basis. Long lead times for some materials and components have in the
past, and may in the future, cause us to purchase inventories of, or enter into
supply contracts for, some parts ourselves. This may increase our costs, the
risk of the parts' obsolescence and the risk of incurring supply contract
cancellation fees if we overestimate our component requirements.
As of December 31, 2000, we had excess inventory and purchase commitments
as a result of customer order cancellations, reductions and delays. As a result,
we recorded a charge in the fourth quarter of 2000 to write down our excess
inventory and to accrue for our estimated purchase commitments. If our customers
continue to cancel, reduce or delay their orders or we fail to attract new
customers, we may in the future have to record additional excess inventory
charges.
WE DEPEND ON A SINGLE CONTRACT MANUFACTURER THAT HAS NO OBLIGATION TO PROVIDE US
WITH FIXED PRICING OR QUANTITIES. IF WE ARE UNABLE TO OBTAIN SUFFICIENT PRODUCTS
FROM OUR CONTRACT MANUFACTURER ON ECONOMICAL TERMS, WE MAY NOT BE ABLE TO TIMELY
FILL CUSTOMER ORDERS.
We rely on a single contract manufacturer, A-Plus Manufacturing, a division
of C-MAC Industries, Inc., to build our products. If A-Plus Manufacturing is
unable to provide us with adequate supplies of high-quality products, or
terminates its relationship with us, we may be unable to fulfill customer orders
on a timely basis, which may delay the DSL deployment schedules of our customers
and strain our relationships with them. Because we currently do not have a
long-term supply contract with A-Plus Manufacturing, they are not obligated to
supply products to us for any specific period, in any specific quantity or at
any certain price, except as may be specified in a particular purchase order.
Our current supply contract with A-Plus Manufacturing can be terminated by
either party with 120 days notice for any reason. If the contract is terminated,
we would be required to purchase any excess inventory held by A-Plus
Manufacturing, they would no longer be obligated to manufacture products for us
and our ability to supply products to our customers could be seriously harmed.
We may be unable to develop alternative manufacturing arrangements on a timely
basis, or at all. In addition, A-Plus Manufacturing may not meet our future
requirements for product quality or timely delivery.
IF WE FAIL TO ENHANCE EXISTING PRODUCTS OR DEVELOP AND SELL NEW PRODUCTS THAT
MEET CUSTOMER REQUIREMENTS, OUR SALES WILL SUFFER.
Our failure to develop products or offer services that satisfy customer
requirements would reduce our sales and harm our operating results. Many of our
current and potential customers may require product features that our products
do not have. In addition, some potential customers have sought to use our
products for uses we have not anticipated, and we have been required to
determine whether the requested functionality could be integrated into our
product. To the extent we are required to add features to our products in order
to achieve a sale, our sales cycle will lengthen, and we will incur increased
development costs for our products. To increase our sales, we must effectively
anticipate and adapt to customer requirements and offer products and services
that meet customer demands.
IF WE DO NOT MANAGE NEW PRODUCT INTRODUCTIONS EFFECTIVELY, WE COULD EXPERIENCE
CANCELLED ORDERS OR PRODUCT RETURNS OR BE REQUIRED TO PURCHASE OBSOLETE
INVENTORY FROM OUR CONTRACT MANUFACTURER.
The introduction of new or enhanced products requires that we manage the
transition from older products in order to minimize disruption in customer
ordering patterns and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. Our inability to effectively
manage a product transition may cause material delays in the deployment of DSL
services by our customers, which could cause
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our customers to cancel orders or return our products. The introduction of new
and enhanced products may cause certain customers to defer or cancel orders for,
or to return, existing products. Although we maintain reserves for product
returns, these reserves may not be adequate. In addition, the development of new
or enhanced products could cause inventory held by our contract manufacturer,
A-Plus Manufacturing, to become obsolete. In that event, we could be obligated
to purchase that inventory from A-Plus Manufacturing.
FCC REGULATIONS REGARDING LINE SHARING MAY REDUCE THE DEMAND FOR OUR PRODUCTS IF
INCUMBENT AND COMPETITIVE LOCAL EXCHANGE CARRIERS DECIDE TO SHARE THEIR LINE
MAINTENANCE SYSTEMS.
On November 18, 1999, the Federal Communications Commission, or FCC,
ordered that line sharing, a network arrangement in which incumbent local
exchange carriers must share the existing subscriber line with competitive local
exchange carriers, be made available to competitive local exchange carriers by
June 6, 2000. To the extent that competitive local exchange carriers elect to
provide DSL services on shared lines that they would have otherwise deployed on
separate lines, the demand for our products could be significantly reduced or
eliminated.
Adjustments to the FCC's regulations regarding line sharing, new FCC
regulations or regulations set forth by other regulatory bodies may also reduce
demand for our products. Because the competitive local exchange carriers do not
have access to the incumbent local exchange carriers' line maintenance systems,
the competitive local exchange carriers have typically implemented an
independent line maintenance system and several have deployed the CX100 as a key
component of this system. In the future, the FCC may expand line sharing to give
competitive local exchange carriers access to incumbent local exchange carriers'
line maintenance infrastructure, which would eliminate or reduce the need for
our products.
BECAUSE OUR PRODUCTS ARE DEPLOYED IN COMPLEX ENVIRONMENTS, THEY MAY HAVE ERRORS
OR DEFECTS THAT ARE FOUND ONLY AFTER FULL DEPLOYMENT, WHICH COULD RESULT IN
LIABILITY CLAIMS AGAINST US.
Errors or other problems in our products could result in:
- loss of or delay in revenues and loss of customers or market share;
- failure of our products to achieve market acceptance;
- diversion of development resources;
- increased service and warranty costs;
- legal actions by our customers; and
- increased insurance costs.
Because our products are designed to provide critical services, if errors,
defects or failures are discovered in our current or future products, or as new
versions are released, we may be exposed to significant legal claims. Any
claims, with or without merit, could damage our reputation and our business,
increase our expenses and impair our operating results. Although we maintain
product liability insurance covering some damages arising from implementation
and use of our products, our insurance may not fully cover claims sought against
us. Liability claims could require us to spend significant time and money in
litigation or to pay significant damages.
Our products are designed for large and complex networks. To date, our
products have been deployed on a limited basis. Consequently, our customers may
discover errors or defects in our hardware or software only after it has been
fully deployed and operated as part of their infrastructure in connection with
products from other vendors, especially DSL access multiplexers and DSL modems.
WE MAY NOT BE ABLE TO GROW OUR BUSINESS IF WE FAIL TO DEVELOP AND MAINTAIN
RELATIONSHIPS WITH THIRD PARTIES TO MARKET AND SELL OUR PRODUCTS.
Our growth will largely be dependent upon relationships with third parties
who market and sell our products. In particular, we and Lucent Technologies are
parties to an original equipment manufacturer
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agreement under which we have agreed to co-brand and sell our products to
Lucent. If Lucent reduces its purchases of our products or breaches or
terminates the agreement, our business will be harmed. Our agreement does not
require Lucent to sell specified volumes of our products. In addition to our
CX100 products, Lucent resells products manufactured by Tollgrade, a competitor.
Lucent has also introduced DSL access multiplexer products that include some of
the same features and functions as our CX100 product. Lucent may choose to sell
these alternative products or other competing products instead of our products.
We have also entered into nonexclusive, territory-based agreements with several
international resellers of our products. If these reseller arrangements are not
successful, our international growth may be slowed.
IF WE CANNOT ATTRACT EXPERIENCED SALES PERSONNEL, SPECIALIZED ENGINEERS AND
HIGHLY-TRAINED CUSTOMER SERVICE PERSONNEL, WE WILL NOT BE ABLE TO SELL AND
SUPPORT OUR PRODUCTS.
Our products and services require a sophisticated selling effort targeted
at several key people within our prospective customers' organizations. This
process requires the efforts of experienced sales personnel as well as
specialized systems and consulting engineers. In addition, the complexity of our
products and the difficulty of configuring and maintaining them require highly
trained customer service and support personnel. We intend to hire a significant
number of engineering, sales, marketing and customer service and support
personnel in the future. We believe our success depends, in large part, upon our
ability to attract and retain these key employees. Competition for such persons
is intense, especially in the San Francisco Bay area. We may not be successful
in attracting and retaining these individuals.
WE DEPEND ON A SINGLE APPLICATION SERVICE PROVIDER FOR INFORMATION SYSTEMS AND
SERVICES. IF THOSE SERVICES ARE INTERRUPTED, OUR ABILITY TO PROCESS TRANSACTIONS
WILL BE IMPAIRED.
We rely on a single application service provider, AristaSoft Corporation,
to provide accounting and operations software and support. If AristaSoft is
unable to provide the level and quality of service we currently anticipate, our
ability to process orders, ship products, prepare invoices and manage our
day-to-day financial transactions will be impaired. Locating and educating a new
application service provider or implementing an alternative solution would be
time consuming and would put further strain on our management personnel. In
addition, the terms of our arrangement with an alternative provider could be
less advantageous, which could increase our expenses. AristaSoft began providing
information systems and services to us on a regular basis in August 1999, at
which time we were their only customer. In December 1999, we entered into a
three year agreement with AristaSoft for access to customer service, financial,
logistics and manufacturing software. In order for us to realize our business
goals, AristaSoft must be able to provide and manage a scalable and reliable
information technology infrastructure to support the growth of our business. If
AristaSoft is unable to meet our expectations, we may be unable to obtain
alternative services on a timely or economical basis.
IF WE FAIL TO MANAGE EXPANSION EFFECTIVELY, THIS WILL PLACE SIGNIFICANT STRAIN
ON OUR MANAGEMENT AND OPERATIONAL RESOURCES.
We have expanded our operations rapidly since our inception and intend to
continue to expand in order to pursue existing and potential market
opportunities. Our growth places a significant strain on management and
operational resources. Our customer relationships could be strained if we are
unable to devote sufficient resources to them.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS THAT COULD LIMIT OUR
SALES AND ADD TO OUR COST OF OPERATIONS.
We market and sell our products in the United States and have recently
started to sell our products internationally. We intend to expand our
international operations substantially and to enter new international markets.
This expansion will require significant management attention and financial
resources. We may not be able to maintain or increase international market
demand for our products.
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We have limited experience in marketing and distributing our products
internationally. International operations are subject to inherent risks,
including:
- tariffs, export controls and other trade barriers;
- longer accounts receivable payment cycles, difficulties in collecting
accounts receivable and foreign currency exchange exposures;
- difficulties and costs of staffing and managing foreign operations;
- certification and regulatory requirements with which we may be
unfamiliar; and
- reduced protection of intellectual property rights in some countries.
RAPID TECHNOLOGICAL CHANGE IN THE TELECOMMUNICATIONS INDUSTRY COULD RENDER OUR
PRODUCTS OBSOLETE.
The markets for high-speed telecommunications products are characterized by
rapid technological developments, frequent enhancements to existing products and
new product introductions, changes in customer requirements and evolving
industry standards. Intense competition among numerous high-speed access
technologies has further driven innovation and increasingly complex product
requirements. We may be unable to improve the performance and features of our
products as needed to respond to these developments. The introduction or market
acceptance of products incorporating superior technologies or the emergence of
alternative technologies or new industry standards could render our existing or
potential future products less economical, obsolete and unmarketable. For
example, if semiconductor, robotic or other technologies become effective
alternatives for our product architecture, our products may become obsolete.
WE COULD LOSE OUR COMPETITIVE ADVANTAGE IF WE ARE UNABLE TO PROTECT OUR
INTELLECTUAL PROPERTY.
If we fail to adequately protect our intellectual property, our competitors
could offer similar products relying on technologies developed by us,
potentially harming our competitive position and decreasing our revenues. We
have filed six patent applications to date. Our existing and future patent
applications, if any, may not be approved, any issued patents may not protect
our intellectual property and any issued patents could be challenged by third
parties. Furthermore, other parties may independently develop similar or
competing technology or design around any patents that may be issued to us.
Attempts may be made to copy aspects of our products or to obtain and use
information that we regard as proprietary. We attempt to protect our
intellectual property by limiting access to the distribution of our software,
documentation and other proprietary information and by relying on a combination
of copyright, trademark and trade secret laws. In addition, we enter into
confidentiality agreements with our employees and certain customers, vendors and
strategic partners. These steps may fail to prevent the misappropriation of our
intellectual property, particularly in foreign countries where the laws may not
protect our intellectual property as fully as in the United States.
IF WE BECOME INVOLVED IN A PROTRACTED INTELLECTUAL PROPERTY DISPUTE, OR ONE WITH
A SIGNIFICANT DAMAGES AWARD, OR WHICH REQUIRES US TO CEASE SELLING OUR PRODUCTS,
WE COULD BE SUBJECT TO SIGNIFICANT LIABILITY AND THE TIME AND ATTENTION OF OUR
MANAGEMENT COULD BE DIVERTED.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights, including among
companies in telecommunications and Internet industries. Intellectual property
claims against us, and any resulting lawsuit, if successful, could subject us to
significant liability for damages and invalidate our intellectual property.
These lawsuits, regardless of their merit, would likely be time-consuming and
expensive to resolve and would divert management time and attention. Any
potential intellectual property litigation also could force us to do one or more
of the following:
- cease selling, incorporating or using products or services that
incorporate the infringed intellectual property;
- obtain from the holder of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on acceptable terms, if at all; or
- redesign those products or services that incorporate the disputed
technology.
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If we are subject to a successful claim of infringement against us and fail
to develop non-infringing technology or license the infringed technology on
acceptable terms and on a timely basis, our revenues may decline or our expenses
may increase.
We may in the future initiate claims or litigation against third parties
for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of competitors.
These claims could result in costly litigation and the diversion of our
technical and management personnel.
CONTROL BY OUR EXISTING STOCKHOLDERS MAY LIMIT YOUR ABILITY TO INFLUENCE MATTERS
REQUIRING STOCKHOLDER APPROVAL AND COULD DELAY OR PREVENT A CHANGE IN CONTROL,
WHICH COULD PREVENT YOU FROM REALIZING A PREMIUM IN THE MARKET PRICE OF OUR
COMMON STOCK.
The concentration of ownership of our common stock by existing stockholders
could delay or prevent a change in our control or discourage a potential
acquirer from attempting to obtain control of us, which could cause the market
price of our common stock to fall or prevent our stockholders from realizing a
premium in the market price associated with an acquisition. As of December 31,
2000, our executive officers, directors and principal stockholders and their
affiliates owned 46,200,899 shares or approximately 70.4% of the outstanding
shares of common stock. These stockholders, if acting together, would be able to
significantly influence all matters requiring approval by our stockholders,
including the election of directors and the approval of mergers or other
business combination transactions. For information about the ownership of common
stock by our executive officers, directors and principal stockholders, see
"Security Ownership of Certain Beneficial Owners and Management".
WE EXPECT TO EXPERIENCE VOLATILITY IN OUR STOCK PRICE WHICH COULD NEGATIVELY
AFFECT YOUR INVESTMENT.
Prior to February 2000, you could not buy or sell our common stock
publicly. An active public market for our common stock may not be sustained in
the future. The market for technology stocks has been extremely volatile. The
following factors could cause the market price of our common stock to fluctuate
significantly from the original purchase prices paid by investors:
- announcements by us or our competitors of significant contracts, new
products or technological innovations, acquisitions, strategic
relationships, joint ventures or capital commitments;
- changes in financial estimates by securities analysts;
- release of lock-up or transfer restrictions on our outstanding shares of
common stock or sales of additional shares of common stock;
- changes in market valuations of networking and telecommunications
companies; and
- fluctuations in stock market prices and volumes.
SHOULD OUR STOCKHOLDERS SELL A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK
IN THE PUBLIC MARKET, THE PRICE OF OUR COMMON STOCK COULD FALL.
Our executive officers, directors and principal stockholders and their
affiliates hold a substantial number of shares, which they are able to sell in
the public market, subject to some restrictions under federal securities laws.
Sales of a substantial number of shares of our common stock at any time could
reduce the market price of our common stock. In addition, the sale of these
shares could impair our ability to raise capital through the sale of additional
equity securities.
WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below 1.5%,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. We currently do not have
backup generators or alternate sources of power in
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the event of a blackout, and our current insurance does not provide coverage for
any damages we or our customers may suffer as a result of any interruption in
our power supply. If blackouts interrupt our power supply, we would be
temporarily unable to continue operations at our facilities. Blackouts may also
impair the operations of A-Plus Manufacturing, upon whom we depend for all our
manufacturing needs, and Aristasoft Corporation, upon whom we depend for
accounting and operations software and support. Any such interruption in our
ability to continue our operations could damage our reputation, harm our ability
to retain existing customers and to obtain new customers, and could result in
lost revenue, any of which could substantially harm our business and results of
operations.
Furthermore, the deregulation of the energy industry instituted in 1996 by
the California government has caused power prices to increase. Under
deregulation, utilities were encouraged to sell their plants, which
traditionally had produced most of California's power, to independent energy
companies that were expected to compete aggressively on price. Instead, due in
part to a shortage of supply, wholesale prices have skyrocketed over the past
year. If wholesale prices continue to increase, our operating expenses will
likely increase, as substantially all of our facilities are located in
California.
THE LOSS OF A-PLUS MANUFACTURING, TURNSTONE'S SOLE MANUFACTURER, DUE TO
INTERRUPTION IN CALIFORNIA'S ELECTRIC POWER SUPPLY, WOULD NEGATIVELY IMPACT
TURNSTONE'S ABILITY TO MANUFACTURE AND SELL ITS PRODUCTS.
We rely on A-Plus Manufacturing as our sole contract manufacturer. The
locations of A-Plus Manufacturing that are responsible for manufacture of our
products are located exclusively in Northern California. Recently, California
has been experiencing a shortage of electric power supply that has resulted in
intermittent loss of power in the form of rolling blackouts. While A-Plus has
not experienced any power failures to date that have prevented their ability to
manufacture our products, the continuance of blackouts may affect A-Plus's
ability to manufacture our products, meet our requirements for product quality,
and meet scheduled delivery needs.
Furthermore, because we currently do not have a long-term supply contract
with A-Plus Manufacturing, they are not obligated to supply products to us for
any specific period, in any specific quantity or at any certain price, except as
may be specified in a particular purchase order. If wholesale prices for
electricity continue to increase, A-Plus may increase the prices they charge us
for manufacturing our products. An increase in the cost of our products could
make our products less competitive and result in lower margins.
ITEM 2. PROPERTIES
Our principal administrative, sales, marketing and research and development
facility occupies approximately 62,500 square feet in Santa Clara, California
under a lease that expires in June 2010. We also have a lease, expiring in
January 2003, for approximately 9,400 square feet of space in Mountain View,
California, which we are currently subleasing to a third party. Our New Zealand
facility occupies approximately 1,100 square meters in Wellington, New Zealand
under a lease that expires in July 2005. We have sales offices throughout the
United States and internationally, including regional sales offices in ten
states and international sales offices in Australia, Germany and the United
Kingdom.
The commercial real estate market in the San Francisco Bay area is volatile
and unpredictable in terms of location, availability and rental rates. We cannot
assure you that additional space will be available or affordable if and when we
require it.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security-holders during the fourth
quarter of the fiscal year covered by this report.
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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their ages, as of December 31, 2000, are as
follows:
NAME AGE POSITION(S)
---- --- -----------
Richard N. Tinsley................... 36 President, Chief Executive Officer and
Director
P. Kingston Duffie................... 40 Chief Technology Officer and Director
Terrence J. Schmid................... 37 Chief Financial Officer
Eric J. Andrews...................... 35 Vice President, Marketing
Gary D. Corbin....................... 52 Chief Information Officer
Michael A. Crumlin................... 39 Vice President, Sales
John Loiacono IV(1).................. 37 Vice President, Business Development
Catherine Millet..................... 48 Vice President, Engineering
Shames S. Panahi..................... 42 Vice President, Operations
M. Denise Savoie(2).................. 45 Vice President, Business Operations
Edward S. Thompson................... 53 Vice President, Customer Service Worldwide
- ---------------
(1) Mr. Loiacono IV has informed us that he intends to resign as an officer and
employee of Turnstone, effective March 21, 2001.
(2) Ms. Savoie resigned as an officer and employee of Turnstone, effective
February 19, 2001.
RICHARD N. TINSLEY cofounded Turnstone Systems in January 1998 and has
served as President and Chief Executive Officer and as a director since that
time. From August 1997 to December 1997, Mr. Tinsley was a consultant to the
venture capital firms Institutional Venture Partners and Benchmark Capital
Partners. From September 1993 to August 1997, Mr. Tinsley held various positions
at Newbridge Networks, a designer and manufacturer of networking products, most
recently as Vice President and General Manager, VIVID Business Unit. Mr. Tinsley
holds an M.B.A. from the University of Dallas and a B.S. in electrical
engineering from Rennselaer Polytechnic Institute.
P. KINGSTON DUFFIE cofounded Turnstone Systems in January 1998 and has
served as Chief Technology Officer and as a director since that time. From
January 1998 to April 1999, he also served as Vice President, Engineering. From
August 1997 to January 1998, Mr. Duffie was a consultant to Institutional
Venture Partners and Matrix Partners. From May 1997 to July 1997, Mr. Duffie was
Assistant Vice President, Engineering, Data Communications division, for Ascend
Communications, a developer and manufacturer of wide area networking equipment.
From March 1993 until April 1997, Mr. Duffie was Chief Technology Officer at
Whitetree, Inc., a developer and manufacturer of high-speed switching products,
which was acquired by Ascend Communications in April 1997. From April 1994 until
August 1996, he also served as Vice President, Engineering of Whitetree. Mr.
Duffie holds an M.S. in electrical engineering from McGill University in
Montreal and a B.Sc. (Eng.) in engineering physics from Queen's University in
Kingston, Ontario.
TERRENCE J. SCHMID joined Turnstone Systems in June 2000 and has served as
Chief Financial Officer since that time. From February 1998 to June 2000 he
served as Chief Financial Officer and Vice President, Finance and Administration
of ONI Systems, an optical networking company. From April 1996 to February 1998,
Mr. Schmid was Vice President, Finance and Chief Financial Officer of The 3DO
Company, an entertainment software company. From 1993 to April 1996, he worked
in the finance division of Electronic Arts, an entertainment software company.
Mr. Schmid holds an M.B.A. from Duke University and a B.A. in Economics from the
University of San Francisco.
ERIC J. ANDREWS joined Turnstone Systems in February 1998 and has served as
Vice President, Marketing since that time. From April 1993 to January 1998, Mr.
Andrews held various marketing positions at Newbridge Networks, most recently as
Assistant Vice President of Marketing, VIVID Business Unit. Mr. Andrews holds an
M.S. and a B.S. in computer science and electrical engineering from the
Massachusetts Institute of Technology.
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GARY D. CORBIN joined Turnstone Systems in January 2000 and has served as
Chief Information Officer since that time. From October 1997 to January 2000, he
was Director of Information Technology for Omnicell Technologies, a provider of
supply and pharmaceutical point-of-use systems to hospitals and clinics. From
January 1997 to August 1997 he served as Director of Business Applications for
Remedy Corporation, a software company. From May 1995 to December 1997 Mr.
Corbin served as Director of Business Applications for Acuson Corporation, a
maker of medical ultrasound devices. From December 1989 to May 1995 he served as
an information technology consultant to Acuson Corporation. Mr. Corbin holds a
B.S. in Industrial Technology from San Jose State University.
MICHAEL A. CRUMLIN joined Turnstone Systems in March 1999 and has served as
Vice President, Sales and Customer Service since that time. From August 1998 to
February 1999, Mr. Crumlin was Vice President of Business Development for
e.spire Communications, a provider of integrated communications services. From
November 1996 to August 1998, Mr. Crumlin was Director of Marketing of Yurie
Systems, a manufacturer of telecommunications equipment, which was acquired by
Lucent Technologies, a provider of communications and networking products, in
May 1998. From April 1995 to August 1996, Mr. Crumlin was a co-founder and
Director of Marketing & Business Development of TSI TelSys, a developer of
satellite data processing systems. Mr. Crumlin holds an M.B.A. from Harvard
Business School and a B.S. in engineering from the United States Military
Academy at West Point.
JOHN LOIACONO IV joined Turnstone Systems in September 1999 and has served
as Vice President, Business Development since that time. From September 1994 to
September 1999, Mr. Loiacono was Director of Systems Engineering, Europe,
Middle-East, Africa at Bay Networks, Inc., a provider of internetworking
solutions, which was acquired by Nortel Networks, a supplier of
telecommunications equipment products, in August 1998. Mr. Loiacono holds a B.S.
in computer science from California State University -- San Francisco.
CATHERINE MILLET joined Turnstone Systems in April 1999 and has served as
Vice President, Engineering since that time. From December 1997 to April 1999,
Ms. Millet held various senior management positions at Advanced Fibre
Communications, a designer and manufacturer of multi-service access solutions
for telecommunications providers, most recently as Vice President of
Engineering. From September 1994 to December 1997, Ms. Millet held various
senior management positions at DSC Communications, a provider of
telecommunications products, most recently as Vice President of Advanced
Planning. Ms. Millet holds an M.S.E.E. equivalent from the Ecole Superieure d'
Electricite in Paris.
SHAMES S. PANAHI joined Turnstone Systems in February 1998 and has served
as Vice President, Operations since that time. From October 1995 to June 1997,
Ms. Panahi was Director of Manufacturing at Whitetree. From June 1992 to October
1995, Ms. Panahi was Manufacturing Engineering Manager at Adaptive/Network
Equipment Technologies, a designer and manufacturer of wide area networks. Ms.
Panahi holds a B.S. in industrial engineering from Northwestern University.
M. DENISE SAVOIE cofounded Turnstone Systems in January 1998 and has served
as Vice President of Business Operations since that time. She also served as
Chief Financial Officer from January 1998 until June 2000. From May 1997 to
December 1997, Ms. Savoie worked as an independent consultant. From May 1993 to
May 1997, Ms. Savoie served as Vice President of Business Operations and Chief
Financial Officer at Whitetree. Ms. Savoie holds a B.A. in economics from the
University of Michigan and a B.A. in art from Whitman College.
EDWARD S. THOMPSON joined Turnstone Systems in December 2000 and has served
as Vice President, Customer Service Worldwide since that time. From May 2000 to
November 2000, Mr. Thompson served as Vice President, U.S. Operations at DG
Systems, Inc., a digital distributor of broadcast advertising. From August 1995
to April 2000, Mr. Thompson served as Vice President of Technical Operations at
Allied Telesyn International, Inc., a provider of networking solutions. Mr.
Thompson holds a B.S. in mathematics from University of Texas and a B.S. in
computer science from Trinity University.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has traded on the Nasdaq National Market under the symbol
"TSTN" since February 1, 2000. The price range per share reflected in the table
below, is the highest and lowest sale price for our