10Q pages 13-17:
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MANAGEMENT OF EXPANSION. The Company is experiencing rapid expansion
in all areas of its operations, particularly in manufacturing, and the Company
anticipates that this expansion will continue in the near future. Total
personnel grew from 841 at October 31, 1997, to 993 at January 31, 1998. The
Company's Atlanta, Georgia research and development support organization grew
from 12 personnel at October 31, 1997 to 32 at January 31, 1998.
Approximately 150 more employees are joining the Company as a result of the
Company's acquisition of Alta, an installation services provider.
This expansion, which now includes the assimilation of a large
number of new employees through the acquisition of Alta, and the attendant
separation and relocation of various functions to different facilities, has
placed strains on the material, financial and personnel resources of the
Company and will continue to do so. The pace of the Company's expansion, in
combination with the complexity of the technology involved in the manufacture
of the Company's systems, demands an unusually high level of managerial
effectiveness in anticipating, planning, coordinating and meeting the
operational needs of the Company and the needs of the Company's customers, who
are among the most demanding customers in the world in terms of requirements
for quality, reliability, timely delivery and post-installation field support.
The rapid pace and volume of new hiring, the timely build out of new
facilities, and the accelerated ramp up in manufacturing capacity, if not
effectively managed, could adversely affect the quality or efficiency of the
Company's manufacturing process. The conversion to full scale production in
fiscal 1998 of the Company's new MultiWave Sentry, MultiWave 4000 and MultiWave
Firefly product lines will also present substantial management and
manufacturing challenges, as the scope of material planning and labor
involvement are different and more expansive than was the case with the
Company's original MultiWave 1600 product line. The assimilation of Alta and
the effective utilization of its installation services personnel, will also be
critical to the Company's efforts to satisfy its larger customers and,
ultimately, to further ramp up its production and sales volume to those
customers.
The Company also continues to increase its flow of materials,
optical assembly, final assembly and final component module and system test
functions, as well as the size of its sales and marketing organization for all
product lines, in anticipation of a level of customer orders that may not be
achieved. Many of the highest cost components in the Company's new products are
also those with the longest lead ordering times. As a result, the importance of
effective coordination between component ordering relative to anticipated
customer orders is increased, and the inability to manage this effectively may
result in increased inventory levels, and potentially, inventory obsolescence,
particularly if there are slips in delivery and final acceptance of the
Company's newest products. Increased inventory levels could also result from
any significant deferral of material purchases from any of the Company's major
customers. This may occur as a result of the recent communication from WorldCom
regarding its plans for substantially reduced DWDM system purchases. See
"Concentration of Potential Customers; Dependence on Major Customers."
Given the small number of existing and potential customers for the
Company's systems, as well as the widely varying volume requirements they may
have once a purchasing decision has been made, the adverse effect on the Company
resulting from a lack of effective management in any of these areas will be
substantially magnified, and the potential exists for additional stock price
volatility if investor expectations do not account for this risk. See "Stock
Price Volatility". Prolonged inability to manage the expansion of the Company's
business would also have a material adverse effect on the Company's longer term
business prospects, financial condition and results of operations.
ANTICIPATING DEMAND FOR BANDWIDTH. The Company's systems enable high
capacity transmission over long distance, and with the introduction of MultiWave
Firefly, certain short-haul portions of, optical communications networks;
however, the Company's customers and target customers determine how much
capacity is required, when it will be deployed, and what equipment
configurations will be used, if any. The Company has encountered a wide variety
of customer views of how much capacity will be needed over what periods of time
and, more importantly, how to convert such capacity into revenue. Those views
reflect the carriers' differing competitive strategies and financial and
marketing resources, and result in widely varying patterns and timing of
evaluation, purchase and deployment of the Company's systems, other DWDM systems
or other capacity solutions. Certain carriers have believed the deployment of
maximum capacity quickly will be a competitive advantage--i.e., they have
assumed the accelerating demand for bandwidth will continue and the capacity
will be utilized quickly. This viewpoint leads to prompt and widespread
deployment of high-channel count DWDM systems. Other carriers have adopted more
of a wait-and-see approach, which dictates a more gradual channel by channel
deployment of
14
higher capacity systems. These views are also subject to abrupt change, as
competition and the evolving marketplace may demand. As an example, WorldCom
informed the Company in February 1998 that its DWDM system requirements for
1998 will be substantially below last year's purchases, due to a change in its
purchasing policies. See "Concentration of Potential Customers; Dependence
on Major Customers". WorldCom's information in February indicates there can be
surprises as network operators and their purchasing groups grapple with
unprecedented changes and challenges to network planning.
Under these circumstances, for so long as the Company remains
dependent on two or even three customers, the Company will be vulnerable to
significant quarterly fluctuations, and to difficulty in predicting the
direction or magnitude of future demand for the Company's systems. While the
Company remains very optimistic about the year to year outlook for growth in
demand for DWDM systems, and also is confident that its products are well
targeted toward the most visible emerging points of congestion in the networks,
the Company is less certain whether it will be able to accurately anticipate
changes in direction or magnitude of near term demand. Unanticipated reductions
in demand would adversely affect the Company's profitability and, depending on
the size of the gap between actual, reduced demand, and investor expectation of
such demand, could result in further stock price volatility irrespective of the
Company's overall competitive position and long term prospects. "See
"Concentration of Potential Customers; Dependence on Major Customers".
RECENT PRODUCT INTRODUCTION. The Company first began commercial
shipments of its MultiWave systems in May 1996 and its first operational systems
began carrying live traffic in October 1996. Accordingly, the Company's systems
do not have a history of live traffic operation over an extended period of time.
The Company's history of installation activity indicates that the newness and
high precision nature of DWDM equipment may require enhanced customer training
and installation support from the Company. The Company is aware of instances
domestically and internationally in which installation and activation of certain
MultiWave systems have been delayed due to faulty components found in certain
portions of these systems. The Company is aware of few performance issues once
the systems are installed and operational. However, if recurring or material
reliability, quality or network monitoring problems should develop, a number of
material and adverse effects could result, including manufacturing rework costs,
high service and warranty expense, high levels of product returns, delays in
collecting accounts receivable, reduced orders from existing customers and
declining level of interest from potential customers. Although the Company
maintains accruals for product warranties, there can be no assurance that actual
costs will not exceed these amounts. There is a considerable number of the
Company's systems scheduled to be turned up for live traffic operation over the
next several months, and many already activated systems may be scheduled to add
new operating channels. The Company expects there will be interruptions or
delays from time to time in the activation of the systems and the addition of
channels, particularly because the Company does not control all aspects of the
installation and activation activities. The Company believes its record to date
of problem identification, diagnosis and resolution has been good, but if
significant interruptions or delays occur, or if their cause is not promptly
identified, diagnosed and resolved, confidence in the MultiWave systems could be
undermined. An undermining of confidence in the MultiWave systems would have a
material adverse effect on the Company's customer relationships, business,
financial condition and results of operations.
NEW PRODUCT DEVELOPMENT DELAYS. The Company's ability to anticipate
changes in technology, industry standards, customer requirements and product
offerings and to develop and introduce new and enhanced products in a timely
fashion relative customer expectations of increasingly short product development
cycles, will be significant factors in the Company's ability to remain a market
leader in the deployment of DWDM systems. The complexity of the technology
involved in product development efforts in the DWDM field, including product
customization efforts for individual customers, can result in unanticipated
delays. The qualification and ramping up of new suppliers for new or customized
products requires extensive planning and can result in unanticipated delays
which affect the Company's ability to deliver such products in a timely fashion.
The failure to deliver new and improved products, or appropriately customized
products, in a timely fashion relative to customer expectations (which
expectations are shaped in part by competitors' announcements of competing
products), would have a material adverse effect on the Company's competitive
position and financial condition. See "Competition". The Company is currently
facing its first major test in this area, with its general commitment to the
delivery of MultiWave Sentry, MultiWave 4000 and MultiWave Firefly in the first
half of calendar 1998. The Company's performance on
15
this commitment relative to customer expectations will likely have a material
impact on the Company's ability to further solidify its position in the telecom
industry as a credible, long-term supplier of multiple products and successive
next-generation solutions. The Company believes it will be successful in this
effort, but there is no assurance of that, and there will likely be few
objective "leading indicators" of the Company's success or failure, other than
continued purchasing by its customers.
COMPETITION. The Company believes the rapid pace at which the need
for higher and more cost-effective bandwidth has developed was not widely
anticipated in the global telecommunications industry. The Company further
believes its MultiWave 1600 is the only commercially deployed and operational
full 16-channel open architecture DWDM system anywhere in the world, and
further believes the commercial manufacturability of its MultiWave 4000 system
gives the Company's high-capacity product offerings a level of credibility not
possessed by its competitors. However, competition in the global
telecommunications industry historically has been dominated by a small number
of very large companies, each of which have greater financial, technical and
marketing resources, greater manufacturing capacity and more extensive and
established customer relationships with network operators than the Company.
Each of Lucent, Alcatel, Nortel, NEC, Pirelli, Siemens and Ericsson are moving
very aggressively to capture market share in the DWDM market. The Company
expects aggressive competitive moves from industry participants, which have to
date included early announcement of competing or alternative products, and
substantial price discounting. Such early announcements of competing products
can cause confusion and delay in customer purchasing decisions, particularly if
the announcements are viewed as credible in terms of both the performance of
the announced product, and the time within which it will be available. For
example, Lucent recently announced a proposed high-capacity DWDM system which
it claims will handle 400 Gb/s of capacity per fiber, and which it further
claims will be commercially available worldwide in the fourth quarter of 1998.
There can be no assurance that announcements like those of Lucent or others
in the industry will not cause confusion and delay in customer purchasing
decisions. Further, if new products announced by competitors are in fact
developed, perform as advertised, and are manufacturable in volume quantities
by the fourth quarter of this year, the likelihood of significant orders from
AT&T and other customers for the Company's 16-channel MultiWave Sentry and
40-channel MultiWave 4000 systems may diminish. The timing of shipments by the
Company and corresponding revenue, if delayed by reason of deferred deployment
of MultiWave Sentry or MultiWave 4000 systems pending evaluation of a
competitor's product, could and likely would cause substantial swings, and
potentially material and adverse effects, on the Company's quarterly financial
condition and results of operations.
In addition, Lucent, Alcatel, Nortel, NEC and Siemens are already
providers of a full complement of switches, fiberoptic transmission terminals
and fiberoptic signal regenerators and thereby can position themselves as
vertically integrated, "one-stop shopping" solution providers to potential
customers.
While competition in general is broadly based on varying
combinations of price, manufacturing capacity, timely delivery, system
reliability, service commitment and installed customer base, as well as on the
comprehensiveness of the system solution in meeting immediate network needs and
foreseeable scaleability requirements, the Company's customers are themselves
under increasing competitive pressure to deliver their services at the lowest
possible cost. This pressure may result in pricing for DWDM systems becoming a
more important factor in customer decisions, which may favor larger competitors
which can spread the effect of price discounts in their DWDM product lines
across an array of products and services, and a customer base, which are larger
than the Company's.
Intellectual property disputes may also be asserted as part of a
competitive effort to reduce the Company's leadership position and limit its
ability to achieve greater market share, even if the merits of specific
disputes are doubtful. Some of the Company's competitors are also key suppliers
of components for the Company's systems. See "Competitors as Suppliers".
There can be no assurance that the Company will be able to compete
successfully with its competitors or that aggressive competitive moves faced by
the Company will not result in lower prices for the Company's products,
decreased gross profit margins, and otherwise have a material adverse effect on
its business, financial condition and results of operations.
LEGAL PROCEEDINGS. See Part II, "Legal Proceedings" for disclosure
concerning recent developments in certain litigation proceedings to which the
Company is a party.
16
FLUCTUATION IN QUARTERLY AND ANNUAL RESULTS. The Company's revenue
and operating results are likely to vary significantly from quarter to quarter
and from year to year as a result of a number of factors, including the size
and timing of orders, product mix and shipments of systems. The timing of order
placement, size of orders, satisfaction of contractual customer acceptance
criteria, as well as order delays or deferrals and shipment delays and
deferrals, may cause material fluctuations in revenue. Delays or deferrals in
purchasing decisions may increase as competitors introduce new competing
products, and as the Company develops or introduces other DWDM products, such
as the MultiWave Sentry, MultiWave 4000, MultiWave Firefly and the MultiWave
Metro. Consolidation among the Company's customers and target customers, such
as that involved in the WorldCom/MCI merger, and the distraction and/or
reorganization attendant to such consolidation, may also lead to delay or
deferral of purchasing decisions. Changes in customers' approaches to bandwidth
deployment can also materially impact purchasing decisions. See "Anticipating
Demand for Bandwidth." The Company's dependence on a small number of existing
and potential customers increases the revenue impact of each customer's actions
relative to these factors. The Company's expense levels in the future will be
partially based on its expectations of long term future revenue and as a result
net income for any quarterly period in which material orders are shipped or
delayed or not forthcoming could vary significantly. The Company's expense
levels for the next two quarters are expected to reflect substantially
increased investment in financial, engineering, manufacturing and logistics
support resources in positioning the AT&T, RBOC, international and other
potential commercial relationships to be successful, even though there is no
assurance as to the volume, duration or timing of any purchases which might
ensue from AT&T or others. Over the near term, this investment of resources
will be evident in increased inventory levels and operating expenses, and in a
rise in the Company's general overhead and expense structure, with the result
that even without the impact of the WorldCom change in purchasing policy, the
Company's near term earnings may moderate or decline, even if revenues
increase. If revenues are flat or decline as a result of the WorldCom change,
or for any other reason, the adverse effect on earnings would be increased. See
"Concentration of Potential Customers; Dependence on Major Customers." In
general, quarter-to-quarter sequential revenue in the first two or three years
of operations are likely to vary widely and therefore may not be reliable
indicators of annual performance.
DEPENDENCE ON SUPPLIERS. Suppliers in the specialized, high
technology sector of the optical communications industry are generally not as
plentiful or, in some case, as reliable, as suppliers in more mature industries.
The Company is dependent on a limited number of suppliers for components of the
MultiWave systems as well as equipment used to manufacture the MultiWave
systems. The MultiWave 1600 system has over 600 components, and the commencement
of full production of the MultiWave Sentry, MultiWave Firefly and MultiWave 4000
systems will increase the number and variety of components significantly. Not
all of the component suppliers for these new systems have demonstrated the
ability to ramp up their production to keep pace with the Company's needs, and
certain of the new components are critical to system operation, such as the
apparatus for multiplexing and demultiplexing of signals in the 24-channel
Firefly system. One of the Company's planned vendors for this apparatus has
notified the Company that it is having difficulty in achieving overall yield and
process stability, and is declining to accept new orders pending resolution of
the problems. The Company believes that its immediate needs for this component
can be met by another vendor, but neither vendor has yet demonstrated the
ability to ramp up as may be necessary to meet the Company's future needs.
Certain key optical and electronic components are currently available only from
a sole source, where the Company has identified no other suppliers for the
component. While alternative suppliers have been identified for certain other
key optical and electronic components, those alternative sources have not been
qualified by the Company. The Company has to date conducted the majority of its
business with suppliers through the issuance of conventional purchase orders
against the Company's forecasted requirements. The Company is seeking to
negotiate long term supply agreements with key suppliers, but currently has only
a few such agreements. The Company has from time to time experienced minor
delays in the receipt of key components, and has noticed a lengthening of lead
times in the ordering of certain components. Any future difficulty in obtaining
sufficient and timely delivery of components could and likely would result in
delays or reductions in product shipments which, in turn, could have a material
adverse effect on the company's business, financial condition and results of
operations.
COMPETITORS AS SUPPLIERS. Certain of the Company's component
suppliers are both primary sources for such components and major competitors in
the market for system equipment. For example, the Company buys certain key
components from Lucent, Alcatel, Nortel, NEC and Siemens, each of which offers
optical communications systems and equipment which are competitive with the
Company's DWDM systems. Lucent is the sole source of two integrated circuits and
is one of two suppliers of Erbium-doped fiber. Alcatel and Nortel are suppliers
of lasers used in the MultiWave systems. NEC is a supplier of certain testing
equipment. The Company's business, financial condition and results of operations
could be materially and adversely affected if
17
these supply relationships were to decline in reliability or otherwise change in
any manner adverse to the Company. Although the Company has been notified by one
of these vendors of certain manufacturability problems in certain high
performance components used in the Company's MultiWave Firefly system, the
Company has not experienced to date any general decline in reliability among
these vendors. See "Dependence on Suppliers" for a further discussion of the
issues relating to the component used in the Firefly system. However, this risk
factor increases in importance given the Company's expansion efforts, new
products, and the increasingly competitive environment in which the Company
operates.
STOCK PRICE VOLATILITY. The Company's Common Stock price has
experienced substantial price volatility, and is likely to continue to do so.
Such volatility can arise as a result of any divergence between the Company's
actual or anticipated financial results and published expectations of analysts
and as a result of announcements by the Company and its competitors. The Company
attempts to address this possible divergence through its public announcements
and reports; however, the degree of specificity the Company can offer in such
announcements, and the likelihood that any forward-looking statements made by
the Company will prove correct in actual results, can and will vary, due
primarily to the uncertainties associated with the Company's dependence on a
small number of existing and potential customers, long and unpredictable sales
cycles and customer purchasing programs, the absence of unconditional minimum
purchase commitments from any customer, a declining level of visibility into its
customers' deployment plans over the course of the capital equipment procurement
year, and the lack of reliable data on which to anticipate core demand for high
bandwidth transmission capacity. An example of this uncertainty is evidenced in
the recent communication from WorldCom that its DWDM system requirements for
1998 will be substantially reduced relative to last year's purchases, due to a
change in its purchasing policies. See "Concentration of Potential Customers;
Dependence on Major Customers."
The WorldCom example indicates that divergence between the Company's
actual or anticipated financial results and published expectations of stock
analysts can occur notwithstanding the Company's efforts to address those
expectations through public announcements and reports. Such divergence will
likely occur from time to time in the future, with resulting stock price
volatility, irrespective of the Company's overall year to year performance or
long term prospects. For so long as the Company remains highly dependent on two
or three customers, and particularly in years, like the current fiscal year,
when substantial majority of purchases by these customers are likely to be
focused on products, such as MultiWave Sentry, MultiWave 4000, and MultiWave
Firefly, being introduced for the first time, there is substantial risk of
widely varying quarterly results, including the so-called "missed quarter"
relative to investor expectations which do not account for these issues, with
attendant risk of higher volatility in the Company's stock price. See
"Concentration of Potential Customers; Dependence on Major Customers";
"Dependence on Effective Transition to Multiple Product Lines"; and
"Anticipating Demand for Bandwidth".
LONG AND UNPREDICTABLE SALES CYCLES. The purchase of network
equipment such as DWDM equipment is typically carried out by network operators
pursuant to multiyear purchasing programs which may increase or decrease
annually as the operators adjust their capital equipment budgets and purchasing
priorities. The Company's customers do not typically share detailed information
on the duration or magnitude of planned purchasing programs, nor do they
consistently provide to the Company advance notice of contemplated changes in
their capital equipment budgets and purchasing priorities. See "Concentration
of Potential Customers; Dependence on Major Customers" for discussion of a
major change in WorldCom's purchasing policies. Additionally, a typical year
end wind-down of customers' annual capital equipment procurement cycles, or a
seasonal slow down in purchasing at year end, neither of which was experienced
by the Company in its first year of product shipments, may be experienced in
this and future years. These uncertainties substantially complicate the
Company's manufacturing planning, and may lead to substantial and unanticipated
fluctuations in the timing of orders and revenue. The Company has in fact
experienced such unanticipated fluctuations in prior quarters, but any
unanticipated reduction in orders from one customer has previously been offset
in part or in whole by unanticipated increases in orders for other routes with
the same customer or in orders from another customer. There can be no assurance
that this historical ability to offset reductions will continue. For example,
the Company may be unable to mitigate the anticipated effect of the recently
announced reduction in order levels from WorldCom.
Any curtailment or termination of customer purchasing programs,
decreases in customer capital budgets or reduction in the purchasing priority
assigned to equipment such as DWDM equipment, particularly if significant and
unanticipated by the Company and not offset by increased purchasing from other
customers, could |
