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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
__________
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended September 30, 2002
----------------------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from ____________________ to __________________
Commission file number 000-30865
AVICI SYSTEMS INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 02-0493372
(State or Other Jurisdiction of Organization) (I.R.S. Employer Identification No.)
101 Billerica Avenue
North Billerica, Massachusetts 01862
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (978) 964-2000
Indicate by check [X] 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 ________
------
At October 30, 2002, 50,422,018 shares of the registrant's Common Stock,
par value $0.0001 per share, were outstanding.
Page 1
AVICI SYSTEMS INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 2002 and
December 31, 2001 ......................................................................... 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 and 2001 ......................................................... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and 2001 ............................................................... 5
Notes to Consolidated Financial Statements ................................................ 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................................. 10
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk ................................ 18
ITEM 4. Controls and Procedures ................................................................... 18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings ........................................................................... 18
ITEM 2. Changes in Securities and Use of Proceeds ................................................... *
ITEM 3. Defaults Upon Senior Securities ............................................................. *
ITEM 4. Submission of Matters to a Vote of Security Holders ......................................... *
ITEM 5. Other Information ........................................................................... *
ITEM 6. Exhibits and Reports on Form 8-K ............................................................ 19
SIGNATURE .................................................................................................. 20
CERTIFICATIONS ............................................................................................. 21
*No information provided due to inapplicability of item.
Page 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVICI SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, Except Share and per share amounts)
(unaudited)
September 30, December 31,
2002 2001
------------- ------------
ASSETS
Current assets:
Cash, cash equivalents and investments $ 91,844 $ 128,935
Trade accounts receivable, net 920 2,830
Inventories, net 2,865 8,109
Prepaid expenses and other current assets 2,329 2,635
--------- ---------
Total current assets 97,958 142,509
Property and equipment, net 31,983 41,728
Long-term marketable securities 41,836 35,506
Other assets 523 534
--------- ---------
Total assets $ 172,300 $ 220,277
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 973 $ 2,319
Accounts payable 5,713 5,901
Accrued payroll and payroll related costs 3,510 2,951
Accrued restructuring costs 1,907 572
Accrued supplier commitments 702 2,636
Accrued other 3,051 3,204
Deferred revenue 8,225 8,254
--------- ---------
Total current liabilities 24,081 25,837
--------- ---------
Long-term obligations, less current maturities 150 753
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value:
Authorized - 5,000,000 shares Issued and outstanding - none -- --
Common stock, $0.0001 par value:
Authorized - 250,000,000 shares Issued and outstanding - 50,428,686
shares at September 30, 2002 and 50,289,099 shares at December 31, 2001 5 5
Additional paid-in capital 461,602 462,961
Common stock warrants 12,200 12,200
Subscription receivable (2,500) (2,500)
Deferred compensation and other consideration (7,072) (15,172)
Accumulated deficit (316,166) (263,807)
--------- ---------
Total stockholders' equity 148,069 193,687
--------- ---------
Total liabilities and stockholders' equity $ 172,300 $ 220,277
========= =========
See accompanying notes.
Page 3
AVICI SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
-------------------------------- ---------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Gross revenue $ 7,264 $ 10,302 $ 25,836 $ 47,427
Common stock warrant discount (816) (817) (2,450) (2,450)
------------ ------------ ------------ ------------
Net revenue 6,448 9,485 23,386 44,977
------------ ------------ ------------ ------------
Cost of revenue (1) 3,510 25,094 13,209 45,842
------------ ------------ ------------ ------------
Gross margin 2,938 (15,609) 10,177 (865)
------------ ------------ ------------ ------------
Operating expenses:
Research and development (2) 15,338 16,375 43,929 47,344
Sales and marketing (2) 3,185 4,866 10,692 15,193
General and administrative (2) 1,595 2,671 5,443 7,493
Stock-based compensation 1,367 2,723 5,071 10,861
Restructuring charges 925 1,134 925 1,134
------------ ------------ ------------ ------------
Total operating expenses 22,410 27,769 66,060 82,025
------------ ------------ ------------ ------------
Loss from operations (19,472) (43,378) (55,883) (82,890)
Interest income, net 1,101 2,141 3,239 8,592
Other income -- -- 285 --
------------ ------------ ------------ ------------
Net loss $ (18,371) $ (41,237) $ (52,359) $ (74,298)
============ ============ ============ ============
Net loss per share:
Basic and diluted $ (.37) $ (.83) $ (1.05) $ (1.51)
============ ============ ============ ============
Weighted average common shares used
in computing net loss per share:
Basic and diluted 49,934,800 49,486,430 49,836,518 49,137,264
============ ============ ============ ============
(1) Cost of revenue for the three and nine-month periods ended September 30, 2002 includes a credit of $772 and $2,468,
respectively, to recognize the utilization of fully reserved inventory previously estimated to be in excess of
foreseeable requirements. Cost of revenue for the three and nine month periods ended September 30, 2001 includes a
charge of $17,165 for obsolete and excess inventory.
(2) Excludes noncash, stock-based
compensation, as follows:
Research and development $ 832 $ 1,808 $ 3,121 $ 7,035
Sales and marketing 295 690 1,165 2,852
General and administrative 240 225 785 974
------------ ------------ ------------ ------------
$ 1,367 $ 2,723 $ 5,071 $ 10,861
============ ============ ============ ============
See accompanying notes.
Page 4
AVICI SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
--------------------------
2002 2001
---- ----
Cash Flows from Operating Activities:
Net loss $ (52,359) $ (74,298)
Adjustments to reconcile net loss to net cash used in
operating activities -
Depreciation and amortization 18,025 12,752
Common stock warrant discount 2,450 2,450
Compensation expense associated with issuance of stock
options to employees and consultants 4,052 9,810
Net (gain) loss on disposal of property and equipment (251) 1,330
Changes in current assets and liabilities:
Trade accounts receivable, net 1,910 (1,270)
Inventories, net 5,244 6,339
Prepaid expenses and other current assets 317 (1,733)
Accounts payable (188) (8,185)
Accrued payroll and payroll related costs 559 710
Accrued restructuring costs 1,335 659
Accrued supplier commitments (1,934) 9,593
Accrued other (153) 328
Deferred revenue (29) (2,602)
--------- ---------
Cash used in operating activities (21,022) (44,117)
--------- ---------
Cash Flows from Investing Activities:
Purchase of long-term marketable securities, net (6,330) (12,592)
Purchases of property and equipment (8,394) (31,856)
Proceeds from sale of equipment 365 --
--------- ---------
Cash used in investing activities (14,359) (44,448)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from employee stock plans 239 4,132
Payments on long-term obligations (1,949) (3,250)
--------- ---------
Cash (used in) provided by financing activities (1,710) 882
--------- ---------
Decrease in Cash and Cash Equivalents (37,091) (87,683)
Cash and Cash Equivalents, beginning of period 128,935 233,392
--------- ---------
Cash and Cash Equivalents, end of period $ 91,844 $ 145,709
========= =========
See accompanying notes.
Page 5
AVICI SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. BASIS OF PRESENTATION
The financial information included herein has been prepared by Avici Systems
Inc., pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) and includes the accounts of Avici Systems Inc. and
subsidiaries (the "Company"). Certain information and footnote disclosures,
normally included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant to such
rules and regulations. In the opinion of the Company, the accompanying
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of the financial
position at September 30, 2002 and December 31, 2001 and the operating results
and cash flows for the three and nine month periods ended September 30, 2002 and
2001. These consolidated financial statements and notes should be read in
conjunction with the Company's consolidated audited financial statements and
notes thereto for the year ended December 31, 2001, which appear in the
Company's annual report on Form 10-K. The consolidated balance sheet at December
31, 2001 has been derived from the audited consolidated financial statements as
of that date.
The results of operations for the three and nine months ended September 30, 2002
are not necessarily indicative of results that may be expected for any other
interim period or for the full fiscal year ending December 31, 2002.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Revenue Recognition
The Company recognizes revenue from product sales upon shipment, provided that a
purchase order has been received or a contract has been executed, there are no
uncertainties regarding customer acceptance, the sales price is fixed or
determinable, and collectibility is deemed probable. If uncertainties regarding
customer acceptance exist, the Company recognizes revenue when those
uncertainties are resolved. For arrangements that include the delivery of
multiple elements, revenue is allocated to the various elements based on
vendor-specific objective evidence of fair value (VSOE). The Company uses the
residual value method when VSOE does not exist for one of the delivered elements
in an arrangement. Revenue from support and maintenance contracts is recognized
ratably over the period of the related agreements. Revenue from installation and
other services is recognized as the work is performed. Amounts collected or
billed prior to satisfying the above revenue recognition criteria are recorded
as deferred revenue.
Warranty costs are estimated based on the Company's historical return rates and
repair costs and are recorded at the time of product revenue recognition.
(b) Cash and Cash Equivalents and Investments
The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. The Company has classified its cash equivalents and investments as
held-to-maturity and recorded them at amortized cost, which approximates market
value. The Company considers all highly liquid investments with original
maturities of three months or less at the date of acquisition to be cash
equivalents. Cash and cash equivalents and investments include money markets,
certificates of deposit and commercial paper. Long-term marketable securities
include commercial paper, corporate bonds and U.S. government obligations with
remaining maturities greater than one year.
Page 6
Cash, Cash Equivalents, Investments and Long-term Marketable Securities consist
of the following (in thousands):
September 30, December 31,
2002 2001
----------------- -----------------
Cash and cash equivalents $ 24,820 $ 65,383
Short-term investments 67,024 63,552
----------------- -----------------
Subtotal 91,844 128,935
Long-term marketable securities 41,836 35,506
----------------- -----------------
$ 133,680 $ 164,441
================= =================
(c) Use of estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
(d) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following (in thousands):
September 30, December 31,
2002 2001
------------- ------------
(unaudited)
Finished goods and work in progres $ 2,469 $ 5,202
Raw materials 396 2,907
------- -------
$ 2,865 $ 8,109
======= =======
The Company regularly reviews inventory quantities on hand and inventory
commitments with suppliers and records a provision for excess and obsolete
inventory based primarily on the estimated forecast of product demand for the
next twelve months.
During the nine months ended September 30, 2002, the Company recorded a credit
to cost of revenue for the utilization of approximately $2.5 million of
inventory previously deemed to be in excess of foreseeable requirements. The
credit is the result of a refund of $1.6 million earned by the Company from a
supplier relating to its use of certain excess inventory, the utilization of
$0.7 million of inventory previously reserved, and a negotiated settlement
relating to future purchase commitments of $0.2 million less than originally
estimated. The agreement with one supplier for the settlement of excess
inventory requires that supplier to keep potentially usable inventory on hand
until March 31, 2003. That supplier may consume additional amounts of such
inventory during the remainder of 2002 and is required to reimburse the Company
should any such inventory be consumed. In addition, reserved inventory on hand
may be utilized by the Company in the future. Accordingly, the Company will
recognize credits to cost of revenue to the extent that such reserved inventory
is actually utilized.
(e) Net Loss per Share
Basic and diluted net loss per share are presented in conformity with SFAS No.
128, Earnings per Share, for all periods presented. In accordance with SFAS No.
128, basic and diluted net loss per common share was determined by dividing net
loss available for common stockholders by the weighted average common shares
outstanding during the period, less shares subject to repurchase. Basic and
diluted net loss per share are the same because all outstanding common stock
options have been excluded, as they are considered antidilutive.
Page 7
(f) Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, Business Combinations. SFAS No. 141 requires that all business combinations
be accounted for under a single method, the purchase method. This statement is
effective for all business combinations initiated after June 30, 2001.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. This statement applies to intangibles and goodwill acquired after June
30, 2001, as well as goodwill and intangibles previously acquired. Under this
statement, goodwill as well as other intangibles determined to have an
indefinite life will no longer be amortized; however these assets will be
reviewed for impairment on a periodic basis, at least annually. The effect of
adoption of this statement as of January 1, 2002 did not have a material impact
on the financial condition or results of operations of the Company.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 addresses the reporting for the
impairment or disposal of long-lived assets and does not apply to goodwill or
intangible assets that are not being amortized and certain other long-lived
assets. This statement supersedes SFAS No. 121, and reporting provisions of APB
No. 30, Reporting the Results of Operations - Reporting the Effects of a
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business
(as previously defined in that Opinion). This statement also amends ARB No. 51,
Consolidated Financial Statements, to eliminate the exception to consolidation
for a subsidiary for which control is likely to be temporary. Management adopted
this statement as of January 1, 2002, and it did not have a material impact on
the Company's consolidated financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal
Activities. This statement requires companies to recognize costs associated with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. This statement supersedes EITF Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. This statement will be effective for disposal
activities initiated after December 31, 2002, and the Company will adopt this
statement for any costs relating to restructuring or disposal activities
initiated after the effective date.
(g) Reclassifications
Certain reclassifications have been made to prior year balances in order to
conform to the current year presentation.
NOTE 3. STOCKHOLDERS' EQUITY
(a) Common Stock Warrant Discount
In December 2000, in connection with the execution of a nonexclusive systems and
services agreement (the Agreement), the Company issued a warrant to a customer
to purchase 850,000 shares of the Company's common stock at a per-share exercise
price of $27.73. The Agreement between the Company and the customer provides the
customer with the ability, but not the obligation, to purchase equipment and
services from the Company. The warrant is non-forfeitable, fully exercisable and
has a term of five years from the date of issuance. The fair value of the
warrant was calculated using the Black-Scholes valuation model to be $9.8
million. The fair value of the warrant has been deferred as a reduction to
equity and is currently being amortized as an offset to gross revenue on a
straight-line basis over the three-year term of the Agreement at the rate of
$0.8 million per quarter. As of September 30, 2002, $6.5 million has been
amortized.
(b) Reverse Stock Split and Stock Repurchase Program
During the third quarter of 2002, the Board of Directors approved a proposal
that would grant the Board of Directors, subject to shareholder approval,
discretionary authority to amend the Fourth Restated Certificate of
Incorporation of the Company to effect a reverse stock split whereby each
outstanding 2, 3, 4, or 5 shares would be combined, converted and changed into
one share of the Company's common stock. The reverse stock split proposal will
facilitate the continued listing of the Company's common stock on the Nasdaq
National Market and will be submitted to shareholders for approval at a special
meeting scheduled for November 8, 2002. The final determination of whether to
implement the split, as well as the actual exchange
Page 8
ratio, will be determined by the Board of Directors following stockholder
approval. The accompanying consolidated financial statements do not reflect the
impact of a possible future reverse stock split.
In addition, the Board of Directors has authorized a share repurchase program to
acquire up to six million shares of the Company's common stock in the open
market, at times and prices considered appropriate by the Company during the
next year. The share repurchase program may be suspended at any time and from
time to time without prior notice.
NOTE 4. RESTRUCTURING AND OTHER CHARGES
In response to unfavorable industry conditions, the Company implemented
restructuring programs during the third and fourth fiscal quarters of 2001
designed to decrease operating expenses and align resources with future growth
opportunities. The restructuring programs included workforce reductions totaling
95 employees, or approximately 24% of the then current workforce. Additionally,
during the third quarter of 2002, the Company reduced its workforce by an
additional 75 employees, or 24% of the then current workforce. The affected
employees received severance and other benefits pursuant to a benefits program.
The Company recorded charges totaling $0.9 million for termination benefits
during the third and fourth fiscal quarters of 2001, and an additional $0.9
million for termination benefits during the third quarter of 2002. Termination
benefits relating to the 2001 workforce reductions were fully paid as of the end
of the first quarter of 2002. Approximately $0.2 million of the termination
benefits relating to the 2002 workforce reduction were paid during third quarter
of 2002 and the remaining $0.7 million will be paid by the end of the first
quarter of 2003. Along with the workforce reductions, the Company recorded a
charge of $1.7 million in 2001, and $1.1 million during the third quarter of
2002, to dispose of redundant assets and to accrue lease payments associated
with excess facility space. Amounts related to the lease payments will be paid
over the respective lease terms through July 2004.
The Company's restructuring related reserves at September 30, 2002 are
summarized as follows (in thousands):
Restructuring
Total Noncash Cash Accrual at
Charges Charges Payments September 30, 2002
--------- --------- -------- ------------------
2001 Restructuring:
Workforce reduction $ 869 $ - $ 869 $ -
Consolidation of facilities and disposal of assets 1,718 1,330 212 176
Reversal of stock based compensation (1,525) (1,525) - -
------- ------- --------- ----------
Subtotal 1,062 (195) 1,081 176
2002 Restructuring:
Workforce reduction 877 - 180 697
Consolidation of facilities and disposal of assets 1,068 34 - 1,034
Reversal of stock based compensation (1,020) (1,020) - -
------- ------- -------- ----------
Total $ 1,987 $(1,181) $ 1,261 $ 1,907
======= ======= ======== ==========
The workforce reductions resulted in the forfeiture of employee stock options.
The restructuring charges include the reversal of $1.5 million in 2001, and $1.0
million during the third quarter of 2002, of non-cash stock based compensation
expense previously recorded for the forfeited options.
Additionally, in the third quarter of 2001 the Company recorded a charge of
$17.2 million as an element of cost of revenue to reflect a write down of
inventories and inventory commitments for long lead time items which were
considered to be in excess of the then foreseeable demand. The charge included
commitments to suppliers including ASICs, module components, and TSR bay
components totaling approximately $9.6 million and inventory components and
finished goods on hand relating to the TSR product, totaling approximately $7.6
million which were identified as in excess of forecasted demand for the next 12
Page 9
months. Since the end of the third quarter of fiscal 2001, the Company has paid
approximately $9.4 million to settle inventory commitments with suppliers, and
has discarded approximately $4.8 million of the excess inventory on hand.
During the second and third quarters of 2002, the Company recorded credits to
cost of revenue for the utilization of an aggregate of approximately $2.5
million of inventory previously deemed to be in excess of foreseeable
requirements. The credit is the result of refunds of $1.6 million earned by the
Company from a supplier relating to its use of certain excess inventory, the
utilization of $0.7 million of inventory previously reserved, and a negotiated
settlement relating to future purchase commitments of $0.2 million less than
originally estimated. The agreement with one supplier for the settlement of
excess inventory requires that supplier to keep potentially usable inventory on
hand until March 31, 2003. That supplier may consume additional amounts of such
inventory during the remainder of 2002 and is required to reimburse the Company
should any such inventory be consumed. In addition, reserved inventory on hand
may be utilized by the Company in the future. Accordingly, the Company will
recognize credits to cost of revenue to the extent that such reserved inventory
is actually utilized.
NOTE 5. LITIGATION
Twelve purported securities class action lawsuits are currently pending against
the Company and one or more of the Company's underwriters in the Company's
initial public offering, and certain officers and directors of the Company. The
lawsuits allege violations of the federal securities laws and have been docketed
in the U.S. District Court for the Southern District of New York as: Felzen, et
al. v. Avici Systems Inc., et al., C.A. No. 01-CV-3363; Lefkowitz, et al. v.
Avici Systems Inc., et al., C.A. No. 01-CV-3541; Lewis, et al. v. Avici Systems
Inc., et al., C.A. No. 01-CV-3698; Mandel, et. al v. Avici Systems Inc., et al.,
C.A. No. 01-CV-3713; Minai, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-3870; Steinberg, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-3983; Pelissier, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-4204; Esther, et al. v. Avici Systems Inc., et al., C.A. No. 01-CV-4352;
Zhous, et al. v. Avici Systems Inc. et al., C.A. No. 01-CV-4494; Mammen, et al.
v. Avici Systems Inc., et. al., C.A. No. 01-CV-5722; Lin, et al. v. Avici
Systems Inc., et al., C.A. No. 01-CV-5674; and Shives, et al. v. Banc of America
Securities, et al., C.A. No. 01-CV-4956. These lawsuits seek unspecified damages
and allege, among other things, that the underwriters of the Company's initial
public offering (IPO) improperly required their customers to pay the
underwriters excessive commissions and to agree to buy additional shares of the
Company's stock in the aftermarket as conditions of receiving shares in the
Company's IPO. The lawsuits further claim that these supposed practices of the
underwriters should have been disclosed in the Company's IPO prospectus and
registration statement. The Company understands that various other plaintiffs
have filed substantially similar class action cases against approximately 300
other publicly traded companies and their IPO underwriters in New York City
which, along with the cases against the Company, have all been transferred to a
single federal district judge for purposes of coordinated case management. The
Company and its officers and directors believe that the claims against the
Company lack merit, and intends to defend the litigation vigorously. In that
regard, on July 15, 2002, the Company, together with the other issuers named as
defendants in these coordinated proceedings, filed a collective motion to
dismiss the consolidated amended complaints against them on various legal
grounds common to all or most of the issuer defendants. This motion is currently
pending. On October 9, 2002, the Court approved a stipulation between the
plaintiffs and the individual defendants providing for the dismissal of the
individual defendants without prejudice. While the Company can make no promises
or guarantees as to the outcome of these actions, the Company believes that the
final result of these actions will have no material effect on its consolidated
financial condition or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for the historical information contained herein, certain matters
discussed in this Report on Form 10-Q constitute forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those stated or implied in forward-looking statements due to a
number of factors, including without limitation those discussed under the
caption "Factors That May Affect Future Results" included in the Company's
annual report on Form 10-K as filed with the Securities and Exchange Commission
and elsewhere herein. Forward-looking statements include statements regarding
the future or the Company's expectations, beliefs, intentions or strategies
regarding the future and may be identified by the words "anticipate," "believe,"
"could," "estimate," "expect," "intend," "may," "should," "will," and "would"
and similar expressions. There may be events in the future that could affect
these matters.
Page 10
Overview
Avici Systems provides high-speed data networking equipment that enables
telecommunications companies and Internet service providers to transmit high
volumes of information across their networks.
Since our inception, we have incurred significant losses. As of September 30,
2002, we had an accumulated deficit of $316.2 million. Our operating activities
from inception through 1999 were primarily devoted to research and development,
including the design and development of our proprietary application specific
integrated circuits, or ASICs, and software, and system testing the Avici
Terabit Switch Router product, or TSR. Revenue was first recognized during the
first quarter of 2000. We have also built our administrative, marketing, sales,
customer support and manufacturing organizations and developed strategic
relationships with systems integrators, distributors, customers and
complementary vendors. We have not achieved profitability on a quarterly or an
annual basis and anticipate that we will continue to incur significant operating
losses in the foreseeable future. We have a lengthy sales cycle for our products
and, accordingly, we expect to incur significant selling and other expenses
before we realize the related revenue. We expect to incur significant sales and
marketing, research and development and general and administrative expenses as
we expand our business and, as a result, we will need to generate significant
revenues to achieve and maintain profitability.
The TSR became commercially available in the fourth quarter of 1999. During
2001, we introduced the Avici Stackable Switch Router product, or SSR, a
rack-mountable scalable router for carriers and service providers with smaller
core networks. The first SSR sale occurred during the fourth quarter of 2001. We
currently market our products to major carriers in North America through a
direct sales force. We also market our products internationally through systems
integrators, distributors, and a direct sales force in Europe. We currently
provide product installation and customer field support through our internal
customer service organization and third-party support organizations.
Our target end-user customers include incumbent local exchange carriers,
inter-exchange carriers, postal telephone and telegraph operators or PTTs
(international incumbent operators), international competitive carriers,
Internet service providers, and agencies of the United States government.
We expect that in the foreseeable future, substantially all of our revenue will
continue to depend on sales of our TSR, SSR and other related products to
current customers and a limited number of potential new customers. Generally,
these customers are not contractually committed to purchase any minimum
quantities of products from us. The TSR has been deployed by AT&T, and the
Company and AT&T have entered into a three year procurement agreement through
December 2003 which describes the conditions under which AT&T may acquire
equipment from the Company. The agreement has no minimum purchase commitment
associated with it.
The Company has a procurement agreement with Qwest Communications which provides
for an undisclosed minimum purchase commitment and expires in July 2003. During
the third quarter of 2002, the Company completed and passed the Qwest field
trials. Qwest has deployed the SSR, and is committed to a five production Points
of Presence ("PoPs") deployment.
In December 2001, the Company amended its procurement agreement with Williams
Communications extending its term through December 2003. The amended agreement
provided for a current cash payment of $8.5 million, which we received in
December 2001 and included $2.7 million for product deliveries made in the
fourth quarter of 2001 and $5.8 million in lieu of remaining purchase
commitments in the original agreement totaling $25 million. The $5.8 million,
which is included in the consolidated balance sheet in deferred revenue at
September 30, 2002, can be used as a credit, applied at varying rates, against
future purchases through 2003. Any unused credits become income to the Company
upon expiration.
The TSR has also been deployed by France Telecom in its VTHD R&D research
network, by Chung Hwa Telecom in its Next Generation Test Bed Network, by
several agencies of the United States government, and by the DARPA-funded
National Transparent Optical Network. The SSR has also been deployed by Global
NAPs as part of a nationwide network expansion. The Company's TSR and SSR
products are currently in various stages of trials and tests with prospective
customers, both internationally and domestically. There can be no assurance as
to the timing of the completion of these trials and tests or that their outcome
will be favorable.
Page 11
In response to unfavorable industry conditions, the Company implemented
restructuring programs during the third and fourth fiscal quarters of 2001
designed to decrease operating expenses and align resources with future growth
opportunities. The restructuring programs included workforce reductions totaling
95 employees, or approximately 24% of the then current workforce. Additionally,
during the third quarter of 2002, the Company reduced its workforce by an
additional 75 employees, or 24% of the then current workforce. The affected
employees received severance and other benefits pursuant to a benefits program.
The Company recorded charges totaling $0.9 million for termination benefits
during the third and fourth fiscal quarters of 2001, and an additional $0.9
million for termination benefits during the third quarter of 2002. Termination
benefits relating to the 2001 workforce reductions were fully paid as of the end
of the first quarter of 2002. Approximately $0.2 million of the termination
benefits relating to the 2002 workforce reduction was paid during third quarter
of 2002 and the remaining $0.7 million will be paid by the end of the first
quarter of 2003. Along with the workforce reductions, the Company recorded a
charge of $1.7 million in 2001, and $1.1 million during the third quarter of
2002, to dispose of redundant assets and to accrue lease payments associated
with excess facility space.
The Company's restructuring related reserves at September 30, 2002 are
summarized as follows (in thousands):
Restructuring
Total Noncash Cash Accrual at
Charges Charges Payments September 30, 2002
--------- --------- -------- ------------------
2001 Restructuring:
Workforce reduction $ 869 $ - $ 869 $ -
Consolidation of facilities and disposal of assets 1,718 1,330 212 176
Reversal of stock based compensation (1,525) (1,525) - -
--------- --------- --------- -------------
Subtotal 1,062 (195) 1,081 176
2002 Restructuring:
Workforce reduction 877 - 180 697
Consolidation of facilities and disposal of assets 1,068 34 - 1,034
Reversal of stock based compensation (1,020) (1,020) - -
--------- --------- -------- -------------
Total $ 1,987 $ (1,181) $ 1,261 $ 1,907
========= ========= ======== =============
The workforce reductions resulted in the forfeiture of employee stock options.
The restructuring charges include the reversal of $1.5 million in 2001, and $1.0
million during the third quarter of 2002, of non-cash stock based compensation
expense previously recorded for the forfeited options.
Additionally, in the third quarter of 2001 the Company recorded a charge of
$17.2 million as an element of cost of revenue to reflect a write down of
inventories and inventory commitments for long lead time items which were
considered to be in excess of the then foreseeable demand. The charge included
commitments to suppliers including ASICs, module components, and TSR bay
components totaling approximately $9.6 million and inventory components and
finished goods on hand relating to the TSR product, totaling approximately $7.6
million which were identified as in excess of forecasted demand for the next 12
months. Since the end of the third quarter of fiscal 2001, the Company has paid
approximately $9.4 million to settle inventory commitments with suppliers, and
has discarded approximately $4.8 million of the excess inventory on hand.
During the second and third quarters of 2002, the Company recorded credits to
cost of revenue for the utilization of an aggregate of approximately $2.5
million of inventory previously deemed to be in excess of foreseeable
requirements. The credit is the result of refunds of $1.6 million earned by the
Company from a supplier relating to its use of certain excess inventory, the
utilization of $0.7 million of inventory previously reserved, and a negotiated
settlement relating to future purchase commitments of $0.2 million less than
originally estimated. The agreement with one supplier for the settlement of
excess inventory requires that supplier to keep potentially usable inventory on
hand until March 31, 2003. That supplier may consume additional amounts of such
inventory during the remainder of 2002 and is required to reimburse the Company
should
Page 12
any such inventory be consumed. In addition, reserved inventory on hand may be
utilized by the Company in the future. Accordingly, the Company will recognize
credits to cost of revenue to the extent that such reserved inventory is
actually utilized.
The Company expects telecommunications service providers to continue to maintain
conservative levels of capital spending in the near term. Accordingly, should
deterioration in the telecommunications equipment market continue, or should
there be a change in the Company's strategy, there can be no assurance that
further restructuring might not be necessary or that such restructuring actions,
if required, would not have an adverse impact on the results of operations and
financial condition of the Company.
Critical Accounting Policies
The Company considers certain accounting policies related to revenue
recognition, inventory and warranty liabilities to be critical accounting
policies due to the estimation processes involved in each.
The Company recognizes revenue from product sales upon shipment, provided that a
purchase order has been received or a contract has been executed, there are no
uncertainties regarding customer acceptance, the sales price is fixed or
determinable and collectibility is deemed probable. If uncertainties regarding
customer acceptance exist, the Company recognizes revenue when those
uncertainties are resolved. For arrangements that include the delivery of
multiple elements, revenue is allocated to the various elements based on
vendor-specific objective evidence of fair value (VSOE). The Company uses the
residual method when VSOE does not exist for one of the delivered elements in an
arrangement. We also generate revenue from support and maintenance as well as
installation and service. We defer revenue from support and maintenance
contracts and recognize it ratably over the period of the related agreements. We
recognize revenue from installation and other services as the work is performed.
Amounts collected or billed prior to satisfying the above revenue recognition
criteria are recorded as deferred revenue.
We value our inventory at the lower of our actual cost or the current estimated
market value. We regularly review inventory quantities on hand and inventory
commitments with suppliers and record a provision for excess and obsolete
inventory based primarily on our estimated forecast of product demand for the
next twelve months. To the extent that inventory previously considered to be in
excess is ultimately utilized, credits are recorded upon utilization. As
demonstrated during 2001, demand for our products can fluctuate suddenly and
significantly due to changes in economic and business conditions. A significant
increase in demand for our products could result in a short-term increase in the
cost of inventory purchases while a significant decrease in demand could result
in an increase in the amount of excess inventory on hand and at suppliers. In
addition, our industry is characterized by rapid technological change, frequent
new product development, and rapid product obsolescence that could result in an
increase in the amount of obsolete inventory on hand and at suppliers.
Therefore, although we make every effort to ensure the accuracy of our forecasts
of future product demand, any significant unanticipated changes in demand or
technological developments could have a significant impact on the value of our
inventory and our reported operating results.
Our warranties require us to repair or replace defective product returned to us
during such warranty period at no cost to the customer. We record an estimate
for warranty-related costs based on our actual historical return rates and
repair costs at the time of sale. While our warranty costs have historically
been within our expectations and the provisions established, we cannot guarantee
we will continue to experience the same warranty return rates or repair costs
that we have in the past. A significant increase in product return rates, or a
significant increase in the costs to repair our products, could have a material
adverse impact on future operating results for the period or periods in which
such returns or additional costs materialize and thereafter.
Results of Operations
Three Months Ended September 30, 2002 Compared to the Three Months Ended
September 30, 2001
Gross Revenue. Gross revenue decreased $3.0 million to $7.3 million for the
third quarter of 2002 from $10.3 million for the third quarter of 2001. Service
revenue decreased $0.2 million to $0.9 million for the third quarter of 2002
from $1.1 million for the third quarter of 2001. The Company experienced lower
sales during the 2002 period as a result of reduced capital spending by
telecommunications service providers. Two customers, namely Qwest Communications
and AT&T, each accounted for in
Page 13
excess of 10% of gross product revenue in the 2002 period. Three customers,
namely AT&T, Enron Broadband Services and the US Government, each accounted for
in excess of 10% of gross product revenue in the 2001 period.
Common Stock Warrant Discount. In December 2000, in connection with the
execution of a nonexclusive systems and services agreement (the Agreement), the
Company issued a warrant to a customer to purchase 850,000 shares of the
Company's common stock at a per-share exercise price of $27.73. The Agreement
between the Company and the customer provides the customer with the ability, but
not the obligation, to purchase equipment and services from the Company. The
warrant is non-forfeitable, fully exercisable and has a term of five years from
the date of issuance. The fair value of the warrant was calculated using the
Black-Scholes valuation model to be $9.8 million. The fair value of the warrant
has been deferred as a reduction to equity and is currently being amortized as
an offset to gross revenue on a straight-line basis over the three-year term of
the Agreement at the rate of $0.8 million per quarter. As of September 30, 2002,
$6.5 million has been amortized.
Cost of Revenue. Cost of revenue was $3.5 million for the third quarter of 2002,
and includes a credit for the utilization of $0.8 million of inventory
previously determined to be in excess of foreseeable requirements. Cost of
revenue for the third quarter of 2001 was $25.1 million, and included a $17.2
million charge for excess and obsolete inventory. Cost of revenue includes the
cost of manufacturing overhead, and certain customer support costs. Excluding
the credit for the utilization of excess inventory in 2002 and charges for
excess and obsolete inventory in 2001, cost of revenue as a percentage of gross
and net revenue for the third quarter of 2002 was approximately 59% and 66%,
respectively, compared to 77% and 84% for the third quarter of 2001. The lower
percentages are a result of cost reductions achieved with key suppliers and a
reduction of fixed overhead costs as a result of restructuring programs
implemented by the Company. We anticipate the cost of revenue as a percentage of
both gross and net revenue to decrease as we sell more higher margin modules as
compared to bays and as fixed overhead costs are spread over an even greater
revenue base.
Research and Development. Research and development expenses decreased $1.1
million to $15.3 million for the third quarter of 2002 from $16.4 million for
the third quarter of 2001. This decrease was due primarily to a decrease of $2.4
million in salary and salary-related expenses as a result of restructuring
programs implemented by the Company, and reduction of other expenses of $0.4
million. This decrease was partially offset by a $0.9 million increase in
depreciation expense associated with the build out of the Company's internal
development and test network, and a $0.8 million increase in prototype costs
incurred to develop and test new products.
Sales and Marketing. Sales and marketing expenses decreased by $1.7 million to
$3.2 million for the third quarter of 2002 from $4.9 million for the third
quarter of 2001. This decrease was due primarily to a decrease of $1.4 million
in salary and salary-related expenses as a result of restructuring programs
implemented by the Company.
General and Administrative. General and administrative expenses decreased by
$1.1 million to $1.6 million for the third quarter of 2002 from $2.7 million for
the third quarter of 2001. The decrease was due primarily to a decrease of $0.4
million in salary and salary-related expenses as a result of restructuring
programs implemented by the Company, and a decrease of $0.2 million in outside
service costs incurred to support new business systems implemented in the prior
year.
Stock-Based Compensation. Stock-based compensation decreased $1.3 million to
$1.4 million for the third quarter of 2002 from $2.7 million for the third
quarter of 2001. This decrease is a result of certain option grants reaching
full vesting, and the related compensation becoming fully amortized, and the
elimination of future stock based compensation due to employee terminations.
Interest Income, Net. Interest income, net of interest expense, decreased by
$1.0 million to $1.1 million for the third quarter of 2002 from $2.1 million for
the third quarter of 2001 due to the decrease in invested cash balances
resulting from the use of cash to fund the operations of the Company, and lower
investment yields available in the market.
Results of Operations
Nine Months Ended September 30, 2002 Compared to the Nine Months Ended September
30, 2001
Gross Revenue. Gross revenue decreased $21.6 million to $25.8 million during the
first nine months of 2002 from $47.4 million for the same period in 2001.
Service revenue increased $0.1 million to $2.8 million during the first nine
months of 2002 from
Page 14
$2.7 million for the same period in 2001. The Company experienced lower sales
during the 2002 period as a result of reduced capital spending by
telecommunications service providers. Two customers, namely Qwest Communications
and AT&T, each accounted for in excess of 10% of gross product revenue in the
2002 period. Three customers, namely AT&T, Qwest Communications and Enron
Broadband Services, each accounted for in excess of 10% of gross product revenue
in the 2001 period.
Common Stock Warrant Discount. In December 2000, in connection with the
execution of a nonexclusive systems and services agreement (the Agreement), the
Company issued a warrant to a customer to purchase 850,000 shares of the
Company's common stock at a per-share exercise price of $27.73. The Agreement
between the Company and the customer provides the customer with the ability, but
not the obligation, to purchase equipment and services from the Company. The
warrant is non-forfeitable, fully exercisable and has a term of five years from
the date of issuance. The fair value of the warrant was calculated using the
Black-Scholes valuation model to be $9.8 million. The fair value of the warrant
has been deferred as a reduction to equity and is currently being amortized as
an offset to gross revenue on a straight-line basis over the three-year term of
the Agreement at the rate of $0.8 million per quarter. As of September 30, 2002,
$6.5 million has been amortized.
Cost of Revenue. Cost of revenue was $13.2 million for the first nine months of
2002, and includes a credit for the utilization of $2.5 million of inventory
previously determined to be in excess of foreseeable requirements. Cost of
revenue for the first nine months of 2001 was $45.8 million, and included a
$17.2 million charge for excess and obsolete inventory. Cost of revenue includes
the cost of manufacturing overhead, and certain customer support costs.
Excluding the credit for the utilization of excess inventory in 2002 and charges
for excess and obsolete inventory in 2001, cost of revenue as a percentage of
gross and net revenue for the first nine months of 2002 was approximately 61%
and 67%, respectively, compared to 60% and 64% for the same period in 2001. The
higher percentage reflects the spreading of fixed overhead costs over a smaller
revenue base in the 2002 period as compared to the 2001 period. The higher
percentages were partially offset by cost reductions achieved with key suppliers
and a reduction of fixed overhead costs as a result of restructuring programs
implemented by the Company. We anticipate the cost of revenue as a percentage of
both gross and net revenue to decrease as we sell more higher margin modules as
compared to bays and as fixed overhead costs are spread over an even greater
revenue base.
Research and Development. Research and development expenses decreased $3.4
million to $43.9 million for the first nine months of 2002 from $47.3 million
for the same period in 2001. This decrease was due primarily to a decrease of
$9.0 million in salary and salary-related expenses as a result of restructuring
programs implemented by the Company. This decrease was partially offset by a
$4.3 million increase in depreciation expense associated with the build out of
the Company's internal development and test network, and a $1.3 million increase
in prototype costs incurred to develop and test new products.
Sales and Marketing. Sales and marketing expenses decreased by $4.5 million to
$10.7 million for the first nine months of 2002 from $15.2 million for the same
period in 2001. This decrease was due primarily to a decrease of $3.6 million in
salary and salary-related expenses as a result of restructuring programs
implemented by the Company.
General and Administrative. General and administrative expenses decreased by
$2.1 million to $5.4 million for the first nine months of 2002 from $7.5 million
for the same period in 2001. The decrease was due primarily to a decrease of
$1.2 million in salary and salary-related expenses as a result of restructuring
programs implemented by the Company, and a decrease of $0.2 million in outside
service costs incurred to support new business systems implemented in the prior
year.
Stock-Based Compensation. Stock-based compensation decreased $5.8 million to
$5.1 million for the first nine months of 2002 from $10.9 million for the same
period in 2001. This decrease is a result of certain option grants reaching full
vesting, and the related compensation becoming fully amortized, and the
elimination of future stock based compensation due to employee terminations.
Other Income. During the second quarter of fiscal 2002, the Company recorded a
gain of $0.3 million relating to the excess of insurance proceeds at replacement
value over the net book value of certain information technology equipment
damaged during the first quarter of fiscal 2002.
Interest Income, Net. Interest income, net of interest expense, decreased by
$5.4 million to $3.2 million for the first nine months of 2002 from $8.6 million
for the same period in 2001 due to the decrease in invested cash balances
resulting from the use of cash to fund the operations of the Company, and lower
investment yields available in the market.
Page 15
Liquidity and Capital Resources
Since our inception, we have financed our operations through private sales of
equity securities, an initial public offering in July 2000, and, to a lesser
extent, equipment lease financing. From inception through September 30, 2002, we
raised approximately $410.3 million from these equity offerings. During the nine
months ended September 30, 2002, we used $21.8 million in cash for operating
activities, compared to $44.1 million used in the same period in 2001. The
decrease in cash usage from the 2002 period as compared to the 2001 period is
due to lower operating expenses as a result of restructuring programs
implemented by the Company. We expect working capital requirements will increase
if product sales increase, creating larger customer receivable balances and the
need to build inventory in advance of shipment. In addition, we will selectively
increase operating costs as needed to support the scale of operations.
Purchases of property and equipment were $8.4 million for the nine months ended
September 30, 2002, compared to $31.9 million for the same period in 2001, and
consisted primarily of purchases of test equipment, computer equipment,
including workstations and servers, and laboratory equipment primarily to
support current research and development activities and customer support
infrastructure. The Company expects that its capital expenditures will be
approximately $3.0 million for the remainder of 2002. The timing and amount of
future capital expenditures will depend primarily on our future growth. As of
September 30, 2002, our future minimum lease payment obligations were $1.2
million under capital leases which require payments of $391,000 for the
remainder of 2002, and annual payments of $738,000 in 2003 and $46,000 in 2004.
In addition, our future minimum lease payment obligations under operating leases
are $6.3 million which require payments of $0.5 million for the remainder of
2002, $1.6 million in 2003, $1.3 million in 2004, $1.1 million in 2005 and 2006
and $0.7 million in 2007.
The Company outsources the manufacture and assembly of its products. During the
normal course of business, in order to maintain competitive lead times for
customers and adequate components supply, the Company enters into agreements
with certain suppliers to procure inventory based upon criteria as defined by
the Company. As of September 30, 2002, the Company was committed to purchase
approximately $4.2 million of inventory based upon such criteria.
During the third quarter of 2002, the Board of Directors approved a proposal
that would grant the Board of Directors, subject to shareholder approval,
discretionary authority to amend the Fourth Restated Certificate of
Incorporation of the Company to effect a reverse stock split whereby each
outstanding 2, 3, 4, or 5 shares would be combined, converted and changed into
one share of the Company's common stock. The reverse stock split proposal will
facilitate the continued listing of the Company's common stock on the Nasdaq
National Market and will be submitted to shareholders for approval at a special
meeting scheduled for November 8, 2002. The final determination of whether to
implement the split, as well as the actual exchange ratio, will be determined by
the Board of Directors following stockholder approval. In addition, the
Company's Board of Directors authorized a share repurchase program to acquire up
to six million shares of the Company's common stock in the open market, at times
and prices considered appropriate by the Company during the next year. The share
repurchase program may be suspended at any time and from time to time without
prior notice.
Other than obligations under capital leases, minimum payments under operating
leases and certain commitments to vendors for long lead-time inventory items,
the Company has no additional debt for which it is a guarantor or direct
obligor.
We expect that working capital and capital expenditure requirements may increase
if product sales increase, creating larger customer receivable balances, the
need to build inventory in advance of shipment and the need for increased levels
of test and management information systems equipment. At September 30, 2002, the
Company had cash, cash equivalents, investments and long-term marketable
securities of $133.7 million. We believe that our existing cash, cash
equivalents and investments together with cash flows from operations will be
sufficient to meet our normal operating and capital requirements through 2004.
However, we could be required, or could elect, to raise additional funds during
that period and we may need to raise additional capital in the future. We may
not be able to obtain additional capital on terms favorable to us or at all. The
issuance of additional equity or equity-related securities will be dilutive to
our stockholders. If we cannot raise funds on acceptable terms, or at all, we
may not be able to develop or enhance our products or respond appropriately to
competitive pressures, which would seriously limit our ability to increase our
revenue and grow our business.
Page 16
Factors That May Affect Future Results
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. These forward-looking statements include management's plans and
objectives for future operations, as well as statements regarding the strategy
and plans of the Company. The Company's actual experience may differ materially
from that discussed in the forward-looking statements. Factors that might cause
such a difference include the limited number of customers; continuing acceptance
of the Company's products and product enhancements; customer purchasing patterns
and commitments; the size, timing and recognition of revenue from customers; the
Company's ability to develop new products and product enhancements; market
acceptance of new product offerings and enhancements to our products and the
Company's ability to predict and respond to market developments; the failure to
keep pace with the rapidly changing requirements of our customers; the Company's
ability to attract and retain key personnel; the development and expansion of
the Company's direct sales force and/or other distributor channels; risks
associated with management of growth; the Company's ability to obtain component
parts; the Company being held liable for defects or errors in our products; the
Company's failure to comply with the listing requirements of the Nasdaq National
Market System; the effects of the reverse stock split; the expense of defending
and the outcome of pending and future shareholder litigation; as well as risks
of a further downturn in economic conditions generally, and in the
telecommunications industry specifically, and risks associated with competition
and competitive pricing pressures. For a more detailed description of the risk
factors associated with the Company, please refer to the Company's Annual Report
on Form 10-K as filed with the Securities and Exchange Commission.
Recent Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141
requires that all business combinations be accounted for under a single method,
the purchase method. This statement is effective for all business combinations
initiated after June 30, 2001.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. This statement applies to intangibles and goodwill acquired after June
30, 2001, as well as goodwill and intangibles previously acquired. Under this
statement, goodwill as well as other intangibles determined to have an
indefinite life will no longer be amortized; however these assets will be
reviewed for impairment on a periodic basis, at least annually. The effect of
adoption of this statement did not have a material impact on the financial
condition or results of operations of the Company.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 addresses the reporting for the
impairment or disposal of long-lived assets and does not apply to goodwill or
intangible assets that are not being amortized and certain other long-lived
assets. This statement supersedes SFAS No. 121, and reporting provisions of APB
No. 30, Reporting the Results of Operations - Reporting the Effects of a
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business
(as previously defined in that Opinion). This statement also amends ARB No. 51,
Consolidated Financial Statements, to eliminate the exception to consolidation
for a subsidiary for which control is likely to be temporary. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001. Management adopted this statement as of January 1, 2002, and
it did not have a material impact on the Company's consolidated financial
position or results of operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal
Activities. This statement requires companies to recognize costs associated with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. This statement supersedes EITF Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. This statement will be effective for disposal
activities initiated after December 31, 2002, and the Company will adopt this
statement for any costs relating to restructuring or disposal activities
initiated after the effective date.
Page 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk involves forward-looking
statements. Actual results could differ materially from those projected in the
forward-looking statements. We are exposed to market risk related to changes in
interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.
Interest Rate Sensitivity
We maintain an investment portfolio consisting mainly of investment grade money
market funds, corporate obligations, federal agency obligations, state and
municipal bonds with a weighted-average maturity of less than one year. These
held-to-maturity securities are subject to interest rate risk and will fall in
value if market interest rates increase. If market interest rates were to
increase immediately and uniformly by 10% from levels at September 30, 2002, the
fair market value of these investments would decline by an immaterial amount. We
have the ability to hold our fixed income investments until maturity. Therefore,
we would not expect our operating results or cash flows to be affected to any
significant degree by a sudden change in market interest rates on our securities
portfolio.
Exchange Rate Sensitivity
We presently operate primarily in the United States, and sales to date have been
primarily made in U.S. dollars. Accordingly, there has not been any material
exposure to foreign currency rate fluctuations.
The Company has no off balance sheet concentrations such as foreign exchange
contracts, option contracts or other foreign hedging arrangements.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
The principal executive officer and principal financial officer have evaluated
the disclosure controls and procedures as of a date within 90 days before the
filing date of this quarterly report. Based on this evaluation they conclude
that the disclosure controls and procedures effectively ensure that information
required to be disclosed in our filings and submissions under the Securities
Exchange Act of 1934 is recorded, processed, summarized, and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
(b) Changes in internal controls
There were no significant changes in our internal controls, or to our knowledge,
in other factors that could significantly affect our disclosure controls and
procedures subsequent to the evaluation date.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Twelve purported securities class action lawsuits are currently pending against
the Company and one or more of the Company's underwriters in the Company's
initial public offering, and certain officers and directors of the Company. The
lawsuits allege violations of the federal securities laws and have been docketed
in the U.S. District Court for the Southern District of New York as: Felzen, et
al. v. Avici Systems Inc., et al., C.A. No. 01-CV-3363; Lefkowitz, et al. v.
Avici Systems Inc., et al., C.A. No. 01-CV-3541; Lewis, et al. v. Avici Systems
Inc., et al., C.A. No. 01-CV-3698; Mandel, et. al v. Avici Systems Inc., et al.,
C.A. No. 01-CV-3713; Minai, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-3870; Steinberg, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-3983; Pelissier, et al. v. Avici Systems Inc., et al., C.A. No.
01-CV-4204; Esther, et al. v. Avici Systems Inc., et al., C.A. No. 01-CV-4352;
Zhous, et al. v. Avici Systems Inc. et al., C.A. No. 01-CV-4494; Mammen, et al.
v. Avici Systems Inc., et. al., C.A. No. 01-CV-5722; Lin, et al. v. Avici
Systems Inc., et al., C.A. No. 01-CV-5674; and Shives, et al. v. Banc of America
Securities, et al., C.A. No. 01-CV-4956. These lawsuits seek unspecified damages
and allege, among other things,
Page 18
that the underwriters of the Company's initial public offering (IPO) improperly
required their customers to pay the underwriters excessive commissions and to
agree to buy additional shares of the Company's stock in the aftermarket as
conditions of receiving shares in the Company's IPO. The lawsuits further claim
that these supposed practices of the underwriters should have been disclosed in
the Company's IPO prospectus and registration statement. The Company understands
that various other plaintiffs have filed substantially similar class action
cases against approximately 300 other publicly traded companies and their IPO
underwriters in New York City which, along with the cases against the Company,
have all been transferred to a single federal district judge for purposes of
coordinated case management. The Company and its officers and directors believe
that the claims against the Company lack merit, and intends to defend the
litigation vigorously. In that regard, on July 15, 2002, the Company, together
with the other issuers named as defendants in these coordinated proceedings,
filed a collective motion to dismiss the consolidated amended complaints against
them on various legal grounds common to all or most of the issuer defendants.
This motion is currently pending. On October 9, 2002, the Court approved a
stipulation between the plaintiffs and the individual defendants providing for
the dismissal of the individual defendants without prejudice. While the Company
can make no promises or guarantees as to the outcome of these actions, the
Company believes that the final result of these actions will have no material
effect on its consolidated financial condition or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
Exhibit No. Exhibit Description
3.1* Amended and Restated Certificate of Incorporation of the
Company
3.2* Amended and Restated By-laws of the Company
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Filed with the Company's Registration Statement on Form S-1 (File No.
333-37316) filed with the Securities and Exchange Commission by the Company in
connection with its initial public offering which became effective July 27,
2000.
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K dated July 1, 2002 and a Report on
form 8-K/A dated July 3, 2002, reporting a change in the Company's
certifying accountant.
The Company filed a Report on Form 8-K dated September 20, 2002 reporting
the approval by the Board of Directors of a reverse stock split and
announcing the intent of the Board of Directors to seek stockholder
approval of a reverse stock split. The Report on Form 8-K also reported the
adoption by the Board of Directors of a stock repurchase program, and the
actions of the Company to lower operating costs.
Page 19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVICI SYSTEMS INC.
Date November 6, 2002 By:/s/ Paul F. Brauneis
------------------------- -------------------------------------------
Paul F. Brauneis
Chief Financial Officer, Treasurer, Senior
Vice President of Finance and
Administration, and Principal Accounting
Officer
Page 20
CERTIFICATIONS
I, Steven B. Kaufman, President and Chief Executive Officer of the Company,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avici Systems
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
By:/s/ Steven B. Kaufman
------------------------
Steven B. Kaufman
President and Chief Executive Officer
November 6, 2002
Page 21
I, Paul F. Brauneis, Chief Financial Officer, Senior Vice President of Finance
and Administration and Treasurer of the Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avici Systems
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
By:/s/ Paul F. Brauneis
-----------------------
Paul F. Brauneis
Chief Financial Officer, Senior Vice President
of Finance and Administration and Treasurer
November 6, 2002
Page 22
EXHIBIT INDEX
Exhibit No. Exhibit Description
3.1* Amended and Restated Certificate of Incorporation of
the Company
3.2* Amended and Restated By-laws of the Company
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
* Filed with the Company's Registration Statement on Form S-1 (File No.
333-37316) filed with the Securities and Exchange Commission by the Company in
connection with its initial public offering which became effective July 27,
2000.
Page 23