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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 2000
COMMISSION FILE NUMBER 000-30362
CROSSROADS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 74-2846643
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
8300 NORTH MOPAC EXPRESSWAY
AUSTIN, TEXAS 78759
(Address of principal executive offices, including Zip Code)
(512) 349-0300
(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:
Title of each class Name of each exchange on which registered
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Common Stock, par value $0.001 per share Nasdaq National Market
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. [X] Yes [ ] No
Indicated by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of Common Stock on January 10,
2001, as reported on the Nasdaq National Market, was approximately $125.9
million (affiliates being, for these purposes only, directors, executive
officers and holders of more than 5% of the Registrant's Common Stock).
As of January 10, 2001, the Registrant had 27,790,696 outstanding shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
(Specific pages incorporated are indicated under the applicable Item herein)
INCORPORATED BY
REFERENCE IN PART NO.
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Our proxy statement filed in connection with our 2000 Annual Meeting of Stockholders............ III
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CROSSROADS SYSTEMS, INC.
Unless otherwise indicated, "we," "us," and "our" mean Crossroads Systems,
Inc. We own the trademark "Crossroads." All other trademarks or tradenames
referred to in this document are the property of their respective owners.
References in this document to "$" or "dollars" are to United States of America
currency. Our fiscal year ends October 31.
TABLE OF CONTENTS
Table of Contents.................................................................................................i
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS................................................................ii
PART I............................................................................................................1
Item 1. Business...........................................................................................1
Additional Factors That May Affect Future Results................................................................12
Item 2. Properties........................................................................................22
Item 3. Legal Proceedings.................................................................................22
Item 4. Submission of Matters to a Vote of Security Holders...............................................22
PART II..........................................................................................................23
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................23
Item 6. Selected Consolidated Financial Data..............................................................24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............25
Item 7A. Qualitative and Quantitative Disclosures About Market Risks.......................................31
Item 8. Financial Statements and Supplementary Data.......................................................32
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.................32
PART III.........................................................................................................33
Item 10. Executive Officers of the Registrant..............................................................33
Item 11. Executive Compensation............................................................................34
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................34
Item 13. Certain Relationships and Related Transactions....................................................34
PART IV..........................................................................................................35
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................35
NOTE ON INCORPORATION BY REFERENCE
Throughout this report, various information and data are incorporated by
reference to portions of our 2001 Proxy Statement. Any reference in this report
to disclosures in our 2001 Proxy Statement shall constitute incorporation by
reference of that specific material into this Form 10-K.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements that involve substantial
risks and uncertainties, such as statements concerning:
o industry trends;
o customer demand for our products;
o growth and future operating results;
o developments in our markets and strategic focus;
o expansion of and enhancements to our manufacturing and engineering
facilities and product offerings;
o customer benefits attributable to our products;
o potential acquisitions and joint ventures and the integration of
acquired businesses;
o technologies and operations;
o strategic relationships with third parties; and
o future economic, business and regulatory conditions.
You can identify these statements by forward-looking words such as "may,"
"will," "expect," "intend," "anticipate," "believe," "estimate," "continue" and
other similar words. You should read statements that contain these words
carefully because they discuss our future expectations, making projections of
our future results of operations of our financial condition or state other
"forward-looking" information. We believe that it is important to communicate
our future expectations to our investors. However, there may be events in the
future that we are not able to accurately predict or control. The factors listed
in the sections captioned "Additional Factors That May Affect Future Results" in
Item 1 of this report and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Item 7 of this report, as well as any
cautionary language in this annual report, provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations we described in our forward-looking statements.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
We are the leading provider of enterprise data center routing solutions for
open system storage area networks, based on our market share of storage routers
shipped. By using our storage routers to serve as the interconnect between
storage area networks, or SANs, and the other devices in a computer network,
organizations are able to more effectively and efficiently store, manage and
ensure the integrity and availability of their data. Specifically, when used in
storage area networks our storage routers decrease congestion in the transfer of
data within a network, reduce the time required to back up data, improve
utilization of storage resources, and preserve and enhance existing server and
storage system investments.
We have developed or acquired extensive expertise in several different
input-output (I/O) and networking protocols, including small computer system
interface (SCSI), Fibre Channel, Enterprise Systems Connection (ESCON),
Asynchronous Transfer Mode (ATM), Ethernet, Transmission Control
Protocol/Internet Protocol (TCP/IP) and InfiniBand. We have applied this
expertise in these protocols to develop solutions for leading server and storage
system providers such as ACAL, ADIC, ATL, Bell Micro, Compaq, Cranel, Datalink,
Dell, Fujitsu-Siemens, Groupe Bull, Hewlett-Packard, Hitachi Data Systems, IBM,
McDATA, SANrise, StorageTek, Sun Microsystems, Tech Data and Unisys which enable
customers to connect to the information that they require to run their
businesses, regardless of the technology or location.
We expanded our product line with the launch of our 4x50 storage router,
our third generation product line. The 4x50 line enables companies to realize
the benefits of managing their mission critical data using applications such as
LAN-free and server-free backup. The 4x50 provides the broadest array of
connectivity options for the departmental workgroup through the enterprise
customer.
The extended router market, which includes the emerging storage-over-
Internet Protocol (IP) market segment, is a new market segment that
we are addressing. We recently introduced our first extended router in our new
conXsan family of products, the Crossroads 7100, which connects Fibre Channel
devices and/or SANs together via an ATM network. The 7100 product also lays the
foundation for our storage-over-IP products, a prototype of which we also
demonstrated at Fall Comdex 2000 and plan to launch in 2001.
In March 2000, we consummated our acquisition of Polaris Communications,
Inc. Polaris was a leading developer and marketer of System 390, or S/390,
mainframe communication interfaces and systems delivering increased connectivity
and bandwidth options to enterprise data centers, focusing on high-speed
connections between open-systems and mainframes. This technology provides us
with access to the S/390 market, where approximately 70 percent of the world's
data resides.
To date, we have sold our products primarily to original equipment
manufacturers, or OEMs, of servers and storage systems. These computer equipment
manufacturers sell our storage routers to end-user organizations for use in
their storage area networks. We also sell our storage routers through companies
that distribute, resell or integrate our storage routers as part of a complete
SAN solution. Recently, we have also begun to establish relationships to sell
our products through storage service providers, or SSPs, an important new class
of service providers which provide storage-related services to customers within
Internet data centers and large metropolitan areas.
INDUSTRY BACKGROUND
Increasing Importance of Information Management
Information management is a strategic imperative for many organizations
today. The broad deployment of distributed computer networks combined with the
widespread use of the Internet, intranets and electronic commerce have enabled
organizations to empower employees, customers and suppliers with access to vast
amounts of data. However, the dramatic growth in the amount of data generated,
stored, protected and accessed has created increasingly serious information
management challenges. Exacerbating these challenges are the greater number and
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types of users who access this data, as well as the proliferation of various
types of software applications across many different computer devices that use
different protocols for the input and output of data. As Internet, intranet and
e-commerce activities expand, activities such as customer information management
and data-mining are integral to an organization's success. The growth of such
valuable information is driving the need for storage solutions that allow
customers to manage and access their information regardless of their technology
or location at higher and higher speeds while maintaining the integrity of that
data. Organizations therefore are seeking to implement processes and systems
that effectively and efficiently store, manage and ensure the integrity and
availability of data 24 hours-a-day, seven days-a-week, 365 days-a-year.
The Interconnect Bottleneck and Limitations of the Point-to-Point Storage
System Architecture
While data storage capacity and microprocessor speeds have increased
dramatically, the speed at which information is transmitted from storage systems
to microprocessors has not increased nearly as rapidly. This imbalance has
resulted in bottlenecks at the interconnection points where the input and output
of data occur. These interconnect points are commonly referred to as the I/O.
These I/O bottlenecks cause large delays in the movement of data within a
network, significantly slowing down the network's day-to-day operations and
frustrating network users. The I/O bottleneck persists, in large part, due to
the limitations of the computer protocols that traditionally have been used to
transport data across the I/O.
A second bottleneck occurs because users can access information residing on
a storage device only from the server connected to that storage device and
because a significant amount of data must be moved across the local area
network, or LAN. First, the amount of data which can traverse the SCSI
interconnect between the server and the storage device at a given time is
severely limited. Therefore, the information going to and coming from the
storage device is more difficult to access and manage, and the risk of data loss
is increased. Moreover, as the number of requests for stored data from the
server grows, congestion within the server increases and server performance
further decreases. Second, the LAN becomes congested, slowing an organization's
day-to-day operations. As a result, many organizations are moving away from
point-to-point storage system architectures to reduce I/O bottlenecks and
improve their overall information management.
Applications Enabled by Fibre Channel SANs
Fibre Channel SANs have enabled a number of important applications,
including:
o LAN-free Backup. Disruptions to a computer system can result in the loss
or corruption of data. Therefore, most organizations regularly perform
data backup by moving data from storage systems to separate or off-site
storage systems or data centers where the data can be safely stored.
Because data backup can account for a significant portion of the data
traffic over local area networks, or LANs, it is often a major
contributor to bottlenecks at the input/output interconnect. LAN-free
backup uses the SAN to move data from a storage system through one
server then directly to a backup storage system. By moving the data
backup function from the LAN to the SAN, LAN-free backup substantially
reduces I/O bottlenecks.
o Server-free Backup. Server-free backup further extends the benefits of
LAN-free backup by virtually removing the server from the backup
process. This application enables automated data movement between
storage systems directly across the SAN, allowing data backup while
utilizing a very small percentage of the server's internal data
processing capacity. As a result, organizations no longer need to
identify lengthy time periods, or "backup windows," for disconnecting
servers from the network in order to perform backup.
o Extended Routers Enabling SANs to Span Longer Distances. Extended
routers enable customers to connect SANs and Fibre Channel devices that
are separated by longer distances, using ATM and TCP/IP networks. This
capability significantly increases the utility of SANs by enabling data
sharing, storage consolidation, data replication and LAN-free and
server-free backups to occur over SANs that span multiple sites
separated by long distances.
o Data Mirroring and Disaster Tolerance. SANs improve an organization's
ability to ensure the integrity of its data by facilitating data
replication, or mirroring, and enhanced disaster tolerance and recovery.
In mirroring, two copies of transaction data are created and maintained
on separate storage systems.
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This redundancy reduces the chance of data loss or corruption. Because
SANs enable very high data transmission rates and support transmission
distances of up to 10 kilometers per Fibre Channel link, SANs enable
mirroring across storage systems that may be many kilometers apart
from each other.
o Shared Storage. In the traditional point-to-point storage architecture,
a significant portion of storage resources are underutilized because
they are accessible only by a single server which may not efficiently
use the resource. With SANs, multiple servers can access the same
storage devices, enabling more stored data to be available to more
users, and reducing the need to add more servers or storage devices to
support greater storage requirements.
o Storage Service Providers. Storage Service Providers, or SSPs, are an
important new class of service provider. They focus primarily on
providing storage-related services to customers within Internet data
centers and in large metropolitan areas. Some of the services that they
offer include storage capacity on demand, backup and restore services
and data replication services.
These applications also facilitate the creation and maintenance of offsite
data centers that support business recovery in the event data is lost at a
primary storage site.
The Need for Storage Routers to Facilitate the Adoption of SANs and
Emerging I/O Protocols
Most organizations have made significant investments in storage devices and
servers that use SCSI, Fibre Channel, ESCON, ATM and Ethernet. Thus, in order to
enable organizations to achieve the benefits of deploying a storage area
network, the SAN must be able to operate in conjunction with the different I/O
protocols employed by the devices which are connected to it or within it.
Several other current and emerging I/O protocols, including InfiniBand and
Internet-based SCSI protocol, or iSCSI, have been, or are expected to be,
incorporated into commercial SAN products, servers and storage systems in the
future. As new protocols achieve commercial acceptance, storage routers will be
increasingly essential to provide compatibility to existing solutions.
THE CROSSROADS SOLUTION
We are the leading provider of enterprise data center routing solutions for
open system storage area networks, based on our market share of storage routers
shipped. By using our storage routers to serve as the interconnect between SANs
and the other devices in a computer network, organizations are able to more
effectively and efficiently store, manage and ensure the integrity and
availability of their data. We have developed or acquired extensive expertise in
several different input-output (I/O) and networking protocols, including SCSI,
Fibre Channel, ESCON, ATM, Ethernet, TCP/IP and InfiniBand. We apply this
expertise in these protocols to develop solutions that enable customers to
connect to the information that they require to run their businesses, regardless
of the technology or location. Our storage routers are designed to operate in
any SAN computing environment. We have utilized this expertise to produce
solutions for leading server and storage system providers such as ACAL, ADIC,
ATL, Bell Micro, Compaq, Cranel, Datalink, Dell, Fujitsu-Siemens, Groupe Bull,
Hewlett-Packard, Hitachi Data Systems, IBM, McDATA, SANrise, StorageTek, Sun
Microsystems, Tech Data and Unisys.
Incorporated into our storage routers is our proprietary storage routing
software that "intelligently" examines data traffic in the SAN to prioritize
transmission and minimize congestion in the flow of data. This software also
enables communication between different I/O protocols, enables sharing of
storage resources by multiple servers and can be adapted to new I/O protocols as
they emerge. Our proprietary software is combined with software management tools
and embedded in our storage routers.
We believe that deploying our storage routers helps organizations improve
and reduce their total cost of information management by offering a number of
important benefits, including:
Providing Broad, Verified Interoperability
Our storage routers are designed to function together, or interoperate,
with all commercially available Fibre Channel switches, as well as other SAN
components, including storage devices, host bus adapters, operating systems and
storage management software. Our storage routers function in over 3,500
different configurations of SANs,
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thereby providing organizations with flexibility in designing their SANs. Our
storage routers can be deployed in SANs which connect servers running diverse
operating systems, including NetWare, Unix and Windows NT and have been tested
and verified through our Crossroads Verified-Storage Area Network (CV-SAN)
program.
Increasing Scalability and Implementation Flexibility
Our storage routers are designed to operate in any SAN computing
environment and to adapt as organizations grow and change their computer
networks to address their increasing data storage and information management
needs. Organizations can incrementally add storage routers as demands grow or as
new storage devices are added to their networks. Our third generation line of
storage routers (the 4x50) provides the broadest array of connectivity options
for the departmental workgroup through the enterprise customer.
Leveraging Customers' Storage Investments
Our storage routers enable an organization's continued use of its large
installed base of servers and storage devices. In addition to enabling
organizations to preserve these existing investments, our storage routers
improve the functionality of those systems when operated in conjunction with a
SAN. By allowing consolidation of storage resources in centralized facilities,
our solutions also reduce the need for organizations to maintain a number of
geographically dispersed and costly data storage centers and enable them to more
efficiently use their existing data storage capacity.
Facilitating Efficient Backup and Recovery
By allowing the backup process to be accomplished across the SAN, rather
than across the local area network, or LAN, our storage routers remove a common
source of congestion within the LAN. As a result, the primary computer network
has greater availability to perform day-to-day operations. LAN-free backup also
provides flexibility to conduct backup at any time of day. This capability is
increasingly important as users demand network availability around the clock and
from geographically dispersed locations. Server-free backup provides further
reductions in network and server utilization.
Enabling SANs to Span Longer Distances
Our extended routers enable customers to connect SANs and Fibre Channel
devices that are separated across a campus, town, country and around the world
using ATM and TCP/IP networks. This capability significantly increases the
utility of SANs by enabling data sharing, storage consolidation, data
replication and LAN-free and server-free backup to occur over SANs that span
multiple sites separated by long distances.
Enhancing Storage Area Network Manageability
The proprietary software embedded in our storage routers enhances the
ability of an organization to manage storage systems that are attached to the
storage router by translating network management protocols to storage management
protocols. We work closely with leading independent software vendors, such as
BMC Software, Computer Associates, Hewlett-Packard, IBM/Tivoli Systems, Sun
Microsystems and Veritas Software, to ensure that our storage routers can be
managed through their network management software products.
OUR STRATEGY
Our mission is to become the company customers trust to link business with
information regardless of technology or location. Our objective is to maintain
our position as the leading provider of storage routers and to leverage this
position to become the leading provider of I/O routing solutions. The key
elements of our strategy include the following:
Providing products compatible with existing technologies to ensure
connectivity for our customers
Our Fibre Channel-to-SCSI routers provide the means for customers to
protect their existing investments in SCSI-based storage devices while taking
advantage of the benefits of Fibre Channel SANs. As technology
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continues to evolve and mature, we will ensure that our customers will be able
to connect their current and future investments to "legacy" infrastructures,
regardless of the technology used for implementation.
Delivering products that are on the cutting edge of technology
By continuing to invest in research and development we seek to ensure that
our products will continue to be on the forefront of the technology required to
meet customer needs. Our conXsan line of extended routers allows data to be
connected over long distances. The Crossroads 7100 product, our Fibre
Channel-to-ATM router, is the first in this family and will be followed by a
Fibre Channel-to-Gigabit Ethernet product that provides connectivity to IP
networks. We are a leader in InfiniBand, a technology that will remove the I/O
bottleneck between servers and SANs. Our new products will incorporate
InfiniBand as both a performance enabling internal technology and as a storage
networking protocol which gives customers control over their storage migration
path.
Expanding field sales force with coverage of key regional and OEMs accounts
Our sales model is based on an indirect sales model executed through OEMs,
distributors, resellers, system integrators, and storage service providers.
During fiscal 2000, we deployed our sales team throughout the United States and
Europe tripling our U.S. field sales and support offices and opened offices in
the UK and Germany. This field sales force is strategically located near key
accounts to provide better service and drive demand creation through joint sales
calls with our partners. We manage these dispersed locations through the use of
web automation tools such as Customer Relationship Management (CRM), Channel
Wave, and our website.
Expanding Distribution Channels
In addition to building upon our established OEM sales channel, we believe
that we can achieve additional growth by selling through distributors, resellers
and system integrators. We are also actively establishing partnerships with the
leading storage service providers to integrate our storage routers and extended
routers into their storage service offerings. We regularly conduct sales
training for prospective distributors, resellers, system integrators and storage
service providers and their respective customers to educate them on the benefits
of our storage routers in their unique SAN environment.
Emphasizing quality through our Crossroads Quality Management (CQM) Program
In fiscal 2000, we established the CQM program to ensure the quality,
continuous improvement and repeatability of all our business processes. CQM
instills a philosophy of setting expectations and quantitatively measuring
performance to those expectations both with our external and internal customers.
Also during fiscal 2000, we named a vice-president of quality and operations,
and earned ISO 9002 registration.
Ensuring broad interoperability with CV-SAN testing and verification
program with leading software vendors
In response to end-user demands for interoperability, we continue to invest
resources in our CV-SAN program. CV-SAN proactively ensures the interoperability
of our products with other SAN components through rigorous testing and
verification. To date, we have tested over 3,500 different SAN configurations
using our storage routers, providing our customers with confidence in the broad,
verified interoperability of our products. We also believe that establishing
relationships with leading enterprise and storage management software companies
is essential to facilitating the efficient and reliable integration of their
capabilities with our storage routers. To this end, we have developed
relationships with leading software vendors, including BMC Software, Computer
Associates, Legato Systems, IBM/Tivoli Systems and Veritas Software. We intend
to continue expanding our relationships with leading software vendors to ensure
the compatibility and interoperability of our storage routers and extended
routers with their software.
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PRODUCTS
The following table summarizes the key features and benefits of our
products:
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FIRST SHIPMENT DEVICE
PRODUCT TO OEM CONFIGURATION BENEFITS
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LOCAL STORAGE ROUTERS
- ------------------------------------------------------------------------------------------------------------------------------
4100 August 1997 o 1 Fibre Channel o Enables LAN-free backup and recovery
o 1 SCSI bus o Supports shared storage (disk, tape and optical)
o 1 Ethernet o Connects up to 15 SCSI devices
management port o Transmits data over distances up to 10 km
o Enables server migration to SANs
4200 May 1998 o 1 Fibre Channel port o Enables LAN-free backup and recovery
o 2 SCSI buses o Supports shared storage (disk, tape and optical)
o 1 Ethernet o Connects up to 30 SCSI devices
management port o Transmits data over distances up to 10 km
o Enables server migration to SANs
4x50 May 1999 o 1 Fibre Channel port o Provides the same benefits as 4200 router
o 1 to 4 SCSI buses o Enable server-free backup
o 1 Ethernet o Double the SCSI throughput via low
management port voltage differential technology
o Provide enhanced software for storage management
- ------------------------------------------------------------------------------------------------------------------------------
EXTENDED STORAGE ROUTER
- ------------------------------------------------------------------------------------------------------------------------------
7100 November 2000 o 1 Fibre Channel o Enables Fibre Channel devices and SANs to be
(in OEM o 1 ATM connected over extended distances via an
evaluation) o 1 Ethernet ATM network
management port o Designed to operate with leading data replication
and backup software
o Easy to configure and manage
o Unique performance features enable faster backups
and data replication
- ------------------------------------------------------------------------------------------------------------------------------
S/390 MAINFRAME CONNECTOR
- ------------------------------------------------------------------------------------------------------------------------------
6950 April 1995 o 1 PCI to 1 ESCON o Direct connection between open system servers
(by Polaris) (NT, UNIX) and mainframe channel
o High-speed throughput of data
o Improved performance of LANs by offloading bulk
file transfers
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Substantially all of our product revenue has been derived from sales of a
limited number of our storage router products. In particular, our 4100 product
accounted for 66% and 17% of our product revenue in fiscal 1999 and 2000,
respectively, and our 4200 product accounted for 30% and 56% of our product
revenue in fiscal 1999 and 2000, respectively.
In November 2000, we launched our conXsan product line. The conXsan family
of products is designed to interconnect storage systems regardless of technology
or location. The first product we are offering in our conXsan family is the 7100
extended router. The 7100 product also lays the foundation for our
storage-over-IP products, a prototype of which we also demonstrated at Fall
Comdex 2000 and plan to launch in 2001.
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We are also developing new products based on InfiniBand technology. During
the Intel Fall Developer's conference, we were the first company to demonstrate
server-free backup operating on early InfiniBand technology. We are a leading
member of the InfiniBand Trade AssociationSM and a member of the Marketing
Working Group.
OUR CUSTOMERS
Our storage routers are currently sold to end-user organizations primarily
through the leading server and storage system providers and to a lesser extent,
through distributors, resellers, system integrators and storage system providers
under the Crossroads brand. Our products are in solutions from ACAL, ADIC, ATL,
Bell Micro, Compaq, Cranel, Datalink, Dell, Fujitsu-Siemens, Groupe Bull,
Hewlett-Packard, Hitachi Data Systems, IBM, McDATA, SANrise, StorageTek, Sun
Microsystems, Tech Data and Unisys.
During fiscal 2000, we broadened our revenue base resulting in the number
of customers representing approximately 75% of our total revenues increasing
from two to six as of October 31, 2000. In fiscal 2000, revenue from Compaq and
StorageTek represented 33% and 21% of our total revenue, respectively. No other
customer accounted for more than 10% of our revenue during fiscal 2000. For
fiscal 2000, our distribution channel of distributors, resellers and system
integrators collectively accounted for approximately 10% of our total revenue.
In 2000, Compaq informed us of its decision to discontinue purchasing our
4100/4200 line of products and has introduced its own competitive product.
SALES AND MARKETING
We base our sales and marketing strategy on an indirect sales model
executed through OEMs and distributors, resellers and system integrators, and
storage system providers. For the past three years, our sales activity has
focused principally on OEM adoption through extensive OEM testing and product
qualification. As the market for SAN products matures, we believe that open
market branded sales through distributors, resellers and system integrators will
represent an increasing percentage of our total revenues. This was evidenced in
fiscal 2000 as our distribution channel accounted for approximately 10% of our
total revenues. While we sell most of our products today through OEMs, with an
expanded sales channel we believe that we will gain broader brand awareness and
a greater presence in the departmental and mid-sized business markets where
distributors, resellers and system integrators generally have a strong presence
and can influence product adoption choices. Recently, we have also begun to
establish relationships to sell our products through storage service providers,
or SSPs, an important new class of service providers which provide
storage-related services to customers within Internet data centers and large
metropolitan areas.
During fiscal 2000, we deployed our sales team throughout the United States
and Europe, tripling our U.S. field sales and support offices and opened offices
in the UK and Germany. We believe that this geographically deployed sales force
will assist our channel partners in creating end user demand for our products
and will enable us to better serve our existing customers and reach new
customers more effectively.
Our marketing organization primarily focuses on coordinating strategic
planning activities which help us to determine market segments to pursue,
understand size and growth characteristics of these market segments, analyze
competition within the market segments, define product features to successfully
penetrate market segments and construct business analyses to measure expected
return on investments. Additionally, our marketing efforts are geared toward
developing key relationships with OEMs, distributors, resellers, system
integrators, independent software vendors and storage service providers;
participating in tradeshows to promote and launch our products; and coordinating
our involvement in various industry standards organizations.
CUSTOMER SERVICE AND SUPPORT
Our customer support engineering organization is a regionalized engineering
force that provides comprehensive training programs and telephone, e-mail and
Web-based direct support to our customers and end-users. These programs allow us
to minimize the need for a large end-user support organization by enabling our
OEMs to provide installation, service and primary technical support to their
customers while we focus on high-level secondary support. We actively assist our
customers and resellers to solve end-user problems.
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TECHNOLOGY
Our storage router products are based on an architecture that combines our
proprietary embedded software and hardware designs using industry standard
components. Our proprietary packet routing software intelligently examines data
packet traffic to prioritize transmission and minimize network congestion in the
flow of I/O transactions between servers and storage systems. This embedded
software also manages delays in data transmissions that result from variances in
I/O speeds and provides accurate communication of transmission status to
connected devices. Our embedded software provides critical interoperability
between diverse I/O protocols, enables sharing of storage resources by multiple
servers and can adapt to new I/O protocols as they emerge. Additionally, our
embedded software is configurable and can be quickly adapted to varying customer
requirements and computing environments. While our software architecture serves
as the foundation for our current products, it is also designed to be able to
accommodate several planned generations of new designs. Our hardware is the
"engine" that provides basic performance and functionality such as operating
speed, data movement, external device connectivity, network management
interfaces and the ability to operate in extreme environmental conditions of
temperature and humidity.
We possess a high level of multi-disciplinary expertise encompassing I/O
technologies, software design, operating systems, hardware and application
specific integrated circuit design and local and wide area network technologies,
which we utilize to design, develop, manufacture and deliver our products. We
believe that our combined expertise in each of these technologies provides us
with a competitive advantage in the ability to develop new products on a timely
basis, verify interoperability, expand our product features and integrate
additional I/O interfaces and functions.
I/O Technologies
We believe that our I/O routing expertise is a critical factor in our
ability to maintain our leadership position in storage routing. The key I/O
technologies in use today are: SCSI and Fibre Channel in open systems (e.g.,
NetWare, Windows NT and Unix) and IBM's ESCON for mainframes. We employ a large
number of engineers and technologists who have significant involvement in the
evolution of these I/O technologies. Based on their expertise and our overall
capabilities, we believe that we possess insight and understanding into the
capabilities and limits of each new technology and the requirements for I/O
routing. As new I/O standards are developed, we expect to contribute to these
developments and leverage our software and technical expertise in developing
additional I/O routers. Such additional areas of focus include ATM, Fibre
Connection (FICON), Gigabit Ethernet, TCP/IP and InfiniBand.
Embedded Software Design
We design, develop and test all of our own embedded software. As of October
31, 2000, our engineering staff included 48 software engineers with expertise in
embedded software, management tools, software applications and graphical user
interface development. We have considerable expertise in I/O protocol standards,
error detection and recovery and support. The flexibility to modify our software
to varying system configurations has enhanced our ability to rapidly achieve
verified interoperability.
MANUFACTURING
Our manufactured product contains printed circuit board assemblies which
consist of the electronics that control the function of our product. The printed
circuit board is assembled and tested by a contract manufacturer, who purchases
the required components to meet demand in accordance with our purchase orders
and our forecast. During product final assembly and test, the printed circuit
board is assembled with the remaining components (power supply, cables,
enclosures, etc.) and tested to create the final product.
Through August 1999, we outsourced substantially all of our manufacturing
requirements to XeTel Corporation, a contract manufacturer, and a significant
portion of our cost of revenue historically has consisted of payments to XeTel.
During fiscal 2000, we have engaged another contract manufacturer, Solectron, to
assemble the printed circuit board for our 4x50 family of products. As the needs
of our customers continue to evolve, we plan to reassess our manufacturing
requirements on a periodic basis and effect appropriate changes to our
manufacturing processes.
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During September 1999, we transferred much of the final assembly and test
portion of our product manufacturing process to our internal facilities. In
connection with this transition, we hired additional employees, purchased the
necessary equipment, initiated customer qualification efforts and leased
additional facilities. During the transition period, our manufacturing costs
increased, and our gross profit decreased, as we incurred costs of final
assembly and test performed both by our contract manufacturer and us.
Although we use standard parts and components for our products where
possible, we and our contract manufacturers currently purchase several key
components used in the manufacture of our products from single or limited
sources. Our contract manufacturers purchase the components used in the printed
circuit board assemblies whereas we purchase the remaining components used
during final assembly including the power supply, fan and chassis materials. We
have an obligation to our contract manufacturers for portions of excess
inventory arising from a sudden reduction in purchase orders by us to the extent
it differs from the forecast which we supply to our contract manufacturers. Our
principal single-source components include application specific integrated
circuits, power supplies, licensed software and chassis.
On June 1, 2000, we implemented SAP, our enterprise resource planning
system, which we believe has resulted in improved inventory management, expense
controls and on-time deliveries. In addition, in 2000 we launched the Crossroads
total quality management program, named a vice-president of quality and
operations, and earned ISO 9002 registration.
RESEARCH AND DEVELOPMENT
We believe that our research and development efforts are essential to our
ability to successfully deliver innovative products that address the needs of
our customers as the I/O routing market evolves. Our research and development
team works closely with our marketing and sales team and OEMs to define product
features and performance. Development activities are conducted with extensive
validation testing at both our company and at our major customers. Members of
our senior engineering team also are actively engaged in development of industry
standards which allows us to focus our product strategies in areas that are
aligned with those standards.
Research and development programs currently underway that focus on our I/O
routing initiatives include:
o SCSI-to-Fibre Channel storage routing: Increased connectivity and port
density, improved manageability, broader interoperability, higher
performance products and "intelligent" data management and data movement
features.
o SAN-to-Gigabit Ethernet routing: Fibre Channel-to-Gigabit Ethernet
transfer mode router products to enable connectivity of multiple SANs
over a customer's IP network.
o InfiniBand Routing: Technology development focused on multi-protocol I/O
routing products for InfiniBand connecting to SCSI, Fibre Channel and
other protocols.
Our research and development expenses, net of stock-based compensation of
$280,000 and $528,000 during fiscal 1999 and 2000, respectively, were $5.3
million and $12.6 million in fiscal 1999 and fiscal 2000, respectively. At
October 31, 2000, we employed 89 software and hardware engineers.
OUR COMPETITION
The market for SAN products generally, and storage routers in particular,
is increasingly competitive. We anticipate that the market for our products will
continually evolve and will be subject to rapid technological change. We
currently face competition from Adva-SAN Ltd., ATTO, Chaparral Network Storage,
Computer Network Technologies and Pathlight Technology. In addition, during 2000
Compaq began selling a product which is
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competitive with our product line. We also expect to face competition in the
future from one or more of the following sources:
o other OEMs, including our customers and potential customers;
o LAN router manufacturers;
o storage system industry suppliers, including manufacturers and vendors
of other SAN products or entire SAN systems; and
o current and future start-up companies.
As the market for SAN products grows, we also may face competition from
traditional networking companies and other manufacturers of networking products.
These networking companies may enter the storage router market by introducing
their own products or by entering into strategic relationships with or acquiring
other existing SAN product providers. Furthermore, we have licensed our 4200 and
4x50 storage router technology to Hewlett-Packard, one of our OEM customers.
Hewlett-Packard currently manufactures the 4200 product under its name and pays
us a royalty.
We believe the competitive factors in the storage router market include the
following:
o OEM endorsement;
o product reliability and verified interoperability;
o customer service and technical support;
o product performance and features;
o brand awareness and credibility;
o ability to meet delivery schedules;
o strength of distribution channel;
o ease-of-use and manageability; and
o price.
INTELLECTUAL PROPERTY
We rely on a combination of patents, trademarks and trade secrets, as well
as confidentiality agreements and other contractual restrictions with employees
and third parties, to establish and protect our proprietary rights. Despite
these precautions, the measures we undertake may not be adequate to protect our
proprietary technology and may not preclude competitors from independently
developing products with functionality or features similar to our products.
In the United States, we currently have five patents issued, two allowed
and 16 patent applications pending with respect to our technology. We have six
pending international patent applications (two in the European Patent Office,
and one in each of Australia, Hong Kong, Canada and Japan). We also have nine
patents pending under the Patent Cooperation Treaty with the intent of filing in
additional countries. However, none of our patents, including patents that may
be issued in the future, may adequately protect our technology from infringement
or prevent others from claiming that our technology infringes that of third
parties. Failure to adequately protect our intellectual property could
materially harm our business. In addition, our competitors may independently
develop similar or superior technology.
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We have issued a license to Hewlett-Packard for our 4200 and 4x50 storage
router technology. This license allows Hewlett-Packard to create and incorporate
into their own products modifications and derivative works of this licensed
technology. The 4200 license expires in April 2001 but will automatically renew
for successive one-year periods after that date unless it is terminated by
either party. The 4x50 license has a rolling three-year term which renews
automatically at the end of each year, unless it is terminated by either party.
Hewlett-Packard currently manufactures the 4200 product under its name and pays
us a royalty.
We have registered the trademark "CROSSROADS" in the United States. We have
filed trademark registration applications for "CROSSROADS SYSTEMS" and "ACTIVE
FABRIC" in the United States. All other trademarks, service marks or trade names
referred to in this prospectus are the property of their respective owners.
EMPLOYEES
In March 2000, we strengthened our management team and announced that Larry
Sanders, the former president and chief executive officer of Fujitsu Computer
Products of America, was named our president and chief operating officer. In
addition, we enhanced our board of directors by adding Morton L. Topfer, a
director and counselor to the chief executive officer of Dell Computer
Corporation, and Paul S. Zito, former chief operating officer of NetSpeed, Inc.
and former chief financial officer of NetWorth, Inc.
At October 31, 2000, we had 219 employees, with 89 engaged in research and
development; 33 in manufacturing; 56 in sales, marketing and customer support;
and 41 in administration, information technology, human resources and finance.
None of our employees are represented by a labor union. We have not experienced
any work stoppages and consider our relations with our employees to be good.
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ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the other information in this Form 10-K, the following
factors should be considered in evaluating Crossroads and our business. These
factors include, but are not limited to the potential for significant losses to
continue; our inability to accurately predict revenues and budget for expenses
for future periods; fluctuations in revenue and operating results; class action
securities litigation; overall market performance; limited product lines;
limited number of OEM customers; lengthy OEM product qualification process;
competition; delays in research and development; inventory risks; the inability
to expand our distribution channels; the loss of our primary contract
manufacturers; risks of delay or poor execution from a variety of sources; final
assembly and test process; inventory risks; limited resources; pricing;
dependence upon key personnel; international operations; product liability
claims; the inability to protect our intellectual property rights, including any
adverse outcome in the our pending patent litigation with certain of our
competitors; potential future acquisitions; concentration of ownership;
volatility of stock price; and the impact on our results or operations due to
changes in accounting standards, including the implementation of SAB 101 with
respect to revenue recognition. The discussion below addresses some of these
factors. Additional risks and uncertainties that we are unaware of or that we
currently deem immaterial also may become important factors that affect us.
WE HAVE INCURRED SIGNIFICANT LOSSES, WE EXPECT FUTURE LOSSES, AND WE MAY NEVER
BECOME PROFITABLE.
We have incurred significant losses in every fiscal quarter since fiscal
1996 and expect to continue to incur losses in the future. As of October 31,
2000, we had an accumulated deficit of $64.4 million. We cannot be certain that
we will be able to sustain growth rates that we will need to realize sufficient
revenue to achieve profitability. We also expect to incur significant sales and
marketing, research and development and general and administrative expenses and,
as a result, we expect to continue to incur losses. Moreover, even if we do
achieve profitability, we may not be able to sustain or increase profitability.
DUE TO OUR LIMITED OPERATING HISTORY AND THE UNCERTAIN DEVELOPMENT OF THE
STORAGE AREA NETWORK MARKET, WE MAY HAVE DIFFICULTY ACCURATELY PREDICTING
REVENUE FOR FUTURE PERIODS AND APPROPRIATELY BUDGETING FOR EXPENSES.
We have generated product revenue for approximately four years and, thus,
we have only a short history from which to predict future revenue. This limited
operating experience, combined with the rapidly evolving nature of the storage
area network market in which we sell our products and other factors which are
beyond our control, reduces our ability to accurately forecast our quarterly and
annual revenue. However, we use our forecasted revenue to establish our expense
budget. Most of our expenses are fixed in the short term or incurred in advance
of anticipated revenue. As a result, we may not be able to decrease our expenses
in a timely manner to offset any shortfall of revenue. We are currently
expanding our staffing and increasing our expense levels in anticipation of
future revenue growth. If our revenue does not increase as anticipated,
significant losses could result due to our higher expense levels.
WE HAVE EXPERIENCED AND EXPECT TO CONTINUE TO EXPERIENCE SIGNIFICANT
PERIOD-TO-PERIOD FLUCTUATIONS IN OUR REVENUE AND OPERATING RESULTS, WHICH MAY
RESULT IN VOLATILITY IN OUR STOCK PRICE.
We have experienced and expect to continue to experience significant
period-to-period fluctuations in our revenue and operating results due to a
number of factors, and any such variations and factors may cause our stock price
to fluctuate. Accordingly, you should not rely on the results of any past
quarterly or annual periods as an indication of our future performance.
It is likely that in some future period our operating results will be below
the expectations of public market analysts or investors. If this occurs, our
stock price may drop, perhaps significantly.
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A number of factors may particularly contribute to fluctuations in our
revenue and operating results, including:
o the timing of orders from, and product integration by, our customers,
particularly our OEMs, and the tendency of these customers to change
their order requirements frequently with little or no advance notice to
us;
o the rate of adoption of storage area networks as an alternative to
existing data storage and management systems;
o the ongoing need for storage routing products in storage area network
architectures;
o the deferrals of customer orders in anticipation of new products,
services or product enhancements from us or our competitors or from
other providers of storage area network products; and
o the rate at which new markets emerge for products we are currently
developing.
In addition, potential and existing OEM customers often place initial
orders for our products for purposes of qualification and testing. As a result,
we may report an increase in sales or a commencement of sales of a product in a
quarter that will not be followed by similar sales in subsequent quarters as
OEMs conduct qualification and testing. This order pattern has in the past and
could in the future lead to fluctuations in quarterly revenue and gross profits.
AN ADVERSE DECISION IN THE VARIOUS CLASS ACTION LAWSUITS FILED AGAINST US MAY
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND FINANCIAL PERFORMANCE.
We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. The plaintiffs in the actions purport to represent
purchasers of our common stock during various periods ranging from January 25,
2000 through August 24, 2000. The Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. We
deny the allegations in the complaints and intend to defend against them
vigorously. We intend to file a motion to dismiss the consolidated amended
complaint once it has been filed. The litigation is at an early stage and it is
not possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, that we might incur in connection
with such actions. An adverse judgement may have a material adverse effect on
our business and financial performance. See Item 8. Financial Statements and
Supplementary Data--Note 5 to Notes to Condensed Consolidated Financial
Statements.
OUR BUSINESS IS DEPENDENT ON THE STORAGE AREA NETWORK MARKET WHICH IS NEW AND
UNPREDICTABLE, AND IF THIS MARKET DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE,
OUR BUSINESS WILL SUFFER.
Fibre Channel-based storage area networks, or SANs, were first deployed in
1997. As a result, the market for SANs and related storage router products has
only recently begun to develop and is rapidly evolving. Because this market is
new, it is difficult to predict its potential size or future growth rate.
Substantially all of our products are used exclusively in SANs and, therefore,
our business is dependent on the SAN market. Accordingly, the widespread
adoption of SANs for use in organizations' computing systems is critical to our
future success. Most of the organizations that potentially may purchase our
products from our customers have invested substantial resources in their
existing computing and data storage systems and, as a result, may be reluctant
or slow to adopt a new approach like SANs. SANs are often implemented in
connection with the deployment of new storage systems and servers. Therefore,
our future success is also substantially dependent on the market for new storage
systems and servers. Furthermore, the ability of the different components used
in a SAN to function effectively, or interoperate, with each other when placed
in a computing system has not yet been achieved on a widespread basis. Until
greater interoperability is achieved, customers may be reluctant to deploy SANs.
Our success in generating revenue in the emerging SAN market will depend on,
among other things, our ability to:
o educate potential OEM customers, distributors, resellers, system
integrators, storage service providers and end-user organizations about
the benefits of SANs and storage router technology, including, in
particular, the ability to use storage routers with SANs to improve
system backup and recovery processes;
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o maintain and enhance our relationships with OEM customers, distributors,
resellers, system integrators, storage system providers and end-user
organizations;
o predict and base our products on standards which ultimately become
industry standards; and
o achieve interoperability between our products and other SAN components
from diverse vendors.
WE HAVE LIMITED PRODUCT OFFERINGS AND OUR SUCCESS DEPENDS ON OUR ABILITY TO
DEVELOP IN A TIMELY MANNER NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET
ACCEPTANCE.
We currently have only three principal products within our storage router
product family that we sell in commercial quantities. In particular, sales of
our 4100 and 4200 products have accounted for the vast majority of our product
revenue to date. To reduce our dependence on these products, we must
successfully develop and introduce to market new products and product
enhancements in a timely manner. On September 1, 2000, we began notifying our
customers that our 4100 product was at its "end of life." Customers who
purchased the 4100 product are migrating to our next generation of products that
we refer to as the 4x50 product line. Sales of our 4x50 product accounted for
approximately 17% of our product revenue during fiscal 2000. Even if we are able
to develop and commercially introduce new products and enhancements, these new
products or enhancements may not achieve market acceptance which could reduce
our revenue.
Factors that may affect the market acceptance of our products, some of
which are beyond our control, include the following:
o growth of, and changing requirements of customers within, the SAN and
storage router markets;
o performance, quality, price and total cost of ownership of our products;
o availability, performance, quality and price of competing products and
technologies;
o our customer service and support capabilities and responsiveness; and
o successful development of our relationships with existing and potential
OEM, distributor, reseller, system integrator and storage system
provider customers.
WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF OUR REVENUE.
THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY CUSTOMERS WOULD
SIGNIFICANTLY REDUCE OUR REVENUE, AND THE FAILURE TO REPLACE REVENUES FROM
COMPAQ, WOULD SUBSTANTIALLY HARM OUR FUTURE RESULTS OF OPERATIONS.
In fiscal 1998, 1999 and 2000, approximately 90%, 85% and 77% of our
revenue, respectively, was derived from six customers. Furthermore, during
fiscal 1998, our four largest customers--ADIC, Compaq, Hewlett-Packard and
StorageTek--accounted for 25%, 20%, 16% and 14% of our total revenue,
respectively. In fiscal 1999, revenue from Compaq and StorageTek represented 36%
and 36% of our total revenue, respectively. In fiscal 2000, Compaq and
StorageTek represented 33% and 21% of our total revenue, respectively. During
fiscal 2000, we recorded a $1.1 million return resulting from StorageTek's shift
in demand to our newer products. Moreover, Compaq informed us that it intends to
discontinue purchasing our 4100/4200 line of storage routers and to internally
manufacture its own solution. If the level of StorageTek's purchases fails to
return to previous levels and if we are unable to replace the revenue lost due
to Compaq's transition away from our 4100/4200 line of routers, our results of
operations and future prospects will suffer.
We rely on OEMs as a primary distribution channel as they are able to sell
our products to a large number of end-user organizations, which enables us to
achieve broad market penetration, with limited sales, marketing and customer
service and support resources from us. Our operating results in the foreseeable
future will continue to depend on sales to a relatively small number of OEM
customers. Therefore, the loss of any of our key OEM customers, or a significant
reduction in sales to any one of them, would significantly reduce our revenue.
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OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS WHICH DOES NOT ASSURE PRODUCT SALES.
Prior to offering our products for sale, our OEM customers require that
each of our products undergo an extensive qualification process, which involves
interoperability testing of our product in the OEM's system as well as rigorous
reliability testing. This qualification process may continue for a year or
longer. However, qualification of a product by an OEM does not assure any sales
of the product to the OEM. Despite this uncertainty, we devote substantial
resources, including sales, marketing and management efforts, toward qualifying
our products with OEMs in anticipation of sales to them. If we are unsuccessful
or delayed in qualifying any products with an OEM, such failure or delay would
preclude or delay sales of that product to the OEM, which may impede our ability
to grow our business.
DEMAND FOR OUR PRODUCTS DEPENDS SIGNIFICANTLY UPON THE NEED TO INTERCONNECT
SCSI-BASED TAPE STORAGE SYSTEMS WITH FIBRE CHANNEL SANS, AND WE EXPECT TO FACE
COMPETITION FROM MANUFACTURERS OF TAPE STORAGE SYSTEMS THAT INCORPORATE FIBRE
CHANNEL INTERFACES INTO THEIR PRODUCTS.
In traditional computer networks, system backup is accomplished by
transferring data from applications and databases over the servers used in the
network to tape drives or other media where the data is safely stored. Tape
storage devices generally rely on an SCSI connection to interface with the
network in receiving and transmitting data. Our routers enable these SCSI-based
storage devices to interface with the Fibre Channel-based components of the SAN.
Because our routers allow communication between SCSI storage devices and a Fibre
Channel SAN, organizations are able to effect their backup processes over the
SAN rather than through the computer network, enabling the servers of the
network to remain available for other computing purposes. We currently derive
the majority of our revenue from sales of storage routers that are used to
connect SCSI-based tape storage systems with SANs. The introduction of tape
storage systems that incorporate Fibre Channel interfaces would enable tape
storage devices to communicate directly with SANs, without using storage
routers. We are aware that a number of manufacturers of storage systems,
including several of our current customers, are developing tape storage systems
with embedded Fibre Channel interfaces, with products expected to be introduced
to market in the near future. If these or other manufacturers are successful in
introducing Fibre Channel-based storage systems, demand for our storage router
products would be materially reduced and our revenue would decline.
OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON UTILIZING EMERGING
TECHNOLOGIES AND STANDARDS AND ANY DELAY OR ABANDONMENT OF EFFORTS TO DEVELOP
THESE TECHNOLOGIES OR STANDARDS BY INDUSTRY PARTICIPANTS, OR FAILURE OF THESE
TECHNOLOGIES OR STANDARDS TO ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR
COMPETITIVE POSITION.
Our products are intended to complement other SAN products to improve the
performance of computer networks by addressing the input/output bottlenecks that
have emerged between the storage systems and the servers within a computing
system. We have devoted and expect to continue to devote significant resources
to developing products based on emerging technologies and standards that reduce
input/output bottlenecks. A number of large companies in the computer hardware
and software industries are actively involved in the development of new
technologies and standards that are expected to be incorporated in our new
products. Should any of these companies delay or abandon their efforts to
develop commercially available products based on these new technologies and
standards, our research and development efforts with respect to such
technologies and standards likely would have no appreciable value. In addition,
if we do not correctly anticipate new technologies and standards, or if our
products based on these new technologies and standards fail to achieve market
acceptance, our competitors may be better able to address market demand than
would we. Furthermore, if markets for these new technologies and standards
develop later than we anticipate, or do not develop at all, demand for our
products that are currently in development would suffer, resulting in less
revenue for these products than we currently anticipate.
WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE MANUFACTURE
PRODUCTS IN ADVANCE OF BINDING COMMITMENTS FROM OUR CUSTOMERS TO PURCHASE OUR
PRODUCTS.
In order to assure availability of our products for some of our largest OEM
customers, we manufacture products in advance of purchase orders from these
customers based on forecasts provided by them. However, these forecasts
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do not represent binding purchase commitments and we do not recognize revenue
for such products until the product is shipped to the OEM. As a result, we incur
inventory and manufacturing costs in advance of anticipated revenue. Because
demand for our products may not materialize, this product delivery method
subjects us to increased risks of high inventory carrying costs and increased
obsolescence and may increase our operating costs.
FAILURE TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS COULD IMPEDE OUR FUTURE GROWTH.
The future growth of our business will depend in part on our ability to
expand our existing relationships with distributors, resellers, system
integrators and storage service providers, develop additional channels for the
distribution and sale of our products and manage these relationships. As part of
our growth strategy, we intend to expand our relationships with distributors,
resellers, system integrators and storage system providers. The inability to
successfully execute this strategy could impede our future growth.
THE LOSS OF OUR PRIMARY CONTRACT MANUFACTURERS, OR THE FAILURE TO FORECAST
DEMAND ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR
PRIMARY CONTRACT MANUFACTURERS SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY
TO MANUFACTURE AND SELL OUR PRODUCTS.
Prior to August 1999, we relied on a third-party manufacturer, XeTel, to
manufacture substantially all of our products on a purchase order basis. We do
not have a long-term supply contract with XeTel and, therefore, XeTel is not
obligated to manufacture products for us for any specific period, or in any
specific quantity, except as may be provided in a particular purchase order. In
August 1999, we engaged another contract manufacturer, Solectron, to make our
4x50 family of products. We believe that this will enable us to reduce our
reliance on XeTel. We generally place orders for products with our contract
manufacturers approximately four months prior to the anticipated delivery date,
with order volumes based on forecasts of demand from our customers. Accordingly,
if we inaccurately forecast demand for our products, we may be unable to obtain
adequate manufacturing capacity from our contract manufacturers to meet our
customers' delivery requirements, or we may accumulate excess inventories. We
have on occasion in the past been unable to adequately respond to unexpected
increases in customer purchase orders, and therefore were unable to benefit from
this incremental demand. Our contract manufacturers have not provided assurances
to us that adequate capacity will be available to us within the time required to
meet additional demand for our products.
OUR PLANS TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS TO MARKET REQUIRE
COORDINATION ACROSS OUR SUPPLIERS AND MANUFACTURERS, WHICH EXPOSES US TO RISKS
OF DELAY OR POOR EXECUTION FROM A VARIETY OF SOURCES.
We plan to introduce new products and product enhancements, which will
require that we coordinate our efforts with those of our component suppliers and
our contract manufacturers to rapidly achieve volume production. If we should
fail to effectively manage our relationships with our component suppliers and
our contract manufacturers, or if any of our suppliers or our manufacturers
experience delays, disruptions, capacity constraints or quality control problems
in their manufacturing operations, our ability to ship products to our customers
could be delayed, and our competitive position and reputation could be harmed.
Qualifying a new component supplier or contract manufacturer and commencing
volume production can be expensive and time consuming. If we are required to
change or choose to change suppliers, we may lose revenue and damage our
customer relationships.
TRANSITIONING THE FINAL ASSEMBLY AND TEST PORTION OF OUR MANUFACTURING PROCESS
TO AN IN-HOUSE FACILITY HAS INCREASED OUR FIXED COSTS AND EXPOSED US TO
INCREASED INVENTORY RISKS.
In September 1999, we transitioned our final assembly and product test
operations in-house. If demand for our products does not support the effective
utilization of our manufacturing employees and additional facilities and
equipment, we may not realize any benefit from replacing these services
previously outsourced to a contract manufacturer with internal final assembly
and testing. Furthermore, internal final assembly and test operations require us
to manage and maintain the components used in our products at our facilities. A
significant portion of this inventory will be useful only in the final assembly
of our products. Any decrease in demand for our products could result in a
substantial part of this inventory becoming excess, obsolete or otherwise
unusable. If our internal final assembly and test operations are underused or
mismanaged, we may incur significant costs that could adversely affect our
operating results.
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WE DEPEND ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY
COMPONENTS, AND IF WE ARE UNABLE TO BUY THESE COMPONENTS ON A TIMELY BASIS, OUR
DELAYED ABILITY TO DELIVER OUR PRODUCTS TO OUR CUSTOMERS MAY RESULT IN REDUCED
REVENUE AND LOST SALES.
We currently purchase Fibre Channel application specific integrated
circuits and other key components for our products from sole or limited sources.
To date, most of our component purchases have been made in relatively small
volumes. As a result, if our suppliers receive excess demand for their products,
we likely will receive a low priority for order fulfillment as large volume
customers will use our suppliers' available capacity. If we are delayed in
acquiring components for our products, the manufacture and shipment of our
products will also be delayed, which will reduce our revenues and may result in
lost sales. We generally use a rolling six-month forecast of our future product
sales to determine our component requirements. Lead times for ordering materials
and components vary significantly and depend on factors such as specific
supplier requirements, contract terms and current market demand for such
components. If we overestimate our component requirements, we may have excess
inventory which would increase our costs. If we underestimate our component
requirements, we may have inadequate inventory which would delay our
manufacturing and render us unable to deliver products to customers on a
scheduled delivery date. We also may experience shortages of certain components
from time to time, which also could delay our manufacturing. Manufacturing
delays could negatively impact our ability to sell our products and damage our
customer relationships.
COMPETITION WITHIN OUR MARKETS MAY REDUCE SALES OF OUR PRODUCTS AND REDUCE OUR
MARKET SHARE.
The market for SAN products generally, and storage routers in particular,
is increasingly competitive. We anticipate that the market for our products will
continually evolve and will be subject to rapid technological change. We
currently face competition from Adva-SAN Ltd., ATTO, Chaparral Network Storage,
Computer Network Technologies and Pathlight Technology. During fiscal 2000,
Compaq informed us of its intent to manufacture its own routers, rather than act
as an OEM for our 4100 and 4200 lines of routers. In addition, other OEM
customers could develop products or technologies internally that would replace
their need for our products and would become a source of competition. We expect
to face competition in the future from OEMs, including our customers and
potential customers, LAN router manufacturers, storage system industry
suppliers, including manufacturers and vendors of other SAN products or entire
SAN systems, and innovative start-up companies. For example, manufacturers of
Fibre Channel hubs or switches could seek to include router functionality within
their SAN products which would obviate the need for our storage routers. As the
market for SAN products grows, we also may face competition from traditional
networking companies and other manufacturers of networking products. These
networking companies may enter the storage router market by introducing their
own products or by entering into strategic relationships with or acquiring other
existing SAN product providers. This could introduce additional competition in
our markets, especially if Compaq or another one of our OEMs begins to
manufacture our higher end storage routers. Moreover, we are currently in
litigation with Chaparral and Pathlight in which we have alleged their
infringement of certain proprietary rights. If we are not successful in this
litigation, our competitive position may be harmed.
WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF OUR
CURRENT AND POTENTIAL COMPETITORS.
Some of our current and potential competitors have longer operating
histories, significantly greater resources, broader name recognition and a
larger installed base of customers than we have. As a result, these competitors
may have greater credibility with our existing and potential customers. They
also may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than us to new or
emerging technologies or changes in customer requirements. In addition, some of
our current and potential competitors have already established supplier or joint
development relationships with decision makers at our current or potential
customers. These competitors may be able to leverage their existing
relationships to discourage these customers from purchasing products from us or
to persuade them to replace our products with their products. Increased
competition could decrease our prices, reduce our sales, lower our margins, or
decrease our market share. These and other competitive pressures may prevent us
from competing successfully against current or future competitors, and may
materially harm our business.
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WE HAVE LICENSED OUR 4200 AND 4X50 STORAGE ROUTER TECHNOLOGY TO A KEY CUSTOMER,
WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.
We have licensed our 4200 and 4x50 storage router technology to
Hewlett-Packard. Hewlett-Packard currently manufactures the 4200 product under
its name and pays us a royalty. Hewlett-Packard has vastly greater resources and
distribution capabilities than we do, and therefore, it could establish market
acceptance in a relatively short time frame for any competitive products that it
may introduce, which, in turn, would reduce demand for our products from
Hewlett-Packard and could reduce demand for our products from other customers.
WE EXPECT UNIT PRICES OF OUR PRODUCTS TO DECREASE OVER TIME, AND IF WE CANNOT
INCREASE OUR SALES VOLUMES OUR REVENUE WILL DECLINE.
Many of our agreements with OEM customers provide for decreases in the
price of our products over time. In addition, we anticipate that, as products in
the SAN market become standardized and more widely available, we may need to
reduce the average unit selling price of our products in the future to respond
to competitive pricing pressures or new product introductions by our
competitors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volume, our revenue will decline.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUE.
Networking products such as ours may contain undetected software or
hardware errors when first introduced or as new versions are released. Our
products are complex and errors have been found in the past and may be found
from time to time in the future. For example in July, 2000, we voluntarily
issued a "stop-ship" on our 4x50 line and part of our 4200 line due to firmware
issues, which negatively affected our product revenues for the fiscal year ended
October 31, 2000. In addition, our products include components from a number of
third-party vendors. We rely on the quality testing of these vendors to ensure
the adequate operation of their products. Because our products are manufactured
with a number of components supplied by various third-party sources, should
problems occur in the operation or performance of our products, it may be
difficult to identify the source. In addition, our products are deployed within
SANs from a variety of vendors. Therefore, the occurrence of hardware and
software errors, whether caused by our or another vendor's SAN products, could
adversely affect sales of our products. Furthermore, defects may not be
discovered until our products are already deployed in the SAN. These errors also
could cause us to incur significant warranty, diagnostic and repair costs,
divert the attention of our engineering personnel from our product development
efforts and cause significant customer relations and business reputation
problems.
WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL AND HIRE
ADDITIONAL PERSONNEL, OUR ABILITY TO SELL OUR PRODUCTS COULD BE HARMED.
We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, engineering and sales and
marketing personnel. In particular, we believe that our future success is highly
dependent on Brian R. Smith, our co-founder, chief executive officer and
chairman of the board, and Larry Sanders, our president and chief operating
officer, to provide continuity in the execution of our growth plans. We do not
have employment contracts with any of our key personnel with the exception of
Mr. Sanders. We have experienced difficulty in hiring engineers with appropriate
qualifications in networking, routing and storage technologies and we may not be
successful in attracting and retaining sufficient levels of such engineers to
support our anticipated growth. The loss of the services of any of our key
employees, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly engineers and sales
personnel, could delay the development and introduction of, and negatively
impact our ability to sell, our products.
WE HAVE INCREASED OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY, WHICH WILL
SUBJECT US TO ADDITIONAL BUSINESS RISKS.
We have opened sales offices in international markets to focus on expanding
our international sales activities in Europe and the Pacific Rim region. Our
planned international sales growth will be limited if we are unable to expand
our international sales channel relationships, hire additional personnel and
continue to develop relationships
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with international distributors, resellers,
system integrators and storage service providers. We may not be able to maintain
or increase international market demand for our products. Our international
sales activities are subject to a number of risks, including:
o increased complexity and costs of managing international operations;
o protectionist laws and business practices that favor local competition
in some countries;
o multiple, conflicting and changing laws, regulations and tax rules;
o longer sales cycles;
o greater difficulty in accounts receivable collection and longer
collection periods; and
o political and economic instability.
To date, all of our sales to international customers have been denominated
in U.S. dollars. As a result, an increase in the value of the U.S. dollar
relative to foreign currencies could make our products more expensive for our
customers to purchase, thus rendering them less competitive.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE.
Our products rely on our proprietary technology, and we expect that future
technological advancements made by us will be critical to sustain market
acceptance of our products. Therefore, we believe that the protection of our
intellectual property rights is and will continue to be important to the success
of our business. We rely on a combination of patent, copyright, trademark and
trade secret laws and restrictions on disclosure to protect our intellectual
property rights. We also enter into confidentiality or license agreements with
our employees, consultants and business partners, and control access to and
distribution of our software, documentation and other proprietary information.
Despite these efforts, unauthorized parties may attempt to copy or otherwise
obtain and use our products or technology. Monitoring unauthorized use of our
products is difficult, and we cannot be certain that the steps we have taken
will prevent unauthorized use of our technology, particularly in foreign
countries where applicable laws may not protect our proprietary rights as fully
as in the United States.
OUR EFFORTS TO PROTECT OUR INTELLECTUAL PROPERTY MAY CAUSE US TO BECOME INVOLVED
IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM OUR BUSINESS.
In recent years, there has been significant litigation in the United States
involving patents, trademarks and other intellectual property rights. Legal
proceedings could subject us to significant liability for damages or invalidate
our intellectual property rights. Any litigation, regardless of its outcome,
would likely be time consuming and expensive to resolve and would divert
management's time and attention. Any potential intellectual property litigation
against us could force us to take specific actions, including:
o cease selling our products that use the challenged intellectual
property;
o obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology or trademark, which
license may not be available on reasonable terms, or at all; or
o redesign those products that use infringing intellectual property or
cease to use an infringing trademark.
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ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION.
As part of our growth strategy, we intend to review opportunities to
acquire other businesses or technologies that would complement our current
products, expand the breadth of our markets or enhance our technical
capabilities. For example, in March 2000, we consummated our acquisition of
Polaris Communications, Inc. Acquisitions entail a number of risks that could
materially and adversely affect our business and operating results, including:
o problems integrating the acquired operations, technologies or products
with our existing business and products;
o diversion of management's time and attention from our core business;
o difficulties in retaining business relationships with suppliers and
customers of the acquired company;
o risks associated with entering markets in which we lack prior
experience; and
o potential loss of key employees of the acquired company.
OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY
CUSTOMERS IN OUR MARKET.
Our products comprise only a part of a SAN. All components of a SAN must
uniformly comply with the same industry standards in order to operate
efficiently together. We depend on companies that provide other components of
the SAN to support prevailing industry standards. Many of these companies are
significantly larger and more influential in effecting industry standards than
we are. Some industry standards may not be widely adopted or implemented
uniformly, and competing standards may emerge that may be preferred by OEM
customers or end users. If larger companies do not support the same industry
standards that we do, or if competing standards emerge, our products may not
achieve market acceptance which would adversely affect our business.
INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER OUR COMPANY AND COULD
DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL.
Our executive officers and directors beneficially own approximately 30.5%
of the total voting power of our company. As a result, these stockholders will
be able to exert significant control over all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions. This concentration of voting power could delay or
prevent an acquisition of us on terms which other stockholders may desire.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT, DELAY OR
IMPEDE A CHANGE IN CONTROL OF US AND MAY REDUCE THE MARKET PRICE OF OUR COMMON
STOCK.
Provisions of our certificate of incorporation and bylaws could have the
effect of discouraging, delaying or preventing a merger or acquisition that a
stockholder may consider favorable. We also are subject to the anti-takeover
laws of the State of Delaware which may discourage, delay or prevent someone
from acquiring or merging with us, which may adversely affect the market price
of our common stock.
OUR STOCK PRICE MAY BE VOLATILE.
The market price of our common stock has been volatile in the past and may
be volatile in the future. The market price of our common stock may be
significantly affected by the following factors:
o actual or anticipated fluctuations in our operating results;
o changes in financial estimates by securities analysts or our failure to
perform in line with such estimates;
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o changes in market valuations of other technology companies, particularly
those that sell products used in SANs;
o announcements by us or our competitors of significant technical
innovations, acquisitions, strategic partnerships, joint ventures or
capital commitments;
o introduction of technologies or product enhancements that reduce the
need for storage routers;
o the loss of one or more key OEM customers; and
o departures of key personnel.
The stock market has experienced extreme volatility that often has been
unrelated to the performance of particular companies. These market fluctuations
may cause our stock price to fall regardless of our performance.
THE RECENT ISSUANCE BY THE SEC OF AN ACCOUNTING BULLETIN RELATED TO REVENUE
RECOGNITION, SAB 101, MAY HAVE A MATERIAL ADVERSE IMPACT ON OUR FINANCIAL
PERFORMANCE.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements, referred to as SAB 101. SAB 101 summarizes
the SEC staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. In addition to other uncertain
risks related to SAB 101, it is possible that SAB 101 will result in increased
fluctuations in our quarterly operating results and increase the likelihood that
we may fail to meet the expectations of securities analysts for any period. We
are currently in the process of evaluating SAB 101 and what effect it may have
on our financial statements. As of this date, we have not determined whether SAB
101 will have a material impact on our financial position or results of
operations; however, it may require a portion of our fiscal year 2001 revenues
to be deferred. In the event that the implementation of SAB 101 requires us to
report a change in accounting principles related to our revenue recognition
policy, we would be required to report such change no later than the quarter
ending October 31, 2001. We are also considering potential changes to the terms
of our sales agreements for equipment sales that could mitigate the impact of
SAB 101. While SAB 101 would not affect the fundamental aspects of our
operations as measured by product shipments and cash flows, it is possible that
implementation of SAB 101 could have a material adverse effect on our reported
results of operations for fiscal year 2001. However, the application of SAB 101
is not expected to have a material impact on our financial statements.
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ITEM 2. PROPERTIES.
Our corporate headquarters facility consists of approximately 63,548 square
feet in Austin, Texas. We lease our headquarters facility pursuant to a lease
agreement that expires in March 2006. The lease represents a commitment of $1.7
million per year until April 2003 and $1.8 million per year thereafter. In
conjunction with entering into the lease agreement, we signed an unconditional,
irrevocable letter of credit with a bank for $1.0 million, which is secured by a
$1.0 million certificate of deposit.
Our Oregon facility consists of approximately 10,488 square feet in
Portland, Oregon. We lease this facility pursuant to a lease agreement that
started in December, 1996 and expires in December 2001.
Our final assembly and test facility of approximately 11,250 square feet is
also located in Austin, Texas. The lease on this facility expires in June 2004.
We also maintain sales offices, each with 400 square feet or less, in
Boston, Massachusetts; Boulder, Colorado; San Diego, California; Manchester,
England and Munich, Germany.
ITEM 3. LEGAL PROCEEDINGS.
On March 31, 2000, we filed a lawsuit against Chaparral Network Storage,
Inc., or Chaparral, alleging that Chaparral has infringed one of our patents
with some of its router products. The lawsuit was filed in United States
District Court for the Western District of Texas, and we are seeking injunctive
relief as well as damages. The case has been assigned to a Federal District
Court Judge, who has already conducted a claims construction hearing and
provided an order resolving claim construction issues. We have started the
discovery process. Trial is currently scheduled to begin in the second half of
2001.
On May 19, 2000, Chaparral filed a counter-suit against us alleging tortious
interference with prospective business relations. The lawsuit was filed in
District Court, Boulder County, Colorado and Chaparral is seeking injunctive
relief as well as damages. Chaparral claims that we have made statements that
Chaparral has infringed our patent rights and that these statements are false
and defamatory. Given the overlapping allegations with the patent litigation,
this case was transferred to the District Court for the Western District of
Texas and consolidated with the aforementioned pending patent litigation. The
complaints are at an early stage. Consequently, at this time it is not possible
to predict whether we will incur any liability or to estimate its amount, if
any.
On April 14, 2000, we filed a lawsuit against Pathlight Technology, Inc., or
Pathlight, alleging that Pathlight has infringed one of our patents with its SAN
Data Gateway Router. The lawsuit was filed in United States District Court for
the Western District of Texas, and we are seeking injunctive relief as well as
damages. The case has been assigned to a Federal District Court Judge, who has
already conducted a claims construction hearing and provided an order resolving
claim construction issues. We have started the discovery process. Trial is
currently scheduled to begin in the first half of 2001.
We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. The plaintiffs in the actions purport to represent
purchasers of our common stock during various periods ranging from January 25,
2000 through August 24, 2000. The Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. We
deny the allegations in the complaints and intend to defend against them
vigorously. We intend to file a motion to dismiss the consolidated amended
complaint once it has been filed. The litigation is at an early stage, and it is
not possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, that we might incur in connection
with such actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock has been quoted on the Nasdaq National Market under the
symbol "CRDS" since our initial public offering on October 20, 1999. Prior to
the initial public offering, there had been no public market for our common
stock. The following table lists the high and low per share sales prices for our
common stock as reported by the Nasdaq National Market for the periods
indicated:
HIGH LOW
---- ---
FISCAL YEAR ENDED OCTOBER 31, 1999
Fourth Quarter (from October 20, 1999).... $ 97.250 $ 36.250
FISCAL YEAR ENDED OCTOBER 31, 2000
First Quarter............................. 102.250 58.375
Second Quarter............................ 202.250 45.500
Third Quarter.............................. 81.500 4.250
Fourth Quarter............................. 15.625 4.375
As of January 10, 2001, there were 27,790,696 shares of our common stock
outstanding held by 321 stockholders of record.
We have never declared or paid cash dividends on our capital stock. We
currently intend to retain any earnings for use in our business and do not
anticipate paying any cash dividends in the foreseeable future. Future
dividends, if any, will be determined by our Board of Directors.
In connection with our acquisition of Polaris Communications, Inc. which we
completed on March 21, 2000, we issued an aggregate of 450,000 shares of our
common stock to the shareholders of Polaris in exchange for all of the
outstanding shares of Polaris common stock. These shares were deemed exempt from
registration under Section 3(a)(10) of the Securities Act of 1933, as amended,
pursuant to a fairness hearing under Oregon law.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," in Item 7 of this Annual Report and other financial
information appearing elsewhere in this Annual Report. The consolidated
statement of operations data set forth below for each of the years in the three
year period ended October 31, 2000 and the balance sheet data as of October 31,
1999 and 2000 are derived from, and qualified by reference to, our audited
consolidated financial statements appearing elsewhere in this Annual Report. The
consolidated statement of operations data for the year ended October 31, 1996
and 1997 and the consolidated balance sheet data as of October 31, 1997 and 1998
are derived from audited consolidated financial statements not included herein.
The consolidated balance sheet data as of October 31, 1996 have been derived
from unaudited consolidated financial statements not included herein.
FISCAL YEAR ENDED OCTOBER 31,
-------------------------------------------------------------
1996 1997 1998 1999 2000
------------ ----------- ----------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Product revenue............................ $ 160 $ 821 $ 2,930 $ 18,859 $ 32,486
Other revenue.............................. 332 188 279 65 562
-------- --------- --------- --------- --------
Total revenue.......................... 492 1,009 3,209 18,924 33,048
Cost of revenue(1)............................. 170 465 1,913 11,079 19,104
-------- --------- --------- --------- --------
Gross profit................................... 322 544 1,296 7,845 13,944
-------- --------- --------- --------- --------
Operating expenses(1):
Sales and marketing........................ -- 641 2,491 4,781 16,007
Research and development................... 291 1,329 2,342 5,551 13,143
General and administrative................. 235 1,323 1,899 3,017 31,242
Amortization of intangibles................ -- -- -- -- 8,808
-------- --------- --------- --------- --------
Total operating expenses............... 526 3,293 6,732 13,349 69,200
-------- --------- --------- --------- --------
Loss from operations........................... (204) (2,749) (5,436) (5,504) (55,256)
Other income (expense), net.................... (8) 56 82 319 4,228
-------- --------- --------- --------- --------
Net loss....................................... (212) (2,693) (5,354) (5,185) (51,028)
Accretion on redeemable
convertible preferred stock................ -- (58) (196) (247) --
-------- --------- --------- --------- --------
Net loss attributable to common stock.......... $ (212) $ (2,751) $ (5,550) $ (5,432) $(51,028)
-------- --------- --------- --------- --------
Basic and diluted net loss per share........... $ (0.04) $ (0.46) $ (0.90) $ (0.74) $ (1.93)
-------- --------- --------- --------- --------
Shares used in computing basic
and diluted net loss per share........... 6,000 6,000 6,146 7,378 26,467
-------- --------- --------- --------- --------
(1) Stock-based compensation for the periods
indicated was allocated as follows:
Cost of revenue............................ $ -- $ -- $ 2 $ 133 $ 288
Sales and marketing........................ -- -- 30 372 4,373
Research and development................... -- -- 6 280 528
General and administrative................. -- -- 3 420 22,501
-------- --------- --------- --------- --------
Total stock-based compensation......... $ -- $ -- $ 41 $ 1,205 $ 27,690
======== ========= ========= ========= ========
OCTOBER 31,
------------------------------------------------------------
1996 1997 1998 1999 2000
-------- --------- --------- --------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments................................. $ -- $ 6,063 $ 3,934 $ 80,820 $60,038
Working capital................................ (168) 5,757 4,461 83,165 62,287
Total assets................................... 150 7,615 7,187 91,730 118,048
Long-term debt, net of current portion......... 82 301 591 1,325 --
Redeemable convertible preferred stock......... -- 9,277 13,438 -- --
Total stockholders' equity (deficit)........... (124) (2,875) (8,347) 84,885 108,752
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the
consolidated selected financial data in Item 6 of this Annual Report and our
consolidated financial statements and notes thereto in Item 8 of this Annual
Report.
OVERVIEW
We are the leading provider of enterprise data center routing solutions for
open system storage area networks, based on our market share of storage routers
shipped. Storage routers are computer equipment that organizations use to
connect servers and storage systems together in a storage area network, or SAN.
A SAN is a high-speed computer network that facilitates data transfers among
servers and storage systems using high performance data communications that
follow the industry-accepted rules and conventions, which are commonly referred
to as computer protocols. By using our storage routers to serve as the
interconnect between SANs and the other devices in a computer network,
organizations are able to more effectively and efficiently store, manage and
ensure the integrity and availability of their data. Specifically, when used in
storage area networks our storage routers decrease congestion in the transfer of
data within a network, reduce the time required to back up data, improve
utilization of storage resources, and preserve and enhance existing server and
storage system investments.
On March 21, 2000, we consummated our acquisition of Polaris
Communications, Inc. Polaris was a leading developer and marketer of S/390
mainframe communication interfaces and systems delivering increased connectivity
and bandwidth options to enterprise data centers, focusing on high-speed
connections between open-systems and mainframes. The aggregate purchase price of
$46.6 million consisted of the issuance of 428,625 shares of our common stock
valued at approximately $44.5 million, the issuance of 21,375 options to
purchase our common stock valued at approximately $1.9 million and $200,000 of
other direct acquisition costs. The acquisition of Polaris was accounted for
under the purchase method of accounting. Amortization of intangibles related to
the Polaris acquisition totaled approximately $8.8 million for the fiscal year
ended October 31, 2000.
To date, we have derived most of our product revenue from sales of storage
routers to server and storage OEMs. To a lesser extent, we have sold products to
distributors, resellers and system integrators. A few OEM customers historically
have accounted for a substantial portion of our revenue. During fiscal 1998, our
four largest customers--ADIC, Compaq, Hewlett-Packard and
StorageTek--respectively accounted for 25%, 20%, 16% and 14% of our total
revenue. During fiscal 1999 and 2000, sales to Compaq and StorageTek
respectively accounted for 36% and 33%, and 36% and 21%, of our total revenue.
No other customer accounted for more than 10% of our total revenue in these
periods.
While we currently sell products to all of our OEM customers, we do not
have contracts with Compaq or with some of our other customers. Although none of
our customers is obligated to purchase minimum quantities of our products, we
seek to enter contracts in order to provide a framework for our customer
relationships. Generally our contracts require our customers to provide us with
forecasts to assist us in our planning process. They also specify payment terms,
allocate liability for potential third party claims and provide other terms
governing the legal rights of the parties. A key element of our growth strategy
is to expand our sales channels. To this end, we have established relationships
with a number of distributors, resellers and system integrators. Recently, we
have also begun to establish relationships to sell our products through storage
service providers, or SSPs, an important new class of service providers which
provide storage-related services to customers within Internet data centers and
large metropolitan areas. Our worldwide distribution channel accounted for
approximately 4% and 10% of our total sales for the years ended October 31, 1999
and 2000, respectively. Although we anticipate that revenue derived from sales
to distributors, resellers and system integrators and through SSPs will increase
as a percentage of our total revenue in future periods, we expect to continue to
experience significant customer concentration in sales to key OEM accounts for
the foreseeable future.
In the past, we have experienced fluctuation in the timing of orders from
our OEM customers, and we expect to continue to experience these fluctuations in
the future. During July 2000, we recorded a $1.1 million return resulting from
StorageTek's shift in demand to our newer products. Moreover, Compaq informed us
that it intends to discontinue purchasing our 4100/4200 line of storage routers
and has begun to internally manufacture its own solution. As a result, we
recorded a $1.3 million write-down of inventory resulting from StorageTek's
shift in demand and Compaq's plan to transition out of our 4100/4200 router
solutions and replace them with its own
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solution. Other fluctuations have resulted from, among other things, OEM
customers placing initial orders for our products for purposes of qualification
and testing. As a result, we may report an increase in sales or a commencement
of sales of a product in a quarter that will not be followed by similar sales in
subsequent quarters as OEMs conduct qualification and testing.
Although we negotiate the prices for our products on an individual basis
with each of our OEM customers, many of our current agreements with our OEM
customers include provisions that require reductions in the sales price for our
products over time. We believe that this practice is common within our industry.
To date, our agreements with OEM customers, including our largest customers,
provide for quarterly reductions in pricing on a product-by-product basis
ranging from 8% to 15% annually, with the actual discount determined according
to the volume potential expected from the customer, the OEM's customer base, the
credibility the OEM may bring to our solution, additional technology the OEM may
help us incorporate with our product, and other Crossroads products the OEM
supports. Notwithstanding, the decreases in our average selling prices of our
older products generally have been offset by higher average selling prices for
our newer products, as well as sales to distributors, resellers and system
integrators where price decreases are not generally required. Nonetheless, we
could experience declines in our average unit selling prices for our products in
the future, especially if our newer products do not receive broad market
acceptance or if our efforts to increase sales to distributors, resellers and
system integrators are not successful. In addition, declines in our average
selling prices may be more pronounced should we encounter significant pricing
pressures from increased competition within the storage router market.
With respect to sales of our products to OEMs, we recognize product revenue
when products are shipped to the OEM. Product sales to distributors, resellers
and system integrators who do not have return rights are recognized at the time
of shipment. To the extent that we sell products to distributors, resellers and
system integrators that have rights of return, we defer revenue and cost of
revenue associated with such sales and recognize these amounts when that
customer sells our products to its customers. At October 31, 2000, our deferred
revenue totaled $1.1 million. We provide a repair or replace warranty of between
15 and 39 months following the sale of our products, and we provide a reserve
for warranty costs when the related product revenue is recognized.
Through August 1999, we outsourced substantially all of our manufacturing
requirements to XeTel Corporation, a contract manufacturer, and a significant
portion of our cost of revenue historically has consisted of payments to XeTel.
During fiscal 2000, we have engaged another contract manufacturer, Solectron, to
supply the printed circuit board for our 4x50 family of products. As the needs
of our customers continue to evolve, we plan to reassess our manufacturing
requirements on a periodic basis and effect appropriate changes to our
manufacturing processes.
In June 2000, we implemented SAP, our enterprise resource planning system
which has resulted in improved inventory management, expense controls and
on-time deliveries. In addition, we launched the Crossroads total quality
management program, named a vice-president of quality and operations, and earned
ISO 9002 certification.
In connection with the grant of stock options to our employees and
directors, we recorded deferred compensation during fiscal 1998, 1999 and 2000
aggregating approximately $18.5 million. Deferred compensation represents, for
accounting purposes, the difference between the deemed fair value of the common
stock underlying these options and their exercise price on the date of grant.
The difference has been recorded as deferred stock-based compensation and is
being amortized over the vesting period of the applicable options, typically
four years. Of the total deferred compensation amount, approximately $8.8
million has been amortized as of October 31, 2000.
In connection with the retirement of our previous president and chief
operating officer, we recorded approximately $16.5 million of stock-based
compensation in connection with accelerating the vesting of certain stock
options previously granted to him. During June 2000, we recorded additional
stock-based compensation of approximately $3.8 million in connection with
accelerating the vesting of certain stock options previously granted to our vice
president of sales, who departed effective June 2, 2000.
During fiscal 2000, we allocated stock-based compensation to specific line
items within the statement of operations based on the classification of the
employees who received the benefit. Stock-based compensation for prior periods
has been reclassified to conform to the October 31, 2000 presentation.
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Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
FISCAL YEAR ENDED OCTOBER 31,
-----------------------------------------
1998 1999 2000
--------- ---------- ----------
Cost of revenue....................... $ 2 $ 133 $ 288
--------- ---------- ----------
Sales and marketing................... 30 372 4,373
Research and development.............. 6 280 528
General and administrative............ 3 420 22,501
--------- ---------- ----------
Total stock-based compensation... $ 41 $ 1,205 $ 27,690
========= ========== ==========
We currently expect to amortize the remaining amounts of deferred
stock-based compensation as of October 31, 2000 in the periods indicated (in
thousands):
FISCAL YEAR ENDED OCTOBER 31,
--------------------------------------------------
2001 2002 2003 2004 TOTAL
------ ------ ------ ------ ------
Cost of revenue ........................ $ 122 $ 56 $ 12 $ -- $ 190
Sales and marketing .................... 156 81 14 -- 251
Research and development ............... 226 101 20 -- 347
General and administrative ............. 5,535 2,378 943 90 8,946
------ ------ ------ ------ ------
Total stock-based compensation ..... $6,039 $2,616 $ 989 $ 90 $9,734
====== ====== ====== ====== ======
In August 2000, we were first to demonstrate server-free backup using early
InfiniBand technology. We are a leading member of the InfiniBand Trade
Association and a member of the Marketing Working Group. This allows us to
influence the standards being drafted, ensure our product leadership and provide
our customers control over their storage migration path. We will continue to
participate in the development of InfiniBand technologies to ensure we are an
integral part of the standards setting process.
We currently have five patents issued, two allowed and 16 patent
applications pending in the United States Patent and Trademark Office with
respect to our technology. We have six pending international patent applications
(two in the European Patent Office, and one in each of Australia, Hong Kong,
Canada and Japan). We also have nine patents pending under the Patent
Cooperation Treaty with the intent of filing in additional countries. However,
none of our patents, including patents that may be issued in the future, may
adequately protect our technology from infringement or prevent others from
claiming that our technology infringes that of third parties. Failure to
adequately protect our intellectual property could materially harm our business.
In addition, our competitors may independently develop similar or superior
technology
We have incurred significant operating losses in every fiscal quarter and
annual period since November 1, 1995 and our accumulated deficit was $64.4
million at October 31, 2000.
As of October 31, 2000, we had approximately $39.6 million of federal net
operating loss carryforwards. These net operating loss carryforwards begin to
expire in 2011. We have not recognized any benefit from the future use of loss
carryforwards for these periods or for any other periods since inception due to
uncertainties regarding the realization of deferred tax assets based on our
taxable earnings history.
Our company was originally formed in 1995 as Infinity Commstor, LLC, a
Texas limited liability company. In 1996, Infinity Commstor was merged into a
newly formed Delaware corporation, which became Crossroads Systems, Inc., with
operations conducted through a wholly-owned Texas corporation subsidiary. Since
mid-1996, our operating activities have related primarily to increasing our
research and development capabilities, designing, developing and marketing our
storage routers, staffing our administrative, marketing and sales organizations
and establishing relationships with OEMs, and distributors, resellers and system
integrators. We began shipping our first product, the Crossroads 4100 storage
router, to OEMs for their evaluation in July 1997.
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RESULTS OF OPERATIONS
The following table sets forth our consolidated financial data for the
periods indicated expressed as a percentage of our total revenue, net of the
aforementioned allocation of stock-based compensation for all periods
presented--See Item 8. Financial Statements--Note 7 to Notes to Condensed
Consolidated Financial Statements.
FISCAL YEAR ENDED OCTOBER 31,
-----------------------------
1998 1999 2000
----- ----- -----
Revenue:
Product revenue ...................... 91.3% 99.7% 98.3%
Other revenue ........................ 8.7 0.3 1.7
----- ----- -----
Total revenue ................ 100.0 100.0 100.0
Cost of revenue ........................ 59.5 57.8 56.9
----- ----- -----
Gross margin ........................... 40.5 42.2 43.1
----- ----- -----
Operating expenses:
Sales and marketing .................. 77.4 23.3 35.2
Research and development ............. 72.1 27.8 38.2
General and administrative ........... 59.1 13.7 26.4
Amortization of intangibles .......... -- -- 26.7
----- ----- -----
Total operating expenses ..... 208.6 64.8 126.5
----- ----- -----
Loss from operations ................... (168.1) (22.6) (83.4)
Other income (expense) ................. 2.6 1.7 12.8
----- ----- -----
Net loss ............................... (165.5)% (20.9)% (70.6)%
===== ===== =====
COMPARISON OF FISCAL YEARS ENDED OCTOBER 31, 1998, 1999, AND 2000
Revenue. Our total revenue increased 489.7% from $3.2 million in fiscal
1998 to $18.9 million in fiscal 1999, and increased 74.6 % to $33.0 million in
fiscal 2000. Without the inclusion of Polaris products and services from the
date of acquisition, total revenue increased 62.4% in fiscal 2000 compared to
fiscal 1999.
Product revenue. Product revenue increased 543.7% from $2.9 million in
fiscal 1998 to $18.9 million in fiscal 1999, and increased 72.3% to $32.5
million in fiscal 2000. As a percentage of total revenue, product revenue
increased from 91.3% in fiscal 1998 to 99.7% in fiscal 1999, and decreased to
98.3% in fiscal 2000. The increases in product revenue resulted from the
introduction of our 4100 and 4200 products in fiscal 1997 and 1998,
respectively. The increase in product revenue in fiscal 1999 and 2000 resulted
from increased sales of our storage router product family through an increased
customer base and increased sales to our significant OEMs, customers,
distributors, resellers and system integrators in conjunction with a growing
demand for storage routers. During fiscal 2000, we deployed our sales team
throughout the United States and Europe tripling our U.S. field sales and
support offices and opened offices in the UK and Germany. This field sales force
is strategically located near key accounts to provide better service and drive
demand creation through joint sales calls with our partners. Also during fiscal
2000, we launched our third generation technology, the Crossroads 4x50 line of
high-performance intelligent routers that enable companies to realize the
benefits of managing their mission critical data using applications such as
Server-free backup and LAN-free backup while protecting the investments made in
their current enterprise systems. Our 4x50 line accounted for approximately 17%
of our product revenue during fiscal 2000.
Other revenue. Other revenue includes sales of licenses for a software
developer's kit, consulting fees and fees received from the licensing of other
intellectual property. Other revenue decreased 76.7% from $279,000 in fiscal
1998 to $65,000 in fiscal 1999, and increased 764.8% to $562,000 in fiscal 2000.
The increase in fiscal 2000 was primarily due to the license of a product design
and royalties.
Cost of revenue and gross margin. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue, net of stock-based
compensation of $2,000, $133,000 and $288,000 during fiscal 1998, 1999 and 2000,
respectively, increased 473% from $1.9 million in fiscal 1998 to $10.9 million
in fiscal 1999, and increased 71.9% to $ 18.8 million in fiscal 2000. These
increases were primarily due to increases in unit sales volume and a
corresponding increase in costs related to manufacturing. Gross profit, net of
stock-based compensation, increased 514.6% from $1.3 million in fiscal 1998 to
$8.0 million in fiscal 1999, and 78.4% to $14.2 million in fiscal 2000. The
increase was primarily due to increased
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product revenue in each of these periods. Gross margin increased from 40.5% in
fiscal 1998 to 42.2% in fiscal 1999, and increased to 43.1% in fiscal 2000. The
increase in gross profit resulted from a favorable customer and product mix in
addition to the benefits of moving our final assembly and test operations to an
in-house facility.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs, other promotional activities and stock-based compensation.
During June 2000, Crossroads recorded approximately $3.8 million of stock-based
compensation in connection with accelerating the vesting of certain stock
options previously granted to our vice president of sales, who departed
effective June 2, 2000. Sales and marketing expenses, net of stock-based
compensation of $30,000, $372,000 and $4.4 million during fiscal 1998, 1999 and
2000, respectively, increased 77.4% from $2.5 million in fiscal 1998 to $4.4
million in fiscal 1999, and increased 163.9% to $11.6 million in fiscal 2000.
The increases in sales and marketing expenses in fiscal 1999 and 2000 were
primarily due to the hiring of additional sales and marketing personnel
resulting in approximately $2.3 million and $2.8 million of increased
compensation expense, respectively, including increased commissions commensurate
with greater sales. Sales and marketing personnel totaled 16, 46 and 56 at
October 31, 1998, 1999 and 2000, respectively. As a percentage of total revenue,
sales and marketing expenses, net of stock-based compensation, decreased from
77.4% in fiscal 1998 to 23.3% in fiscal 1999 and increased to 35.2% in fiscal
2000. We anticipate that sales and marketing expenses will continue to increase
in absolute dollars and may fluctuate as a percentage of total revenue, due to
the planned expansion of our sales and marketing efforts and increased marketing
activity that is intended to broaden awareness of the benefits of our products.
Research and development. Research and development expenses consist
primarily of salaries and other personnel-related costs, product development,
prototyping expenses and stock-based compensation. Research and development
expenses, net of stock based compensation of $6,000, $280,000 and $528,000
during fiscal 1998, 1999 and 2000, respectively, increased 127.9% from $2.3
million in fiscal 1998 to $5.3 million in fiscal 1999, and increased 139.4% to
$12.6 million in fiscal 2000. The increases in research and development expenses
in fiscal 1999 and 2000 were primarily due to the hiring of additional research
and development personnel resulting in approximately $2.0 and $3.5 million of
increased compensation expense, respectively. Research and development personnel
totaled 22, 58 and 89 at October 31, 1998, 1999 and 2000. The increase in fiscal
2000 was also due in part to increased prototyping costs of approximately
$500,000 related to the development of our 4x50 product line, increased
consulting expenses of approximately $400,000 and approximately $1.1 million of
increased depreciation expense. As a percentage of total revenue, research and
development expenses, net of stock-based compensation, decreased from 72.1% in
fiscal 1998 to 27.8% in fiscal 1999, and increased to 38.2% in fiscal 2000. We
expect that research and development expenses will continue to increase in
absolute dollars and will fluctuate as a percentage of our total revenue, due to
the importance of research and development in developing our technologies and
expanding our product offerings.
General and administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs, facilities and other
costs of our administrative, executive and information technology departments,
as well as legal and accounting expenses, insurance costs and stock-based
compensation. During fiscal 2000, we recorded approximately $22 million in
stock-based compensation in connection with the transition of our president and
chief operating officer from Mr. Moore to Mr. Sanders resulting from
approximately $16.5 million of stock-based compensation recorded in connection
with accelerating the vesting of certain stock options previously granted to Mr.
Moore and approximately $5.0 million in stock-based compensation associated with
Mr. Sanders' options. General and administrative expenses, net of stock-based
compensation of $3,000, $420,000 and $22.5 million during fiscal 1998, 1999 and
2000, respectively, increased 37.0% from $1.9 million in fiscal 1998 to $2.6
million in fiscal 1999, and increased 236.4% to $8.7 million in fiscal 2000. The
increases in general and administrative expenses in fiscal 1998, 1999 and 2000
were primarily due to the hiring of administrative personnel resulting in
approximately $240,000, $770,000 and $2.0 million of increased compensation
expense, respectively. These additions were necessary to manage and support the
growth in our business as a public company. General and administrative personnel
totaled 11, 27 and 41 at October 31, 1998, 1999 and 2000. In addition, during
fiscal 2000, we incurred one-time expenses totaling approximately $500,000
related to the transition from Mr. Moore to Mr. Sanders as president and chief
operating officer, and the relocation of our corporate headquarters. Legal costs
associated with patent infringement and class action shareholder lawsuits
totaled approximately $1.4 million during fiscal 2000. As a percentage of total
revenue, general and administrative expenses decreased from 59.1% in fiscal 1998
to 13.7% in fiscal 1999, and increased to 26.4% in fiscal 2000. We anticipate
that general and administrative
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expenses will continue to increase in absolute dollars for the foreseeable
future as we accommodate growth, add related infrastructure and incur expenses
related to being a public company. However, if our revenue continues to
increase, general and administrative expenses should decrease as a percentage of
total revenue.
Other income, net. Other income, net consists primarily of interest income
on short-term investments partially offset by interest expense. Other income,
net was $82,000, $319,600 and $4.2 million during fiscal 1998, 1999 and 2000,
respectively, representing 2.6%, 1.7% and 12.8% of total revenues, respectively.
The increase in other income, net in fiscal 2000 was primarily due to increased
cash, cash equivalents and short-term investment balances resulting from the
proceeds from our initial public offering in October 1999.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity at October 31, 2000 consisted of $42.4
million in cash and cash equivalents, $17.6 million in short-term investments.
At October 31, 2000, we had a bank credit facility, which includes a revolving
line of credit providing borrowings up to the lesser of (a) $2.5 million or (b)
80% of eligible accounts receivable plus 25% of eligible inventories; and an
equipment loan agreement providing for financing of up to $1.9 million. In
November 2000, we extended the line of credit arrangement and the equipment line
through December 2000, and we are currently negotiating to extend this credit
facility. The line of credit and equipment loan agreement contain provisions
that prohibit the payment of cash dividends and require the maintenance of
specified levels of tangible net worth and certain financial performance
covenants measured on a monthly basis. As of October 31, 2000, there were no
borrowings outstanding under the revolving line of credit and no term loans
outstanding (see Note 4 to the Consolidated Financial Statements).
In February 2000, we entered into a $1.0 million letter of credit in
connection with the lease requirements of our new facility.
During fiscal 1998, cash utilized for operating activities was $5.8
million, compared to $5.3 million in fiscal 1999 and $9.7 million in fiscal
2000. The increase in net cash utilized in fiscal 2000 reflected increased
losses from operations and working capital required to fund the expansion of our
operations.
During fiscal 1998, cash utilized for investing activities was $3.2
million, compared to $20.1 million in fiscal 1999 and $7.4 million in fiscal
2000. The decrease in net cash utilized in fiscal 2000 reflected the maturity of
held-to-maturity investments, net of purchases, of $1.9 million, and cash
acquired from business acquisitions, net of cash payments, of $1.0 million.
Capital expenditures were $956,000, $2.3 million and $10.7 million in
fiscal 1998, 1999 and 2000, respectively. These expenditures reflect our
investments in computer equipment and software, test equipment, software
development tools and leasehold improvements, all of which were required to
support our business expansion. We anticipate additional capital expenditures
through fiscal 2001 of approximately $10.6 million to continue funding our
purchase of a new enterprise resource planning system; leasehold improvements;
costs associated with the transition to an in-house facility of the final
assembly and test portions of our manufacturing process, including modification
to our facilities and test and other manufacturing equipment; and equipment and
software to support our projected growth in personnel.
During fiscal 1998, cash provided by financing activities was $4.6 million,
compared to $85.1 million in fiscal 1999 and cash utilized for financing
activities of $1.7 million in fiscal 2000. The increase in cash utilized in
fiscal 2000 reflected the payment of our existing debt of $2.4 million in
December 1999 in addition to $1.0 million in proceeds from issuance of common
stock pursuant to option exercises. We have funded our operations to date
primarily through sales of preferred stock and our initial public offering,
resulting in aggregate gross proceeds to us of $98.2 million (which amount
includes the $12.0 million of proceeds received from the private placement of
our Series E preferred stock in August 1999), product sales and, to a lesser
extent, bank debt.
We believe the net proceeds we received from our initial public offering,
together with our existing cash balances, the net proceeds from the sale of our
Series E preferred stock in August 1999 and our credit facilities, will be
sufficient to meet our capital requirements through at least the next 12 months.
However, we could be required, or could elect, to seek additional funding prior
to that time. Our future capital requirements will depend on many
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factors, including the rate of revenue growth, the timing and extent of spending
to support product development efforts and expansion of sales and marketing
activities, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. On March 21, 2000, we
consummated our acquisition of Polaris Communications, Inc. and we may enter
into additional acquisitions or strategic arrangements in the future which also
could require us to seek additional equity or debt financing. We cannot assure
you that additional equity or debt financing, if required, will be available to
us on acceptable terms, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued,
Statement of Financial Accounting Standards, or SFAS, No. 133, "Accounting for
Derivatives and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including derivative instruments embedded
in other contracts, and for hedging activities. SFAS No. 133, as amended by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral
of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement
No. 133," is effective for all fiscal quarters of fiscal years beginning after
June 15, 2000. We do not currently engage or plan to engage in hedging
activities or intend to own or plan to purchase any derivative instruments.
In March 2000, the FASB issued FASB Interpretation No. 44 "Accounting for
Certain Transactions Involving Stock Compensation--an interpretation of APB
Opinion 25" ("Interpretation No. 44"), which is generally effective July 1,
2000. Interpretation No. 44 clarifies the application of APB Opinion 25 for
certain matters, specifically (a) the definition of an employee for purposes of
applying APB Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. The adoption of Interpretation No. 44 did not have a material
impact on the financial position or the results of operations.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. We are currently in the process
of evaluating SAB 101 and what effect it may have on our financial statements.
As of this date, we have not determined whether SAB 101 will have a material
impact on our financial position or results of operations; however, it may
require a portion of our fiscal year 2001 revenues to be deferred. In the event
that the implementation of SAB 101 requires us to report a change in accounting
principles related to our revenue recognition policy, we would be required to
report such change no later than the quarter ending October 31, 2001.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS
Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the nature of our short-term investments, we have
concluded that there is no material market risk exposure. Therefore, no
quantitative tabular disclosures are required.
We invest our cash in a variety of financial instruments, including bank
time deposits, and taxable and tax-advantaged variable rate and fixed rate
obligations of corporations, municipalities, and local, state and national
government entities and agencies. These investments are denominated in U.S.
dollars.
Interest income on our investments is carried in "Other income, net." We
account for our investment instruments in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115").
All of the cash equivalents and short-term investments are treated as held to
maturity under SFAS 115.
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, our future investment income may fall
short of expectations due to changes in interest rates or we may suffer losses
in principal if forced to sell securities which have seen a decline in market
value due to changes in interest rates. Our
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investment securities are held for purposes other than trading. While certain of
the investment securities had maturities in excess of 90 days, we intend to
liquidate such securities within one year. The weighted-average interest on
investment securities at October 31, 2000 was 6.63%. The fair value of
securities held at October 31, 2000 was $55.2 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included in Part IV Item 14 (a)(1)
and (2).
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
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PART III
ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth, as of December 31, 2000, certain
information concerning our executive officers:
NAME AGE POSITION(s)
---- --- -----------
Brian R. Smith........................... 35 Chief Executive Officer and Chairman of the Board of Directors
Larry Sanders............................ 54 President and Chief Operating Officer
Reagan Y. Sakai.......................... 41 Vice President, Chief Financial Officer, Secretary and Treasurer
Phillip R. Bell.......................... 45 Vice President of Worldwide Sales and Support
John R. Middleton........................ 43 Vice President of Engineering
Patricia E. Prince....................... 36 Vice President and Corporate Counsel
Robert C. Sims........................... 33 Vice President of Operations and Quality
Allen R. Sockwell........................ 40 Vice President of Human Resources
BRIAN R. SMITH, a co-founder of Crossroads, has served as our Chief
Executive Officer and Chairman of the Board of Directors since our inception in
April 1995. From inception until October 1997, Mr. Smith also served as our
President. From October 1994 to April 1995, Mr. Smith was President of a
consulting services company. From January 1985 to October 1994, Mr. Smith held
various development and management positions at IBM. Among other things, he led
the development of IBM's Fibre Channel products and FDDI products and worked on
several ESCON projects. He was also a technical representative for IBM on the
Fibre Channel Systems Initiative for TCP/IP and SCSI. Mr. Smith has served on
the American National Standards Institute committee developing many Fibre
Channel standards since 1992. Mr. Smith holds a B.S.E.E. from the University of
Cincinnati and an M.S.E.E. from Purdue University.
LARRY SANDERS has served as our President and Chief Operating Officer since
February 2000. High technology marketing, sales and management form the core of
his experience. Before Crossroads, he was the President and Chief Executive
Officer of Fujitsu Computer Products of America, where he was responsible for
the strategic direction and management of the company's sales, marketing,
research, development and manufacturing operations. While at Fujitsu Computer
Products, he successfully re-engineered the organization and spearheaded its
move toward becoming a leading global supplier of storage and imaging products.
He began his career in the high technology industry with IBM where he held
several sales and marketing management positions over 12 years. From IBM, he
moved on to Lockheed's Anaheim-based subsidiary, CalComp, a computer graphics
peripherals manufacturer and distributor that marketed more than 100 products
internationally. At CalComp, he held a number of senior management positions,
eventually serving as Group President. Immediately prior to joining Fujitsu, he
worked for Conner Peripherals, a $2.5 billion manufacturer of hard disk drives
and other peripheral storage devices. As the vice president of Far East sales
and then vice president of international sales, he led the entire sales,
marketing and support organization in the Far East and Europe.
REAGAN Y. SAKAI has served as our Vice President, Chief Financial Officer,
Secretary and Treasurer since May 1999. From August 1996 to April 1999, he
served as the Director of Corporate Finance and as Division Controller of the
Eagle Product Division at Exabyte, a public data storage company. From April
1994 to July 1996, he served as Director of Corporate Financial Planning and
Analysis at Maxtor, a disk drive company. He also worked extensively on
corporate cost reductions and strategic merger and acquisitions analyses. Sakai
managed and directed all treasury activities at McDATA Corporation including
planning, forecasting, product line analyses, risk management, and external
financial relationships & partnerships. At StorageTek Corporation, he managed
the International Business Planning group responsible for the financial planning
& analysis for 8 foreign subsidiaries and 3 distributor groups. Mr. Sakai holds
a B.S. in finance and an M.B.A., both from the University of Colorado.
PHILLIP R. BELL will serve as our Vice President of Worldwide Sales and
Support beginning January 15, 2001. With more than 20 years experience, Bell
comes to Crossroads from Dell Computer Corporation where he served from November
1999 to December 2000 as Vice President of Sales for Large Corporate Accounts
and as Director of Sales & Service for the Internet Partner Division. From
February 1999 to November 1999, Mr. Bell served as an independent consultant for
Lucent's new venture group and Bell Labs on a planned independent venture. From
December 1997 to February 1999, Mr. Bell served as Vice President, Worldwide
Sales & Service with Integrated Systems, Inc. Prior to this, he held a number of
vice president and management positions at Structural Dynamics and with AT&T. He
holds a bachelor's degree in business administration from Rutgers College.
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JOHN R. MIDDLETON has served as our Vice President of Engineering since
July 1999. From February 1997 to July 1999, Mr. Middleton served as our Senior
Director of Engineering. From November 1995 to January 1997, Mr. Middleton
served as an Engineering Manager at Compaq, where he managed the development of
LAN switches and hubs. From July 1992 to November 1995, he served as an
Engineering Manager at Thomas-Conrad Corporation, a networking company, and was
responsible for Ethernet, token ring and FDDI products. At KMW Systems (later
acquired by Andrew Corporation), he led development of IBM I/O channel products,
as well as token ring networking products. Prior to that, held various
engineering positions at Datapoint, Corp. developing processors and I/O
interfaces. Mr. Middleton holds a B.S.E.E. from the University of Texas at
Austin.
ALLEN R. SOCKWELL joined us as our Vice President of Human Resources in
September 1999. From October 1998 to August 1999, Mr. Sockwell served as Vice
President of Human Resources, and from February 1996 to October 1998 as Director
of Human Resources, at Compaq, where he managed human resources activities for
Compaq's global supply chain management and manufacturing operations. From June
1982 to February 1996, Mr. Sockwell was employed by IBM where he last served as
Manager of Human Resources for a semiconductor design and fabrication facility.
Mr. Sockwell holds a B.S. in general management from Purdue University.
ROBERT C. SIMS has served as our Vice President of Operations and Quality
Control since July 2000. From March 1999 to July 2000, Mr. Sims served as our
Director of Operations. Prior to joining Crossroads, he managed the advanced
manufacturing and product test organizations at Kentek Corp., developing
high-speed back office printers. From 1990 to 1998, Sims was with Exabyte where
he last served as manager of the manufacturing engineering and quality
organizations for the high-end tape drive division. Sims holds a bachelor's in
electrical engineering from Colorado State University.
PATRICIA E. PRINCE has served as our Vice President and Corporate Counsel
since July 2000. From October 1999 to July 2000, Ms. Prince served as our
General Counsel. Prior to joining Crossroads, she served as the general counsel
for Dazel Corp. from 1996 to May 1999, when it was acquired by Hewlett Packard.
From 1994 to 1996, she was with Tadpole Technology, Inc., a wholly owned
subsidiary of Tadpole Technology Plc, a listed corporation on the London Stock
Exchange. At Tadpole, she last served as counsel for the designer and
manufacturer of portable, mobile computing solutions for professional markets.
Prince is licensed to practice law in New York and Connecticut and holds a
bachelor's degree from Indiana University and a J.D. from Pace University.
Further information required by this Item is incorporated by reference to
our Proxy Statement under the sections captioned "Matters to be Considered at
Annual Meeting--Proposal One: Election of Directors" and "Compliance with
Section 16(a) of the Securities Exchange Act of 1934."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to our
Proxy Statement under the sections captioned "Executive Compensation and Other
Information" and "Certain Transactions."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to our
Proxy Statement under the section captioned "Ownership of Securities."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to our
Proxy Statement under the section captioned "Certain Transactions."
34
38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Form 10-K:
1. Consolidated Financial Statements. The following consolidated
financial statements of Crossroads Systems, Inc. are filed as a part of this
Form 10-K on the pages indicated:
PAGE
----
Report of Independent Accountants......................................................................... F-1
Consolidated Balance Sheets as of October 31, 1999 and 2000............................................... F-2
Consolidated Statements of Operations for each of the three years in the period ended October 31, 2000.... F-3
Consolidated Statements of Changes in Stockholders' (Deficit) Equity for each of the three years in the
period ended October 31, 2000.......................................................................... F-4
Consolidated Statements of Cash Flows for each of the three years in the period ended October 31, 2000.... F-5
Notes to Consolidated Financial Statements................................................................ F-6
2. Consolidated Financial Statement Schedules. The following
consolidated financial statement schedule of Crossroads Systems, Inc. is filed
as a part of this Form 10-K on the pages indicated:
PAGE
----
Report of Independent Accountants......................................................................... S-1
Schedule II - Valuation and Qualifying Accounts........................................................... S-2
Schedules not listed above have been omitted because the information required to
be set forth therein is not applicable or is shown in the consolidated financial
statements or the notes thereto.
3. Exhibits.
EXHIBIT
NUMBER DESCRIPTION
3.1* Sixth Amended and Restated Certificate of Incorporation (filed as
Exhibit 3.1 to the Registrant's Registration Statement on Form S-1
(SEC File No. 333-85505) (the "IPO Registration Statement") and
incorporated herein by reference)
3.2* Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO
Registration Statement and incorporated herein by reference)
4.1* Specimen certificate for shares of common stock (filed as Exhibit
4.1 to the IPO Registration Statement and incorporated herein by
reference)
10.1* Form of Indemnity Agreement between Registrant and each of its
directors and executive officers (filed as Exhibit 10.1 to the IPO
Registration Statement and incorporated herein by reference)
10.2* Crossroads Systems, Inc. 1999 Stock Incentive Plan (filed as
Exhibit 10.2 to the IPO Registration Statement and incorporated
herein by reference)
10.3* Crossroads Systems, Inc. 1999 Employee Stock Purchase Plan (filed
as Exhibit 10.3 to the IPO Registration Statement and incorporated
herein by reference)
10.4* Fourth Amended and Restated Investors Rights Agreement dated August
6, 1999 by and among Registrant and certain purchasers of
Registrant's preferred stock (filed as Exhibit 10.4 to the IPO
Registration Statement and incorporated herein by reference)
35
39
EXHIBIT
NUMBER DESCRIPTION
10.5*+ OEM Agreement dated April 23, 1998 by and between Registrant and
Storage Technology Corporation (filed as Exhibit 10.5 to the IPO
Registration Statement and incorporated herein by reference)
10.6* Form of Stock Pledge Agreement by and between Registrant and both
of Reagan Y. Sakai and John R. Middleton (filed as Exhibit 10.12 to
the IPO Registration Statement and incorporated herein by
reference)
10.7* Form of Note Secured by Stock Pledge Agreement issued to Registrant
by both of Reagan Y. Sakai and John R. Middleton (filed as Exhibit
10.13 to the IPO Registration Statement and incorporated herein by
reference)
10.8* Amended and Restated Loan and Security Agreement dated August 17,
1999 by and between Registrant and Silicon Valley Bank (filed as
Exhibit 10.14 to the IPO Registration Statement and incorporated
herein by reference)
10.9 Loan Modification Agreement dated August 30, 2000 by and between
Registrant and Silicon Valley Bank
10.10* Office Building Lease dated October 8, 1999 by and between
Registrant and Maplewood Associates, L.P. (filed as Exhibit 10.15
to the IPO Registration Statement and incorporated herein by
reference)
10.11* CP4200 License Agreement dated April 15, 1998 by and between
Registrant and Hewlett-Packard Company (filed as Exhibit 10.16 to
the IPO Registration Statement and incorporated herein by
reference)
10.12 Letter Agreement dated February 22, 2000 by and between Registrant
and James Moore
10.13 Letter Agreement dated February 28, 2000 by and between Registrant
and Larry Sanders
10.14 Letter Agreement dated May 22, 2000 by and between Registrant and
Robert F. LiVolsi
21.1 List of Principal Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney, pursuant to which amendments to this Form 10-K
may be filed, is included on the signature page contained on Part
IV of this Form 10-K
* Incorporated herein by reference to the indicated filing
+ Confidential treatment previously granted
(b) Reports on Form 8-K filed during the last quarter of the period covered
by this report.
None.
36
40
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CROSSROADS SYSTEMS, INC.
By: /s/ Brian R. Smith
---------------------------------
Brian R. Smith,
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby severally constitutes and appoints, Brian R. Smith and Reagan Y.
Sakai, and each or any of them, his true and lawful attorney-in-fact and agent,
each with the power of substitution and resubstitution, for him in any and all
capacities, to sign any and all amendments to this Annual Report on Form 10-K
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- ---- ----- ----
/s/ BRIAN R. SMITH Chief Executive Officer and Chairman of January 12, 2001
- -------------------------------------------- the Board (principal executive officer)
Brian R. Smith
/s/ REAGAN Y. SAKAI Chief Financial Officer (principal January 12, 2001
- -------------------------------------------- financial and accounting officer)
Reagan Y. Sakai
/s/ RICHARD D. EYESTONE Director January 12, 2001
- --------------------------------------------
Richard D. Eyestone
/s/ DAVID L. RIEGEL Director January 12, 2001
- --------------------------------------------
David L. Riegel
/s/ MORTON L. TOPFER Director January 12, 2001
- --------------------------------------------
Morton L. Topfer
/s/ WILLIAM P. WOOD Director January 12, 2001
- --------------------------------------------
William P. Wood
/s/ PAUL S. ZITO Director January 12, 2001
- --------------------------------------------
Paul S. Zito
41
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Crossroads Systems, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders' (deficit) equity
and cash flows present fairly, in all material respects, the financial position
of Crossroads Systems, Inc. and its Subsidiaries at October 31, 1999 and 2000,
and the results of their operations and their cash flows for each of the three
years in the period ended October 31, 2000 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
Austin, Texas
November 28, 2000
F-1
42
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
OCTOBER 31,
------------------------
1999 2000
--------- ---------
Current assets:
Cash and cash equivalents ....................................................................... $ 61,320 $ 42,447
Short-term investments .......................................................................... 19,500 17,591
--------- ---------
Total cash, cash equivalents and short-term investments ..................................... 80,820 60,038
Accounts receivable, net of allowance for doubtful
accounts of $95 and $231, respectively ....................................................... 3,654 5,590
Inventories, net ................................................................................ 3,278 3,918
Prepaids and other current assets ............................................................... 933 2,037
--------- ---------
Total current assets .................................................................... 88,685 71,583
Note receivable from related party, net ........................................................... 154 159
Property and equipment, net ....................................................................... 2,273 10,062
Intangibles, net .................................................................................. -- 35,686
Other assets ...................................................................................... 618 558
--------- ---------
Total assets ............................................................................ $ 91,730 $ 118,048
========= =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................................................ $ 3,328 $ 4,852
Accrued expenses ................................................................................ 735 2,933
Accrued warranty costs .......................................................................... 309 414
Deferred revenue ................................................................................ 117 1,097
Current portion of long-term debt ............................................................... 1,031 --
--------- ---------
Total current liabilities ................................................................. 5,520 9,296
Long-term debt, net of current portion ............................................................ 1,325 --
Commitments and contingencies
Redeemable convertible preferred stock, $.001 par value, 25,000,000
shares authorized, none designated, and none issued and outstanding ............................ -- --
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
26,549,919 and 27,690,673 shares issued and outstanding, respectively .......................... 27 28
Additional paid-in capital ........................................................................ 102,461 183,390
Deferred stock-based compensation ................................................................. (3,718) (9,734)
Notes receivable from stockholders ................................................................ (463) (249)
Accumulated deficit ............................................................................... (13,420) (64,448)
Treasury stock at cost (22,500 and 405,961 shares, respectively) .................................. (2) (235)
--------- ---------
Total stockholders' equity .............................................................. 84,885 108,752
--------- ---------
Total liabilities, redeemable convertible preferred
stock and stockholders' equity ..................................................... $ 91,730 $ 118,048
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
43
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
YEARS ENDED OCTOBER 31,
------------------------------------------------
1998 1999 2000
------------ ------------ ------------
Revenue:
Product revenue ....................................... $ 2,930 $ 18,859 $ 32,486
Other revenue ......................................... 279 65 562
------------ ------------ ------------
Total revenue ................................. 3,209 18,924 33,048
Cost of revenue (including stock-based compensation
expense of $2, $133 and $288, respectively) ........ 1,913 11,079 19,104
------------ ------------ ------------
Gross profit ............................................ 1,296 7,845 13,944
------------ ------------ ------------
Operating expenses:
Sales and marketing (including stock-based compensation
expense of $30, $372 and $4,373, respectively) ..... 2,491 4,781 16,007
Research and development (including stock-based
compensation expense of $6, $280 and
$528, respectively) ................................ 2,342 5,551 13,143
General and administrative (including stock-based
compensation expense of $3, $420 and
$22,501, respectively) ............................. 1,899 3,017 31,242
Amortization of intangibles ........................... -- -- 8,808
------------ ------------ ------------
Total operating expenses ...................... 6,732 13,349 69,200
------------ ------------ ------------
Loss from operations .................................... (5,436) (5,504) (55,256)
Other income (expense):
Interest income ....................................... 183 433 4,347
Interest expense ...................................... (65) (122) (37)
Other income (expense) ................................ (36) 8 (82)
------------ ------------ ------------
Other income, net .................................. 82 319 4,228
------------ ------------ ------------
Net loss ................................................ (5,354) (5,185) (51,028)
Accretion on redeemable convertible
preferred stock ....................................... (196) (247) --
------------ ------------ ------------
Net loss attributable to common stock ................... $ (5,550) $ (5,432) $ (51,028)
============ ============ ============
Basic and diluted net loss per share .................... $ (0.90) $ (0.74) $ (1.93)
============ ============ ============
Shares used in computing basic and
diluted net loss per share ............................ 6,146,115 7,377,984 26,466,601
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
44
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK ADDITIONAL DEFERRED
------------------------- PAID-IN STOCK-BASED
SHARES AMOUNT CAPITAL COMPENSATION
---------- ---------- ---------- ------------
Balance at November 1, 1997 .. 6,000,000 $ 6 $ -- $ --
Issuance of common stock
upon exercise of stock
options .................. 378,468 -- 39 --
Purchase of treasury
stock .................... -- -- -- --
Stock-based compensation ... -- -- 229 (188)
Accretion on redeemable
convertible preferred
stock .................... -- -- (196) --
Net loss ................... -- -- -- --
---------- ---------- ---------- ----------
Balance at October 31, 1998 .. 6,378,468 6 72 (188)
Issuance of common stock
upon exercise of stock
options .................. 2,534,112 3 753 --
Stock-based compensation ... -- -- 4,735 (3,530)
Accretion on redeemable
convertible preferred
stock .................... -- -- (247) --
Conversion of redeemable
convertible preferred
stock .................... 13,599,839 14 30,920 --
Initial public offering .... 4,037,500 4 66,228 --
Accrued interest on notes
receivable from
stockholders .............. -- -- -- --
Net loss ................... -- -- -- --
---------- ---------- ---------- ----------
Balance at October 31, 1999 .. 26,549,919 27 102,461 (3,718)
Issuance of common stock
upon exercise of stock
options .................. 662,791 1 95 --
Issuance of common stock
for purchase
acquisitions ............. 428,625 -- 46,373 --
Issuance of common stock for
employee stock purchase
plan ..................... 49,338 -- 755 --
Purchase of treasury
stock .................... -- -- -- --
Stock-based compensation ... -- -- 33,706 (6,016)
Payments on notes receivable
from stockholders ........ -- -- -- --
Accrued interest on notes
receivable from
stockholders ............. -- -- -- --
Net loss ................... -- -- -- --
---------- ---------- ---------- ----------
Balance at October 31, 2000 .. 27,690,673 $ 28 $ 183,390 $ (9,734)
========== ========== ========== ==========
NOTES
RECEIVABLE TOTAL
FROM ACCUMULATED TREASURY STOCKHOLDERS'
STOCKHOLDERS DEFICIT STOCK (DEFICIT) EQUITY
------------ ----------- ---------- ----------------
Balance at November 1, 1997 .. $ -- $ (2,881) $ -- $ (2,875)
Issuance of common stock
upon exercise of stock
options .................. -- -- -- 39
Purchase of treasury
stock .................... -- -- (2) (2)
Stock-based compensation ... -- -- -- 41
Accretion on redeemable
convertible preferred
stock .................... -- -- -- (196)
Net loss ................... -- (5,354) -- (5,354)
---------- ---------- ---------- ----------
Balance at October 31, 1998 .. -- (8,235) (2) (8,347)
Issuance of common stock
upon exercise of stock
options .................. (447) -- -- 309
Stock-based compensation ... -- -- -- 1,205
Accretion on redeemable
convertible preferred
stock .................... -- -- -- (247)
Conversion of redeemable
convertible preferred
stock .................... -- -- -- 30,934
Initial public offering .... -- -- -- 66,232
Accrued interest on notes
receivable from
stockholders .............. (16) -- -- (16)
Net loss ................... -- (5,185) -- (5,185)
---------- ---------- ---------- ----------
Balance at October 31, 1999 .. (463) (13,420) (2) 84,885
Issuance of common stock
upon exercise of stock
options .................. -- -- -- 96
Issuance of common stock
for purchase
acquisitions ............. -- -- -- 46,373
Issuance of common stock for
employee stock purchase
plan ..................... -- -- -- 755
Purchase of treasury
stock .................... -- -- (233) (233)
Stock-based compensation ... -- -- -- 27,690
Payments on notes receivable
from stockholders ........ 235 -- -- 235
Accrued interest on notes
receivable from
stockholders ............. (21) -- -- (21)
Net loss ................... -- (51,028) -- (51,028)
---------- ---------- ---------- ----------
Balance at October 31, 2000 .. $ (249) $ (64,448) $ (235) $ 108,752
========== ========== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
45
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED OCTOBER 31,
------------------------------------
1998 1999 2000
-------- -------- --------
Cash flows from operating activities:
Net loss ...................................................... $ (5,354) $ (5,185) $(51,028)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation ................................................ 471 971 2,942
Amortization of intangibles ................................. -- -- 8,808
Stock-based compensation .................................... 41 1,205 27,690
Loss on disposal of property and equipment .................. 136 9 --
Provision for doubtful accounts receivable .................. 6 81 136
Provision for excess and obsolete inventory ................. 35 296 1,758
Changes in assets and liabilities:
Accounts receivable ....................................... (559) (2,829) (1,664)
Inventories ............................................... (734) (2,678) (2,006)
Prepaids and other assets ................................. (130) (703) (978)
Accounts payable .......................................... 239 2,453 1,505
Accrued expenses .......................................... 40 906 2,047
Accrued warranty expenses ................................. -- -- 105
Deferred revenue and other ................................ (7) 138 994
-------- -------- --------
Net cash used in operating activities ................... (5,816) (5,336) (9,691)
-------- -------- --------
Cash flows from investing activities:
Purchase of property and equipment ............................ (956) (2,306) (10,653)
Cash acquired, net of payments for business acquisitions ...... -- -- 1,013
Proceeds from sale of property and equipment .................. 13 21 --
Purchase of held-to-maturity investments ...................... (2,239) (19,500) (17,591)
Maturity of held-to-maturity investments ...................... -- 2,239 19,500
Payment of note receivable from related party ................. -- (100) 226
Other assets .................................................. 17 (456) 60
-------- -------- --------
Net cash used in investing activities ................... (3,165) (20,102) (7,445)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock ........................ 39 309 851
Proceeds from initial public offering ......................... -- 72,675 --
Costs associated with initial public offering ................. -- (6,443) (40)
Proceeds from issuance of preferred stock, net of
issuance costs .............................................. 3,965 17,249 --
Purchase of treasury stock .................................... (2) -- (233)
Borrowings under long-term debt agreements .................... 852 1,750 --
Repayment of long-term indebtedness ........................... (241) (477) (2,356)
Other ......................................................... -- -- 41
-------- -------- --------
Net cash provided by (used in) financing activities ..... 4,613 85,063 (1,737)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ............ (4,368) 59,625 (18,873)
Cash and cash equivalents, beginning of period .................. 6,063 1,695 61,320
-------- -------- --------
Cash and cash equivalents, end of period ........................ $ 1,695 $ 61,320 $ 42,447
======== ======== ========
Supplemental disclosure of non-cash investing and
financing activities:
The Company purchased all of the assets of Polaris
Communications, Inc. during fiscal year 2000. Assets
acquired and liabilities assumed were as follows:
Fair value of assets acquired ............................... $ -- $ -- $ 46,751
Liabilities assumed ......................................... -- -- (171)
Stock issued in connection with the acquisition ............... -- -- (44,483)
Options issued in connection with the acquisition ............. -- -- (1,890)
-------- -------- --------
Cash payments for acquisition of Polaris ...................... $ -- $ -- $ 207
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
46
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
1. ORGANIZATION AND BUSINESS:
Headquartered in Austin, Texas, Crossroads Systems, Inc. ("Crossroads" or
the "Company"), a Delaware corporation, is the leading provider of enterprise
data center routing solutions for open system storage area networks ("SANs")
including S/390 connections. Crossroads sells its products and services
primarily to leading storage system and server original equipment manufacturers,
distributors, resellers, system integrators and storage service providers. The
Company is organized and operates as one business segment.
Crossroads completed the acquisition of Polaris Communications, Inc.
("Polaris") during the second quarter of fiscal 2000. This acquisition was
accounted for under the purchase method of accounting (Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Fiscal Year
During 1999, the Company changed its fiscal year-end from December 31 to
October 31. The Company's consolidated financial statements have been restated
for all periods presented to reflect this change. This change did not have a
material impact on Crossroads' financial statements for all periods presented.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. See Note 3 for information regarding the
acquisition of Polaris. All inter-company transactions and balances have been
eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from those estimates and such
differences may be material to the financial statements.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and on deposit. All highly
liquid investments with maturity of three months or less when purchased are
considered to be cash equivalents. Cash equivalents consist primarily of cash
deposited in money market accounts and high-grade commercial paper. Cash
equivalents totaled $59.8 and $41.2 million at October 31, 1999 and 2000,
respectively. In conjunction with entering into a lease agreement for its
headquarters, the Company signed an unconditional, irrevocable letter of credit
with a bank for $1.0 million, which is secured by a $1.0 million certificate of
deposit. While the Company's cash and cash equivalents are on deposit with high
quality FDIC insured financial institutions, at times such deposits exceed
insured limits. The Company has not experienced any losses in such accounts.
Short-Term Investments
Short-term investments consist primarily of high grade commercial paper and
corporate debt with original maturities at the date of purchase greater than
three months and less than twelve months. All short-term investments have been
classified as held to maturity and are carried at amortized cost, which
approximates fair value, due to the short period of time to maturity.
F-6
47
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.
Inventories consist of the following:
OCTOBER 31,
--------------------
1999 2000
------- -------
Raw materials .............................................. $ 2,577 $ 4,154
Work-in-process ............................................ -- 183
Finished goods ............................................. 1,032 1,670
------- -------
3,609 6,007
Less: Allowance for excess and obsolete inventory ..... (331) (2,089)
------- -------
$ 3,278 $ 3,918
======= =======
Concentrations
Financial instruments that potentially expose the Company to concentrations
of credit risk consist primarily of cash and cash equivalents and short-term
investments and accounts receivable. The Company invests only in high credit
quality short-term debt instruments and limits the amount of credit exposure to
any one entity.
The Company's sales are primarily concentrated in the United States and are
primarily derived from sales to original equipment manufacturers in the computer
storage and server industry. The Company had trade accounts receivable from four
customers, which comprised approximately 72% and 51% of total trade accounts
receivable at October 31, 1999 and 2000, respectively. The Company performs
credit evaluations of its customers and generally does not require collateral on
accounts receivable balances and provides allowances for potential credit losses
and product sales returns.
The Company's products are concentrated in the storage area network industry
that is highly competitive and subject to rapid technological change. The
Company's supplier arrangement for the production of certain vital components of
its storage routers is concentrated with a small number of key suppliers.
Revenue is concentrated with several major customers. The loss of a major
customer, a change of suppliers or significant technological change in the
industry could affect operating results adversely.
The percentage of sales to significant customers was as follows:
YEAR ENDED OCTOBER 31,
---------------------------
1998 1999 2000
---- ---- ----
Customer A........................... 20% 36% 33%
Customer B........................... 14% 36% 21%
Customer C........................... 25% 4% 7%
Customer D........................... 16% 3% 6%
The level of sales to any customer may vary from quarter to quarter.
However, the Company expects that significant customer concentration will
continue for the foreseeable future. The loss of any one of these customers, or
a decrease in the level of sales to any one of these customers, could have a
material adverse impact on the Company's financial condition or results of
operations. In July 2000, Crossroads recorded a $1.3 million write-down of
inventory resulting from StorageTek Technology Corporation's ("StorageTek")
shift in demand to the Company's newer products and Compaq Computer
Corporation's ("Compaq") plan to transition out of the Company's 4100/4200
router solutions and replace them with its own solution.
F-7
48
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
Fair Value of Financial Instruments
The fair values of the Company's cash and cash equivalents and accrued
expenses approximate their carrying values due to their short maturities. The
fair value of the Company's debt obligations approximates their carrying values
based on interest rates currently available for instruments with similar terms.
Property and Equipment
The Company's property and equipment are stated at cost and depreciated
using the straight-line method over the estimated useful lives of the respective
assets, generally one to three years for equipment and five years for furniture
and fixtures. Leasehold improvements are amortized on a straight-line basis over
the shorter of the estimated useful life of the related asset or the remaining
life of the lease. Upon retirement or disposition of assets, the cost and
related accumulated depreciation are removed from the accounts, and the related
gains or losses are reflected in operations.
Property and equipment consist of the following:
OCTOBER 31,
----------------------
1999 2000
-------- --------
Equipment ............................................. $ 3,536 $ 12,013
Furniture and fixtures ................................ 146 1,911
Leasehold improvements ................................ 245 916
-------- --------
3,927 14,840
Less: accumulated depreciation and amortization ....... (1,654) (4,778)
-------- --------
$ 2,273 $ 10,062
======== ========
Goodwill and Purchased Intangible Assets
Goodwill and purchased intangible assets are carried at cost less
accumulated amortization. Amortization is computed using the straight-line
method over the economic lives of the respective assets, generally three to
fifteen years.
Revenue Recognition
Revenue from product sales to customers that do not have rights of return,
including product sales to original equipment manufacturers and certain
distributors, resellers and system integrators, are recognized upon shipment.
Sales and cost of sales related to customers that have rights of return are
deferred and subsequently recognized upon sell-through to end-users. The Company
provides for the estimated cost to repair or replace products under warranty and
technical support costs when the related product revenue is recognized. Deferred
revenues as of October 31, 1999 and 2000 were approximately $117 and $1,097,
respectively.
Advertising Costs
The Company expenses all advertising costs as incurred.
Stock-Based Compensation
Stock-based compensation is recognized using the intrinsic value method
prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," ("APB 25") and related interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the fair value of the Company's stock at the date of grant over the
amount an employee must pay to acquire the stock amortized over the vesting
period. In 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123"), which
establishes a fair value based method of accounting for stock-based plans.
Companies that elect to account for stock-based compensation plans in
F-8
49
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
accordance with APB 25 are required to disclose the pro forma net income (loss)
that would have resulted from the use of the fair value based method.
Accordingly, pro forma disclosures that are required under SFAS No. 123 are
included in Note 8.
Income Taxes
The Company accounts for income taxes in accordance with the liability
method. Under the liability method, deferred tax assets and liabilities are
recorded for the expected future tax consequences of temporary differences
between the financial reporting and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized. The Company recorded
no income tax expense during the years ended October 31, 1998, 1999, and 2000.
The Company has provided a full valuation allowance because the realization of
tax benefits associated with net operating loss carry-forwards is not considered
more likely than not.
Computation of Net Loss Per Share
The Company adopted the provisions of SFAS No. 128, "Earnings Per Share,"
("SFAS No. 128") for all periods presented. SFAS No. 128 was adopted by the
Company beginning January 1, 1998. Pursuant to the Securities and Exchange
Commission Staff Accounting Bulletin No. 98, common stock and convertible
preferred stock issued or granted for nominal consideration prior to the
anticipated effective date of an initial public offering must be included in the
calculation of basic and diluted net income (loss) per common share as if such
stock had been outstanding for all periods presented. To date, the Company has
not had any issuances or grants for nominal consideration.
In accordance with SFAS No. 128, basic earnings per share is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding for the period, less shares subject to repurchase.
Diluted earnings per share is computed by giving effect to all dilutive
potential common shares that were outstanding during the period. Basic earnings
per share excludes the dilutive effect of common stock equivalents such as stock
options, while earnings per share, assuming dilution, includes such dilutive
effects. Future weighted-average shares outstanding calculations will be
impacted by the following factors: (i) the ongoing issuance of common stock
associated with stock option exercises; (ii) the issuance of common shares
associated with the Company's employee stock purchase program; (iii) any
fluctuations in the Company's stock price, which could cause changes in the
number of common stock equivalents included in the earnings per share, assuming
dilution computation; and (iv) the issuance of common stock to effect business
combinations should the Company enter into such transactions.
The Company has excluded all redeemable convertible preferred stock, up
until the date of their conversion, and all outstanding stock options from the
calculation of diluted net loss per share because all such securities are
antidilutive for all periods presented. The total number of common stock
equivalents excluded from the calculations of diluted net loss per common share
were 13,556,157, 15,103,255, and 4,653,318 for the years ended October 31, 1998,
1999 and 2000, respectively.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," ("SFAS No. 130"). SFAS No. 130 was adopted by
Crossroads beginning on November 1, 1997. This standard defines comprehensive
income as the changes in equity of an enterprise except those resulting from
stockholders transactions. Accordingly, comprehensive income (loss) includes
certain changes in equity that are excluded from net income (loss). The Company
has had no items of comprehensive income for each of the three years presented
and accordingly, comprehensive loss for all periods presented approximated net
loss.
Reportable Segments
In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," ("SFAS No. 131"). SFAS No. 131 establishes
standards for disclosures about operating segments,
F-9
50
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
products and services, geographical areas and major customers. The Company is
organized and operates as one operating segment, the design, development,
manufacturing, marketing and selling of Fibre Channel storage solutions for
SAN's. Service revenues to date have not been significant. The Company operates
principally in one geographic area, the United States. During fiscal 2000, the
Company opened a sales office in the United Kingdom. Subsequent to October 31,
2000, the Company opened a sales office in Germany. Major customers are
discussed above.
Impairment of Long-Lived Assets
The Company assesses long-lived assets for impairment under FASB's SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of."
Under those rules, goodwill associated with assets acquired in a purchase
business combination is included in impairment evaluations when events or
circumstances exist that indicate the carrying amount of those assets may not be
recoverable based on the undiscounted cash flows of the businesses acquired over
the remaining amortization period. Should the review indicate that goodwill is
not recoverable, the Company's carrying value of the goodwill would be reduced
by the estimated shortfall of the cash flows.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," (SFAS No. 133) which establishes accounting and reporting
standards for derivative instruments, including derivative instruments embedded
in other contracts, and for hedging activities. SFAS No. 133, as amended by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities --
Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB
Statement No. 133," is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. The Company does not currently engage or plan to
engage in hedging activities or intend to own or plan to purchase any derivative
instruments.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation -- an interpretation of APB
Opinion 25," ("Interpretation No. 44") which is generally effective July 1,
2000. Interpretation No. 44 clarifies the application of APB Opinion 25 for
certain matters, specifically (a) the definition of an employee for purposes of
applying APB Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. The adoption of Interpretation No. 44 did not have a material
impact on the financial position or the results of operations.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," ("SAB No. 101") which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements. SAB No. 101 will
be effective for all fiscal quarters of fiscal years beginning after December
15, 1999. The Company is currently in the process of evaluating SAB 101 and what
effect it may have on its financial statements. As of this date, the Company has
not determined whether SAB 101 will have a material impact on it financial
position or results of operations; however, it may require a portion of the
fiscal year 2001 revenues to be deferred. In the event that the implementation
of SAB 101 requires the Company to report a change in accounting principles
related to its revenue recognition policy, the Company would be required to
report such change no later than the quarter ending October 31, 2001.
Reclassifications
Certain reclassifications have been made to prior year balances in order to
conform to current year presentation.
3. ACQUISITION OF POLARIS:
On March 21, 2000, Crossroads consummated its acquisition of Polaris.
Polaris was a leading developer and marketer of S/390 mainframe communication
interfaces and systems delivering increased connectivity and
F-10
51
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
bandwidth options to enterprise data centers, focusing on high-speed connections
between open-systems and mainframes. The aggregate purchase price of $46.6
million consisted of the issuance of 428,625 shares of Crossroads common stock
valued at approximately $44.5 million, the issuance of 21,375 options to
purchase Crossroads common stock valued at approximately $1.9 million and $0.2
million of other direct acquisition costs. The results of operations of Polaris
and the estimated fair value of the assets acquired and liabilities assumed are
included in Crossroads' financial statements from the date of acquisition.
The purchase price was allocated to the assets acquired and liabilities
assumed based on Crossroads' estimates of fair value. The fair value assigned to
intangible assets acquired was based on a valuation prepared by an independent
third-party appraisal company and consists of proven research and development,
the in-place workforce and the installed customer base. The purchase price
exceeded the amounts allocated to tangible and intangible assets acquired less
liabilities assumed by approximately $41.3 million. The assigned values are
being amortized on a straight-line basis. Amortization of intangibles totaled
approximately $8.8 million for the fiscal year ended October 31, 2000.
The Company's allocation of the purchase price and the resulting assigned
values for the net assets acquired as of March 21, 2000 are as follows:
VALUE ASSIGNED AMORTIZABLE
TO NET ASSETS LIFE
BALANCE SHEET CATEGORY ACQUIRED (YEARS)
------------------------------------------ -------------- -----------
Intangible assets:
Proven research and development $ 1,030 5 - 7
In-place workforce 1,800 4
Customer base 340 15
Goodwill 41,324 3
--------
44,494
Less: accumulated amortization (8,808)
--------
Intangible assets, net at October 31, 2000 $ 35,686
========
Other assets, net of liabilities assumed $ 2,121
========
The following table represents unaudited consolidated pro forma information
as if Crossroads and Polaris had been combined as of the beginning of the
periods presented. The pro forma data is presented for illustrative purposes
only and is not necessarily indicative of the combined financial position or
results of operations of future periods or the results that actually would have
occurred had Crossroads and Polaris been a combined company during the specified
periods. The pro forma combined results include the effects of the purchase
price allocation, amortization of intangible assets, and certain adjustments
required to conform to Crossroads' accounting policies.
PRO FORMA
YEAR ENDED
OCTOBER 31,
----------------------
1999 2000
-------- --------
Total revenue ........... $ 21,255 $ 35,248
Net loss ................ $(20,341) $(62,652)
Net loss per share ...... $ (2.60) $ (2.33)
4. LINE OF CREDIT AND DEBT:
At October 31, 2000, the Company had an unused line of credit of $2,500 and
an equipment line of $1,900. The amount available for borrowings under the line
of credit arrangement at any point in time is based upon eligible accounts
receivable and inventory balances. Borrowings under the equipment line may be
used to purchase general operating equipment. Interest accrues and is payable
monthly on outstanding balances under these lines at the bank's prime rate
(8.25% and 9.5% at October 31, 1999 and 2000, respectively). Outstanding
borrowings under the equipment
F-11
52
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
line were $1.1 million and $0 at October 31, 1999 and 2000, respectively. The
last draw date under the line of credit arrangement and the equipment line was
in August 2000. In November 2000, the Company extended the line of credit
arrangement and the equipment line through December 2000, and the Company is
currently negotiating to extend the credit facility.
At October 31, 1999, the Company had a term loan with a bank, the proceeds
of which were used to finance equipment purchases. Borrowings outstanding under
the term loan bear interest at the bank's prime rate plus 0.5% (8.75% at October
31, 1999) and were payable in equal monthly installments of principal and
interest through April 2002.
Borrowings under the line of credit and equipment line arrangements are
collateralized by substantially all assets of the Company, excluding
intellectual property. Under the provisions of these credit arrangements, the
Company is prohibited from declaring or paying dividends. Additionally, the
Company must meet certain quarterly minimum financial covenants, including
minimum tangible net worth, liquidity ratio and profitability covenants. During
certain quarters in 1999 and 2000, the Company was not in compliance with its
profitability covenant.
In December 1999, the Company paid off the remaining balance, principal plus
accrued interest, under its existing term loan and equipment line.
5. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases office space and equipment under long-term operating
lease agreements that expire on various dates through January 31, 2006. Rental
expense under these agreements was approximately $327, $466, and $1,611 for the
years ended October 31, 1998, 1999, and 2000, respectively. In April 2000,
Crossroads relocated its headquarters in accordance with an agreement to lease
approximately 63,548 square feet of general office, laboratory, and
administrative space in Austin, Texas. The term of the lease agreement is six
years, from April 1, 2000 through March 31, 2006, and represents a lease
commitment of $1.7 million per year for the first three years and $1.8 million
per year, thereafter. In conjunction with entering into the lease agreement,
Crossroads signed an unconditional, irrevocable letter of credit with a bank for
$1.0 million, which is secured by a $1.0 million certificate of deposit.
The minimum annual future rentals under the terms of these leases at October
31, 2000 are as follows:
FISCAL YEAR
-----------
2001 ......................................... $ 2,028
2002 ......................................... 1,924
2003 ......................................... 1,924
2004 ......................................... 1,940
2005 ......................................... 1,825
thereafter ................................... 758
-------
$10,399
=======
Legal Proceedings
On March 31, 2000, Crossroads filed a lawsuit against Chaparral Network
Storage, Inc. ("Chaparral") alleging that Chaparral has infringed one of its
patents with some of their router products. The lawsuit was filed in United
States District Court for the Western District of Texas, and the Company is
seeking injunctive relief as well as damages. The case has been assigned to a
Federal District Court Judge, who has already conducted a claims construction
hearing and provided an order resolving claim construction issues. The Company
has started the discovery process. Trial is currently scheduled to begin in the
second half of 2001. Management intends to vigorously prosecute its claims. The
Company believes it should ultimately prevail on this litigation. However, no
assurance can be given as to the outcome of this action.
F-12
53
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
On April 14, 2000, Crossroads filed a lawsuit against Pathlight Technology,
Inc. ("Pathlight") alleging that Pathlight has infringed one of its patents with
their SAN Data Gateway Router. The lawsuit was filed in United States District
Court for the Western District of Texas and the Company is seeking injunctive
relief as well as damages. The case has been assigned to a Federal District
Court Judge, who has already conducted a claims construction hearing and
provided an order resolving claim construction issues. The Company has started
the discovery process. Trial is currently scheduled to begin in the first half
of 2001. Management intends to vigorously prosecute its claims. The Company
believes it should ultimately prevail on this litigation. However, no assurance
can be given as to the outcome of this action.
On May 19, 2000, Chaparral filed a counter-suit against Crossroads alleging
tortious interference with prospective business relations. The lawsuit was filed
in District Court, Boulder County, Colorado and Chaparral is seeking injunctive
relief as well as damages. Chaparral claims that the Company has made statements
that Chaparral has infringed the Company's patent rights and that these
statements are false and defamatory. Given the overlapping allegations with the
patent litigation, this case was transferred to the District Court for the
Western District of Texas and consolidated with the aforementioned pending
patent litigation. The complaints are at an early stage. Consequently, at this
time it is not possible to predict whether the Company will incur any liability
or to estimate its amount, if any.
The Company and several of its officers and directors were named as
defendants in several class action lawsuits filed in the United States District
Court for the Western District of Texas. The plaintiffs in the actions purport
to represent purchasers of the Company's common stock during various periods
ranging from January 25, 2000 through August 24, 2000. The Court consolidated
the actions and appointed a lead plaintiff under the Private Securities
Litigation Reform Act of 1995. The Company intends to file a motion to dismiss
the consolidated amended complaint once it has been filed. The Company believes
that it has meritorious defenses to the lawsuit and intends to defend itself
vigorously. However, no assurance can be given as to the outcome of this action.
The inability of the Company to prevail in this action could have a material
adverse effect on the Company's future business, financial condition and results
of operations. At October 31, 2000, the Company has accrued $555 for estimated
attorneys' fees to be incurred in the defense of this action.
Other
If the Company reduces or cancels production orders with its third party
contract manufacturer, the Company may be required to reimburse its contract
manufacturer for materials purchased on its behalf.
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK:
Conversion
All shares of the Company's redeemable convertible preferred stock were
converted into common stock of the Company on October 19, 1999, the effective
date of the Company's initial public offering, at the rate of 1.5 to 1.
Authorized Shares
The Company has the authority to issue 25,000,000 million shares of
preferred stock, par value $.001 per share, subject to the designation of the
board of directors. At October 31, 1999 and 2000, no shares of preferred stock
were issued or outstanding.
7. STOCKHOLDERS' (DEFICIT) EQUITY:
Amendment to Certificate of Incorporation and Stock Split
On September 15, 1999, the Company's board of directors authorized the
amendment of the Company's Certificate of Incorporation and changed the
aggregate number of shares of capital stock authorized to be issued to
175,000,000 shares of common stock and 25,000,000 shares of preferred stock. The
board of directors also
F-13
54
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
authorized and the Company effected a three-for-two stock split for outstanding
shares of common stock. All share information included in the accompanying
consolidated financial statements and notes thereto have been retroactively
adjusted to reflect the stock split and the increase in the number of authorized
shares.
Initial Public Offering
In October 1999, the Company completed its initial public offering of
4,312,500 shares of its common stock including the exercise of the underwriters'
over-allotment option. A total of 4,037,500 of those shares of common stock were
sold by the Company resulting in net proceeds of $66,232 after deducting
offering expenses and the underwriting discount of $6,443.
Deferred Compensation
In connection with the grant of certain stock options to employees and
directors, the Company recorded deferred compensation aggregating $18.5 million
in 1998, 1999, and 2000, representing the difference between the deemed fair
value of the common stock underlying these options and their exercise price at
the date of grant. Such amount is presented as a reduction of stockholders'
equity and is being amortized over the vesting period of the applicable periods,
generally four years. Deferred compensation expense is decreased in the period
of forfeiture for any accrued but unvested compensation arising from the early
termination of an option holder's services. Of the total deferred compensation
amount, approximately $8.8 million has been amortized as of October 31, 2000.
On March 1, 2000, Crossroads announced that Larry Sanders was named
president and chief operating officer of the Company. He succeeds Jim Moore, who
retired effective March 3, 2000. The Company recorded approximately $16.5
million of stock-based compensation in connection with accelerating the vesting
of certain stock options previously granted to Mr. Moore.
During June 2000, Crossroads recorded approximately $3.8 million of
stock-based compensation in connection with accelerating the vesting of certain
stock options previously granted to the Company's vice president of sales, who
departed effective June 2, 2000.
The Company allocates stock-based compensation to specific line items within
the statement of operations based on the classification of the employees who
received the benefit.
Stock-based compensation for the periods indicated was allocated as follows
(in thousands):
YEAR ENDED OCTOBER 31,
-------------------------------
1998 1999 2000
------- ------- -------
Cost of revenue ........................ $ 2 $ 133 $ 288
Sales and marketing .................... 30 372 4,373
Research and development ............... 6 280 528
General and administrative ............. 3 420 22,501
------- ------- -------
Total stock-based compensation ....... $ 41 $ 1,205 $27,690
======= ======= =======
The Company currently expects to amortize the remaining amounts of deferred
stock-based compensation as of October 31, 2000 in the periods indicated (in
thousands):
YEAR ENDED OCTOBER 31,
---------------------------------------
2001 2002 2003 2004 TOTAL
------ ------ ------ ------ ------
Cost of revenue ........................ $ 122 $ 56 $ 12 $-- $ 190
Sales and marketing .................... 156 81 14 -- 251
Research and development ............... 226 101 20 -- 347
General and administrative ............. 5,535 2,378 943 90 8,946
------ ------ ------ ------ ------
Total stock-based compensation .... $6,039 $2,616 $ 989 $ 90 $9,734
====== ====== ====== ====== ======
F-14
55
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
8. STOCK INCENTIVE/PURCHASE PLANS:
1999 Stock Incentive Plan
The 1999 Stock Incentive Plan the ("1999 Plan") is the successor program
to the Company's 1996 Stock Option/Stock Issuance Plan (the "1996 Plan"). The
1999 Plan became effective in October 1999. At that time, all outstanding
options under the 1996 Plan transferred to the 1999 Plan, and no further options
will be granted under the 1996 Plan. The 1999 Plan has five separate programs:
- the discretionary option grant program, under which eligible employees
may be granted options to purchase shares of the Company's common stock at
an exercise price not less than the fair market value of those shares on the
grant date;
- the stock issuance program, under which eligible individuals may be
issued shares of common stock directly, upon the attainment of performance
milestones, the completion of a specified period of service or as a bonus
for past services;
- the salary investment option grant program, under which the Company's
executive officers and other highly compensated employees may be given the
opportunity to apply a portion of their base salary each year to the
acquisition of special below-market stock option grants;
- the automatic option grant program, under which option grants will
automatically be made at periodic intervals to eligible non-employee board
members to purchase shares of common stock at an exercise price equal to the
fair market value of those shares on the grant date; and
- the director fee option grant program, under which the Company's
non-employee board members may be given the opportunity to apply a portion
of any retainer fee otherwise payable to them in cash each year to the
acquisition of special below-market option grants.
The 1999 Plan provides for a maximum number of common shares to be
optioned/issued of 6,375,000. Accordingly, the Company has reserved a sufficient
number of shares of common stock to permit exercise of options or issuance of
common shares in accordance with the terms of the Plan. The share reserve under
the 1999 Plan will automatically increase on the first trading day in January of
each calendar year, beginning with calendar year 2001, by an amount equal to two
percent (2%) of the total number of shares of common stock outstanding on the
last trading day of December in the prior calendar year, but in no event will
this annual increase exceed 500,000 shares. Non-Statutory stock options may be
granted to Company employees, members of the board, and consultants at the
exercise price determined by the board of directors or by the Company's
compensation committee.
Stock appreciation rights may be issued to certain officers subject to
Section 16 of the Securities Exchange Act of 1934 under the discretionary option
grant program. These rights will provide the holders with the election to
surrender their outstanding options for a payment from us equal to the fair
market value of the shares subject to the surrendered options less the exercise
price payable for those shares. The Company may make the payment in cash or in
shares of common stock. None of the options originally issued under the 1996
Plan have any stock appreciation rights.
F-15
56
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
The following table summarizes stock option activity under all of the Plans
for all periods presented:
YEAR ENDED OCTOBER 31,
---------------------------------------------------------------------------------------------
1998 1999 2000
------------------------- -------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ---------- ---------- ---------- --------- ----------
Outstanding at beginning
of period ................. 2,197,500 $ 0.10 2,614,125 $ 0.16 1,470,336 $ 673
Granted ...................... 1,273,500 0.25 1,590,646 6.48 2,820,895 45.72
Exercised .................... (400,968) 0.10 (2,534,112) 0.30 (447,990) 0.63
Cancelled .................... (455,907) 0.15 (200,322) 0.45 (425,725) 33.13
--------- --------- ---------
Outstanding at end of
period .................... 2,614,125 $ 0.16 1,470,337 $ 6.73 3,417,516 $ 36.42
========= ========= =========
Options exercisable at the
end of the period ......... 2,614,125 1,470,337 841,371
========= ========= =========
At October 31, 2000 the Company had the right to repurchase 213,605 shares
of outstanding common stock issued upon exercise of stock options with a
weighted average exercise price of $0.74.
The Company has elected to follow the provisions prescribed by APB 25 and
its related interpretations, for financial reporting purposes, whereby the
difference between the exercise price and the fair value at the date of grant is
recognized as compensation expense (see Note 7, Stockholders' (Deficit) Equity -
Deferred Compensation).
The Company has adopted the disclosure provisions of SFAS No. 123.
Accordingly, no compensation expense has been recognized for the Plan under the
provisions of SFAS No. 123. Had compensation cost for the Plan been determined
based upon the fair value at the grant date for employee awards under the Plan
consistent with the methodology prescribed under SFAS No. 123, the Company's net
loss would have been increased or decreased, respectively, to the following pro
forma amounts:
YEAR ENDED OCTOBER 31,
------------------------------------------
1998 1999 2000
---------- ---------- ----------
Net loss attributable to common stock -- as reported ....... $ (5,550) $ (5,432) $ (51,027)
Net loss attributable to common stock -- pro forma ......... $ (5,598) $ (5,625) $ (24,909)
Basic and diluted net loss per share -- as reported ........ $ (0.90) $ (0.74) $ (1.93)
Basic and diluted net loss per share -- pro forma .......... $ (0.91) $ (0.76) $ (0.94)
YEAR ENDED OCTOBER 31,
-------------------------------------------------
1998 1999 2000
------------- ------------- -------------
Weighted average grant-date fair value of options granted:
Exercise price equal to market price of stock on
the grant date:
Aggregate value ................................ $ 38 $ 3,933 $ 68,757
============= ============= =============
Per share value ................................ $ 0.04 $ 6.65 $ 33.48
============= ============= =============
Exercise price less than the market price of
stock on the grant date:
Aggregate value ................................ $ 288 $ 4,891 $ 60,571
============= ============= =============
Per share value ................................ $ 0.84 $ 4.90 $ 78.95
============= ============= =============
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1998, 1999 and 2000: no dividend yield; risk-free
interest rate of 5.71%, 5.57% and 6.07%; expected volatility of 0%, 109%, and
120%; expected lives of four years, respectively.
F-16
57
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
The following table summarizes information with respect to stock options
outstanding under all plans at October 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- -----------------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING REMAINING YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------------------- ----------- ---------------- ---------------- ----------- ----------------
$ 0.23 - $ 0.23........... 53,302 6.6 $ 0.23 53,302 $ 0.23
$ 0.50 - $ 0.50........... 78,668 8.1 $ 0.50 78,668 $ 0.50
$ 0.83 - $ 1.00........... 161,522 8.1 $ 0.95 161,522 $ 0.95
$ 1.33 - $ 1.33........... 69,779 8.7 $ 1.33 69,779 $ 1.33
$ 4.56 - $ 5.00........... 1,053,740 9.7 $ 4.56 2,250 $ 5.00
$ 6.94 - $ 10.00........... 332,330 9.4 $ 8.63 148,550 $ 10.00
$ 11.25 - $ 13.81........... 39,830 9.8 $ 13.20 -- $ --
$ 18.00 - $ 25.25........... 335,925 8.6 $ 18.19 326,925 $ 18.00
$ 39.88 - $ 39.88........... 481,670 9.5 $ 39.88 -- $ --
$ 64.88 - $ 90.25........... 355,270 9.3 $ 84.80 375 $ 84.50
$103.25 - $142.75........... 455,480 9.3 $ 132.89 -- $ --
--------- --------- --------- --------- ---------
$ 0.23 - $142.75........... 3,417,516 9.3 $ 36.42 841,371 $ 9.16
========= ========= ========= ========= =========
Options granted to non-employees are recorded at fair value in accordance
with SFAS No. 123. These options were issued pursuant to the 1996 Plan and 1999
Plan and are reflected in the disclosures above. The Company granted 7,500, 0
and 5,000 options to non-employees for consulting services in fiscal 1998, 1999,
and 2000 at a weighted average exercise price of $0.23, $0, and $6.94,
respectively. In connection with the grant of the stock options to
non-employees, the Company recorded deferred compensation during October 2000
aggregating approximately $35. The amortization associated with these options
totaled approximately $4 during the fiscal year ended October 31, 2000.
The 1999 Plan includes change in control provisions that may result in the
accelerated vesting of outstanding option grants and stock issuances. The 1999
Plan will terminate no later than September 30, 2009.
Employee Stock Purchase Plan
The Company's Employee Stock Purchase Plan (the "Plan") became effective
immediately upon the effective date of the Company's initial public offering.
The Plan is designed to allow eligible employees to purchase shares of common
stock, at semi-annual intervals, with their accumulated payroll deductions. The
Company has reserved 450,000 shares of common stock for issuance under the Plan.
The reserve will automatically increase on the first trading day of January in
each calendar year, beginning in calendar year 2001, by an amount equal to one
percent (1%) of the total number of outstanding shares of common stock on the
last trading day of December in the prior calendar year. In no event will any
such annual increase exceed 250,000 shares.
Eligible employees may contribute up to 15% of his or her base salary
through payroll deductions, and the accumulated deductions will be applied to
the purchase of shares on each semi-annual purchase date. The purchase price per
share will be equal to 85% of the fair market value per share on the
participant's entry date into the eligible offering period or, if lower, 85% of
the fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of May and November each
year. However, a participant may not purchase more than 750 shares on any one
semi-annual purchase date, and no more than 75,000 shares may be purchased in
total by all participants on any one semi-annual purchase date.
Should the Company be acquired by merger or sale of substantially all of its
assets or more than fifty percent of its voting securities, then all outstanding
purchase rights will automatically be exercised immediately prior to the
effective date of the acquisition. The purchase price will be equal to 85% of
the market value per share on the participant's entry date into the offering
period in which an acquisition occurs or, if lower, 85% of the fair market value
per share immediately prior to the acquisition.
F-17
58
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
The Plan will terminate no later than the last business day of November
2009. The board may at any time amend, suspend or discontinue the Plan. However,
certain amendments may require stockholder approval.
9. INCOME TAXES:
As of October 31, 1999 and 2000 the Company had federal net operating loss
carryforwards of approximately $10,512 and $39,571, respectively and research
and experimentation tax credit carryforwards of approximately $370 and $475,
respectively. The Company's net operating loss carryforward is subject to a
limitation on its utilization.
Under the provisions of SFAS No. 109, "Accounting for Income Taxes," ("SFAS
109") the components of the net deferred tax amounts recognized in the
accompanying balance sheets are as follows:
OCTOBER 31,
----------------------
1999 2000
-------- --------
Deferred tax assets:
Net operating losses ................................ $ 3,898 $ 14,246
Inventory and other reserves ........................ 440 4,078
Basis of property and equipment ..................... 133 524
Research and experimentation credit ................. 455 475
-------- --------
Net deferred tax assets before valuation allowance .... 4,926 19,323
Valuation allowance ................................... (4,926) (19,323)
-------- --------
Net deferred tax asset ................................ $ -- $ --
======== ========
Due to the uncertainty surrounding the realization of the benefits of its
favorable tax attributes in future tax returns, the Company has placed a
valuation allowance against all of its otherwise recognizable net deferred tax
asset.
Following is a reconciliation of the amount of the income tax benefit that
would result from applying the statutory Federal income tax rates to pretax loss
and the reported amount of income tax benefit:
YEAR ENDED OCTOBER 31,
------------------------------------
1998 1999 2000
-------- -------- --------
Tax benefit at statutory rate of 36% ............. $ 1,810 $ 1,874 $ 18,370
State income tax benefit ......................... 160 -- --
Research and experimentation credit .............. 92 246 19
Net increase in valuation allowance .............. (2,060) (1,694) (14,397)
Amortization of stock-based compensation ......... -- (410) --
Non-deductible goodwill .......................... -- (31) (4,111)
Prior period net operating loss adjustment ....... -- -- 208
Permanent difference and other ................... (2) 15 (89)
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
Under the Tax Reform Act of 1986, the amount of and the benefit from net
operating losses that can be carried forward may be impaired in certain
circumstances. Events that may cause changes in the Company's tax carryovers
include, but are not limited to, a cumulative ownership change of more than 50%
over a three-year period. Certain of the Company's operating losses that can be
utilized in any one taxable year for federal tax purposes have been limited by
one or more such ownership changes. For federal income tax purposes, net
operating loss carryforwards begin to expire in 2011.
10. RELATED PARTY TRANSACTIONS:
Product Sales
The Company recorded product sales of $1,343 and $1,235 to certain holders
of shares of redeemable convertible preferred stock of the Company for the years
ended October 31, 1998 and 1999, respectively. Accounts
F-18
59
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
receivable from these preferred stockholders totaled approximately $181 and $378
at October 31, 1998 and 1999, respectively. During 1999, all shares of the
Company's redeemable convertible preferred stock were converted into common
stock (see Note 6). The Company recorded product sales of $4,151 to these
significant shareholders for the year ended October 31, 2000 while the related
accounts receivable totaled approximately $1,150 at October 31, 2000.
Notes Receivable
During May 1999, the Company's board of directors approved the acceptance of
full recourse notes in the amount of $442 from certain of the Company's officers
as consideration for the exercise of 1,014,999 options. The notes accrue
interest at 7% per year, compounded semi-annually and principal and accrued
interest are due in one lump sum in 2003. In March 2000, the Company repurchased
232,500 unvested shares for approximately $123 upon the retirement of the
Company's former president and chief operating officer. In June 2000, the
Company repurchased 88,125 unvested shares for approximately $52 and collected
approximately $59 in principal and interest payments upon the retirement of the
Company's former vice-president of sales. The principal balance of these full
recourse notes was approximately $215 as of October 31, 2000.
In October 1999, the Company loaned an officer of the Company $100 in
exchange for a full recourse promissory note due in full, with accrued interest,
in 6 years or upon the date in which the officer ceases to remain in service.
The note accrues interest at 7% per year, compounded annually and principal and
accrued interest are due in one lump sum on December 31, 2006.
11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest totaled $65, $113, and $34 during fiscal year 1998,
1999 and 2000, respectively.
Accretion on redeemable convertible preferred stock totaled $196, $247, and
$0 during fiscal year 1998, 1999 and 2000, respectively.
Loans to officers and notes receivable from stockholders totaled $0, $542,
and $365 during fiscal year 1998, 1999 and 2000, respectively.
12. EMPLOYEE BENEFITS:
In 1996, the Company established the Crossroads Systems, Inc. 401(k) Savings
Plan (the "1996 Plan"), which is a qualified plan under section 401(k) of the
Internal Revenue Code. All employees who have attained 18 years of age are
eligible to enroll in the 1996 Plan. The Company may make matching contributions
to those employees participating in the 1996 Plan based upon Company
productivity and profitability. Company contributions vest over a period of six
years. In October 2000, the Company adopted a new 401(k) Savings Plan that meets
all of the criteria set forth above in the 1996 Plan. The Company made no
matching contributions under any plan for the years ended October 31, 1998,
1999, and 2000.
13. EVENT (UNAUDITED) SUBSEQUENT TO DATE OF REPORT OF INDEPENDENT ACCOUNTANTS:
During January 2000, the Company's Board of Directors approved stock option
grants totaling 950,000 to certain of its officers pursuant to the 1999 Plan.
14. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA:
QUARTER
----------------------------------------------------------- FISCAL
FIRST SECOND THIRD FOURTH YEAR 2000
-------- -------- -------- -------- ---------
Total revenue(1) .............................. $ 8,793 $ 11,123 $ 4,779 $ 8,353 $ 33,048
Gross profit(1)(2) ............................ $ 4,070 $ 5,458 $ 590 $ 3,826 $ 13,944
Net loss ...................................... $ (923) $(21,631) $(17,830) $(10,644) $(51,028)
Basic and diluted net loss per share .......... $ (0.04) $ (0.83) $ (0.67) $ (0.39) $ (1.93)
(1) During the third quarter of fiscal 2000, the Company recorded a $1.1
million return and a $1.3 million write-down of inventory resulting from
StorageTek's shift in demand to the Company's newer products and Compaq's
plan to transition out of the Company's 4100/4200 router solutions and
replace them with their own solution.
(2) Gross profit for the first and second quarters have been restated to
include stock-based compensation expense of $85 and $82, respectively. See
Note 7.
F-19
60
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders of Crossroads Systems, Inc. and
Subsidiaries
Our audits of the consolidated financial statements referred to in our
report dated November 28, 2000 appearing in the 2000 Annual Report to
Shareholders of Crossroads Systems, Inc. (which report and consolidated
financial statements are included in this Annual Report on Form 10-K) also
included an audit of the financial statement schedule listed in Item 14(a)(2) of
this Form 10-K. In our opinion, this financial statement schedule presents
fairly, in all materials respects, the information set forth therein when read
in conjunction with the related financial statements.
PRICEWATERHOUSECOOPERS LLP
Austin, Texas
November 28, 2000
S-1
61
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
(IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
---------- ---------- ---------- ----------
Year ended October 31, 1998:
Allowance for doubtful accounts ................ $ 8 $ 6 $ -- $ 14
Allowance for excess and obsolete inventory .... $ -- $ 44 $ (9) $ 35
Year ended October 31, 1999:
Allowance for doubtful accounts ................ $ 14 $ 81 $ -- $ 95
Allowance for excess and obsolete inventory .... $ 35 $ 296 $ -- $ 331
Year ended October 31, 2000:
Allowance for doubtful accounts ................ $ 95 $ 136 $ -- $ 231
Allowance for excess and obsolete inventory .... $ 331 $2,071 $ (313) $2,089
S-2
62
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1* Sixth Amended and Restated Certificate of Incorporation (filed
as Exhibit 3.1 to the Registrant's Registration Statement on
Form S-1 (SEC File No. 333-85505) (the "IPO Registration
Statement") and incorporated herein by reference)
3.2* Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO
Registration Statement and incorporated herein by reference)
4.1* Specimen certificate for shares of common stock (filed as
Exhibit 4.1 to the IPO Registration Statement and incorporated
herein by reference)
10.1* Form of Indemnity Agreement between Registrant and each of its
directors and executive officers (filed as Exhibit 10.1 to the
IPO Registration Statement and incorporated herein by reference)
10.2* Crossroads Systems, Inc. 1999 Stock Incentive Plan (filed as
Exhibit 10.2 to the IPO Registration Statement and incorporated
herein by reference)
10.3* Crossroads Systems, Inc. 1999 Employee Stock Purchase Plan
(filed as Exhibit 10.3 to the IPO Registration Statement and
incorporated herein by reference)
10.4* Fourth Amended and Restated Investors Rights Agreement dated
August 6, 1999 by and among Registrant and certain purchasers of
Registrant's preferred stock (filed as Exhibit 10.4 to the IPO
Registration Statement and incorporated herein by reference)
10.5*+ OEM Agreement dated April 23, 1998 by and between Registrant and
Storage Technology Corporation (filed as Exhibit 10.5 to the IPO
Registration Statement and incorporated herein by reference)
10.6* Form of Stock Pledge Agreement by and between Registrant and
both of Reagan Y. Sakai and John R. Middleton (filed as Exhibit
10.12 to the IPO Registration Statement and incorporated herein
by reference)
10.7* Form of Note Secured by Stock Pledge Agreement issued to
Registrant by both of Reagan Y. Sakai and John R. Middleton
(filed as Exhibit 10.13 to the IPO Registration Statement and
incorporated herein by reference)
10.8* Amended and Restated Loan and Security Agreement dated August
17, 1999 by and between Registrant and Silicon Valley Bank
(filed as Exhibit 10.14 to the IPO Registration Statement and
incorporated herein by reference)
10.9 Loan Modification Agreement dated August 30, 2000 by and between
Registrant and Silicon Valley Bank
10.10* Office Building Lease dated October 8, 1999 by and between
Registrant and Maplewood Associates, L.P. (filed as Exhibit
10.15 to the IPO Registration Statement and incorporated herein
by reference)
10.11* CP4200 License Agreement dated April 15, 1998 by and between
Registrant and Hewlett-Packard Company (filed as Exhibit 10.16
to the IPO Registration Statement and incorporated herein by
reference)
10.12 Letter Agreement dated February 22, 2000 by and between
Registrant and James Moore
10.13 Letter Agreement dated February 28, 2000 by and between
Registrant and Larry Sanders
10.14 Letter Agreement dated May 22, 2000 by and between Registrant
and Robert F. LiVolsi
21.1 List of Principal Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney, pursuant to which amendments to this Form
10-K may be filed, is included on the signature page contained
on Part IV of this Form 10-K
* Incorporated herein by reference to the indicated filing
+ Confidential treatment previously granted