SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 1, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-32269
RIVERSTONE NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4596178
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
5200 Great America Parkway, Santa Clara, CA 95054
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (408) 878-6500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES - X NO -
As of January 7, 2002 there were 121,211,066 shares of the Registrant's common
stock outstanding.
1
INDEX
RIVERSTONE NETWORKS, INC.
Page
Facing Page 1
Index 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - December 1, 2001 and March 3, 2001 3
Condensed Consolidated Statements of Operations - Three months and nine months
ended December 1, 2001 and December 2, 2000 4
Condensed Consolidated Statements of Cash Flows - Nine months ended December 1,
2001 and December 2, 2000 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
2
PART 1. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Riverstone Networks Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
December 1, March 3,
2001 2001
---- ----
Assets
Current Assets:
Cash and cash equivalents ...................... $162,537 $136,765
Cash due from former parent .................... -- 31,184
Short-term investments ......................... 136,231 21,540
Accounts receivable, net ....................... 47,451 29,891
Inventories, net ............................... 16,737 11,169
Prepaid expenses and other current assets ...... 16,835 10,999
-------- --------
Total current assets ......................... 379,791 241,548
-------- --------
Property and equipment, net .................... 20,655 14,020
Intangible and other long-term assets, net ..... 25,236 8,475
Long-term investments .......................... 202,298 --
-------- --------
Total assets ................................. $627,980 $264,043
======== ========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable ............................... $ 30,362 $ 24,514
Deferred revenue ............................... 8,256 10,550
Accrued expenses ............................... 19,382 10,197
-------- --------
Total current liabilities .................... 58,000 45,261
-------- --------
Convertible subordinated notes ................... 175,000 --
Commitments and contingencies
Stockholders' equity:
Common stock ................................... 1,204 1,075
Additional paid in capital ..................... 443,704 269,200
Accumulated deficit ............................ (43,977) (41,488)
Unearned stock-based compensation .............. (7,622) (9,708)
Accumulated other comprehensive income ......... 1,671 (297)
-------- --------
Total stockholders' equity ................... 394,980 218,782
-------- --------
Total liabilities and stockholders' equity ....... $627,980 $264,043
======== ========
See accompanying notes to the unaudited condensed consolidated financial
statements.
3
Riverstone Networks Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
Three months ended Nine months ended
December 1, December 2, December 1, December 2,
2001 2000 2001 2000
---- ---- ---- ----
Net revenues ............................ $ 60,056 $ 26,784 $ 159,473 $ 63,116
Cost of revenues ........................ 25,570 11,643 68,375 28,071
Stock-based compensation ................ 252 -- 438 --
----------- ------------ ----------- ------------
Total cost of revenues ................ 25,822 11,643 68,813 28,071
----------- ------------ ----------- ------------
Gross profit ......................... 34,234 15,141 90,660 35,045
Operating expenses
Research and development .............. 11,399 10,061 38,276 30,566
Sales and marketing ................... 14,497 10,012 41,284 24,902
General and administrative ............ 6,530 3,344 17,345 9,655
Stock-based compensation .............. 764 27,410 2,383 30,662
----------- ------------ ----------- ------------
Total operating expenses ............. 33,190 50,827 99,288 95,785
----------- ------------ ----------- ------------
Operating income/(loss) .............. 1,044 (35,686) (8,628) (60,740)
Interest income, net .................... 1,322 779 6,349 1,545
----------- ------------ ----------- ------------
Net income/(loss) before income taxes 2,366 (34,907) (2,279) (59,195)
----------- ------------ ----------- ------------
Provision for income taxes .............. 210 -- 210 --
----------- ------------ ----------- ------------
Net income/(loss) .................... $ 2,156 $ (34,907) $ (2,489) $ (59,195)
=========== ============ =========== ============
Basic net income/(loss) per share ....... $ 0.02 $(349,070.00) $ (0.02) $(591,950.00)
=========== ============ =========== ============
Weighted average shares used in computing
basic net income/(loss) per share ...... 117,634,310 100 112,014,232 100
=========== ============ =========== ============
Diluted net income/(loss) per share ..... $ 0.02 $(349,070.00) $ (0.02) $(591,950.00)
=========== ============ =========== ============
Weighted average shares used in computing
diluted net income/(loss) per share .... 136,054,605 100 112,014,232 100
============= ============= ============= =============
Pro forma net loss per share:
Basic and diluted ..................... -- $ (0.38) -- $ (0.64)
============= ============= ============= =============
Pro forma weighted average number
of shares outstanding:
Basic and diluted ..................... -- 92,088,235 -- 92,088,235
============= ============= ============= =============
See accompanying notes to the unaudited condensed consolidated financial
statements.
4
Riverstone Networks Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months ended
December 1, December 2,
2001 2000
---- ----
Cash flows from operating activities:
Net loss .............................................................. $ (2,489) $ (59,195)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization .................................. 7,928 5,716
Provision for losses on accounts receivable .................... 5,025 308
Stock-based compensation ....................................... 2,821 30,662
Other non-cash items ........................................... (2,500) --
Changes in assets and liabilities:
Accounts receivable ......................................... (21,862) (1,867)
Inventories ................................................. (3,378) (3,324)
Prepaid expenses and other assets ........................... (4,276) (11,523)
Accounts payable and accrued expenses ....................... 16,483 9,452
Deferred revenue ............................................ (22) 4,711
--------- ---------
Net cash used in operating activities ................. (2,270) (25,060)
--------- ---------
Cash flows from investing activities:
Capital expenditures .................................................. (10,847) (10,207)
Proceeds from matured investments ..................................... 346,786 --
Purchases of short-term, long-term and restricted investments ......... (661,879) --
--------- ---------
Net cash used in investing activities ................. (325,940) (10,207)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock ................................ 149,459 --
Principal payments on note payable .................................... -- (98)
Net transfers from former parent ...................................... 2,799 63,983
Net proceeds from issuance of convertible subordinated notes .......... 170,540 --
Proceeds from issuance of stock purchase rights ....................... -- 7,168
--------- ---------
Net cash provided by financing activities ............. 322,798 71,053
--------- ---------
Net increase/(decrease) in cash and cash equivalents .................. (5,412) 35,786
Cash and cash equivalents at the beginning of period .................. 167,949 --
--------- ---------
Cash and cash equivalents at the end of period ........................ $ 162,537 $ 35,786
========= =========
Other cash flow information:
Cash paid for interest ......................................... $ 280 $ 4
========= =========
Non-cash investing and financing activities:
Issuance of common stock for long-term investments .............. $ 13,000 $ --
========= =========
Assets acquired from and liabilities transferred to former parent $ 8,640 $ --
========= =========
See accompanying notes to the unaudited condensed consolidated financial
statements.
5
RIVERSTONE NETWORKS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note (1) Business Operations
On February 10, 2000, Cabletron Systems, Inc. ("Cabletron") announced its plan
to create an independent publicly-traded company, Riverstone Networks, Inc.
("Riverstone" or the "Company"), comprised of Cabletron's Internet
infrastructure solutions business for Internet service providers and other
service providers. After the completion of Riverstone's initial public offering
on February 22, 2001, Cabletron owned 92,088,235 shares of common stock,
representing approximately 86% of Riverstone's outstanding common stock.
On June 3, 2000, Cabletron, Riverstone and certain related parties entered into
a Transformation Agreement, and Cabletron and Riverstone entered into a
Contribution Agreement. In accordance with the Transformation Agreement,
Cabletron transferred to Riverstone the Cabletron-owned assets and liabilities
which related to the Riverstone business on August 28, 2000 (the "Contribution
Date"). Zeitnet, a Cabletron subsidiary, was also contributed to and then merged
into Riverstone. The accompanying financial statements for the three and nine
months ended December 2, 2000 reflect the historical basis of the
Cabletron-owned assets and liabilities, which were transferred at the
Contribution Date.
On July 24, 2001, Riverstone issued 7,117,757 shares of common stock to
Cabletron in exchange for approximately $122 million in cash and certain
strategic investments, with an historic cost of approximately $13 million. On
August 6, 2001 (the "Distribution Date"), Cabletron distributed all of its
shares of Riverstone's common stock to its stockholders and Riverstone ceased to
be a subsidiary of Cabletron. In connection with Cabletron's distribution of the
Company's common stock to its stockholders, Riverstone was required to issue
warrants to certain of Cabletron's investors to purchase 230,364 shares of its
common stock. Additionally, Riverstone was obligated to grant supplemental
options under its 2000 Equity Incentive Plan to acquire 3,146,272 shares of its
common stock to those persons who held compensatory Cabletron stock options.
On the Distribution Date, Cabletron merged its subsidiary Enterasys Networks,
Inc. into itself and renamed itself Enterasys Networks, Inc. The terms Cabletron
and Enterasys included hereafter refer to Enterasys Networks, Inc. (formerly
known as Cabletron Systems, Inc.) and Old Enterasys refers to the Enterasys
Networks, Inc. that existed as a subsidiary of Cabletron prior to its merger
into Cabletron.
Note (2) Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The unaudited condensed consolidated financial statements have been prepared by
Riverstone pursuant to the rules and regulations of the Securities and Exchange
Commission and include the accounts of Riverstone and its wholly-owned
subsidiaries. Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States, have been condensed or omitted pursuant to such
rules and regulations. While in the opinion of the Company, the unaudited
financial statements reflect all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of the financial position
at December 1, 2001 and the operating results and cash flows for the nine months
ended December 1, 2001 and December 2, 2000, these financial statements and
notes should be read in conjunction with the Company's audited consolidated
financial statements and notes for the year ended March 3, 2001 included in the
Company's Annual Report on Form 10-K filed with the Securities and Exchange
Commission. The condensed consolidated balance sheet at March 3, 2001 has been
derived from audited financial statements as of that date.
Operating results for the nine months ended December 1, 2001 are not necessarily
indicative of the results that may be expected for the fiscal year ending
March 2, 2002.
The consolidated financial statements as of December 2, 2000 have been prepared
using Cabletron's historical basis in the assets and liabilities and the
historical results of operations of Riverstone.
The consolidated financial information for the period prior to the Distribution
Date includes allocations of certain Cabletron expenses, including centralized
legal, accounting, treasury, real estate, information technology, distribution,
customer service, advertising, sales, marketing, engineering and other Cabletron
corporate services and infrastructure costs. All of the allocations and
estimates in the financial statements are based upon assumptions that the
Company's and Cabletron's management believed to be reasonable reflections of
the cost of services provided or benefit received by Riverstone. However, these
financial statements do not necessarily indicate the financial position or
results of operations that would have occurred if the Company
6
were a stand-alone entity during the applicable periods.
Revenue Recognition
The Company generally recognizes revenue upon shipment of products provided
there are no uncertainties regarding customer acceptance, persuasive evidence of
an arrangement exists, the sales price is fixed and determinable and
collectibility is deemed probable. If uncertainties exist, amounts billed in
excess of revenue recognized is deferred and is then recognized in the period
when such uncertainties are resolved. Revenues from service and maintenance
contracts are deferred and recognized ratably over the period the services are
performed, typically twelve months or less. When the Company provides a
combination of products and services to a customer, revenue is allocated based
on the relative fair values. Estimated costs to repair or replace products that
may be returned under warranty are accrued at the time of shipment. The
Company's warranty period typically extends twelve months from the date of
shipment. Sales to customers in which the Company receives an equity instrument
as consideration are recorded at the estimated fair value of the instrument
received as determined by an independent appraisal or a recent cash equity
transaction received by the customer from an unrelated third party.
Lease Financing. The Company occasionally enters into transactions in which
customers receive financing for the purchase of Company equipment from third
party leasing organizations, who in turn remit payment to the Company. In
certain transactions, the Company has guaranteed a portion of the customer's
lease payments to be made to the lessor. When the Company provides a financing
guarantee, it records revenue at the time of shipment, subject to a sales
reserve. The Company bases the amount of the reserve on a percentage of the
guaranteed lease payments, based on specific customer analysis, supplemented
with industry experience. Accordingly, the Company has deferred revenue subject
to this reserve that will be recognized by the end of the respective lease terms
if all lease payments are made by end users.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying footnotes. Actual results could differ from these estimates.
Note (3) Cash, Cash Equivalents and Investments
The Company considers all highly liquid investments with original maturity dates
of 90 days or less at the date of acquisition to be cash equivalents. Cash
equivalents and investments consist of money market funds, commercial paper,
government securities, and marketable debt securities. To date all investments
have been classified as available-for-sale and are carried at fair value. Any
unrealized gains or losses are reported as a separate component of stockholders'
equity when significant. Premiums and discounts are amortized over the period
from acquisition to maturity and are included in investment income, along with
interest and dividends.
The Company has entered into various letters of credit with certain vendors
through a financial institution. In connection with the issuance of these
letters of credit, the Company has restricted $11.4 million of its investments
as collateral for these specified obligations. Restricted investments are
included in other long-term investments in the accompanying condensed
consolidated balance sheet as of December 1, 2001. There were no restricted
investments at March 3, 2001.
The Company has also invested in equity and debt of non-publicly-traded
companies. These investments have been made in order to establish relationships
with companies in markets that the Company believes are consistent with its
long-term strategic direction. Riverstone holds less than 20% of the equity of
each of these companies and does not have the ability to exercise significant
influence over their operations. Accordingly, these investments are accounted
for using the cost method. These investments which total approximately $44.5
million, including those transferred from Cabletron in July 2001, are included
in long-term investments in the accompanying condensed consolidated balance
sheet as of December 1, 2001.
Note (4) Inventories
The following is a summary of inventories by major category (in thousands):
December 1, March 3,
2001 2001
---- ----
Raw materials.......................... $ 3,421 $ 2,473
Finished goods......................... 8,064 3,557
Consignment ........................... 5,252 5,139
------- -------
$16,737 $11,169
======= =======
7
Note (5) Convertible Subordinated Notes
In November 2001 the Company issued to qualified institutional buyers $175
million aggregate principal amount of 3.75% convertible subordinated notes due
December 1, 2006 (the "Notes"). The Notes are subordinated to any future senior
indebtedness and other liabilities of the Company. The Notes are convertible, at
the option of the holders, into common shares at a conversion rate of 55.0661
shares per one thousand dollars principal amount of Notes at any time before the
maturity date, subject to adjustment in certain events. In lieu of issuing
common shares, the Company may choose to make cash payment equal to 105% of the
value of the common shares issuable upon conversion. The Notes are redeemable at
the Company's option, in whole or in part, on or after December 3, 2004, at a
redemption price of 100% plus accrued and unpaid interest. Each holder of the
Notes has the right to cause the Company to repurchase all of such holder's
convertible notes at 100% of the principal amount plus accrued interest upon the
occurrence of certain events, including but not limited to, liquidation,
consolidation, merger or recapitalization. Interest on the Notes is paid
semi-annually in arrears on June 1 and December 1 of each year, beginning June
1, 2002. The debt issuance costs are being amortized using the interest method.
The Company intends to use the proceeds of the issuance for general corporate
purposes.
Note (6) Customer Concentration
During the quarter ended December 1, 2001, no individual customer accounted for
more than 10% of net revenues, compared with two customers individually
accounting for 13% and 12% of net revenues in the quarter ended December 2,
2000. During the three months ended December 1, 2001, sales to affiliated
investee companies represented approximately 19.8% of net revenues, with sales
to no one investee company exceeding 7% of net revenues.
Note (7) Segment Reporting
Revenues based on product shipment destination to unaffiliated customers by
geographic region are as follows:
Three months ended Nine months ended
December 1, December 2, December 1, December 2,
2001 2000 2001 2000
---- ---- ---- ----
Sales to unaffiliated
customers (trade):
United States ....... $ 26,478 $ 19,223 $ 81,591 $ 44,204
China ............... 13,586 213 28,752 546
Japan ............... 4,153 1,922 12,003 1,922
United Kingdom ...... 944 1,577 9,344 4,204
Other ............... 14,895 3,185 27,386 9,558
-------- -------- -------- --------
Total trade sales ........ 60,056 26,120 159,076 60,434
Sales to related parties.. -- 664 397 2,682
-------- -------- -------- --------
Total sales .............. $ 60,056 $ 26,784 $159,473 $ 63,116
======== ======== ======== ========
Substantially all of the Company's assets are located in the United States.
Note (8) Net Income/(Loss) Per Share
Basic net income or loss per common share and diluted net income or loss per
common share are presented in conformity with Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128") for all periods presented. In
accordance with SFAS 128, basic net income or loss per common share has been
calculated using the weighted-average number of shares of common stock
outstanding during the period. For the three months ended December 1, 2001,
diluted net income per common share has been calculated assuming the conversion
of all dilutive potential common stock.
Pro Forma Basic and Diluted Net Income/(Loss) Per Share
The Company's then outstanding Series A Convertible Preferred Stock
automatically converted into common stock at the 1:1 conversion rate upon the
closing of the Company's initial public offering. The pro forma basic and
diluted net loss per share information included in the accompanying statements
of operations for the three months and nine months ended December 2, 2000
reflects the impact on pro forma basic and diluted net loss per share of such
conversion as of the beginning of the period using the if-converted method.
8
The following tables present the calculation of historical basic and diluted net
income/(loss) per share, and pro forma basic and diluted net loss per share (in
thousands, except share and per share data):
Three months ended Nine months ended
December 1, December 2, December 1, December 2,
2001 2000 2001 2000
---- ---- ---- ----
Numerator:
Numerator for basic and diluted earnings/(loss)
per share - net income (loss) .................. $ 2,156 $ (34,907) $ (2,489) $ (59,195)
============= ============= ============= =============
Denominator:
Denominator for basic earnings/(loss) per
share - weighted average shares ................. 117,634,310 100 112,014,232 100
Effect of dilutive securities:
Stock options ................................ 18,420,295 -- -- --
------------- ------------- ------------- -------------
Denominator for diluted earnings/(loss)
per share ...................................... 136,054,605 100 112,014,232 100
============= ============= ============= =============
Basic earnings (loss) per share .................. $ 0.02 $ (349,070.00) $ (0.02) $ (591,950.00)
------------- ------------- ------------- -------------
Diluted earnings (loss) per share ................ $ 0.02 $ (349,070.00) $ (0.02) $ (591,950.00)
------------- ------------- ------------- -------------
Pro forma:
Numerator:
Numerator for basic and diluted earnings/(loss)
per share - net income (loss) .................. $ -- $ (34,907) $ -- $ (59,195)
============= ============= ============= =============
Denominator:
Denominator for basic earnings (loss) per
share - weighted average shares ................. -- 100 -- 100
Effect of dilutive securities:
Assumed conversion of Series A Convertible
Preferred Stock ............................. -- 92,088,135 -- 92,088,135
------------- ------------- ------------- -------------
Denominator for diluted earnings/(loss) per share . -- 92,088,235 -- 92,088,235
============= ============= ============= =============
Pro forma - Basic and diluted loss per share ...... $ -- $ (0.38) $ -- $ (0.64)
============= ============= ============= =============
For the three and nine months ended December 2, 2000, Riverstone has excluded
all outstanding stock options as well as stock purchase rights held by private
investors because of the anti-dilutive effect these securities have on the
earnings per share for these periods. For the three months ended December 1,
2001, 9.6 million shares from the assumed conversion of the Notes were excluded
from the calculation of diluted net income per common share because their effect
on earnings per share was anti-dilutive. For the nine months ended December 1,
2001, options to purchase 21.8 million shares and an additional of 9.6 million
shares from the assumed conversion of the Notes were excluded from the
computation of diluted net loss per share because their effect on earnings per
share was also anti-dilutive.
Note (9) Recently Issued Accounting Standards
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. SFAS No. 142 is
effective for all fiscal years beginning after December 15, 2001, and changes
the accounting for goodwill from an amortization method to an impairment-only
approach.
The Company is required to adopt certain provisions of SFAS No. 141 immediately
and SFAS No. 142 effective March 3, 2002. The adoption of SFAS No. 141 did not
have a material impact on the Company's financial position or results of
operations. Beginning in the first quarter of fiscal year 2003, goodwill will no
longer be amortized but will be subject to annual impairment tests. All other
intangible assets will continue to be amortized over their estimated useful
lives. Application of the non-amortization provisions of these rules is expected
to result in a decrease of expense of approximately $1.5 million per year.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. While SFAS No.
144 supersedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," it retains many
of the fundamental provisions of that Statement. Statement No. 144 also
supersedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business. However,
it retains the requirement in Opinion No. 30 to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is
9
classified as held for sale. Statement No. 144 is effective for fiscal years
beginning after December 15, 2001 and interim periods within those fiscal years.
The Company is currently reviewing and assessing the impact of SFAS No. 144 on
its financial position and results of operations.
Note (10) Contingencies
As a result of the nature of the persons who received certain options to
purchase common stock of the Company granted prior to February 22, 2001 under
the Company's 2000 Equity Incentive Plan and the vesting provisions of these
options, the Company may have violated California state securities laws. Because
these option grants may not have been qualified under California state
securities laws, certain persons residing in California who received these
options may have a claim against the Company. Accordingly, the Company currently
intends to offer to repurchase outstanding options to purchase shares of its
common stock granted under its 2000 Equity Incentive Plan prior to February 22,
2001 to persons who resided in California at the time of grant.
On August 28, 2001, Tellabs Operations, Inc. filed an action against Riverstone
in the Chancery Division of the Circuit Court of Cook County, Illinois alleging
that Riverstone breached the Strategic Alliance Agreement dated as of November
17, 2000 between Riverstone and Tellabs and committed various torts by (i)
failing to provide Tellabs with CMTS products that met the technical
specifications in the agreement; (ii) misrepresenting to Tellabs the technical
capabilities of Riverstone's CMTS products; and (iii) improperly selling
Riverstone products to Tellabs customers. Tellabs' complaint seeks compensatory
damages in excess of $10 million, plus punitive damages and costs in unspecified
amounts. On that same date, Tellabs purported to terminate the agreement and is
seeking a declaratory judgment that it has no further obligations under the
agreement. The Company believes that Tellabs' claims are without merit and
intends to vigorously defend this proceeding. On August 29, 2001, Riverstone
filed suit against Tellabs in the Superior Court for Santa Clara County,
California seeking compensatory damages in excess of $60 million, including over
$56 million in unfulfilled minimum purchase obligations Tellabs was required to
make under the agreement. Riverstone has filed a motion in the Illinois case to
have that action dismissed or stayed, so that the parties' dispute can be heard
in the first instance in the California case.
Note (11) Other Comprehensive Income
The components of comprehensive income (loss), net of tax, were as follows (in
thousands):
Three months ended Nine months ended
------------------------ -------------------------
December 1, December 2, December 1, December 2,
2001 2000 2001 2000
----------- ----------- ----------- -----------
Net income (loss) .............................................. $ 2,156 $ (34,907) $ (2,489) $ (59,195)
Other comprehensive income (loss):
Change in net unrealized gain (loss) on available-for-sale
investments, net of tax ..................................... 980 -- 1,556 --
Other ........................................................ 293 -- 412 (285)
----------- ----------- ----------- -----------
Total ..................................................... $ 3,429 $ (34,907) $ (521) $ (59,480)
=========== =========== =========== ===========
The components of accumulated comprehensive income (loss),
net of tax, were as follows (in thousands):
December 1, March 2,
2001 2001
----------- -----------
Comprehensive income (loss):
Accumulated net unrealized gain on available-for-sale
investments, net of tax ..................................... $ 1,556 $ --
Other ........................................................ 115 (297)
----------- -----------
Total accumulated other comprehensive income .............. $ 1,671 $ (297)
=========== ===========
Note (12) Income Taxes
Riverstone's operating results historically have been included in Cabletron's
consolidated U.S. and state income tax returns and in the tax returns of certain
Cabletron foreign subsidiaries. Prior to August 7, 2001, the provision for
income taxes in Riverstone's consolidated financial statements has been
determined using the separate company return method. Effective August 7, 2001,
Riverstone will no longer file its federal and state tax returns on a
consolidated basis with Cabletron and the Company's provision for income taxes
will be computed on a standalone basis. Deferred tax assets and liabilities are
recognized for the expected tax consequences of temporary differences between
the tax bases of assets and liabilities and their reported amounts subject to
the continuing requirement for a valuation allowance for net deferred tax
assets.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read together with our consolidated financial statements
and related notes appearing elsewhere in this Form 10-Q, and our Annual Report
on Form 10-K filed on June 1, 2001 with the Securities and Exchange Commission.
When used in the discussion below, the words "expect," "anticipate," "estimate,"
"plan," "believe," "intend" and similar expressions are intended to identify
forward-looking statements. These statements, which include statements as to our
expectations regarding net income or losses, trends in average selling prices
and gross margins, expectations regarding expenses, including increases in sales
and marketing, product development, research and development and general and
administrative expenses, expected stock-based compensation expenses, the
adequacy of capital resources and expected variations in capital requirements,
expected cost of revenues and sources of revenues, expectations regarding
product mix, product developments and enhancements, expectations regarding
capital expenditures and growth of operations and infrastructure, plans to hire
additional employees and expand sales organizations, expectations regarding the
development and maintenance of strategic distribution relationships and our
exchange risk management strategy, are subject to risks and uncertainties that
could cause actual results to differ materially from those projected. These
risks and uncertainties include, but are not limited to, those risks discussed
below, as well as our ability to successfully bring future products to market,
gain market share and compete against established companies in our market, the
impact of alternative technological advances and competitive products, our
ability to develop and maintain strategic relationships, and the matters
discussed in "Factors That May Affect Future Results and Market Price of Our
Stock." These forward-looking statements speak only as of the date hereof. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.
Overview
We are a leading provider of Internet infrastructure equipment to
telecommunications service providers in the metropolitan area network. The
metropolitan area network, or MAN, encompasses service providers, the Internet
infrastructure connecting these service providers with their customers and the
Internet backbone. Our routers contain bandwidth management and provisioning,
accounting and billing, quality of service and content delivery capabilities
that enable service providers to deliver advanced applications and
differentiated services to their customers. The majority of our revenue comes
from sales of our RS router family. We account for sales in which we receive
equity as consideration by estimating the fair value of the equity instrument
through an independent appraisal or a recent equity transaction received by the
issuer from an unrelated third party.
Our industry has experienced erosion of average selling prices. We anticipate
that the average selling prices of our products will decrease in the future in
response to competitive pricing pressures, which may reduce our gross margins or
revenues. We expect our quarterly gross margins to fluctuate with changes in our
product mix. Most of our sales within the United States have been through direct
sales channels. We intend to add and maintain a limited number of strategic
distribution relationships, including with key original equipment manufacturers,
or OEMs, who may offer products or distribution channels that complement ours.
International sales are made through a combination of direct and indirect sale
efforts. We initiated sales and marketing efforts internationally during fiscal
2001, focusing initially on Europe and Asia. As part of this effort, we have
negotiated separate reseller agreements with various distributors and network
integrators in Europe and Asia.
Revenue Recognition. We generally recognize revenue upon shipment of products
provided there are no uncertainties regarding customer acceptance, persuasive
evidence of an arrangement exists, the sales price is fixed and determinable and
collectibility is deemed probable. If uncertainties exist, amounts billed in
excess of revenue recognized is deferred and is then recognized in the period
when such uncertainties are resolved. Revenues from service and maintenance
contracts are deferred and recognized ratably over the period the services are
performed, typically twelve months or less. When we provide a combination of
products and services to a customer, revenue is allocated based on the relative
fair values. Estimated costs to repair or replace products that may be returned
under warranty are accrued at the time of shipment. Our warranty period
typically extends twelve months from the date of shipment. Sales to customers in
which we receive an equity instrument as consideration are recorded at the
estimated fair value of the instrument received as determined by an independent
appraisal or a recent cash equity transaction received by the customer from an
unrelated third party.
Lease Financing. We occasionally enter into transactions in which customers
receive financing for the purchase of Company equipment from third party leasing
organizations, who in turn remit payment to us. In certain transactions, we have
guaranteed a portion of the customer's lease payments to be made to the lessor.
When we provide a financing guarantee, we record revenue at the time of
shipment, subject to a sales reserve. We base the amount of the reserve on a
percentage of the guaranteed lease
11
payments, based on specific customer analysis, supplemented with industry
experience. Accordingly, we have deferred revenue subject to this reserve that
will be recognized by the end of the respective lease terms if all lease
payments are made by end users.
Cost of Revenues. Cost of revenues include costs of raw materials, direct labor,
manufacturing overhead and amounts paid to third-party contract manufacturers,
and other costs related to warranty and contractual obligations and customer
service and support.
Research and Development. Research and development expenses consist primarily of
salaries and related personnel expenses, consultants and outside service
provider fees, non-recurring engineering charges and prototype costs related to
the development, testing and enhancement of our ASICs and software, and the
depreciation of property and equipment related to these activities. Our research
and development efforts can require significant expenditures, the timing of
which can cause quarterly variability in our expenses. We believe continued
investment in product enhancements and new product development are critical to
attain our strategic objectives, and we expect research and development expenses
to continue to increase in absolute dollars in the foreseeable future.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries,
commissions and related expenses for personnel engaged in marketing, sales and
customer support functions, and trade shows, advertising and promotional
expenses. We intend to expand our worldwide direct and indirect sales
organizations substantially by hiring additional sales personnel and
establishing additional sales offices. We plan to initiate additional marketing
programs to support our existing and new products and to build brand awareness
of the Riverstone name. We believe that continued investment in sales and
marketing is critical to our success and expect these expenses to increase in
absolute dollars in the near future.
General and Administrative. General and administrative expenses consist
primarily of employee compensation and related expenses for executive, finance
and administrative personnel, professional fees and other general corporate
costs. Included in general and administrative expenses are expenses for services
provided by Cabletron under our services agreement with them through August 6,
2001. Before the effective date of the services agreement, March 1, 2000,
Cabletron allocated to us general and administrative expenses that it incurred
on our behalf, based on headcount and revenue. We expect general and
administrative expenses to increase slightly in absolute dollars over the next
year as we complete the build-out of our own administrative infrastructure.
Additional Option and Warrant Obligation. On August 6, 2001, Cabletron
distributed the 99,205,992 shares of Riverstone's common stock that it held to
its stockholders. In connection with this stock distribution, we were required
to issue to certain of Cabletron's investors warrants to purchase 230,364 shares
of our common stock, which number of shares was based on the number of shares
that the investors would have received in the distribution if the investors had
exercised the Cabletron warrants they held immediately before the record date of
the distribution. These warrants have a weighted average exercise price of
$29.18 and will expire on August 30, 2007. In addition, in connection with the
distribution, we were required to grant options under our 2000 Equity Incentive
Plan to purchase 3,146,272 shares of our common stock to those persons who held
compensatory Cabletron stock options. These options have a weighted average
exercise price of $7.93.
Stock-Based Compensation. We have recorded approximately $11.1 million of
unearned stock-based compensation primarily related to stock option grants to
employees based on the excess of the determined fair market value over the
exercise price at the date of grant. This compensation expense is being
recognized over the four-year option vesting period on a straight-line basis.
Stock-based compensation expense is classified as cost of revenues or operating
expense depending upon the classification of the respective employee.
Stock-based compensation expense of $764,000 for the three months ended December
1, 2001 was allocated to research and development ($464,000), sales ($101,000),
marketing ($74,000), and general and administrative ($125,000). Stock-based
compensation expense of $2.4 million for the nine months ended December 1, 2001
was allocated to research and development ($1.1 million), sales ($297,000),
marketing ($212,000), and general and administrative ($798,000). We expect to
recognize stock-based compensation expenses of $3.4 million, $2.7 million, $2.7
million and $1.6 million during our fiscal years 2002, 2003, 2004 and 2005.
Basis of Presentation
Our fiscal year 2001 condensed consolidated financial statements have been
derived from the consolidated financial statements of Cabletron using historical
results of operations and historical basis of the assets and liabilities
attributable to our operations. The consolidated financial statements for fiscal
2001 and 2002 include allocations to us of Cabletron corporate expenses,
including legal, accounting, treasury, real estate, information technology,
distribution, customer services, sales, marketing, engineering and other
corporate services and infrastructure costs. All of the allocations and
estimates in our financial statements are based upon assumptions that our
management and Cabletron's management believe to be reasonable reflections of
the cost of services
12
provided or the benefit received by us.
The financial information presented in this Form 10-Q is not indicative of our
financial position, results of operations or cash flows in the future, nor is it
necessarily indicative of what our financial position, results of operations or
cash flows would have been had we been a separate, stand-alone company for the
periods presented.
Results of Operations
The following table sets forth for the period indicated certain financial data
as a percentage of net revenues:
Three months ended Nine months ended
------------------------ -------------------------
December 1, December 2, December 1, December 2,
2001 2000 2001 2000
----------- ----------- ----------- -----------
Net revenues ................................... 100% 100% 100% 100%
Cost of revenues ............................... 43 43 43 44
Stock based compensation ....................... -- -- -- --
----------- ----------- ----------- -----------
Total cost of revenues .................... 43 43 43 44
Gross profit .............................. 57 57 57 56
Operating expenses:
Research and development ....................... 19 38 24 48
Sales and marketing ............................ 24 37 26 39
General and administrative ..................... 11 12 11 15
Stock-based compensation ....................... 1 103 2 50
----------- ----------- ----------- -----------
Total operating expenses ................ 55 190 63 152
Operating income/(loss) ................. 2 (133) (6) (96)
Interest income, net .................... 2 3 4 2
----------- ----------- ----------- -----------
Net income/(loss) before income taxes ... 4 (130) (2) (94)
Provision for income tax ................ -- -- -- --
Net income/(loss) ....................... 4% (130)% (2)% (94)%
=========== =========== =========== ===========
Three and nine months ended December 1, 2001 and December 2, 2000
Net Revenues. Net revenues were $60.1 million for the three months ended
December 1, 2001, a $33.3 million or 124% increase as compared with net revenues
of $26.8 million for the three months ended December 2, 2000. Net revenues were
$159.5 million for the nine months ended December 1, 2001, a $96.4 million or
153% increase as compared with $63.1 million for the nine months ended December
2, 2000. The increase in net revenues was primarily due to the addition of new
customers both in the United States and internationally. During the first nine
months of fiscal year 2002, revenues from international regions grew at a faster
rate than revenues from within the United States. International revenues for the
third quarter of fiscal year 2002 were 56% of revenues compared with 26% of
revenues in the same period of fiscal year 2001. For the first nine months of
fiscal year 2002, international revenues were 49% of revenues compared with 26%
of revenues in the same period of fiscal year 2001.
Cost of Revenues. Cost of revenues for the three months ended December 1, 2001
were $25.8 million with a gross margin of 57.0%, compared with cost of revenues
of $11.6 million for the three months ended December 2, 2000 and a gross margin
of 56.5%. Cost of revenues for the nine months ended December 1, 2001 were $68.8
million with a gross margin of 56.8%, compared with cost of revenues of $28.1
million for the nine months ended December 2, 2000 and a gross margin of 55.5%.
The increase in cost of revenues is primarily related to the increase in sales
volume. We expect cost of revenues to continue to increase in absolute dollars
as net revenues increase. The improvement in gross margin is primarily
attributable to economies of scale achieved from increased sales levels.
Research and Development. Research and development expenses excluding
stock-based compensation were $11.4 million for the three months ended December
1, 2001, an increase of $1.3 million over the comparable quarter in fiscal year
2001. Research and development expenses excluding stock-based compensation were
$38.3 million for the nine months ended December 1, 2001, representing an
increase of $7.7 million over the comparable period in fiscal year 2001.
Research and development expenses, excluding stock-based compensation, as a
percentage of net revenues were 19% and 38% of net revenues in the three months
ended December 1, 2001 and December 2, 2000, respectively. For the first nine
months of fiscal years 2002 and 2001, research and development expenses,
excluding stock-based compensation, as a percentage of net revenues were 24% and
48%,
13
respectively. The decrease in research and development expenses as a percentage
of revenues for the three months and nine months ended December 1, 2001 compared
with the three months and nine months ended December 2, 2000 was primarily due
to the increase in revenues. The increase in absolute dollars represented our
continued investments in personnel and related costs to support our product and
prototype development efforts.
Sales and Marketing. Sales and marketing expenses excluding stock-based
compensation were $14.5 million for the three months ended December 1, 2001, an
increase of $4.5 million over the comparable quarter in fiscal year 2001. Sales
and marketing expenses excluding stock-based compensation were $41.3 for the
nine months ended December 1, 2001, representing an increase of $16.4 million
over the comparable period in fiscal year 2001. Sales and marketing expenses,
excluding stock-based compensation, as a percentage of net revenues were 24% and
37% of net revenues in the three months ended December 1, 2001 and December 2,
2000, respectively. For the first nine months of fiscal years 2002 and 2001,
sales and marketing expenses, excluding stock-based compensation, as a
percentage of net revenues were 26% and 39%, respectively. The decrease in sales
and marketing expenses as a percentage of revenues for the three months and nine
months ended December 1, 2001 compared with the three months and nine months
ended December 2, 2000 was primarily attributable to the increase in revenues.
The increase in absolute dollars in sales and marketing expenses was due
primarily to the addition of sales and marketing personnel to support increased
sales and marketing activities.
General and Administrative. General and administrative expenses excluding
stock-based compensation were $6.5 million for the three months ended December
1, 2001, an increase of $3.2 million over the comparable quarter in fiscal year
2001. General and administrative expenses excluding stock-based compensation
were $17.3 million for the nine months ended December 1, 2001, representing an
increase of $7.7 million over the comparable period in fiscal year 2001. General
and administrative expenses, excluding stock-based compensation, as a percentage
of net revenues were 11% and 12% in the three months ended December 1, 2001 and
December 2, 2000, respectively. For the first nine months of fiscal years 2002
and 2001, general and administrative expenses, excluding stock-based
compensation, as a percentage of net revenues were 11% and 15%, respectively.
The increase in absolute dollars was due to the addition of personnel to support
the increase in revenues and general corporate expenses consistent with the
increased scale of operations as a public company.
Interest Income, Net. Interest income primarily consists of income on
available-for-sale investments. Interest income was $1.3 million for the three
months ended December 1, 2001, compared with $779,000 for the three months ended
December 2, 2000. The increase in interest income is a direct result of
increased cash and investment balances, resulting from the Company's initial
public offering in February 2001, the exercise of warrants by strategic
investors at the time of the initial public offering, proceeds from the issuance
of common stock to Cabletron in July 2001, stock option exercises, and net
proceeds from the issuance of convertible subordinated notes in November 2001.
Income taxes. We recorded a $210,000 provision for income taxes for the three
and nine months ended December 1, 2001. The provision for income taxes results
primarily from certain foreign and minimum tax liabilities arising in
jurisdictions in which we operate.
Liquidity and Capital Resources
Prior to our initial public offering, Cabletron administered our cash. We
transferred cash receipts related to our business to Cabletron periodically, and
Cabletron provided funds to cover our disbursements. On March 3, 2001, we
reported cash of $31.2 million in our intercompany cash account. Cabletron
administered this intercompany account, as provided by our services agreement
with them, up to the completion of our separation from Cabletron in August 2001
when all intercompany accounts were settled. We completed our initial public
offering on February 22, 2001 and realized net proceeds of $108.8 million. At
the completion of our initial public offering, we also received $46.6 million
from the exercise of stock purchase rights by strategic investors. Pursuant to a
transfer agreement between Cabletron and us, on July 24, 2001, we issued
7,117,757 shares of our common stock to Cabletron in exchange for approximately
$122.2 million in cash and certain strategic investments with a historic cost of
approximately $13 million. At December 1, 2001, we had cash and cash equivalents
of $162.5 million and short-term investments of $136.2 million compared with
$136.8 million in cash and cash equivalents and short-term investments of $21.5
million at March 3, 2001. The cash and short-term investment accounts have been
managed by us, and we began managing the cash from our intercompany account with
Cabletron upon the completion of our separation from Cabletron. Cash equivalents
consist of government and non-government debt securities and money market funds
with original maturities of less than three months. Short-term investments are
comprised of U.S. debt securities and commercial paper with original maturities
greater than three months but less than a year. Long-term investments primarily
consist of government and non-government debt securities with original
maturities greater than a year and minority investments in non-publicly-traded
companies.
Net cash used in operating activities for the nine months ended December 1, 2001
and December 2, 2000 was $2.3 million and $25.1 million, respectively. Cash used
by operating activities in these periods was primarily attributable to general
operating expenses, and increases in accounts receivable, inventories and other
working capital items offset by an increase in accounts
14
payable and other accrued expenses.
Net cash used in investing activities of $325.9 million for the nine months
ended December 1, 2001 consisted of capital expenditures and purchases of
short-term, long-term and restricted investments partially offset by proceeds
from matured investments. For the nine months ended December 2, 2000 investing
activities of $10.2 million were primarily capital expenditures. Capital
expenditures during both periods were for the procurement of production
equipment, research and development equipment, computers, enterprise resource
planning software applications and facility-related improvements.
Cash provided by financing activities was $322.8 million for the nine months
ended December 1, 2001, as compared to $71.1 million for the nine months ended
December 2, 2000. The net cash provided for the nine months ended December 1,
2001 primarily consisted of net proceeds from issuance of common stock and
convertible subordinated notes, exercise of stock options and net transfers from
Cabletron under our agreement with them. The net cash provided for the nine
months ended December 2, 2000 was primarily attributable to net transfers from
Cabletron.
We have a revolving line of credit with a bank facility providing total
borrowings of up to $15 million. At December 1, 2001, no amounts were
outstanding under this line of credit.
Our future capital requirements will depend on a number of factors, including
the timing and rate of the expansion of our business. We anticipate an increase
in our capital expenditures to support growth in operations and infrastructure.
We believe that our existing cash and cash equivalents, and short-term and
long-term investments will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures over the next twelve months. However,
our underlying assumed levels of revenues and expenses may prove to be
inaccurate. We may choose to or need to raise additional funds through public or
private financing or other arrangements to:
. support more rapid expansion of our business than we anticipate;
. develop and introduce new or enhanced products or services;
. respond to competitive pressures;
. invest in or acquire businesses or technologies; or
. respond to unanticipated requirements or developments.
Financing may not be available to us, if needed, on favorable terms or at all.
If we raise additional funds through the issuance of equity securities or
convertible debt securities, dilution to existing stockholders may result. If
sufficient funds are not available, we may be unable to introduce new products
and services, expand our sales force and service organization or compete
effectively in our markets, any of which could materially harm our business,
financial condition and results of operations.
15
Factors That May Affect Future Results and Market Price of Our Stock
Factors Related to Our Business
We have a general history of losses and cannot assure you that we will operate
profitably in the future.
We achieved profitability in the second and third quarters of fiscal year 2002.
Net income for the three months ended September 1 and December 1, 2001 was
$64,000 and $2.2 million, respectively. However, the financial position, results
of operations and cash flow of these periods may not necessarily be indicative
of results to be expected for the full fiscal year or any future periods. We
cannot be certain that we will realize sufficient revenue to sustain
profitability in the future. Portions of our historical financial data are based
on Cabletron's financial statements. During fiscal 2000 and 2001, we incurred
net losses of $37.4 million and $65.8 million, respectively. During the first
nine months of fiscal 2002, our net loss amounted to $2.5 million. We anticipate
incurring significant and increasing sales and marketing, product development
and general and administrative expenses, requiring us to realize significantly
higher revenue to sustain profitability.
Because the United States is experiencing a recession and there is an economic
slowdown in Europe and Asia-Pacific, our ability to increase or sustain our
revenues may be limited. The events on September 11 in New York, N.Y. and
Washington, D.C. and other terrorist attacks, as well as concerns regarding any
related conflicts or similar events worldwide, have increased the uncertainty in
the U.S. economy. These events have decreased our ability to project our revenue
in future quarters and may decrease the amount of funds our customers commit to
information technology infrastructure spending. Any reduction in or delay of
capital spending by our customers due to the events of September 11 and recent
economic, political and social turmoil will reduce our future revenue and
profitability.
Our focus on sales to service provider customers subjects us to risks that may
be greater than those for providers with a more diverse customer base.
Our customers consist of carriers, content hosting providers and metropolitan
area service providers, as well as traditional Internet service providers, whose
businesses depend on the continuing demand for differentiated services by their
customers. If this demand does not continue or the Internet does not continue to
expand as a widespread communications medium and commercial marketplace, the
demand for our products could decline. Our exposure to this risk is greater than
other vendors who sell to a more diversified customer base. We believe that
there are risks arising from doing business with service providers in these
markets that may not be faced by our competitors in their relationships with
corporate and other customers, including:
. any failure of a service provider's service to its customers that it
attributes to our products, whether or not our products actually
failed, which could lead to substantial negative publicity and
undermine our sales;
. the low level of brand loyalty demonstrated by service providers,
which may cause them to switch to another supplier that provides, or
that they believe provides, superior performance or
cost-effectiveness;
. the introduction, or the planned introduction, of new products and
product enhancements, which could cause service providers to cancel,
reduce or delay existing orders; and
. service providers that are heavily dependent upon financing,
particularly from the high yield debt market, to build out their
infrastructure, who may decrease their infrastructure purchases if
interest rates increase or if credit availability in these markets
decreases.
The occurrence of one or more of these events is likely to harm our operating
results.
Our quarterly revenue and operating results are likely to fluctuate,
particularly as we expand and if, as expected, our expenses rise, which could
cause us to miss quarterly revenue targets and result in a decline in our stock
price.
We base our operating expenses on anticipated revenue trends. A high percentage
of our expenses remain relatively fixed despite changes in revenue, including
marketing, research and development and general administrative expenses and
expenses for employee compensation other than sales commissions. This means that
any failure to achieve anticipated revenues could cause our quarterly operating
results to fall below the expectations of public market analysts or investors,
which could cause the price of our common stock to fall. As we expand, we expect
our expenses to rise significantly, which increases the magnitude of this risk.
Our quarterly revenue and operating results may vary significantly in the future
due to a number of factors, including:
16
. fluctuations in demand for our products and services;
. unexpected product returns or the cancellation or rescheduling of
significant orders;
. our ability to develop, introduce, ship and support new products and
product enhancements and manage product transitions;
. the timing and amount of non-cash stock based compensation charges;
. our ability and our suppliers' ability to attain and maintain
production volumes and quality levels for our products; and
. the mix of products sold and the mix of distribution channels through
which they are sold.
Due to these factors, we believe that you should not rely on period-to-period
comparisons of our operating results as an indicator of our future performance.
We generally do not have binding commitments from our customers and if
significant customers cancel, reduce or delay a large purchase, our revenues may
decline and the price of our stock may fall.
Historically, a limited number of customers have accounted for a significant
portion of our revenues. For fiscal year 2001, Telseon accounted for 11% of our
net revenues. For the three months and nine months ended December 1, 2001, no
individual customer accounted for more than 10% of net revenues. Customers
making large purchases from us are likely to vary over time, due to changes in
our product cycles, customer needs, competition or economic circumstances. For
example, some of our former significant customers, Vitts Networks and Metricom,
have recently filed for bankruptcy and ceased operations and Tellabs is
purporting to terminate its agreement with us. Although our largest customers
may vary from period to period, we anticipate that our operating results for any
given period will continue to depend significantly on large orders from a small
number of customers. We generally do not have binding commitments from most of
our customers. If any of our large customers cancel, reduce or delay purchases,
our revenue and profitability would be harmed because of our dependence on large
customers.
Because the purchase of our products often represents a significant decision on
the part of potential customers, we may expend significant resources on
potential customers without achieving actual sales.
Purchases of our products often represent a significant strategic decision and
capital investment by our customers related to their communications
infrastructure and typically involve significant internal procedures involving
the evaluation, testing, implementation and acceptance of new technologies. This
evaluation process frequently results in a lengthy sales process, often ranging
from one month to longer than a year, and purchases of our products are subject
to a number of significant risks, including customer budgetary constraints and
internal acceptance reviews. During this time we may incur substantial sales and
marketing expenses and expend significant management effort. The length of the
sales cycle, and the magnitude of our investment in the sales process, is more
substantial for our service provider customers than it would typically be with
corporate customers. If sales forecasts from a specific customer for a
particular quarter are not realized in that quarter, we may be unable to
compensate for the shortfall, which could harm our operating results.
We may be unable to expand our sales and direct and indirect distribution
channels, which may hinder our ability to target multiple levels of a
prospective customer's organization as well as our ability to increase sales and
revenues.
Our products and services require a sophisticated sales and marketing effort
targeted at several levels within a prospective customer's organization. Unless
we expand our sales force and maintain high levels of marketing activity, we
will be unable to increase revenues. Although we plan to continue to hire
additional sales personnel, competition for qualified sales personnel is
intense, and we may be unable to hire the sales personnel we require.
Our sales and distribution strategy relies on value-added resellers, original
equipment manufacturers, or OEMs, our direct and indirect international sales
efforts and our ability to package our products into a complete network
infrastructure solution by working with other technology vendors. If we are
unable to establish new value-added reseller or OEM relationships, or if our
OEMs and valued-added resellers are unsuccessful in distributing our products,
our sales could suffer. Because we are not a vertically integrated network
infrastructure provider, if we fail to maintain existing technology vendor
relationships or to establish new ones, we will be unable to satisfy our
customers' need for complete, fully-integrated solutions and our business could
suffer.
Certain of our customers rely on us to arrange financing for our products, which
subjects us to credit and market risks.
17
Certain of our customers do not have or do not wish to commit the financial
resources required to purchase our products without financing, and these
customers expect us to arrange their financing. These financing arrangements can
expose us to our customers' credit risk, and in the past we have experienced
customer defaults. If customers default on their financing payments in the
future, our recognition of revenue from those customers will be harmed. Due to
recent public market volatility, a number of our current or prospective
customers may be unable to raise funding through the issuance of their equity
securities or otherwise in a timely fashion. This difficulty could result in an
increased need for financing provided either by us or with our assistance and an
increased risk of customer default. In the past, we benefited from Cabletron's
resources and credit in arranging financing for our customers. As a result of
our separation from Cabletron, we are a much smaller, stand-alone company, which
could impair our ability to provide or arrange and support customer financing.
If third party financing were to become less available due to credit market
factors, our ability to arrange third party financing for our customers could be
significantly limited, potentially resulting in reduced revenues.
We purchase several key components for our products from single or limited
sources and could lose sales if these sources fail to fulfill our needs.
We purchase several key components used in the manufacture of our products from
single or limited sources and are dependent upon supply from these sources to
meet our needs. We have worked with NEC and Agere to develop several of our key
proprietary application specific integrated circuits, or ASICs. These
proprietary ASICs are very complex, and NEC and Agere are our sole source
suppliers for the specific types of ASICs that they supply to us. We do not have
a long-term fixed price or minimum volume agreement with either of these
suppliers. Should we encounter problems with NEC or Agere, we may not be able to
develop an alternate source in a timely manner, which could hurt our ability to
deliver our routers.
We base our purchasing decisions on a forecast of anticipated orders of our
products, and if we miscalculate our needs or are not able to obtain necessary
components, our business could be harmed.
We use a forward-looking forecast of anticipated product orders to determine our
material requirements, and if customer orders do not match forecasts, we may
have excess or inadequate inventory of materials and components. In the past, we
have experienced shortages of some components, resulting in delays in filling
orders. For example, recent high demand in the cellular phone industry for
Tantalum capacitors, a component required to manufacture our products, has led
to shortages and price increases for these capacitors. We have also experienced
delays in the prototyping of our ASICs during initial product development, which
in turn has led to delays in product introductions. If we cannot obtain
necessary components, we may not be able to meet customer orders and our
business and results of operations could suffer.
We depend on a single contract manufacturer for all of our manufacturing
requirements, and a failure by this contract manufacturer would impair our
ability to deliver products.
We outsource all of our manufacturing to one company, Flextronics International,
Ltd., which manufactures our products in San Jose, California. If the demand for
our products grows, we will need to increase our material purchases and our
contract manufacturing capacity with Flextronics or add additional contract
manufacturers. Our existing and future contract manufacturers may not meet our
future requirements. We have experienced a delay in product shipments from our
contract manufacturer in the past, which in turn delayed product shipments to
our customers. We may in the future experience similar and other problems, such
as insufficient quantity of product, which could materially harm our business
and operating results. The inability of our contract manufacturer to provide us
with adequate supplies of high-quality products or the loss of our contract
manufacturer would cause a delay in our ability to fulfill orders while we
obtain a replacement manufacturer and would have a significant negative effect
on our business, operating results and financial condition.
Substantially all of our revenues come from sales of our RS router family,
making us dependent on widespread market acceptance of these products.
Substantially all of our revenues result from sales of our RS router family.
Continuing market acceptance of our products is critical to our future success,
and we are more dependent on the market acceptance of our individual product
family than competitors with broader product offerings. Factors that may affect
the market acceptance of our products include:
. adoption of advanced routing and switching products and technologies;
. the performance, price and total cost of ownership of our products;
. the availability and price of competing products and technologies;
. brand recognition of the Riverstone name; and
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. the success and development of our sales and marketing organizations
and resellers.
If we fail to achieve and maintain market acceptance for our router family, our
revenues may be harmed.
The market for network equipment is subject to rapid technological change, and
if we fail to accurately predict and respond to market developments or demands,
we will be unable to compete successfully.
The market for network equipment is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements and
evolving industry standards. Our future performance will depend on our
successful development and introduction and the market acceptance of new and
enhanced products that address customer requirements in a cost-effective manner.
We may be unsuccessful in completing the development or introduction of these
product enhancements or new products on a timely basis or at all. The failure of
these enhancements or new products to operate as expected could delay or prevent
future sales. Developments in routers and routing software could also
significantly reduce demand for our product. Alternative technologies and
customer requirements could achieve widespread market acceptance and displace
the technologies, protocols and service requirements on which our product lines
are based. Our technological approach may not achieve broad market acceptance,
and other technologies or devices may supplant our approach.
If we and the third parties providing services for us are unable to deliver the
high level of customer service and support demanded by our customers, we may
lose customers and our operating results will suffer.
Our customers demand a high level of customer service and support. Our customer
service and support functions are provided by a combination of our internal
product support group and Digital Equipment (India). We are in the process of
transitioning the services provided by Digital Equipment (India) to internal
field service and support services. We may experience a disruption in our
ability to support customers during this transition period, which could
significantly reduce customer satisfaction and impair our ability to retain
customers and make future sales. We are also considering other third parties to
provide certain customer support services. We may be unable to manage
effectively those third parties who provide support services for us and they may
provide inadequate levels of customer support.
Our products are very complex, and undetected defects may increase our costs and
harm our reputation with our customers.
Networking products are extremely complex and must operate successfully with
equally complex products of other vendors. These products frequently contain
undetected software or hardware errors when first introduced or as new upgrades
are released. Additionally, the pressures we face to be the first to market new
products increases the possibility that we will offer products in which we or
our customers later discover errors. We have experienced new product and product
upgrade errors in the past and may experience similar problems in the future.
These problems could result in our incurring significant warranty and repair
costs, divert the attention of our engineering personnel from our product
development efforts and cause significant customer relations problems and our
stock price to fall.
We have limited ability to engage in acquisitions and other strategic
transactions using our equity because of the federal income tax requirements for
a tax-free distribution.
For the distribution of our stock by Cabletron (now known as Enterasys) to
qualify as tax-free to Enterasys, there must not be a change in ownership of 50%
or greater in either the voting power or value of either our stock or Enterasys'
stock that is considered to be part of a plan or series of transactions related
to the distribution. If there is a direct or indirect acquisition of our or
Enterasys' stock by one or more persons during the four-year period beginning
two years before and ending two years after the distribution, it will be
presumed to be part of a plan or series of related transactions related to
Enterasys' intended distribution of our stock. Unless this presumption is
successfully rebutted, the distribution will be taxable to Enterasys.
We have entered into a tax sharing agreement with Enterasys Networks Inc.,
Aprisma Management Technologies and Global Network Technology Services. This
agreement requires us to indemnify the other parties if the distribution by
Cabletron of its Riverstone shares does not qualify as tax-free due to actions
we take or that otherwise relate to us, including any change of ownership of us.
The process for determining whether a change of ownership has occurred under the
tax rules is complex. If we do not carefully monitor our compliance with these
rules, we might inadvertently cause a change of ownership to occur, triggering
our obligation to indemnify Enterasys and the other parties to the tax sharing
agreement. Our obligation to indemnify these parties if a change of ownership
causes the distribution not to be tax-free could discourage or prevent a third
party from making a proposal to acquire us. The amount of any such
indemnification would be substantial.
For the reasons described above, our ability to use our stock for acquisitions
and other similar strategic transactions or for compensation for employees and
others is restricted. Many of our competitors use their equity to complete
acquisitions, to expand
19
their product offerings and speed the development of new technology and to
attract and retain employees and other key personnel, giving them a potentially
significant competitive advantage over us.
We jointly own with Enterasys some of our intellectual property, and our
business could be harmed if Enterasys uses this intellectual property to compete
with us.
Intellectual property that relates to a family of ASICs used in both our RS
router family and Enterasys' Smart Switch Router product family is owned jointly
by Enterasys and us. Enterasys is primarily a provider of local area network
products for the enterprise market. There are no contractual provisions that
prohibit Enterasys from developing products that are competitive with our
products, including products based upon the jointly owned intellectual property.
If Enterasys is acquired by one of our competitors, there are no contractual
provisions that would prohibit the combined company from developing products
competitive with our products.
Our limited ability to protect our intellectual property may hinder our ability
to compete.
We rely on a combination of patent, copyright, trademark and trade secret laws
and restrictions on disclosure of confidential information to protect our
intellectual property rights. We cannot assure you that any patents that we hold
will protect our intellectual property or will not be challenged by third
parties. Other parties may also independently develop similar or competing
products that do not infringe our patents. Although we attempt to protect our
intellectual property rights, we may be unable to prevent the misappropriation
of our intellectual property, particularly in foreign countries where the laws
may not protect our proprietary rights as fully as in the United States.
We may be subject to claims that our intellectual property infringes upon the
proprietary rights of others, and a successful claim could harm our ability to
sell and develop our products.
If other parties claim that our products infringe upon their intellectual
property we would be forced to defend ourselves or our customers, manufacturers
or suppliers against those claims. We could incur substantial costs to prosecute
or defend those claims. A successful claim of infringement against us and our
failure or inability to develop non-infringing technology or license the
infringed technology on acceptable terms and on a timely basis could harm our
business, results of operations and financial condition.
We have recently begun to expand our international sales effort, and marketing
and distributing our products outside of the United States may require increased
expenses and greater exposure to risks that we may not be able to successfully
address.
Our growth strategy depends in part on the expansion of our international sales
and operations. International sales, which were negligible in fiscal 1999,
increased to 23% of our net revenues in fiscal 2000 and 32% in fiscal 2001.
During the three and nine months ended December 1, 2001, our international sales
were 56% and 49% of net revenues, respectively. The international market for our
products is less mature than the market in the United States, and our strategy
of selling to service providers that operate in the metropolitan area network
may be unsuccessful on an international basis. Operating internationally exposes
us to risks such as longer accounts receivable collection cycles, difficulties
in staffing and managing operations across disparate geographic areas and
tariffs, export controls and other trade barriers. We conduct our international
sales in either U.S. dollars or local currencies and a change in the value of
the U.S. dollar relative to foreign currencies could make our products less
competitive in international markets. We are also subject to fluctuations in
exchange rates between the U.S. dollar and the particular local currency. We may
engage in hedging transactions to minimize the risk of fluctuations, and if we
are not successful in managing hedging transactions, we could incur losses.
If we fail to address the strain on our resources caused by our growth or if we
are unable to attract and retain qualified personnel, we may not be able to
achieve our objectives and our business could be harmed.
We have experienced a period of rapid growth and expansion, which has placed,
and continues to place, a significant strain on our management, operational and
financial resources. From February 28, 1999 to December 1, 2001, the number of
our employees increased from 163 to 513 and is expected to continue to increase.
Our management team has only been recently formed and has had limited experience
managing rapidly growing companies. Our success depends to a significant degree
upon the continued contributions of our key management, engineering, sales and
marketing, customer support and manufacturing personnel, many of whom would be
difficult to replace. In particular, we believe that our future success is
highly dependent on Romulus Pereira, our president and chief executive officer.
We believe our future success also depends on our ability to attract and retain
highly skilled managerial, engineering, sales and marketing, finance, customer
support and manufacturing personnel. Competition for these personnel is intense,
especially in the San Francisco bay area, and we have had difficulty hiring
employees in the timeframe we desire, particularly software and
20
hardware engineers. We may be unsuccessful in attracting and retaining
personnel. The loss of the services of any of our key personnel, the inability
to attract or retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers and sales personnel, could make it
difficult for us to manage our business and meet key objectives, such as timely
product introductions.
We rely on independent service providers to supply certain of our back-office
functions, and if they fail to deliver adequate services, our business will
suffer.
We rely on service providers to supply us with many of our operational and
back-office functions, including human resources applications, enterprise
resource management applications and customer relationship management
applications. Although these functions are critical to our business, we neither
own the software that performs these functions nor, in some cases, the hardware
on which these programs and our data reside. If there is a significant
degradation or failure in service, we may be unable to quickly and
cost-effectively transition to other service providers or provide the necessary
functionality ourselves and our business could be disrupted.
We face risks associated with our strategic investments and may not realize the
anticipated benefits of such investments.
In order to establish relationships with companies in markets consistent with
our long-term strategic direction, we have invested in equity and debt of
non-publicly-traded companies. In some cases, we have received and in the future
may receive equity securities in exchange for our products and services. As of
December 1, 2001, on a cost basis these investments totaled approximately $44.5
million, including strategic investments with a cost basis of approximately $13
million acquired from Enterasys in July 2001. During the three months ended
December 1, 2001, sales to these strategic investee companies represented 19.8%
of net revenues, with sales to no one investee company exceeding 7% of net
revenues.
We plan to continue to make strategic investments in the future. However, we may
not realize in full the anticipated benefits of our current and future strategic
investments. The companies in which we invest may not make, may reduce or may
terminate product purchases from us. We may lose all or a portion of the amount
invested. We assess the fair value of our strategic investments quarterly and
may be required to record impairment charges against our strategic investments.
Factors we consider important that could trigger an impairment charge include
the likelihood that the related company would have insufficient cash flows to
operate for the next twelve months, significant changes in the operating
performance or operating model, and/or changes in market conditions. If we
determine to reduce the carrying value of one of our investments, such reduction
could adversely affect our financial condition and results of operations.
Factors Related to Our Industry
Intense competition in the market for network equipment could prevent us from
increasing revenues and sustaining profitability.
The market for network equipment is very competitive and has historically been
dominated by Cisco Systems. Other principal competitors include established
companies such as Extreme Networks Inc., Foundry Networks Inc., Juniper Networks
Inc., Lucent Technologies Inc. and Nortel Networks Corporation. We also
experience competition from a number of other smaller public and private
companies. These competitors may have developed or could in the future develop
new technologies that compete with our products or even make our products
obsolete. Consolidation in our industry is occurring and is likely to continue.
Future acquisitions by, and mergers among, our competitors and potential
competitors could expand their product offerings and accelerate their
development of new technologies, providing them with a competitive advantage.
Many of our competitors have significantly more established customer support and
professional services organizations and substantially greater financial
resources than we do. Many of our competitors also have much greater name
recognition and have a more extensive customer base and broader customer
relationships and product offerings than we do. These companies can rely on
their customer bases and broader product offerings and adopt aggressive pricing
policies to gain market share. We expect that competitive pressures may result
in price reductions, reduced margins and loss of market share, which would
materially harm our business, results of operations and financial condition.
We expect the average selling prices of our products to decrease rapidly, which
may reduce our gross margins or revenues.
Our industry has experienced rapid erosion of average selling prices. We
anticipate that the average selling prices of our products will decrease in the
future in response to competitive pricing pressures, increased sales discounts,
new product introductions by us or our competitors and increasing availability
of relatively inexpensive standard microprocessors that can perform some of our
products' functionality. If we are unable to achieve sufficient cost reductions
and increases in sales volumes, this decline in average selling prices will
reduce our revenues and gross margins.
21
If our products do not comply with complex governmental regulations and evolving
industry standards, our products may not be widely accepted, which may prevent
us from sustaining our revenues or profitability.
The market for network equipment products is characterized by the need to
support industry standards as different standards emerge, evolve and achieve
acceptance. To be competitive, we must continually introduce new products and
product enhancements that meet these emerging standards. We have had to delay
the introduction of new products to comply with third party standards testing.
We may be unable to address compatibility and interoperability issues that arise
from technological changes and evolving industry standards. In the United
States, our products must comply with various governmental regulations and
industry regulations and standards, including those defined by the Federal
Communications Commission, Underwriters Laboratories and Networking Equipment
Building Standards, or NEBS. Internationally, products that we develop may be
required to comply with standards or obtain certifications established by
telecommunications authorities in various countries and with recommendations of
the International Telecommunications Union. If we do not comply with existing or
evolving industry standards or fail to obtain timely domestic or foreign
regulatory approvals or certificates, we will be unable to sell our products
where these standards or regulations apply, which may prevent us from sustaining
our revenues or achieving or maintaining profitability.
Factors Related to Our Separation from Cabletron
Our historical financial information may not be representative of our results as
a separate company.
Our consolidated financial statements are based on the consolidated financial
statements of Cabletron, using the historical results of operations and
historical bases of the assets and liabilities of the Cabletron router and
switch business contributed to us. The historical financial information we have
included in this Report on Form 10-Q does not necessarily reflect what our
financial position, results of operations and cash flows would have been had we
been a separate, stand-alone entity during the periods presented. Cabletron did
not account for us as a separate, stand-alone entity before June 3, 2000. Our
costs and expenses include allocations from Cabletron for centralized corporate
services and infrastructure costs, including:
. customer service;
. sales;
. information technology;
. distribution;
. legal and accounting;
. real estate; and
. treasury.
These allocations have been determined on bases that we and Cabletron considered
to be reasonable reflections of the utilization of services provided to or the
benefit received by us. The historical financial information is not necessarily
indicative of what our results of operations, financial position and cash flows
will be in the future. We have not made adjustments to our historical financial
information to reflect many significant changes related to our cost structure,
funding and operations due to our separation from Cabletron, including increased
costs from reduced economies of scale, increased marketing expenses related to
building a company brand identity separate from Cabletron and the increased
costs of being a publicly traded, stand-alone company.
Cabletron no longer provides us administrative services, and we no longer use
Cabletron's operational and administrative infrastructure. Our ability to
operate our business may suffer if we do not successfully replace this
infrastructure and services.
Under a services agreement, prior to its distribution of our common stock, we
used Cabletron's administrative infrastructure and Cabletron provided us
centralized corporate functions, including legal, accounting, payroll and other
services. If we are not successful in replacing the services and infrastructure
systems previously provided by Cabletron, or if there is a failure or
significant downtime in our systems, our business could be harmed. To
successfully implement and operate our own systems, we must be able to attract
and retain a significant number of highly skilled employees.
We cannot rely on Cabletron to fund our future capital requirements, and
financing from other sources may not be available on
22
favorable terms or at all.
In the past, our capital needs were satisfied by Cabletron. However, following
our separation, Cabletron is no longer a source of funds to finance our working
capital or other cash requirements or to support customer financing. Financing
or financial support from other sources, if needed, may not be available on
favorable terms or at all.
We believe our capital requirements will vary greatly from quarter to quarter.
Capital expenditures, fluctuations in our operating results, financing
activities, acquisitions, investments and inventory and receivables management
may contribute to these fluctuations. We believe that the proceeds from our
initial public offering, our sale of common stock to Cabletron in July 2001, our
issuance of convertible subordinated notes in November 2001, and our future cash
flow from operations, will be sufficient to satisfy our working capital, capital
expenditure and research and development requirements for at least the next
twelve months. However, we may require or choose to obtain additional debt or
equity financing to finance acquisitions or other investments in our business.
Future equity financings may be dilutive to the existing holders of our common
stock. Future debt financings could involve restrictive covenants. We will
likely not be able to obtain debt financing with interest rates and other terms
as favorable as those that Cabletron could obtain.
The plaintiffs in Cabletron's outstanding class action suit might seek to add us
to this litigation or seek payment of any related damages.
Since December 1997, Cabletron has been party to an outstanding class action
suit alleging that during the period from March 3, 1997 through December 2,
1997, Cabletron released false and misleading information about its operations
and that Cabletron's accounting practices resulted in the disclosure of
materially misleading financial results. The plaintiffs' complaint does not
specify the amount of damages, but if the plaintiffs prevail Enterasys (formerly
Cabletron) could be required to pay substantial damages. The plaintiffs in this
matter might seek to involve us in this litigation or, if they prevail in this
litigation, might seek to recover damages from us, particularly if Cabletron has
insufficient assets.
Conflicts of interest may arise because our directors and executive officers
have ownership interests in Enterasys and Aprisma.
Many of our directors and executive officers have a substantial amount of their
personal financial portfolios in Enterasys common stock and options to purchase
Enterasys common stock. Our directors also hold options to purchase stock of
Aprisma. Conflicts of interest may arise between Enterasys and us in a number of
areas relating to our past and ongoing relationships, including tax,
indemnification, intellectual property and other matters arising from our
separation from Cabletron, which is now Enterasys. These factors could create,
or appear to create, potential conflicts of interest when directors and officers
are faced with decisions that could have different implications for Enterasys,
Aprisma and us. In our certificate of incorporation we have renounced any
interest in business opportunities that are presented to Cabletron (now known as
Enterasys), its subsidiaries other than us, or our officers or directors who are
employees of Enterasys or its subsidiaries other than us at the time the
opportunity is presented.
We could incur significant tax liability if the distribution does not qualify
for tax-free treatment, which could require us to pay Enterasys a substantial
amount of money.
Cabletron (now known as Enterasys) announced that it received from the U.S.
Internal Revenue Service a private letter ruling that its distribution of shares
of our common stock will be free of U.S. federal income taxes. Although private
letter rulings are generally binding on the IRS, Enterasys will not be able to
rely on the ruling if any of the factual representations or assumptions made to
obtain the ruling are, or become, incorrect or untrue in any material respect.
We have entered into a tax sharing agreement which is among Enterasys, Aprisma,
GNTS and us. The tax sharing agreement requires us to indemnify the other
parties if the distribution by Cabletron of its Riverstone shares does not
qualify as tax-free due to actions we take or that otherwise relate to us. In
addition to our liability under the tax sharing agreement, under United States
Federal income tax laws, we would be jointly and severally liable for the
federal income taxes of Cabletron resulting from the distribution being taxable.
This means that even if we do not have to indemnify Enterasys under the tax
sharing agreement because we did not take any specific action to cause the
distribution to fail as a tax-free event, we may still be liable for any part
of, including the whole amount of, these liabilities and expenses if Enterasys
fails to pay them.
Factors Related to Our Stock
Our stock price has been and may continue to be volatile, which could result in
substantial losses for individual stockholders.
The stock markets in general, and the markets for high technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. For example, during the
calendar year 2001, the Nasdaq Composite Index had a closing low of 1423.19,
representing a decline of 50.2% from its closing high of 2859.15 during that
period. The market price of our common stock has been volatile, and we expect
that it will continue to be volatile.
23
Anti-takeover provisions could make it more difficult for a third party to
acquire us.
We have adopted a stockholder rights plan and declared a dividend distribution
of one right for each outstanding share of common stock to stockholders of
record as of July 26, 2001. Each right entitles the holder to purchase upon
certain events one one-thousandth of a share of our Series A Preferred Stock for
$115. Under certain circumstances, if a person or group acquires 15% or more of
our outstanding common stock, holders of the rights (other than the person or
group triggering their exercise) will be able to purchase, in exchange for the
exercise price, shares of our common stock, and in certain cases, shares of
stock of a company into which we are merged, having a value of double the
exercise price. Because the rights may substantially dilute the stock ownership
of a person or group attempting to take us over without the approval of our
board of directors, our rights plan could make it more difficult for a third
party to acquire us, or a significant percentage of our outstanding capital
stock, without first negotiating with our board of directors regarding such
acquisition.
In addition, our board of directors has the authority to issue up to 2,000,000
shares of preferred stock (of which 200,000 shares have been designated as
Series A Preferred Stock) and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the stockholders. The rights of the holders of
common stock may be subject to, and may be adversely affected by, the rights of
the holders of any preferred stock that may be issued in the future. The
issuance of preferred stock may have the effect of delaying, deferring or
preventing a change of control of us without further action by the stockholders
and may adversely affect the voting and other rights of the holders of common
stock. Further, certain provisions of our charter documents may have the effect
of delaying or preventing changes in control or management of Riverstone.
24
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents
and short-term investments in a variety of securities, including commercial
paper, government and non-government debt securities and money market funds. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate.
Foreign Currency Exchange Risk
The Company, as a result of its global operating and financing activities, is
exposed to changes in foreign currency exchange rates. Subsequent to December 2,
2001, the Company has commenced a hedging program using foreign exchange forward
contracts to hedge some balance sheet exposure against future movements in
foreign exchange rates. Gains and losses on the forward contracts, to the extent
they are effective, are largely offset by gains and losses on the underlying
exposure. Our exchange risk management strategy is intended to be such that a
sudden or significant change in foreign exchange rates would not have a material
impact on future net income or cash flows. We do not now or in the future intend
to use derivative financial instruments for trading purposes.
25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
A consolidated class action lawsuit raising claims against Cabletron and some
officers and directors of Cabletron was filed in the United States district
court for the district of New Hampshire and, following transfer, is pending in
the district of Rhode Island. The complaint alleges that Cabletron and several
of its officers and directors made materially false and misleading statements
about Cabletron's operations and acted in violation of Section 10(b) of and Rule
10b-5 under the Securities Exchange Act of 1934 during the period between March
3, 1997 and December 2, 1997. The complaint also alleges that Cabletron's
accounting practices resulted in the disclosure of materially misleading
financial results during the same period. More specifically, the complaint
challenged Cabletron's revenue recognition policies, accounting for product
returns, and the validity of some sales. The complaint does not specify the
amount of damages sought on behalf of the class. The plaintiffs served a second
consolidated class action complaint and Cabletron filed a motion to dismiss this
complaint. In a ruling dated May 23, 2001, the district court dismissed this
complaint with prejudice. The plaintiffs have appealed this ruling to the First
Circuit Court of Appeals. If the plaintiffs were to prevail on appeal, and
ultimately prevail on the merits of the case, Enterasys (formerly known as
Cabletron) could be required to pay substantial damages.
We have not assumed any liabilities from Enterasys for this litigation. We have
not been named as a defendant in this litigation and none of our officers or
directors is named as a defendant to this litigation. However, the plaintiffs
might attempt to involve us in this litigation or might seek to have us pay
damages if Enterasys has insufficient assets to cover any resulting damages. Any
involvement in this litigation could be protracted and may result in a diversion
of management and other resources. The payment of substantial legal costs or
damages, or the diversion of our management and other resources, could have a
material adverse effect on our business, financial condition or results of
operations.
On August 28, 2001, Tellabs Operations, Inc. filed an action against Riverstone
in the Chancery Division of the Circuit Court of Cook County, Illinois alleging
that Riverstone breached the Strategic Alliance Agreement dated as of November
17, 2000 between Riverstone and Tellabs and committed various torts by (i)
failing to provide Tellabs with CMTS products that met the technical
specifications in the agreement; (ii) misrepresenting to Tellabs the technical
capabilities of Riverstone's CMTS products; and (iii) improperly selling
Riverstone products to Tellabs customers. Tellabs' complaint seeks compensatory
damages in excess of $10 million, plus punitive damages and costs in unspecified
amounts. On that same date, Tellabs purported to terminate the agreement and is
seeking a declaratory judgment that it has no further obligations under the
agreement. We believe that Tellabs' claims are without merit and intend to
vigorously defend this proceeding. On August 29, 2001, Riverstone filed suit
against Tellabs in the Superior Court for Santa Clara County, California seeking
compensatory damages in excess of $60 million, including over $56 million in
unfulfilled minimum purchase obligations Tellabs was required to make under the
agreement. Riverstone has filed a motion in the Illinois case to have that
action dismissed or stayed, so that the parties' dispute can be heard in the
first instance in the California case.
We have granted options to purchase shares of our common stock under our 2000
equity incentive plan to our employees and employees of Cabletron and its
affiliates and to our advisors and consultants. As a result of the nature of the
persons who received these options and the vesting provisions of these options
granted prior to February 22, 2001, we may have violated the California state
securities. Because these option grants may not have been qualified under
California state securities laws, certain persons residing in California who
received these options may have a claim against us. Accordingly, we currently
intend to offer to repurchase outstanding options to purchase shares of our
common stock granted under our 2000 equity incentive plan prior to February 22,
2001 to persons who resided in California at the time of grant.
We are not aware of any other legal proceedings against us that, individually or
in the aggregate, would have a material adverse effect on our business,
operating results or financial condition. We may in the future be party to
litigation arising in the course of our business, including claims that we
allegedly infringe third-party trademarks and other intellectual property
rights. These claims, even if not meritorious, could result in the expenditure
of significant financial and managerial resources.
Item 2. Changes in Securities and Use of Proceeds
In November 2001, the Company issued to qualified institutional buyers $175
million aggregate principal amount of 3.75% convertible subordinated notes due
December 1, 2006 (the "Notes"). The Notes are subordinated to any future senior
indebtedness and other liabilities of the Company. The Notes are convertible, at
the option of the holders, into common shares at a conversion rate of 55.0661
shares per one thousand dollars principal amount of Notes at any time before the
maturity date, subject to adjustment in certain events. In lieu of issuing
common shares, the Company may choose to make cash payment equal to 105% of the
value of the common shares issuable upon conversion. The Notes are redeemable at
the Company's option, in whole or in part, on or after December 3, 2004, at a
redemption price of 100% plus accrued and unpaid interest. Each holder of the
Notes has
26
the right to cause the Company to repurchase all of such holder's convertible
notes at 100% of the principal amount plus accrued interest upon the occurrence
of certain events, including but not limited to, liquidation, consolidation,
merger or recapitalization. Interest on the Notes is paid semi-annually in
arrears on June 1 and December 1 of each year, beginning June 1, 2002. The debt
issuance costs are being amortized using the interest method. The Company
intends to use the proceeds of the issuance for general corporate purposes. The
issuance was made pursuant to Rule 144A, promulgated under the Securities Act of
1933, as amended.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
4.1 Indenture dated as of November 21, 2001 between the Company and State
Street Bank and Trust Company of California, N.A.
10.1 Registration Rights Agreement dated as of November 21, 2001 by and among
the Company and Morgan Stanley & Co. Incorporated and Salomon Smith
Barney Inc.
(b) Reports on Form 8-K.
On November 29, 2001, the Company filed a current report on Form 8-K reporting
under items 4 and 7 a change in the Company's independent accountants for the
fiscal year ending March 2, 2002.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RIVERSTONE NETWORKS, INC.
(Registrant)
Dated: January 15, 2002 By: /s/ Romulus S. Pereira
------------------------------------------
Romulus S. Pereira
President, Chief Executive Officer and
Director
(Duly Authorized Officer)
Dated: January 15, 2002 By: /s/ Robert Stanton
-----------------------------------------
Robert Stanton
Executive Vice President of Finance and
Chief Financial Officer
(Principal Financial Officer)
28
EXHIBIT INDEX
Exhibit
Number Description of Document
------- -----------------------
4.1 Indenture dated as of November 21, 2001 between the Company
and State Street Bank and Trust Company of California, N.A.
10.1 Registration Rights Agreement dated as of November 21, 2001 by
and among the Company and Morgan Stanley & Co. Incorporated
and Salomon Smith Barney, Inc.