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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number 000-27843
SOMERA
Communications, Inc.
(Exact name of registrant as specified in its charter)
Delaware 77-0521878
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5383 Hollister Avenue, Santa Barbara, CA 93111
(Address of principal executive offices and zip code)
(805) 681-3322
(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 per share
(Title of Class)
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, 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. Yes |_| No |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No |_|
The aggregate market value of the voting stock held by non-affiliates of
the Registrant (based on the closing sale price of the Common Stock as reported
on the NASDAQ National Market as of June 28, 2002) was approximately
$348,447,986. The number of outstanding shares of the Registrant's Common Stock
as of the close of business on March 14, 2003 was 49,097,103.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for the 2003
Annual Meeting of Stockholders are incorporated by reference in Part III of this
Form 10-K to the extent stated herein.
SOMERA COMMUNICATIONS, INC.
INDEX
Page
PART I
Item 1. Business.................................................................................... 1
Item 2. Properties.................................................................................. 9
Item 3. Legal Proceedings........................................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......................................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................... 10
Item 6. Selected Financial Data..................................................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 12
Item 7A. Qualitative and Quantitative Disclosures About Market Risk.................................. 26
Item 8. Financial Statements........................................................................ 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........ 51
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................... 51
Item 11. Executive Compensation...................................................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 51
Item 13. Certain Relationships and Related Transactions.............................................. 51
Item 14. Controls and Procedures..................................................................... 51
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................. 52
PART I
This Annual Report on Form 10-K contains forward-looking statements that
are subject to a number of risks and uncertainties, many of which are beyond our
control. These statements, other than statements of historical facts included in
this Annual Report on Form 10-K, regarding our strategy, future operations,
financial position, estimated revenues or losses, projected costs, prospects,
plans and objectives of management are forward-looking statements. When used in
this Annual Report on Form 10-K, the words "may," "will," "should," "plan,"
"anticipate," "believe," "intend," "estimate," "expect," "project" and similar
expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain such identifying words. All
forward-looking statements speak only as of the date of this Annual Report on
Form 10-K. You should not place undue reliance on these forward-looking
statements.
Although we believe that our plans, intentions and expectations reflected
in or suggested by the forward-looking statements we make in this Annual Report
on Form 10-K are reasonable, we can give no assurance that these plans,
intentions or expectations will be achieved. We disclose important factors in
"Risks Factors" and elsewhere in this Annual Report that could cause our actual
results to differ materially from the forward-looking statements in this Form
10-K. These cautionary statements qualify all forward-looking statements
attributable to us or persons acting on our behalf. We undertake no duty to
update any of the forward-looking statements after the date of this report to
conform these statements to actual results or to changes in our expectations.
ITEM 1. BUSINESS
The Markets we Serve
Wireless, wireline and data services are provided by nearly 2,000 network
operators around the world. During the period of rapid growth from 1996 - 2001
these network operators purchased trillions of dollars of new equipment. Much of
that investment was never deployed or has never been fully utilized. Since 2001
there has been very little capital available to network operators to complete
the projects already planned or to upgrade their networks to accommodate
changing customer requirements. Continually increasing downward pressure on
capital spending and operating budgets have encouraged network operators to rely
upon the large supply of previously purchased equipment to satisfy their
network's hardware requirements. Using previously purchased equipment avoids
additional spending and improves key financial metrics (cash flow, return on
assets, etc.) But, there is often a mis-match between the excess equipment that
they already own and the specific hardware that their network needs today. This
overhang of excess equipment has driven further reductions in new equipment
purchased. Manufacturers have responded by slashing prices to dispose of their
excess inventories and reducing their work forces to lower their break-even
points and return to profitability. As a result there is a large overhang of
recent vintage hardware, a mis-match within each network of equipment they
already own vs. equipment they need today and a lack of technical personnel
available to put the right equipment in the right place in the right network.
The Somera Solution
We provide telecommunications operators with equipment deployment services
to support their need to optimize their networks and equipment assets more
efficiently and cost-effectively. Our equipment deployment services are
categorized into three primary areas. First, working with the operator to
determine the feasibility of redeploying existing equipment within their own
network or valuing that same equipment for possible re-marketing to another
operators network. Second, supplying operators with the optimum combination of
new and redeployed equipment based on their implementation strategy, budget and
time-to-market requirements. Finally, providing value-added services to
supplement or replace resources to execute programs and projects that our
customers traditionally managed themselves.
Somera is uniquely qualified to address this market need by understanding
the complexities of equipment deployment, whether that be a function of
operators redeploying equipment assets within their own network ("intra-network"
deployment) or disposing of assets outside of their network ("inter-network"
deployment) for redeployment into another operators' network. By working with
Somera, operators can make multi-vendor equipment purchase, equipment
disposition, and service decisions, from a single cost-effective source.
A key differentiator for Somera is the application of our "intellectual
capital" in data, people, and operations, which we believe enables executional
excellence and provides a distinct competitive advantage. Our proprietary global
database of customers and networks enable us to value, find, redeploy and
dispose of equipment assets at the
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greatest return to our customers. The experience and skills of our people
deliver unbiased solutions to our customers' problems. Our equipment deployment
services competencies are supported by our world-class operations, certified
expertise, and program management skills.
Equipment Deployment Services
Equipment Placement & Valuation
We help our customers determine the market value of idle and sub-optimized
equipment assets. The financial potential from these assets may provide a source
of capital to offset the expense of other equipment and services purchases. As
part of the evaluation, we assess the viability of redeploying this equipment
within the operator's own network ("intra-network" deployment) or outside of the
operator's network ("inter-network" deployment). The metrics for valuation are
based on the data that we capture in our proprietary global database. The
database consists of product information and its respective market value, the
installed technology base within our customers' networks, network build-out and
de-installation plans, and demand and supply of equipment on the secondary
market. The data domiciled within our database and applied to the valuation and
marketability process is captured primarily through our sales and purchase
transactions and interactions with customers. The data is interpreted by our
internal sales, procurement, and supply organization.
We help our customers place equipment and maximize the value of idle or
sub-optimized equipment while minimizing their expense and management attention
to the process. We offer four types of equipment placement programs. After
collaborative investigation with the customer, we execute one, or a combination,
based on the type of equipment the customer wants to dispose of, the current
market demand for the equipment, the viability and condition of the equipment,
and the customer's network deployment strategy. Our four types of equipment
placement programs are as follows: Consignment, Asset Exchange, Direct Purchase
and Equipment Disposal.
Consignment. Our consignment program is designed to reduce the customer's
excess inventory levels while maximizing recovery return based on market value.
In the consignment program, we do not take title to the equipment, but rather
the customer owns and typically stores the excess inventory in our warehouse.
Our sales force then promotes the sale of the consigned equipment into our
network of customers and prospects. Net proceeds from the consigned sales are
shared between the customer and us based on negotiated terms.
Asset Exchange. Our asset exchange program is designed to help customers
maximize their capital budget by substituting, or exchanging, equipment from the
customer's existing inventory for equipment that the customer wants to purchase.
The equipment desired by the customer is supplied from our own inventory, from
virtual inventory identified from the proprietary global database or from
inventory to which we contractually have access. Exchange deals are typically
executed for high demand infrastructure equipment.
Direct Purchase. Our direct purchase program involves our directly
purchasing equipment from the operator either through direct payment or credit
for future purchases. Direct purchase deals are typically executed for equipment
where we have an existing order of that equipment pending in the system.
Equipment Disposal. Some equipment is no longer marketable and should be
disposed of or scrapped. We can provide support to customers to manage the
disposition of this equipment in a manner that complies with environmental
regulations.
Equipment Supply
We are focused on accelerating the return on investment of equipment
purchased by our customers. We are a vendor neutral source for
telecommunications carriers' equipment needs. We offer our customers multiple
categories of telecommunications infrastructure equipment to address their
specific and changing equipment requirements primarily for network maintenance
and incremental build-outs. We support analog, T1, T2, SONET, TDMA, CDMA, and
GSM for voice and data communications. The equipment we sell includes new and
redeployed items from a variety of manufacturers. In 2002, we had a database of
over 25,000 different items, from over 350 different manufacturers. We offer the
original manufacturer's warranty on all new equipment. On redeployed equipment,
we offer our own warranty which guarantees that the equipment will perform up to
the manufacturer's original specifications.
The new equipment we offer consists of telecommunications equipment
purchased primarily from the original equipment manufacturers ("OEM") directly
or distributors. The redeployed equipment we offer consists primarily of
equipment removed from the existing telecommunications networks of
telecommunications operators, many of
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whom are also our customers, and equipment purchased from resellers. Our sources
for redeployed equipment are typically the original owners of such equipment and
either the operator, another third party, or a Somera trained professional
removes the equipment from the network on behalf of the operator.
Substantially all of our equipment sourcing activities are made on the
basis of purchase orders rather than long-term agreements. Although we seek, as
part of our asset management strategy to establish strategic contract
relationships with operators, we anticipate that operating results for any given
period will continue to be dependent, to a significant extent, on purchase order
based transactions.
The equipment we sell is grouped into several general product categories
and includes core, edge, and ancillary infrastructure support.
Switching. Switching equipment is used by operators to manage call traffic
and to deliver value-added services. Switches and related equipment are located
in the central office of a telecommunications operator and serve to determine
pathways and circuits for establishing, breaking or completing voice and data
communications over the public switched telephone network ("PSTN"). We provide a
variety of switching equipment, including switches, circuit cards, shelves,
racks and other ancillary items in support of carrier upgrades and
reconfigurations. Manufacturers of switching equipment whose products we sell
include Alcatel USA, Lucent Technologies and Nortel Networks.
Transmission. Transmission equipment is used by operators to carry
information to multiple points in their network. Transmission equipment serves
as the backbone of a telecommunications operator's network and transmits voice
and data traffic in the form of standard electrical or optical signals. We sell
a broad range of transmission products, including channel banks, M13
multiplexers, digital cross-connect systems, digital loop carriers, SONET ADMs,
DSX panels and echo cancellers. Manufacturers of transmission equipment whose
products we sell include ADC Telecommunications, Carrier Access, Fujitsu, Lucent
Technologies, NEC, Nortel Networks, Telco Systems and Tellabs.
Wireless. Cell sites and related ancillary wireless products are used by
cellular, PCS and paging operators to provide wireless access. This equipment is
used to amplify, transmit and receive signals between mobile users and
transmission sites, including cell sites and transmission towers. We sell a
broad range of wireless equipment including radio base stations, towers,
shelters, combiners, transceivers and other related items. Manufacturers of
wireless and cell site equipment whose products we sell include Telefon AB LM
Ericsson, Lucent Technologies, Motorola, Nortel Networks, Paragon Networks and
Siemens.
Data. Data networking equipment is used to transmit, route and switch data
communications traffic within a wireless or wireline operator's network. We
provide a wide variety of data networking products including routers, digital
subscriber lines, ATM switches, LAN switches and bridges. Manufacturers of data
networking equipment whose products we sell include Cisco Systems, Lucent
Technologies, Motorola, Nortel Networks, Redback and Riverstone.
Microwave. Microwave systems are used by operators to transmit and receive
voice, data and video traffic. These systems enable point-to-point and
point-to-multipoint high speed wireless communications. We provide a variety of
microwave systems, including antennas, dishes, coaxial cables and connectors.
Manufacturers of microwave systems whose products we sell include Alcatel, DMC
Stratex Networks, Harris-Farinon, Nortel Networks and Proxim.
Power. Power equipment is used by operators to provide direct current (DC)
and/or alternate current (AC) power to support their network infrastructure
equipment. We sell a broad range of power equipment, including power bays,
rectifiers, batteries, breaker panels and converters. Manufacturers of power
equipment whose products we sell include Argus, Lucent Technologies, Marconi and
Nortel Networks.
As part of the equipment supply offering, we will support customers'
access to critical maintenance spares to minimize network downtime and potential
revenue loss. Under this program, we stock new and redeployed equipment and
co-locate the inventory at the customers' facilities or in locations in close
geographic proximity to the customers' network operations for immediate access.
Services
Resource allocation has become a more critical concern among operators in
the execution of their network deployment strategy. Resources once focused on
asset management and network (re)deployment are now being redirected to core
operator business strategies to generate revenue and implement new services. In
response to this
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market trend, we have expanded and enhanced our services strategy to include
planning, deployment, engineering, and logistics and materials management
services. Our ability to deliver a combined equipment and services solution,
which supplements or replaces services that our customers traditionally
performed themselves, can enable operators to reduce operating expenses and
focus on growth strategies.
Services revenue has not been material to date, but is becoming a growing
part of the company's business with revenues generated primarily from North
American operators. In 2002, we advanced this strategy and strengthened our
competencies through the purchase of certain assets of Compass Telecom, LLC, a
provider of outsourced services. Additionally, all work is performed to ISO
9001:2000 certification standards.
We provide the following services in connection with our equipment supply:
o Planning Services: Our strategy is to support our customers' need to
execute their network plans in a manner that will maximize the impact
to their business. Our planning services are designed to support this
objective, which include business case analysis, value engineering,
and assessing/valuing existing equipment and determining optimal use
or disposition of identified excess assets.
o Network Deployment Services: We provide customers with deployment
services for network build-outs and existing network modifications.
Deployment support is defined as program management, site acquisition,
site development, construction management, and installation.
- Program Management: We provide a full spectrum of program
management support. Our qualified program managers oversee many
of the assignments that have traditionally been managed by the
operator's own personnel.
- Site Acquisition, Development, and Construction Management: We
support the site and construction requirements for new and
existing network developments. This includes strategic site
planning and mapping, leasing, documentation, zoning, regulatory
compliance, process engineering, and design and construction.
- Installation/De-Installation: Installation/De-installation
support has become increasingly important to our customers. The
complexity of today's networks makes it difficult for any one
manufacturer to support the multi-product, multi-platform network
installation/de-installation process. We work with our customers
to define the appropriate level of certified engineering
resources required to complete a project. Trained technicians are
dispatched to the location, where removal of the equipment is
performed. Our broad-based technical expertise in over 350
different technologies and platforms enables us to support this
need. Typically, the equipment de-installed from the site is
shipped to our distribution and operations center for
refurbishment and reconfiguration.
o Engineering Services: We provide our customers with turnkey solutions
for end-to-end program execution. Our program offering is defined
based on existing or emergency opportunities. Our engineering services
support fixed network, wireless backhaul, site design, structural
analysis, E911, and DAS strategies.
o Logistic & Materials Management Services: We provide customers with
repair & refurbishment spares management, customization, equipment
disposal, testing, and kitting & staging services.
- Testing, Repair & Refurbishment: To ensure the reliability of
redeployed equipment we sell, many of our products are subjected
to a rigorous testing and evaluation process. The process
includes loop-back testing, field simulation testing, and
self-diagnostics. We also perform repair services for
customer-owned equipment. Refurbishment is completed to
manufacturer specifications and customer input.
- Spares Management: Availability of critical maintenance spares is
essential to managing and minimizing network downtime. We work
with our customers to develop a spares program to ensure critical
spares availability based on historical utilization rates and
other data. Material will either be co-located at our customers'
facilities or in close geographic proximity to the deployment
site.
- Customization: We offer customized assembly of multi-vendor
equipment, tailored to the network's specific configuration. In
support of this process, Somera may provide customers with
ancillary equipment and components to complete the project and
staged deployment based on the network implementation schedule.
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- Equipment Disposal: Somera works with customers to identify what
equipment is no longer marketable or deployable and should be
disposed or scrapped. We then manage our customer's disposition
needs in a manner that complies with environmental regulations
and maximizes the customer's return on such equipment.
We execute our services strategy through a combination of internal
expertise and strategic partnerships. Services performed by us either at the
customers' site or at one of our facilities in California, Georgia, New Jersey
or Texas. We have announced plans to consolidate these facilities to a new
central operation in Texas by the third quarter of 2003. Services performed for
the Europe, Middle East, and Africa ("EMEA") region are managed out of
Amsterdam, The Netherlands.
Sales and Marketing
Our sales and marketing strategy is to be in close geographic proximity to
our customers. The United States sales organization is located at both our
corporate headquarters in Santa Barbara, California and at strategic locations
in California, Illinois, New Jersey, Texas, and Georgia. The Latin America
region is supported primarily from Florida with operations in Mexico and Brazil.
Operations for the EMEA region are headquartered in Amsterdam, The Netherlands
with agent or sales offices in countries throughout the region including the
United Kingdom, Sweden and Russia. Operations for Asia Pacific are conducted by
our offices located in Singapore and Hong Kong.
As of December 31, 2002, we employed over 225 sales, services and
procurement professionals. We generate sales leads primarily through direct
sales contact, telemarketing, customer referrals and various marketing outreach
programs.
In the U.S, our sales force is organized by market segment, including
specialized teams focused on the Regional Bell Operating Companies ("RBOCs"),
incumbent local exchange carriers ("ILECs"), long distance carriers ("IXCs"),
competitive local exchange carriers ("CLECs"), national wireless carriers,
including cellular, personal communications service companies ("PCSs"), and
rural wireless carriers. Within these segments, our sales force operates on a
defined strategic account basis with sales operatives in geographic proximity to
our customers. Within each segment, we employ dedicated teams with extensive
market knowledge to meet the specific requirements of these customers.
For our customers in other countries, we approach the business on a
geographic basis, rather than a defined account basis, due to language,
cultural, and country specific considerations.
Another key feature of our selling effort is the relationships we
establish at various levels in our customers' organizations. This structure
allows us to establish multiple contacts with each customer across their
management, engineering and purchasing operations. An integral part of our asset
management strategy is establishing more senior level relationships. We believe
this is important to the company's future as the industry consolidates, buying
decisions become centralized, and relationships become established by
overarching or master agreements. We have account teams focused on each of the
large national telecommunications operators and dedicated sales/support teams
for others.
An account team comprises equipment sales, procurement, services and
logistic responsibilities. This level of integration enables us to respond more
rapidly to customer requirements and provides consistent high quality customer
service, which builds long-term relationships with our customers. Sales teams
are further supported by product line managers responsible for matching supply
with demand to assure equipment availability and monitoring the category to
identify emerging trends that might impact our customers.
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Each team member has access to, and is supported by, our proprietary
global database. This real time proprietary information system allows each team
to:
o respond to customer requirements by accessing our database of excess
and redeployed equipment located at operators, manufacturers,
distributors and other third parties worldwide, as well as by
accessing our select inventory;
o identify cross-selling opportunities for equipment and services;
o access relevant detailed purchase and sale information;
o access technical and system configuration information;
o trace and track all customer and vendor order activity; and
o project and anticipate customer network deployment requirements and
sales opportunities.
Substantially all of our sales are made on the basis of purchase orders
rather than long-term agreements. As a result, we may commit resources to the
procurement and testing of products without having received advance purchase
commitments from customers. Although our asset management strategy seeks to
establish strategic contractual relationships with operators, we anticipate that
operating results for any given period will continue to be dependent, to a
significant extent, on purchase orders. These purchase orders often can be
modified, delayed or canceled by our customers without penalty. Additionally, as
telecommunications equipment supplier competition increases, we may need to
lower our selling prices or pay more for the equipment we procure. Consequently,
our gross margins may decrease over time. We recognize revenue, net of estimated
provision for sales returns and warranty obligations, when we ship equipment to
our customers, provided that there are no significant post-delivery obligations.
As we attempt to expand our sales, marketing and procurement efforts into
international markets, we face a number of challenges, including:
o recruiting skilled sales and technical support personnel;
o creation of new supply and customer relationships;
o difficulties and costs of managing and staffing international
operations; and
o developing relationships with local suppliers.
Any of these factors could potentially harm our future international
operations.
Our marketing efforts are focused on defining the category and enhancing
our brand therein. Activities to support this strategy include public relations,
advertising in key telecommunications industry publications, e-marketing,
cooperative marketing, industry trade shows, professional sales presentations
and brochures, and customer events. We believe the size and scope of our
operations in our highly fragmented industry gives us both a unique advantage
and opportunity to further build and enhance our brand recognition.
Customers
We sell to every major segment of the telecommunications sector. We sell
equipment to ILECs, RBOCs, IXCs, wireless operators including cellular, PCS,
paging and SMRs, and CLECs. We have a healthy account diversity with over 1,400
customers worldwide with the majority located in the United States. In 2002,
Verizon Communications accounted for 13.4% of our net revenue, with no other
customers accounting for more than 10% of our net revenue. In 2001 and 2000,
Verizon Communications accounted for 16.1% and 11.3%, respectively, of our net
revenue. No other customers accounted for greater than 10% of our net revenue in
2001 and 2000. Sales to customers outside of the United States accounted for
14.9% of our net revenue in 2002, 9.7% of our net revenue in 2001, and 7.8% of
our net revenue in 2000. Customers from whom we recognized at least $5.0 million
in net revenue in 2002 include leading operators such as Verizon Communications,
AT&T, Bellsouth, Cingular, Lucent Technologies, Triton and United States
Cellular.
Competition
The market for asset management, equipment and services, is highly
competitive. Constrained capital budgets, the over-abundance of
telecommunications infrastructure equipment on the market, and continued
pressures to improve balance sheet metrics among operators and manufacturers
will further intensify competition in our industry
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for the foreseeable future. Increased competition may result in price
reductions, lower gross margins and loss of our market share in the future.
As we expand our services strategy, we are likely to face a new set of
competitors. Many of these competitors have longer operating histories,
significantly greater resources and name recognition, and a larger base of
customers. These factors are likely to give these competitors a substantial
competitive advantage.
Increased competition in the secondary equipment market from distributors
and other secondary market dealers for redeployed telecommunications equipment
could also heighten demand for the limited supply of redeployed equipment, which
would lead to increased prices for, and reduce the availability of, this
equipment. Any increase in these prices could significantly impact our ability
to maintain our gross margins. Any reduction in the availability of this
equipment could cause us to be able to meet customer demand.
Also on the equipment front, we currently face competition directly from
OEMs who may aggressively discount or extend terms to gain share, reduce
inventories, and meet quarterly financial expectations. Many of these
competitors have longer operating histories, significantly greater resources and
name recognition, and a larger base of customers. These competitors are also
likely to enjoy substantial competitive advantages over us, including the
following:
o ability to devote greater resources to the development, promotion and
sale of their equipment and related services;
o ability to adopt more aggressive pricing policies than we can;
o ability to expand existing customer relationships and more effectively
develop new customer relationships than we can, including securing
long term purchase agreements;
o ability to leverage their customer relationships through volume
purchasing contracts, and other means intended to discourage customers
from purchasing products from us;
o ability to more rapidly adopt new or emerging technologies and
increase the array of products offered to better respond to changes in
customer requirements;
o greater focus and expertise on specific manufacturers or product
lines; and
o ability to form new alliances or business combinations to rapidly
acquire significant market share.
There can be no assurance that we will have the resources to compete
successfully in the future or that competitive pressures will not harm our
business.
Employees
As of December 31, 2002, we had 354 full-time employees. We consider our
relations with our employees to be satisfactory. We have never had a work
stoppage, and none of our employees is represented by a collective bargaining
agreement. We believe that our future success will depend in part on our ability
to attract, integrate, retain and motivate highly qualified personnel, and upon
the continued service of our senior management and key sales personnel. Demand
for qualified personnel in the telecommunications equipment industry and our
primary geographic locations is competitive. We may not be successful in
attracting, integrating, retaining and motivating a sufficient number of
qualified employees to conduct our business in the future.
Where You Can Find More Information
Our principal executive offices are located at 5383 Hollister Avenue,
Santa Barbara, California 93111, and our telephone number at this address is
(805) 681-3322. You may request a copy of our annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments
to these reports filed pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934, at no cost, by writing or telephoning us at our address
above (Attention: Investor Relations). Our SEC filings are also available to the
public from the SEC's web site at http://www.sec.gov. Our Internet address is
http://www.somera.com. The information on our web site is not incorporated by
reference into this report.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the Company's
current executive officers as of February 28, 2003.
Name Age Position
Rick Darnaby........................ 51 President, Chief Executive Officer and Director
Dan Firestone....................... 41 Chairman of the Board of Directors
C. Stephen Cordial.................. 52 Chief Financial Officer
Warren B. Grayson................... 52 Vice President, General Counsel & Secretary
Brandt A. Handley................... 44 Vice President, Chief Marketing Officer
Rick Darnaby has served as our President and Chief Executive Officer since
joining Somera Communications in September 2001. Prior to joining Somera, Mr.
Darnaby was employed in a number of positions at Motorola, Inc. From December
1999 to April 2001, Mr. Darnaby served as Regional President, Senior Vice
President & General Manager - EMEA for the personal communications business,
from February 1998 to December 1999, Mr. Darnaby served as Senior Vice President
& General Manager, Consumer Solutions Group, and from November 1996 to January
1998, Mr. Darnaby served as Corporate Vice President & Director, Global Brand
Management for Motorola. From 1994 to 1996, Mr. Darnaby served as President, and
from 1991 to 1994 served as executive in various capacities for The Nutrasweet
Group a division of Monsanto Company. From 1989 to 1991, Mr. Darnaby served as
President & Chief Executive Officer of Monsanto, Canada, Inc. Prior to 1989, Mr.
Darnaby served in various positions of management for Monsanto Company. Mr.
Darnaby holds a B.S. degree in business administration and an M.B.A. from
Oklahoma State University. Mr. Darnaby also holds an Advanced Management Degree
in International Business from I.N.S.E.A.D. (Institute of European
Administration) Fountainbleau, France.
Dan Firestone co-founded Somera Communications in July 1995, and has
served as our Executive Chairman of the Board since September 2001. Mr.
Firestone served as our Chief Executive Officer from 1996 to September 2001,
served as our President from December 1998 to September 2001, and has also
served as our Chairman of the Board since our inception. From 1994 to the
present, Mr. Firestone has also operated SDC Business Consulting, a private
business-consulting firm. In 1984, Mr. Firestone co-founded Century Computer
Marketing, a distributor of computer service spare parts and related products,
and served as its Chief Executive Officer until May 1994. Mr. Firestone also
serves as President of Somera Ventures, LLC.
C. Stephen Cordial has served as our Chief Financial Officer since joining
Somera Communications in August 2002. Prior to joining Somera, Mr. Cordial held
executive positions with industry leading companies in the technology and
telecom sectors, including Texas Instruments, PMC-Sierra, and Xylan (which was
acquired by Alcatel). Mr. Cordial also served as Chief Financial Officer for En
Pointe Technologies in 1999, iReady Corp in 2000, and Nexsi Systems Corp in 2001
and 2002. Mr. Cordial holds a bachelors degree from Stanford University, and a
MBA from the University of Santa Clara.
Warren B. Grayson has served as our Vice President, General Counsel since
joining Somera Communications in June 2002 and was appointed Secretary of the
Corporation in August 2002. Mr. Grayson came to Somera from McWhorter
Technologies, Inc. where he served as Vice President, General Counsel and
Secretary from June 1999 to December 31, 2001. From September 1989 through May
1999, Mr. Grayson held a variety of in-house legal positions with The NutraSweet
Company, then a subsidiary of Monsanto Company, ultimately serving as Deputy
General Counsel from June 1995 to May 1999. Prior to joining Monsanto, from 1980
to 1989, Mr. Grayson was Division General Counsel and Assistant Secretary with
Carson Pirie Scott & Company, a publicly held retail company. Mr. Grayson
received his undergraduate degree from the University of Illinois, Chicago and
his law degree from The John Marshall Law School.
Brandt A. Handley has served as our Vice President, Chief Marketing
Officer since December 2002. Previously Mr. Handley served as our Vice
President, International from January 2001 to December 2002. From September 1999
to December 2000, Mr. Handley founded and operated Seedvest, Inc., an equity
investment and consultancy firm. From 1991 to September 1999, Mr. Handley served
as a vice president at The Walt Disney
8
Company, establishing two start-up companies in Asia. From 1982 to 1991, Mr.
Handley served in various management capacities in the marketing department of
The Procter & Gamble Company, including assignments in the U.S., the Middle
East, Europe and Asia. Mr. Handley holds a B.A. in international business from
the University of Oregon and is a graduate of the Advanced Management Program
from the Wharton School at the University of Pennsylvania.
ITEM 2. PROPERTIES
Our principal executive and corporate offices, located in Santa Barbara,
California, occupy approximately 43,000 square feet under several lease
agreements that expire from March 2003 to March 2004. Additionally, we occupy
nine office sites in the United States under lease agreements, totaling
approximately 75,000 square feet.
At December 31, 2002, we operated three distribution facilities in the
United States, occupying approximately 150,000 square feet, under several lease
agreements that expire from May 2004 to December 2005. Our primary distribution
center is located in Oxnard, California, and occupies approximately 100,000
square feet under a lease agreement that expires in May 2004. We have another US
distribution center in Norcross, Georgia and a repair center in Euless, Texas.
In December 2002, we announced we were consolidating our smaller distribution
and repair facilities into a larger facility in Dallas, Texas. We entered into a
facility lease agreement for space in Dallas, Texas, occupying 210,000 square
feet, which begins in March 2003 and expires in March 2010. We expect the Dallas
distribution and repair facility to be fully operational by July 2003. At that
time, the Oxnard and Norcross facilities will be vacated.
We lease additional properties outside the U.S. Our European headquarters
and distribution center, located in Amsterdam, The Netherlands, occupies
approximately 14,000 square feet under a lease agreement that expires in October
2005. We have two other sales offices in Singapore and Brazil. We believe that
our facilities are adequate for our current operations and that additional space
can be obtained as needed.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in legal proceedings and litigation
arising in the ordinary course of business. As of the date hereof, we are not a
party to or aware of any litigation or other legal proceeding that could
materially harm our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of holders of Common Stock during the
quarter ended December 31, 2002.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock has been traded on the Nasdaq National Market under the
symbol "SMRA" since our initial public offering on November 12, 1999. The
following table sets forth, for the periods indicated, the high and low closing
sale prices for our common stock as reported by the Nasdaq National Market:
High Low
------- -------
Year Ended December 31, 2002
First quarter............................. $8.70 $7.00
Second quarter............................ $8.56 $5.58
Third quarter............................. $7.29 $2.01
Fourth quarter............................ $3.26 $1.74
Year Ended December 31, 2001
First quarter............................. $11.69 $4.50
Second quarter............................ $7.23 $4.00
Third quarter............................. $7.05 $3.95
Fourth quarter............................ $8.15 $4.14
On March 14, 2003, the last reported sale price for our common stock on
the Nasdaq National Market was $1.07 per share. As of March 14, 2003, there were
approximately 164 holders of record. Because many of such shares are held in
street name by brokers and other institutions on behalf of stockholders, we are
unable to estimate the total number of stockholders represented by these record
holders.
While we do not plan to pay dividends, any future determination to pay
dividends will be at the discretion of the board of directors and will depend
upon our financial condition, operating results, capital requirements and other
factors the board of directors deems relevant. We currently plan to retain cash
from earnings for use in the operation of our business and to fund future
growth.
10
ITEM 6. SELECTED FINANCIAL DATA
You should read the following selected financial data together with our
financial statements and related notes and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" appearing elsewhere in this
Annual Report on Form 10-K. Historical results are not necessarily indicative of
the results to be expected in the future.
Year Ended December 31,
-------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(in thousands except per share/unit data)
Statements of Operations:
Net revenue (1) ............................. $199,200 $221,256 $211,192 $126,861 $73,180
Cost of net revenue (1) ..................... 145,590 148,478 134,618 82,761 44,126
-------- -------- -------- -------- -------
Gross profit ................................ 53,610 72,778 76,574 44,100 29,054
-------- -------- -------- -------- -------
Operating expenses:
Sales and marketing .................... 32,334 24,902 20,312 10,320 5,747
General and administrative ............. 25,934 22,049 16,108 8,756 3,939
Amortization of intangible assets (3) .. 689 1,484 302 -- --
Asset impairment ....................... 1,593 -- -- -- --
Restructuring charges .................. 2,759 352 -- -- --
-------- -------- -------- -------- -------
Total operating expenses .......... 63,309 48,787 36,722 19,076 9,686
-------- -------- -------- -------- -------
Income (loss) from operations ............... (9,699) 23,991 39,852 25,024 19,368
Interest income (expense), net .............. 1,037 1,724 2,376 (2,193) (187)
-------- -------- -------- -------- -------
Income (loss) before income taxes ........... (8,662) 25,715 42,228 22,831 19,181
Income tax provision (benefit) .............. (3,508) 10,929 17,737 (17,403) --
-------- -------- -------- -------- -------
Net income (loss) ...................... $ (5,154) $ 14,786 $ 24,491 $ 40,234 $19,181
======== ======== ======== ======== =======
Net income (loss) per share/unit--basic (2) . $ (0.11) $ 0.31 $ 0.51 $ 1.02 $ 0.50
======== ======== ======== ======== =======
Weighted average shares/units--basic ........ 48,645 48,260 47,928 39,408 38,063
======== ======== ======== ======== =======
Net income (loss) per share/unit--diluted (2) $ (0.11) $ 0.30 $ 0.51 $ 1.02 $ 0.50
======== ======== ======== ======== =======
Weighted average shares/units--diluted ...... 48,645 48,625 48,329 39,484 38,063
======== ======== ======== ======== =======
December 31,
---------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Working capital ............................... $ 77,332 $ 90,476 $ 78,513 $67,888 $ 9,482
Total assets .................................. 165,090 143,572 178,076 115,751 17,009
Notes payable--net of current portion ......... -- -- -- -- 3,457
Mandatorily redeemable Class B units .......... -- -- -- -- 51,750
Stockholders' equity/members' capital (deficit) 128,100 132,016 114,497 86,786 (45,136)
(1) During 2000, we adopted new guidance for the accounting for shipping and
handling revenues and expenses, and accordingly have reclassified the prior
period balances to conform with our current policy for the years ended
December 31, 2000, 1999, and 1998. See also Note 2 of Notes to the
Consolidated Financial Statements.
(2) See Note 2 of Notes to the Consolidated Financial Statements for an
explanation of the calculation of net income (loss) per share/unit--basic
and diluted.
(3) The acquisition of MSI Communications, Inc. in October 2000 and Asurent
Technologies in October 2001 includes amortization totaling $302,000 in
2000 and $1.4 million in 2001 related to goodwill and acquired workforce.
Pursuant to SFAS 142 guidelines, for years subsequent to December 31, 2001,
the carrying values will be assessed for impairment and no amortization
will be recorded. See Note 5 of notes to consolidated financial statements.
11
Our fiscal years are on a 52 and 53 week basis. For presentation purposes
we are using a calendar quarter and calendar year end convention. Our fiscal
years 2002, 2001, 2000, 1999 and 1998 ended on December 29, 2002, December 30,
2001, December 31, 2000, January 2, 1999 and January 3, 1998, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of financial condition and results of operations
should be read in conjunction with the consolidated financial statements and
related notes appearing elsewhere in this Annual Report on Form 10-K. Our actual
results could differ materially from the results contemplated by these
forward-looking statements as a result of factors, including those discussed
previously, under "Risk Factors" or in other parts of this Annual Report on Form
10-K.
Corporate History
Somera Communications, Inc. was formed in August 1999 and is incorporated
under the laws of the State of Delaware. In November 1999, we raised
approximately $107 million in net proceeds from our initial public offering.
Since that time, our common stock has traded on the Nasdaq National market under
the symbol SMRA.
Business Combinations.
In October 2000, we acquired MSI Communications Inc. ("MSI"). This
acquisition has enabled us to strengthen our product offering in data networking
equipment and services, increase our national presence, and provide key
personnel. This transaction was accounted for as a purchase. We paid $10.6
million in cash, including acquisition costs and issued 693,391 shares of our
common stock. As of December 31, 2002, all shares have been earned and no shares
are in escrow.
In October 2001, we completed the acquisition of the equipment repair
business of Asurent Technologies, Inc. ("Asurent") for $6.3 million in cash and
acquisition costs. The acquisition of Asurent provides us with enhanced
equipment repair capabilities, key personnel, and additional customer and
supplier relationships. The financial results of these acquisitions have been
included in our consolidated financial statements from the dates of acquisition.
In October 2002, we acquired Compass Telecom, LLC ("Compass"), to
strengthen our services offerings, provided key personnel, and contributed
additional customer relationships. We paid $9.5 million in cash, including
acquisition costs, and accrued $2.9 million as a result of earn out obligations.
In addition, under the terms of the acquisition agreement, we may also be
obligated to pay up to $7.1 million in cash over the next three years as a
result of a contingent earn out that is based on achieving future performance
targets.
For further details about these acquisitions, see Note 3 of Notes to the
Consolidated Financial Statements.
Results of Operations
2002 Compared to 2001
Net Revenue. Substantially all of our net revenue consists of sales of new
and redeployed telecommunications and data networking equipment, including
switching, transmission, access, wireless, microwave and power products, net of
estimated provision for returns. Net revenue decreased 10% to $199.2 million in
2002 from $221.3 million in 2001. The decrease in net revenue was primarily
driven by a 30% decrease in new equipment sales, partly offset by a 4% increase
in redeployed equipment sales. Net revenues from customers in the United States
decreased 15% to $169.5 million from $199.8 million, primarily due to reduced
new equipment sales. Net revenues from customers outside of the United States
increased 39% to $29.7 million in 2002 from $21.4 million in 2001 due to the
expansion of our international operations, primarily in Europe, Asia and Latin
America and our increased focus on international sales. Net revenue attributable
to new equipment sales decreased to $63.7 million in 2002 from $90.9 million in
2001. The decrease in net revenue attributable to new equipment sales was due
primarily to the financial distress of the telecommunications industry, which
has reduced customers' demand for new equipment. In addition, telecommunications
operators' capital spending budgets continue to be reduced and we see increased
pricing pressure caused by OEMs' reduction of their equipment prices. Net
revenue attributable to redeployed equipment sales increased to $135.5 million
in 2002 from $130.4 million in 2001. The increase in net revenue attributable to
redeployed equipment sales was due to greater demand among our customers in
connection with the
12
build-out and servicing of their existing networks. We also see an increased
preference expressed by our customers for redeployed equipment as a
cost-effective alternative to new equipment. We believe net revenue attributable
to new and redeployed equipment will continue to vary from quarter to quarter as
customers' demand for such equipment fluctuates. We believe net revenue from
customers in the United States will decrease but that net revenues from
customers outside of the United States will increase in both absolute dollars
and as a percentage of overall net income as we continue to expand our
international operations. Service revenue was not material at 9% of total
revenues in 2002 and given that such services are sold in conjunction with
equipment sales, we have included it with equipment.
Cost of Net Revenue. Substantially all of our cost of net revenue consists
of the costs of the equipment we purchase from third party sources. Cost of net
revenue decreased 2% to $145.6 million in 2002 from $148.5 million in 2001. The
decrease in cost of net revenue during this period is primarily attributable to
decreases in our net revenues of new equipment sales, offset by an $11.9 million
increase to our inventory reserve in the fourth quarter 2002. The increase in
inventory reserve resulted from continued weakness in the telecommunications
industry and changes in our business strategy. Cost of net revenue attributable
to new equipment sales decreased to $57.0 million in 2002 from $73.2 million in
2001, primarily due to lower volumes of new equipment sales, offset by an
increase in the inventory reserve during the fourth quarter of $2.4 million
relating to obsolete, but new equipment. Cost of net revenue attributable to
redeployed equipment sales increased to $88.6 million in 2002 from $75.3 million
in 2001. The increase in cost of net revenue attributable to redeployed
equipment was due primarily to a $9.5 million increase in inventory reserve in
the fourth quarter related to redeployed equipment, increased volume of
redeployed equipment sales and an increase in the cost to acquire redeployed
equipment. We believe that the cost of net revenue attributable to redeployed
equipment will continue to fluctuate in absolute dollar terms as our volume of
redeployed equipment sales fluctuates in response to customer demand.
Gross profit as a percentage of net revenue, or gross margin, decreased to
26.9% in 2002 from 32.9% in 2001. The decrease in gross margin was primarily due
to an $11.9 million increase to our inventory reserve we made in fourth quarter
2002. We anticipate increased pricing pressure on new and redeployed equipment
due to OEMs' reduction of their equipment prices during the fourth quarter as a
result of the slow-down of the economy in 2001 and 2002. Gross margin
attributable to new equipment sales decreased to 10.5% in 2002 from 19.4% in
2001. The decrease in gross margin attributable to new equipment sales was
primarily due to an increase in the inventory reserve of $2.4 million during the
fourth quarter, which related to new equipment and increased pricing pressures.
Gross margin attributable to redeployed equipment sales decreased to 34.6% in
2002 from 42.3% in 2001. The decrease in gross margin attributable to redeployed
equipment sales was due primarily to an increase in the inventory reserve of
$9.5 million during the fourth quarter related to redeployed equipment and
increased price pressure on redeployed equipment. We believe that gross margins
attributable to redeployed equipment sales may continue to fluctuate depending
upon the mix of redeployed equipment we sell, our ability to procure inventory
at favorable prices, and the pace of recovery of the economy in general and the
telecommunications industry in particular.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and benefits for sales, marketing and procurement
employees as well as costs associated with advertising, promotions and our
e-commerce initiative. Our e-commerce initiative was terminated during the
fourth quarter of 2002. A majority of our sales and marketing expenses are
incurred in connection with establishing and maintaining long-term relationships
with a variety of operators. Sales and marketing expenses increased to $32.3
million, or 16.2% of net revenue, in 2002 from $24.9 million, or 11.3% of net
revenue, in 2001. This increase was primarily due to an increase of $5.1 million
in salaries and wages associated with the hiring of additional sales and
procurement personnel, an increase of $1.2 million in travel related costs
associated with our intensified sales efforts, and an increase of $804,000 in
marketing primarily associated with a market study on the redeployed
telecommunications space, partially offset by a decrease of $948,000 in lower
absolute commissions corresponding to lower gross profit on which commissions
are based. The absolute dollar increase in salaries and wages and decrease in
commissions were also due to a change in compensation structure for our senior
sales personnel, wherein base salaries were increased and commission rates were
reduced as well as severance packages paid to employees who were terminated as
part of a reduction in workforce we completed in the third quarter of 2002. We
expect that our sales and marketing expenses will decrease in 2003 as a result
of our restructuring in the fourth quarter of 2002.
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for executive and administrative
personnel, professional fees and facility costs. General and administrative
expenses increased to $25.9 million, or 13.0% of net revenue, in 2002 from $22.0
million, or 10.0% of net revenue, in 2001. This increase was due primarily to an
increase of $742,000 in relocation costs, an increase of $253,000
13
associated with facilities costs and an increase of $1.2 million in
depreciation. We expect that general and administrative expenses will decrease
due to our cost saving measures.
Restructuring and Asset Impairment Charges. In the fourth quarter of 2002,
the Company announced and began implementation of its operational restructuring
plan to reduce operating costs and streamline its operating facilities. This
initiative involved the reduction of employee staff by 29 positions throughout
the Company in managerial, professional, clerical and operational roles and
consolidation of the Oxnard, Norcross and Euless distribution and repair
facilities to one centralized location in Dallas.
For the year ended December 31, 2002, the charges associated with the
restructuring were as follows (in thousands):
Total Charge
------------
Restructuring Charge
Continuing lease obligations........................... $ 995
Termination benefits................................... 1,764
-----
Total Restructuring Charge.................................. 2,759
Asset Impairments...................................... 1,593
-----
Total Charge................................................ $ 4,352
Continuing lease obligations primarily relate to closure of the Oxnard,
Norcross, and Euless facilities. Amounts expensed represent estimates of
undiscounted future cash outflows, offset by anticipated third-party sub-lease
rentals. At December 31, 2002, the Company remains obligated under lease
obligations of $1.5 million associated with its December 2002 operational
restructuring, offset by estimates of future sub-lease rentals of $575,000. The
lease obligations expire in 2006. The Company expects cash savings of $500,000 a
quarter beginning in the third quarter of 2003 and thereafter.
Termination benefits are comprised of severance-related payments for all
employees to be terminated in connection with the operational restructuring.
Termination benefits do not include any amounts for employment-related services
prior to termination. Other restructuring costs include broker commissions,
professional fees and other miscellaneous expenses directly attributable to the
restructuring.
At December 31, 2002, the accrued liability associated with the
restructuring charge was $2.6 million and consisted of the following (in
thousands):
Restructuring Balance at
Charge Payments December 31, 2002
------ -------- -----------------
Lease obligations, net of estimated
Sublease income ............................. $ 995 $ -- $ 995
Termination benefits .............................. 1,764 (155) 1,609
------ ----- ------
Total ............................................. $2,759 $(155) $2,604
====== ===== ======
As of December 31, 2002, 20 employees had been terminated, and actual
termination benefits paid were $155,000.
Asset impairments primarily relate to e-commerce software the Company
invested in, in anticipation of on-line sales. The online market did not
materialize and in the fourth quarter of 2002, the Company eliminated the
department and wrote-off the assets. The Company expects $1.5 million in
amortization savings in 2003 and none thereafter.
Restructuring charges in 2001 relate to a reorganization in which the
domestic workforce was reduced by 28 people, or approximately 10% of the then
existing workforce. The total charges associated with the reorganization were
$352,000 and represented accrued salaries and wages, severance, accrued
vacation, payroll taxes and other directly related costs, all which were paid in
2001.
Amortization of Intangible Assets. Intangible assets consist of customer
contracts, non-compete covenants and goodwill related to our acquisitions during
2000, 2001 and 2002 which were amortized on a straight-line basis over their
estimated economic lives. Amortization of intangible assets decreased to
$689,000 in 2002 from $1.5 million in 2001. The decline in amortization of
intangible assets relates to our adoption of SFAS No. 141 "Business
Combinations" and 142 "Goodwill and other Intangibles", which requires that
workforce intangibles be subsumed into goodwill and that goodwill no longer be
amortized. This resulted in a $1.4 million decrease in amortization in
14
2002. This is partially offset by additional intangible asset amortization of
$182,000 resulting from the Compass acquisition completed in October, 2002. We
expect amortization to increase slightly during 2003 to reflect a full year
amortization of intangible assets relating to the Compass acquisition.
Interest Income (Expense), Net. Interest income (expense), net consists of
investment earnings on cash and cash equivalent balances. Interest income, net
decreased to $1.0 million in 2002 from $1.7 million in 2001. The decrease in
interest income was primarily due to lower interest rates in effect during 2002
and a declining cash balance from January 2002 to December 2002. We had no
long-term debt outstanding as of December 31, 2002.
Income Tax Provision / (Benefit). In 2002 we had an income tax benefit of
$3.5 million, with an effective tax rate of 40.5%. In 2001, we had a tax
provision of $10.9 million with an effective tax rate of 42.5%. Our tax rate
decrease is due primarily to Goodwill no longer being amortized as a result of
SFAS 141 and 142 and tax efficiencies gained as an indirect consequence of
internally restructuring domestic business operations.
2001 Compared to 2000
Net Revenue. Net revenue increased to $221.3 million in 2001 from $211.2
million in 2000. The increase in net revenue was primarily attributable to a
general increase in our equipment and services offerings rather than significant
increases in the price of the products we sold, expansion of our international
operations, and growth in significant customer accounts. Net revenues from
customers outside of the United States increased to $21.4 million in 2001 from
$16.5 million in 2000 due to the expansion of our international operations. Our
acquisitions of MSI in October 2000 and the equipment repair business of Asurent
in October 2001 contributed to the general increase in equipment and service
offerings. These increases were partially offset by the effects of the general
slow-down in the telecommunications operators' capital spending levels,
including increased price pressure on our redeployed equipment prices, caused by
OEMs' reduction of their equipment prices. Net revenue attributable to new
equipment sales increased slightly to $90.9 million in 2001 from $90.7 million
in 2000. Net revenue attributable to redeployed equipment sales increased to
$130.4 million in 2001 from $120.5 million in 2000. The increase in net revenue
attributable to redeployed equipment sales was due to greater demand among our
customers in connection with the build-out and servicing of their existing
networks. We believe net revenue attributable to new and redeployed equipment
will increase as our customers continue to build their existing networks.
Cost of Net Revenue. Cost of net revenue increased to $148.5 million in
2001 from $134.6 million in 2000. The increase in cost of net revenue during
this period is primarily attributable to increases in our volume of redeployed
equipment sales. Cost of net revenue attributable to new equipment sales
decreased slightly to $73.2 million in 2001 from $73.8 million in 2000. Cost of
net revenue attributable to redeployed equipment sales increased to $75.3
million in 2001 from $60.8 million in 2000. The increase in cost of net revenue
attributable to redeployed equipment was due primarily to increased volume of
redeployed equipment sales.
Gross profit as a percentage of net revenue, or gross margin, decreased to
32.9% in 2001 from 36.3% in 2000. The decrease in gross margin was primarily due
to increased price pressure on redeployed equipment due to OEMs' reduction of
their equipment prices, as a result of the slow-down of the economy in 2001.
Gross margin attributable to new equipment sales increased to 19.4% in 2001 from
18.6% in 2000. The increase in gross margin attributable to new equipment sales
was primarily a function of equipment mix. We believe gross margin attributable
to new equipment sales will continue to fluctuate depending upon the mix of the
new equipment we sell. Gross margin attributable to redeployed equipment sales
decreased to 42.3% in 2001 from 49.5% in 2000. The decrease in gross margin
attributable to redeployed equipment sales was due primarily to increased price
pressure on redeployed equipment.
Sales and Marketing. Sales and marketing expenses increased to $24.9
million, or 11.3% of net revenue, in 2001 from $20.3 million, or 9.6% of net
revenue, in 2000. This increase was primarily due to an increase of $4.2 million
in salaries and wages associated with the hiring of additional sales and
procurement personnel, and an increase of $800,000 in travel related costs
associated with our intensified sales efforts, partially offset by a decrease of
$2.4 million in lower absolute commissions corresponding to lower gross profit
on which commissions are based. The absolute increase in salaries and wages and
decrease in commissions were also due to a change in compensation structure for
our senior sales personnel, wherein base salaries were increased and commission
rates were reduced.
General and Administrative. General and administrative expenses increased
to $22.0 million, or 10.0% of net revenue, in 2001 from $16.1 million, or 7.6%
of net revenue, in 2000. This increase was due primarily to an increase of $3.6
million in compensation costs and benefits associated with the increase in
employees relating to the
15
expansion of our operations, an increase of $1.2 million associated with
facilities costs and an increase of $1.7 million in depreciation.
Stock Based Compensation. Stock-based compensation was $148,000 and
$367,000 for 2001 and 2000, respectively. Stock based compensation includes
stock-based charges resulting from variable accounting treatment of certain
stock options issued to key directors. The number of shares of common stock
subject to outstanding vested and unvested employee stock awards was
approximately $10.1 million and $6.8 million, or 21% and 14% of our outstanding
common stock, at December 31, 2002 and 2001, respectively.
Amortization of Intangible Assets. Intangible assets consist of acquired
workforce, customer contract and goodwill related to our acquisitions during
2000 and 2001 which were amortized on a straight-line basis over their estimated
economic lives. Amortization of intangible assets increased to $1.5 million in
2001 from $302,000 in 2000. This increase in 2001 reflected a full year of
amortization of the goodwill and purchased intangibles arising from the MSI
acquisition compared with three months of amortization in 2000.
Restructuring Charges. On March 8, 2001, in light of the economic
environment and the state of the telecommunications industry, we undertook a
reorganization in which the domestic workforce was reduced by 28 people, or
approximately 10% of the then existing workforce. The terminations were not
concentrated in any particular aspect of the business. We recorded total
associated charges of $352,000 representing accrued salaries and wages,
severance, accrued vacation, payroll taxes and other directly related costs, all
of which were paid during 2001.
Interest Income (Expense), Net. Interest income (expense), net consists of
investment earnings on cash and cash equivalent balances. Interest income, net
decreased to $1.7 million in 2001 from $2.4 million in 2000. The decrease was
primarily due to lower interest rates in effect during 2001. We had no long-term
debt outstanding as of December 31, 2001.
Income Tax Provision. Income tax provision decreased to $10.9 million in
2001, an effective tax rate of 42.5%, from $17.7 million in 2000, an effective
tax rate of 42.0%.
16
Quarterly Results of Operations
The following tables set forth unaudited statement of operations data for
each of the eight quarters in the period ended December 31, 2002, as well as the
percentage of our net revenue represented by each item. In our opinion, this
unaudited information has been prepared on the same basis as the annual
financial statements. This information includes all adjustments (consisting only
of normal recurring adjustments) necessary for fair presentation when read in
conjunction with the financial statements and related notes included elsewhere
in this Annual Report on Form 10-K. The operating results for any quarter are
not necessarily indicative of results for any future period.
Quarter Ended
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
--------- -------- --------- -------- --------- -------- --------- --------
2001 2001 2001 2001 2002 2002 2002 2002
---- ---- ---- ---- ---- ---- ---- ----
(unaudited)
(in thousands)
Statements of Operations Data:
Net revenue ........................ $47,809 $60,103 $54,973 $58,371 $55,001 $49,217 $50,495 $ 44,487
Cost of net revenue ................ 32,475 41,747 36,035 38,221 36,210 32,961 34,560 41,859
------- ------- ------- ------- ------- ------- ------- --------
Gross profit ....................... 15,334 18,356 18,938 20,150 18,791 16,256 15,935 2,628
Operating expenses:
Sales and marketing ........... 5,567 5,914 6,464 6,957 7,293 8,338 9,309 7,394
General and administrative .... 5,281 5,024 5,575 6,169 5,473 6,625 6,358 7,478
Amortization of intangible
assets ...................... 350 350 350 434 127 127 127 308
Asset impairment .............. -- -- -- -- -- -- -- 1,593
Restructuring charges ......... 352 -- -- -- -- -- -- 2,759
------- ------- ------- ------- ------- ------- ------- --------
Total operating
expenses ................ 11,550 11,287 12,389 13,561 12,893 15,090 15,794 19,532
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) from operations ...... 3,784 7,069 6,549 6,589 5,898 1,166 141 (16,904)
Interest income (expense), net ..... 507 470 461 286 218 490 181 148
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) before
income taxes .................... 4,291 7,539 7,010 6,875 6,116 1,656 322 (16,756)
Income tax provision (benefit) ..... 1,818 3,210 2,979 2,922 2,477 671 130 (6,786)
------- ------- ------- ------- ------- ------- ------- --------
Net income (loss) .................. $ 2,473 $ 4,329 $ 4,031 $ 3,953 $ 3,639 $ 985 $ 192 $ (9,970)
======= ======= ======= ======= ======= ======= ======= ========
As a Percentage of Net Revenue:
Net revenue ........................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of net revenue ................ 67.9 69.5 65.6 65.5 65.8 67.0 68.4 94.1
------- ------- ------- ------- ------- ------- ------- --------
Gross profit ....................... 32.1 30.5 34.4 34.5 34.2 33.0 31.6 5.9
Operating expenses:
Sales and marketing ........... 10.6 9.3 11.0 11.5 13.3 16.9 18.4 16.6
General and administrative .... 12.1 8.9 10.9 11.0 10.0 13.4 12.6 16.8
Amortization of intangible
assets ...................... 0.7 0.6 0.6 0.7 0.2 0.3 0.3 0.7
Asset impairment .............. -- -- -- -- -- -- -- 3.6
Restructuring charges ......... 0.7 -- -- -- -- -- -- 6.2
------- ------- ------- ------- ------- ------- ------- --------
Total operating
expenses ................ 24.1 18.8 22.5 23.2 23.5 30.6 31.3 43.9
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) from operations ...... 8.0 11.7 11.9 11.3 10.7 2.4 0.3 (38.0)
Interest income (expense), net ..... 1.0 0.8 0.8 0.5 0.4 1.0 0.3 0.3
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) before
income taxes .................... 9.0 12.5 12.7 11.8 11.1 3.4 0.6 (37.7)
Income (loss) tax
provision (benefit) ............. 3.8 5.3 5.4 5.0 4.5 1.4 0.2 (15.3)
------- ------- ------- ------- ------- ------- ------- --------
Net income (loss) .................. 5.2% 7.2% 7.3% 6.8% 6.6% 2.0% 0.4% (22.4)%
======= ======= ======= ======= ======= ======= ======= ========
Goodwill and acquired workforce related to the acquisition of MSI
Communications, Inc. in October 2000 and Asurent technologies, Inc. in October
2001 includes $302,000 amortization in 2000 and $1.4 million of amortization in
2001. Pursuant to SFAS 142 guidelines, for years subsequent to December 31,
2001, the carrying values will be assessed for impairment and no amortization
will be recorded.
17
Liquidity and Capital Resources
Our principal source of liquidity is our cash and cash equivalents. Our
cash and cash equivalents balance was $50.4 and $54.5 million at December 31,
2002 and 2001, respectively.
We finance our operations primarily through cash flows from operations.
Net cash generated by operating activities in 2002 was $10.4 million. The
primary increase in net cash provided by operating activities was a decrease in
accounts receivable of $19.5 million. We saw over a $6.0 million dollar decline
in net revenues in the fourth quarter. Decreasing revenues and continued focus
on cash collection caused the balance to decrease significantly over the prior
year. The inventory provision increased by $13.7 million, primarily due to a
$11.9 million increase in the inventory reserve taken in the fourth quarter
2002. In the fourth quarter we experienced a significant decline in market
demand over the previous quarter and continued to see increased pricing
pressures. Historically, the value of inventory increased as it aged and became
scarce in the market. In addition, when the decision was made to consolidate
operations in Dallas, we recognized the cost of transporting some of the items
exceeded the market price. At the time we made the decision to consolidate our
distribution facilities in Dallas, we reviewed inventory for impairment and
concluded that a write-down of $11.9 million was necessary. Increases in our
operating activities were offset by a $10.6 million decrease in Accounts
Payable, $9.1 million increase in inventories and a $4.5 million decrease in
income taxes payable.
Net cash provided by operating activities in 2001 was $32.3 million. The
primary increases in operating activities comprised of net income of $14.8
million, depreciation and amortization of $5.0 million, a $3.0 million increase
in inventory reserve, an increase in accounts payable of $4.6 million, increase
in deferred revenue of $4.6 million and increase in income taxes payable of $5.2
million. The increases in operating activities were partially offset by
decreases in accounts receivable of $4.7 million and inventories of $2.4
million. Net cash used in operating activities in 2000 was $3.2 million. The
primary increase in operating activities was net income of $24.5 million. Net
income was offset by increases in accounts receivable of $18.8 million and
inventories of $13.1 million.
Net cash used in investing activities in 2002 comprised primarily our
acquisition of Compass for $9.5 million in cash including acquisition costs,
acquisition of property and equipment of $4.3 million and a loan to an officer
for $2.0 million. Net cash used in investing activities in 2001 comprised
primarily our acquisition of Asurent for $6.3 million in cash, including
acquisition costs, and acquisition of property and equipment of $4.7 million.
Net cash used in investing activities in 2000 comprised primarily of our
acquisition of MSI for $10.6 million in cash, including acquisition costs and
acquisition of property and equipment of $6.1 million.
Cash flows from financing activities for the years ended December 31, 2002
and 2001, included proceeds from employee stock purchases of $586,000 and
$580,000, respectively. Cash flow used in financing activity for the year ended
December 31, 2000 was $1.5 million, which primarily relates to a repayment of a
line of credit for $1.0 million and a repayment of capital leases of $830,000.
At December 31, 2002, we had $50.4 million in cash and cash equivalents.
We do not currently plan to pay dividends, but rather to retain earnings for use
in the operation of our business and to fund future growth. We had no long-term
debt outstanding as of December 31, 2002.
The following summarizes our contractual obligations under various
operating leases for both office and warehouse space as at December 31, 2002,
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods. The remaining lease terms range in length from one to
four years with future minimum lease payments, net of sublease proceeds of
$108,000 in 2003, as follows (in thousands):
2003 2004 2005 2006 2007 Thereafter
---- ---- ---- ---- ---- ----------
Restructuring related leases (see note 11) $ 561 $ 592 $ 304 $ 22 $ 0 $ 0
Operating Leases ......................... 2,247 2,256 1,913 1,108 912 1, 989
------ ------ ------ ------ ---- ------
Total commitments .................. $2,808 $2,848 $2,217 $1,130 $912 $1,989
====== ====== ====== ====== ==== ======
We have not included contingent earn out payments in the table above. The
potential earn out payments to the former owners of Compass is $3.85 million
during 2003 and $3.25 million in 2004 if the earnings before interest, taxes,
depreciation and amortization exceed $3.5 million in 2003 and $4.6 million in
2004.
18
We are also exposed to credit risk in the event of default of the
sub-lessee of certain facilities, because we are still liable to meet our
obligations under the terms of the original lease agreement.
We anticipate fluctuations in working capital in the future primarily as a
result of fluctuations in sales of equipment and relative levels of inventory.
We will also continue to expend significant amounts of capital on property and
equipment related to the restructuring of our corporate headquarters,
consolidation of our distribution centers, equipment testing infrastructure, and
additional facilities to support our growth, as well as expending significant
resources in support of our information technology projects.
We believe that cash and cash equivalents and anticipated cash flow from
operations will be sufficient to fund our working capital and capital
expenditure requirements for at least the next 12 months.
Critical Accounting Policies
We consider certain accounting policies related to revenue recognition,
valuation allowances, valuation of goodwill and intangible assets, and income
taxes to be critical policies.
Revenue Recognition. Substantially all of our revenue is derived from the
sale of new and redeployed telecommunications equipment. With the exception of
exchange transactions, revenue is recognized upon our delivery of equipment
provided that, at the time of delivery, there is evidence of a contractual
arrangement with the customer, the fee is fixed or determinable, collection of
the resulting receivable is reasonably assured and there are no significant
remaining obligations. Delivery occurs when title and risk of loss transfer to
the customer, generally at the time the product is shipped to the customer.
We also generate services revenue in connection with equipment sales.
Revenue for transactions that include multiple elements such as equipment and
services is allocated to each element based on its relative fair value (or in
the absence of fair value, the residual method) and recognized when the revenue
recognition criteria have been met for each element. We recognize revenue for
delivered elements only when the following criteria are satisfied: (1)
undelivered elements are not essential to the functionality of delivered
elements, (2) uncertainties regarding customer acceptance are resolved, and (3)
the fair value for all undelivered elements is known. For 2002 revenue from
services represented approximately 9% of net revenue. Services represented less
than 5% of net revenues prior to 2002.
Revenue is deferred when customer acceptance is uncertain, when
significant obligations remain, or when undelivered elements are essential to
the functionality of the delivered products. A reserve for sales returns and
warranty obligations is recorded at the time of shipment and is based on our
historical experience. Actual results could differ from those estimates, which
could affect our operating results. At December 31, 2002, the reserve for sales
returns and warranty obligations was $990,000.
We supply equipment to companies in exchange for redeployed equipment or
to companies from which redeployed equipment was purchased under separate
arrangements executed within a short period of time ("reciprocal arrangements").
For reciprocal arrangements, the Company considers Accounting Principles Board
("APB") No. 29, "Accounting for Nonmonetary Transactions," and Emerging Issues
Task Force ("EITF") Issue No. 86-29, "Nonmonetary Transactions: Magnitude of
Boot and Exceptions to the Use of Fair Value, Interpretation of APB No. 29,
Accounting for Nonmonetary Transactions." Revenue is recognized when the
equipment received in accordance with the reciprocal arrangement is sold through
to a third party. Revenues recognized under reciprocal arrangements were $1.3
million and $1.4 million for the fiscal years ended December 31, 2002 and 2001,
respectively. There were no revenues recognized under reciprocal arrangements
during 2000.
Valuation Allowances. The preparation of financial statements in
conformity with generally accepted accounting principles requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Specifically, we make estimates of doubtful accounts and
slow-moving and obsolete inventory. These estimates are made based on a
consideration of various factors, including historical experience, knowledge of
customers and the telecommunications equipment market, and current economic
trends. Actual results could differ from those estimates, which could affect our
operating results.
At December 31, 2002, the estimate for slow-moving and obsolete inventory
was $14.5 million. During the year ended December 31, 2002 we recorded a $13.7
million increase to the inventory reserve, resulting from continued weakness in
the telecommunications industry and changes in our business strategy.
At December 31, 2002, the estimate for doubtful accounts was $692,000.
19
Valuation of Goodwill and Intangible Assets. The cost of acquired
companies is allocated to the assets acquired and liabilities assumed based on
estimated fair values at the date of acquisition. Costs allocated to
identifiable intangible assets are generally amortized on a straight-line basis
over the remaining estimated useful lives of the assets, as determined by
underlying contract terms or appraisals. Such lives range from fifteen months to
three years.
We conduct our annual goodwill impairment tests during June or more
frequently based on an ongoing assessment of events and circumstances that would
more than likely reduce the fair value of the Company below its carrying value.
Events or circumstances that might require the need for more frequent tests
include, but are not limited to: the loss of a number of significant clients,
the identification of other impaired assets within the Company, the disposition
of a significant portion of the Company, or a significant adverse change in
business climate or regulations. Accordingly, as a result of the restructuring
activities and inventory write-downs, the Company conducted a second impairment
test at December 31, 2002. The estimated fair value of the Company exceeded the
carrying value in both tests conducted in 2002, indicating the underlying
goodwill was not impaired at the respective testing dates. The goodwill balances
at December 31, 2002 and 2001 were $26.5 million and $16.3 million,
respectively.
Deferred Taxes. The carrying value of our net deferred tax assets assumes
that we will be able to generate sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions. If these estimates and
related assumptions change in the future, we may be required to record valuation
allowances against our deferred tax assets resulting in additional income tax
expense. We evaluate the realizability of the deferred tax assets quarterly and
assess the need for additional valuation allowances related to our net deferred
tax assets. As of December 31, 2002, we had no valuation allowances recorded
against our deferred tax assets.
Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This standard requires that costs
associated with exit or disposal activities be recognized when they are incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.146
will apply to exit or disposal activities initiated after fiscal year 2002. The
provisions of EITF No. 94-3 shall continue to apply for an exit activity
initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the
adoption of SFAS No. 146. The effect on adoption of SFAS No. 146 will change on
a prospective basis the timing of when restructuring charges are recorded from
commitment date approach to when the liability is incurred.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure." This Statement amends
SFAS No. 123, "Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The disclosure provisions of this Statement are effective for fiscal
years ending after December 15, 2002 and have been incorporated into these
financial statements and accompanying footnotes.
In March 2003, the EITF reached a consensus on Issue 00-21, addressing how
to account for arrangements that involve the delivery or performance of multiple
products, services, and/or rights to use assets. Revenue arrangements with
multiple deliverables are divided into separate units of accounting if the
deliverables in the arrangement meet the following criteria: (1) the delivered
item has value to the customer on a standalone basis; (2) there is objective and
reliable evidence of the fair value of undelivered items; and (3) delivery of
any undelivered item is probable. Arrangement consideration should be allocated
among the separate units of accounting based on their relative fair values, with
the amount allocated to the delivered item being limited to the amount that is
not contingent on the delivery of additional items or meeting other specified
performance conditions. The final consensus is applicable to agreements entered
into in fiscal periods beginning after June 15, 2003 with early adoption
permitted. We are currently assessing the impact of EITF 00-21 on our
consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of changes in the entity's product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are
20
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements of FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. We have not assessed the impact of the recognition and measurement
provisions of FIN 45 on our consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. We are currently
assessing the impact of FIN 46 on our consolidated financial statements.
Risk Factors
You should carefully consider the risks described below. If any of the
following risks actually occur, our business could be harmed and the trading
price of our common stock could decline. You should also refer to other
information contained in this Annual Report on Form 10-K, including our
financial statements and related notes.
Our operating results are likely to fluctuate in future periods, which might
lead to reduced prices for our stock.
Our annual or quarterly operating results are difficult to predict and are
likely to fluctuate significantly in the future as a result of numerous factors,
many of which are outside of our control. If our annual or quarterly operating
results do not meet the expectations of securities analysts and investors, the
trading price of our stock could significantly decline. Factors that could
impact our operating results include:
o the rate, timing and volume of orders for the telecommunications
infrastructure equipment we sell;
o the rate at which telecommunications operators de-install their
equipment;
o decreases in our selling prices due to competition in the secondary
market or price pressure from OEMs;
o our ability to obtain products cost-effectively from OEMs,
distributors, operators and other secondary sources of
telecommunications equipment;
o our ability to provide equipment and service offerings on a timely
basis to satisfy customer demand;
o variations in customer capital spending patterns due to seasonality,
economic conditions for telecommunications operators and other
factors;
o write-offs due to inventory defects or obsolescence;
o the sales cycle for equipment we sell, which can be relatively
lengthy;
o delays in the commencement of our operations in new market segments
and geographic regions; and
o costs relating to possible acquisitions and integration of new
businesses.
Our business depends upon our ability to match third party redeployed equipment
supply with carrier demand for this equipment and failure to do so could reduce
our net revenue.
Our success depends on our continued ability to match the equipment needs
of telecommunications operators with the supply of redeployed equipment
available in the secondary market. We depend upon maintaining business
relationships with third parties who can provide us with redeployed equipment
and information on available redeployed equipment. Failure to effectively manage
these relationships and match the needs of our customers with available supply
of redeployed equipment could damage our ability to generate net revenue. In the
event operators decrease the rate at which they de-install their networks, or
choose not to de-install their networks at all, it would be more difficult for
us to locate this equipment, which could negatively impact our net revenue.
21
A continued downturn in the telecommunications industry or an industry trend
toward reducing or delaying additional equipment purchases due to cost-cutting
pressures could reduce demand for our products.
We rely significantly upon customers concentrated in the
telecommunications industry as a source of net revenue and redeployed equipment
inventory. In 2002, we experienced a general downturn in the level of capital
spending by our telecommunications customers. This slow-down in capital spending
could result in postponement of network upgrades and reduced sales to our
customers. There can be no assurance that the level of capital spending in the
telecommunications industry or by our customers specifically will increase or
remain at current levels.
The market for supplying equipment to telecommunications operators is
competitive, and if we cannot compete effectively, our net revenue and gross
margins might decline.
Competition among companies who supply equipment to telecommunications
operators is intense. We currently face competition primarily from three
sources: OEMs, distributors and secondary market dealers who sell new and
redeployed telecommunications infrastructure equipment. If we are unable to
compete effectively against our current or future competitors, we may have to
lower our selling prices and may experience reduced gross margins and loss of
market share, either of which could harm our business.
Competition is likely to increase as new companies enter this market, as
current competitors expand their products and services or as our competitors
consolidate. Increased competition in the secondary market for
telecommunications equipment could also heighten demand for the limited supply
of redeployed equipment which would lead to increased prices for, and reduce the
availability of, this equipment. Any increase in these prices could
significantly impact our ability to maintain our gross margins.
We do not have many formal relationships with suppliers of telecommunications
equipment and may not have access to adequate product supply.
In fiscal year 2002, 68% of our net revenue was generated from the sale of
redeployed telecommunications equipment. Typically, we do not have supply
contracts to obtain this equipment and are dependent on the de-installation of
equipment by operators to provide us with much of the equipment we sell. Our
ability to buy redeployed equipment from operators is dependent on our
relationships with them. If we fail to develop and maintain these business
relationships with operators or they are unwilling to sell redeployed equipment
to us, our ability to sell redeployed equipment will suffer.
Our customer base is concentrated and the loss of one or more of our key
customers would have a negative impact on our net revenue.
Historically, a significant portion of our sales have been to relatively
few customers. Sales to our ten largest customers accounted for 49.4% of our net
revenue in 2002, 39.7% of our net revenue in 2001, and 39.5% in 2000. Verizon
Communications accounted for 13.4%, 16.1% and 11.3% of our net revenue in 2002,
2001 and 2000, respectively. In addition, substantially all of our sales are
made on a purchase order basis, and no customer has entered into a long-term
purchasing agreement with us. As a result, we cannot be certain that our current
customers will continue to purchase from us. The loss of, or any reduction in
orders from, a significant customer would have a negative impact on our net
revenue.
We may be forced to reduce the sales prices for the equipment we sell, which may
impair our ability to maintain our gross margins.
In the future we expect to reduce prices in response to competition and to
generate increased sales volume. In 2002 some manufacturers reduced their prices
of new telecommunications equipment. If manufacturers reduce the prices of new
telecommunications equipment, we may be required to further reduce the price of
the new and redeployed equipment we sell. If we are forced to reduce our prices
or are unable to shift the sales mix towards higher margin equipment sales, we
will not be able to maintain current gross margins.
The market for redeployed telecommunications equipment is relatively new and it
is unclear whether our equipment and service offerings and our business will
achieve long-term market acceptance.
The market for redeployed telecommunications equipment is relatively new
and evolving, and we are not certain that our potential customers will adopt and
deploy redeployed telecommunications equipment in their
22
networks. For example, with respect to redeployed equipment that includes a
significant software component, potential customers may be unable to obtain a
license or sublicense for the software. Even if they do purchase redeployed
equipment, our potential customers may not choose to purchase redeployed
equipment from us for a variety of reasons. Our customers may also re-deploy
their displaced equipment within their own networks which would eliminate their
need for our equipment and service offerings. These internal solutions would
also limit the supply of redeployed equipment available for us to purchase,
which would limit the development of this market.
We may fail to continue to attract, develop and retain key management and sales
personnel, which could negatively impact our operating results.
We depend on the performance of our executive officers and other key
employees. The loss of key members of our senior management or other key
employees could negatively impact our operating results and our ability to
execute our business strategy. In addition, we depend on our sales professionals
to serve customers in each of our markets. The loss of key sales professionals
could significantly disrupt our relationships with our customers. We do not have
"key person" life insurance policies on any of our employees.
Our future success also depends on our ability to attract, retain and
motivate highly skilled employees. Competition for employees in the
telecommunications equipment industry is intense. Additionally, we depend on our
ability to train and develop skilled sales people and an inability to do so
would significantly harm our growth prospects and operating performance.
Our business may suffer if we are not successful in our efforts to keep up with
a rapidly changing market.
The market for the equipment and services we sell is characterized by
technological changes, evolving industry standards, changing customer needs and
frequent new equipment and service introductions. Our future success in
addressing the needs of our customers will depend, in part, on our ability to
timely and cost-effectively:
o respond to emerging industry standards and other technological
changes;
o develop our internal technical capabilities and expertise;
o broaden our equipment and service offerings; and
o adapt our services to new technologies as they emerge.
Our failure in any of these areas could harm our business. Moreover, any
increased emphasis on software solutions as opposed to equipment solutions could
limit the availability of redeployed equipment, decrease customer demand for the
equipment we sell, or cause the equipment we sell to become obsolete.
The lifecycles of telecommunications infrastructure equipment may become
shorter, which would decrease the supply of, and carrier demand for, redeployed
equipment.
Our sales of redeployed equipment depend upon telecommunications operator
utilization of existing telecommunications network technology. If the lifecycle
of equipment comprising operator networks is significantly shortened for any
reason, including technology advancements, the installed base of any particular
model would be limited. This limited installed base would reduce the supply of,
and demand for, redeployed equipment which could decrease our net revenue.
Many of our customers are telecommunications operators that may at any time
reduce or discontinue their purchases of the equipment we sell to them.
If our customers choose to defer or curtail their capital spending
programs, it could have a negative impact on our sales to those
telecommunications operators, which would harm our business. A significant
portion of our customers are emerging telecommunications operators who compete
against existing telecommunications companies. These new participants only
recently began to enter these markets, and many of these operators are still
building their networks and rolling out their services. They require substantial
capital for the development, construction and expansion of their networks and
the introduction of their services. If emerging operators fail to acquire and
retain customers or are unsuccessful in raising needed funds or responding to
any other trends, such as price reductions for their services or diminished
demand for telecommunications services in general, then they could be forced to
reduce their capital spending programs.
23
If we fail to implement our strategy of purchasing equipment from and selling
equipment to regional bell operating companies, our growth will suffer.
One of our strategies is to develop and expand our relationships with
regional bell operating companies, or RBOCs. We believe the RBOCs could provide
us with a significant source of additional net revenue. In addition, we believe
the RBOCs could provide us with a large supply of redeployed equipment. We
cannot assure you that the implementation of this strategy will be successful.
RBOCs may not choose to sell redeployed equipment to us or may not elect to
purchase this equipment from us. RBOCs may instead develop those capabilities
internally or elect to compete with us and resell redeployed equipment to our
customers or prospective customers. If we fail to successfully develop our
relationships with RBOCs or if RBOCs elect to compete with us, our growth could
suffer.
If we do not continue to expand our international operations our growth could
suffer.
We intend to continue expanding our business in international markets.
This expansion will require significant management attention and financial
resources to develop a successful international business, including sales,
procurement and support channels. Following this strategy, we opened our
European headquarters in the fourth quarter of 2000, and in 2002 established
sales offices in Singapore, Brazil, Sweden and Russia. However, we may not be
able to maintain or increase international market demand for the equipment we
sell, and therefore we might not be able to expand our international operations.
Our experience in providing equipment outside the United States is increasing,
but still developing. Sales to customers outside of the United States accounted
for 14.9% of our net revenue in 2002, 9.7% of our net revenue in 2001, and 7.8%
of our net revenue in 2000.
If we do engage in selective acquisitions, we may experience difficulty
assimilating the operations or personnel of the acquired companies, which could
threaten our future growth.
If we make acquisitions in the future, we could have difficulty
assimilating or retaining the acquired companies' personnel or integrating their
operations, equipment or services into our organization. These difficulties
could disrupt our ongoing business, distract our management and employees and
increase our expenses. Moreover, our profitability may suffer because of<