UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________________ TO __________________
Commission File Number: 000-26485
--------------------------------------------------------------------------------
PARADYNE NETWORKS, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 75-2658219
------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8545 126TH AVENUE NORTH, LARGO, FLORIDA 33773
--------------------------------------------------------------------------------
(Address, including zip code, of principal
executive offices, including zip code)
(727) 530-2000
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
None
--------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 [ ].
The number of shares outstanding of the Registrant's Common Stock as
of October 31, 2001 was 33,005,595.
PARADYNE NETWORKS, INC.
FOR THE PERIOD ENDED SEPTEMBER 30, 2001
INDEX
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Condensed Consolidated Balance Sheets at September 30, 2001
and December 31, 2000 1
Condensed Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 2001 and September 30, 2000 2
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and September 30, 2000 3
Notes to Condensed Consolidated Financial Statements 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
ITEM 3. Quantitative and Qualitative Disclosures about Market
Risk 12
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings 12
ITEM 2. Changes in Securities and Use of Proceeds 13
ITEM 5. Other Information 13
SIGNATURES 13
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
UNAUDITED
-----------------------------------
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 27,194 $ 19,821
Accounts receivable less allowance for doubtful accounts of $3,206 and $3,919
at September 30, 2001 and December 31, 2000, respectively 13,840 23,770
Income tax receivables 180 4,000
Inventories (See Note 3) 17,932 38,628
Prepaid expenses and other current assets 1,976 2,563
------------- -------------
Total current assets 61,122 88,782
Property, plant and equipment, less accumulated depreciation of $24,690 and
$21,704 at September 30, 2001 and December 31, 2000, respectively 14,536 20,299
Other assets 503 8,199
------------- -------------
Total assets $ 76,161 $ 117,280
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,308 $ 17,032
Current portion of debt 537 638
Payroll & benefit related liabilities 5,108 7,647
Other current liabilities 6,217 8,620
------------- -------------
Total current liabilities 20,170 33,937
Long term liabilities 553 684
------------- -------------
Total liabilities 20,723 34,621
============= =============
Stockholders' equity:
Preferred stock, par value $.001; 5,000,000 shares authorized, none issued
or outstanding
Common stock, par value $.001; 60,000,000 shares authorized, 32,985,894 and
32,556,127 shares issued and outstanding as of September 30, 2001 and
December 31, 2000, respectively 33 33
Additional paid-in capital 104,425 104,019
Accumulated deficit (48,421) (19,759)
Other equity adjustments (599) (1,634)
------------- -------------
Total stockholders' equity 55,438 82,659
------------- -------------
Total liabilities and stockholders' equity $ 76,161 $ 117,280
============= =============
See accompanying Notes to Condensed Consolidated Financial Statements
1
PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- ---------
Revenues:
Sales $ 33,109 $ 54,960 $ 92,099 $ 192,700
Services 1,128 716 3,210 2,804
Royalties 0 40 250 290
-------- -------- -------- ---------
Total Revenues 34,237 55,716 95,559 195,794
Total cost of sales 19,897 70,979 66,477 153,061
-------- -------- -------- ---------
Gross Margin 14,340 (15,263) 29,082 42,733
Operating expenses:
Research and development 5,074 10,262 19,675 30,285
Selling, general & administrative 7,926 12,151 28,642 46,192
Impairment of intangible assets 0 0 5,761 0
Amortization of intangible assets and
deferred stock compensation 71 437 843 889
Business restructuring charges 0 0 3,807 0
-------- -------- -------- ---------
Total operating expenses 13,071 22,850 58,728 77,366
-------- -------- -------- ---------
Operating Income (loss) 1,269 (38,113) (29,646) (34,633)
Other (income) expenses:
Interest, net (195) (432) (550) (2,049)
Other, net (47) 119 (434) (206)
-------- -------- -------- ---------
Income (loss) before provision for income tax 1,511 (37,800) (28,662) (32,378)
Provision (benefit) for income taxes 0 (2,298) 0 (617)
-------- -------- -------- ---------
Net Income (loss) $ 1,511 ($35,502) ($28,662) ($ 31,761)
======== ======== ======== =========
Weighted average number of common shares outstanding
Basic 32,986 31,661 32,780 31,506
Diluted 32,986 31,661 32,780 31,506
Earnings (loss) per common share
Basic $ 0.05 $ (1.12) $ (0.87) $ (1.01)
Diluted $ 0.05 $ (1.12) $ (0.87) $ (1.01)
Consolidated Statements of Comprehensive Income (loss)
Net Income (loss) $ 1,511 $(35,502) $(28,662) $ (31,761)
Translation Adjustments (110) 16 (34) 26
-------- -------- -------- ---------
Comprehensive Income (loss) $ 1,401 $(35,486) $(28,696) $ (31,735)
======== ======== ======== =========
See accompanying Notes to Condensed Consolidated Financial Statements
2
PARADYNE NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2001 2000
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (28,662) $ (31,761)
Adjustments to reconcile net income (loss) to cash provided by
(used in) operating activities:
Loss on purchase commitment -- 11,378
Inventory write-down 10,905 23,553
Loss on sale of assets 412 15
Increase/(decrease) in allowance for bad debts (713) 563
Depreciation and amortization 6,292 6,237
Impairment of intangible asset 5,761 --
(Increase) decrease in assets:
Receivables 14,463 (723)
Inventories 9,791 (52,598)
Other assets 1,945 (3,030)
Increase (decrease) in liabilities:
Accounts payable (7,224) 8,774
Payroll related (2,539) (470)
Other current liabilities (2,259) 11,821
---------- ----------
Net cash provided by (used in) operating activities 8,172 (26,241)
---------- ----------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Cash used to acquire net assets (1,500) (7,596)
Capital expenditures (843) (7,381)
Proceeds from sale of property, plant and equipment 747 3
---------- ----------
Net cash used in investing activities (1,596) (14,974)
---------- ----------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Net proceeds from stock transactions 1,208 4,830
Repayment of bank line of credit and other short term obligations -- (17)
Borrowings under other debt obligations 231 534
Repayments under other debt obligations (608) (462)
---------- ----------
Net cash provided by financing activities 831 4,885
---------- ----------
Effect of foreign exchange rate changes on cash (34) 26
---------- ----------
Net Increase (decrease) in cash and cash equivalents 7,373 (36,304)
Cash and cash equivalents at beginning of period 19,821 62,885
---------- ----------
Cash and cash equivalents at end of period $ 27,194 $ 26,581
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
NON-CASH TRANSACTIONS
Stock issued for notes $ (291) $ (635)
========== ==========
Recoverable taxes related to stock option exercises $ -- $ 5,291
========== ==========
See accompanying Notes to Condensed Consolidated Financial Statements
3
PARADYNE NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND BASIS OF PRESENTATION:
Paradyne Networks, Inc. (the "Company") designs, manufactures, and
markets data communications and networking products for network service
providers and business customers. The Company's products enable business
customers to efficiently access wide area network services and allow network
service providers to provide customers with high-speed services for data, voice,
video and multimedia applications.
The accompanying condensed unaudited consolidated financial statements
include the results of the Company and its wholly-owned subsidiaries: Paradyne
Corporation; Paradyne Canada Ltd.; Paradyne International Ltd.; Paradyne
Worldwide Corp.; Ark Electronic Products Inc.; Paradyne GmbH; Paradyne Finance
Corporation; and Paradyne International Sales Ltd. Intercompany accounts and
transactions have been eliminated in consolidation.
The accompanying condensed unaudited consolidated financial statements
of the Company have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not contain all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. However, in the opinion
of management, such statements reflect all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of interim
period results. These financial statements should be read in conjunction with
the December 31, 2000 audited financial statements and notes thereto included in
the Company's Annual Report on Form 10-K as filed with the Securities and
Exchange Commission on April 2, 2001.
The results of operations for the interim periods are not necessarily
indicative of results to be expected for the entire year or for other future
interim periods.
2. RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 2000, the FASB issued Statement No. 138, "Accounting for
Certain Hedging Activities", which amended Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." Statement No. 138 must be
adopted concurrently with the adoption of Statement No. 133. The Company has
adopted these new statements effective January 1, 2001. These Statements
required the Company to recognize all derivatives on the balance sheet at fair
value. As of September 30, 2001, the Company does not have any derivative
instruments as defined in the statements or engage in hedging activities and
therefore this SFAS 138 does not have an impact on its financial statements.
In July 2001 the FASB issued SFAS 141, 142 and 143. SFAS 141, "Business
Combinations" requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Use of the pooling of
interests method of accounting will be prohibited.
SFAS 142, "Goodwill and Other Intangible Assets" changes the accounting
for goodwill from an amortization method to an impairment-only approach.
Amortization of goodwill, including goodwill recorded in past business
combinations, will cease for fiscal years beginning after December 15, 2001. The
Company does not have any goodwill or other intangible assets recorded on its
books at September 30, 2001; therefore this standard has no current impact
on the Company's financial statements.
SFAS 143, "Accounting for Asset Retirement Obligations" requires the
recognition of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the carrying
amount of the related long-lived asset is correspondingly increased. Over time,
the liability is accreted to its present value and the related capitalized
charge is depreciated over the useful life of the asset. SFAS 143 is effective
for fiscal years beginning after June 15, 2002. The Company is currently
reviewing the impact of SFAS 143 on its financial statements.
In August 2001, the FASB issued SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses accounting and
reporting for the impairment or disposal of long-lived assets, including the
disposal of a segment of a business. SFAS 144 is effective for fiscal years
beginning after December 15, 2001, with earlier application encouraged. The
Company is currently reviewing the impact of SFAS 144 on its financial
statements.
4
3. INVENTORY:
Inventories at September 30, 2001 and December 31, 2000 are summarized
as follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
2001 2000
Raw Materials $ 14,063 $ 30,088
Work In Process 2,000 5,533
Finished Goods 1,869 3,007
------------ ------------
$ 17,932 $ 38,628
============ ============
In June 2001, the Company recorded a provision for the write-down of
inventory in the amount of $10,905. This charge was required because of the
sustained downturn in the telecommunications equipment sector overall and the
uncertainty of the Company's ability to liquidate its inventory at or above its
current cost basis.
4. EARNINGS PER SHARE:
The following table summarizes (in thousands, except per share data)
the weighted average shares outstanding for basic and diluted earnings per share
for the periods presented.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER SEPTEMBER
-------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- ---------
Net Income (loss) $ 1,511 $(35,502) $(28,662) $ (31,761)
Weighted average number of common shares outstanding
Basic 32,986 31,661 32,780 31,506
Dilutive effect of stock options -- -- -- --
-------- -------- -------- ---------
Diluted 32,986 31,661 32,780 31,506
-------- -------- -------- ---------
Earnings per common share:
Basic $ 0.05 $ (1.12) $ (0.87) $ (1.01)
Dilutive effect of stock options $ -- $ -- $ -- $ --
Diluted $ 0.05 $ (1.12) $ (0.87) $ (1.01)
-------- -------- -------- ---------
5. BUSINESS RESTRUCTURING CHARGES:
In the first nine months of 2001, the Company recorded additional
business restructuring charges of $3,807. The charges relate to the
Company's plans to reduce expenses necessitated by the softening of the
telecommunications equipment market, which has resulted in fewer orders for
the Company's equipment. The expense reductions include severance payments
for the termination of approximately 220 employees in addition to certain
costs incurred in conjunction with the plan to consolidate facilities
located in Redbank and Fairlawn, New Jersey and Largo, Florida.
During the first nine months of 2001, the Company paid $4,464 related
to business restructurings. The remaining $548 accrued as of the end of
September 30, 2001, substantially all of which is expected to be paid
during 2001, is related to both U.S. and international business
restructuring. The following table summarizes (in thousands) the activity
in the business restructurings accrual for the first nine months of 2001:
Beginning Balance at January 1, 2001 $ 1,205
Additions to accrual in the first nine months of 2001 3,807
Less payments made in the first nine months of 2001
(related to prior periods and current period restructuring) (4,464)
-------
Ending Balance at September 30, 2001 $ 548
=======
5
6 IMPAIRMENT OF INTANGIBLE ASSETS:
As part of the restructuring that occurred in the first quarter of
2001, which included the closing of a development facility located in
Fairlawn, New Jersey, the Company recorded a $1,602 charge for the
impairment of an intangible asset. This charge represented the net book
value of the "Acquired Workforce" intangible that was originally recorded
in the second quarter of 2000 as part of the purchase of substantially all
of the assets of Control Resources Corporation (CRC). Since the value of
the in place work force (who were terminated) was the basis for recording
the acquired workforce intangible, this intangible asset had no future
economic value; therefore the Company was required to record impairment for
the remaining value of the asset.
Additionally, during June 2001 the Company recorded a $4,159 charge
for the impairment of goodwill. This charge represented the unamortized
goodwill that was originally recorded as part of the CRC purchase mentioned
above. During the second quarter of 2001 revenues from the sale of the
products and technology acquired as part of the CRC acquisition were
minimal. Because of the Company's uncertainty of its ability to sell these
products in the future, this intangible asset had no future economic value.
Consequently, the Company was required to write off the unamortized balance
of the asset.
7. REVOLVING CREDIT FACILITY
On July 16, 2001, the Company entered into an agreement (the "Credit
Agreement") with Foothill Capital Corporation, a wholly-owned subsidiary of
Wells Fargo & Company, to provide a secured revolving line of credit in the
amount of $17.5 million with availability subject to a borrowing base
formula. At the Company's option, the interest rate will either be the
prime rate published by Wells Fargo plus .75% or the LIBOR (London
Interbank Offered Rate) rate plus 2.75%. In no event will the borrowing
rate be lower than 7%. The Credit Agreement contains financial covenants
limiting the maximum amount of capital expenditures the Company can make
and requiring it to meet minimum Earnings Before Interest, Taxes,
Depreciation, and Amortization ("EBITDA") targets. The Company is able to
borrow up to a maximum of $17.5 million which is secured by the value of
its accounts receivable and its inventory. There are restrictions on the
eligible amounts of both the accounts receivable and the inventory. In
order to obtain this line of credit, the Company paid the lender a closing
fee of $150 thousand, and will pay a monthly servicing fee of $4 thousand,
an unused line fee of .375% of the balance not borrowed under the line of
credit each month, and the Company will be responsible for audit and
appraisal fees. If the Company fails to pay amounts due under the loan when
due and payable, or if it fails to perform specified terms of the Credit
Agreement, it will be in default if it has previously borrowed under the
Credit Agreement. In the event of default the Company will no longer be
able to borrow under the Credit Agreement and it would have to immediately
repay any amounts owed the lender. The Company may cancel the loan Credit
Agreement at any time but it would have to pay a cancellation premium
starting at 3% of the maximum borrowing at the inception of the Credit
Agreement, reducing as the Credit Agreement matures to 1% of the maximum
borrowing during the last year of the Credit Agreement. No borrowings have
been made under the Credit Agreement as of September 30, 2001.
8. PENDING LITIGATION
The Company is subject to legal proceedings, claims and liabilities
that arise in the ordinary course of business. Due to inherent
uncertainties of the litigation process and the judicial system, the
Company is unable to predict the outcome of these legal proceedings. The
Company has provided, however, for all loss contingencies where it believes
it is probable and reasonably estimable (in accordance with SFAS 5) that a
liability has been incurred. Following the Company's September 28, 2000
press release regarding contemplated third quarter of 2000 results, several
securities class action suits (collectively, the "Securities Actions")
against Paradyne and certain of its officers and directors; Andrew May,
Paradyne's Chief Executive Officer and President at the time; Patrick
Murphy, Paradyne's Chief Financial Officer and Senior Vice President; and
Thomas Epley, Paradyne's Chairman of the Board (collectively, the
"Defendants"), were filed in October 2000 in the United States District
Court for the Middle District of Florida, Tampa Division (the "Court").
Sean E. Belanger, the Company's current President and Chief Executive
Officer and a director, was added as a Defendant in the litigation in April
2001. These actions were later consolidated into one case and the Court
appointed Frank Gruttadauria and Larry Spitcaufsky as the lead plaintiffs
and the law firms of Milberg Weiss Bershad Hynes & Lerach LLP and Barrack
Rodos & Bacine as the lead counsel. The Amended Consolidated Complaint
alleges violations by the Defendants of the securities anti-fraud
provisions of the federal securities laws, specifically Section 10(b) of
the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder. It further alleges that the individual Defendants are liable
under Section 20(a) of the Securities Exchange Act as "control persons of
Paradyne". The plaintiffs purport to represent a class of investors during
a purported class period of September 28, 1999 through September 28, 2000
and allege, in effect, that the Defendants during that time, through
material misrepresentations and omissions, fraudulently or recklessly
inflated the market price of the Company's stock by allegedly erroneously
reporting that the Company was performing well, that its inventories were
properly stated, and that its customer base and product demand were solid.
The Securities Actions seek damages in an unspecified amount for the
purported class for the alleged inflated amount of the stock
6
price during the class period. The Defendants believe the claims are
without merit and intend to vigorously defend them, although they cannot
predict the outcome. The Defendants filed a motion on May 25, 2001, asking
the court to dismiss the complaint, with prejudice, after which the
Plaintiffs filed a memorandum of law in opposition to Defendant's dismissal
motion on July 2, 2001. The Defendant's dismissal motion is pending with
the court and we are unable to predict how long the court will take to rule
on the motion. The Company has engaged the law firm of Holland & Knight,
LLP as its legal counsel in this litigation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and other sections of this Form 10-Q contain
forward-looking statements that involve risks and uncertainties. These
forward-looking statements are made pursuant to the "safe-harbor" provisions of
the Private Securities Litigation Reform Act of 1995 and are made based on
management's current expectations or beliefs as well as assumptions made by, and
information currently available to, management. All statements regarding future
events, our future financial performance and operating results, our business
strategy and our financing plans are forward-looking statements. In many cases,
you can identify forward-looking statements by terminology, such as "may,"
"will," "should," "expects," "intends," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or "continue," or the negative of such
terms and other comparable terminology. These statements are only predictions.
Known and unknown risks, uncertainties and other factors could cause our actual
results to differ materially from those projected in the forward-looking
statements
The information contained in this Form 10-Q is not a complete
description of our business or the risks associated with an investment in us.
Readers are referred to documents filed by Paradyne with the Securities and
Exchange Commission, specifically our most recent Form 10-K and other filings,
which identify important risk factors that could cause actual results to differ
from those contained in the forward-looking statements, including: the timing
and amount of expense reduction; the uncertainty of litigation, including
punitive stockholder class actions; a reliance on international sales; rapid
technological change could render Paradyne's products obsolete; the uncertain
acceptance of new telecommunications services based on DSL; substantial
dependence on network service providers who may reduce or discontinue their
purchase of products or services at any time; the timing and amount of, or
cancellation or rescheduling of, orders of Paradyne's products to existing and
new customers; possible inability to sustain revenue growth or profitability;
dependence on only a few customers for a substantial portion of Paradyne's
revenue; highly competitive markets; reliance on sales of access products to BB
Technologies Corporation (a newly formed subsidiary of SOFTBANK CORP.), Lucent
Technologies and Avaya Inc.; dependence on sole and single-source suppliers and
the reliability of the raw materials supplied by them to manufacture products
under customer contracts; a long and unpredictable sales cycle; the number of
DSL lines actually deployed by BB Technologies Corporation and other DSL
customers as compared to forecasts; Paradyne's ability to manufacture adequate
quantities of products at forecasted costs under customer contracts; and
Paradyne's ability to manufacture products in accordance with its published
specifications.
OVERVIEW
We are a leading developer, manufacturer and distributor of broadband
and narrowband network access products for network service providers ("NSPs")
and business customers. We offer solutions that enable business class, service
level managed, high-speed connectivity over the existing telephone network
infrastructure and provide for cost-effective access speeds of up to 45 Megabits
per second. We market and sell our products worldwide to NSPs and business
customers through a multi-tier distribution system that includes direct sales,
strategic partner sales, NSP sales and traditional distributor or value added
reseller sales. Lucent Technologies was our only 10% or greater customer during
the first nine months of 2001. A majority of our sales to Lucent represented
sales as a reseller of our products. Direct and indirect sales and services
provided to Lucent during the first nine months of 2001 were $9.8 million. Since
Avaya Inc. was spun off from Lucent during the fourth quarter of 2000, for
comparison purposes with the prior year, revenues from both Lucent and Avaya are
combined. Collectively, we estimate that direct and indirect sales to, and
service performed for, Lucent and Avaya accounted for approximately 19% of our
total revenues in the first nine months of 2001 versus 23% in the same period of
2000. This percentage reduction principally results from lower Lucent and Avaya
equipment sales of some of our older products in 2001. A loss or a significant
reduction or delay in sales to major customers could materially and adversely
affect our business, financial condition and results of operations.
Revenue from equipment sales is recognized when the following has
occurred: evidence of a sales arrangement exists; delivery has occurred or
services have been rendered; our price to the buyer is fixed or determinable;
and collectibility is reasonably assured. Revenue from services, which consists
mainly of repair of out-of-warranty products, is recognized when the services
are performed and all substantial contractual obligations have been satisfied.
Amounts billed to customers in sales transactions related to shipping and
handling are classified as product revenue. Provision is made currently for
estimated product returns. Royalty revenue is
7
recognized when we have completed delivery of technical specifications and
performed substantially all required services under the related agreement.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2000
REVENUES. Total revenues decreased $21.5 million, or 39%, to $34.2 million for
the three months ended September 30, 2001 from $55.7 million for the same period
in 2000. As a percentage of total revenues, equipment sales were 97% of total
revenues for the three months ended September 30, 2001 and 99% for the three
months ended September 30, 2000. This decrease in percentage is mostly
attributable to an increase in service revenues and the decrease in equipment
sales. Total revenues for the nine months ended September 30, 2001 decreased
$100.2 million, or 51%, to $95.6 million from $195.8 million for the first nine
months of 2000. The three and nine month decreases in total revenue were mostly
attributable to significant decreases in the volume of sales of our broadband
access products as a result of the continued deterioration in the overall
competitive local exchange carrier (CLEC) market to new and existing customers.
Equipment sales were 96% of total revenues for the nine months ended September
30, 2001 compared to 98% for the same period in 2000. This percentage decrease
was mostly due to an increase in service revenues and a reduction in equipment
sales during the first nine months of 2001 versus 2000.
GROSS MARGIN. Gross margin increased $29.6 million, to $14.3 million for the
three months ended September 30, 2001 from a negative margin of $15.3 million
for the three months ended September 30, 2000 and decreased $13.7 million, or
32%, to $29.1 million for the nine months ended September 30, 2001 from $42.8
million for the nine months ended September 30, 2000. These decreases in gross
margin are primarily due to the following. The gross margin for the three and
nine months ended September 30, 2000 includes a large provision for excess
inventory and loss on non-cancelable purchase commitments in the total amount of
$34.9 million. No such provision was made during the three months ended
September 30, 2001, but in June 2001 we recorded a $10.9 million provision for
the write-down of excess and obsolete inventory because of the sustained
downturn in the telecommunications sector and uncertainty surrounding our
ability to liquidate certain of our inventory at its current cost basis. The net
impact of the smaller provision for the write-down of inventory for the nine
months ended September 30, 2001 compared to the nine months ended September 30,
2000 was a $24.0 million improvement to margin. Partially offsetting some of
the margin increase resulting from the above-mentioned items was a decrease in
margin due to a decrease in the volume of sales of our broadband access
products as a result of the continued deterioration in the CLEC and U.S.
broadband markets.
Gross margin as a percentage of total revenues increased to 42% for the
three months ended September 30, 2001 from a negative 27% in the same period in
2000. For the nine months ended September 30, 2001, gross margin as a percentage
of total revenues increased to 30% from 22% in the same period in 2000. These
increases in gross margin percentage primarily result from the net impact of the
inventory provisions during the three and nine months ended September 30, 2000.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased
$5.2 million, or 51%, to $5.1 million for the three months ended September 30,
2001 from $10.3 million for the same period in 2000. For the nine months ended
September 30, 2001, research and development expenses decreased $10.6 million,
or 35%, to $19.7 million compared to $30.3 million for the same period in 2000.
These decreases for the three months and nine months ended September 30, 2001
resulted primarily from reductions in personnel-related costs, expenditures for
engineering prototype supplies and professional fees for contracted labor. Most
of the reduced expenditures are the result of our business restructuring in the
first quarter of 2001 that included the termination of approximately 120
research and development employees and the closing of facilities in Redbank and
Fairlawn, New Jersey. (See "Note 5 - Business Restructuring Charges" in the
Notes to Condensed Consolidated Financial Statements in this Form 10-Q for
further information.) For the three months ended September 30, 2001, research
and development expense as a percentage of total revenues, decreased to 16% from
18% in the same period in 2000. This decrease results principally from the
overall decrease in research and development expenses largely offset by the 39%
decrease in revenues for the current quarter versus the third quarter of 2000.
For the nine months ended September 30, 2001, research and development expense
as a percentage of total revenues, increased to 21% from 15% for the same period
in 2000. The increase is primarily attributable to the 51% decrease
in revenue during the nine month period of 2001, largely offset by the
above-discussed reductions in research and development expenses.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES. SG&A expenses decreased
$4.2 million, or 35%, to $7.9 million for the three months ended September 30,
2001 from $12.1 million for the three months ended September 30, 2000 and
decreased $17.6 million, or 38%, to $28.6 million for the nine months ended
September 30, 2001 from $46.2 million for the nine months ended September 30,
2000. Most of the decreases for the three months ended September 30, 2001 were
due to decreases in expenses related
8
to personnel, travel, and facilities. Most of the decrease for the nine months
ended September 30, 2001 were for reasons described above in addition to
decreases in advertising (primarily joint advertising with a major customer
associated with the sales of new products in the prior year not repeated in
2001). With the exception of advertising expenses, most of the reduced
expenditures are the result of our first quarter business restructuring that
included the termination of approximately 80 SG&A employees and the closing of
facilities in Redbank and Fairlawn, New Jersey. (See "Note 5 - Business
Restructuring Charges" in the Notes to Condensed Consolidated Financial
Statements in this Form 10-Q for further information.) SG&A expense as a
percentage of revenue increased from 22% for the three months ended September
30, 2000 to 23% for the three months ended September 30, 2001 and from 24% for
the nine months ended September 30, 2000 to 30% for the nine months ended
September 30, 2001. These increases were primarily attributable to the decreases
in revenue during the three and nine month periods, respectively.
IMPAIRMENT OF INTANGIBLE ASSETS. Impairment of intangible assets includes a $4.2
million charge that occurred in the second quarter of 2001 and a $1.6 million
charge that occurred in the first three months of 2001 resulting in a total of
$5.8 million for the first nine months of 2001. The $4.2 million charge results
from the write off of the unamortized balance of goodwill that was originally
recorded as part of the Control Resources Corporation (CRC) purchase in April
2000. Revenues from the sale of the products and technology acquired as part of
the CRC acquisition have been minimal in 2001. Because of uncertainty related to
our ability to sell the products from the product line acquired from CRC, we
determined that this intangible asset had no future economic value, and
consequently, we were required to write off the unamortized balance of the
asset. The $1.6 million charge for impairment of intangible assets results from
the write-off of the net book value of an "Acquired Workforce" intangible that
was originally recorded in the second quarter of 2000 as part of the purchase of
substantially all of the assets of CRC. As part of the restructuring that
occurred in the first quarter of 2001, we announced that we were closing the
Fairlawn, New Jersey facility and that substantially all of the employees at
that facility would be terminated in 2001. Since the value of the in place work
force (who were terminated) was the basis of recording the acquired workforce
intangible, we recorded an impairment charge for the remaining value of the
asset.
AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED STOCK COMPENSATION. The
amortization of intangible assets and deferred stock compensation decreased by
$.3 million to $.1 million for the three months ended September 30, 2001 from
$.4 million for the same period in 2000 and decreased by $.1 million to $.8
million for the nine month period ended September 30, 2001 from $.9 million for
the same period in 2000. The amortization of intangible assets is attributable
to goodwill and acquired work force that resulted from the purchase of
substantially all of the assets of CRC in the second quarter of 2000 (see
discussion above of "Impairment of Intangible Asset"). Since all ($5.8 million)
intangible assets were written off in the first six months of 2001 as a result
of the impairment of intangible assets, amortization of these intangible assets
amounting to approximately $1.5 million on an annual basis will no longer be
recorded. The amortization of deferred stock compensation is related to the
granting of stock options to key employees at prices deemed to be below fair
market value for financial reporting purposes.
BUSINESS RESTRUCTURING CHARGES. During the first quarter of 2001 we incurred
expenses of $3.8 million related to our plans to reduce expenses. This action
was necessitated by the deterioration of the telecommunications equipment
market, which has resulted in reduced demand for our equipment. These expenses
include severance payments for the termination of approximately 220 employees in
addition to costs incurred in conjunction with the consolidation of our
facilities by closing two development centers located in New Jersey and one
office building in Florida. No additional restructuring expenses have been
incurred during the second or third quarter of 2001.
INTEREST AND OTHER (INCOME) EXPENSE, NET. Interest and other (income) expense,
net, decreased by $.1 million to $.2 million of income for the three months
ended September 30, 2001, from $.3 million of income for the same period in 2000
and decreased $1.3 million to $1.0 million of income for the nine months ended
September 30, 2001, from $2.3 million of income for the same period in 2000.
Interest and other (income) expense, net, is related to interest income on short
term investments, technology sales, income from fees, interest on notes payable
and borrowings under lines of credit and foreign exchange gains and losses. This
decrease in income for the three months ended September 30, 2001 was primarily
attributable to a reduction in interest income due to our significantly lower
cash position resulting in lower earnings on short-term investments offset in
part by a decrease in exchange losses. The decrease in income for the nine
months ended September 30, 2001 includes the items previously mentioned in
addition to a reduction in the amount of income from the sale of patents, offset
in part by the recognition of commitment fee income net of expenses, received in
connection with the termination of a credit facility with a customer.
PROVISION (BENEFIT) FOR INCOME TAXES. Benefit for income taxes decreased by $2.3
million to $0 for the three months ended September 30, 2001, from $2.3 million
of benefit for the same period in 2000 and decreased by $.6 million to $0 for
the first nine months of 2001, from $.6 million of benefit for the same period
in 2000. Since we incurred a pretax loss for both the first and second quarters
of 2001, had a loss carryover from the prior year and are not expected to
generate pretax income as of the end of the year, no tax provision is required.
9
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations for the nine months ended September 30,
2001 totaled $8.2 million. The net loss of $28.7 million, adjusted for non-cash
impacting items such as depreciation, amortization, impairment of intangible
assets, reserve for inventory write-off and allowance for bad debts and loss on
sale of assets results in a negative cash flow of $6.0 million for the period.
Further decreases to cash from operating activities were principally driven by a
$7.2 million reduction in accounts payable, as previously incurred purchase
commitments were executed and paid off. Also contributing to cash outflows were
$4.5 million of payments related to business restructuring initiatives made
during the first nine months of 2001. Contributing to cash provided from
operations resulting in a net positive cash flow from operations of $8.2 million
were decreases in accounts receivables of $10.6 million due to strong
collections and decreased revenues, receipt of $3.8 million in income tax
refunds receivable, and a decrease in inventories (excluding the $10.9 million
write-down in the second quarter of 2001) of $9.8 million. As a result of
employee terminations, the closing of facilities related to restructurings
recorded in the first quarter of 2001 and other expense reduction measures
initiated in the second quarter of 2001, we estimate that our annual cash flow
needs for operating expenses will be approximately $18 million lower than
beginning of the year levels.
The primary use of funds in investing activities was due to $1.5
million of contingent consideration made during the first quarter of 2001 to the
sellers of the CRC business. This payment resulted because product sales
generated by the CRC business in 2000 exceeded the 2000 target set as part of
the acquisition. There were minimal other investing activities during the year
as proceeds from the sale of property, plant and equipment were comparable to
net capital expenditures, resulting in a slightly negative cash impact of $.1
million. The low level of capital expenditures reflects the very tight controls
placed on cash expenditures as a result of a slowdown in business activity.
Because these tight controls are being continued and with reduced need for
research and development capital (due to reduced research and development
personnel), it is expected that cash outflows to meet capital requirements for
the remainder of the year will be less than $.5 million.
Net cash provided by financing activities during the first nine months
was approximately $.8 million, almost all of which was proceeds from the
Employee Stock Purchase Plan (ESPP).
We had $27.2 million of cash and cash equivalents at September 30,
2001, representing an increase of $7.4 million from $19.8 million at December
31, 2000. Working capital decreased $13.8 million from $54.8 million at December
31, 2000 to $41.0 million at September 30, 2001.
In July 2001, we entered into an agreement with Foothill Capital
Corporation, a wholly owned subsidiary of Wells Fargo & Company, for a $17.5
million, three-year secured revolving line of credit. At our option the interest
rate will either be the prime rate published by Wells Fargo plus .75% or the
LIBOR (London Interbank Offered Rate) rate plus 2.75%. In no event will the
borrowing rate be lower than 7%. The loan agreement contains financial covenants
limiting the maximum amount of capital expenditures we can make and requiring us
to meet minimum EBITDA targets. We are able to borrow up to a maximum of $17.5
million based on the amount of our accounts receivable and on our inventory.
There are restrictions on the eligible amounts of both the accounts receivable
and the inventory. In order to obtain this line of credit we were required to
pay the lender a closing fee of $150 thousand, a monthly servicing fees of $4
thousand, an unused line fee of .375% of the balance not borrowed, and we will
be responsible for audit and appraisal fees. If we fail to pay amounts due under
the loan when due and payable, or if we fail to perform specified terms of the
loan agreement, we will be in default if we have previously borrowed under the
loan agreement. In the event of default we will no longer be able to borrow
under the agreement and we would have to immediately repay any amounts owed the
lender.
In September 2001 our Board of Directors authorized a stock repurchase
program of up to $1.0 million worth of outstanding Paradyne Common Stock over a
period of one year, effective immediately. Any repurchased shares will be
returned to "authorized but unissued" shares and may be used for general
corporate purposes. We may repurchase the shares in the open market, through
block trades or in privately negotiated transactions, from time to time, at
prices deemed appropriate by us. Any repurchases will be subject to market
conditions and other factors and will be made in compliance with applicable
legal requirements. Depending on market conditions and other factors these
repurchases may be commenced or suspended at any time or from time to time
without prior notice. If we repurchase stock under the repurchase program we
will have to obtain a waiver from Foothill Capital prior to borrowing under the
line of credit because the repurchase will be considered a prohibited
distribution under the Credit Agreement. Since we have not yet borrowed under
the agreement, we are not currently in violation.
We may cancel the loan agreement with Foothill Capital at any time
but we would have to pay a cancellation premium starting at 3% of the maximum
borrowing at the inception of the agreement, reducing as the agreement matures
to 1% of the maximum borrowing during the last year of the agreement. The
foregoing summary description of our new credit facility does not purport to be
complete and is qualified in its entirety by reference to the Loan and Security
Agreement filed as Exhibit 10.1 to our Form 10-Q for the second quarter of 2001.
10
In late July 2001, we entered into a $46.0 million contract with
Broadband Technologies Corporation ("BBT"), a Japanese service provider for our
Hotwire(R) Reach DSL product. Under the terms of the contract, as orders are
placed by the customer they will be secured by letters of credit payable
approximately 30 days after shipment of the product. Because we are able to
collect payment quickly through our letter of credit arrangement with BBT we
believe that we will be able to manage this contract without material net cash
usage through the fourth quarter of 2001. Although BBT is not a 10% customer for
the nine months ended September 30, 2001, we estimate that direct and indirect
sales (through one of our distributors, Sonet International Corporation) to BBT
for the three months ended September 30, 2001 accounted for approximately 19% or
$6.6 million of our total revenues during this period.
We believe that our current cash position, together with cash
flows from operations, our ability to monitor and control expenditures and our
new line of credit facility with Foothill Capital, will be sufficient to meet
our working capital needs for at least the next twelve months.
RECENT TRENDS AND DEVELOPMENTS
There have been reductions in spending on networking equipment among
smaller communications companies, including CLECs. Companies are continuing to
change their build-out strategies amid increased competition, and some companies
are experiencing decreases in funds available from the capital investment
markets.
As noted above, in late July 2001, we were awarded and signed a $46.0
million contract with BBT for our Hotwire(R) Reach DSL product. The service
provider has agreed to deploy over 200,000 lines of our ReachDSL solution. The
contract requires that BBT make payments to us in U.S. dollars. For the fourth
quarter of 2001, in accordance with terms of our contract, we project BBT to
purchase at least $17.0 million of product making it our largest customer for
the fourth quarter. The remaining portion of the contract is expected to be
fulfilled in 2002.
The foregoing discussion regarding sales to BBT contains
forward-looking statements. These forward-looking statements are made pursuant
to the "safe-harbor" provisions of the Private Securities Litigation Reform Act
of 1995 and are made based on management's current expectations or beliefs as
well as assumptions made by, and information currently available to, management.
The following factors, among others, could cause our actual results to differ
materially from those described in the forward-looking statements made above:
our ability to manufacture adequate quantities of products at forecasted costs
under the customer contract; the uncertain acceptance of new telecommunications
services based on DSL; the timing and amount of or rescheduling of the
BBT's orders of our products; our dependence on sole and single-source
suppliers and the reliability of the raw materials supplied by them to
manufacture products under the customer contract; and our ability to manufacture
products in accordance with our published specifications.
INFLATION
Because of the relatively low levels of inflation experienced in 2000
and 2001 to date, inflation did not have a significant effect on our results in
such periods.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 2000, the FASB issued Statement No. 138, "Accounting for
Certain Hedging Activities", which amended Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." Statement No. 138 must be
adopted concurrently with the adoption of Statement No. 133. We have adopted
these new statements effective January 1, 2001. These Statements required us to
recognize all derivatives on the balance sheet at fair value. As of September
30, 2001, we do not have any derivative instruments as defined in the statements
or engage in hedging activities and therefore this SFAS 138 would not have an
impact on our financial statements.
In July 2001 the FASB issued SFAS 141, 142 and 143. SFAS 141, "Business
Combinations" requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Use of the pooling of
interests method of accounting will be prohibited.
SFAS 142, "Goodwill and Other Intangible Assets" changes the accounting
for goodwill from an amortization method to an impairment-only approach.
Amortization of goodwill, including goodwill recorded in past business
combinations, will cease for fiscal years beginning after December 15, 2001. We
do not have any goodwill or other intangible assets recorded on our books at
September 30, 2001; therefore this Standard has no current impact on our
financial statements.
11
SFAS 143, "Accounting for Asset Retirement Obligations" requires the
recognition of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the carrying
amount of the related long-lived asset is correspondingly increased. Over time,
the liability is accreted to its present value and the related capitalized
charge is depreciated over the useful life of the asset. SFAS 143 is effective
for fiscal years beginning after June 15, 2002. We are currently reviewing the
impact of SFAS 143 on its financial statements.
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 addresses accounting and reporting for
the impairment or disposal of long-lived assets, including the disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001, with earlier application encouraged. We are currently
reviewing the impact of SFAS 144 on its financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in investing in or trading market risk sensitive
instruments. We also do not purchase, for investing, hedging, or for purposes
"other than trading", instruments that are likely to expose us to market risk,
whether interest rate, foreign currency exchange, commodity price or equity
price risk, except as noted in the following paragraph. We have not entered into
any forward or futures contracts, purchased any options or entered into any
interest rate swaps. Additionally, we do not currently engage in foreign
currency hedging transactions to manage exposure for transactions denominated in
currencies other than U.S. dollars.
If we were to borrow from our revolving line of credit facility with
Foothill Capital Corporation, we would be exposed to changes in interest rates.
We are also exposed to changes in interest rates from investments in some
held-to maturity securities. Under our current policies, we do not use interest
rate derivative instruments to manage exposure to interest rate changes.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Following Paradyne's September 28, 2000 press release regarding
contemplated third quarter of 2000 results, several securities class action
suits (collectively, the "Securities Actions") against Paradyne and certain of
its officers and directors; Andrew May, Paradyne's Chief Executive Officer and
President at the time; Patrick Murphy, Paradyne's Chief Financial Officer and
Senior Vice President; and Thomas Epley, Paradyne's Chairman of the Board
(collectively, the "Defendants"), were filed in October 2000 in the United
States District Court for the Middle District of Florida, Tampa Division (the
"Court"). Sean E. Belanger, our current President and Chief Executive Officer
and a director was added as a Defendant in the litigation in April 2001. These
actions were later consolidated into one case and the Court appointed Frank
Gruttadauria and Larry Spitcaufsky as the lead plaintiffs and the law firms of
Milberg Weiss Bershad Hynes & Lerach LLP and Barrack Rodos & Bacine as the lead
counsel. The Amended Consolidated Complaint alleges violations by the Defendants
of the securities anti-fraud provisions of the federal securities laws,
specifically Section 10(b) of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder. It further alleges that the individual
Defendants are liable under Section 20(a) of the Securities Exchange Act as
"control persons of Paradyne". The plaintiffs purport to represent a class of
investors during a purported class period of September 28, 1999 through
September 28, 2000 and allege, in effect, that the Defendants during that time,
through material misrepresentations and omissions, fraudulently or recklessly
inflated the market price of Paradyne's common stock by allegedly erroneously
reporting that Paradyne was performing well, that its inventories were properly
stated, and that its customer base and product demand were solid. The Securities
Actions seek damages in an unspecified amount for the purported class for the
alleged inflated amount of the stock price during the class period. The
Defendants believe the claims are without merit and intend to vigorously defend
them, although they cannot predict the outcome. The Defendants filed a motion on
May 25, 2001, asking the court to dismiss the complaint, with prejudice, after
which the plaintiffs filed a memorandum of law in opposition to Defendant's
dismissal motion on July 2, 2001. The Defendant's dismissal motion is pending
with the court and we are unable to predict how long the court will take to rule
on the motion. Paradyne has engaged the law firm of Holland & Knight, LLP as its
legal counsel in this litigation.
12
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Our Registration Statement on Form S-1 (Registration No. 333-76385) was
declared effective on July 15, 1999 and our initial public offering commenced on
July 16, 1999. We received net proceeds of approximately $62.2 million after
deducting estimated underwriting discounts, commissions, and offering expenses.
As of September 30, 2001, we had used approximately $52.5 million of the net
proceeds to repay all the outstanding indebtedness from our now expired
revolving line of credit facility with Bank of America, to pay for certain
capital expenditures, for working capital, and to fund the acquisition of CRC.
We intend to use the remainder of the net proceeds for general corporate
purposes, including working capital and additional capital expenditures. We
continue to assess the specific uses and allocations for these remaining funds.
ITEM 5. OTHER INFORMATION
On September 30, 2001, David M. Stanton resigned as a Class III
director of Paradyne Networks, Inc. Mr. Stanton resigned for personal reasons
and not due to any disagreement with Paradyne. Mr. Stanton's term was scheduled
to expire at the 2002 Annual Meeting of Stockholders.
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.
Paradyne Networks, Inc.
Date: November 14, 2001 /s/ Sean E. Belanger
-----------------
Sean E. Belanger
President, Chief Executive
Officer and Director
Date: November 14, 2001
/s/ Patrick M. Murphy
-----------------
Patrick M. Murphy
Senior Vice President,
Chief Financial Officer,
Corporate Secretary and Treasurer
(Principal Financial and Accounting
Officer)
13