-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BiAsvTAmMqozp5l1GIGw4Z+vGFs/OsNy39Cobb0zvL+EjEcwDat8LZEKas/Btasd 2j9LgWhciOtihXxylVs+qw== 0000950134-03-001207.txt : 20030129 0000950134-03-001207.hdr.sgml : 20030129 20030129172822 ACCESSION NUMBER: 0000950134-03-001207 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20021031 FILED AS OF DATE: 20030129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CROSSROADS SYSTEMS INC CENTRAL INDEX KEY: 0001093207 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 742846643 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-30362 FILM NUMBER: 03530610 BUSINESS ADDRESS: STREET 1: 8300 NORTH MOPAC EXPRESSWAY CITY: AUSTIN STATE: TX ZIP: 78759 BUSINESS PHONE: 5123490300 MAIL ADDRESS: STREET 1: 9390 RESEARCH BOULEVARD SUITE II-300 CITY: AUSTIN STATE: TX ZIP: 78759 10-K 1 h02058e10vk.txt FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED OCTOBER 31, 2002 COMMISSION FILE NUMBER 000-30362 CROSSROADS SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 74-2846643 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8300 NORTH MOPAC EXPRESSWAY AUSTIN, TEXAS 78759 (Address of Registrant's principal executive offices, including Zip Code) (512) 349-0300 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock, par value $0.001 per share Nasdaq National Market
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). [ ] Yes [X] No The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based upon the closing sale price of Common Stock on April 30, 2002, as reported on the Nasdaq National Market, was approximately $60.6 million (affiliates being, for these purposes, directors and executive officers only). As of January 17, 2003, the Registrant had 24,859,408 outstanding shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE: (Specific pages incorporated are indicated under the applicable Item herein)
INCORPORATED BY REFERENCE IN PART NO. --------------------- Our proxy statement filed in connection with our 2003 Annual Meeting of Stockholders............ III
================================================================================ CROSSROADS SYSTEMS, INC. FORM 10-K Unless otherwise indicated, "we," "us," "our" and the "Company" mean Crossroads Systems, Inc. We own the trademark "Crossroads." All other trademarks or tradenames referred to in this document are the property of their respective owners. References in this document to "$" or "dollars" are to United States of America currency. Our fiscal year ends October 31. TABLE OF CONTENTS Table of Contents........................................................................................................i SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.......................................................................ii PART I...................................................................................................................1 Item 1. Business...................................................................................................1 Additional Factors That May Affect Future Results...................................................................14 Item 2. Properties................................................................................................24 Item 3. Legal Proceedings.........................................................................................25 Item 4. Submission of Matters to a Vote of Security Holders.......................................................25 PART II.................................................................................................................26 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.....................................26 Item 6. Selected Consolidated Financial Data......................................................................27 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................28 Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................................39 Item 8. Financial Statements and Supplementary Data...............................................................40 Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.........................40 PART III................................................................................................................41 Item 10. Directors and Executive Officers of the Registrant........................................................41 Item 11. Executive Compensation....................................................................................41 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................41 Item 13. Certain Relationships and Related Transactions............................................................42 Item 14. Controls and Procedures...................................................................................42 PART IV.................................................................................................................43 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..........................................43
NOTE ON INCORPORATION BY REFERENCE Throughout this report, various information and data are incorporated by reference to portions of our 2003 Proxy Statement. Any reference in this report to disclosures in our 2003 Proxy Statement shall constitute incorporation by reference of that specific material into this Form 10-K. i SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This document contains forward-looking statements that involve substantial risks and uncertainties, such as statements concerning: o industry trends; o customer demand for our products; o growth and future operating results; o developments in our markets and strategic focus; o expansion of and enhancements to our manufacturing and engineering facilities and product offerings; o customer benefits attributable to our products; o potential acquisitions and joint ventures and the integration of acquired businesses; o technologies and operations; o strategic relationships with third parties; and o future economic, business and regulatory conditions. You can identify these statements by forward-looking words such as "may," "will," "expect," "intend," "anticipate," "believe," "estimate," "continue" and other similar words. You should read statements that contain these words carefully because they discuss our future expectations, making projections of our future results of operations of our financial condition or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able to accurately predict or control. The factors listed in the sections captioned "Additional Factors That May Affect Future Results" in Item 1 of this report and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this report, as well as any cautionary language in this annual report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we described in our forward-looking statements. ii PART I ITEM 1. BUSINESS. OVERVIEW We are a leading provider of enterprise data routing solutions for open system storage area networks (SANs), based on our market share of storage routers shipped. By using our storage routers to serve as the interconnect between SANs and the other devices in a computer network, organizations are able to more effectively and efficiently store, manage and ensure the integrity and availability of their data. Specifically, when used in SANs our storage routers: o decrease congestion in the transfer of data within a network; o reduce the time required to back up and restore data; o improve utilization of storage resources; and o preserve and enhance existing server and storage system investments. Our mission is to be the company customers trust to link business with information, regardless of technology or location. Our objective is to maintain our position as the leading provider of storage routing solutions as storage, server, and network technologies and markets continue to grow and evolve. The key elements of our strategy are: o to solve customer storage issues; o to grow our current market position and expand into adjacent markets; and o to increase our market leadership by continual investment in intellectual property. We have developed or acquired extensive expertise in several different input-output (I/O) and networking protocols, including small computer system interface (SCSI), fibre channel, Ethernet, Transmission Control Protocol/Internet Protocol (TCP/IP), Internet-based SCSI protocol (iSCSI) and InfiniBand. We provide our products in a variety of configurations including both stand-alone box and library-embedded router form factors with varying port counts. We have applied our expertise in these protocols to develop solutions for leading server and storage system providers such as ACAL, ACS, Arrow, ATL, Bell Micro, Cranel/Adexis, Datalink, Dell, Fujitsu-Siemens, Groupe Bull, Hewlett-Packard (including Compaq), Hitachi Data Systems, IBM, Overland Storage, StorageTek, Sun Microsystems, Tech Data, TidalWire and Unisys, which enable customers to connect to the information that they require to run their businesses, regardless of the technology or location. To date, we have sold our products primarily to original equipment manufacturers, or OEMs, of storage systems. These computer equipment manufacturers sell our storage routers to end-user organizations for use in their SANs. We also sell our storage routers through companies that distribute, resell or integrate our storage routers as part of a complete SAN solution. A few OEM customers historically have accounted for a substantial portion of our revenue. During fiscal 2001, sales to Hewlett-Packard, Compaq and StorageTek accounted for 26%, 2%, and 23% of our total revenue, respectively. During fiscal 2002, sales to Hewlett-Packard (including sales to Compaq and to the combined company) and StorageTek accounted for 51% and 24% of our total revenue, respectively. Fluctuations in revenue have resulted from, among other things, product and customer transitions, OEM qualification and testing and reduced IT spending rates. We were incorporated on September 26, 1996 as Crossroads Holding Corporation and are the successor to operations of our predecessor Texas corporation, Crossroads Systems (Texas), Inc. We are headquartered in Austin, Texas, and operate satellite offices in other U.S. cities. The mailing address for our headquarters is 8300 North MoPac Expressway, Austin, Texas, 78759, telephone number: (512) 349-0300. We can also be reached at our Web site at www.crossroads.com. We had 122 employees at October 31, 2002. 1 INDUSTRY BACKGROUND Information Growth and the Management Challenge The volume of data storage that companies utilize and process continues to grow rapidly, along with the cost of administering that data. This challenge has driven many organizations to reassess the way they manage their storage environments. Companies need simple, cost-effective ways to scale and manage their storage systems. Until the advent of SANs, the connection between data storage capacity and servers had been facilitated by a direct connection to SCSI. SANs have gained traction in the enterprise as an effective and efficient way to manage an expanding storage infrastructure. Numerous enterprise customers use SANs as the method of storage interconnection today. SANs Solve Data Growth Problems SANs provide a wide range of benefits and advantages for the storage administrator. Many of these advantages relate to consolidated, and centralized storage, improved manageability, reduction in local area network (LAN) traffic and ease of incremental storage addition. Given that storage assets can be consolidated with SANs, administrators can effectively utilize more of their storage assets, reduce administrative workloads and increase flexibility in server access of consolidated storage. One critical problem with data growth is the expanding backup and recovery time needed to protect the data. These processes were accomplished by using the LAN before SANs were available. By moving these processes to the SAN, LAN congestion is reduced. With the added performance of SANs, the backup and recovery time is shortened. Companies need simple, cost-effective ways to back up their data, scale for growth and manage their storage systems. They have increasing demand for secured ways to manage their data and provide for disaster recovery. Finally, as organizations continue to add storage over time, SANs provide the most flexible architecture to manage their infrastructure. Applications SANs Enable o Consolidated and Shared Storage. In the direct-attach storage architecture, a significant portion of storage resources are underutilized because they are accessible only by a single server which may not efficiently use the resource. With SANs, multiple servers can access a common storage device, enabling more stored data to be available to more users, and reducing the need to add servers or storage devices to support greater storage requirements. With consolidated storage comes the requirement for data security and access control. The storage administrator must contend with the challenge of open access to the consolidated storage. o LAN-free and Server-free Backup. Disruptions to a computer system can result in the loss or corruption of data. Therefore, most organizations regularly perform data backup by moving data from storage systems to separate on or off-site storage systems or data centers where the data can be safely stored. Because data backup can account for a significant portion of the data traffic over LANs, it is often a major contributor to bottlenecks at the input/output interconnect. LAN-free backup uses the SAN to move data from a storage system through one server then directly to a backup storage system. By moving the data backup function from the LAN to the SAN, LAN-free backup substantially reduces bottlenecks. Server-free backup further extends the benefits of LAN-free backup by removing the server from the backup process. This application enables automated data movement between storage systems directly across the SAN. By removing the backup server from the data path, the backup process is faster and more efficient. o Data Security and Manageability. When making the transition from a traditional direct-attach storage environment to a SAN, the storage administrator has multiple servers potentially accessing each SAN attached storage device. In this scenario, control of data access, appropriate security provisions and manageability across all storage assets becomes critically important. 2 THE CROSSROADS SOLUTION Our router products help our customers improve and reduce their total cost of information management. We develop solutions that enable customers to connect to the information required to run their businesses, regardless of the technology or location. Our routers are designed to operate in any SAN computing environment. Crossroads routers undergo extensive testing in many SAN configurations with a wide range of SAN hardware components and software applications. Crossroads products are certified by leading independent software vendors and independent hardware vendors, including Brocade, Computer Associates, EMC, Legato and VERITAS Software. ServerAttach Product Line Our most recent announced product line, the Crossroads ServerAttach, quickly enables customers' existing SCSI-based servers to access fibre channel storage. The first product in this family is the ServerAttach SA40. Prior to the ServerAttach product line, many customers who deployed servers did not have a fibre channel option. Also, when running critical applications that cannot move to newer servers, customers were unable to attach those server resources into the SAN and therefore unable to capitalize on all the benefits of shared, consolidated, and LAN-free storage. The ServerAttach product line also brings a number of added benefits including: o secured storage access; o ease of manageability; o simple installation with offline pre-configuration; and o minimal impact to server uptime with no hardware or software modifications required to servers or applications. Storage Router Product Line Also, this year Crossroads announced the fifth generation storage router products, the Crossroads 6000 and the Crossroads 10000. The storage router product line delivers the ability to attach SCSI storage devices into a fibre channel fabric. The product line delivers both an entry-level solution, the 6000, as well as a completely modular, enterprise-level solution, in the 10000. The product line delivers a number of added benefits including: o secured storage access; o multi-protocol connectivity; o ease of manageability; o LAN-free and Server-free backup functionality in the SAN; o controller in the SAN enabling Server-free commands to be executed; and o quick setup and configuration. OUR STRATEGY Our mission is to become the company customers trust to link business with information regardless of technology or location. Our objective is to provide customers with innovative solutions focused on solving the problems facing their growing data storage infrastructure. The key elements of our strategy include the following: Solve Customer Storage Issues Crossroads is focused on delivering solutions to our customers that enable them to leverage their existing investments in servers and storage devices. Our products deliver value by providing simple, easy to manage solutions that reduce complexity and overhead for the storage administrator. This is fulfilled in our easy to manage multi-protocol platform that provides connectivity to new and existing storage architectures. 3 Grow Our Current Market Position and Expand Into Adjacent Markets As storage networking evolves, new technologies and solutions are often being introduced. In order to ensure that businesses can access information regardless of technology, we will remain protocol agnostic to the type of technology a customer chooses to implement. We will continue: o to introduce products that provide the connectivity to both existing and future servers, storage devices and networks; o to provide a broader range of solutions to our existing customers; o to secure new customers with innovative technology to meet their demands; and o to introduce new solutions such as our ServerAttach product line and iSCSI related solutions. Increase Our Market Leadership by Continual Investment in Intellectual Property As we develop our products, we continue to identify and develop intellectual property that we believe will provide a competitive advantage and expand our market opportunities. As of October 31, 2002, we had 14 issued patents and over 80 pending worldwide. We vigorously defend our patent portfolio, as evidenced in fiscal 2001, when we successfully defended one of our patents (5,941,972), the'972 patent, in a $15.0 million settlement. In addition, we have successfully launched our patent licensing campaign and have entered into agreements with Adaptac and ADIC to license our technology. We continue to believe it to be a critical component in our market share growth. In addition, we utilize our intellectual property to set standards for the industry. 4 OUR PRODUCTS Storage Router Products The following table summarizes the key features and benefits of our products:
DEVICE PRODUCT FIRST SHIPMENT CONFIGURATION BENEFITS ------- -------------- ------------- -------- TAPE ATTACH STORAGE ROUTERS 4x50 May 1999 o 1 1Gb/s fibre channel o Connects up to 30 SCSI devices port o Enables server migration to SANs o 1, 2, or4 SCSI LVD o Transmits data over distances up Ultra2 or HVD buses to 10 km o 1 Ethernet o Enables LAN-free Backup and recovery management port o Support for Server-free backup o Box and embedded o Supports shared storage (disk, product tape and optical) via Storage Area Network (SAN) connectivity 6000 May 2002 o 1 2Gb/s fibre channel o Provides same benefits as 4x50 port o Connection to 1 or 2 Gigabit per o 2 SCSI LVD Ultra2 ports second (Gb/s) fibre channel SANs o 1 Ethernet management o Provides Crossroads Visual Manager port (CVM) for enhanced software for o Box and embedded storage management product o 'Access Controls' for added security and device sharing between multiple hosts o Supports enhanced Server-free Backup 8000 August 2001 o 2 1Gb/s fibre channel o Provides same benefits as 4x50 ports o Provides modular software in o 4 SCSI LVD Ultra2 Crossroads Router OS and/or HVD ports o Provides Crossroads Visual Manager o 1 Ethernet (CVM) for enhanced software for management port storage management o Redundant power supplies and fans with dual storage network (fibre channel) ports o 'Access Controls' for added security and device sharing between multiple hosts o Supports enhanced Server-free Backup 10000 April 2002 o 2 or 4 2Gb/s fibre o Same benefits as 8000 channel ports o Field replaceable modular o 4, 8, or 12 LVD connectivity options (Ultra3) and/or HVD o Best-in-class performance SCSI ports o Redundant, hot swappable fans and o 1 Ethernet power supplies management port o Designed for enterprise o Expansion capability environments to iSCSI SERVERATTACH STORAGE ROUTERS SA20 Not Yet o 1 2Gb/s fibre channel o Extends life of existing SCSI Shipped port servers by bringing them into o 2 SCSI HVD ports fibre channel SAN architectures o 1 Ethernet management o Supports IBM eServer (AS/400, port RS/6000), DEC Alpha, and Hewlett-Packard mid-range servers with future support planned for other server environments SA40 December 2002 o 2 2Gb/s fibre channel o Extends life of existing SCSI ports servers by bringing them into o 4 SCSI LVD Ultra3 or fibre channel SAN architectures HVD ports o Supports IBM eServer pSeries o 1 Ethernet management (RS/6000) ), DEC Alpha, and port Hewlett-Packard mid-range servers with future support planned for other server environments o Redundant, hot-swappable fans and power supplies o Field replacement I/O modules
5 On a product basis, sales have shifted to our fourth and fifth generation of products, the 6000, 8000 and 10000, and to our embedded line of products. Sales of our older family of products, the 4100, 4200 and 4x50 lines, accounted for approximately 90%, 70% and 41% of our product revenue during the years ended October 31, 2000, 2001 and 2002, respectively. This decrease was partially offset by increased sales of our fourth and fifth generation products, which accounted for approximately 24% of our product revenue during the year ended October 31, 2002. As storage networking continues to mature we have seen a trend towards simplification of networking components and management. The impact of this trend on our business has been the push for, and subsequent ramp up of, embedded routers being shipped with tape libraries. Sales of our embedded products accounted for approximately 2%, 15% and 27% of our product revenue during the years ended October 31, 2000, 2001 and 2002, respectively. In August 2001, we expanded our product line with the launch of our fourth generation product line -- the Crossroads 8000 storage router and management software. The 8000 is the first in a new line of multi-protocol enabled routers designed to connect storage devices into fibre channel and iSCSI storage networks. One element of the 8000 is the Crossroads Visual Manager(TM) (CVM(TM)) software. This software increases the intelligence in the SAN and reduces the cost of storage management. In conjunction with Compaq, Intel, Microsoft, StorageTek, and VERITAS, we unveiled the Crossroads Internet SCSI - or iSCSI - for storage networking in October 2001 at Storage Networking World (SNW). The demonstration utilized a Crossroads iSCSI storage router performing data movement with an Intel PRO/1000 T IP Storage Adapter, StorageTek L40 tape library and a server running Microsoft Windows.Net Server Beta and Windows 2000 Professional. The demonstration showcased the combined technology and interoperability of these industry leaders. In January 2002, we expanded our product line with the launch of our fifth generation product line -- the Crossroads 10000 Multi-Protocol Storage Router for enterprise environments. The Crossroads 10000 is a fully redundant, modular storage router that increases the reliability, flexibility and performance of tape backup in networked storage environments through technologies such as LAN-free, Server-free backup and multi-protocol connectivity. One of the other capabilities of the 10000 is 'Access Controls' which provides enhanced security and prevent server conflicts so that multiple servers can share storage devices. Advances LUN zoning capabilities allow an entire library (or even specific tape drives) to be masked from selected servers while remaining visible to others. In April 2002, we began shipping the Crossroads 10000 for SAN data protection to Compaq, now part of Hewlett-Packard. In October 2002, we also began shipping the Crossroads 10000 to StorageTek. In April 2002 at the SNW spring show we further demonstrated leading iSCSI interoperability with a prototype of our Crossroads 10000 platform in a joint demonstration with Adaptec, CommVault, Hewlett-Packard, and Microsoft. In May 2002, we launched the industry's first low-cost two-gigabit fibre channel storage router, the Crossroads 6000. Targeted at the small to mid-sized market, the Crossroads 6000 complements the Crossroads 10000, which is intended for the enterprise market. In May 2002 we also began shipping the 6000 to Compaq, now part of Hewlett-Packard. The 6000 provides customers an alternative to purchasing newer equipment by enabling them to continue to leverage existing equipment, such as SCSI tape libraries. Also in May 2002, at the NetWorld + Interop Conference, we demonstrated broad interoperability with iSCSI storage routing in a joint demonstration with Intel, IBM, and StorageTek. The demonstration combined the Crossroads 10000 with an Intel PRO/1000 T IP Storage Adapter, StorageTek L40 tape library, IBM eServer xSeries, and an IBM Total Storage IP Storage 200i system. The 10000 storage router performed data movement and data backup over Gigabit Ethernet using the emerging iSCSI protocol and forwarded the data to the StorageTek library. By working with leading companies such as IBM, Intel and StorageTek, Crossroads demonstrated expertise in developing next-generation industry-standard I/O products and further supported its goal of positioning itself to deliver simple, cost-effective and interoperable iSCSI solutions to customers. In December 2002, we launched the Crossroads ServerAttach SA40, the first appliance to connect SCSI servers to networked storage. With ServerAttach, Crossroads leveraged its existing tape attach technology but in a that allows attachment of servers into fibre channel SANs . The ServerAttach SA40 is the first offering in the company's new ServerAttach family of products that will be sold through Crossroads' distribution channel, broadening the company's potential customer base. With ServerAttach, 6 Crossroads has moved into an adjacent market that we believe will increase beyond our existing tape attach opportunities, and which will allow our customers to save both time and money by leveraging existing servers with access to storage network resources. DISTRIBUTION MODEL Our products are marketed, sold, and supported worldwide through a wide range of distribution partners, including OEM partners, value-added distributors, systems integrators, and value-added resellers. o o Our OEM partners are leading storage systems and subsystems providers who offer our products under their own private label or as Crossroads branded solutions. Sales through OEM partners comprise the majority of our business. o Other distribution partners include Crossroads-authorized value added distributors, systems integrators, and VARs. These partners are authorized by us to market, sell, and support our family of storage routers. Some also sell product education and other value-added services. We have OEM or distribution agreements with many of the companies that sell the world's storage systems and subsystems. Prior to offering our products for sale through OEMs, our OEM customers require that each of our products undergo an extensive qualification process, which involves interoperability testing of our product in the OEM's system as well as rigorous reliability testing. This qualification process may continue for a year or longer. However, qualification of a product by an OEM does not assure any sales of the product to the OEM. Despite this uncertainty, we devote substantial resources, including sales, marketing and management efforts, toward qualifying our products with OEMs in anticipation of sales to them. If we are unsuccessful or delayed in qualifying any products with an OEM, such failure or delay would preclude or delay sales of that product to the OEM, which may impede our ability to grow our business. OUR CUSTOMERS We provide our products in a variety of configurations, including both stand-alone box and embedded router form factors with varying port counts. Our products are in solutions from ACAL, ACS, Arrow, ATL, Bell Micro, Cranel/Adexis, Datalink, Dell, Fujitsu-Siemens, Groupe Bull , Hewlett-Packard (including Compaq), Hitachi Data Systems, IBM, Overland Storage, StorageTek, Sun Microsystems, Tech Data, TidalWire and Unisys. During fiscal 2002, our revenue base consolidated significantly which resulted in the number of our customers representing approximately 75% of our total revenue decreasing from ten in fiscal 2001 to three in fiscal 2002. In fiscal 2002, sales to our OEM customers accounted for approximately 82% of our total revenue. For the year ended October 31, 2000, 2001 and 2002, our distribution channel, which consists of distributors, VARs and systems integrators, accounted for approximately 10%, 11% and 13% of our total revenue, respectively. A significant portion of our revenue is concentrated among a relatively small number of OEM customers and the merger of Hewlett-Packard and Compaq has resulted in substantial additional concentration. During fiscal 2002, sales to Hewlett-Packard (including Compaq) and StorageTek, accounted for 51% and 24% of our total revenue, respectively. No other customer accounted for more than 10% of our revenue during fiscal 2002. The level of sales to any single customer may vary and the loss of any one significant customer, or a decrease in the level of sales to any one significant customer, particularly Hewlett-Packard (including Compaq), would seriously harm our financial condition and results of operations. We expect that a significant portion of our future revenue will continue to come from sales of products to a relatively small number of customers. In March 2002, we announced that we entered into an exclusive reseller business relationship with Luminex Software, Inc. Under the terms of the agreement, Luminex became the exclusive reseller of our mainframe products, which we originally acquired from Polaris. The agreement expands an already existing customer relationship and includes a license to the hardware, software and firmware designs of our mainframe products. At the end of the agreement, provided that Luminex meets specified minimum purchase thresholds, Luminex will have the option to purchase the assets and intellectual property related to our mainframe products, including the right to manufacture those products, for a nominal amount. Luminex has a seven-year history of working with us as an OEM and shares a similar customer and OEM base. Luminex hired the entire Crossroads-Oregon engineering and marketing team, and operates the business from its current location in Beaverton, Oregon. With our product line, Luminex will now provide focused software and hardware development for the data center and enterprise class customer. As a result, Luminex now supports all Crossroads-Oregon customers. We expect that Luminex will meet specified minimum purchase thresholds during the second fiscal quarter of 2003, and at that time, we will consummate a transfer of assets to Luminex. SALES AND MARKETING We base our sales and marketing strategy on an indirect sales model executed through global OEMs and distributors, VARs and system integrators. Our sales activity has focused principally on OEM adoption through extensive OEM testing and product qualification. Because we sell most of our products today though our OEMs, we have restructured our selling efforts to focus on growing within those OEM accounts. We hope to expand our distribution channel by qualifying new leads in a sales/marketing 'funnel' process. We have used an email marketing campaign in conjunction with online marketing surveys which are generating product interest with end-users. After qualification, the end-users are referred to the appropriate sales representatives or channel partners. End-users are also input into a database that is used for our email marketing efforts. We also enable our channel 7 partners to better handle customer leads by providing them with access to online product training, sales literature, and technical documentation as well as other information via a partner website, which is intended to facilitate the sales process. Our marketing organization primarily focuses on coordinating strategic product planning and tactical adoption activities with our major OEM customers and channel partners. This helps us to determine which market segments to pursue, understand their size and growth characteristics, analyze competition, define product features, construct business analyses to measure expected return on investments, and finally to enhance the indirect distribution process for our products by provisioning the sales and marketing tools needed. Our marketing efforts are geared toward: o developing key relationships with OEMs, distributors, VARs, system integrators, and independent software vendors; o participating in tradeshows to promote and launch our products; and o coordinating our involvement in various industry standards organizations, such as the Storage Networking Industry Association. CUSTOMER SERVICE AND SUPPORT Our customer support organization provides comprehensive training programs and telephone, e-mail and Web-based direct support to our customers and end-users. These programs allow us to minimize the need for a large end-user support organization by enabling our OEMs to provide installation, service and primary technical support to their customers while we focus on high-level secondary support. We actively assist our OEM customers, distributors and VARs to solve end-user problems. OUR COMPETITION The market for SAN products generally, and storage routers in particular, is increasingly competitive. We anticipate that the market for our products will continually evolve and will be subject to rapid technological change. We currently face competition from ADIC through their acquisition of Pathlight Technology in 2001, ATTO, and Chaparral Network Storage. We also expect to face competition in the future from one or more of the following sources: o other OEMs, including our customers and potential customers; o native fibre channel vendors; o LAN switch manufacturers; o future iSCSI vendors; o storage system industry suppliers, including manufacturers and vendors of other SAN products or entire SAN systems; and o current and future start-up companies. As the market for SAN products grows, we also may face competition from traditional networking companies and other manufacturers of networking products. These networking companies may enter the storage router market by introducing their own products or by entering into strategic relationships with or acquiring other existing SAN product providers. Furthermore, we have licensed our 4200 and 4x50 storage router technology to Hewlett-Packard, one of our OEM customers. Hewlett-Packard currently manufactures the 4200 product under its name and pays us a royalty. Hewlett-Packard has vastly greater resources and distribution capabilities than we do, and therefore, it could establish market acceptance in a relatively short time frame for any competitive products that it may introduce, which, in turn, would reduce demand for our products from Hewlett-Packard and could reduce demand for our products from other customers. We believe the competitive factors in the storage router and ServerAttach markets include the following: 8 o market share and position; o OEM endorsement; o product reliability and verified interoperability; o customer service and technical support; o product performance and features; o brand awareness and credibility; o ability to meet delivery schedules; o strength of distribution channel; o ease-of-use and manageability; and o price. TECHNOLOGY Our storage router products are based on an architecture that combines our Crossroads OS and hardware designs using industry standard components. Our proprietary packet routing software intelligently examines data packet traffic to prioritize transmission and minimize network congestion in the flow of transactions between servers and storage systems. This routing software also: o manages delays in data transmissions that result from variances in speeds; o provides accurate communication of transmission status to connected devices; o provides critical interoperability between diverse protocols; o enables sharing of storage resources by multiple servers; and o can adapt to new protocols as they emerge. Additionally, our embedded software is configurable and can be quickly adapted to varying customer requirements and computing environments. While our software architecture serves as the foundation for our current products, it is also designed to be able to accommodate several planned generations of new designs. Our hardware is the "engine" that provides basic performance and functionality such as operating speed, data movement, external device connectivity, network management interfaces and the ability to operate in extreme environmental conditions of temperature and humidity. We possess a high level of multi-disciplinary expertise encompassing technologies, software design, operating systems, hardware and application specific integrated circuit design and storage area network technologies. We utilize these skills to design, develop, manufacture and deliver our products. We believe that our combined expertise in each of these technologies provides us with a competitive advantage in the ability to develop new products on a timely basis, verify interoperability, expand our product features and integrate additional interfaces and functions. I/O Technologies We believe that our routing expertise is a critical factor in our ability to maintain our leadership position in storage routing. The key technologies in use today are: SCSI and fibre channel in open systems (e.g., Windows NT and Unix). As of October 31, 2002, we employed 66 research and development personnel who have significant involvement in the evolution of these technologies. Based on their expertise and our overall capabilities, we believe that we possess insight and understanding into the capabilities and limits of each new technology and the requirements for routing. As new standards are developed, we expect to contribute to these developments and 9 leverage our software and technical expertise in developing additional routers. Such additional areas of focus include: o iSCSI over Gigabit Ethernet; o SRP over InfiniBand; o Serial Attached SCSI; and o Serial ATA. Embedded Software Design We design, develop and test all of our own embedded software. As of October 31, 2002, our engineering staff included 24 software engineers with expertise in embedded software, management tools, software applications and graphical user interface development. We have considerable expertise in protocol standards, error detection and recovery and support. The flexibility to modify our software to varying system configurations has enhanced our ability to rapidly achieve verified interoperability. RESEARCH AND DEVELOPMENT The storage networking industry in which we compete is subject to rapid technological developments, evolving industry standards, changes in customer requirements, and new product introductions. As a result, we believe that our research and development efforts are essential to our ability to successfully deliver innovative products that address the needs of our customers as the routing market evolves. Our research and development team works closely with our marketing and sales team and OEMs to define product features and performance. Development activities are conducted with extensive validation testing at both our company and at our major customers. We have invested heavily in research and development to support current and future product development. We continue to enhance and extend our products to anticipate and meet customer requirements. We continue to increase the speed and performance of our storage routing products and to deliver higher port density and more cost-optimized solutions. Our products are designed to support current industry standards and will continue to support emerging standards that are consistent with our product strategy. Members of our senior engineering team also are actively engaged in development of industry standards which allows us to focus our product strategies in areas that are aligned with those standards. Research and development programs currently underway that focus on our routing initiatives include: o fibre channel-to-SCSI storage routing: Increased connectivity and port density, smaller form factors, improved manageability, broader interoperability, higher performance products and "intelligent" data management and data movement features. o iSCSI-to-SCSI storage routing: To enable connectivity of SCSI storage devices to an Ethernet network using the iSCSI protocol. o iSCSI-to-fibre channel storage routing: To enable connectivity of IP networks to fibre channel SANs for both data movement and management. o InfiniBand Routing: Technology development focused on multi-protocol routing products for InfiniBand connecting to iSCSI, fibre channel and other protocols. Our research and development expenses, net of stock-based compensation of $440,000 and $369,000 during fiscal 2001 and 2002, respectively, were $17.7 million and $16.2 million in fiscal 2001 and 2002, respectively. At October 31, 2002, we employed 66 research and development personnel. All expenditures for research and development costs have been expensed as incurred. We expect to continue to maintain our high level of investment in research and development. 10 MANUFACTURING In November 2002, we amended our existing licensing agreement with Hewlett-Packard. Pursuant to this amendment, beginning in the second quarter of 2003, we will outsource the manufacturing of our embedded routers to Hewlett-Packard. We believe this agreement will allow us to leverage the strengths of both companies. We will use Hewlett-Packard's economies of scale in manufacturing and systems integration expertise and combine that with our software, value-added applications and intellectual property. Under the amended agreement, Hewlett-Packard will manufacture the hardware and license the software from us for its current line of embedded solutions. In addition, we will be able to purchase from Hewlett-Packard embedded routers for sales to our other customers. Further, we will continue to manufacture our box-based 4x50, 6000 and 10000 products for Hewlett-Packard, as well as for our other OEMs for whom we will also continue to manufacture branded solutions. Together, we should be able to drive efficiencies for both companies while delivering cost-effective storage solutions to end-users. We use Solectron Corporation, a third-party contract manufacturer, to assemble the printed circuit board for our current products, including our 4x50, 6000, 8000, 10000, and embedded router family of products (which we are in the process of transitioning to Hewlett-Packard pursuant to the amended license agreement, described above). Our manufactured products contain printed circuit board assemblies which consist of the electronics that control the function of our product. Solectron purchases the required components for our printed circuit board to meet demand in accordance with our purchase orders and our forecast. During product final assembly and test, the printed circuit board is assembled with the remaining components (power supply, cables and enclosures) and tested to create the final product. Solectron invoices us based on prices and payment terms mutually agreed upon and set forth in purchase orders we issue to Solectron. The pricing takes into account component costs, manufacturing costs, and margin requirements. Although the purchase orders we place with Solectron are cancelable, the terms of our manufacturing agreement with Solectron would require us to purchase all excess or obsolete material not returnable or usable by other customers. As the needs of our customers continue to evolve, we plan to reassess our manufacturing requirements on a periodic basis and effect appropriate changes to our manufacturing processes. Although we use standard parts and components for our products where possible, we and Solectron currently purchase several key components used in the manufacture of our products from single or limited sources. Solectron purchases the components used in the printed circuit board assemblies, whereas we purchase the remaining components used during final assembly including the power supply, fan and chassis materials. We have an obligation to our contract manufacturers for portions of excess inventory arising from a sudden reduction in purchase orders by us to the extent it differs from the forecast which we supply to our contract manufacturers. Our principal single-source components include application specific integrated circuits, licensed software and chassis. During fiscal 2002, we have maintained our ISO 9002 registration. PATENTS, INTELLECTUAL PROPERTY AND LICENSING We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements, and other contractual restrictions with employees and third parties to establish and protect our proprietary rights. Despite these precautions, the measures we undertake may not prevent misappropriation or infringement of our proprietary technology. These measures may not preclude competitors from independently developing products with functionality or features similar to our products. We maintain a program to identify and obtain patent protection for our inventions. It is possible that we will not receive patents for every application we file. Furthermore, our issued patents may not adequately protect our technology from infringement or prevent others from claiming that our products infringe the patents of those third parties. Failure to protect our intellectual property could materially harm our business. In addition, our competitors may independently develop similar or superior technology. It is possible that litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources and could materially harm our business. Some of our products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe that such licenses generally could be obtained on commercially reasonable terms. 11 In May 2002, Adaptec, Inc. became the first RAID company to license the Crossroads '972 patent, which provides access controls vital to networked storage systems. Adaptec will add this technology to RAID controllers that ship with its DuraStor(TM) 7220SS, a fibre channel-to-SCSI storage subsystem. Specifically, the technology enables Adaptec's RAID cards to protect data in shared storage from unauthorized access and overwrites by multiple hosts. In December 2002, Adaptec added the DuraStor(TM) 7320SS, a fibre channel-to-SCSI storage subsystem to its license with Crossroads. We have 14 patents issued and 80 patents pending worldwide. 24 patent applications are pending in the United States Patent and Trademark Office with respect to our technology. We have 56 pending international patent applications (11 in the European Patent Office, 10 in Canada, 10 in Japan, 7 in Australia, 5 in Hong Kong, 4 in Indonesia and 4 in China). We also have 5 international patent applications pending under the Patent Cooperation Treaty. We have issued a license to Hewlett-Packard for our 4200 and 4x50 storage router technology. This license allows Hewlett-Packard to create and incorporate into its own products modifications and derivative works of this licensed technology. This license expired in April 2001 but automatically renewed and will continue to renew for successive one-year periods after that date, unless it is terminated by either party. Hewlett-Packard currently manufactures the 4200 product under its name and pays us a royalty. During fiscal 2001, we succeeded in two important lawsuits that demonstrated our ability to protect important aspects of our intellectual property portfolio. In June 2001, Pathlight Technology, a wholly owned subsidiary of Advanced Digital Information Corp., admitted both the validity and infringement of one of our patents (5,941,972), the '972 patent, in a $15.0 million settlement. In September 2001, a jury and judge validated that same patent against Chaparral Network Storage Corporation, while extending the patent's application to all RAID and router products using Access Controls or LUN zoning, awarding us damages and punitive damages. In fiscal 2002, Chaparral appealed the judgment against it, contending that the '972 patent is invalid and not infringed. Crossroads intends to vigorously defend the appeal. During fiscal 2002, we were awarded an additional patent, the '035 patent, which is an extension of our '972 patent for access controls that are vital to network storage environments. We have registered the trademark "CROSSROADS", "CROSSROADS SYSTEMS" and "iBOD" in the United States. All other trademarks, service marks or trade names referred to in this Annual Report on Form 10-K are the property of their respective owners. EMPLOYEES At October 31, 2002, we had 122 employees, with 66 engaged in research and development, 26 in manufacturing, 13 in sales, marketing and customer support, and 17 in administration, information technology, human resources and finance. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good. Competition for technical personnel in the computing industry continues to be significant. We believe that our success depends in part on our ability to hire, assimilate, and retain qualified personnel. We cannot assure you that we will continue to be successful at hiring, assimilating, and retaining employees in the future. 12 EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth, as of January 17, 2002, certain information concerning our executive officers:
NAME AGE POSITION(s) ---- --- ----------- Brian R. Smith............... 37 President, Chief Executive Officer, Chairman of the Board Robert C. Sims............... 35 Chief Operating Officer Andrea Wenholz............... 37 Vice President, Chief Financial Officer, Secretary and Treasurer
BRIAN R. SMITH is our Chairman of the Board, President and Chief Executive Officer of Crossroads. Mr. Smith is a co-founder and has served as our Chairman of the Board since our inception in April 1995, as our Chief Executive Officer from our inception until October 31, 2001 and from May 2002 to the present, and as our President from our inception until October 1997 and from May 2002 to the present. From November 2001 to December 2002, Mr. Smith served as the managing partner of Convergent Investors, a venture capital firm located in Austin, Texas. From October 1994 to April 1995, Mr. Smith was President of a consulting service company which successfully evolved into Crossroads. From January 1985 to October 1994, he also held various development and management positions with IBM. At IBM his accomplishments included leading the development of IBM's fibre channel and FDDI products. Mr. Smith holds a B.S.E.E from the University of Cincinnati and an M.S.E.E. from Purdue University. ROBERT C. SIMS has served as our Chief Operating Officer since May 2002. From April 2001 to May 2002, Mr. Sims served as our Vice President of Engineering and Operations. From July 2000 to April 2001, Mr. Sims served as our Vice President of Operations and Corporate Quality. From March 1999 to July 2000, Mr. Sims served as our Director of Operations. From January, 1998 to March 1999, Mr. Sims managed the advanced manufacturing and product test organizations at Kentek Corp., developing high-speed back office printers. From 1990 to 1998, Sims was with Exabyte where he last served as manager of the manufacturing engineering and quality organizations for the high-end tape drive division. Mr. Sims received a B.S. in electrical engineering from Colorado State University. ANDREA WENHOLZ joined Crossroads as our Vice President, Chief Financial Officer, Secretary and Treasurer in January 2003. From May 2001 to December 2002, Ms. Wenholz served as the Controller for U.S. Operations at Parthus Technologies, plc, a leading provider of application-specific platform IP, which eventually became ParthusCeva, following its merger with Ceva, the former licensing division of DSP Group, Inc. Prior to that, from September 2000 to May 2001 Ms. Wenholz was Chief Financial Officer at Chicory Systems, Inc., a semiconductor intellectual property company, which was acquired by Parthus. Ms. Wenholz served as a Business Unit Controller at Cisco Systems, Inc. from April 1998 to September 2000, and prior to that as Controller at NetSpeed, Inc. from August 1996 to April 1998, where she was involved in the implementation and manufacturing transition of Cisco's acquisition of NetSpeed. Ms. Wehnolz is a C.P.A and received a B.B.A. from Texas A&M University. Further information required by this Item is incorporated by reference to our Proxy Statement under the sections captioned "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934." 13 FACTORS THAT MAY AFFECT FUTURE RESULTS In addition to the other information in this Annual Report on Form 10-K, the following factors should be considered in evaluating Crossroads and our business. These factors include, but are not limited to the potential for significant losses to continue; our inability to accurately predict revenue and budget for expenses for future periods; fluctuations in revenue and operating results; class action securities litigation; overall market performance; limited product lines; limited number of OEM customers; lengthy OEM product qualification process; competition; delays in research and development; inventory risks; the loss of our primary contract manufacturers; risks of delay or poor execution from a variety of sources; inventory risks; limited resources; pricing; dependence upon key personnel; product liability claims; the inability to protect our intellectual property rights; concentration of ownership; volatility of stock price; and the impact on our results or operations due to changes in accounting standards, including the implementation of SAB NO. 101 with respect to revenue recognition. The discussion below addresses some of these factors. Additional risks and uncertainties that we are unaware of or that we currently deem immaterial also may become important factors that affect us. WE HAVE INCURRED SIGNIFICANT LOSSES AND NEGATIVE CASH FLOW, WE EXPECT FUTURE LOSSES AND NEGATIVE CASH FLOW, AND WE MAY NEVER BECOME PROFITABLE OR CASH FLOW POSITIVE. We have incurred significant losses in every fiscal quarter since fiscal 1996 and expect to continue to incur losses in the future. As of October 31, 2002, we had an accumulated deficit of $141.0 million. We cannot be certain that we will be able to generate sufficient revenue to achieve profitability or become cash flow positive. Although we engaged in a restructuring plan in 2002 pursuant to which we significantly reduced our expense structure, we still expect to incur significant sales and marketing, research and development and general and administrative expenses and, as a result, we expect to continue to incur losses. Moreover, even if we do achieve profitability, we may not be able to sustain or increase profitability or cash flow. DUE TO THE UNCERTAIN AND SHIFTING DEVELOPMENT OF THE STORAGE AREA NETWORK MARKET, WE MAY HAVE DIFFICULTY ACCURATELY PREDICTING REVENUE FOR FUTURE PERIODS AND APPROPRIATELY BUDGETING FOR EXPENSES. We have generated product revenue for approximately five years and, thus, we have only a limited history from which to predict future revenue. This limited operating experience, combined with the rapidly evolving nature of the storage area network market in which we sell our products, the current weak economic environment which has resulted in decreased corporate IT spending and other factors that are beyond our control, reduces our ability to accurately forecast our quarterly and annual revenue. Most of our expenses are fixed in the short term or incurred in advance of anticipated revenue. As a result, we may not be able to decrease our expenses in a timely manner to offset any shortfall of revenue. WE HAVE EXPERIENCED AND EXPECT TO CONTINUE TO EXPERIENCE SIGNIFICANT PERIOD-TO-PERIOD FLUCTUATIONS IN OUR REVENUE AND OPERATING RESULTS, WHICH MAY RESULT IN VOLATILITY IN OUR STOCK PRICE. We have experienced and expect to continue to experience significant period-to-period fluctuations in our revenue and operating results due to a number of factors, and any such variations and factors may cause our stock price to fluctuate. Accordingly, you should not rely on the results of any past quarterly or annual periods as an indication of our future performance. It is likely that in some future period our operating results will be below the expectations of public market analysts or investors. If this occurs, our stock price may drop, perhaps significantly. A number of factors may particularly contribute to fluctuations in our revenue and operating results, including: o changes in general economic conditions and specific economic conditions in the computer, storage, and networking industries. In particular, continuing economic uncertainty has resulted in a general reduction in IT spending. This reduction in IT spending has lead to a decline in our growth rates compared to historical trends; o the timing of orders from, and product integration by, our customers, particularly our OEMs, and the tendency of these customers to change their order requirements frequently with little or no advance notice 14 to us; o the rate of adoption of SANs as an alternative to existing data storage and management systems; o the ongoing need for storage routing products in storage area network architectures; o the deferrals of customer orders in anticipation of new products, services or product enhancements from us or our competitors or from other providers of storage area network products; o the rate at which new markets emerge for products we are currently developing; o the successful launch and customer acceptance of our new ServerAttach family of products; o disruptions or downturns in general economic activity resulting from terrorist activity and armed conflict; o increases in prices of components used in the manufacture of our products; and o variations in the mix of our products sold and the mix of distribution channels through which they are sold. In addition, potential and existing OEM customers often place initial orders for our products for purposes of qualification and testing. As a result, we may report an increase in sales or a commencement of sales of a product in a quarter that will not be followed by similar sales in subsequent quarters as OEMs conduct qualification and testing. This order pattern has in the past and could in the future lead to fluctuations in quarterly revenue and gross profits. GLOBAL ECONOMIC CONDITIONS MAY CONTINUE TO ERODE, WHICH MIGHT NEGATIVELY IMPACT US, AND THE PRICE OF OUR COMMON STOCK. The macroeconomic environment and capital spending on information technology have continued to erode, resulting in continued uncertainty in our revenue expectations. The operating results of our business depend on the overall demand for storage area network products. Because our sales are primarily to major corporate customers whose businesses fluctuates with general economic and business conditions, continued soft demand for storage area network products caused by a weakening economy and budgetary constraints have resulted in decreased revenue. We may be especially prone to this as a result of the relatively high percentage of revenue we have historically derived from the high-tech industry, which has been more adversely impacted by the current weak economic environment. Customers may continue to defer or reconsider purchasing products if they continue to experience a lack of growth in their business or if the general economy fails to significantly improve, resulting in a continued decrease in our product revenue. THE STORAGE TECHNOLOGY MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL EVOLUTION, AND OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW PRODUCTS. The market for our products is characterized by rapidly changing technology and evolving industry standards and is highly competitive with respect to timely innovation. At this time, the storage technology market is particularly subject to change with the emergence of fibre channel and iSCSI protocols and other new storage technologies and solutions. The introduction of new products embodying new or alternative technology or the emergence of new industry standards could render our existing products obsolete or unmarketable. Our future success will depend in part on our ability to anticipate changes in technology, to gain access to such technology for incorporation into our products and to develop new and enhanced products on a timely and cost-effective basis. Risks inherent in the development and introduction of new products include: o delay in our initial shipment of new products; o the difficulty in forecasting customer demand accurately; o our inability to expand production capacity fast enough to meet customer demand; 15 o the possibility that new products may cannibalize our current products; o competitors' responses to our introduction of new products; and o the desire by customers to evaluate new products for longer periods of time before making a purchase decision. In addition, we must be able to maintain the compatibility of our products with future device technologies, and we must rely on producers of new device technologies to achieve and sustain market acceptance of those technologies. Development schedules for high-technology products are subject to uncertainty, and we may not meet our product development schedules. If we are unable, for technological or other reasons, to develop products in a timely manner or if the products or product enhancements that we develop do not achieve market acceptance, our business will be harmed. FAILURE TO MANAGE OUR BUSINESS EFFECTIVELY COULD SERIOUSLY HARM OUR BUSINESS, FINANCIAL CONDITION, AND PROSPECTS. Our ability to successfully implement our business plan, develop and offer products, and manage our business in a rapidly evolving market requires a comprehensive and effective planning and management process. We continue to change the scope of our operations, including managing our headcount appropriately. Changes in our business, headcount, organizational structure and relationships with customers and other third parties has placed, and will continue to place, a significant strain on our management systems and resources. Our failure to continue to improve upon our operational, managerial, and financial controls, reporting systems, and procedures, and our failure to continue to train and manage our work force, could seriously harm our business and financial results. OUR COMMON STOCK IS CURRENTLY TRADING ABOVE $1.00 PER SHARE. HOWEVER, IF THE CLOSING BID PRICE OF OUR COMMON STOCK WERE TO FALL BELOW $1.00 PER SHARE FOR MORE THAN 30 CONSECUTIVE TRADING DAYS, OUR STOCK COULD AGAIN BE AT RISK OF BEING DELISTED FROM THE NASDAQ NATIONAL MARKET. In December 2002, Nasdaq sent us a notice that we were to be delisted from the Nasdaq National Market for failure to maintain the $1.00 minimum bid price requirement for listing on the Nasdaq National Market. While we were awaiting our hearing with Nasdaq to appeal our delisting, the closing bid price of our common stock remained above $1.00 for twelve consecutive trading days and we received a notice from Nasdaq that our hearing was cancelled and that we would remain on the Nasdaq National Market. While we recently avoided the threat of delisting, in the event that the closing bid price of our stock were to fall below $1.00 for 30 consecutive trading days, we would again be in danger of having our stock delisted from the Nasdaq National Market. Delisting could make our stock more difficult to trade, reduce the trading volume of our stock and further depress our stock price. In addition, delisting or the threat of delisting could impair our ability to raise funds in the capital markets, which could materially impact our business, results of operations and financial condition. AN ADVERSE DECISION IN THE VARIOUS SECURITIES CLASS ACTION AND DERIVATIVE LAWSUITS FILED AGAINST US MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND FINANCIAL PERFORMANCE. We and several of our officers and directors were named as defendants in several class action lawsuits filed in the United States District Court for the Western District of Texas. The plaintiffs in the actions purport to represent purchasers of our common stock during various periods ranging from January 25, 2000 through August 24, 2000. The court consolidated the actions and appointed a lead plaintiff under the Private Securities Litigation Reform Act of 1995. The amended consolidated complaint was filed in February 2001. On November 22, 2002, the court granted our motion for summary judgment, concluding that the plaintiffs failed to demonstrate an essential element to their claim of securities fraud. We anticipate the plaintiffs will file an appeal to the Fifth Circuit Court of Appeals. The litigation is at an early stage and it is not possible at this time to predict whether we will incur any liability or to estimate the damages, or the range of damages, that we might incur in connection with such actions. An adverse judgment may have a material adverse effect on our business and financial performance. See Note 5 to Notes to Condensed Consolidated Financial Statements. On November 21, 2001, a derivative state action was filed in the 261st District Court of Travis County, Texas on behalf of Crossroads by James Robke and named several of our officers and directors as defendants. The derivative 16 state action is based upon the same general set of facts and circumstances outlined above in connection with the purported securities class action litigation. The derivative state action alleges that certain of the individual defendants sold shares while in possession of material inside information in purported breach of their fiduciary duties to Crossroads. The derivative state action also alleges waste of corporate assets. On January 28, 2002, we filed an answer and general denial to the derivative state action. We believe the allegations in the derivative state action are without merit and intend to defend ourselves vigorously. Our inability to prevail in this action could have a material adverse effect on our future business, financial condition and results of operations. See Note 5 to Notes to Condensed Consolidated Financial Statements. OUR BUSINESS IS DEPENDENT ON THE STORAGE AREA NETWORK MARKET WHICH IS NEW AND UNPREDICTABLE, AND IF THIS MARKET DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE, OUR BUSINESS WILL SUFFER. Fibre channel-based SANs, were first deployed in 1997. As a result, the market for SANs and related storage router products has only recently begun to develop and is rapidly evolving. Because this market is relatively new, it is difficult to predict its potential size or future growth rate. Substantially all of our products are used exclusively in SANs and, therefore, our business is dependent on the SAN market. Accordingly, the widespread adoption of SANs for use in organizations' computing systems is critical to our future success. Most of the organizations that would be likely to purchase our products have invested substantial resources in their existing computing and data storage systems and, as a result, may be reluctant or slow to adopt a new approach like SANs, particularly in the current economic environment. SANs are often implemented in connection with the deployment of new storage systems and servers. Therefore, our future success is also substantially dependent on the market for new storage systems and servers. Furthermore, the ability of the different components used in a SAN to function effectively, or interoperate, with each other when placed in a computing system has not yet been achieved on a widespread basis. Until greater interoperability is achieved, customers may be reluctant to deploy SANs. Our success in generating revenue in the emerging SAN market will depend on, among other things, our ability to: o educate potential OEM customers, distributors, VARs, system integrators, storage service providers and end-user organizations about the benefits of SANs and storage router technology, including, in particular, the ability to use storage routers with SANs to improve system backup and recovery processes; o maintain and enhance our relationships with OEM customers, distributors, VARs, system integrators, storage system providers and end-user organizations; o predict and base our products on standards which ultimately become industry standards; and o achieve interoperability between our products and other SAN components from diverse vendors. WE HAVE LIMITED PRODUCT OFFERINGS AND OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP IN A TIMELY MANNER NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE. We currently have a limited number of principal products within our storage router product family that we sell in commercial quantities. Our future growth and competitiveness will depend greatly on the market acceptance of our newly introduced product lines, including the 6000, 8000 and 10000 storage routers and our ServerAttach family of products, which we released in December 2002. We have just begun to receive revenue from the sale of our 6000, 8000 and 10000 storage routers. However, their market acceptance remains uncertain. Sales of our 6000, 8000 and 10000 storage routers accounted for approximately 1% and 24% of our product revenue during fiscal 2001 and 2002, respectively. If any of these four product lines do not achieve sufficient market acceptance, our future growth prospects could be seriously harmed. Moreover, even if we are able to develop and commercially introduce new products and enhancements, these new products or enhancements may not achieve market acceptance. 17 Factors that may affect the market acceptance of our products, some of which are beyond our control, include the following: o growth of the SAN market; o changing requirements of customers within the SAN market; o performance, quality, price and total cost of ownership of our products; o availability, performance, quality and price of competing products and technologies; o our customer service and support capabilities and responsiveness; and o successful development of our relationships with existing and potential OEM, distributor, VAR, system integrator and storage system provider customers. WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF OUR REVENUE. THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY CUSTOMERS WOULD SIGNIFICANTLY REDUCE OUR REVENUE AND WOULD SUBSTANTIALLY HARM OUR FUTURE RESULTS OF OPERATIONS. In fiscal 2000, 2001 and 2002, approximately 77%, 70% and 78% of our total revenue, respectively, was derived from six customers. In fiscal 2001, Hewlett-Packard and StorageTek represented 26% and 23% of our total revenue, respectively. In fiscal 2002, Hewlett-Packard (including sales to Company and to the combined company) and StorageTek represented 51% and 24% of our total revenue, respectively. In May 2002, the merger between Hewlett-Packard and Compaq was consummated which significantly increased our customer concentration. In fiscal 2002, sales to Hewlett-Packard and Compaq prior to the merger and to the combined company following the merger represented approximately 51% of our total revenue. If we experience any adverse effect of the acquisition of Compaq by Hewlett-Packard, including the risks due to the increase in customer concentration, any change in product focus or strategy which adversely affects anticipated revenue or margins or our overall relationship with the newly combined company our results of operations and future prospects will suffer. Our operating results in the foreseeable future will continue to depend on sales to a relatively small number of OEM customers. Therefore, the loss of any of our key OEM customers, or a significant reduction in sales to any one of them, would significantly reduce our revenue. OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE QUALIFICATION PROCESS THAT DOES NOT ASSURE PRODUCT SALES. Prior to offering our products for sale, our OEM customers require that each of our products undergo an extensive qualification process, which involves interoperability testing of our product in the OEM's system as well as rigorous reliability testing. This qualification process may continue for a year or longer. However, qualification of a product by an OEM does not assure any sales of the product to the OEM. Despite this uncertainty, we devote substantial resources, including sales, marketing and management efforts, toward qualifying our products with OEMs in anticipation of sales to them. If we are unsuccessful or delayed in qualifying any products with an OEM, such failure or delay would preclude or delay sales of that product to the OEM, which may impede our ability to grow our business. DEMAND FOR OUR PRODUCTS DEPENDS SIGNIFICANTLY UPON THE NEED TO INTERCONNECT SCSI-BASED TAPE STORAGE SYSTEMS WITH FIBRE CHANNEL SANS, AND WE EXPECT TO FACE COMPETITION FROM MANUFACTURERS OF TAPE STORAGE SYSTEMS THAT INCORPORATE FIBRE CHANNEL INTERFACES INTO THEIR PRODUCTS. In traditional computer networks, system backup is accomplished by transferring data from applications and databases over the servers used in the network to tape drives or other media where the data is safely stored. Tape storage devices generally rely on a SCSI connection to interface with the network in receiving and transmitting data. Our routers enable these SCSI-based storage devices to interface with the fibre channel-based components of the SAN. Because our routers allow communication between SCSI storage devices and a fibre channel SAN, organizations are able to affect their backup processes over the SAN rather than through the computer network, enabling the servers of the network to remain available for other computing purposes. We currently derive the majority of our revenue from sales of storage routers that are used to connect SCSI-based tape storage systems with SANs. The introduction of tape storage systems that incorporate fibre channel interfaces would enable tape storage 18 devices to communicate directly with SANs, without using storage routers. We are aware that a number of manufacturers of storage systems, including several of our current customers, are developing tape storage systems with embedded fibre channel interfaces, with products expected to be introduced to market in the near future. If these or other manufacturers are successful in introducing fibre channel-based storage systems, demand for our storage router products would be materially reduced and our revenue would decline. OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON UTILIZING EMERGING TECHNOLOGIES AND STANDARDS AND ANY DELAY OR ABANDONMENT OF EFFORTS TO DEVELOP THESE TECHNOLOGIES OR STANDARDS BY INDUSTRY PARTICIPANTS, OR FAILURE OF THESE TECHNOLOGIES OR STANDARDS TO ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR COMPETITIVE POSITION. Our products are intended to complement other SAN products to improve the performance of computer networks by addressing the I/O bottlenecks that have emerged between the storage systems and the servers within a computing system. We have devoted and expect to continue to devote significant resources to developing products based on emerging technologies and standards that reduce I/O bottlenecks, such as iSCSI. A number of large companies in the computer hardware and software industries are actively involved in the development of new technologies and standards that we expect to incorporate in our new products. Should any of these companies delay or abandon their efforts to develop commercially available products based on these new technologies and standards, our research and development efforts with respect to such technologies and standards likely would have no appreciable value. In addition, if we do not correctly anticipate new technologies and standards, or if our products based on these new technologies and standards fail to achieve market acceptance, our competitors may be better able to address market demand than would we. Furthermore, if markets for these new technologies and standards develop later than we anticipate, or do not develop at all, demand for our products that are currently in development would suffer, resulting in less revenue for these products than we currently anticipate. UNCERTAINTIES INVOLVING SALES AND DEMAND FORECASTS FOR OUR PRODUCTS COULD NEGATIVELY AFFECT OUR BUSINESS. We have limited ability to forecast the demand for our products. In preparing sales and demand forecasts, we rely largely on input from our distribution partners. If our distribution partners are unable to accurately forecast demand, or we fail to effectively communicate with our distribution partners about end-user demand or other time sensitive information, sales and demand forecasts may not reflect the most accurate, up-to-date information. Because we make business decisions based on our sales and demand forecasts, if these forecasts are inaccurate, our business and financial results could be negatively impacted. Furthermore, we may not be able to identify these forecast differences until late in our fiscal quarter. Consequently, we may not be able to make adjustments to our business model without negatively impacting our business and results of operations. WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE MANUFACTURE PRODUCTS IN ADVANCE OF BINDING COMMITMENTS FROM OUR CUSTOMERS TO PURCHASE OUR PRODUCTS. In order to assure availability of our products for some of our largest OEM customers, we manufacture products in advance of purchase orders from these customers based on forecasts provided by them. However, these forecasts do not represent binding purchase commitments and we do not recognize revenue for such products until the product is shipped and risk of loss has passed to the OEM. As a result, we incur inventory and manufacturing costs in advance of anticipated revenue. Because demand for our products may not materialize, this product delivery method subjects us to increased risks of high inventory carrying costs and increased obsolescence and may increase our operating costs. THE LOSS OF OUR PRIMARY CONTRACT MANUFACTURER, OR THE FAILURE TO FORECAST DEMAND ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR PRIMARY CONTRACT MANUFACTURER SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY TO MANUFACTURE AND SELL OUR PRODUCTS. We rely on a limited number of contract manufacturers, primarily Solectron, to assemble the printed circuit board for our current shipping programs, including our 4x50, 6000, 8000 and 10000. We generally place orders for products with Solectron approximately four months prior to the anticipated delivery date, with order volumes based on forecasts of demand from our customers. Accordingly, if we inaccurately forecast demand for our products, we may be unable to obtain adequate manufacturing capacity from Solectron to meet our customers' delivery requirements, or we may accumulate excess inventories. We have on occasion in the past been unable to adequately respond to unexpected increases in customer purchase orders, and therefore were unable to benefit from this incremental demand. Solectron has not provided assurance to us that adequate capacity will be available to us within 19 the time required to meet additional demand for our products. WE HAVE ENGAGED IN RESTRUCTURING EFFORTS IN 2002 WHICH HAVE REDUCED OUR SALES AND MARKETING ORGANIZATION FROM 37 EMPLOYEES TO 13 EMPLOYEES, A REDUCTION OF 65%. THIS REDUCTION IN OUR SALES AND MARKETING FORCE MAY DECREASE OUR ABILITY TO AGGRESSIVELY TARGET NEW MARKETS. In May 2002, we had a reduction in force which impacted our sales and marketing organization significantly. While we feel that our sales and marketing organization is sufficient to support our current products and customer base, the current size of our sales and marketing organization may prohibit us from actively pursuing new markets or opportunities. OUR PLANS TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS TO MARKET REQUIRE COORDINATION ACROSS OUR SUPPLIERS AND MANUFACTURERS, WHICH EXPOSES US TO RISKS OF DELAY OR POOR EXECUTION FROM A VARIETY OF SOURCES. We have recently introduced new products and product enhancements, which requires that we coordinate our efforts with those of our component suppliers and our contract manufacturers to rapidly achieve volume production. In addition, we are in the process of transitioning the manufacture of our embedded router products to Hewlett-Packard. If we should fail to effectively manage our relationships with our component suppliers, our contract manufacturers and other manufacturers of our products or if any of our suppliers or our manufacturers experience delays, disruptions, capacity constraints or quality control problems in their manufacturing operations, our ability to ship products to our customers could be delayed, and our competitive position and reputation could be harmed. Qualifying a new component supplier or contract manufacturer and commencing volume production can be expensive and time consuming. If we are required to change or choose to change suppliers, we may lose revenue and damage our customer relationships. WE DEPEND ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY COMPONENTS, AND IF WE ARE UNABLE TO BUY THESE COMPONENTS ON A TIMELY BASIS, OUR DELAYED ABILITY TO DELIVER OUR PRODUCTS TO OUR CUSTOMERS MAY RESULT IN REDUCED REVENUE AND LOST SALES. We currently purchase fibre channel application specific integrated circuits and other key components for our products from sole or limited sources. To date, most of our component purchases have been made in relatively small volumes. As a result, if our suppliers receive excess demand for their products, we likely will receive a low priority for order fulfillment, as large volume customers will use our suppliers' available capacity. If we are delayed in acquiring components for our products, the manufacture and shipment of our products will also be delayed, which will reduce our revenue and may result in lost sales. We generally use a rolling six-month forecast of our future product sales to determine our component requirements. Lead times for ordering materials and components vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for such components. If we overestimate our component requirements, we may have excess inventory which would increase our costs. If we underestimate our component requirements, we may have inadequate inventory that would delay our manufacturing and render us unable to deliver products to customers on a scheduled delivery date. We also may experience shortages of certain components from time to time, which also could delay our manufacturing. Manufacturing delays could negatively impact our ability to sell our products and damage our customer relationships. COMPETITION WITHIN OUR MARKETS MAY REDUCE SALES OF OUR PRODUCTS AND REDUCE OUR MARKET SHARE. The market for SAN products generally, and storage routers in particular, is increasingly competitive. We anticipate that the market for our products will continually evolve and will be subject to rapid technological change. We currently face competition from ADIC through their acquisition of Pathlight in 2001, ATTO and Chaparral Network Storage. In addition, other OEM customers could develop products or technologies internally, or by entering into strategic relationships with or acquiring other existing SAN product providers that would replace their need for our products and would become a source of competition. We expect to face competition in the future from OEMs, including our customers and potential customers, LAN router manufacturers, storage system industry suppliers, including manufacturers and vendors of other SAN products or entire SAN systems, and innovative start-up companies. For example, manufacturers of fibre channel hubs or switches could seek to include router functionality within their SAN products that would obviate the need for our storage routers. As the market for SAN products grows, we also may face competition from traditional networking companies and other manufacturers of networking products. These networking companies may enter the storage router market by introducing their own products or by entering into strategic relationships with or acquiring other existing SAN product providers. This 20 could introduce additional competition in our markets, especially, if one of our OEMs begins to manufacture our higher end storage routers. While we do not currently face significant competition for our ServerAttach products, we anticipate we will see increased competition as this market develops. WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF OUR CURRENT AND POTENTIAL COMPETITORS. Some of our current and potential competitors have longer operating histories, significantly greater resources, broader name recognition and a larger installed base of customers than Crossroads. As a result, these competitors may have greater credibility with our existing and potential customers. They also may be able to adopt more aggressive pricing policies and devote greater resources to the development, promotion and sale of their products than we can to ours, which would allow them to respond more quickly than us to new or emerging technologies or changes in customer requirements. In addition, some of our current and potential competitors have already established supplier or joint development relationships with decision makers at our current or potential customers. These competitors may be able to leverage their existing relationships to discourage these customers from purchasing products from us or to persuade them to replace our products with their products. Increased competition could decrease our prices, reduce our sales, lower our margins, or decrease our market share. These and other competitive pressures may prevent us from competing successfully against current or future competitors, and may materially harm our business. WE HAVE LICENSED OUR 4200 AND 4X50 STORAGE ROUTER TECHNOLOGY TO A KEY CUSTOMER, WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US. We have licensed our 4200 and 4x50 storage router technology to Hewlett-Packard. Hewlett-Packard currently manufactures the 4200 product under its name and pays us a royalty. Hewlett-Packard has vastly greater resources and distribution capabilities than we do, and therefore, it could establish market acceptance in a relatively short time frame for any competitive products that it may introduce, which, in turn, would reduce demand for our products from Hewlett-Packard and could reduce demand for our products from other customers. WE EXPECT UNIT PRICES OF OUR PRODUCTS TO DECREASE OVER TIME, AND IF WE CANNOT INCREASE OUR SALES VOLUMES, OUR REVENUE WILL DECLINE. As storage networking continues to mature as an industry, we have seen a trend towards simplification of networking components and management. The impact of this trend on our business has been the push for, and subsequent ramp of embedded routers being shipped with tape libraries. These embedded routers are lower cost than the stand-alone box routers and this lower cost is passed on to our OEM customers. As our mix shifts from box routers to embedded routers, we will see a reduction in average price per unit and revenue will decline if volume does not increase. Additionally, many of our current agreements with our OEM customers include provisions that require reductions in the sales price for our products over time. We believe that this practice is common within our industry. To date, our agreements with OEM customers, including our largest customers, provide for quarterly reductions in pricing on a product-by-product basis, with the actual discount determined according to the volume potential expected from the customer, the OEM's customer base, the credibility the OEM may bring to our solution, additional technology the OEM may help us incorporate with our product, and other Crossroads products the OEM supports. Notwithstanding, the decreases in our average selling prices of our older products generally have been partially offset by higher average selling prices for our newer products, as well as sales to distributors, VARs and system integrators where price decreases are not generally required. Nonetheless, we could experience declines in our average unit selling prices for our products in the future, especially if our newer products do not receive broad market acceptance. In addition, declines in our average selling prices may be more pronounced should we encounter significant pricing pressures from increased competition within the storage router market. OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS THAT COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUE. Networking products such as ours may contain undetected software or hardware errors when first introduced or as new versions are released. Our products are complex and errors have been found in the past and may be found from time to time in the future. In addition, our products include components from a number of third-party vendors. We rely on the quality testing of these vendors to ensure the adequate operation of their products. Because our products are manufactured with a number of components supplied by various third-party sources, should problems occur in the operation or performance of our products, it may be difficult to identify the source. In addition, our products are deployed within SANs from a variety of vendors. Therefore, the occurrence of hardware and software 21 errors, whether caused by our or another vendor's SAN products, could adversely affect sales of our products. Furthermore, defects may not be discovered until our products are already deployed in the SAN. These errors also could cause us to incur significant warranty, diagnostic and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations and business reputation problems. WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL AND HIRE ADDITIONAL PERSONNEL, OUR ABILITY TO SELL OUR PRODUCTS COULD BE HARMED. We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, engineering and sales and marketing personnel. The loss of the services of any of our key employees or key management, particularly after we eliminated several management positions and reallocated those responsibilities among the remaining management in connection with our recent restructuring, would harm our business. Additionally, our inability to attract or retain qualified personnel in the future or any delays in hiring required personnel, particularly engineers and sales personnel, could delay the development and introduction of, and negatively impact our ability to sell, our products. WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY AFFECT OUR ABILITY TO COMPETE. Our products rely on our proprietary technology, and we expect that future technological advancements made by us will be critical to sustain market acceptance of our products. Therefore, we believe that the protection of our intellectual property rights is and will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our software, documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where applicable laws may not protect our proprietary rights as fully as in the United States. OUR EFFORTS TO PROTECT OUR INTELLECTUAL PROPERTY MAY CAUSE US TO BECOME INVOLVED IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM OUR BUSINESS. In recent years, there has been significant litigation in the United States involving patents, trademarks and other intellectual property rights. Legal proceedings could subject us to significant liability for damages or invalidate our intellectual property rights. Any litigation, regardless of its outcome, would likely be time consuming and expensive to resolve and would divert management's time and attention. Any potential intellectual property litigation against us could force us to take specific actions, including: o cease selling our products that use the challenged intellectual property; o obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology or trademark, which license may not be available on reasonable terms, or at all; or o redesign those products that use infringing intellectual property or cease to use an infringing trademark. As we have discussed elsewhere in this Annual Report, we have engaged in lengthy and costly litigation regarding our '972 patent. While we have prevailed to date in these cases, Chaparral has appealed the judgment against it and there can be no assurance we will prevail in this appeal. Moreover, we cannot assure you that we would prevail in any future effort to enforce our rights in the '972 patent. ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL CONDITION. As part of our growth strategy, we intend to review opportunities to acquire other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities. This would entail a number of risks that could materially and adversely affect our business and operating results, including: 22 o problems integrating the acquired operations, technologies or products with our existing business and products; o diversion of management's time and attention from our core business; o difficulties in retaining business relationships with suppliers and customers of the acquired company; o risks associated with entering markets in which we lack prior experience; and o potential loss of key employees of the acquired company. OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY CUSTOMERS IN OUR MARKET. Our products comprise only a part of a SAN. All components of a SAN must uniformly comply with the same industry standards in order to operate efficiently together. We depend on companies that provide other components of the SAN to support prevailing industry standards. Many of these companies are significantly larger and more influential in effecting industry standards than we are. Some industry standards may not be widely adopted or implemented uniformly, and competing standards may emerge that may be preferred by OEM customers or end users. If larger companies do not support the same industry standards that we do, or if competing standards emerge, our products may not achieve market acceptance which would adversely affect our business. INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER OUR COMPANY AND COULD DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL. Our executive officers and directors, and their affiliates, beneficially own approximately 27% of the total voting power of our company. As a result, these stockholders will be able to exert significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Our ongoing open market stock repurchase program has also increased the control our affiliates have over us. This concentration of voting power could delay or prevent an acquisition of us on terms that other stockholders may desire. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT, DELAY OR IMPEDE A CHANGE IN CONTROL OF US AND MAY REDUCE THE MARKET PRICE OF OUR COMMON STOCK. Provisions of our certificate of incorporation and bylaws could have the effect of discouraging, delaying or preventing a merger or acquisition that a stockholder may consider favorable. We also are subject to the anti-takeover laws of the State of Delaware that may discourage, delay or prevent someone from acquiring or merging with us, which may adversely affect the market price of our common stock. On August 21, 2002, our Board of Directors approved, adopted and entered into a Stockholder Rights Plan. The plan is similar to plans adopted by many other companies, and was not adopted in response to any attempt to acquire us, nor were we aware of any such efforts at the time of adoption. The plan is designed to enable our stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire the company. Adoption of the plan is intended to deter coercive takeover tactics including the accumulation of shares in the open market or through private transactions and to prevent an acquiror from gaining control of the company without offering a fair price to all of our stockholders. The rights will expire on September 3, 2012. Under the plan, we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of the close of business on September 3, 2002. Each right initially entitles stockholders to purchase one unit of a share of our preferred stock at $12 per share. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires or announces a tender or exchange offer that would result in the acquisition of 15 percent or more of our common stock while the stockholder rights plan remains in place, then, unless the rights are redeemed by us for $0.01 per right, all rights holders except the acquirer will be entitled to acquire our common stock at a significant discount. The rights are intended to enable all stockholders to realize the long-term value of their investment in the company. The rights will not prevent a takeover attempt, but should encourage anyone seeking to acquire us to negotiate with the board prior to attempting to takeover. 23 OUR STOCK PRICE MAY BE VOLATILE. The market price of our common stock has been volatile in the past and may be volatile in the future. For example, during fiscal 2002, the market price of our common stock as quoted on the NASDAQ National Market System has fluctuated between $0.38 and $6.75. Although our stock price is currently over $1.00, our stock price was recently below $1.00 for an extended period, which caused us additional challenges, such as the risk of being delisted from the Nasdaq National Market. In the event the price of our common stock were to fall below $1.00 per share for an extended period, we would again face the challenge of being delisted from the Nasdaq National Market. The market price of our common stock may be significantly affected by the following factors: o actual or anticipated fluctuations in our operating results; o changes in financial estimates by securities analysts or our failure to perform in line with such estimates; o changes in market valuations of other technology companies, particularly those that sell products used in SANs; o announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments; o introduction of technologies or product enhancements that reduce the need for storage routers; o the loss of one or more key OEM customers; and o departures of key personnel. The stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our performance. ITEM 2. PROPERTIES. Our corporate headquarters facility consists of approximately 63,548 square feet in Austin, Texas. We lease our headquarters facility pursuant to a lease agreement that expires in April 2006. The lease represents a commitment of $1.9 million per year through April 2006. In conjunction with entering into the lease agreement, we signed an unconditional, irrevocable letter of credit with a bank for $500,000, which is secured by a $3.0 million line of credit. On August 1, 2002, we abandoned 18,180 square feet of our headquarters facility pursuant to the execution of our business restructuring plan. The site consolidation resulted in a $2.1 million facility lease loss charge, of which $1.8 million relates to the base rent and fixed operating expenses of the vacated space through the end of the lease term on April 15, 2006. Our final assembly and test facility of approximately 11,250 square feet is also located in Austin, Texas. The lease on this facility expires in June 2004. As of October 31, 2002, we also operate satellite sales offices in Annapolis, Boston, Denver, Los Angeles and San Jose. 24 ITEM 3. LEGAL PROCEEDINGS. Intellectual Property Litigation On March 31, 2000, we filed a lawsuit against Chaparral Network Storage, Inc. ("Chaparral") alleging that Chaparral has infringed one of our patents (5,941,972, hereinafter the "972 patent") with some of their products. In September 2001, the jury found that the '972 patent was valid and that all of Chaparral's RAID and router products that contained LUN Zoning had infringed all claims of the Crossroads '972 patent. The federal judge in this matter issued a permanent injunction against Chaparral from manufacturing any RAID or router product that contained LUN Zoning or access controls and assessed punitive damages. As a result, we were awarded damages with a royalty amount of 5% for Chaparral's router product line and 3% for their RAID product line. Chaparral has appealed the judgment against it, contending that the '972 patent is invalid and not infringed. We intend to vigorously defend the appeal. On April 14, 2000, we filed a lawsuit against Pathlight Technology, Inc. alleging that Pathlight has infringed one of our patents with their SAN Data Gateway Router. Pathlight was subsequently acquired by ADIC on May 11, 2001. In June 2001, ADIC paid the Company $15.0 million in connection with the settlement of this lawsuit, this payment was recognized as contra operating expense in the statement of operations for the year ended October 31, 2001. In connection with the settlement of the lawsuit, we granted ADIC a non-exclusive license under the '972 patent. On May 19, 2000, Chaparral filed a counter-suit against us alleging tortious interference with prospective business relations. We moved to have this matter dismissed, which the judge ordered, with prejudice, in April 2001. Securities Class Action Litigation We and several of our officers and directors were named as defendants in several class action lawsuits filed in the United States District Court for the Western District of Texas. The plaintiffs in the actions purport to represent purchasers of our common stock during various periods ranging from January 25, 2000 through August 24, 2000. The Court consolidated the actions and appointed a lead plaintiff under the Private Securities Litigation Reform Act of 1995. The amended consolidated complaint was filed in February 2001. On November 22, 2002, the court granted our motion for summary judgment, concluding that the plaintiffs failed to demonstrate an essential element to their claim of securities fraud. We anticipate that the plaintiffs will appeal this judgment to the Fifth Circuit Court of Appeals. The plaintiffs are seeking unspecified amounts of compensatory damages, interests and costs, including legal fees. We deny the allegations in the complaint and will continue to defend ourselves vigorously. The class action lawsuit is still at an early stage. Consequently, it is not possible at this time to predict whether we will incur any liability or to estimate the damages, or the range of damages, if any, that we might incur in connection with this lawsuit. Our inability to prevail in this action could have a material adverse effect on our future business, financial condition and results of operations. Derivative State Action On November 21, 2001, a derivative state action was filed in the 261st District Court of Travis County, Texas on behalf of Crossroads by James Robke and named several of our officers and directors as defendants. The derivative state action is based upon the same general set of facts and circumstances outlined above in connection with the purported securities class action litigation. The derivative state action alleges that certain of the individual defendants sold shares while in possession of material inside information in purported breach of their fiduciary duties to Crossroads. The derivative state action also alleges waste of corporate assets. On January 28, 2002, we filed an answer and general denial to the derivative state action. We believe the allegations in the derivative state action are without merit and intend to defend ourselves vigorously. The derivative state action is still at an early stage. Consequently, it is not possible at this time to predict whether we will incur any liability or to estimate the damages, or the range of damages, if any, that we might incur in connection with this action. Our inability to prevail in this action could have a material adverse effect on our future business, financial condition and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 25 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our common stock has been quoted on the Nasdaq National Market under the symbol "CRDS" since our initial public offering on October 20, 1999. Prior to the initial public offering, there had been no public market for our common stock. The following table lists the high and low per share sales prices for our common stock as reported by the Nasdaq National Market for the periods indicated:
HIGH LOW ---- --- FISCAL YEAR ENDED OCTOBER 31, 2001 First Quarter ................................. $11.438 $3.844 Second Quarter ................................ 10.750 3.406 Third Quarter ................................. 9.720 2.640 Fourth Quarter ................................ 3.470 1.870 FISCAL YEAR ENDED OCTOBER 31, 2002 First Quarter.................................. 6.750 2.700 Second Quarter................................. 6.070 2.850 Third Quarter.................................. 3.190 0.780 Fourth Quarter................................. 0.850 0.380
As of January 27, 2003, there were 24,859,408 shares of our common stock outstanding held by 294 stockholders of record. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any earnings for use in our business and do not anticipate paying any cash dividends in the foreseeable future. Future dividends, if any, will be determined by our board of directors. 26 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA. The following selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," in Item 7 of this Annual Report and other financial information appearing elsewhere in this Annual Report. The consolidated statement of operations and balance sheet data set forth below for each of the years in the three year period ended October 31, 2000, 2001 and 2002 are derived from, and qualified by reference to, our audited consolidated financial statements appearing elsewhere in this Annual Report. The consolidated statement of operations and balance sheet data for the year ended October 31, 1998 and 1999 are derived from audited consolidated financial statements not included herein.
FOR THE YEARS ENDED OCTOBER 31, -------------------------------------------------------------------------- 1998 1999 2000 2001 2002 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue: Product revenue .............................. $ 2,930 $ 18,859 $ 32,486 $ 35,896 $ 33,429 Other revenue ................................ 279 65 562 1,434 559 ---------- ---------- ---------- ---------- ---------- Total revenue ............................ 3,209 18,924 33,048 37,330 33,988 Cost of revenue(1) ............................... 1,913 11,079 19,104 22,013 22,661 ---------- ---------- ---------- ---------- ---------- Gross profit ..................................... 1,296 7,845 13,944 15,317 11,327 ---------- ---------- ---------- ---------- ---------- Operating expenses(1): Sales and marketing .......................... 2,491 4,781 16,007 15,202 6,126 Research and development ..................... 2,342 5,551 13,143 18,118 16,520 General and administrative ................... 1,899 3,017 31,242 16,043 9,158 Amortization of intangibles .................. -- -- 8,808 9,680 278 Impairment of intangibles and other assets ....................................... -- -- -- 25,007 2,047 Business restructuring expenses .............. -- -- -- -- 3,666 Litigation settlement ........................ -- -- -- (15,000) -- ---------- ---------- ---------- ---------- ---------- Total operating expenses ................. 6,732 13,349 69,200 69,050 37,795 ---------- ---------- ---------- ---------- ---------- Loss from operations ............................. (5,436) (5,504) (55,256) (53,733) (26,468) Other income (expense), net ...................... 82 319 4,228 2,776 979 ---------- ---------- ---------- ---------- ---------- Net loss before cumulative effect of accounting change ............................ (5,354) (5,185) (51,028) (50,957) (25,489) Cumulative effect of accounting change ........... -- -- -- (130) -- ---------- ---------- ---------- ---------- ---------- Net loss ......................................... $ (5,354) $ (5,185) $ (51,028) $ (51,087) $ (25,489) ---------- ---------- ---------- ---------- ---------- Accretion on redeemable convertible preferred stock .............................. (196) (247) -- -- -- ---------- ---------- ---------- ---------- ---------- Net loss attributable to common stock ............ $ (5,550) $ (5,432) $ (51,028) $ (51,087) $ (25,489) ========== ========== ========== ========== ========== Basic and diluted net loss per share ............. $ (0.90) $ (0.74) $ (1.93) $ (1.86) $ (0.95) ---------- ---------- ---------- ---------- ---------- Shares used in computing basic and diluted net loss per share ............... 6,146 7,378 26,467 27,414 26,878 ---------- ---------- ---------- ---------- ---------- (1) Stock-based compensation for the periods indicated was allocated as follows: Cost of revenue .............................. $ 2 $ 133 $ 288 $ 123 $ 84 Sales and marketing .......................... 30 372 4,373 215 481 Research and development ..................... 6 280 528 440 369 General and administrative ................... 3 420 22,501 6,283 3,640 ---------- ---------- ---------- ---------- ---------- Total stock-based compensation ........... $ 41 $ 1,205 $ 27,690 $ 7,061 $ 4,574 ---------- ---------- ---------- ---------- ----------
FOR THE YEARS ENDED OCTOBER 31, ----------------------------------------------------------------------- 1998 1999 2000 2001 2002 ---------- ---------- ---------- ---------- ---------- CONSOLIDATED BALANCE SHEET DATA: ................. (IN THOUSANDS) Cash, cash equivalents and short-term investments ................................... $ 3,934 $ 80,820 $ 60,038 $ 53,686 $ 34,311 Working capital .................................. 4,461 83,165 62,287 51,271 34,855 Total assets ..................................... 7,187 91,730 118,048 75,403 50,459 Long-term debt, net of current portion ........... 591 1,325 -- -- -- Redeemable convertible preferred stock ........... 13,438 -- -- -- -- Total stockholders' equity (deficit) ............. (8,347) 84,885 108,752 64,246 41,559
27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis of financial condition and results of operations should be read in conjunction with the selected consolidated financial data in Item 6 of this Annual Report and our consolidated financial statements and notes thereto in Item 15 of this Annual Report. This Item 7 contains "forward looking" statements. Please see the "Cautionary Statement" and "Factors That May Affect Future Results" under Item 1 for a discussion of the uncertainties, risks and assumptions associated with these statements. OVERVIEW We are a leading provider of enterprise data routing solutions for open system storage area networks (SANs), based on our market share of storage routers shipped. By using our storage routers to serve as the interconnect between SANs and the other devices in a computer network, organizations are able to more effectively and efficiently store, manage and ensure the integrity and availability of their data. Specifically, when used in SANs our storage routers: o decrease congestion in the transfer of data within a network; o reduce the time required to back up and restore data; o improve utilization of storage resources; and o preserve and enhance existing server and storage system investments. Our mission is to be the company customers trust to link business with information, regardless of technology or location. Our objective is to maintain our position as the leading provider of storage routing solutions as storage, server, and network technologies and markets continue to grow and evolve. The key elements of our strategy are: o to solve customer storage issues; o to grow our current market position and expand into adjacent markets; and o to increase our market leadership by continual investment in intellectual property. To date, we have sold our products primarily to original equipment manufacturers, or OEMs, of servers and storage systems. These computer equipment manufacturers sell our storage routers to end-user organizations for use in their SANs. We also sell our storage routers through companies that distribute, resell or integrate our storage routers as part of a complete SAN solution. A significant portion of our revenue is concentrated among a relatively small number of OEM customers, and the merger of Hewlett-Packard and Compaq in May 2002 has resulted in substantial additional concentration. For the three years ended October 31, 2000, 2001 and 2002, two customers (StorageTek and Compaq), two customers (StorageTek and Hewlett-Packard) and two customers (StorageTek and Hewlett-Packard including Compaq), each contributed greater than 10% of our total revenue for combined totals of 54%, 49% and 75% of our total revenue, respectively. For the years ended October 31, 2000, 2001 and 2002, our distribution channel, consisting of our distributors, VARs and Systems Integrators, accounted for 10%, 11% and 13% of our total revenues, respectively. The level of sales to any single customer may vary and the loss of any one significant customer, or a decrease in the level of sales to any one significant customer, particularly Hewlett-Packard (including Compaq), would seriously harm our financial condition and results of operations. Fluctuations in revenue have resulted from, among other things, product and customer transitions, OEM qualification and testing and reduced IT spending rates. We expect that a significant portion of our future revenue will continue to come from sales of products to a relatively small number of customers. On a product basis, sales have shifted to our fourth and fifth generation of products, the 6000, 8000 and 10000, and to our embedded line of products. Sales of our older family of products, the 4100, 4200 and 4x50 lines, accounted for approximately 90%, 70% and 41% of our product revenue during the years ended October 31, 2000, 2001 and 2002, respectively. This decrease was partially offset by increased sales of our fourth and fifth generation products, which accounted for approximately 24% of our product revenue during the year ended October 31, 2002. 28 We anticipate that sales of our older products will continue to decrease as we successfully transition our customers to our newer product platforms. Additionally, as storage networking continues to mature as an industry, we have seen a trend towards simplification of networking components and management. The impact of this trend on our business has been the push for, and subsequent ramp up of, embedded routers being shipped with tape libraries. Sales of our embedded products accounted for approximately 2%, 15% and 27% of our product revenue during the years ended October 31, 2000, 2001 and 2002, respectively. RECENT EVENTS In January 2002, we expanded our product line with the launch of our fifth generation product line -- the Crossroads 10000 Multi-Protocol Storage Router for enterprise environments. The 10000 is a fully redundant, modular storage router that performs protocol and storage management functions between storage devices and the network. It provides multi-protocol connectivity and management of SCSI and fibre channel storage devices into fibre channel, with the capability for future iSCSI application in storage networks. We have seen recent price strength in the 10000 line because of its software capabilities and we have also been able to realize manufacturing savings. We anticipate that both of these factors should drive higher gross margins. In May 2002, we launched the industry's first low-cost two-gigabit fibre channel storage router, the Crossroads 6000, which is targeted at the small to mid-sized market. The 6000 provides customers an alternative to purchasing newer equipment by enabling them to continue to leverage existing equipment, such as SCSI tape libraries. During 2002, we successfully transitioned our major OEM customers, including StorageTek and Hewlett-Packard (including Compaq) to the 10000 and 6000 product platforms. In May 2002, our board of directors approved, and we completed, a restructuring plan to reduce our workforce by approximately 25%, or 40 people (primarily in the sales, marketing and general and administrative areas), to scale down our infrastructure and consolidate operations. In connection with the restructuring, Brian R. Smith, our founder and chairman, returned as chief executive officer and president, replacing Larry Sanders. Robert C. Sims, formerly vice president of engineering and operations, was named chief operating officer and also assumed management of sales and marketing. In fiscal 2002, we recorded $3.7 million in business restructuring expenses and a $1.2 million impairment of assets charge. We have completed our restructuring plan and are not currently planning any further restructuring efforts; however, there can be no assurance future restructuring efforts will not be necessary. In November 2002, we amended our existing licensing agreement with Hewlett-Packard. We believe this agreement will allow us to leverage the strengths of both companies. Under the agreement, Hewlett-Packard will manufacture the hardware and license the software from us for its current line of embedded solutions. Together, we should be able to drive efficiencies for both companies while delivering cost-effective storage solutions to end-users. We anticipate that the transition of the manufacturing of our embedded routers will increase our gross margins due to HP's ability to manufacture the hardware with greater economies of scale. We are currently working under the new agreement and plans are to transition the manufacturing of our embedded solutions by the beginning of our fiscal second quarter 2003. In December 2002, Crossroads launched the Crossroads ServerAttach SA40, the first appliance to connect SCSI servers to networked storage. With ServerAttach, Crossroads leveraged its existing tape attach technology but in a reversed application to allow attachment of servers into fibre channel architectures or SANs. Our ServerAttach products are a natural extension of our core technology to a broader market and potential customer base while requiring only a modest incremental investment. We believe this is an underserved market that offers great value to our customers and higher gross margins for the company. 29 RESULTS OF OPERATIONS The following table sets forth our consolidated financial data for the periods indicated expressed as a percentage of our total revenue, net of the aforementioned allocation of stock-based compensation for all periods presented--See Item 15. Financial Statements--Note 7 to Notes to Consolidated Financial Statements.
FISCAL YEAR ENDED OCTOBER 31, ---------------------------- 2000 2001 2002 -------- -------- -------- Revenue: Product revenue ................................ 98.3% 96.2% 98.4% Other revenue .................................. 1.7 3.8 1.6 -------- -------- -------- Total revenue .......................... 100.0 100.0 100.0 Cost of revenue .................................. 56.9 58.6 66.4 -------- -------- -------- Gross margin ..................................... 43.1 41.4 33.6 -------- -------- -------- Operating expenses: Sales and marketing ............................ 35.2 40.1 16.6 Research and development ....................... 38.2 47.4 47.5 General and administrative ..................... 26.4 26.1 16.2 Amortization of intangibles .................... 26.7 25.9 0.8 Impairment of intangibles and other assets ..... -- 67.0 6.1 Business restructuring expense ................. -- -- 10.8 Litigation settlement .......................... -- (40.2) -- -------- -------- -------- Total operating expenses ............... 126.5 166.3 98.0 -------- -------- -------- Loss from operations ............................. (83.4) (124.9) (64.4) Other income (expense) ........................... 12.8 7.4 2.9 -------- -------- -------- Net loss ......................................... (70.6)% (117.5)% (61.5)% ======== ======== ========
COMPARISON OF FISCAL YEARS ENDED OCTOBER 31, 2000, 2001, AND 2002 Revenue. Our total revenue increased 13.0% from $33.0 million in fiscal 2000 to $37.3 million in fiscal 2001, and decreased 9.0% to $34.0 million in fiscal 2002. The level of sales to any single customer may vary and the loss of any one significant customer, or a decrease in the level of sales to any one significant customer, could seriously harm our financial condition and results of operations. We expect to continue to experience significant customer concentration in sales to key OEM accounts for the foreseeable future. During fiscal 2002, this concentration was evidenced by volume from our top three customers representing 74.6% of our total revenue, all of which individually accounted for 10.0% or more of our revenue. In addition, Hewlett-Packard and Compaq, two of our three largest OEM customers, have merged which could result in a disruption in our sales to these two customers. In recent quarters, unfavorable economic conditions and reduced information technology, or IT, spending rates in the United States, Europe, and Asia have lead to a decline in our growth rates compared to historical trends. We are unable to predict when IT spending rates will return to historical levels, if at all. Our post-sales obligations are generally limited to product warranties with a duration of 12 to 39 months following the sale of our products. Warranty costs, sales returns, and other allowances are accrued based on experience when the related product revenue is recognized. Service revenue is recognized over the service period. Product revenue. Product revenue increased 10.5% from $32.5 million in fiscal 2000 to $35.9 million in fiscal 2001, and decreased 6.9% to $33.4 million in fiscal 2002. The decrease in product revenue resulted from decreased sales of our storage router product family due to customers postponing purchases of our older products in anticipation of, the release of our newer product families. In addition, various product and customer transitions, overall unfavorable economic conditions and reduced IT spending rates worldwide have also contributed to a decrease in product revenue. As a percentage of total revenue, product revenue decreased from 98.3% in fiscal 2000 to 96.2% in fiscal 2001, and increased to 98.4% in fiscal 2002. With respect to sales of our products to OEMs, product revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, fee is fixed or determinable, collectibility is probable and risk of loss has passed to the OEM. Revenue from sales to distributors, VARs and system integrators is recognized upon reported sell-through. To the extent that we sell products to distributors, VARs and system integrators that have rights of 30 return, we defer revenue and the related cost of revenue associated with such sales and recognize these amounts when that customer sells our products to its customers. At October 31, 2002, our deferred revenue totaled approximately $727,000. Other revenue. Other revenue includes sales of maintenance contracts, consulting fees and fees received from the licensing of other intellectual property. Other revenue increased 150% from $562,000 in fiscal 2000 to $1.4 million in fiscal 2001, and decreased 61.0% to $559,000 in fiscal 2002. The increase in fiscal 2001 and subsequent decrease in fiscal 2002 was primarily due to the non-recurring licensing revenue from the technology acquired from Polaris of $775,000. Cost of revenue and gross margin. Cost of revenue consists primarily of contract manufacturing costs, materials costs, manufacturing overhead, warranty costs and stock-based compensation. Cost of revenue, net of stock-based compensation of $288,000, $123,000 and $84,000 during fiscal 2000, 2001 and 2002, respectively, increased 16.3% from $18.8 million in fiscal 2000 to $21.9 million in fiscal 2001, and increased 3.1% to $ 22.6 million in fiscal 2002. These increases were primarily due to increases in unit sales volume and a corresponding increase in manufacturing costs. Gross profit, net of stock-based compensation, increased 8.5% from $14.2 million in fiscal 2000 to $15.4 million in fiscal 2001, and decreased 26.1% to $11.4 million in fiscal 2002. The decrease in fiscal 2002 was primarily due to decreased product revenue and lower margin product mix. Gross margin decreased from 43.1% in fiscal 2000 to 41.4% in fiscal 2001, and decreased to 33.6% in fiscal 2002. This decrease in gross margin was primarily due to a lower margin product mix resulting from the increase in sales of our lower margin embedded routers during fiscal 2002. These embedded routers are lower cost than the stand-alone box routers and this lower cost is passed on to our OEM customers. The decrease was also due to lower margin OEM product sales. In November 2002, we amended our existing licensing agreement with Hewlett-Packard. Pursuant to this amendment, beginning in February 2003, we will outsource the manufacturing of our embedded routers to Hewlett-Packard. We believe this agreement will allow us to leverage the strengths of both companies. We will use Hewlett-Packard's economies of scale in manufacturing and systems integration expertise and combine that with our software, value-added applications and intellectual property. Under the agreement, Hewlett-Packard will manufacture the hardware and license the software from us for its current line of embedded solutions. Together, we should be able to drive efficiencies for both companies while delivering cost-effective storage solutions to end-users. We anticipate that the transition of the manufacturing of our embedded routers will increase our gross margins due to Hewlett-Packard's ability to manufacture the hardware with greater economies of scale. We will continue to manufacture our box-based 4x50, 6000 and 10000 products for Hewlett-Packard, as well as for our other OEMs for whom we will also continue to manufacture our Crossroads branded solutions. We have seen recent price strength in the 10000 line because of its software capabilities and we have also realized manufacturing savings. Both of these factors should drive higher gross margins. We are currently working under the new agreement and plan to transition the manufacturing of our embedded solutions by the beginning of our fiscal second quarter 2003. Sales and marketing. Sales and marketing expenses consist primarily of salaries, commissions and other personnel-related costs, travel expenses, advertising programs, other promotional activities and stock-based compensation. Sales and marketing expenses, net of stock-based compensation of approximately $4.4 million, $215,000 and $481,000 during fiscal 2000, 2001 and 2002, respectively, increased 28.8% from $11.6 million in fiscal 2000 to $15.0 million in fiscal 2001, and decreased 62.3% to $5.6 million in fiscal 2002. The decrease in sales and marketing expenses in fiscal 2002 was primarily due to our restructuring efforts which resulted in approximately $5.2 million of decreased compensation expense. Sales and marketing personnel totaled 56, 37 and 13 at October 31, 2000, 2001 and 2002, respectively. This reduction in force also resulted in decreased travel and entertainment expenses of approximately $1.1 million, decreased corporate allocations of approximately $715,000, decreased professional fees of approximately $442,000, decreased prototype expenses of approximately $253,000, decreased tradeshow expenses of approximately $180,000 and decreased depreciation of approximately $127,000. As a percentage of total revenue, sales and marketing expenses, net of stock-based compensation, increased from 35.2% in fiscal 2000 to 40.1% in fiscal 2001 and decreased to 16.6% in fiscal 2002. We anticipate that sales and marketing expenses may fluctuate as a percentage of total revenue, due to our ongoing sales and marketing efforts intended to broaden awareness of the benefits of our existing and recently introduced products. Research and development. Research and development expenses consist primarily of salaries and other personnel-related costs, product development, prototyping expenses and stock-based compensation. Research and development expenses, net of stock based compensation of approximately $528,000, $440,000 and $369,000 during 31 fiscal 2000, 2001 and 2002, respectively, increased 40.1% from $12.6 million in fiscal 2000 to $17.7 million in fiscal 2001, and decreased 8.6% to $16.2 million in fiscal 2002. This decrease in research and development expenses during fiscal 2002 was primarily due to our restructuring efforts which resulted in approximately $705,000 of decreased compensation expense and decreased prototyping costs of approximately $591,000. Research and development personnel totaled 89, 93 and 66 at October 31, 2000, 2001 and 2002, respectively. As a percentage of total revenue, research and development expenses, net of stock-based compensation, increased from 38.2% in fiscal 2000 to 47.4% in fiscal 2001, and increased to 47.5% in fiscal 2002. We anticipate that research and development expenses may fluctuate as a percentage of total revenue, due to our ongoing research and development in developing our technologies and expanding our product offerings. General and administrative. General and administrative expenses consist primarily of salaries and other personnel-related costs, facilities and other costs of our administrative, executive and information technology departments, as well as legal and accounting expenses, insurance costs and stock-based compensation. General and administrative expenses, net of stock-based compensation of approximately $22.5 million, $6.3 million and $3.6 million during fiscal 2000, 2001 and 2002, respectively, increased 11.7% from $8.7 million in fiscal 2000 to $9.8 million in fiscal 2001, and decreased 43.5% to $5.5 million in fiscal 2002. The decrease in general and administrative expenses during fiscal 2002 was primarily due to our restructuring efforts which resulted in approximately $2.3 million of decreased compensation expense and approximately $1.7 million of decreased professional fees, primarily related to increased litigation expenses in fiscal 2001. General and administrative personnel totaled 41, 37 and 17 at October 31, 2000, 2001 and 2002, respectively. Legal costs associated with patent infringement and class action shareholder lawsuits totaled approximately $939,000, $2.6 million and $254,000 during fiscal 2000, 2001 and 2002, respectively. As a percentage of total revenue, general and administrative expenses decreased from 26.4% in fiscal 2000 to 26.1% in fiscal 2001, and decreased to 16.2% in fiscal 2002. We anticipate that general and administrative expenses will increase due to increased D&O insurance costs and increased costs associated with compliance with the additional reporting and other obligations imposed by the Sarbanes-Oxley Act of 2002 and related legislation and regulatory changes. Litigation settlement. During fiscal 2001, we received approximately $15.0 million from ADIC in connection with the settlement of our patent infringement lawsuit filed against Pathlight Technology, Inc., which was acquired by ADIC in May 2001. In connection with the settlement of the lawsuit, we granted ADIC a non-exclusive license under the related patent. Stock based compensation. In connection with the grant of stock options to our employees and directors, we recorded deferred compensation aggregating approximately $22.6 million since fiscal 1998. Deferred compensation represents, for accounting purposes, the difference between the deemed fair value of the common stock underlying these options and their exercise price on the date of grant. The difference has been recorded as deferred stock-based compensation and is being amortized over the vesting period of the applicable options, typically four years. Of the total deferred compensation amount, approximately $22.3 million has been amortized as of October 31, 2002. Stock-based compensation for the periods indicated was allocated as follows (in thousands):
YEAR ENDED OCTOBER 31, ---------------------------------- 2000 2001 2002 -------- -------- -------- Cost of revenue ........................ $ 288 $ 123 $ 84 Sales and marketing .................... 4,373 215 481 Research and development ............... 528 440 369 General and administrative ............. 22,501 6,283 3,640 -------- -------- -------- Total stock-based compensation ....... $ 27,690 $ 7,061 $ 4,574 ======== ======== ========
We expect to amortize the remaining amounts of deferred stock-based compensation as of October 31, 2002 in the periods indicated (in thousands):
YEAR ENDED OCTOBER 31, ---------------------------------- 2003 2004 TOTAL -------- -------- -------- Cost of revenue ............................. $ 21 $ -- 21 Sales and marketing ......................... 59 2 61 Research and development .................... 92 2 94 General and administrative .................. 129 6 135 -------- -------- -------- Total stock-based compensation ........... $ 301 $ 10 $ 311 ======== ======== ========
32 Business restructuring expenses and asset impairment charges. In May 2002, our board of directors approved, and we completed, a restructuring plan to reduce our workforce by approximately 25%, or 40 people (primarily in the sales, marketing and general and administrative areas), to scale down our infrastructure and consolidate operations. In connection with the restructuring, Brian R. Smith, our founder and chairman, returned as chief executive officer and president, replacing Larry Sanders. Robert C. Sims, formerly vice president of engineering and operations, was named chief operating officer and also assumed management of sales and marketing. In fiscal 2002, we recorded $3.7 million in business restructuring expenses and a $1.2 million impairment of assets charge. Components of business restructuring expenses, asset impairments and the remaining restructuring accruals as of October 31, 2002 are as follows (in thousands):
EMPLOYEE SEPARATION FACILITY LEASE ASSET AND OTHER ABANDONMENT IMPAIRMENTS COSTS TOTAL -------------- ----------- ----------- --------- Effect of restructuring plan and impact to accrued liabilities .............................. $ 2,114 $ 1,208 $ 1,552 $ 4,874 Cash activity .................................... (157) -- (1,051) (1,208) Non-cash activity ................................ -- (1,208) (175) (1,383) --------- --------- --------- --------- Balance as of October 31, 2002 ................... $ 1,957 $-- $ 326 $ 2,283 ========= ========= ========= =========
As of October 31, 2002, remaining cash expenditures resulting from the restructuring are estimated to be $2.3 million and relate primarily to facility lease abandonment losses. Excluding facility lease abandonment losses, we estimate that these costs will be substantially incurred within one year of the restructuring. We have substantially implemented our restructuring efforts initiated in conjunction with the restructuring announcement made during fiscal 2002; however, there can be no assurance that we will not undertake future restructuring efforts. Consolidation of excess facilities. Facility lease abandonment losses relate to lease commitments for excess office space we have vacated as a result of the restructuring plan. We recorded $2.1 million in restructuring expenses in relation to a site consolidation during fiscal 2002. Total lease commitments include the remaining lease liabilities, leasehold improvements required to sub-lease the vacated space and brokerage commissions. The estimated costs of vacating these leased facilities, including estimated costs to sublease, were based on market information and trend analysis as estimated by management. However, we expect that actual results may differ from these estimates in the near term and such differences could be material to our financial statements. Of the $2.1 million charge recorded during fiscal 2002, approximately $1.9 million relates to the base rent and fixed operating expenses of the vacated space through the lease term which ends April 15, 2006. Asset impairments. Asset impairments recorded pursuant to Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", relate to the impairment of computer equipment, software, furniture and fixtures and certain leasehold improvements. The majority of fixed assets were impaired as a direct result of our restructuring plan, reducing our workforce by 25%, and decision to vacate certain office space, resulting in an impairment of $836,000 during fiscal 2002. The remaining fixed assets considered impaired of $372,000 relate to IT infrastructure and unique test equipment that can no longer be utilized based on the current product roadmap and business environment. Employee separation and other costs. Employee separation and other costs, which include severance, related taxes, outplacement and other benefits payable to approximately 40 terminated employees, totaled $1.6 million during fiscal 2002. Employee groups impacted by the restructuring efforts include personnel in positions throughout the company, primarily in the sales, marketing and general administrative functions. The Company completed its restructuring plan and is not currently planning any further restructuring efforts; however, there can be no assurance future restructuring efforts will not be necessary. Impairment of other assets. In fiscal 2000, we purchased shares of Series A preferred stock of Banderacom Corporation (formerly known as INH Semiconductor Corporation) for $99,999. In fiscal 2001, we purchased shares of Series B preferred stock of Banderacom Corporation for $192,000. Banderacom is a fabless semiconductor company focused on supplying InfiniBand semiconductor devices used to increase the bandwidth, scalability, and reliability, of computer, networking, storage, and server system products. We hold less than 20 percent of the voting equity of Banderacom, and neither have nor seek corporate governance or significant influence over its operating 33 and financial policies. We monitor this investment for impairment on a quarterly basis and make appropriate reductions in the carrying value when such impairment is determined to be other-than-temporary. Due to the downturn in the private equity markets generally and the performance of Banderacom in particular, we recorded an impairment charge of the remaining carrying value of our investment in Banderacom of approximately $292,000 in the fourth quarter of fiscal 2002. Other income, net. Other income, net consists primarily of interest income on short-term investments partially offset by interest expense. Other income, net was approximately $4.2 million, $2.8 million and $979,000 during fiscal 2000, 2001 and 2002, respectively, representing 12.8%, 7.4% and 2.9% of total revenue respectively. The decrease in other income, net is due to decreasing cash balances and decreased interest income on short-term investments resulting from weakening macro economic conditions and, thus, lower yields on our investments. NET OPERATING LOSSES Since our inception in mid 1995, we have incurred substantial costs to develop our technology and products, to market, sell and service these products, to recruit and train personnel and to build a corporate infrastructure. As a result, we have incurred significant operating losses in every fiscal quarter and annual period since mid 1995 and our accumulated deficit was $141.0 million at October 31, 2002. As of October 31, 2002, we had approximately $70.4 million of net operating loss carryforwards. These net operating loss carryforwards begin to expire in 2011. We have not recognized any benefit from the future use of loss carryforwards for these periods or for any other periods since inception due to uncertainties regarding the realization of deferred tax assets based on our taxable earnings history. Under the Tax Reform Act of 1986, the amount of and the benefit from net operating losses that can be carried forward may be limited in certain circumstances. Events that may cause a limitation on our tax carryovers include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. We believe our success depends on the continued development and acceptance of our products and services, the growth of our customer base as well as the overall growth in the storage router market. Accordingly, we intend to invest in research and development, sales, marketing, professional services and to a lesser extent our operational and financial systems, as necessary. LIQUIDITY AND CAPITAL RESOURCES The following table presents selected financial statistics and information (dollars in thousands):
OCTOBER 31, OCTOBER 31, 2001 2002 ----------- ----------- Cash and cash equivalents $ 43,686 $ 14,723 Short-term investments $ 10,000 $ 19,588 Working capital $ 51,271 $ 34,855 Current ratio 5.6:1 4.9:1 Days of sales outstanding - for the quarter ended 40 64
Our principal sources of liquidity at October 31, 2002 consisted of $14.7 million in cash and cash equivalents and $19.6 million in short-term investments. In January 2002, we extended our existing line of credit with Silicon Valley Bank. The committed revolving line is an advance of up to $3.0 million with a borrowing base of 80% of eligible accounts receivable. The line of credit contains provisions that prohibit the payment of cash dividends and require the maintenance of specified levels of tangible net worth and certain financial performance covenants measured on a monthly basis. The line of credit matures on February 1, 2003 at which time we intend to extend the term. As of October 31, 2002, there were no borrowings outstanding under the revolving line of credit and no term loans outstanding. In February 2002, we extended a $500,000 letter of credit in connection with the lease requirements of our headquarters. During fiscal 2002, cash utilized for operating activities was $15.7 million, compared to $33,000 in fiscal 2001 and $9.7 million in fiscal 2000. The increase in net cash utilized primarily reflects proceeds from a $15.0 million litigation settlement in fiscal 2001, which significantly reduced cash utilized in operating activities for fiscal 2001. 34 In addition, there were increases in accounts receivable and decreases in accounts payable and accrued liabilities in fiscal 2002. During fiscal 2002, cash utilized by investing activities was $11.4 million, compared to $1.9 million in cash provided for investing activities in fiscal 2001 and $7.4 million utilized in fiscal 2000. The increase in net cash utilized in fiscal 2002 reflected the purchase of held-to-maturity investments, net of maturities, of $9.6 million: Capital expenditures were $10.7 million, $5.6 million and $1.9 million in fiscal 2000, 2001 and 2002, respectively. These expenditures reflect our investments in computer equipment and software, test equipment, software development tools and leasehold improvements, all of which were required to support new product offerings. During fiscal 2002, cash utilized for financing activities was $1.9 million, compared to $611,000 in fiscal 2001 and $1.7 million in fiscal 2000. The increase in cash utilized in fiscal 2002 reflected an increase in the repurchase and retirement of common stock through our stock repurchase program. In fiscal 2001 and 2002, we repurchased and retired common stock in the amount of $1.4 million and $2.3 million of our common stock, respectively. In addition, we received less common stock proceeds in fiscal 2002. Proceeds from issuance of common stock in fiscal 2001 and 2002 were $825,000 and $444,000, respectively. We have funded our operations to date primarily through sales of preferred stock and our initial public offering, resulting in aggregate gross proceeds to us of $98.2 million, product sales and, to a lesser extent, bank debt (equipment loan). We believe our existing cash balances and our credit facilities will be sufficient to meet our capital requirements beyond the next 12 months. However, we could be required or could elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including the rate of revenue growth, the timing and extent of spending to support product development efforts and expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, and market acceptance of our products. Additionally, we may enter into additional acquisitions or strategic arrangements in the future that also could require us to seek additional equity or debt financing. We cannot assure you that additional equity or debt financing, if required, will be available to us on acceptable terms, or at all. STOCK REPURCHASE PROGRAM In September 2001, our board of directors authorized the repurchase of up to $5.0 million of our common stock in the open market pursuant to which we repurchased 661,300 shares of our common stock for an aggregate purchase of $2.1 from May 2002 million during the six-month period from September 2001 to April 2002. In May 2002, the board of directors authorized the extension of our stock repurchase program by approving a program to repurchase up to an additional $5.0 million worth of our common stock in the open market pursuant to which we repurchased 1,714,465 shares of our common stock for an aggregate purchase of $1.7 million from May 2002 through October 31, 2002. In October 2002, the board of directors authorized the further extension of our stock repurchase program through 2003. As of October 31, 2002, we had repurchased an aggregate of 2,375,765 shares of our common stock for an aggregate purchase price of $3.8 million. Under the repurchase program, the stock will be purchased in the open market or privately negotiated transactions from time to time in compliance with the SEC's Rule 10b-18, subject to market conditions, applicable legal requirements and other factors. The timing and amounts of any purchases will be as determined by our management from time to time or may be suspended at any time without prior notice, depending on market conditions and other factors they deem relevant. The timing and size of any future stock repurchases are subject to market conditions, stock prices, cash position and other cash requirements. STOCKHOLDER RIGHTS PLAN On August 21, 2002, our board of directors approved, adopted and entered into a Stockholder Rights Plan ("The Plan". The Plan is similar to plans adopted by many other companies and was not adopted in response to any attempt to acquire us, nor were we aware of any such efforts at the time of adoption. The Plan is designed to enable our stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire the company. Adoption of the Plan is intended to deter coercive takeover tactics including the accumulation of shares in the open market or through private transactions and to prevent an acquiror from gaining control of the company without offering a fair price to all of our stockholders. Under the Plan, we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of the close of business on September 3, 2002. Each right initially entitles stockholders to 35 purchase one unit of a share of our preferred stock at $12 per share. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires or announces a tender or exchange offer that would result in the acquisition of 15 percent or more of our common stock while the Plan remains in place, then, unless the rights are redeemed by us for $0.01 per right, all rights holders except the acquirer will be entitled to acquire our common stock at a significant discount. The rights are intended to enable all stockholders to realize the long-term value of their investment in the company. The rights will not prevent a takeover attempt, but should encourage anyone seeking to acquire us to negotiate with the board prior to attempting a takeover. The rights will expire on September 3, 2012. Management by Objective Bonus Program On , our board of directors approved .... --------- 36 CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to customer programs and incentives, product returns, bad debts, inventories, intangible assets, warranty obligations, restructuring, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements: o Revenue recognition o Warranty obligations o Excess and obsolete inventories o Allowance for doubtful accounts o Facility lease abandonment losses Revenue recognition. With respect to sales of our products to OEMs, we recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, fee is fixed or determinable, collectibility is probable and risk of loss has passed to the OEM. Product sales to distributors, VARs and system integrators who do not have return rights are recognized upon reported sell-through to end-users. To the extent that we sell products to distributors, VARs and system integrators that have rights of return, we defer revenue and the related cost of revenue associated with such sales and recognize these amounts when that customer sells our products to its customers. Deferred revenue as of October 31, 2002 was approximately $727,000. As described above, management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates. Warranty obligations. We provide for the estimated cost of product warranties at the time revenue is recognized. These estimates are developed based on historical information. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from management's estimates, revisions to the estimated warranty liability would be required. Excess and obsolete inventories. We write down our inventories for estimated obsolescence or unmarketable inventory based on the difference between the cost of inventories and the estimated market value based upon assumptions about future demand and market conditions. If actual demand and/or market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Allowance for doubtful accounts. We continuously assess the collectibility of outstanding customer invoices and in doing such, we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: o historical collection experience; o a customer's current credit-worthiness; o customer concentrations; o age of the receivable balance, both individually and in the aggregate; and o general economic conditions that may affect a customer's ability to pay. 37 Actual customer collections could differ from our estimates. For example, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Facility lease abandonment losses. We vacated excess leased facilities as a result of the restructuring plan we initiated during fiscal 2002. We recorded an accrual of $2.1 million for the remaining lease liabilities of such vacated properties, leasehold improvements required to sublease the vacated space, as well as brokerage commissions. We estimated costs of vacating these leased facilities, including estimated costs to sublease, based on market information and trend analysis. It is reasonably possible that actual results will differ from these estimates in the near term, and such differences could be material to our financial statements. Of the $2.1 million charge recorded during fiscal 2002, approximately $1.8 million relates to the base rent and fixed operating expenses of the vacated space through the lease term which ends April 15, 2006. CONTRACTUAL CASH OBLIGATIONS AND COMMITMENTS We lease office space and equipment under long-term operating lease agreements that expire on various dates through April 15, 2006. Rental expense under these agreements was approximately $1.6 million, $2.3 million and $2.2 million for the years ended October 31, 2000, 2001 and 2002, respectively. In April 2000, we relocated our headquarters in accordance with an agreement to lease approximately 63,548 square feet of general office, laboratory, and administrative space in Austin, Texas. The term of the lease agreement is six years, from April 1, 2000 through April 15, 2006, and represents a lease commitment of $1.9 million per year through the lease term. In conjunction with entering into the lease agreement, we signed an unconditional, irrevocable letter of credit with a bank for $500,000, which is secured by a $3.0 million line of credit. The following summarizes our contractual cash obligations as of October 31, 2002 (in thousands):
PAYMENTS DUE BY PERIOD ------------------------------------------------------------------------------ FISCAL FISCAL FISCAL FISCAL TOTAL 2003 2004 2005 2006 BEYOND -------- -------- -------- -------- -------- -------- Operating leases ................... $ 7,107 $ 2,114 $ 2,131 $ 1,908 $ 954 $ -- ======== ======== ======== ======== ======== ======== (Total contractual cash obligations)
The following summarizes our other manufacturing commitments as of October 31, 2002 (in thousands):
AMOUNT OF COMMITMENT EXPIRATION BY PERIOD ------------------------------------------------------------------------------ FISCAL FISCAL FISCAL FISCAL TOTAL 2003 2004 2005 2006 BEYOND -------- -------- -------- -------- -------- -------- Manufacturing commitments............... $ 50 $ 50 $ --- $ --- $ --- $ -- ======= ======== ======== ======== ======= ======== (Total manufacturing commitments)
RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which requires that all business combinations be accounted for under the purchase method and defines the criteria for identifying intangible assets for recognition apart from goodwill. SFAS No. 141 applies to business combinations initiated after June 30, 2001 and all business combinations accounted for using the purchase method for which the acquisition date is July 1, 2001 or later. We have not initiated any business combinations subsequent to June 30, 2001; therefore, the adoption of SFAS No. 141 did not have a material impact on our financial position or results of operations. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which changes how goodwill and other intangible assets are accounted for subsequent to their initial recognition. Under this standard, goodwill and other intangibles assets having indefinite useful lives are no longer amortized, but are subjected to periodic assessments of impairment. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. Effective November 1, 2001, we early adopted SFAS No. 142. We currently do not have any goodwill; therefore, the adoption of SFAS No. 142 did not have a material impact on our financial position or results of operations. 38 In October 2001, the FASB issued SFAS No. 144, "Impairment of Long-lived Assets," which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and the fair value of the asset. SFAS No. 144 removes goodwill from its scope. SFAS No. 144 is applicable to financial statements issued for fiscal years beginning after December 15, 2001, or for our fiscal year ended October 31, 2003. The adoption of SFAS No. 144 is not expected to have a material impact on our financial position or results of operations. In May 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4,44, and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002." This statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that statement," SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." This Statement amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS No. 145 is effective for financial statements issued for fiscal years beginning after May 15, 2002, the adoption of which is not expected to have a material impact on our financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting for restructuring costs and supersedes previous accounting guidance, principally EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF Issue No. 94-3"). SFAS No. 146 requires that the liability associated with exit or disposal activities be recognized when the liability is incurred. Under EITF Issue No. 94-3, liabilities for exit costs were recognized when a Company commits to an exit plan. SFAS No. 146 also establishes that a liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing and amount of recognizing restructuring costs. We will adopt the provisions of SFAS No. 146 for any restructuring activities initiated after December 31, 2002. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 is not expected to have a material effect on our financial position, results of operations, or cash flows. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years beginning after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. We do not expect the adoption of SFAS No. 148 to have a material effect on our financial position, results of operations, or cash flows. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS. All of our investments are entered into for other than trading purposes. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required. We invest our cash in a variety of financial instruments, including bank time deposits and taxable and tax- 39 advantaged variable rate and fixed rate obligations of corporations, municipalities, and local, state and national government entities and agencies. These investments are denominated in U.S. dollars. Interest income on our investments is carried in "Other income, net." We account for our investment instruments in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). All of the cash equivalents and short-term investments are treated as held to maturity under SFAS No. 115. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates. Our investment securities are held for purposes other than trading. While certain of the investment securities had maturities in excess of 90 days, we intend to liquidate such securities within one year. The weighted-average interest on investment securities at October 31, 2002 was 2.35%. The fair value of securities held at October 31, 2002 was approximately $21.6 million, of this, $19.6 million was classified as short-term investments. We believe that our investment policy is conservative, both in terms of the average maturity of our investments and the credit quality of the investments we hold. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by this item is included in Part IV, Item 15 (a)(1) and (2). ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 40 PART III ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this section is incorporated by reference from the information in the section entitled "Election of Directors" in the Proxy Statement. Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is contained in the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement and is incorporated by reference herein. The information required by this Item with respect to the Company's executive officers is contained in Item 1 of Part I of this Annual Report under the heading "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to our Proxy Statement under the sections captioned "Executive Compensation and Other Information" and "Certain Transactions." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to our Proxy Statement under the section captioned "Ownership of Securities." 41 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to our Proxy Statement under the section captioned "Certain Transactions." ITEM 14. CONTROLS AND PROCEDURES. We performed an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective as of January 17, 2003 to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no significant changes in our internal controls or other factors that could significantly affect our internal controls subsequent to January 17, 2003. 42 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this Form 10-K: 1. Consolidated Financial Statements. The following consolidated financial statements of Crossroads Systems, Inc. are filed as a part of this Form 10-K on the pages indicated:
PAGE ---- Report of Independent Accountants........................................................................F-1 Consolidated Balance Sheets as of October 31, 2001 and 2002..............................................F-2 Consolidated Statements of Operations for each of the three years in the period ended October 31, 2002..........................................................................F-3 Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended October 31, 2002.......................................................F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended October 31, 2002..........................................................................F-5 Notes to Consolidated Financial Statements...............................................................F-6
2. Consolidated Financial Statement Schedules. The following consolidated financial statement schedule of Crossroads Systems, Inc. is filed as a part of this Form 10-K on the pages indicated:
PAGE ---- Report of Independent Accountants.......................................................................S-1 Schedule II - Valuation and Qualifying Accounts.........................................................S-2
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or the notes thereto. 3. Exhibits. EXHIBIT NUMBER DESCRIPTION 3.1* Sixth Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 (SEC File No. 333-85505) (the "IPO Registration Statement") and incorporated herein by reference) 3.2* Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO Registration Statement and incorporated herein by reference) 4.1* Specimen certificate for shares of common stock (filed as Exhibit 4.1 to the IPO Registration Statement and incorporated herein by reference) 10.1* Form of Indemnity Agreement between Registrant and each of its directors and executive officers (filed as Exhibit 10.1 to the IPO Registration Statement and incorporated herein by reference) 10.2* Crossroads Systems, Inc. 1999 Employee Stock Purchase Plan (filed as Exhibit 10.3 to the IPO Registration Statement and incorporated herein by reference) 10.3* Fourth Amended and Restated Investors Rights Agreement dated August 6, 1999 by and among Registrant and certain purchasers of Registrant's preferred stock (filed as Exhibit 10.4 to the IPO Registration Statement and incorporated herein by reference) 10.4*+ OEM Agreement dated April 23, 1998 by and between Registrant and Storage Technology Corporation (filed as Exhibit 10.5 to the IPO Registration Statement and incorporated herein by reference) 10.5* Form of Stock Pledge Agreement by and between Registrant and Reagan Y. Sakai (filed as Exhibit 10.12 to the IPO Registration Statement and incorporated herein by reference) 43 EXHIBIT NUMBER DESCRIPTION 10.6* Form of Note Secured by Stock Pledge Agreement issued to Registrant by Reagan Y. Sakai (filed as Exhibit 10.13 to the IPO Registration Statement and incorporated herein by reference) 10.7 Loan Modification Agreement dated December 31, 2000 by and between Registrant and Silicon Valley Bank 10.8* Office Building Lease dated October 8, 1999 by and between Registrant and Maplewood Associates, L.P. (filed as Exhibit 10.15 to the IPO Registration Statement and incorporated herein by reference) 10.9* CP4200 License Agreement dated April 15, 1998 by and between Registrant and Hewlett-Packard Company (filed as Exhibit 10.16 to the IPO Registration Statement and incorporated herein by reference) 10.10* Crossroads Systems, Inc. Amended and Restated 1999 Stock Incentive Plan (filed as Exhibit 99. (d)(2) to the Registrant's Schedule TO/I (SEC File No. 5-57603) and incorporated herein by reference) 10.11* Rights Agreement, dated as of August 21, 2002, by and between Registrant and American Stock Transfer & Trust Company, which includes the form of Certificate of Designation for the Series A junior participating preferred stock as Exhibit A, the form of Rights Certificate as Exhibit B and the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C (field as Exhibit 4 to the Registrant's Current Report on Form 8-K dated August 21, 2002 and incorporated herein by reference) 10.12 Employment Agreement, dated as of January 6, 2003 by and between Registrant and Andrea Wenholz 10.13 Fiscal Year 2002 Stock Bonus Incentive Program Letter Agreement, dated as of November 13, 2001, from Registrant to Rob Sims 10.14 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated November 4, 2002 from Registrant to Rob Sims 10.15 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated November 20, 2002 from Registrant to Brian R. Smith 10.16 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated January 6, 2003, from Registrant to Andrea Wenholz 21.1 Subsidiaries of the Registrant 23.1 Consent of PricewaterhouseCoopers LLP 24.1 Power of Attorney, pursuant to which amendments to this Form 10-K may be filed, is included on the signature page contained on Part IV of this Form 10-K 99.1 Certification to the Securities and Exchange Commission, as required by Section 906 of the Sarbanes-Oxley Act of 2002 * Incorporated herein by reference to the indicated filing + Confidential treatment previously granted (b) Reports on Form 8-K filed during the last quarter of the period covered by this report. During the three months ended October 31, 2002, we filed the following Current Reports on Form 8-K: o We filed a Form 8-K dated August 21, 2002 (Item 5) announcing that our board of directors adopted a stockholder rights plan in which preferred share purchase rights will be distributed as a dividend at a rate of one right for each share of common stock outstanding as of the date of business on September 3, 2002. o We filed a Form 8-K dated August 30, 2002 (Item 5) announcing that we had received a notice from NASDAQ that for 30 consecutive trading days the bid price of our common stock closed below the minimum $1.00 per share required for continued inclusion on the NASDAQ National Market. 44 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CROSSROADS SYSTEMS, INC. By: /s/ Brian R. Smith --------------------------------- Brian R. Smith, President, Chief Executive Officer and Chairman of the Board POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby severally constitutes and appoints, Brian R. Smith and Andrea Wenholz, and each or any of them, his or her true and lawful attorney-in-fact and agent, each with the power of substitution and resubstitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE - ---- ----- ---- /s/ BRIAN R. SMITH President, Chief Executive Officer and January 29, 2003 - -------------------------------- Chairman of the Board (principal Brian R. Smith executive officer) /s/ ANDREA WENHOLZ Vice President, Chief Financial Officer, January 29, 2003 - -------------------------------- Secretary and Treasurer Andrea Wenholz (principal financial and accounting officer) /s/ RICHARD D. EYESTONE Director January 29, 2003 - -------------------------------- Richard D. Eyestone /s/ DAVID L. RIEGEL Director January 29, 2003 - -------------------------------- David L. Riegel /s/ WILLIAM P. WOOD Director January 29, 2003 - -------------------------------- William P. Wood /s/ PAUL S. ZITO Director January 29, 2003 - -------------------------------- Paul S. Zito
CERTIFICATIONS I, Brian R. Smith, certify that: 1. I have reviewed this annual report on Form 10-K of Crossroads Systems, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons fulfilling the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: January 28, 2003 /s/ Brian R. Smith - --------------------- Brian R. Smith Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) 2 CERTIFICATIONS I, Andrea Wenholz, certify that: 1. I have reviewed this annual report on Form 10-K of Crossroads Systems, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons fulfilling the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: January 28, 2003 /s/ Andrea Wenholz - ----------------------- Andrea Wenholz Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Accounting Officer) 3 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Crossroads Systems, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, changes in stockholders' equity and cash flows present fairly, in all material respects, the financial position of Crossroads Systems, Inc. and Subsidiaries at October 31, 2001 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PRICEWATERHOUSECOOPERS LLP Austin, Texas November 26, 2002 F-1 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS OCTOBER 31, ------------ ------------ 2001 2002 ------------ ------------ Current assets: Cash and cash equivalents ............................................... $ 43,686 $ 14,723 Short-term investments .................................................. 10,000 19,588 ------------ ------------ Total cash, cash equivalents and short-term investments ............ 53,686 34,311 Accounts receivable, net of allowance for doubtful accounts of $388 and $277, respectively .............................. 3,768 5,721 Inventories, net ........................................................ 3,080 2,767 Prepaids and other current assets ....................................... 1,894 956 ------------ ------------ Total current assets ............................................... 62,428 43,755 Note receivable from related party, net ................................... 244 63 Property and equipment, net ............................................... 11,021 6,106 Intangibles, net .......................................................... 997 173 Other assets .............................................................. 713 362 ------------ ------------ Total assets ....................................................... $ 75,403 $ 50,459 ============ ============ LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ........................................................ $ 7,070 $ 4,165 Accrued expenses ........................................................ 2,744 3,393 Accrued warranty costs .................................................. 597 615 Deferred revenue ........................................................ 746 727 ------------ ------------ Total current liabilities .......................................... 11,157 8,900 Commitments and contingencies Redeemable convertible preferred stock, $.001 par value, 25,000,000 shares authorized, none designated, and none issued and outstanding -- -- Stockholders' equity: Common stock, $.001 par value, 175,000,000 shares authorized, 27,542,664 and 25,870,508 shares issued, respectively .............. 28 26 Additional paid-in capital ................................................ 184,042 183,253 Deferred stock-based compensation ......................................... (3,914) (311) Notes receivable from stockholder ......................................... (118) (126) Accumulated deficit ....................................................... (115,535) (141,024) Treasury stock at cost (467,794 and 469,237 shares, respectively) ......... (257) (259) ------------ ------------ Total stockholders' equity ......................................... 64,246 41,559 ------------ ------------ Total liabilities, redeemable convertible preferred stock and stockholders' equity .................................. $ 75,403 $ 50,459 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-2 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)
YEAR ENDED OCTOBER 31, 2000 2001 2002 ------------ ------------ ------------ Revenue: Product revenue ................................................... $ 32,486 $ 35,896 $ 33,429 Other revenue ..................................................... 562 1,434 559 ------------ ------------ ------------ Total revenue ......................................... 33,048 37,330 33,988 Cost of revenue (including stock-based compensation expense of $288, $123 and $84, respectively) ........................... 19,104 22,013 22,661 ------------ ------------ ------------ Gross profit ......................................................... 13,944 15,317 11,327 ------------ ------------ ------------ Operating expenses: Sales and marketing (including stock-based compensation expense of $4,373, $215 and $481, respectively) ................. 16,007 15,202 6,126 Research and development (including stock-based compensation expense of $528, $440 and $369, respectively) ...... 13,143 18,118 16,520 General and administrative (including stock-based compensation expense of $22,501, $6,283 and $3,640, respectively) ................................................... 31,242 16,043 9,158 Amortization of intangibles ....................................... 8,808 9,680 278 Impairment of intangibles and other assets ........................ -- 25,007 2,047 Business restructuring expenses ................................... -- -- 3,666 Litigation settlement ............................................. -- (15,000) -- ------------ ------------ ------------ Total operating expenses .............................. 69,200 69,050 37,795 ------------ ------------ ------------ Loss from operations ................................................. (55,256) (53,733) (26,468) Other income (expense): Interest income ................................................... 4,347 2,763 979 Interest expense .................................................. (37) -- -- Other income (expense) ............................................ (82) 13 -- ------------ ------------ ------------ Other income, net ............................................. 4,228 2,776 979 ------------ ------------ ------------ Net loss before cumulative effect of accounting change ............... (51,028) (50,957) (25,489) Cumulative effect of accounting change ............................... -- (130) -- ------------ ------------ ------------ Net loss ............................................................. $ (51,028) $ (51,087) $ (25,489) ============ ============ ============ Basic and diluted net loss per share: Before cumulative effect of accounting change ..................... $ (1.93) $ (1.85) $ (0.95) Cumulative effect of accounting change ............................ -- (0.01) -- ------------ ------------ ------------ Basic and diluted net loss per share .......................... $ (1.93) $ (1.86) $ (0.95) ============ ============ ============ Pro forma amounts assuming accounting change is applied retroactively: Net loss .......................................................... $ (51,085) $ -- $ -- Net loss per share, basic and diluted ............................. $ (1.93) $ -- $ -- ------------ ------------ ------------ Shares used in computing basic and diluted net loss per share ........ 26,466,601 27,414,078 26,878,387 ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-3 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
NOTES COMMON STOCK ADDITIONAL DEFERRED RECEIVABLE ------------------------------ PAID-IN STOCK-BASED FROM SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS ------------- ------------- ------------- ------------- ------------- Balance at October 31, 1999 ............... 26,549,919 27 102,461 (3,718) (463) Issuance of common stock upon exercise of stock options .............................. 662,791 1 95 -- -- Issuance of common stock for purchase acquisitions ................ 428,625 -- 46,373 -- -- Issuance of common stock for employee stock purchase plan ........................ 49,338 -- 755 -- -- Purchase of treasury stock (383,461 shares) ............... -- -- -- -- -- Stock-based compensation ................ -- -- 33,706 (6,016) -- Payments on notes receivable from stockholders ......... -- -- -- -- 235 Accrued interest on notes receivable from stockholders ... -- -- -- -- (21) Net loss ................................ -- -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at October 31, 2000 ............... 27,690,673 28 183,390 (9,734) (249) Issuance of common stock upon exercise of stock options .............................. 174,440 -- 160 -- -- Issuance of common stock for employee stock purchase plan ........................ 149,851 -- 665 -- -- Purchase of treasury stock (61,833 shares) ................ -- -- -- -- -- Stock-based compensation ................ -- -- 1,241 5,820 -- Payments on notes receivable from stockholders ......... -- -- -- -- 140 Accrued interest on notes receivable from stockholders .................... -- -- -- -- (9) Retirement of shares purchased under stock buy-back program ..................... (472,300) -- (1,414) -- -- Net loss ................................. -- -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at October 31, 2001 ............... 27,542,664 $ 28 $ 184,042 $ (3,914) $ (118) Issuance of common stock upon exercise of stock options .............................. 94,522 -- 102 -- -- Issuance of common stock for employee stock purchase plan ........................ 136,787 -- 342 -- -- Retirement of shares purchased under stock buy-back program ..................... (1,903,465) (2) (2,338) -- -- Purchase of treasury stock (1,443 shares) ................. -- -- -- -- -- Stock-based compensation ................. -- -- 1,105 3,603 -- Accrued interest on notes receivable from stockholders ......................... -- -- -- -- (8) Net loss ................................ -- -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at October 31, 2002 ............... 25,870,508 $ 26 $ 183,253 $ (311) $ (126) ============= ============= ============= ============= ============= TOTAL ACCUMULATED TREASURY STOCKHOLDERS' DEFICIT STOCK EQUITY ------------- ------------- ------------- Balance at October 31, 1999 ............... (13,420) (2) 84,885 Issuance of common stock upon exercise of stock options .............................. -- -- 96 Issuance of common stock for purchase acquisitions ................ -- -- 46,373 Issuance of common stock for employee stock purchase plan ........................ -- -- 755 Purchase of treasury stock (383,461 shares) ............... -- (233) (233) Stock-based compensation ................ -- -- 27,690 Payments on notes receivable from stockholders ......... -- -- 235 Accrued interest on notes receivable from stockholders ... -- -- (21) Net loss ................................ (51,028) -- (51,028) ------------- ------------- ------------- Balance at October 31, 2000 ............... (64,448) (235) 108,752 Issuance of common stock upon exercise of stock options .............................. -- -- 160 Issuance of common stock for employee stock purchase plan ........................ -- -- 665 Purchase of treasury stock (61,833 shares) ................ -- (22) (22) Stock-based compensation ................ -- -- 7,061 Payments on notes receivable from stockholders ......... -- -- 140 Accrued interest on notes receivable from stockholders .................... -- -- (9) Retirement of shares purchased under stock buy-back program ..................... -- -- (1,414) Net loss ................................ (51,087) -- (51,087) ------------- ------------- ------------- Balance at October 31, 2001 ............... $ (115,535) $ (257) $ 64,246 Issuance of common stock upon exercise of stock options .............................. -- -- 102 Issuance of common stock for employee stock purchase plan ........................ -- -- 342 Retirement of shares purchased under stock buy-back program ..................... -- -- (2,340) Purchase of treasury stock (1,443 shares) ................. -- (2) (2) Stock-based compensation ................ -- -- 4,708 Accrued interest on notes receivable from stockholders ......................... -- -- (8) Net loss ................................ (25,489) -- (25,489) ------------- ------------- ------------- Balance at October 31, 2002 ............... $ (141,024) $ (259) $ 41,559 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-4 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED OCTOBER 31, -------------------------------------------------- 2000 2001 2002 -------------- -------------- -------------- Cash flows from operating activities: Net loss ......................................................... $ (51,028) $ (51,087) $ (25,489) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation .................................................. 2,942 4,640 5,559 Amortization of intangibles ................................... 8,808 9,680 278 Impairment of intangibles and other assets .................... -- 25,007 2,047 Stock-based compensation ...................................... 27,690 7,061 4,574 Loss on disposal of property and equipment .................... -- 24 -- Provision for doubtful accounts receivable .................... 136 157 (111) Provision for excess and obsolete inventory ................... 1,758 (309) (791) Business restructuring expenses ............................... -- -- 2,283 Changes in assets and liabilities: Accounts receivable ......................................... (1,664) 1,665 (1,842) Inventories ................................................. (2,006) 1,147 1,104 Prepaids and other assets ................................... (978) 143 938 Accounts payable ............................................ 1,505 2,218 (2,905) Accrued expenses ............................................ 2,047 (189) (1,379) Accrued warranty costs ...................................... 105 183 18 Deferred revenue and other .................................. 994 (373) 26 -------------- -------------- -------------- Net cash used in operating activities .................... (9,691) (33) (15,690) -------------- -------------- -------------- Cash flows from investing activities: Purchase of property and equipment ............................... (10,653) (5,623) (1,866) Cash acquired, net of payments for business acquisitions ......... 1,013 -- -- Proceeds from sale of property and equipment ..................... -- -- 14 Purchase of held-to-maturity investments ......................... (17,591) (11,967) (52,537) Maturities of held-to-maturity investments ....................... 19,500 19,558 42,950 Payment of note receivable from related party .................... 226 140 64 Other assets ..................................................... 60 (225) -- -------------- -------------- -------------- Net cash provided by (used in) investing activities ...... (7,445) 1,883 (11,375) -------------- -------------- -------------- Cash flows from financing activities: Proceeds from issuance of common stock ........................... 851 825 444 Costs associated with initial public offering .................... (40) -- -- Repurchase and retirement of common stock ........................ -- (1,414) (2,340) Purchase of treasury stock ....................................... (233) (22) (2) Repayment of long-term indebtedness .............................. (2,356) -- -- Other ............................................................ 41 -- -- -------------- -------------- -------------- Net cash provided by (used in) financing activities ...... (1,737) (611) (1,898) -------------- -------------- -------------- Net increase (decrease) in cash and cash equivalents ............... (18,873) 1,239 (28,963) Cash and cash equivalents, beginning of period ..................... 61,320 42,447 43,686 -------------- -------------- -------------- Cash and cash equivalents, end of period ........................... $ 42,447 $ 43,686 $ 14,723 ============== ============== ============== Supplemental disclosure of non-cash investing and financing activities: The Company purchased all of the assets of Polaris Communications, Inc. during fiscal year 2000. Assets acquired and liabilities assumed were as follows: Fair value of assets acquired ................................. $ 46,751 $ -- $ -- Liabilities assumed ........................................... (171) -- -- Stock issued in connection with the acquisition .................. (44,483) -- -- Options issued in connection with the acquisition ................ (1,890) -- -- -------------- -------------- -------------- Cash payments for acquisition of Polaris ......................... $ 207 $ -- $ -- ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. F-5 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION: The accompanying consolidated financial statements include the accounts of Crossroads Systems, Inc. ("Crossroads" or the "Company") and its wholly-owned subsidiaries. Headquartered in Austin, Texas, Crossroads, a Delaware corporation, is a leading global provider of connectivity for storage networking solutions. Crossroads sells its products and services primarily to leading storage system and server original equipment manufacturers, distributors, VARs, system integrators and storage service providers. The Company is organized and operates as one business segment. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. Crossroads completed the acquisition of Polaris Communications, Inc. ("Polaris") during the second quarter of fiscal 2000. This acquisition was accounted for under the purchase method of accounting. All intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates are used for, but not limited to, the useful lives of property and equipment, allowances for doubtful accounts and product returns, inventory and warranty reserves, impairment charges, facilities lease losses and other charges, accrued liabilities and other reserves and contingencies. Actual results could differ from those estimates and such differences may be material to the financial statements. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand, cash on deposit and all highly liquid investments with original maturities at the date of purchase less than three months . Cash equivalents consist primarily of cash deposited in money market accounts and high-grade commercial paper. Cash equivalents totaled $43.7 million and $14.7 million at October 31, 2001 and 2002, respectively. In conjunction with entering into a lease agreement for its headquarters, the Company signed an unconditional, irrevocable letter of credit with a bank for $500,000, which is secured by a $3.0 million line of credit. While the Company's cash and cash equivalents are on deposit with high quality FDIC insured financial institutions, at times such deposits exceed insured limits. The Company has not experienced any losses in such accounts. Short-Term Investments Short-term investments consist primarily of U.S. government agency debt, municipal debt instruments, corporate obligations and certificates of deposit with original maturities at the date of purchase greater than three months and less than twelve months. All short-term investments have been classified as held to maturity and are carried at amortized cost, which approximates fair value, due to the short period of time to maturity. As of October 31, 2001 and 2002, the fair value and amortized cost of short-term investments were approximately $10.0 million and $19.6 million, respectively. Inventories Inventories are stated at the lower of cost or market. Cost is determined using standard cost, which approximates the first-in, first-out method. Provisions, when required, are made to reduce excess and obsolete inventories to their estimated net realizable values. F-6 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Inventories consist of the following (in thousands):
YEAR ENDED OCTOBER 31, ---------------------------- 2001 2002 ------------ ------------ Raw materials ................................................ $ 3,692 $ 2,089 Finished goods ............................................... 1,168 1,667 ------------ ------------ 4,860 3,756 Less: Allowance for excess and obsolete inventory .... (1,780) (989) ------------ ------------ $ 3,080 $ 2,767 ============ ============
Investments The Company accounted for its investment in Banderacom Corporation (formerly INH Semiconductor Corporation) ("Banderacom") using the cost method because the Company's investment represents less than a 20% ownership interest and the Company is not able to exert significant influence over Banderacom. However, in fiscal 2002, the Company wrote off its investment in Banderacom, which was included in other non-current assets. The Company's investment in Banderacom was approximately $292,000 and $0 at October 31, 2001 and 2002, respectively. Concentrations Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and short-term investments and accounts receivable. The Company invests only in high credit quality short-term debt instruments and limits the amount of credit exposure to any one entity. The Company's sales are primarily concentrated in the United States and are primarily derived from sales to original equipment manufacturers in the computer storage and server industry. Revenue is concentrated with several major customers. The loss of a major customer, a change of suppliers or significant technological change in the industry could affect operating results adversely. The Company had trade accounts receivable from four customers, which comprised approximately 36% and 58% of total trade accounts receivable at October 31, 2001 and 2002, respectively. The Company performs credit evaluations of its customers and generally does not require collateral on accounts receivable balances and provides allowances for potential credit losses and product sales returns. The Company has established reserves for credit losses and sales returns and other allowances. The Company has not experienced material credit losses in any of the periods presented. The Company's business is concentrated in the storage area networking industry, which has been impacted by unfavorable economic conditions and reduced information technology (IT) spending rates. Accordingly, the Company's future success depends upon the buying patterns of customers in the storage area networking industry, their response to current and future IT investment trends, and the continued demand by such customers for the Company's products. The Company's continued success will depend upon its ability to enhance its existing products and to develop and introduce, on a timely basis, new cost-effective products and features that keep pace with technological developments and emerging industry standards. The Company's supplier arrangement for the production of certain vital components of its storage routers is concentrated with a small number of key suppliers. Additionally, the Company relies on a limited number of contract manufacturers to provide manufacturing services for its products. The inability of any contract manufacturer or supplier to fulfill supply requirements could materially impact future operating results. The percentage of sales to significant customers was as follows:
YEAR ENDED OCTOBER 31, ----------------------------------------------------- 2000 2001 2002 --------------- --------------- --------------- Compaq* .............................. 33% 2% 6% StorageTek ........................... 21% 23% 24% ADIC ................................. 7% 8% 0% Hewlett Packard* ..................... 6% 26% 16% Hewlett Packard (including Compaq)* .. 0% 0% 29%
In May 2002, Hewlett-Packard completed its acquisition of Company. These percentages reflect sales to Hewlett-Packard and Company prior to the merger and sales to the combined company after the merger. F-7 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The level of sales to any customer may vary from quarter to quarter. However, we expect that significant customer concentration will continue for the foreseeable future. The loss of any one of these customers, or a decrease in the level of sales to any one of these customers, could have a material adverse impact on the Company's financial condition or results of operations. During April 2001, Advanced Digital Information Corporation ("ADIC") transitioned out of the Company's router products when it acquired Pathlight Technology, Inc. ("Pathlight"). Sales to ADIC were approximately $2.3 million, $3.0 million and $13,000 during the year ended October 31, 2000, 2001 and 2002, respectively. Fair Value of Financial Instruments The fair values of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their carrying values due to their short maturities. Property and Equipment The Company's property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets, generally one to three years for equipment and five years for furniture and fixtures. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life of the related asset or the remaining life of the lease. Upon retirement or disposition of assets, the cost and related accumulated depreciation are removed from the accounts, and the related gains or losses are reflected in operations. The Company assesses long-lived assets other than goodwill for impairment under Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of." Impairment of goodwill is assessed under SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 121 requires long-lived assets to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When performing this review, the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment charge is recognized. Impairment charges related to long-lived assets other than goodwill were approximately $0, $0 and $2.0 million for the years ended October 31, 2000, 2001 and 2002, respectively. Property and equipment consist of the following (in thousands):
OCTOBER 31, ------------------------------ 2001 2002 ------------- ------------- Equipment ............................................. $ 17,509 $ 16,534 Furniture and fixtures ................................ 1,878 1,367 Leasehold improvements ................................ 906 707 ------------- ------------- 20,293 18,608 Less: accumulated depreciation and amortization ....... (9,272) (12,502) ------------- ------------- $ 11,021 $ 6,106 ============= =============
Goodwill and Purchased Intangible Assets In June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No.142 addresses the accounting and reporting for acquired goodwill and other intangible assets. SFAS No. 142 discontinues amortization of acquired goodwill and instead requires annual impairment testing of acquired goodwill. Intangible assets are amortized over their useful economic life and tested for impairment in accordance with SFAS No.121. The Company adopted SFAS No.142 effective November 1, 2002. During the fiscal years ended October 31, 2000 and 2001, the Company had goodwill amortization of approximately $8.4 million and $9.2 million, respectively. There was no goodwill amortization expense for the year ended October 31, 2002. F-8 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During fiscal 2001, in response to uncertain macroeconomic conditions and the resulting decline in demand and product revenue, management reassessed the Company's product strategy, initiated a market sizing exercise on its core business and examined the expense structure in an attempt to realign its business plan to achieve profitability. The strategic review triggered a reduction in force and an impairment evaluation of the intangible assets related to the Polaris acquisition under SFAS No. 121. Based on a valuation prepared by an independent third-party appraisal company, the Company recorded a write-down of these intangible assets totaling $25.0 million, including all remaining unamortized goodwill. During fiscal 2002, a further write-down of the remaining balance of unamortized intangible assets relating to the Polaris acquisition was made in the amount of $0.5 million, based on an evaluation of future undiscounted cash flows under SFAS No. 121. Accumulated amortization of intangible assets was $___ and $____ at October 31, 2001 and 2002, respectively. The following table reflects the effect of SFAS No. 142 on net loss and net loss per share as if SFAS No. 142 had been in effect for all periods presented (in thousands except per share amounts):
YEAR ENDED OCTOBER 31, ------------------------------ 2000 2001 2002 -------- -------- -------- Net loss: Reported net loss $(51,028) $(51,087) $(25,489) Add back goodwill amortization 8,428 9,195 -- -------- -------- -------- Adjusted net loss $(42,600) $(41,892) $(25,489) ======== ======== ======== Basic and diluted net loss per share: Reported net loss per share $ (1.93) $ (1.86) $ (.95) Add back goodwill amortization .32 .33 -- -------- -------- -------- Adjusted net loss per share $ (1.61) $ (1.53) $ (.95) ======== ======== ========
Accrued Liabilities Accrued liabilities consist of the following (in thousands):
OCTOBER 31, --------------------- 2001 2002 --------- --------- Facility lease abandonment - restructuring ............ $ -- $ 1,957 Employee separation and other costs - restructuring ... -- 326 Vacation .............................................. 374 305 Marketing development funds ........................... 378 251 Payroll related ....................................... 1,595 214 Property, state and franchise taxes ................... 115 144 Other ................................................. 282 196 --------- --------- $ 2,744 $ 3,393 ========= =========
Treasury Stock Treasury stock purchases are accounted for under the cost method whereby the entire cost of the acquired stock is recorded as treasury stock. Gains and losses on the subsequent reissuance of shares are credited or charged to capital in excess of par value using the average-cost method. Revenue Recognition Product revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, price is fixed or determinable, and collectibility is probable. Revenue from product sales to customers that do not have rights of return, including product sales to original equipment manufacturers and certain distributors, VARs and system integrators, are recognized upon shipment. Sales and cost of sales related to customers that have F-9 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS rights of return are deferred and subsequently recognized upon sell-through to end-users. The Company provides for the estimated cost to repair or replace products under warranty and technical support costs when the related product revenue is recognized. Deferred revenue as of October 31, 2001 and 2002 were approximately $746,000 and $727,000, respectively. In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Effective November 1, 2000, the Company adopted SAB No. 101. The adoption of SAB No. 101 resulted in a change in method of revenue recognition for certain product shipments due to the specified shipping terms for these shipments. The cumulative effect of this accounting change was $130,000, which has been included in net loss for the year ended October 31, 2001. Advertising Costs The Company expenses all advertising costs as incurred. Advertising costs for the years ended October 31, 2000, 2001 and 2002 were $287,000, $228,000 and $22,000, respectively. Stock-Based Compensation Stock-based compensation is recognized using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock amortized over the vesting period. In 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which establishes a fair value based method of accounting for stock-based plans. Companies that elect to account for stock-based compensation plans in accordance with APB Opinion No. 25 are required to disclose the pro forma net income (loss) that would have resulted from the use of the fair value based method. Accordingly, pro forma disclosures that are required under SFAS No. 123 are included in Note 8. Income Taxes The Company accounts for income taxes in accordance with the liability method. Under the liability method, deferred tax assets and liabilities are recorded for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company recorded no income tax expense or benefit during the years ended October 31, 2001, 2001 and 2002. The Company has provided a full valuation allowance because the realization of tax benefits associated with net operating loss carryforwards is not considered more likely than not. Computation of Net Loss Per Share In accordance with SFAS No. 128, "Earnings Per Share," basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period, less shares subject to repurchase. Diluted earnings per share is computed by giving effect to all dilutive potential common shares that were outstanding during the period. Basic earnings per share excludes the dilutive effect of common stock equivalents such as stock options, while earnings per share, assuming dilution, includes such dilutive effects. Future weighted-average shares outstanding calculations will be impacted by the following factors: (i) the ongoing issuance of common stock associated with stock option exercises; (ii) the issuance of common shares associated with our employee stock purchase program; (iii) any fluctuations in our stock price, which could cause changes in the number of common stock equivalents included in the earnings per share, assuming dilution computation; and (iv) the issuance of common stock to effect business combinations should we enter into such transactions. F-10 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has excluded all outstanding stock options from the calculation of diluted net loss per share because all such options are antidilutive for all periods presented. The total number of common stock equivalents excluded from the calculations of diluted net loss, per common share were 4,653,318, 4,980,563 and 6,149,369 for the years ended October 31, 2000, 2001 and 2002, respectively. Comprehensive Income The Company reports comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income". This standard defines comprehensive income as the changes in equity of an enterprise except those resulting from stockholders transactions. Accordingly, comprehensive income (loss) includes certain changes in equity that are excluded from net income (loss). The Company has had no items of other comprehensive income (loss) for each of the three years presented and accordingly, comprehensive (loss) for all periods presented approximated net loss. Reportable Segments In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information". SFAS No. 131 establishes standards for disclosures about operating segments, products and services, geographical areas and major customers. The Company is organized and operates as one operating segment, with the objective of designing, developing, manufacturing, marketing and selling its storage router and ServerAttach product lines. Service revenue to date has not been significant. The Company operates principally in one geographic area, the United States. Major customers are discussed above. Recent Accounting Pronouncements In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which requires that all business combinations be accounted for under the purchase method and defines the criteria for identifying intangible assets for recognition apart from goodwill. SFAS No. 141 applies to business combinations initiated after June 30, 2001 and all business combinations accounted for using the purchase method for which the acquisition date is July 1, 2001 or later. The Company has not initiated any business combinations subsequent to June 30, 2001; therefore, the adoption of SFAS No. 141 did not have a material impact on the Company's financial position or results of operations. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which changes how goodwill and other intangible assets are accounted for subsequent to their initial recognition. Under this standard, goodwill and other intangibles assets having indefinite useful lives are no longer amortized, but are subjected to periodic assessments of impairment. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. Effective November 1, 2001, the Company early adopted SFAS No. 142. The Company currently does not have any goodwill; therefore, the adoption of SFAS No. 142 did not have a material impact on the Company's financial position or results of operations. In October 2001, the FASB issued SFAS No. 144, "Impairment of Long-lived Assets," which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and the fair value of the asset. SFAS No. 144 removes goodwill from its scope. SFAS No. 144 is applicable to financial statements issued for fiscal years beginning after December 15, 2001, or for our fiscal year ended October 31, 2003. The adoption of SFAS No. 144 is not expected to have a material impact on the Company's financial position or results of operations. In May 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4,44, and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002." This Statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement", SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." This Statement amends SFAS No. 13, "Accounting for Leases", to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or F-11 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS describe their applicability under changed conditions. SFAS No. 145 is effective for financial statements issued for fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material impact on the Company's financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting for restructuring costs and supersedes previous accounting guidance, principally EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF Issue No. 94-3"). SFAS No. 146 requires that the liability associated with exit or disposal activities be recognized when the liability is incurred. Under EITF Issue No. 94-3, liabilities for exit costs were recognized when a Company commits to an exit plan. SFAS No. 146 also establishes that a liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing and amount of recognizing restructuring costs. The Company will adopt the provisions of SFAS No. 146 for any restructuring activities initiated after December 31, 2002. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN45 is not expected to have a material effect on the Company's financial position, results of operations, or cash flows. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years beginning after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company does not expect the adoption of SFAS No. 148 to have a material effect on our financial position, results of operations, or cash flows. Reclassifications Certain reclassifications have been made to prior year balances in order to conform to current year presentation. 3. BUSINESS RESTRUCTURING EXPENSES AND ASSET IMPAIRMENT: In May 2002, our board of directors approved and the company subsequently completed a restructuring plan to reduce its workforce by approximately 25 percent, or 40 people (primarily in the sales, marketing and general and administrative areas), to scale down our infrastructure and to consolidate operations. In connection with the restructuring, Brian R. Smith, our founder and chairman, returned as chief executive officer and president, replacing Larry Sanders. Robert C. Sims, formerly vice president of engineering and operations, was named chief operating officer and also assumed management of sales and marketing. F-12 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As a result of this restructuring plan, we recorded $3.7 million in business restructuring expenses and a $1.2 million impairment of assets charge. Components of business restructuring expenses, asset impairments and the remaining restructuring accruals as of October 31, 2002 are as follows (in thousands):
EMPLOYEE SEPARATION FACILITY LEASE ASSET AND OTHER ABANDONMENT IMPAIRMENTS COSTS TOTAL --------------- --------------- --------------- --------------- Effect of restructuring plan and impact to accrued liabilities ........................................... $ 2,114 $ 1,208 $ 1,552 $ 4,874 Cash activity ......................................... (157) -- (1,051) (1,208) Non-cash activity ..................................... -- (1,208) (175) (1,383) --------------- --------------- --------------- --------------- Balance as of October 31, 2002 ........................ $ 1,957 $ -- $ 326 $ 2,283 =============== =============== =============== ===============
As of October 31, 2002, remaining cash expenditures resulting from the restructuring are estimated to be $2.3 million and relate primarily to facility lease abandonment losses. Excluding facility lease abandonment losses, we estimate that these costs will be substantially incurred within one year of the restructuring. We have substantially completed our restructuring efforts initiated in conjunction with the restructuring announcement made during fiscal 2002; however, there can be no assurance future restructuring efforts will not be necessary. Facility Lease Abandonment. Facility lease abandonment losses relate to lease obligations for excess office space we have vacated as a result of the restructuring plan. We recorded $2.1 million in business restructuring expenses in relation to a site consolidation during fiscal 2002. Total lease commitments include the remaining lease liabilities, leasehold improvements required to sub lease the vacated space and brokerage commissions. The estimated costs of vacating these leased facilities, including estimated costs to sublease, were based on market information and trend analysis as estimated by management. However, we expect actual results may differ from these estimates in the near term, and such differences could be material to our financial statements. Of the $2.1 million charge recorded during fiscal 2002, approximately $1.8 million relates to the base rent and fixed operating expenses of the vacated space through the lease term which ends April 15, 2006. Asset Impairments. Asset impairments recorded pursuant to Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of", relate to the impairment of computer equipment, software, furniture and fixtures and certain leasehold improvements. The majority of fixed assets were impaired as a direct result of our restructuring plan, reducing our workforce by 25%, and decision to vacate certain office space, resulting in an impairment of approximately $836,000 during fiscal 2002. The remaining fixed assets considered impaired of approximately $372,000 relate to IT infrastructure and unique test equipment that can no longer be utilized based on the current product roadmap and business environment. Employee Separation and Other Costs. Employee separation and other costs, which include severance, related taxes, outplacement and other benefits, payable to approximately 40 terminated employees, totaled approximately $1.6 million during fiscal 2002. Employee groups impacted by the restructuring plan include personnel in positions throughout the company, primarily in the sales, marketing and general administrative functions. The Company completed its restructuring plan and is not currently planning any further restructuring efforts, however, there can be no assurance future restructuring efforts will not be necessary. 4. LINE OF CREDIT AND DEBT: In January 2001, the Company extended its existing line of credit with its bank. The committed revolving line is an advance of up to $3.0 million with a borrowing base of 80% of eligible accounts receivable. The line of credit matures on February 1, 2003 at which time we intend to extend the term accordingly. The amount available for borrowings under the line of credit arrangement at any point in time is based upon eligible accounts receivable and inventory balances. Borrowings under the equipment line may be used to purchase general operating equipment. F-13 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interest accrues and is payable monthly on outstanding balances under these lines at the bank's prime rate. There were no outstanding borrowings under the equipment line at October 31, 2001 and 2002. The amount available to borrow against our credit line was $3.0 million as of October 31, 2002. Borrowings under the line of credit and equipment line arrangements are collateralized by substantially all assets of the Company, excluding intellectual property. Under the provisions of these credit arrangements, the Company is prohibited from declaring or paying dividends. Additionally, the Company must meet certain quarterly minimum financial covenants, including minimum tangible net worth, liquidity ratio and profitability covenants. 5. COMMITMENTS AND CONTINGENCIES: Leases The Company leases office space and equipment under long-term operating lease agreements that expire on various dates through April 15, 2006. Rental expense under these agreements was approximately $1.6 million, $2.3 million and $2.2 million for the years ended October 31, 2000, 2001 and 2002, respectively. In April 2000, Crossroads relocated its headquarters in accordance with an agreement to lease approximately 63,548 square feet of general office, laboratory, and administrative space in Austin, Texas. The term of the lease agreement is six years, from April 1, 2000 through April 15, 2006, and represents a lease commitment of $1.9 million per year through the lease term. On August 1, 2002, the Company abandoned 18,180 square feet of our headquarter facility pursuant to the execution of our business restructuring plan. The site consolidation resulted in a $2.1 million facility lease loss charge, of which $1.8 million relates to the base rent and fixed operating expenses of the vacated space through the end of the lease term on April 15, 2006. In conjunction with entering into the lease agreement, Crossroads signed an unconditional, irrevocable letter of credit with a bank for $500,000, which is secured by a $3.0 million line of credit. The minimum annual future rentals under the terms of these leases at October 31, 2002 are as follows (in thousands):
FISCAL YEAR 2003......................................................... $ 2,114 2004......................................................... 2,131 2005......................................................... 1,908 2006......................................................... 954 Thereafter................................................... -- ----------- $ 7,107 ===========
Legal Proceedings Intellectual Property Litigation On March 31, 2000, the Company filed a lawsuit against Chaparral Network Storage, Inc. ("Chaparral") alleging that Chaparral has infringed one of its patents (5,941,972, hereinafter the "972 patent") with some of their products. In September 2001, the jury found that the '972 patent was valid and that all of Chaparral's RAID and router products that contained LUN Zoning had infringed all claims of the Crossroads '972 patent. The federal judge in this matter issued a permanent injunction against Chaparral from manufacturing any RAID or router product that contained LUN Zoning or access controls and assessed punitive damages. As a result, the Company was awarded damages with a royalty amount of 5% for Chaparral's router product line and 3% for their RAID product line. Chaparral has appealed the judgment against it, contending that the '972 patent is invalid and not infringed. The Company intends to vigorously defend the appeal. On April 14, 2000, the Company filed a lawsuit against Pathlight Technology, Inc. alleging that Pathlight has infringed one of its patents with their SAN Data Gateway Router. Pathlight was subsequently acquired by ADIC on F-14 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS May 11, 2001. In June 2001, ADIC paid the Company $15.0 million in connection with the settlement of this lawsuit, this payment was recognized as contra operating expense in the statement of operations for the year ended October 31, 2001. In connection with the settlement of the lawsuit, the Company granted ADIC a non-exclusive license under the '972 patent. On May 19, 2000, Chaparral filed a counter-suit against us alleging tortious interference with prospective business relations. The Company moved to have this matter dismissed, which the judge ordered, with prejudice, in April 2001. Securities Class Action Litigation The Company and several of its officers and directors were named as defendants in several class action lawsuits filed in the United States District Court for the Western District of Texas. The plaintiffs in the actions purport to represent purchasers of our common stock during various periods ranging from January 25, 2000 through August 24, 2000. The Court consolidated the actions and appointed a lead plaintiff under the Private Securities Litigation Reform Act of 1995. The amended consolidated complaint was filed in February 2001. On November 22, 2002, the court granted our motion for summary judgment, concluding that the plaintiffs failed to demonstrate an essential element to their claim of securities fraud. The Company anticipates that the plaintiffs will appeal this judgment to the Fifth Circuit Court of Appeals. The plaintiffs are seeking unspecified amounts of compensatory damages, interests and costs, including legal fees. The Company denies the allegations in the complaint and will continue to defend itself vigorously. The class action lawsuit is still at an early stage. Consequently, it is not possible at this time to predict whether we will incur any liability or to estimate the damages, or the range of damages, if any, that we might incur in connection with this lawsuit. Our inability to prevail in this action could have a material adverse effect on our future business, financial condition and results of operations. Derivative State Action On November 21, 2001, a derivative state action was filed in the 261st District Court of Travis County, Texas on behalf of Crossroads by James Robke and named several of its officers and directors as defendants. The derivative state action is based upon the same general set of facts and circumstances outlined above in connection with the purported securities class action litigation. The derivative state action alleges that certain of the individual defendants sold shares while in possession of material inside information in purported breach of their fiduciary duties to Crossroads. The derivative state action also alleges waste of corporate assets. On January 28, 2002, the Company filed an answer and general denial to the derivative state action. The Company believes the allegations in the derivative state action are without merit and intends to defend itself vigorously. The derivative state action is still at an early stage. Consequently, it is not possible at this time to predict whether we will incur any liability or to estimate the damages, or the range of damages, if any, that the Company might incur in connection with this action. The Company's inability to prevail in this action could have a material adverse effect on its future business, financial condition and results of operations. Other From time to time, the Company may be involved in litigation relating to claims arising out of its ordinary course of business. Management believes that, other than the matters described above, there are no claims or actions pending or threatened against the Company, the ultimate disposition of which would have a material impact on the Company's financial position, results of operations or cash flows. If the Company reduces or cancels production orders with its third party contract manufacturer, the Company may be required to reimburse its contract manufacturer for materials purchased on its behalf in the normal course of business. 6. REDEEMABLE CONVERTIBLE PREFERRED STOCK: Conversion All shares of the Company's redeemable convertible preferred stock were converted into common stock of the Company on October 19, 1999, the effective date of the Company's initial public offering, at the rate of 1.5 to 1. F-15 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Authorized Shares The Company has the authority to issue 25,000,000 million shares of preferred stock, par value $.001 per share, subject to the designation of the board of directors. At October 31, 2001 and 2002, no shares of preferred stock were issued or outstanding. 7. STOCKHOLDERS' EQUITY: Deferred Compensation In connection with the grant of certain stock options to our employees and directors, the Company recorded deferred compensation aggregating $22.6 million since fiscal 1998, representing the difference between the deemed fair value of the common stock underlying these options and their exercise price at the date of grant. Such amount is presented as a reduction of stockholders' equity and is being amortized over the vesting period of the applicable individual options, generally four years. Deferred compensation expense is decreased in the period of forfeiture for any accrued but unvested compensation arising from the early termination of an option holder's services. Of the total deferred compensation amount, approximately $22.3 million has been amortized or cancelled as of October 31, 2002. The Company allocates stock-based compensation to specific line items within the statement of operations based on the classification of the employees who received the benefit. Stock-based compensation for the periods indicated was allocated as follows (in thousands):
YEAR ENDED OCTOBER 31, ------------------------------------ 2000 2001 2002 ---------- ---------- ---------- Cost of revenue ...................... $ 288 $ 123 $ 84 Sales and marketing .................. 4,373 215 481 Research and development ............. 528 440 369 General and administrative ........... 22,501 6,283 3,640 ---------- ---------- ---------- Total stock-based compensation ..... $ 27,690 $ 7,061 $ 4,574 ========== ========== ==========
We expect to amortize the remaining amounts of deferred stock-based compensation as of October 31, 2002 in the periods indicated (in thousands):
YEAR ENDED OCTOBER 31, ------------------------------------------ 2003 2004 TOTAL ------------ ------------ ------------ Cost of revenue ........................ $ 21 $ -- 21 Sales and marketing .................... 59 2 61 Research and development ............... 92 2 94 General and administrative ............. 129 6 135 ------------ ------------ ------------ Total stock-based compensation ...... $ 301 $ 10 $ 311 ============ ============ ============
8. STOCK INCENTIVE/PURCHASE PLANS: 1999 Stock Incentive Plan The 1999 Stock Incentive Plan the ("1999 Plan") is the successor program to the Company's 1996 Stock Option/Stock Issuance Plan (the "1996 Plan"). The 1999 Plan became effective in October 1999. At that time, all outstanding options under the 1996 Plan transferred to the 1999 Plan, and no further options will be granted under the 1996 Plan. F-16 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The 1999 Plan provides for a maximum number of common shares to be issued of 8,838,160. Accordingly, the Company has reserved a sufficient number of shares of common stock to permit exercise of options or issuance of common shares in accordance with the terms of the 1999 Plan. The share reserve under the 1999 Plan will automatically increase on the first trading day in January of each calendar year, beginning with calendar year 2001, by an amount equal to four percent (4%) of the total number of shares of common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 1,000,000 shares. Non-Statutory stock options may be granted to Company employees, members of the board, and consultants at the exercise price determined by the board of directors or by the Company's compensation committee. Options granted under the plan may have a term of no more than 10 years. Stock appreciation rights may be issued to certain officers subject to Section 16 of the Securities Exchange Act of 1934 under the discretionary option grant program. These rights will provide the holders with the election to surrender their outstanding options for a payment from us equal to the fair market value of the shares subject to the surrendered options less the exercise price payable for those shares. The Company may make the payment in cash or in shares of common stock. None of the options originally issued under the 1996 Plan have any stock appreciation rights. The following table summarizes stock option activity under all of the Plans for all periods presented:
YEAR ENDED OCTOBER 31, ------------------------------------------------------------------------------------------- 2000 2001 2002 ---------------------------- ---------------------------- ----------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------------ ------------ ------------ ------------ ------------ ------------- Outstanding at beginning of period ................. 1,470,336 $ 6.73 3,432,571 $ 36.27 4,396,063 $ 11.16 Granted ...................... 2,825,895 45.65 2,924,400 4.64 3,306,837 2.46 Exercised .................... (438,990) 0.64 (117,039) 1.30 (94,547) 1.08 Forfeited .................... (424,668) 33.21 (1,843,869) 48.20 (2,218,968) 12.03 ------------ ------------ ------------ Outstanding at end of period .................... 3,432,571 $ 36.27 4,396,063 $ 11.16 5,389,385 $ 5.64 ============ ============ ============ Options exercisable at the End of the period ......... 841,371 $ 9.16 1,215,635 $ 16.06 2,744,818 $ 6.57 ============ ============ ============
At October 31, 2002 the Company had the right to repurchase 5,729 shares of outstanding common stock issued upon exercise of stock options with a weighted average exercise price of $1.08. The Company has elected to follow the provisions prescribed by APB Opinion No. 25 and its related interpretations, for financial reporting purposes, whereby the difference between the exercise price and the fair value at the date of grant is recognized as compensation expense (see Note 7, Stockholders' Equity - - Deferred Compensation). The Company has adopted the disclosure provisions of SFAS No. 123. Accordingly, no compensation expense has been recognized for the 1999 Plan under the provisions of SFAS No. 123. Had compensation cost for the 1999 Plan been determined based upon the fair value at the grant date for employee awards under the 1999 Plan consistent with the methodology prescribed under SFAS No. 123, the Company's net loss would have been increased or decreased, respectively, to the following pro forma amounts (in thousands):
YEAR ENDED OCTOBER 31, -------------------------------------------- 2000 2001 2002 ------------ ------------ ------------ Net loss -- as reported .................................... $ (51,028) $ (51,087) $ (25,489) Net loss -- pro forma ...................................... $ (43,242) $ (49,630) $ (33,141) Basic and diluted net loss per share -- as reported ........ $ (1.93) $ (1.86) $ (0.95) Basic and diluted net loss per share -- pro forma .......... $ (1.63) $ (1.81) $ (1.23) Pro forma compensation expense ............................. $ (19,904) $ (5,604) $ (12,226) Cumulative pro forma compensation expense since inception .. $ (21,400) $ (27,004) $ (39,230)
F-17 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED OCTOBER 31, ------------------------------------------------ 2000 2001 2002 -------------- -------------- -------------- Weighted average grant-date fair value of options granted: Exercise price equal to market price of stock on the grant date: Aggregate value ............................................... $ 68,757 $ 7,204 $ 4,969 ============== ============== ============== Per share value ............................................... $ 33.48 $ 3.39 $ 1.84 ============== ============== ============== Exercise price less than the market price of stock on the grant date: Aggregate value ............................................... $ 60,571 $ 2,719 $ 1,797 ============== ============== ============== Per share value ............................................... $ 78.95 $ 5.44 $ 2.06 ============== ============== ============== Exercise price greater than the market price of stock on the grant date: Aggregate value ............................................... $ -- $ 1,538 $ -- ============== ============== ============== Per share value ............................................... $ -- $ 5.13 $ -- ============== ============== ==============
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2000, 2001 and 2002: no dividend yield; risk-free interest rate of 6.07%, 4.64% and 3.87%, respectively; expected volatility of 120%, 120% and 105%, respectively; expected lives of four years. The following table summarizes information with respect to stock options outstanding under all plans at October 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------------- ------------------------------------- NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES OUTSTANDING REMAINING YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ------------------------ ------------ ---------------- ---------------- ------------------ --------------- $ 0.23 - $ 0.23 19,688 5.3 $ 0.23 19,688 $ 0.23 $ 0.50 - $ 0.71 247,095 9.5 $ 0.65 169,995 $ 0.69 $ 0.83 - $ 1.00 132,529 7.6 $ 0.90 91,978 $ 0.93 $ 1.33 - $ 1.55 1,579,447 9.5 $ 1.55 352,566 $ 1.53 $ 2.51 - $ 3.54 1,357,677 6.3 $ 2.65 805,752 $ 2.62 $ 4.49 - $ 6.49 1,547,898 5.8 $ 5.03 986,846 $ 4.87 $ 6.94 - $ 10.00 212,838 7.7 $ 8.72 128,344 $ 8.86 $ 11.25 - $ 13.81 12,730 7.8 $ 13.30 6,364 $ 13.30 $ 18.00 - $ 25.25 37,090 6.9 $ 18.59 35,777 $ 18.34 $ 39.88 - $ 39.88 152,926 7.5 $ 39.88 86,634 $ 39.88 $ 64.88 - $ 84.50 70,557 6.5 $ 71.48 49,056 $ 71.46 $ 103.25 - $ 142.75 18,910 7.4 $ 128.61 11,818 $ 128.61 ------------ ------------- --------------- ------------------ --------------- $ 0.00 - $ 142.75 5,389,385 7.7 $ 5.64 2,744,818 $ 6.57 ============ ============= =============== ================== ===============
Options granted to non-employees are recorded at fair value in accordance with SFAS No. 123. These options were issued pursuant to the 1996 Plan and 1999 Plan and are reflected in the disclosures above. The Company granted 5,000 options to non-employees for consulting services in fiscal 2000 at a weighted average exercise price of $6.94 and did not grant any options to non-employees for consulting services in fiscal 2001 and 2002. The 1999 Plan includes change in control provisions that may result in the accelerated vesting of outstanding option grants and stock issuances. The 1999 Plan will terminate no later than September 30, 2009. OPEN - INSERT RESTRICTED SHARE LANGUAGE BASED ON MILESTONES Employee Stock Purchase Plan The Company's Employee Stock Purchase Plan (the "ESPP") became effective immediately upon the effective date of the Company's initial public offering. The ESPP is designed to allow eligible employees to purchase shares of common stock, at semi-annual intervals, with their accumulated payroll deductions. The Company has reserved F-18 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 450,000 shares of common stock for issuance under the ESPP. The reserve will automatically increase on the first trading day of January in each calendar year, beginning in calendar year 2001, by an amount equal to one percent (1%) of the total number of outstanding shares of common stock on the last trading day of December in the prior calendar year. In no event will any such annual increase exceed 250,000 shares. Eligible employees may contribute up to 15% of his or her base salary through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% of the fair market value per share on the participant's entry date into the eligible offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of May and November each year. However, a participant may not purchase more than 750 shares on any one semi-annual purchase date, and no more than 75,000 shares may be purchased in total by all participants on any one semi-annual purchase date. Should the Company be acquired by merger or sale of substantially all of our assets or more than fifty percent of its voting securities, then all outstanding purchase rights will automatically be exercised immediately prior to the effective date of the acquisition. The purchase price will be equal to 85% of the market value per share on the participant's entry date into the offering period in which an acquisition occurs or, if lower, 85% of the fair market value per share immediately prior to the acquisition. The ESPP will terminate no later than the last business day of November 2009. The board may at any time amend, suspend or discontinue the ESPP. However, certain amendments may require stockholder approval. 9. INCOME TAXES: As of October 31, 2001 and 2002, the Company had federal net operating loss carryforwards of approximately $55.6 million and $70.4 million, respectively, and research and experimentation tax credit carryforwards of approximately $751,000 and $1.2 million, respectively. The Company's net operating loss carryforward is subject to a limitation on its utilization. Under the provisions of SFAS No. 109, "Accounting for Income Taxes," the components of the net deferred tax amounts recognized in the accompanying balance sheets are as follows (in thousands):
OCTOBER 31, ---------------------------- 2001 2002 ------------ ------------ Deferred tax assets: Net operating losses ..................................... $ 20,033 $ 26,752 Inventory and other reserves ............................. 6,540 8,362 Basis of property and equipment .......................... 370 832 Research and experimentation credit ...................... 751 1,196 Net deferred tax assets before valuation allowance ......... 27,694 37,142 Valuation allowance ........................................ (27,694) (37,142) ------------ ------------ Net deferred tax asset ..................................... $ -- $ -- ============ ============
Due to the uncertainty surrounding the realization of the benefits of its favorable tax attributes in future tax returns, the Company has placed a valuation allowance against all of its otherwise recognizable net deferred tax asset. Following is a reconciliation of the amount of the income tax benefit that would result from applying the statutory Federal income tax rates to pretax loss and the reported amount of income tax benefit:
YEAR ENDED OCTOBER 31, -------------------------------------------------- 2000 2001 2002 -------------- -------------- -------------- Tax benefit at statutory rate of 34% ... $ 18,370 $ 18,391 $ 8,666 Research and experimentation credit .... 19 276 445 Non-deductible goodwill ................ (4,111) (12,487) (297) Other .................................. 119 2,191 634 Net increase in valuation allowance .... (14,397) (8,371) (9,448) -------------- -------------- -------------- $ -- $ -- $ -- ============== ============== ==============
F-19 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Under the Tax Reform Act of 1986, the amount of and the benefit from net operating losses that can be carried forward may be impaired in certain circumstances. Events that may cause changes in the Company's tax carryovers include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. Certain of the Company's operating losses that can be utilized in any one taxable year for federal tax purposes have been limited by one or more such ownership changes. For federal income tax purposes, net operating loss carryforwards begin to expire in 2011. 10. RELATED PARTY TRANSACTIONS: Notes Receivable During May 1999, the Company's board of directors approved the acceptance of full recourse notes in the amount of approximately $442,000 from certain of the Company's officers as consideration for the exercise of 1,014,999 options. The notes accrue interest at 7% per year, compounded semi-annually and principal and accrued interest is due in one lump sum in 2003. In March 2000, the Company repurchased 232,500 unvested shares for approximately $123,000 and subsequently collected $114,000 in principal and interest upon the retirement of the Company's former president and chief operating officer. In June 2000, the Company repurchased 88,125 unvested shares for approximately $52,000 and collected approximately $59,000 in principal and interest upon the retirement of the Company's former vice-president of sales. In January 2001, the Company repurchased 13,594 unvested shares for approximately $9,000 and collected approximately $16,000 in principal and interest upon the retirement of the Company's former vice-president of engineering. The balance of these full recourse notes was approximately $126,000 as of October 31, 2002. In October 1999, the Company loaned an officer of the Company $100,000 for personal reasons, not equity related, in exchange for a full recourse promissory note due in full, with accrued interest, in 6 years or upon the date in which the officer ceases to remain in service. The note accrues interest at 7% per year, compounded annually and principal and accrued interest is due in one lump sum on December 31, 2006. During fiscal 2002, the Company forgave the balance of this note of approximately $120,000 due under this note as part of a severance agreement entered into as a result of the Company's restructuring plan. In July 2000, the Company loaned an employee of the Company $50,000 for personal reasons, not equity related, in exchange for a full recourse promissory note due in full, with accrued interest, in 2 years or upon the date in which the employee ceases to remain in service. The note accrues interest at 10.5% per year, compounded semi-annually and principal and accrued interest was due in one lump sum on July 1, 2002. The terms on this note were extended and the balance is approximately $63,000 as of October 31, 2002. In April 2001, the Company loaned an officer of the Company $45,000 for personal reasons, not equity related, in exchange for a full recourse promissory note due in full, with accrued interest, in 6 months or upon the date in which the officer ceases to remain in service. The note accrues interest at 7.5% per year, compounded semi-annually and principal and accrued interest was due in one lump sum on October 16, 2001. During fiscal 2002, the Company collected the balance of approximately $47,000 due under this note. In May 2001, the Company loaned an employee of the Company $25,000 for personal reasons, not equity related, in exchange for a full recourse promissory note due in full, with accrued interest, in 18 months or upon the date in which the employee ceases to remain in service. The note accrues interest at 7.5% per year, compounded semi-annually and principal and accrued interest was due in one lump sum on November 14, 2002. During fiscal 2002, the Company collected the balance of approximately $26,000 due under this note. F-20 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest totaled $34,000, $0 and $0 during fiscal years 2000, 2001 and 2002, respectively. Cash paid for taxes totaled $23,000, $97,000 and $114,000 during fiscal years 2000, 2001 and 2002, respectively. 12. EMPLOYEE BENEFITS: In 1996, the Company established the Crossroads Systems, Inc. 401(k) Savings Plan (the "Savings Plan"), which is a qualified plan under section 401(k) of the Internal Revenue Code. All employees who have attained 18 years of age are eligible to enroll in the Savings Plan. The Company may make matching contributions to those employees participating in the Savings Plan based upon Company productivity and profitability. Company contributions vest over a period of six years. In October 2000, the Company adopted a new 401(k) Savings Plan that meets all of the criteria set forth above in the Savings Plan. The Company made no matching contributions under any plan for the years ended October 31, 2000, 2001 and 2002. 13. STOCKHOLDER RIGHTS PLAN: On August 21, 2002, the Company's Board of Directors approved, adopted and entered into a Stockholder Rights Plan ("Rights Plan"). The Rights Plan is similar to plans adopted by many other companies, and was not adopted in response to any attempt to acquire the Company, nor was the Company aware of any such efforts at the time of adoption. The Rights Plan is designed to enable the Company's stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire the Company. Adoption of the Rights Plan is intended to deter coercive takeover tactics including the accumulation of shares in the open market or through private transactions and to prevent an acquiror from gaining control of the Company without offering a fair price to all of the Company's stockholders. Under the Rights Plan, the Company declared and paid a dividend of one right for each share of common stock held by stockholders of record as of the close of business on September 3, 2002 (the "Rights"). Each Right initially entitles stockholders to purchase one unit of a share of the Company's preferred stock at $12 per share. However, the Rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires or announces a tender or exchange offer that would result in the acquisition of 15 % or more of the Company's common stock while the Rights Plan remains in place, then, unless the Rights are redeemed by the Company for $0.01 per right, all Rights holders except the acquirer will be entitled to acquire the Company's common stock at a significant discount. The Rights are intended to enable all stockholders to realize the long-term value of their investment in the Company. The Rights will not prevent a takeover attempt, but should encourage anyone seeking to acquire the Company to negotiate with the Board of Directors prior to attempting a takeover. The Rights will expire on September 3, 2012. 14. SUBSEQUENT EVENTS: In January 2003, the Company announced that its Board of Directors approved a voluntary stock option exchange program (the "Program") for employees. Under the Program, employees were offered the opportunity to exchange outstanding stock options with exercise prices equal to or greater than $0.01 per share for new stock options. Participating employees will exchange outstanding stock options for new stock options exercisable for a number of shares determined by an exchange ratio of either 1 for 3, 1 for 4, or 1 for 5, depending on the exercise price of the exchanged stock option. The Company expects to grant the new options to purchase shares of its common stock on or promptly after August 12, 2003, which is the first business day that is six months and one day after the cancellation of the exchanged options. F-21 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA:
QUARTER ------------------------------------------------------------ FISCAL FIRST SECOND THIRD FOURTH YEAR 2001 ------------ ------------ ------------ ------------ ------------ Total revenue ................ $ 9,974 $ 10,214 $ 8,430 $ 8,712 $ 37,330 Gross profit ................. $ 5,098 $ 4,077 $ 3,190 $ 2,952 $ 15,317 Net loss ..................... $ (10,740) $ (11,618) $ (20,782) $ (7,947) $ (51,087) Basic and diluted net loss per share ................ $ (0.39) $ (0.42) $ (0.75) $ (0.30) $ (1.86)
QUARTER ------------------------------------------------------------ FISCAL FIRST SECOND THIRD FOURTH YEAR 2002 ------------ ------------ ------------ ------------ ------------ Total revenue ................ $ 9,197 $ 9,064 $ 7,495 $ 8,232 $ 33,988 Gross profit ................. $ 3,321 $ 3,079 $ 2,405 $ 2,522 $ 11,327 Net loss ..................... $ (6,394) $ (5,479) $ (8,229) $ (5,387) $ (25,489) Basic and diluted net loss per share ................ $ (0.23) $ (0.20) $ (0.31) $ (0.21) $ (0.95)
F-22 CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors and Stockholders of Crossroads Systems, Inc. and Subsidiaries Our audits of the consolidated financial statements referred to in our report dated November 26, 2002 appearing in this Annual Report on Form 10-K of Crossroads Systems, Inc. and Subsidiaries also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all materials respects, the information set forth therein when read in conjunction with the related, consolidated financial statements. PRICEWATERHOUSECOOPERS LLP Austin, Texas November 26, 2002 S-1 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF OF PERIOD EXPENSES DEDUCTIONS PERIOD --------------- --------------- --------------- --------------- Year ended October 31, 2000: Allowance for doubtful accounts ................ $ 95 $ 136 $ -- $ 231 Allowance for excess and obsolete inventory .... $ 331 $ 2,071 $ (313) $ 2,089 Year ended October 31, 2001: Allowance for doubtful accounts ................ $ 231 $ 157 $ -- $ 388 Allowance for excess and obsolete inventory .... $ 2,089 $ 1,021 $ (1,330) $ 1,780 Year ended October 31, 2002: Allowance for doubtful accounts ................ $ 388 $ (125) $ 14 $ 277 Allowance for excess and obsolete inventory .... $ 1,780 $ 520 $ (1,311) $ 989
S-2 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1* Sixth Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 (SEC File No. 333-85505) (the "IPO Registration Statement") and incorporated herein by reference) 3.2* Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO Registration Statement and incorporated herein by reference) 4.1* Specimen certificate for shares of common stock (filed as Exhibit 4.1 to the IPO Registration Statement and incorporated herein by reference) 10.1* Form of Indemnity Agreement between Registrant and each of its directors and executive officers (filed as Exhibit 10.1 to the IPO Registration Statement and incorporated herein by reference) 10.2* Crossroads Systems, Inc. 1999 Employee Stock Purchase Plan (filed as Exhibit 10.3 to the IPO Registration Statement and incorporated herein by reference) 10.3* Fourth Amended and Restated Investors Rights Agreement dated August 6, 1999 by and among Registrant and certain purchasers of Registrant's preferred stock (filed as Exhibit 10.4 to the IPO Registration Statement and incorporated herein by reference) 10.4*+ OEM Agreement dated April 23, 1998 by and between Registrant and Storage Technology Corporation (filed as Exhibit 10.5 to the IPO Registration Statement and incorporated herein by reference) 10.5* Form of Stock Pledge Agreement by and between Registrant and Reagan Y. Sakai (filed as Exhibit 10.12 to the IPO Registration Statement and incorporated herein by reference) 10.6* Form of Note Secured by Stock Pledge Agreement issued to Registrant by each of James H. Moore, Reagan Y. Sakai (filed as Exhibit 10.13 to the IPO Registration Statement and incorporated herein by reference) 10.7* Loan Modification Agreement dated December 31, 2000 by and between Registrant and Silicon Valley Bank 10.8* Office Building Lease dated October 8, 1999 by and between Registrant and Maplewood Associates, L.P. (filed as Exhibit 10.15 to the IPO Registration Statement and incorporated herein by reference) 10.9* CP4200 License Agreement dated April 15, 1998 by and between Registrant and Hewlett-Packard Company (filed as Exhibit 10.16 to the IPO Registration Statement and incorporated herein by reference) 10.10* Crossroads Systems, Inc. Amended and Restated 1999 Stock Incentive Plan (filed as Exhibit 99.(d)(2) to the Registrant's Schedule TO/I (SEC File No. 5-57603) and incorporated herein by reference) 10.11* Rights Agreement, dated as of August 21, 2002, by and between Registrant and American Stock Transfer & Trust Company, which includes the form of Certificate of Designation for the Series A junior participating preferred stock as Exhibit A, the form of Rights Certificate as Exhibit B and the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C (field as Exhibit 4 to the Registrant's Current Report on Form 8-K dated August 21, 2002 and incorporated herein by reference) 10.12 Employment Agreement, dated as of January 6, 2003 by and between Registrant and Andrea Wenholz 10.13 Fiscal Year 2002 Stock Bonus Incentive Program Letter Agreement, dated as of November 13, 2001, from Registrant to Rob Sims
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.14 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated November 4, 2002 from Registrant to Rob Sims 10.15 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated November 20, 2002 from Registrant to Brian R. Smith 10.16 Fiscal Year 2003 Stock Bonus Incentive Program Letter Agreement, dated January 6, 2003, from Registrant to Andrea Wenholz 21.1 Subsidiaries of the Registrant 23.1 Consent of PricewaterhouseCoopers LLP 24.1 Power of Attorney, pursuant to which amendments to this Form 10-K may be filed, is included on the signature page contained on Part IV of this Form 10-K 99.1 Certification to the Securities and Exchange Commission, as required by Section 906 of the Sarbanes-Oxley Act of 2002
* Incorporated herein by reference to the indicated filing + Confidential treatment previously granted EX-10.12 3 h02058exv10w12.txt EMPLOYMENT AGREEMENT - ANDREA WENHOLZ EXHIBIT 10.12 EMPLOYMENT AGREEMENT This Employment Agreement (this "AGREEMENT") is made and entered into effective as of January 6, 2003, by and between Crossroads Systems, Inc., a Delaware corporation (the "COMPANY"), and Andrea Wenholz, an individual (the "EXECUTIVE"). RECITALS WHEREAS, the Company desires to hire Executive and Executive desires to become employed by the Company; and; WHEREAS, the Company and Executive have determined that it is in their respective best interest to enter into this Agreement on the terms and conditions as set forth herein. AGREEMENT NOW, THEREFORE, in consideration of the premises and the mutual covenants and promises contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. EMPLOYMENT TERMS AND DUTIES 1.1 EMPLOYMENT. The Company hereby agrees to employ Executive, and Executive hereby accepts employment by the Company, upon the terms and conditions set forth in this Agreement. 1.2 DUTIES AND OUTSIDE ACTIVITIES. 1.2.1 DUTIES. Executive shall serve as Chief Financial Officer and shall report directly to the Company's Chief Executive Officer. Executive shall have the authority and perform the duties customarily associated with her title and office, together with such additional duties of a senior executive nature and commensurate with her title as may from time to time be assigned by the Chief Executive Officer. During the term of Executive's employment hereunder, Executive shall devote her full working time and efforts to the performance of her duties and the furtherance of the interests of the Company and shall not be otherwise be employed except for permitted outside activities as set forth in Section 1.2.2. 1.2.2 PERMITTED OUTSIDE ACTIVITIES. Executive may serve as a director or trustee of other organizations or engage in charitable, civic and/or governmental activities, provided that such service and activities do not prevent Executive from performing the duties required of Executive under this Agreement, as determined in the judgment of the Company, and further provided that Executive obtains written consent for all such activities from the Company, which consent will not be unreasonably withheld. Executive also may engage in personal activities, including, without limitation, personal investments, provided that such activities do not, in the judgment of the Company, impair or interfere with Executive's ability to perform the duties required of Executive under this Agreement. 1.3 TERM. The Company's employment of Executive under this Agreement shall commence on January 6, 2003 (the "HIRE DATE") and shall continue on an "at-will" basis. Executive and the Company understand and agree that the employment relationship between Executive and the Company is "at-will" and may be terminated at any time, upon written notice to the other party, with or without cause, at the option of either the Company or Executive and subject to the provisions of the special severance benefit program set forth in that certain letter agreement between the Company and Executive dated DATE, 2003 attached hereto as Exhibit A (the "SEVERANCE BENEFIT PLAN"). The time period for which Executive is actually employed under this Agreement shall be referred to herein as the "EMPLOYMENT TERM." 1.4 COMPENSATION AND BENEFITS. 1.4.1 BASE SALARY. In consideration of the services rendered to the Company hereunder by Executive and Executive's covenants hereunder and in the Company's Proprietary Information and Inventions Agreement, the Company shall, during the Employment Term, pay Executive a base salary in the amount of $11,666.67 per month ($140,000 annualized) (the "BASE SALARY"), less statutory deductions and withholdings, payable in accordance with the Company's regular payroll practices. 1.4.2 BENEFITS PACKAGE. In addition to the Base Salary, during the Employment Term, Executive shall be eligible to receive such employee benefits and holidays as may be in effect from time to time as are afforded to other executives of the Company. 1.4.3 VACATION. Executive shall be eligible for the Company's executive vacation plan. 1.4.4 EXPENSES. The Company shall, upon receipt from Executive of supporting receipts to the extent required by applicable income tax regulations and the Company's reimbursement policies, reimburse Executive for all out-of-pocket business expenses reasonably incurred by Executive in connection with her employment hereunder. 1.5 STOCK OPTION. Subject to approval by the Company's Board of Directors, the Company shall grant to Executive, in accordance with the terms of the Crossroads Systems, Inc. 1999 Stock Incentive Plan (the "PLAN"), a non-statutory stock option to purchase a total of 140,000 shares of the Company's common stock ("COMMON STOCK") at an exercise price equal to the fair market of the Common Stock on the Hire Date (the "OPTION"). The Option shall vest over four (4) years in accordance with the following vesting schedule: twenty-five percent (25%) of the Option shall become exercisable upon completion of one year of Service (as defined in the Plan) measured from the Hire Date and the balance of the Option shall vest in twelve (12) successive equal quarterly installments upon the completion of each additional quarter of Service during the three (3)-year period following the first anniversary of the Hire Date. 1.6 BONUS PLAN. Executive will be eligible to participate in the Company's bonus plans as may be in effect from time to time and as afforded to other executives of the Company. 1.7 TERMINATION AND SEVERANCE. 1.7.1 TERMINATION. Executive's employment and this Agreement may be terminated at any time, upon written notice to the other party, with or without cause, at the option of either the Company or Executive subject to the provisions set forth in the Severance Benefit Plan. 1.7.2 SEVERANCE BENEFITS. Executive shall be entitled to the severance benefits set forth in the Severance Benefit Plan. 1.7.3 WARN ACT OFFSET. In the event that Executive's Involuntary Termination (as defined in the Severance Benefit Plan) is covered by the Worker Adjustment Retraining 2 Notification Act ("WARN") at the time of Executive's termination, or is deemed to be covered by WARN retrospectively within 90 days after Executive's termination, the amount of any severance benefit Executive is entitled to receive pursuant to the Severance Benefit Plan shall be reduced by an amount equal to any payments the Company is required to provide Executive under WARN or by the amount of pay Executive receives during any portion of WARN's 60-day notice period where Executive does not perform any work for the Company. 2. PROTECTION OF COMPANY'S PROPRIETARY INFORMATION AND INVENTIONS. This Agreement, and Executive's employment hereunder, is contingent upon Executive's execution of the Company's Confidentiality, Proprietary Information and Inventions Agreement, attached hereto as Exhibit B and incorporated herein by this reference, before Executive begins working for the Company. The Confidentiality, Proprietary Information and Inventions Agreement survives the termination of this Agreement, the Employment Term and/or the Executive's employment with the Company. 3. REPRESENTATIONS AND WARRANTIES BY EXECUTIVE Executive represents and warrants to the Company that (i) this Agreement is valid and binding upon and enforceable against her in accordance with its terms, (ii) Executive is not bound by or subject to any contractual or other obligation that would be violated by her execution or performance of this Agreement, including, but not limited to, any non-competition agreement presently in effect, and (iii) Executive is not subject to any pending or, to Executive's knowledge, threatened claim, action, judgment, order, or investigation that could adversely affect her ability to perform her obligations under this Agreement or the business reputation of the Company. Executive has not entered into, and agrees that she will not enter into, any agreement either written or oral in conflict herewith. 4. MISCELLANEOUS 4.1 NOTICES. All notices, requests, and other communications hereunder must be in writing and will be deemed to have been duly given only if (i) delivered personally against written receipt, (ii) delivered by facsimile transmission with answer back confirmation, (iii) mailed (postage prepaid by certified or registered mail, return receipt requested), (iv) delivered by overnight courier to the parties, or (v) delivered by electronic communication (as set forth below) at the following addresses, facsimile numbers, or electronic mail addresses: If to the Executive, to: Andrea Wenholz 9001 Glenlake Drive Austin, Texas 78730 Electronic Mail Address: awenholz@austin.rr.com 3 If to the Company, to: Crossroads Systems, Inc. 8300 North MoPac Expressway Austin, Texas 78759 Facsimile: 512-349-0304 Attn: Compensation Committee of the Board of Directors All such notices, requests and other communications will (i) if delivered personally to the address as provided in this Section 4.1, be deemed given upon delivery, (ii) if delivered by facsimile transmission to the facsimile number as provided in this Section 4.1, be deemed given upon receipt, and (iii) if delivered by mail in the manner described above to the address as provided in this Section 4.1, be deemed given upon receipt (in each case regardless of whether such notice, request, or other communication is received by any other person to whom a copy of such notice, request or other communication is to be delivered pursuant to this Section). An electronic communication ("ELECTRONIC NOTICE") shall be deemed written notice for purposes of this Section 4.1 if sent with return receipt requested to the electronic mail address specified by the receiving party, in a signed writing in a nonelectronic form. Electronic Notice shall be deemed received at the time the party sending Electronic Notice receives verification of receipt by the receiving party. Any party receiving Electronic Notice may request and shall be entitled to receive the notice on paper, in a nonelectronic form ("NONELECTRONIC NOTICE") which shall be sent to the requesting party within ten (10) days of receipt of the written request for Nonelectronic Notice. Any party from time to time may change its address, facsimile number, electronic mail address, or other information for the purpose of notices to that party by giving written notice specifying such change to the other parties hereto. 4.2 AUTHORIZATION TO BE EMPLOYED. This Agreement, and Executive's employment hereunder, is subject to Executive providing the Company with legally required proof of Executive's authorization to be employed in the United States of America. 4.3 ENTIRE AGREEMENT. This Agreement, and the attached exhibits, supersede all prior discussions and agreements among the parties with respect to the subject matter hereof and contain the sole and entire agreement between the parties hereto with respect thereto. 4.4 SURVIVAL. The respective rights and obligations of the parties, including but not limited to Sections 1.7.2, 1.7.3, 2, 4.1, and 4.5, 4.7, 4.9, 4.10, 4.12, 4.13, and 4.14 shall survive the termination of this Agreement, the Employment Term and/or the Employee's employment with the Company. 4.5 WAIVER. Any term or condition of this Agreement may be waived at any time by the party that is entitled to the benefit thereof, but no such waiver shall be effective unless set forth in a written instrument duly executed by or on behalf of the party waiving such term or condition. No waiver by any party hereto of any term or condition of this Agreement, in any one or more instances, shall be deemed to be or construed as a waiver of the same or any other term or condition of this Agreement on any future occasion. All remedies, either under this Agreement or by law or otherwise afforded, will be cumulative and not alternative. 4.6 AMENDMENT. This Agreement may be amended, supplemented, or modified only by a written instrument duly executed by or on behalf of each party hereto. 4.7 RECOVERY OF ATTORNEY'S FEES. In the event of any litigation arising from or relating to this Agreement, the prevailing party in such litigation proceedings shall be entitled to recover, 4 from the non-prevailing party, the prevailing party's reasonable costs and attorney's fees, in addition to all other legal or equitable remedies to which it may otherwise be entitled. 4.8 TAX AND LEGAL ADVICE. Executive has had an opportunity to consult with her legal counsel and tax and other advisors regarding the preparation of this Agreement and the Severance Benefit Plan. Executive understands that Brobeck, Phleger & Harrison LLP has acted solely as legal counsel for the Company with respect to the preparation of this Agreement and the Severance Benefit Plan and has not acted as legal counsel for Executive. 4.9 NO THIRD PARTY BENEFICIARY. The terms and provisions of this Agreement are intended solely for the benefit of each party hereto and the Company's successors or assigns, and it is not the intention of the parties to confer third-party beneficiary rights upon any other person. 4.10 NO ASSIGNMENT; BINDING EFFECT. This Agreement shall inure to the benefit of any successors or assigns of the Company. Executive shall not be entitled to assign her obligations under this Agreement. 4.11 HEADINGS. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof. 4.12 SEVERABILITY. The Company and Executive intend all provisions of this Agreement to be enforced to the fullest extent permitted by law. Accordingly, if a court of competent jurisdiction determines that the scope and/or operation of any provision of this Agreement is too broad to be enforced as written, the Company and Executive intend that the court should reform such provision to such narrower scope and/or operation as it determines to be enforceable. If, however, any provision of this Agreement is held to be illegal, invalid, or unenforceable under present or future law, and not subject to reformation, then (i) such provision shall be fully severable, (ii) this Agreement shall be construed and enforced as if such provision was never a part of this Agreement, and (iii) the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by illegal, invalid, or unenforceable provisions or by their severance. 4.13 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS APPLICABLE TO CONTRACTS EXECUTED AND PERFORMED IN SUCH STATE WITHOUT GIVING EFFECT TO CONFLICTS OF LAWS PRINCIPLES. 4.14 JURISDICTION. With respect to any suit, action, or other proceeding arising from (or relating to) this Agreement, the Company and Executive hereby irrevocably agree to the exclusive personal jurisdiction and venue of the United States District Court for the Western District of Texas (and any Texas State Court within Travis County, Texas). 4.15 COUNTERPARTS. This Agreement may be executed in any number of counterparts and by facsimile, each of which will be deemed an original, but all of which together will constitute one and the same instrument. [SIGNATURE PAGE TO EMPLOYMENT AGREEMENT FOLLOWS] 5 IN WITNESS WHEREOF, the parties hereto have caused this Employment Agreement to be executed on the date first written above. "COMPANY" CROSSROADS SYSTEMS, INC. By: ----------------------------------- Name: --------------------------------- Title: -------------------------------- "EXECUTIVE" NAME -------------------------------------- Executive's Signature -------------------------------------- Address -------------------------------------- Address EXHIBIT A: Severance Benefit Plan EXHIBIT B: Confidentiality, Proprietary Information and Inventions Agreement [SIGNATURE PAGE TO EMPLOYMENT AGREEMENT] EX-10.13 4 h02058exv10w13.txt 2002 STOCK BONUS INCENTIVE PROGRAM - ROBERT SIMS EXHIBIT 10.13 [CROSSROADS LETTERHEAD] STRICTLY PRIVATE To: Robert Sims From: Allen Sockwell Date: 11/13/01 Subject: Fiscal Year 2002 Stock Bonus Incentive Program The fiscal year 2002 Stock Bonus Incentive Program has been developed to reward individual contributions through Company success and to incent and reward high individual performance. The specifics of the plan are: 1.) You will be eligible to receive a stock performance grant for 24,129 shares of the Company's common stock (the "Shares") at a zero cost basis except for applicable withholding taxes. You will receive the Shares in accordance with the following schedule: a. You will receive up to fifty percent (50%) of the Shares on December 15, 2002, provided (i) the performance goals specified in Paragraph 2 below are attained for fiscal year 2002 which ends on October 31, 2002 and (ii) you are an employee of the Company through such date. The actual number of Shares to be issued to you on December 15, 2002 will depend on the level of achievement of the performance goals as specified in Paragraph 2 below. b. You will receive one-half (1/2) of the remaining Shares on June 15, 2003, provided you remain an employee of the Company through such date. c. You will receive the remaining Shares on December 15, 2003, provided you remain an employee of the Company through such date. 2.) The number of Shares payable to you on December 15, 2002 will be determined as follows: a. Ten percent (10%) of the Shares will be paid provided 100% of the pre-determined Company target revenue for fiscal year 2002 is achieved. If less than 100% of the target revenue is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. b. Fifteen percent (15%) of the Shares will be issued provided 100% of the pre-determined Company target pre-tax income for fiscal year 2002 is achieved. If less than 100% of the target pre-tax income is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. 1 c. Five percent (5%) of the Shares will be issued on December 15, 2002 for fiscal year 2002 upon achievement of EACH of the Management by Objective (MBO) components as defined below such that a total of twenty-five percent (25%) of the Shares will be issued if all the MBOs are achieved: i. Individual contribution-subjective management assessment (5%) ii. Customer satisfaction-one customer satisfaction objective (5%) iii. Financial performance-one financial performance objective (5%) iv. Selectable-one objective not already selected in any of the four areas based on organization primary objectives (5%) v. Team development-one team development objective (5%) The target Company revenue and pre-tax income will be determined by the Company at its sole discretion. There will be an update quarterly on Company performance goals. The MBOs will be selected and approved at the sole discretion of the executive you report to. The objectives are key to current and future business plans of the Company. The objectives will be reviewed quarterly with you to validate the continued relevance of the objective and to communicate your performance in relation to the objective. An objective can be adjusted at the discretion of the Company during the year with one over one approval (two management levels) for unusual or windfall events. 3.) The number of Shares issuable on December 15, 2002 for fiscal year 2002 on the basis of the achievement of less than 100% of the Company's performance measures (revenue (10%) and pre-tax income (15%)) will be determined as follows:
PERCENT OF PERCENT OF SHARES PERCENT OF PERCENT OF SHARES TARGET ACHIEVED ALLOCATED TO TARGET TARGET ACHIEVED ALLOCATED TO TARGET - --------------- ------------------- --------------- ------------------- <85% 0% 96% 96% =85% 85% 97% 97% 86% 86% 98% 98% 87% 87% 99% 99% 88% 88% 100% 100% 89% 89% 90% 90% 91% 91% 92% 92% 93% 93% 94% 94% 95% 95%
2 Income Tax Consequences: You will recognize taxable income upon receipt of the Shares. The amount of taxable income will be equal to the fair market value of the Shares received. Such income will be subject to all applicable income and employment withholding taxes. No Shares will be issued to you until receipt by the Company of such taxes. Change in Control: Any Shares remaining payable at the time of a Change in Control but not otherwise payable at such time will automatically accelerate and be paid immediately following the effective date of such transaction. The term Change in Control is as defined in the Appendix, page A-1, item D, of the Crossroads Systems, Inc. 1999 Stock Incentive Plan. General Provisions: 1) Employees who leave the Company prior to the completion of the stock bonus issuance schedule as stated above will not be eligible to receive the remaining shares of the grant. 2) The 2002 discretionary Stock Bonus Incentive Program has been developed for fiscal year 2002 only and is subject to change annually and/or as business conditions from time to time dictate. 3) This plan is confidential to you. The sharing of this information may be grounds for removing you from the Plan. 3 EX-10.14 5 h02058exv10w14.txt 2003 STOCK BONUS INCENTIVE PROGRAM - ROBERT SIMS EXHIBIT 10.14 [CROSSROADS LETTERHEAD] STRICTLY PRIVATE To: Robert Sims From: Brian R. Smith, Chairman and CEO Date: 11/04/02 Subject: Fiscal Year 2003 Stock Bonus Incentive Program The fiscal year 2003 Stock Bonus Incentive Program has been developed to reward individual contributions through Company success and to incent and reward high individual performance. The specifics of the plan are: 1.) You will be eligible to receive a stock performance grant for 160,000 shares of the Company's common stock (the "Shares") at a zero cost basis except for applicable withholding taxes. You will receive the Shares in accordance with the following schedule: a. You will receive up to fifty percent (50%) of the Shares on December 15, 2003, provided (i) the performance goals specified in Paragraph 2 below are attained for fiscal year 2003 which ends on October 31, 2003 and (ii) you are an employee of the Company through such date. The actual number of Shares to be issued to you on December 15, 2003 will depend on the level of achievement of the performance goals as specified in Paragraph 2 below. b. You will receive one-half (1/2) of the remaining Shares on June 15, 2004, provided you remain an employee of the Company through such date. c. You will receive the remaining Shares on December 15, 2004, provided you remain an employee of the Company through such date. 2.) The number of Shares payable to you on December 15, 2003 will be determined as follows: a. Seventeen and one-half percent (17.5%) of the Shares will be paid provided 100% of the pre-determined Company target revenue for fiscal year 2003 is achieved. If less than 100% of the target revenue is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. b. Seventeen and one-half percent (17.5%) of the Shares will be issued provided 100% of the pre-determined Company target pre-tax income for fiscal year 2003 is achieved. If less than 100% of the target pre-tax income is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. 1 c. Three percent (3.0%) of the Shares will be issued on December 15, 2003 for fiscal year 2003 upon achievement of EACH of the Management by Objective (MBO) components as defined below such that a total of fifteen percent (15.0%) of the Shares will be issued if all the MBOs are achieved: i. Individual contribution-subjective management assessment (3%) ii. Customer satisfaction-one customer satisfaction objective (3%) iii. Financial performance-one financial performance objective (3%) iv. Selectable-one objective not already selected in any of the four areas based on organization primary objectives (3%) v. Team development-one team development objective (3%) The target Company revenue and pre-tax income will be determined by the Company at its sole discretion. There will be an update quarterly on Company performance goals. The MBOs will be selected and approved at the sole discretion of the executive you report to. The objectives are key to current and future business plans of the Company. The objectives will be reviewed quarterly with you to validate the continued relevance of the objective and to communicate your performance in relation to the objective. An objective can be adjusted at the discretion of the Company during the year with one over one approval (two management levels) for unusual or windfall events. 3.) The number of Shares issuable on December 15, 2003 for fiscal year 2003 on the basis of the achievement of less than 100% of the Company's performance measures (revenue (17.5%) and pre-tax income (17.5%)) will be determined as follows:
PERCENT OF PERCENT OF SHARES PERCENT OF PERCENT OF SHARES TARGET ACHIEVED ALLOCATED TO TARGET TARGET ACHIEVED ALLOCATED TO TARGET - --------------- ------------------- --------------- ------------------- <85% 0% 96% 96% =85% 85% 97% 97% 86% 86% 98% 98% 87% 87% 99% 99% 88% 88% 100% 100% 89% 89% 90% 90% 91% 91% 92% 92% 93% 93% 94% 94% 95% 95%
2 Income Tax Consequences: You will recognize taxable income upon receipt of the Shares. The amount of taxable income will be equal to the fair market value of the Shares received. Such income will be subject to all applicable income and employment withholding taxes. No Shares will be issued to you until receipt by the Company of such taxes. Change in Control: Any Shares remaining payable at the time of a Change in Control but not otherwise payable at such time will automatically accelerate and be paid immediately following the effective date of such transaction. The term Change in Control is as defined in the Appendix, page A-1, item D, of the Crossroads Systems, Inc. 1999 Stock Incentive Plan. General Provisions: 1) Employees who leave the Company prior to the completion of the stock bonus issuance schedule as stated above will not be eligible to receive the remaining shares of the grant. 2) The 2003 discretionary Stock Bonus Incentive Program has been developed for fiscal year 2003 only and is subject to change annually and/or as business conditions from time to time dictate. 3) This plan is confidential to you. The sharing of this information may be grounds for removing you from the Plan. 3 EX-10.15 6 h02058exv10w15.txt 2003 STOCK BONUS INCENTIVE PROGRAM - BRIAN SMITH EXHIBIT 10.15 [CROSSROADS LETTERHEAD] STRICTLY PRIVATE To: Brian R. Smith From: Kathy Blair, Director of Human Resources Date: 11/20/02 Subject: Fiscal Year 2003 Stock Bonus Incentive Program The fiscal year 2003 Stock Bonus Incentive Program has been developed to reward individual contributions through Company success and to incent and reward high individual performance. The specifics of the plan are: 1.) You will be eligible to receive a stock performance grant for 174,000 shares of the Company's common stock (the "Shares") at a zero cost basis except for applicable withholding taxes. You will receive the Shares in accordance with the following schedule: a. You will receive up to fifty percent (50%) of the Shares on December 15, 2003, provided (i) the performance goals specified in Paragraph 2 below are attained for fiscal year 2003 which ends on October 31, 2003 and (ii) you are an employee of the Company through such date. The actual number of Shares to be issued to you on December 15, 2003 will depend on the level of achievement of the performance goals as specified in Paragraph 2 below. b. You will receive one-half (1/2) of the remaining Shares on June 15, 2004, provided you remain an employee of the Company through such date. c. You will receive the remaining Shares on December 15, 2004, provided you remain an employee of the Company through such date. 2.) The number of Shares payable to you on December 15, 2003 will be determined as follows: a. Seventeen and one-half percent (17.5%) of the Shares will be paid provided 100% of the pre-determined Company target revenue for fiscal year 2003 is achieved. If less than 100% of the target revenue is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. b. Seventeen and one-half percent (17.5%) of the Shares will be issued provided 100% of the pre-determined Company target pre-tax income for fiscal year 2003 is achieved. If less than 100% of the target pre-tax income is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. 1 c. Three percent (3.0%) of the Shares will be issued on December 15, 2003 for fiscal year 2003 upon achievement of EACH of the Management by Objective (MBO) components as defined below such that a total of fifteen percent (15.0%) of the Shares will be issued if all the MBOs are achieved: i. Individual contribution-subjective management assessment (3%) ii. Customer satisfaction-one customer satisfaction objective (3%) iii. Financial performance-one financial performance objective (3%) iv. Selectable-one objective not already selected in any of the four areas based on organization primary objectives (3%) v. Team development-one team development objective (3%) The target Company revenue and pre-tax income will be determined by the Company at its sole discretion. There will be an update quarterly on Company performance goals. The MBOs will be selected and approved at the sole discretion of the executive you report to. The objectives are key to current and future business plans of the Company. The objectives will be reviewed quarterly with you to validate the continued relevance of the objective and to communicate your performance in relation to the objective. An objective can be adjusted at the discretion of the Company during the year with one over one approval (two management levels) for unusual or windfall events. 3.) The number of Shares issuable on December 15, 2003 for fiscal year 2003 on the basis of the achievement of less than 100% of the Company's performance measures (revenue (17.5%) and pre-tax income (17.5%)) will be determined as follows:
PERCENT OF PERCENT OF SHARES PERCENT OF PERCENT OF SHARES TARGET ACHIEVED ALLOCATED TO TARGET TARGET ACHIEVED ALLOCATED TO TARGET - --------------- ------------------- --------------- ------------------- <85% 0% 96% 96% =85% 85% 97% 97% 86% 86% 98% 98% 87% 87% 99% 99% 88% 88% 100% 100% 89% 89% 90% 90% 91% 91% 92% 92% 93% 93% 94% 94% 95% 95%
2 Income Tax Consequences: You will recognize taxable income upon receipt of the Shares. The amount of taxable income will be equal to the fair market value of the Shares received. Such income will be subject to all applicable income and employment withholding taxes. No Shares will be issued to you until receipt by the Company of such taxes. Change in Control: Any Shares remaining payable at the time of a Change in Control but not otherwise payable at such time will automatically accelerate and be paid immediately following the effective date of such transaction. The term Change in Control is as defined in the Appendix, page A-1, item D, of the Crossroads Systems, Inc. 1999 Stock Incentive Plan. General Provisions: 1) Employees who leave the Company prior to the completion of the stock bonus issuance schedule as stated above will not be eligible to receive the remaining shares of the grant. 2) The 2003 discretionary Stock Bonus Incentive Program has been developed for fiscal year 2003 only and is subject to change annually and/or as business conditions from time to time dictate. 3) This plan is confidential to you. The sharing of this information may be grounds for removing you from the Plan. 3 EX-10.16 7 h02058exv10w16.txt 2003 STOCK BONUS INCENTIVE PROGRAM-ANDREA WENHOLZ EXHIBIT 10.16 [CROSSROADS LETTERHEAD] STRICTLY PRIVATE To: Andrea Wenholz From: Brian R. Smith, Chairman and CEO Date: 01/06/03 Subject: Fiscal Year 2003 Stock Bonus Incentive Program The fiscal year 2003 Stock Bonus Incentive Program has been developed to reward individual contributions through Company success and to incent and reward high individual performance. The specifics of the plan are: 1.) You will be eligible to receive a stock performance grant for 112,000 shares of the Company's common stock (the "Shares") at a zero cost basis except for applicable withholding taxes. You will receive the Shares in accordance with the following schedule: a. You will receive up to fifty percent (50%) of the Shares on December 15, 2003, provided (i) the performance goals specified in Paragraph 2 below are attained for fiscal year 2003 which ends on October 31, 2003 and (ii) you are an employee of the Company through such date. The actual number of Shares to be issued to you on December 15, 2003 will depend on the level of achievement of the performance goals as specified in Paragraph 2 below. b. You will receive one-half (1/2) of the remaining Shares on June 15, 2004, provided you remain an employee of the Company through such date. c. You will receive the remaining Shares on December 15, 2004, provided you remain an employee of the Company through such date. 2.) The number of Shares payable to you on December 15, 2003 will be determined as follows: a. Seventeen and one-half percent (17.5%) of the Shares will be paid provided 100% of the pre-determined Company target revenue for fiscal year 2003 is achieved. If less than 100% of the target revenue is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. b. Seventeen and one-half percent (17.5%) of the Shares will be issued provided 100% of the pre-determined Company target pre-tax income for fiscal year 2003 is achieved. If less than 100% of the target pre-tax income is achieved, the number of Shares issuable with respect to this performance goal will be reduced in the proportion specified in Paragraph 3. 1 c. Three percent (3.0%) of the Shares will be issued on December 15, 2003 for fiscal year 2003 upon achievement of EACH of the Management by Objective (MBO) components as defined below such that a total of fifteen percent (15.0%) of the Shares will be issued if all the MBOs are achieved: i. Individual contribution-subjective management assessment (3%) ii. Customer satisfaction-one customer satisfaction objective (3%) iii. Financial performance-one financial performance objective (3%) iv. Selectable-one objective not already selected in any of the four areas based on organization primary objectives (3%) v. Team development-one team development objective (3%) The Company must meet a minimum of 85% of the target Company revenue and pre-tax income objectives for MBOs to be payable as defined above. The target Company revenue and pre-tax income will be determined by the Company at its sole discretion. There will be an update quarterly on Company performance goals. The MBOs will be selected and approved at the sole discretion of the executive you report to. The objectives are key to current and future business plans of the Company. The objectives will be reviewed quarterly with you to validate the continued relevance of the objective and to communicate your performance in relation to the objective. An objective can be adjusted at the discretion of the Company during the year with one over one approval (two management levels) for unusual or windfall events. 3.) The number of Shares issuable on December 15, 2003 for fiscal year 2003 on the basis of the achievement of less than 100% of the Company's performance measures (revenue (17.5%) and pre-tax income (17.5%)) will be determined as follows:
PERCENT OF PERCENT OF SHARES PERCENT OF PERCENT OF SHARES TARGET ACHIEVED ALLOCATED TO TARGET TARGET ACHIEVED ALLOCATED TO TARGET - --------------- ------------------- --------------- ------------------- <85% 0% 96% 96% =85% 85% 97% 97% 86% 86% 98% 98% 87% 87% 99% 99% 88% 88% 100% 100% 89% 89% 90% 90% 91% 91% 92% 92% 93% 93% 94% 94% 95% 95%
2 Income Tax Consequences: You will recognize taxable income upon receipt of the Shares. The amount of taxable income will be equal to the fair market value of the Shares received. Such income will be subject to all applicable income and employment withholding taxes. No Shares will be issued to you until receipt by the Company of such taxes. Change in Control: Any Shares remaining payable at the time of a Change in Control but not otherwise payable at such time will automatically accelerate and be paid immediately following the effective date of such transaction. The term Change in Control is as defined in the Appendix, page A-1, item D, of the Crossroads Systems, Inc. 1999 Stock Incentive Plan. General Provisions: 1) Employees who leave the Company prior to the completion of the stock bonus issuance schedule as stated above will not be eligible to receive the remaining shares of the grant. 2) The 2003 discretionary Stock Bonus Incentive Program has been developed for fiscal year 2003 only and is subject to change annually and/or as business conditions from time to time dictate. 3) This plan is confidential to you. The sharing of this information may be grounds for removing you from the Plan. 3 EX-21.1 8 h02058exv21w1.txt SUBSIDIAIRES OF THE COMPANY EXHIBIT 21.1 SUBSIDIARIES OF THE COMPANY The Company's sole subsidiary is Crossroads Systems (Texas), Inc., a corporation organized under the laws of the State of Texas. EX-23.1 9 h02058exv23w1.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-92467, 333-37584 and 333-62336) of Crossroads Systems, Inc. and Subsidiaries of our report dated November 26, 2002 relating to the consolidated financial statements, which appears in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated November 26, 2002 relating to the financial statement schedule, which appears in this Form 10-K. PRICEWATERHOUSECOOPERS LLP Austin, Texas January 28, 2003 EX-99.1 10 h02058exv99w1.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER Pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, each of the undersigned officers of Crossroads Systems, Inc. (the "Company") hereby certify that: (i) the accompanying Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 2002 as filed with the Securities and Exchange Commission (the "Report") fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated January 29, 2003 /s/ Brian R. Smith - ------------------ Brian R. Smith Chairman of the Board, Chief Executive Officer and President /s/ Andrea Wenholz - ------------------ Andrea Wenholz Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----