CORV - ANYONE HAVE A TAKE ON THIS?
Recent filings: Aug 28, 2000 (Qtrly Rpt) | Nov 13, 2000 (Qtrly Rpt) | May 11, 2001 (Qtrly Rpt) | Aug 13, 2001 (Qtrly Rpt)
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August 13, 2001
CORVIS CORP (CORV)
Quarterly Report (SEC form 10-Q)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis along with our unaudited condensed consolidated financial statements and the notes to those statements included elsewhere in this report and in conjunction with our Form 10-K filed on March 29, 2001 with the Securities and Exchange Commission.
Overview
We design, manufacture and sell high performance optical communication systems that lower the overall cost of network ownership for service providers. Our all-optical products have enabled a fundamental shift in network design and efficiency by allowing for the transmission, switching and management of communication traffic entirely in the optical domain, thereby eliminating the capital and operational expense of electrical regeneration and switching equipment in the backbone network. Our point to point and repeaterless transmission products and optical switching products allow us to offer high performance solutions that address a broad range of networking requirements encountered by service providers.
We currently have five customers, including Broadwing Communications, Inc., Williams Communications, Inc., Qwest Communications Corporation, Telefonica, and a major global carrier with a business arrangement under a non-disclosure agreement. During the first half of 2000, we shipped, installed and activated laboratory trial systems and field trial systems for both Broadwing and Williams Communications to allow for customer testing and inspection. In July 2000, we successfully completed the Broadwing Communications field trial and Broadwing agreed to purchase $200 million of our products and services over a two-year period. Throughout the remainder of 2000, we began the deployment of both transmission and switching equipment to Broadwing and built-up finished goods inventory necessary to support customer orders in early 2001.
In January 2001, the field trial system provided to Williams Communications was accepted and Williams Communications agreed to purchase up to $300 million of our products and services over a multi-year period. Shipment of commercial equipment to Williams Communications began late in the first quarter of 2001 and continues to date.
Qwest has agreed to purchase $150 million of our products, some of which are currently under development, over a two-year period. In April 2001, we received a commitment of $110 million to purchase both transmission and switching equipment under the aforementioned agreement with shipments commencing during fiscal 2001. Qwest's acceptance of delivered equipment is contingent upon certain shipment pre-requisites.
In the second quarter 2001, the Company entered into a contract with a global carrier and reached agreement with Spanish operator Telefonica for the delivery of our next generation optical products. These contracts are in early stages; however, we hope to develop these arrangements into long-term business relationships.
We are also in discussions with other service providers to begin field trials and to purchase our products and services.
Recently, unfavorable economic conditions have resulted in reduced capital expenditures by telecommunications service providers. In response to these conditions, we implemented a restructuring plan, approved by the Company's Board of Directors, designed to decrease the Company's business expenses and to align resources for long-term growth opportunities. Additionally, we evaluated the carrying value of our long-lived assets. In the second quarter, the Company recorded business restructuring and impairment charges of approximately $714.6 million. These charges included $99.2 million associated with inventory write-downs and open purchase commitments which
were recorded in costs of revenue, $606.7 associated with workforce reduction, consolidation of excess facilities, write-down of idle equipment, and impairment of goodwill recorded in restructuring and other charges; and $8.7 million associated with impairment of certain investments carried at cost recorded as interest income and other expense, net.
Revenue. Revenue from product sales is recognized upon execution of a contract and the completion of all delivery obligations provided that there are no uncertainties regarding customer acceptance and collectibility is deemed probable. If uncertainties exist, revenue is recognized when such uncertainties are resolved.
Revenue from installation services is recognized as the services are performed. Revenues from installation service fixed price contracts are recognized on the percentage-of-completion method, measured by the percentage of costs incurred to date compared to estimated total costs for each contract. Amounts received in excess of revenue recognized are included as deferred revenue in our consolidated balance sheets.
Costs of Revenue. Costs of revenue include the costs of manufacturing our products and other costs associated with warranty and other contractual obligations, inventory obsolescence costs and overhead related to our manufacturing, engineering, finishing and installation. Warranty reserves are determined based upon actual warranty cost experience, estimates of component failure rates and management's industry experience.
Research and Development, Excluding Equity-Based Expense. Research and development, excluding equity-based expense consists primarily of salaries and related personnel costs, test and prototype expenses related to the design of our hardware and software products, laboratory units and facilities costs. All costs related to product development, both hardware and software, are recorded as expenses in the period in which they are incurred. Due to the timing and nature of the expenses associated with this process, significant quarterly fluctuations may result. We believe that research and development is critical in achieving current and future strategic product objectives.
Sales and Marketing, Excluding Equity-Based Expense. Sales and marketing, excluding equity-based expense consists primarily of salaries and related personnel costs, laboratory trial systems provided to customers, trade shows, other marketing programs and travel expenses. We intend to continue to adjust our sales operations in order to increase market awareness and acceptance of our products. We also expect to initiate additional marketing programs to support our current products. Our success depends on establishing and maintaining key customer relationships.
General and Administrative, Excluding Equity-Based Expense. General and administrative, excluding equity-based expense consists primarily of salaries and related personnel costs, information systems support, recruitment expenses and facility demands associated with establishing the proper infrastructure to support our organization. This infrastructure consists of executive, financial, legal, information systems and other administrative responsibilities.
Equity-based Expense. Equity-based expense consists primarily of charges associated with employee options granted at below fair market value prior to our initial public offering.
Amortization of Goodwill and Other Intangible Assets. Amortization of goodwill and other intangible assets primarily relates to the amortization of goodwill associated with the acquisition of Algety Telecom S.A. As discussed above, the Company recorded a charge of approximately $588.3 million, which was recorded in restructuring and other special charges discussed below, to reduce this
goodwill to its current estimated fair value. As a result, amortization expense should significantly decrease in future periods.
Results of Operations
Three months ended June 30, 2001 compared to three months ended July 1, 2000
Revenue. Revenue increased to $65.0 million for the three months ended June 30, 2001 from zero for the three months ended July 1, 2000. The increase in revenue is attributable to the sale of network hardware and associated software for commercial use to two customers.
Gross Profit. Costs of revenue consists of component costs, direct compensation costs, warranty and other contractual obligations, inventory obsolescence costs and overhead related to our manufacturing and engineering, finishing and installation operations. In association with discontinued product lines under the Company's restructuring plan, the Company recorded cost of revenue charges totaling $99.2 million, comprised of inventory write-downs and certain open purchase commitments of approximately $65.8 million and $33.4 million, respectively. Gross profit (loss) was $(74.7) million for the three months ended June 30, 2001. Gross margin as a percentage of revenues was (115.1)%. Excluding special charges of $99.2 million for the three months ended June 30, 2001, gross profit and gross margin were $24.5 million and 37.6%, respectively.
Research and Development, Excluding Equity-Based Expense. Research and development expenses, excluding equity-based expense increased to $41.9 million for the three months ended June 30, 2001 from $13.5 million for the three months ended July 1, 2000. The increase in expenses was primarily attributable to significant increases in headcount, as well as material costs associated with prototype development and laboratory materials.
Sales and Marketing, Excluding Equity-Based Expense. Sales and marketing expenses, excluding equity-based expense increased to $15.1 million for the three months ended June 30, 2001 from $4.4 million for the three months ended July 1, 2000. The increase in expenses was primarily attributable to significant increases in headcount and increases in promotions and trade show activities.
General and Administrative, Excluding Equity-Based Expense. General and administrative expenses, excluding equity-based expense increased to $8.5 million for the three months ended June 30, 2001 from $5.5 million for the three months ended July 1, 2000. The increase in expenses was primarily attributable to salaries and related benefits due to the hiring of additional personnel and increased costs associated with establishing the proper infrastructure to support our organization.
Equity-based Expense. Equity-based expense related to research and development, sales and marketing and general and administrative functions decreased to $25.4 million for the three months ended June 30, 2001 from $37.9 million for the three months ended July 1, 2000. Equity-based expense for the three months ended June 30, 2001 primarily relates to charges associated with the granting of employee options at below fair market value prior to our initial public offering. Equity-based expense for the three months ended July 1, 2000 primarily relates to the waiving of certain forfeiture provisions contained in warrants granted to certain customers.
Amortization of Goodwill and Intangible Assets. Amortization of intangible assets expenses increased to $49.6 million for the three months ended June 30, 2001 from $0.1 million for the three months ended July 1, 2000. The increase was primarily attributable to the amortization of intangibles resulting from our recent acquisitions.
Restructuring and Other Charges. Restructuring and other charges increased to $606.7 million for the three months ended June 30, 2001 from zero for the three months ended July 1, 2000. These charges were comprised of $9.4 million associated with workforce reduction, $9.0 million associated with consolidation of facilities and write-down of idle equipment, and $588.3 million associated with the write-down of goodwill associated with the acquisition of Algety Telecom S. A.
Interest Income and Other, Net. Interest income, net of interest and other expenses, decreased to $0.3 million for the three months ended June 30, 2001 from $0.9 million for the three months ended July 1, 2000. The decrease was primarily attributable to the write-down of certain equity investments of approximately $8.7 million associated with the permanent impairment of certain investments carried at cost and interest expense incurred under various credit facilities, offset in part by interest income attributable to invested cash balances from the proceeds of initial public offering and various private placements.
Six months ended June 30, 2001 compared to six months ended July 1, 2000
Revenue. Revenue increased to $149.0 million for the six months ended June 30, 2001 from zero for the six months ended July 1, 2000. The increase in revenue is attributable to the acceptance of a field trial system and the sale of network hardware and associated software for commercial use. Revenue for the period is attributable to two customers.
Gross Profit. Costs of revenue consists of component costs, direct compensation costs, warranty and other contractual obligations, inventory obsolescence costs and overhead related to our manufacturing and engineering, finishing and installation operations. In association with discontinued product lines under the Company's restructuring plan, the Company recorded cost of revenue charges totaling $99.2 million, comprised of inventory write-downs and certain purchase commitments of approximately $65.8 million and $33.4 million, respectively. Gross profit was $(43.6) million for the six months ended June 30, 2001. Gross margin as a percentage of revenues was (29.2)%. Excluding special charges of $99.2 million for six months ended June 30, 2001, gross profit and gross margin were $55.6 million and 37.3%, respectively.
Research and Development, Excluding Equity-Based Expense. Research and development expenses, excluding equity-based expense increased to $82.9 million for the six months ended June 30, 2001 from $33.7 million for the six months ended July 1, 2000. The increase in expenses was primarily attributable to significant increases in headcount, as well as material costs associated with prototype development and laboratory materials.
Sales and Marketing, Excluding Equity-Based Expense. Sales and marketing expenses, excluding equity-based expense increased to $30.5 million for the six months ended June 30, 2001 from $9.0 million for the six months ended July 1, 2000. The increase in expenses was primarily attributable to significant increases in headcount and increases in promotions and trade show activities.
General and Administrative, Excluding Equity-Based Expense. General and administrative expenses, excluding equity-based expense increased to $19.5 million for the six months ended June 30, 2001 from $8.1 million for the six months ended July 1, 2000. The increase in expenses was primarily attributable to significant increases in headcount, and increased costs associated with establishing the proper infrastructure to support our organization.
Equity-based Expense. Equity-based expense related to research and development, sales and marketing and general and administrative functions increased to $51.1 million for the six months ended June 30, 2001 from $38.6 million in the six months ended July 1, 2000. The increase in equity-based
compensation primarily resulted from an increase in charges associated with stock options granted prior to our initial public offering at an exercise price below fair value on the date of grant.
Amortization of Goodwill and Intangible Assets. Amortization of intangible assets expenses increased to $101.9 million for the six months ended June 30, 2001 from $0.2 million for the six months ended July 1, 2000. The increase was primarily attributable to the amortization of intangibles resulting from our recent acquisitions.
Restructuring and Other Charges. Restructuring and other charges increased to $606.7 million for the six months ended June 30, 2001 from zero for the six months ended July 1, 2000. These charges were comprised of $9.4 million associated with workforce reduction, $9.0 million associated with consolidation of excess facilities and write-down of idle equipment, and $588.3 million associated with the write-down of goodwill associated with the acquisition of Algety Telecom S.A.
Interest Income and Other, Net. Interest income, net of interest and other expense, increased to $13.5 million for the six months ended June 30, 2001 from $2.4 million for the six months ended July 1, 2000. The increase was primarily attributable to higher invested cash balances from the proceeds of the initial public offering and various private placements, offset in part by interest expense incurred under various credit facilities and a write-down of certain equity investments of approximating $8.7 million associated with the permanent impairment of certain investments carried at cost.
Liquidity and Capital Resources
Since inception through June 30, 2001, we have financed a significant portion of our operations, capital expenditures and working capital primarily through public and private sales of our capital stock, borrowings under credit and lease facilities and cash generated from operations. At June 30, 2001, our cash and cash equivalents totaled $771.6 million.
Net cash used in operating activities was $151.0 million for the six months ended June 30, 2001. Cash used in operating activities for the six months ended June 30, 2001 was primarily attributable to a net loss of $922.7 million, $51.4 million of increases in accounts receivable, $23.5 million increase in net inventory, partially offset by non-cash expense items including depreciation and amortization of $122.8 million, equity-based expense of $51.1 million and restructuring, inventory write-down, and other charges of $663.3 million.
Net cash used in investing activities for the six months ended June 30, 2001 was $101.3 million which was primarily attributable to purchases of manufacturing and test equipment, information systems and office equipment. We continue to evaluate our need for production and administrative equipment and facilities to accommodate our current and future operations. Capital expenditures for the remainder of 2001 are expected to total between $10 million and $20 million.
Net cash provided by financing activities for the six months ended June 30, 2001 was $2.1 million, primarily attributable to proceeds from the exercise of warrants and employee stock options.
As of June 30, 2001, long-term restricted cash totaled $46.3 million, of which $43.5 million represents cash held as security under a note payable. This restriction will be released upon repayment of the note which is due in November 2002. In addition, as of June 30, 2001, we had outstanding irrevocable letters of credit aggregating $2.8 million relating to lease obligations for various manufacturing and office facilities and other business arrangements. These letters of credit are collateralized by funds in our operating account. Various portions of the letters of credit expire at the end of each respective lease term or agreement term.
Currently, our industry is experiencing significant competitive pricing pressures and a general slow down in telecommunication infrastructure spending. As such, we expect gross margins for the remainder of the year to decrease from previous levels. Lower gross margins are likely to result from several factors including, but not limited to, selling our products to customers at lower prices, providing financing to customers and reduced manufacturing efficiencies due to changes in volume.
Certain of our customer agreements include customer acceptance provisions associated with equipment delivery. Unexpected delays in customer acceptance may give rise to delays in cash collection and related revenue recognition. Such delays could adversely impact our liquidity and results of operations.
In light of the current economic environment, we slowed expansion within current operations during the first six months of 2001 and implemented plans to strategically lower operating expenses for the remainder of the fiscal year. Plans included personnel reductions, elimination of excess facilities and other measures to streamline operating costs. The Company currently is developing additional cost reduction plans, which will be at lower levels than those implemented in the second quarter of 2001. If we are unable to execute these cost reduction measures effectively or in a timely manner, or if margin pressures continue for longer than expected, our liquidity and capital resources could be adversely effected.
Our liquidity will also be dependent on our ability to manufacture and sell our products. Changes in the timing and extent of the sale of our products will affect our liquidity, capital resources and results of operations. We currently have five customers that could provide substantially all of our revenues for the near future. The loss of any of these customers, any substantial reduction in current or anticipated orders or an inability to attract new customers, could materially adversely affect our liquidity and results of operations. We plan to diversify our customer base by seeking new customers both domestically and internationally.
We believe that our current cash and cash equivalents and cash generated from operations will satisfy our expected working capital, capital expenditure, and investment requirements through at least the next twelve months.
If cash on hand and cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. To the extent that we raise additional capital through the sale of equity or debt securities, the issuance of such securities could result in dilution to our existing shareholders. If additional funds are raised through the issuance of debt securities, the terms of such debt could impose additional restrictions on our operations. Additional capital, if required, may not be available on acceptable terms, or at all. If we are unable to obtain additional financing, we may be required to reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial condition and operating results. Increasingly, as a result of the financial demands of major network deployments, service providers are looking to their suppliers for financing assistance. From time to time, we may provide or commit to extend credit or credit support to our customers that we deem appropriate in the course of our business.
Litigation
On July 19, 2000, Ciena Corporation ("Ciena") filed a lawsuit in the United States District Court for the District of Delaware alleging that we are willfully infringing three of Ciena's patents. Ciena is seeking injunctive relief, an unspecified amount of damages including treble damages, as well as costs of the lawsuit, including attorneys' fees. On September 8, 2000, we filed an answer to the complaint, as well as counter-claims alleging, among other things, invalidity and/or unenforceability of the three patents in
question. On March 5, 2001, a motion was granted, allowing Ciena to amend its complaint to include allegations that we are willfully infringing two additional patents. We are currently in the discovery phase of the litigation and a trial date has been set for April 1, 2002. We intend to defend ourselves vigorously against these claims and we believe that we will prevail in this litigation. An adverse determination in, or settlement of, the Ciena litigation could involve the payment of significant amounts by us, or could include terms in addition to payments, such as a redesign of some of our products, which could have a material adverse effect on our business, financial condition and results of operations. If we are required to redesign our products, we have to stop selling our current products until they have been redesigned. We believe that defense of the lawsuit may be costly and may divert the time and attention of some members of our management.
Between May 7, 2001 and June 15, 2001, nine putative class action lawsuits were filed in the United States District Court for the Southern District of New York relating to our initial public offering on behalf of all persons who purchased our stock between July 28, 2000 and the filing of the complaints. Each of the complaints names as defendants: Corvis, our directors and officers who signed the registration statement in connection with our initial public offering, and certain of the underwriters that participated in our initial public offering. The complaints allege that the registration statement and prospectus relating to our initial public offering contained material misrepresentations and/or omissions in that those documents did not disclose (1) that certain of the underwriters had solicited and received undisclosed fees and commissions and other economic benefits from some investors in connection with the distribution of our common stock in the initial public offering and (2) that certain of the underwriters had entered into arrangements with some investors that were designed to distort and/or inflate the market price for our common stock in the aftermarket following the initial public offering. The complaints ask the court to award to members of the class the right to rescind their purchases of Corvis common stock (or to be awarded rescissory damages if the class member has sold its Corvis stock) and prejudgment and post-judgment interest, reasonable attorneys' and experts witness' fees and other costs. The plaintiffs have moved to appoint lead plaintiff, to appoint lead counsel and to consolidate the actions. These motions are pending. No discovery has yet occurred. We intend to vigorously defend ourselves and our officers and directors.
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