<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30,
2000.
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
____________.
Commission File No. 333-64483
DIVA Systems Corporation
(Exa125
ct name of Registrant as specified in its charter)
Delaware 94-3226532
(State or other jurisdiction of (IRS Employer
Incorporation or organization) Identification Number)
800 Saginaw Drive
Redwood City, CA 94063
(Address of principal executive offices)
(650) 779-3000
(Registrant's telephone number, including area code)
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
The number of shares of Registrant's classes of Common Stock at October
31, 2000 was:
Title of each class
-------------------
Common Stock, $.001 par value 17,943,944
Class C Common Stock,$.001 par value 857,370
<PAGE>
DIVA SYSTEMS CORPORATION
Quarterly Report on Form 10-Q
Table of Contents
Quarter Ended September 30, 2000
PART I - FINANCIAL INFORMATION
<TABLE>
<S> <C>
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet at September 30, 2000 and
June 30, 2000 1
Condensed Consolidated Statement of Operations for the three months
ended September 30, 2000 and 1999 2
Condensed Consolidated Statement of Cash Flows for the three months
ended September 30, 2000 and 1999 3
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
September 30, June 30,
Assets 2000 2000
------------------ ------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 47,659 $ 66,253
Short-term investments 30,360 26,429
Accounts receivable 13,961 264
Inventory 7,115 3,143
Prepaid expenses and other current assets 963 3,520
------------------ ------------------
Total current assets 100,058 99,609
Property and equipment, net 12,101 12,648
Debt issuance costs, net 6,064 6,500
Deposits and other assets 578 596
Intangible assets, net 89 134
------------------ ------------------
Total assets $ 118,890 $ 119,487
================== ==================
Liabilities, Redeemable Warrants and Stockholders' Deficit
Current liabilities:
Accounts payable $ 6,167 $ 5,121
Other current liabilities 3,253 4,441
Deferred revenue 983 1,015
Current portion of capital lease obligation 690 676
------------------ ------------------
Total current liabilities 11,093 11,253
Notes payable 322,899 312,815
Redeemable put warrants 7,326 11,989
Long - term portion of lease payable 850 1,029
Deferred rent 810 780
------------------ ------------------
Total liabilities 342,978 337,866
------------------ ------------------
Redeemable warrants 4,603 7,007
------------------ ------------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 80,000,000 shares authorized; 25,051,528
and 24,495,463 shares issued and outstanding as of September 30, 2000,
and June 30, 2000, respectively.
Common stock, $0.001 par value; 165,000,000 shares authorized; 25 24
18,691,887 and 18,615,618 shares issued and outstanding as
of September 30, 2000, and June 30, 2000, respectively. 19 19
Additional paid-in capital 147,249 138,211
Deferred compensation (6,491) (5,954)
Accumulated deficit (369,493) (357,686)
------------------ ------------------
Total stockholders' deficit (228,691) (225,386)
------------------ ------------------
Total liabilities, redeemable warrants and stockholders' deficit $ 118,890 $ 119,487
================== ==================
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
1
<PAGE>
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
2000 1999
----------------- ---------------
<S> <C> <C>
Revenues:
Product $ 35 $ --
License 36 --
Service 314 68
----------------- ---------------
Total revenues 385 68
Operating expenses:
Cost of product revenue 185 --
Programming 1,048 1,242
Operations 1,815 1,471
Engineering and development 8,011 5,281
Sales and marketing 1,472 1,613
General and administrative 5,505 4,690
Depreciation and amortization 1,522 1,474
Warrant benefit (181) --
Amortization of stock compensation 1,128 205
----------------- ---------------
Total operating expenses 20,505 15,976
----------------- ---------------
Operating loss 20,120 15,908
----------------- ---------------
Other (income) expense:
Interest income (671) (1,585)
Gain on sale of investments (12,896) --
Gain on sale of property and equipment (40) --
Interest expense 5,294 9,186
----------------- ---------------
Total other (income)/expense, (8,313) 7,601
net
----------------- ---------------
Net loss 11,807 23,509
(Decrement)/Accretion of redeemable warrants (2,404) 152
----------------- ---------------
Net loss attributable to
common stockholders $ 9,403 $ 23,661
================= ===============
Basic and diluted net loss per share: $ .50 $ 1.36
================= ===============
Shares used in per share computation 18,670 17,389
================= ===============
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
2
<PAGE>
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
2000 1999
------------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (11,807) $ (23,509)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,522 1,474
(Gain)/loss on disposition of property and equipment (40) 74
Amortization of debt issuance costs and
accretion of discount on notes payable 5,857 9,184
Amortization of deferred stock compensation 1,128 205
Warrant benefit (181) --
Changes in operating assets and liabilities:
Other assets 558 333
Accounts receivable (11,699) --
Inventory (3,972) (409)
Accounts payable 1,046 484
Other current liabilities (1,187) 225
Deferred rent 30 --
Deferred revenue (32) --
------------------- ----------------
Net cash used for operating activities (18,777) (11,939)
------------------- ----------------
Cash flows from investing activities:
Purchases of property and equipment (1,015) (2,377)
Deposits on property and equipment 19 (31)
Proceeds from the sale of assets 125 --
Purchases of short-term investments (3,931) (17,486)
Proceeds from the sale of short-term investments -- 10,940
------------------- ----------------
Net cash used for investing activities (4,802) (8,954)
------------------- ----------------
Cash flows from financing activities:
Issuance of preferred stock, net 5000 --
Exercise of stock options, series AA preferred stock
options and issuance of common stock 150 80
Payments on capital lease (165) --
Payments on note payable -- (4)
------------------- ----------------
Net cash provided by financing activities 4,985 76
------------------- ----------------
Net decrease in cash and cash equivalents (18,594) (20,817)
Cash and cash equivalents at beginning of period 66,253 89,239
------------------- ----------------
Cash and cash equivalents at end of period $ 47,659 $ 68,422
=================== ================
</TABLE>
3
<PAGE>
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows (Continued)
(in thousands)
(unaudited)
<TABLE>
<S> <C> <C>
Noncash investing and financing activities:
(Decrement)/Accretion of redeemable warrants $ (2,404) $ 152
=============== =============
Deferred compensation associated with stock options $ 1,665 $ --
=============== =============
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
4
<PAGE>
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1--The Company And Basis Of Presentation
DIVA Systems Corporation (the Company), is a provider of interactive,
video-on-demand products and services. The Company was in the development stage
from July 1, 1995 (inception) to September 30, 1999, and its primary activity
was performing research and development, licensing program content,
manufacturing the necessary equipment, developing a service offering,
establishing strategic alliances, deploying service trials and limited
commercial launches with cable operators and raising capital. As of October 1,
1999, the Company commenced principal operations, which consists of
manufacturing, selling, licensing and providing operational support for its
video-on-demand products and services.
The interim unaudited financial statements as of September 30, 2000, for
the three months ended September 30, 2000 and 1999 have been prepared on
substantially the same basis as the Company's audited financial statements for
the year ended June 30, 2000 and include all adjustments, consisting only of
normal recurring adjustments, that, in the opinion of management, are necessary
for a fair presentation of the financial information set forth herein. The
results of operations for current interim periods are not necessarily indicative
of results to be expected for the current year or any other period.
These interim unaudited financial statements should be read in conjunction
with the Company's annual financial statements, included in the Company's Form
10-K for the year ended June 30, 2000 (Fiscal 2000).
Note 2--Basic and Diluted Net Loss Per Share
Basic and diluted net loss per share is computed using net loss adjusted
for the accretion of the redeemable warrants and the weighted-average number of
outstanding shares of common stock. Potentially dilutive securities, including
options, warrants, restricted common stock, and preferred stock, (amounting to
44,775,430 shares of common stock) has been excluded from the computation of
diluted net loss per share because the effect of this inclusion would be
antidilutive. Information pertaining to potentially dilutive securities is
included in Notes 6, 7 and 8 of notes to consolidated financial statements
included in the Company's Fiscal 2000 Form 10-K.
Note 3--Revenue Recognition Policy
The Company's contracts are generally multiple-element arrangements with a
network operator involving a combination of video-on-demand hardware products,
licenses for system software and selected content and operational services. As a
result the Company recognizes revenue in accordance with the American Institute
of Certified Public Accountants Statement of Position 97-2 (SOP 97-2), "Software
Revenue Recognition," and Statement of Position 98-9 (SOP 98-9), "Software
Revenue Recognition, with Respect to Certain Transactions." SOP 97-2 generally
requires revenue earned on software arrangements involving multiple elements to
be allocated to each element based on the relative fair values of the elements.
The fair value of an element must be based on vendor specific objective
5
<PAGE>
evidence of the relative fair values of the elements. Vendor specific objective
evidence is determined by the price charged when the element is sold separately.
SOP 98-9 requires recognition of revenue using the residual method in a multiple
element arrangement when fair value does not exist for one or more of the
delivered elements in the arrangement. Under the residual method, revenue for
the undelivered elements is deferred and subsequently recognized in accordance
with Statement of Position 97-2. Evidence of the fair value of the individual
elements in our current agreements does not exist.
As a result, upon the delivery of the Company's video-on-demand hardware
products, revenue is recognized to the extent of the cost of these hardware
products. Any remaining product revenue is amortized on a straight-line basis
over the remaining term of the agreement. The Company recognizes license
revenues ratably over the term of the agreement. If the Company's services are
provided on a fee-for-service basis, service revenues are recognized as the
services are performed. If the services are provided on a revenue sharing basis,
service revenues are recognized based on program purchases by subscribers.
The Company provides limited warranty rights to its customers. Estimated
warranty obligations are provided by charges to operations in the period in
which the related revenue is recognized. To date, the estimated warranty
obligations have not been considered significant.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of our financial condition and results of
operations should be read in conjunction with the unaudited consolidated interim
financial statements for the three months ended September 30, 2000 and 1999
included elsewhere in this Form 10-Q. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results may differ
materially from the results discussed in the forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those
discussed below. The forward-looking statements contained herein are made as of
the date hereof, and we assume no obligation to update such forward-looking
statements or to update the reason actual results could differ materially from
those anticipated in such forward-looking statements. Forward-looking statements
are statements identified with an asterisk (*). All forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by the cautionary statements set forth below and in "Factors
Affecting Operating Results."
Overview
We are a leading provider of interactive, on-demand television products and
services. We have commercially deployed our video-on-demand service with several
cable operators in North America. We have also recently introduced an
interactive program guide as a stand-alone product. Both our video-on-demand
service and interactive program guide operate on industry-standard digital set-
top boxes and operating systems and provide flexible and cost-effective
interactive television solutions for cable and other broadband operators, which
we refer to as network operators. Since our inception, we have devoted
substantially all of our resources to developing our video-on-demand products
and services, establishing industry relationships, carrying out initial
marketing activities, negotiating deployment agreements and establishing the
operations necessary to support the commercial deployment of our video-on-demand
products and services.
Prior to June 1999, we offered our video-on-demand service only as an end-
to-end system solution for network operators. Under this approach, we own,
install and fund all hardware and software components of our system. We manage
and deliver the end-to-end video-on-demand service offering to cable
subscribers. We generate revenues from deployment agreements with network
operators based on a share of the revenues generated by the network operators
from video-on- demand revenues and other monthly subscriber fees.
Beginning in June 1999, we shifted our sales and marketing strategy to
emphasize selling our video-on-demand hardware products, licensing our system
software, and providing a suite of content acquisition and operational support
services on an a'la carte basis to network operators. Under this approach, the
network operator purchases the video-on-demand system hardware and takes the
capital and operating expense risk associated with such ownership. The network
operator licenses our system software and can then select the other
video-on-demand support services it wants to utilize. The network operator can
select either the entire package of content and operational support services and
pay us a portion of the revenues they receive from video-on-demand services, or
select some or all of these services on a fee-for-service basis. We expect that
the substantial majority of our future revenues will be derived from this new
strategy.*
7
<PAGE>
Through September 30, 2000, we have generated minimal revenues and have
incurred significant losses and substantial negative cash flow, primarily due to
engineering and development expenditures and other costs required to develop our
video-on-demand products and services. Since our inception through September 30,
2000, we have an accumulated deficit of $369.5 million and have not achieved
profitability on a quarterly or annual basis. We expect to continue to incur
substantial net losses and negative cash flow for at least the next few years.*
Our historical revenues and expenditures are not necessarily indicative of, and
should not be relied upon as an indicator of, revenues that may be attained or
expenditures that may be incurred by us in future periods.
Revenues
Revenue is comprised of three components: product revenue resulting from
the sale of our video-on-demand hardware products; licensing revenue resulting
from the licensing of our systems software and on-screen video-on-demand
navigator applications; and service revenue resulting from programming services
and operations support services. Since our inception through September 30, 2000,
we have not recognized any revenue from our interactive program guide.
Our contracts are generally multiple-element arrangements with a network
operator involving a combination of video-on-demand hardware products, licenses
for system software and selected content and operational services. As a result
we recognize revenue in accordance with the American Institute of Certified
Public Accountants Statement of Position 97-2 (SOP 97-2), "Software Revenue
Recognition," and Statement of Position 98-9 (SOP 98-9), "Software Revenue
Recognition, with respect to certain arrangements." SOP 97-2 generally requires
revenue earned on software arrangements involving multiple elements to be
allocated to each element based on the relative fair values of the elements. The
fair value of an element must be based on vendor specific objective evidence of
the relative fair values of the elements. Vendor specific objective evidence is
determined by the price charged when the element is sold separately. SOP 98-9
requires recognition of revenue using the residual method in a multiple element
arrangement when fair value does not exist for one or more of the delivered
elements in the arrangement. Under the residual method, the total fair value of
the undelivered elements is deferred and subsequently recognized in accordance
with Statement of Position 97-2. Evidence of the fair value of the individual
elements in our current agreements does not exist.
As a result, upon the delivery of our video-on-demand hardware products,
revenue is recognized to the extent of the cost of these hardware products. Any
remaining product revenue is amortized on a straight-line basis over the
remaining term of the agreement. We recognize license revenues ratably over the
term of the agreement. If our services are provided on a fee-for-service basis,
service revenues are recognized as the services are performed. If the services
are provided on a revenue sharing basis, service revenues are recognized based
on program purchases by subscribers.
Operating Expenses
Cost of Product Revenue. Cost of product revenue consists of contract
manufacturing costs, component and material costs, and other direct product
expenditures associated specifically with our video-on-demand hardware products.
8
<PAGE>
Programming. Programming expense includes license fees payable to content
providers, costs related to the acquisition and production of digitally encoded
programming content (including movies, videos, previews and promotions) and
content duplication and distribution expenses. Historically, programming expense
has represented a significant portion of our operating expenses, since we
provided all programming content as an integral component of our end-to-end
video-on-demand service. In the future, we expect that programming expenses will
decrease as a percentage of total operating expenses because we anticipate that
some larger network operators will take responsibility for acquiring their own
content.* We expect to continue to incur programming expenses for network
operators that elect to have us provide programming content or contract for an
end-to-end video-on-demand service from us.*
Operations. Operations expense includes the cost of field operations, both
for initial launches and for ongoing support of our installed video-on-demand
base. These costs include personnel and other costs for technical support,
customer service training, installation, launch support, and maintenance costs
for our video-on-demand system. In addition, operations expense includes
personnel and other costs which support our ongoing manufacturing relationships
for our video-on-demand hardware products with third-party manufacturers. We
expect operations expense to increase in the future due to an increase in the
manufacture and sale of our video-on-demand hardware.* To the extent network
operators elect to contract with us for operations support, operations expense
would increase in the area of field support and maintenance.
Engineering and Development. Engineering and development expense consists
of salaries, consulting fees, prototype hardware and other costs to support
product development. Our engineering and development efforts involve ongoing
system software development, system integration and new technology. To date, the
most substantial portion of our operating expenses have been engineering and
development expense. We expect to continue to incur significant engineering and
development expenditures for continued development and enhancements to our
video-on-demand products and services.* We believe these expenditures are
necessary to remain competitive, to assure our products and services are
integrated with industry standards and to offer new services, such as our
recently introduced interactive program guide, and enhancements to our
customers.*
Sales and Marketing. To date, our sales and marketing expense has consisted
of the costs of marketing our video-on-demand products and services to network
operators and their customers and has included business development and
marketing personnel, travel expenses, trade shows, consulting fees and
promotional costs. Historically, our sales and marketing expense has also
included telemarketing, direct mailings, targeted advertising and promotional
campaigns and other direct marketing costs related to acquiring subscribers
under our end-to-end video-on-demand service. In the future, we expect that
direct marketing costs will not represent a significant component of total sales
and marketing expense, as most network operators will take responsibility for
marketing video-on-demand services to their subscribers.* To the extent we
provide these services, they will likely be performed under individual service
agreements with the network operators and, accordingly, will fluctuate with
revenues. Our future sales and marketing costs will consist primarily of market
development and product management expenses.*
General and Administrative. General and administrative expense consists
primarily of salaries and related expenses of management and administrative
personnel, professional fees and general
9
<PAGE>
corporate and administrative expenses. In addition, general and administrative
expense includes costs associated with the development, support and growth of
our management information system infrastructure. We expect general and
administrative expense to increase over time to support the expansion of our
business activities.*
Depreciation and Amortization. Depreciation and amortization expense
includes depreciation of property and equipment, including our video-on-demand
hardware. Generally, depreciation is calculated using the straight-line method
over the estimated useful lives of the assets, which range from three to five
years. Historically, depreciation expense has been a significant component of
our operating expenses. This resulted from the significant investment in capital
equipment necessary to deploy our end-to-end video-on-demand service. We expect
depreciation expense to decrease as a component of operating expense in the
future as network operators purchase the various video-on-demand hardware
components directly from us.*
Warrant (Benefit)/Expense. Warrant (benefit)/expense represents the cost of
the warrants issued to customers and a strategic business partner based on their
estimated fair value, as determined using the Black-Scholes model, at the
earlier of the grant date or the date it becomes probable that the warrants
will be earned.
Amortization of Deferred Stock Compensation. Deferred stock compensation
represents the difference between the estimated fair value of our common stock
for accounting purposes and the option exercise price of such options at the
grant date.
Other Income and Expense
Other income and expense primarily consists of interest income and
interest expense. Interest income consists of earnings on cash, cash equivalents
and short-term investments. Gain on sale of investments consists of proceeds
from the sale of an investment in common stock held by us. Interest expense
consists primarily of accreted interest on our outstanding debt and revaluation
of redeemable put warrants.
Results of Operations
Revenue
Total revenue for the three months ended September 30, 2000 was $385,000
compared to $68,000 for the three months ended September 30, 1999.
Product revenue. Product revenue was $35,000 for the three months ended
September 30, 2000. We did not record any product revenue for the three months
ended September 30, 1999.
License revenue. License revenue was $36,000 for the three months ended
September 30, 2000. We did not record any license revenue for the three months
ended September 30, 1999.
10
<PAGE>
Service revenue. Service revenue was $314,000 and $68,000 for the three
months ended September 30, 2000 and 1999, respectively. This increase was
primarily due to an increase in the number of video-on-demand subscribers.
Operating Expenses
Cost of Product Revenue. Cost of product revenue was $185,000 for the
three months ended September 30, 2000. We did not record cost of product revenue
for the three months ended September 30, 1999.
Programming. Programming expense was $1.0 million and $1.2 million for the
three months ended September 30, 2000 and 1999, respectively. The decrease in
programming expense was primarily attributable to reduced labor and other
related program production service costs. In addition, we have reduced the
number of trailers, previews, promotions, and other encoding related costs,
resulting in a reduction of overall expenditures in this area. The three months
ended September 30, 2000 reflect this reduced level of expenditures when
compared to the three months ended September 30, 1999.
Operations. Operations expense was $1.8 million and $1.5 million for
the three months ended September 30, 2000 and 1999, respectively. The increase
in operations expense was primarily attributable to increased personnel costs in
the manufacturing area as we commercially introduced our video-on-demand
products and services in multiple network operators' plants and increased
expenses related to operations activity in our United Kingdom office.
Engineering and Development. Engineering and development expense was
$8.0 million and $5.3 million for the three months ended September 30, 2000 and
1999, respectively. The increase in engineering and development expense was
attributable to the hiring of additional engineering and development personnel,
outside consultants and other engineering expenses in connection with the
further development and enhancement of our video-on-demand technology. In
addition, the increase included expenditures for the development of new products
and services such as our interactive program guide and integration activities
related to digital broadcast platforms and middleware applications required for
deployment by network operators. Included in engineering and development
expenses for the three months ended September 30, 2000 was $1.1 million in
development related expenses pursuant to a development contract with a third
party. There was no similar expense for the three months ended September 30,
1999.
Sales and Marketing. Sales and marketing expense was $1.5 million and
$1.6 million for the three months ended September 30, 2000 and 1999,
respectively. There was no significant variance in sales and marketing expense
between the three months ended September 30, 2000 and 1999.
General and Administrative. General and administrative expense was $5.5
million and $4.7 million for the three months ended September 30, 2000 and 1999,
respectively. Overall, these expenses have increased as a direct result of the
growth in all phases of our operations. In addition to the increase in personnel
related expenses, the increase in general and administrative expense is the
result of increased rent expense due to the relocation of our corporate
headquarters to a new facility and international business development expenses,
including the operations of an office in the United Kingdom and expenses related
to the filing of a registration statement on Form S-1.
11
<PAGE>
Depreciation and Amortization. Depreciation and amortization expense was
$1.5 million for the three months ended September 30, 2000 and 1999.
Amortization of Deferred Stock Compensation. Amortization of deferred
stock compensation expense was $1.1 million and $205,000 for the three months
ended September 30, 2000 and 1999, respectively. The increase in deferred stock
compensation expense was related to an increase in stock options granted to
employees and consultants. We expect to continue to grant options to employees
which may result in an increase in deferred stock-based compensation which will
be amortized over the applicable vesting periods of the options.
Other Income and Expenses
Interest income was $671,000 and $1.6 million for the three months ended
September 30, 2000 and 1999, respectively. The decrease in interest income is
the result of a decrease in cash and cash equivalent balances, which are
invested in short-term, interest bearing accounts and a decrease in short-term
investments. Gain on sale of investments was $12.9 million for the three months
ended September 30, 2000. Gain on sale of investment is due to the sale of
shares of PMC-Sierra, Inc. common stock previously acquired by us in connection
with the acquisition by PMC-Sierra, Inc., of a company in which we held a small
minority interest. Interest expense was $5.3 million and $9.2 million for the
three months ended September 30, 2000 and 1999, respectively. Included in
interest expense for the three months ended September 30, 2000 is a gain on the
revaluation of redeemable put warrants of $4.7 million.
Provision for Income Taxes
We have not provided for or paid federal income taxes due to our net
losses. As of June 30, 2000, we had net operating loss carryforwards of
approximately $215.7 million to offset future income subject to federal income
taxes and $112.9 million available to offset future California taxable income.
As of June 30, 2000, we had $21.8 million in net operating losses to offset
future New Jersey taxable income and we had $11.0 million in net operating
losses to offset future Pennsylvania taxable income. The extent to which such
loss carryforwards can be used to offset future taxable income may be limited
because of ownership changes pursuant to Section 382 of the Internal Revenue
Code of 1986, as amended.
Liquidity and Capital Resources
From inception through September 30, 2000, we have financed our operations
primarily through the gross proceeds of private placements totaling
approximately $108.3 million of equity and $250.0 million of high yield debt
securities, net of repayments. During the three months ended September 30, 2000,
we raised $5.0 million by issuing preferred stock to Charter Communications. As
of September 30, 2000, we had cash and cash equivalents and short-term
investments totaling $78.0 million.
On February 19, 1998, we received $250.0 million in gross proceeds from
an offering of 463,000 units consisting of senior discount notes with an
aggregate principal amount at maturity of $463.0 million and warrants to
purchase an aggregate of 2,778,000 shares of common stock. The notes are
12
<PAGE>
senior unsecured indebtedness, and rank pari passu with any future
unsubordinated unsecured indebtedness. The notes will be senior to any future
subordinated indebtedness, but effectively will be subordinated to any future
secured indebtedness.
The indenture governing our senior discount notes imposes operating and
financial restrictions on us and our subsidiaries. These restrictions in certain
cases significantly limit or prohibit our ability directly and through our
subsidiaries to incur additional indebtedness, create liens upon assets, apply
the proceeds from the disposal of assets, make investments, make dividend
payments and other distributions on capital stock and redeem capital stock.
These covenants may limit our ability to finance our future operations or to
engage in other business activities that may be in our best interest.
The senior discount notes were sold at a significant discount, and must be
repaid at maturity on March 1, 2008. Commencing September 1, 2003, we are
required to make semi-annual interest payments of $29.2 million, based on the
aggregate par value of $463.0 million. There are no principal payments due on
the senior discount notes prior to maturity on March 1, 2008.
The net proceeds from the offering of the notes were approximately $199.9
million, after deducting placement fees and other offering costs, the
extinguishment of all the subordinated discount notes issued in a previous
offering and a premium paid in connection with the early extinguishment of these
notes. In connection with the offering, we allocated approximately $18.1 million
of the proceeds to the warrants.
We expect to require significant working capital and incur significant
operating expenses in the future.* Working capital requirements include
inventory expenditures for our video-on-demand and interactive program guide
hardware and general capital expenditures associated with our anticipated
growth. Our working capital needs will, in part, be determined by the rate at
which network operators purchase and introduce our video-on-demand products and
services. In addition to working capital, we intend to make significant
expenditures for continued development and enhancement of our video-on-demand
technology, development of new services and other expenses associated with the
delivery of our video-on-demand products and services. Our actual cash
requirements may vary from expectations and will depend on numerous factors and
conditions, many of which are outside of our control. We may also use a portion
of our cash resources to purchase some of our outstanding indebtedness in the
open market from time to time depending on market conditions.
We believe our cash, cash equivalents and short-term investments will be
sufficient to satisfy our cash requirements at least through the current fiscal
year.* Thereafter, we will need to raise significant additional funds to support
our operations. However, we may need to raise additional funds earlier if our
estimates of working capital and operating expenditure requirements change or
prove to be inaccurate. We may also need to raise significant additional funds
in order to respond to unforeseen technological or marketing hurdles or to take
advantage of unanticipated opportunities. We have no present commitments or
arrangements assuring us of any future equity or debt financing, and there can
be no assurance that we will be able to obtain any such equity or debt financing
on favorable terms or at all. In the event that we are unable to obtain such
additional capital, we will be required to delay the expansion of our business
or take other actions that would harm our business and our ability to achieve
sufficient cash flow to service our indebtedness. To the extent we raise
additional cash by issuing equity securities, our existing stockholders will be
diluted.
13
<PAGE>
Recent Accounting Pronouncements
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, hedging activities, and exposure
definition. SFAS No. 133 requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. In June 2000, the FASB issued Statement of
Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities, and amendment to FASB Statement No.
133". Statement No. 138 addresses a limited number of issues causing
implementation difficulties for companies that are required to apply Statement
No.133. Statement 133, as amended by SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the effective date of FASB
Statement No. 133", and Statement No. 138 are effective for all fiscal quarters
of all fiscal years beginning after June 15, 2000. The adoption of SFAS 133 and
SFAS 138 has not had a material effect on our financial position or results of
operations.
In December 1999, the Securities and Exchange Commission issued SAB No.
101, "Revenue Recognition in Financial Statements," which is effective in the
first quarter of fiscal 2001 but does not have to be adopted till the fourth
quarter of fiscal 2001. We are currently analyzing this statement, but do not
expect it to have a material impact on our consolidated financial statements.
In March 2000, the Financial Accounting Standards Board issued Financial
Accounting Standard Interpretation No. 44 (FIN 44) "Accounting for Certain
Transactions Involving Stock Compensation - an Interpretation of Accounting
Principles Board Opinion (APB) No. 25." FIN 44 clarifies the application of APB
Opinion No. 25 and is effective July 1, 2000. The adoption of FIN 44 has not had
a material effect on our financial position or results of operations.
14
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The following discussion about our market risk disclosures contains
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements. We are exposed to market risk related to changes
in interest rates, foreign currency exchange rates and derivatives.
Interest Rate Sensitivity
We maintain a short-term investment portfolio consisting mainly of
income securities with an average maturity of less than one year. These
available-for-sale securities are subject to interest rate risk and will fall
in value if market interest rates increase. We have the ability to hold our
fixed income investments until maturity and therefore, we would not expect our
operating results or cash flows to be affected to any significant degree by
the effect of a sudden change in market interest rates on its securities
portfolio.
Our short-term investments have generally been available-for-sale.
Gross unrealized gains and losses were not significant as of September 30,
2000.
The following table presents the principal amounts and related
weighted-average yields for our fixed rate investment portfolio (in thousands,
except average yields) at September 30, 2000.
<TABLE>
<CAPTION>
Carrying Average
Amount Yield
-------- -------
<S> <C> <C>
U.S government obligation $ 8,316 6.32%
Commercial paper 46,589 6.56%
Certificates of deposits 2,103 4.55%
Money market instruments 4,111 6.25%
Auction rate preferred stock certificates 16,900 6.55%
-------
Total 78,019
Included in cash and cash equivalents 47,659
Included in short-term investments 30,360
-------
Total $78,019
=======
</TABLE>
Foreign Currency Risks
We believe that our exposure to currency exchange fluctuation risk is
insignificant because our transactions with international vendors are
generally denominated in U.S. dollars, which is considered to be the functional
currency for our company and subsidiaries.*The currency exchange impact on
intercompany transactions was $106,000.
Factors Affecting Operating Results
We will require a significant amount of cash to service our indebtedness, and
our ability to generate cash depends on many factors beyond our control
We expect to continue to generate substantial net losses and negative
cash flow for the next few years. We may be unable to achieve a level of cash
flow from operations sufficient to permit us to pay the principal and interest
on our current indebtedness and any additional indebtedness we may incur. The
senior discount notes were sold at a significant discount and must be repaid at
maturity on March 1, 2008. Commencing September 1, 2003, we are required to make
semi-annual interest payments of $29.2 million, based on the aggregate par value
of $463.0 million. Our ability to make scheduled debt service payments will
depend upon our ability to achieve significant and sustained growth in our cash
from operations and to complete necessary additional financings.
If we are unable to generate sufficient cash from operations to service
our indebtedness, we may have to forego or delay development and enhancement of
our video-on-demand system and service, restructure or refinance our
indebtedness or seek additional equity capital or debt financing. We may not be
able to effect any refinancing or new financing strategy on satisfactory terms,
if at all. If we fail to satisfy our obligations with respect to our
indebtedness, this could result in a default under the indenture governing our
senior discount notes and could cause a default under agreements governing our
other indebtedness. In the event of a default, the holders of indebtedness would
have enforcement rights, including the right to accelerate the debt and the
right to commence an involuntary bankruptcy proceeding against us. This would
significantly harm the price of our common stock. Absent successful commercial
deployments of our video-on-demand and interactive program guide services,
ongoing technical development and enhancement of our video-on-demand system and
significant growth of our cash flow, we will not be able to service our
indebtedness.
Our leverage is substantial and will increase, making it more difficult to
respond to changing business conditions
We are highly leveraged. As of September 30, 2000, we had senior
discount notes payable of approximately $322.9 million. The senior discount
notes were sold at a significant discount and must be repaid at maturity on
March 1, 2008 at the aggregate par value of $463.0 million. The degree to which
we are leveraged could have important consequences to us and our investors,
including, but not limited to, the following:
. our ability to obtain additional financing in the future for working
capital, operating expenses in connection with system deployments,
development and enhancement of our video-on-demand
15
<PAGE>
system, capital expenditures, acquisitions and other general corporate
purposes may be materially limited or impaired;
. our cash flow, if any, will not be available for our business because a
substantial portion of our cash flow must be dedicated to the payment of
principal and interest on our indebtedness;
. the terms of future permitted indebtedness may limit our ability to redeem
our outstanding senior discount notes in the event of a change of control;
and
. our high degree of leverage may make us more vulnerable to economic
downturns, may limit our ability to withstand competitive pressures and may
reduce our flexibility in responding to changing business and economic
conditions.
Our indebtedness contains restrictive covenants that could significantly limit
our ability to engage in business activities that may be in our best interest
The indenture governing our senior discount notes imposes operating and
financial restrictions on us and our subsidiaries. These restrictions in
specified cases significantly limit or prohibit our ability to:
. incur additional indebtedness;
. create liens upon assets;
. apply the proceeds from the disposal of assets;
. make investments;
. make dividend payments and other distributions on capital stock; and
. redeem capital stock.
These covenants may limit our ability to finance our future operations
or to engage in other business activities that may be in our best interest.
We are an early stage company with limited revenues and a history of losses, we
expect to continue to incur substantial losses and negative cash flow and we may
never achieve or sustain profitability
We are an early stage company with limited commercial operating
history. We have generated revenues of $2.7 million and have incurred net losses
of approximately $369.4 million since our inception through September 30, 2000.
We expect to continue to incur substantial losses and experience substantial
negative cash flow for at least the next few years as we continue to develop our
video-on-demand service capability and sell and license our products and
services. We do not expect to generate substantial revenues unless and until our
video-on-demand products and services are deployed at a significant number of
additional cable systems and a significant number of viewers access our service.
If we do not achieve and sustain profitability in the future, then we may be
unable to continue our operations.
Our prospects should be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. Our
future success depends on a number of factors, including the following:
. our ability to enter into agreements for broad distribution of our
video-on-demand and interactive program guide products and services to
network operators;
16
<PAGE>
. the extent to which network operators upgrade their cable plant to enable
two-way operation and deploy digital set-top boxes;
. the extent to which viewers use our products and services for interactive,
on-demand television;
. our ability to continue integrating our software and hardware with other
digital applications and services selected by network operators in the
United States and internationally, including set-top boxes, application
managers and set-top box operating systems, cable system components and
electronic program guides;
. the extent to which third-party cable suppliers adapt their equipment to
integrate with our equipment and reduce the cost and physical space
requirements for their equipment;
. our ability to continue further technical development of our video server,
our access equipment, our service software and our other video-on-demand
system components in order to reduce their manufacturing cost and enhance
their functionality; and
. our ability to operate existing contracted video-on-demand deployments with
acceptable system performance and viewer acceptance.
Because we have a limited operating history, we have limited historical
financial data on which to base planned operating expenses, and investors may
find it difficult to evaluate our business and future prospects
Our limited operating history makes it very difficult to evaluate our
business and future prospects. As a result of our limited operating history, it
is difficult for us to accurately forecast our revenues, and we have limited
meaningful historical financial data on which to base planned operating
expenses. We are unable to accurately forecast our revenues because:
. we participate in an emerging market;
. our current deployment agreements with network operators are for a single
system or a limited number of systems, and we are unable to predict whether
they will be expanded to cover additional systems;
. we cannot predict the rate at which cable subscribers will sign up for our
service;
. we expect to sign new sales, service and licensing agreements on an
irregular basis, if at all, and there may be long periods of time during
which we do not enter into new agreements or expanded arrangements; and
. we have a lengthy sales cycle, which makes it difficult to forecast the
quarter during which a sale will occur.
We have recently expanded our sales and marketing strategy, from one
under which we owned all hardware and software components of our video-on-demand
system and delivered the video-on-demand service offering to cable subscribers,
to include the option under which the network operator purchases, owns and
maintains all or part of the video-on-demand system hardware and takes the
capital and operating expense risk associated with such ownership. It is
difficult to predict the timing and amount of revenue that will be generated
following this change in strategy.
We expect our financial results to fluctuate significantly because we depend on
a small number of relatively large orders and other factors
17
<PAGE>
Our quarterly operating results will fluctuate significantly in the
future as a result of a variety of factors, either alone or in combination. In
the short term, we expect our quarterly revenues to be significantly dependent
on a small number of relatively large orders for our products and services. As a
result, our quarterly operating results may fluctuate significantly if we are
unable to complete one or more substantial sales in any given quarter. Factors
that will affect our quarterly results, many of which are outside our control,
include:
. the timing of deployments by network operators of our video-on-demand and
interactive program guide products and services;
. the terms of our contractual arrangements with network operators, who may
either contract to have us manage and operate an end-to-end solution or
purchase software and hardware components separately to create their own
video-on-demand systems;
. the mix of services revenues, which depends on the extent to which network
operators purchase services from us on a fee-for-service basis or a revenue
sharing basis;
. competitive pressure, which may cause us to change our pricing structures;
and
. demand for and viewer acceptance of our video-on-demand service.
A significant portion of our operating expenses are relatively fixed
and necessary to develop our business. These expenses are largely independent of
the revenue generated in any given quarter from sales of products and services
to network operators. To the extent that increased expenses are not subsequently
followed by increased revenues, our operating results will suffer. If revenue
falls below expectations in any quarter, the adverse impact of the revenue
shortfall on operating results in that quarter may be increased by our inability
to adjust fixed spending to compensate for the shortfall.
Due to these and other factors, we believe that period-to-period
comparisons of our operating results may not be meaningful or indicative of
future performance. You should not rely on our results for any one quarter as an
indication of our future performance. It is likely that in some future quarters
or years our operating results will fall below the expectations of securities
analysts or investors.
If we do not achieve broad deployment of our video-on-demand and interactive
program guide products and services, our business will not grow
Our future success depends in large part on our ability to sell our
products and services and deploy our video-on-demand system in a broad base of
cable systems, on terms that will generate a profit. We believe that network
operators will initially be unwilling to commit to broad deployments of our
video-on-demand services and products until they have completed trials of our
services as well as those of competitors.* Our ability to achieve broad network
operator deployments will depend on our success in demonstrating that:
. our products and services are reliable and scalable and integrate with
products and services provided by other cable industry suppliers chosen by
the network operator;
. video-on-demand is a compelling consumer product and viewers will purchase
video-on-demand content at prices and in quantities that will justify the
network operator's investment in our video-on-demand products and services
rather than alternative entertainment services such as pay-per-view and
near-video-on-demand;
18
<PAGE>
. our video-on-demand and interactive program guide products are compatible
with industry standards as they evolve; and.
. our technology enables the network operator to add new revenue generating
services.
If we are unable to persuade network operators to purchase our products or
services and deploy video-on-demand broadly in their cable systems, the growth
of our business will suffer.
If the limited commercial deployments of our video-on-demand service with
network operators are not expanded, our results of operations and our reputation
will suffer
We have deployed our video-on-demand service in two cable systems owned
by Charter, a multiple-headend cable system owned by AT&T, and three cable
systems owned by Insight. In May 2000, we entered into an agreement with Charter
to deploy our video-on-demand service in a number of additional cable systems.
In September 2000, we entered into an agreement with AT&T to deploy our
video-on-demand service in a number of cable systems owned by AT&T. The existing
deployments with Charter, Chambers, Insight and AT&T, currently serve a limited
number of approximately 35,000 customers. These network operators may not
continue these deployments beyond the terms of our existing agreements, and they
may choose not to broadly deploy our video-on-demand service in existing or
additional cable systems. In the past, we had limited scope video-on-demand
trials with other network operators that did not result in broad deployments. If
we are unable to add a substantial number of cable systems to the existing
contracts with the network operators currently deploying our products and
services, our results of operations will suffer. In addition, our reputation and
our ability to enter into agreements with other network operators could be
impaired.
Our products and services will not achieve widespread adoption unless network
operators upgrade their cable plant, deploy digital set-top boxes, roll out our
service and market our services to subscribers, all of which are beyond our
control
Our video-on-demand service and interactive program guide require
deployment on cable systems upgraded to hybrid fiber/coaxial architecture with
the return path from the customer to the headend activated to enable two-way
operation. According to the Cablevision Blue Book, approximately 45% of the
total U.S. homes passed by cable had been upgraded to hybrid fiber/coaxial
architecture with return path capability at the end of 1998, but only a limited
portion of the upgraded plant is currently activated for two-way transmission.
The failure of network operators to complete planned upgrades in a timely and
satisfactory manner, and the lack of suitable cable plant, would harm our
business.
Our ability to achieve widespread adoption of our video-on-demand and
interactive program guide products and services also depends on a number of
other factors, many of which are beyond our control, including:
. the rate at which network operators upgrade their cable infrastructures and
deploy digital set-top boxes;
. the ability of network operators to coordinate timely and effective
marketing campaigns with the availability of cable infrastructure upgrades;
. the ability of network operators to maintain their cable infrastructure and
headends in accordance with system specifications provided by us;
19
<PAGE>
. the success of network operators in marketing our video-on-demand service;
. the prices that network operators set for our video-on-demand service and
for its installation;
. the speed at which network operators can complete the installations
required to initiate service for new subscribers;
. the quality of customer and technical support provided by us and network
operators; and
. the quality of content delivered to subscribers through our video-on-demand
service.
We expect rapid technological developments to occur in our industry and,
accordingly, must continue to enhance our current products as well as develop
new technologies, or competitors could render our products and services obsolete
We expect rapid technological developments to occur in the market for
interactive home video entertainment products and services. As a result, we have
modified and expect to continue to modify our engineering and development plans.
These modifications have resulted in delays and increased costs. Furthermore, we
expect that we will be required to continue to enhance our current
video-on-demand products and services and develop and introduce increased
functionality and performance to keep pace with technological developments and
consumer preferences. In addition, we may not be successful in developing and
marketing product and service enhancements or new services that respond to
technological and market changes, and we may experience difficulties that could
delay or prevent the successful development, introduction and marketing of such
new product and service enhancements. Our failure to successfully develop these
projects could harm our business. We have encountered delays in product
development, service integration and field tests and other difficulties
affecting both software and hardware components of our system and our ability to
operate successfully over hybrid fiber/coaxial plant. In addition, many of our
competitors have substantially greater resources than we to devote to further
technological and new product development. Technological and market changes or
other significant developments by our competitors may render our video-on-demand
and interactive program guide products and services obsolete.
Our interactive program guide is a new product that has not been accepted by
network operators and competes with well-established products from competitors
having significantly greater resources
Our interactive program guide is a new product in a well-established
market. The market for electronic program guides has two major participants, TV
Guide and Gemstar, which have agreed to merge into one company. Our interactive
program guide competes with those companies' guides, which are already broadly
deployed by network operators. Our guide also competes with interactive guides
being introduced by TV Guide and Gemstar and with an interactive program guide
currently being deployed by Interactive Channel. We expect that our interactive
program guide will not be broadly deployed until its features are fully
developed and field tested. In addition, network operators' acceptance of our
interactive program guide will depend on the appeal of our business model for
the guide, which is unproven. As a result, network operators may not accept our
interactive program guide and may choose to use guides from more
well-established competitors. Our competitors have significantly greater
resources than we do, and TV Guide has an exclusive long-term agreement with the
largest cable operator, AT&T. Consequently, we may not be able to compete
effectively or at all in the electronic program guide market.
20
<PAGE>
If we do not obtain substantial additional funds in the future, we may be unable
to continue to grow our business or repay our indebtedness
We will require substantial additional funds in order to continue the
development, sale, license and provision of our video-on-demand and interactive
program guide products and services and, commencing on September 1, 2003, to
make cash interest payments on our indebtedness. We have made and expect to
continue to make significant investments in working capital in order to fund
development activities, commercially deploy our video-on-demand service, sell
our products and services and fund operations. We expect to continue to incur
significant operating losses and expect that our operating cash flow will be
increasingly negative over at least the next few years. We believe our existing
cash, cash equivalents and short-term investments will be sufficient to meet our
cash requirements through the next twelve months.* However, we may need to raise
additional funds earlier if our estimates of working capital or capital
expenditure requirements change or prove to be inaccurate. We may also need to
raise significant additional funds in order to respond to unforeseen
technological, marketing or competitive hurdles or to take advantage of
unanticipated opportunities.
We have no present commitments or arrangements assuring us of any
future equity or debt financing, and we may not be able to obtain any equity or
debt financing on favorable terms or at all. In the event that we are unable to
obtain additional capital, we will need to delay the expansion of our business
or take other actions that could harm our business and may need to cease
operations. We may also not be able to pay interest and principal on our
indebtedness when due.
Our lengthy sales cycle may cause fluctuations in our operating results
We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a network operator. In
many cases, the decision to purchase our products and services requires network
operators to change their established business practices and conduct their
business in new ways. As a result, we need to educate network operators on the
use and benefits of our products and services, which can require significant
time and resources without necessarily resulting in revenues. In addition,
network operators generally must consider a wide range of other issues before
committing to purchase and incorporate our technology into their offerings and
obtain approval at a number of levels of management. Our sales cycle has ranged
from six months to a number of years. Our lengthy sales cycle limits our ability
to forecast the timing and amount of specific sales.
The market for our video-on-demand products and services is intensely
competitive, and our current and potential competitors have significantly
greater resources than we do. Consequently, we may not be able to compete
effectively, which would harm our operating results
Competition in both the video-on-demand market and the broader market
for in-home video entertainment is intense and subject to rapid technological
change. We expect competition in the market for video-on-demand products and
services to intensify in the future. We categorize our video-on-demand
competitors as follows:
. server manufacturers, such as Concurrent, nCUBE and SeaChange;
. software providers, such as Prasara and Scientific-Atlanta; and
21
<PAGE>
. system integrators, such as Time Warner and Scientific-Atlanta.
We provide products and services that compete in all three categories.
Although none of our video-on-demand competitors offer products and services in
all of these categories, some of them may form alliances in order to develop an
integrated end-to-end video-on-demand system that may be more attractive to
network operators and their subscribers than ours. Some of our video-on-demand
competitors have long standing business relationships with network operators and
may be able to use those relationships to gain a competitive advantage over us.
In addition to video-on-demand competitors, we compete in the market
for in-home video entertainment. We believe our competitors fall into three
groups:
. companies that provide in-home video entertainment over cable networks,
including providers of pay-per-view and near-video-on-demand;
. companies that deliver in-home video entertainment over networks, such as
regular telephone lines, digital subscriber lines, or DSL, satellite or the
Internet, and some providers of video streaming technology; and
. companies that enable the viewer to store and access content on an
"on-demand" basis, including providers of personal video recorders, such as
TiVo and Replay, and companies that rent and sell videotapes.
Many of our competitors and potential competitors have longer operating
histories, greater name recognition and significantly greater financial,
technical, marketing and distribution resources than we have. As a result, they
may be able to respond to new or emerging technologies and changes in customer
requirements faster than we do. They may also be able to devote greater
resources to the development, promotion and sale of their products and services
in a more effective manner. We may be unable to compete successfully against
current or future competitors, and competitive pressures that we face may harm
our business.
If we fail to manage our growth effectively, our ability to implement our
business strategies may be limited
In order to execute our business strategy, we must meet aggressive
engineering, integration, product delivery and installation targets. The growth
in our business has placed and is expected to continue to place significant
demands on our management, operating, development, third party manufacturing and
financial and accounting resources. Our ability to manage growth effectively
will require continued implementation of and improvements to our operating,
manufacturing, development and financial and accounting systems and will require
us to expand and continue to train and manage our employee base. These demands
likely will require the addition of new management personnel and the development
of additional expertise by existing management personnel. Our systems,
procedures or controls or financial resources may be inadequate to support our
operations, and our management may be unable to keep pace with this growth. If
we are unable to manage our growth effectively, our business ability to
successfully implement our business strategies will suffer.
22
<PAGE>
If we are unable to adequately protect or enforce our intellectual property
rights, we could suffer competitively, incur costly litigation expenses or lose
valuable assets
Our future success depends, in part, on our ability to protect our
intellectual property and maintain the proprietary nature of our technology
through a combination of patents, licenses and other intellectual property
arrangements. We have been awarded patents and have filed applications and
intend to file additional applications for patents covering various aspects of
our video-on-demand and interactive program guide products and services. Any
patents issued may be challenged, invalidated or circumvented, and the rights
granted under any patents may not provide proprietary protection to us. We may
not be successful in maintaining these proprietary rights, and our competitors
may independently develop or patent technologies that are substantially
equivalent or superior to our technologies. To the extent we integrate our
products with those of third parties, we may be required to disclose or license
intellectual property to those companies, and these companies could appropriate
our technology or otherwise improperly exploit the information gained through
this integration. If we believe third parties are infringing our intellectual
property, we may be forced to expend significant resources enforcing our rights
or suffer competitive injury.
If third parties claim that we infringe their intellectual property, our ability
to use some technologies and products could be limited, and we may incur
significant costs to resolve these claims
From time to time, we have received notices from third parties claiming
infringement of intellectual property rights. Although we do not believe that we
infringe any third party's intellectual property rights, we could encounter
similar claims or litigation in the future. Gemstar, a primary provider of
interactive program guides, has actively assembled and continues to acquire a
portfolio of intellectual property in the field of interactive program guides
and has aggressively sought recourse against any parties that it believes
infringes its intellectual property. Although we believe that we do not infringe
any published patents relating to our implementation of an interactive program
guide and have not been served notice of any potential infringement, this
provider may make such a claim in the future, which could result in legal
action. Because patent applications in the United States are not publicly
disclosed until the patent has been issued, applications may have been filed
that, if issued as patents, would relate to our products. In addition, we have
not completed a comprehensive patent search relating to the technology used in
our video-on-demand and interactive program guide products and services.
Parties making claims of infringement may be able to obtain injunctive
or other equitable relief that could effectively block our ability to provide
our products and services in the United States and internationally and could
result in an award of substantial damages. In the event of a successful claim of
infringement, we and our customers may be required to obtain one or more
licenses from third parties, which may not be available at a reasonable cost or
at all. The defense of any lawsuit could result in time consuming and expensive
litigation regardless of the merits of such claims, and damages, license fees,
royalty payments and restrictions on our ability to provide our video-on-demand
or interactive program guide products or services, any of which could harm our
business.
23
<PAGE>
We rely on several sole or limited source suppliers and manufacturers, and our
production will be seriously harmed if these suppliers and manufacturers are not
able to meet our demand and alternative sources are not available
We subcontract manufacturing of our hardware to a single contract
manufacturer. We do not have a contract with this manufacturer and operate on a
purchase order basis. Because of the complexity of our hardware components,
manufacturing and quality control are time consuming processes. Our contract
manufacturer may be unable to meet our requirements in a timely and satisfactory
manner, and we may be unable to find or maintain a suitable relationship with
alternate qualified manufacturers. Our reliance on a third-party manufacturer
involves a number of additional risks, including the absence of guaranteed
capacity and reduced control over delivery schedules, quality assurance,
production yields and costs. In the event we are unable to obtain such
manufacturing on commercially reasonable terms, our production would be
seriously harmed.
Various subassemblies and components used in our video server and
access equipment are procured from single sources and others are procured only
from a limited number of sources. Consequently, we may be adversely affected by
worldwide shortages of components, significant price increases, reduced control
over delivery schedules, and manufacturing capability, quality and cost.
Although we believe alternative suppliers of products, services, subassemblies
and components are available, the lack of alternative sources could harm our
ability to deploy our video-on-demand and interactive program guide systems.
Manufacturing lead times can be as long as nine months for some critical
components. Therefore, we may require significant working capital to pay for
such components well in advance of both hardware orders and revenues. Moreover,
a prolonged inability to obtain components could harm our business and could
result in damage to network operator relationships.
If we are unable to acquire programming content on reasonable terms, our ability
to derive revenues from deployments where we provide programming content will be
limited
In those network operator deployments where we provide programming
content, our success will depend, in part, on our ability to obtain access to
sufficient movies (including new releases and library titles), special interest
videos and other programming content on commercially acceptable terms. Although
we have entered into arrangements with most of the major movie studios and a
number of other content providers for our initial deployments, we may not be
able to continue to obtain the content during the segment of time available to
video-on-demand providers and others such as pay-per-view providers, to support
our video-on-demand service beyond the geographic area of our initial
deployments. Studios may require us to make prepayments prior to the time that
customers pay for viewing a title or require us to enter into long-term
contracts with minimum payments. Further, studios may increase the license fees
currently charged to us. If we are unable to obtain timely access to content on
commercially acceptable terms, our ability to obtain revenue from deployments
where we provide content will be limited.
Competition for qualified personnel is intense in technology industries such as
ours, and we may not be able to maintain or expand our business if we are unable
to hire and retain sufficient technical, sales, marketing and managerial
personnel
24
<PAGE>
Competition for qualified personnel in technology industries is
intense, particularly in Silicon Valley. We may not be able to attract and
retain qualified personnel in the future. If we are unable to hire and retain
sufficient technical, sales and marketing and managerial personnel, our business
will suffer. Our future success depends in part on the continued service of our
key engineering, sales, marketing, manufacturing, finance and executive
personnel. If we fail to retain and hire a sufficient number and type of
personnel, we will not be able to maintain and expand our business.
We intend to expand our international offering and operations, and these efforts
may not be successful in generating revenues sufficient to offset the associated
expense
Although we have yet to generate any international revenue, we plan to
create an international product offering and to increase our international sales
and operations. We expect to expend significant financial and managerial
resources to do so. If our revenues from international operations do not meet
our expectations, our operating results will be adversely affected. We face
risks inherent in conducting business internationally, including:
. unexpected changes in regulatory requirements and tariffs that may be
imposed on our services;
. difficulties and costs of staffing and managing international operations;
. differing technology standards and difficulties in obtaining export and
import licenses;
. longer payment cycles, difficulties in collecting accounts receivable and
longer collection periods;
. political and economic instability;
. fluctuations in currency exchange rates;
. imposition of currency exchange controls;
. potentially adverse tax consequences; and
. reduced protection for intellectual property rights in some countries.
Any of these factors could adversely affect our international
operations and, consequently, our business and operating results. Specifically,
our failure to successfully manage our international growth could result in
higher operating costs than anticipated, or could delay or preclude our ability
to generate revenues in key international markets.
Network operators are subject to government regulations that could require us to
change our products and services
In the United States, the Federal Communications Commission, or FCC,
has broad jurisdiction over network operators. The FCC does not regulate us, but
requirements imposed on network operators could force us to undertake
development that would consume significant resources and require changes to our
products and services. If we do not change our products so that they comply with
FCC rules, or if our products are not integrated with ones that comply with FCC
requirements, our products and services will not be broadly deployed, and our
business will suffer.
In addition, video-on-demand services in Canada and in the United
Kingdom and other European Union members are licensed in a variety of ways. We
are seeking to determine how best to offer our video-on-demand products and
services in Canada, the United Kingdom and other European Union countries. We
may not be able to obtain distribution rights to movie titles in non-U.S.
jurisdictions under regulatory and financial arrangements acceptable to us.
25
<PAGE>
Control by Insiders
Our executive officers and named directors, together with entities
affiliated with such individuals, and Acorn Ventures, Inc. beneficially own
approximately 34.7% of the Common Stock (assuming conversion of all outstanding
Preferred Stock into Common Stock). Accordingly, these stockholders have
significant influence over our affairs. This concentration of ownership could
have the effect of delaying or preventing a change in control of the Company.
26
<PAGE>
PART II OTHER INFORMATION
Item 1, Item 3 and Item 5 are not applicable with respect to the
current reporting period.
Item 2. Changes in Securities and Use of Proceeds
During the three months ended September 30, 2000, we issued and sold an
aggregate of 76,269 shares of Common Stock to our employees and
consultants for an aggregate purchase price of $149,705 pursuant to
exercises of options under its 1995 and 1998 Stock Plans. These
issuances were deemed exempt from registration under the Securities Act
of 1933, as amended, in reliance upon Rule 701 promulgated thereunder.
In addition, during the three months ended September 30, 2000 we issued
and sold 555,556 shares of Series F Preferred Stock for an aggregate
purchase price of $5,000,000 to one strategic investor. This issuance
was deemed exempt from registration under the Securities Act in
reliance upon Section 4(2) thereof.
Item 4. Submission of Matters to a Vote of Security Holders
On August 23, 2000, we held an annual meeting of Shareholders for which
we solicited votes by proxy. The following is a brief description of
the matters voted upon at the meeting and a statement of the number of
votes cast for and against, and the number of abstentions as to each
matter.
1. Election of the Directors of the Company:
NOMINEES For Withheld
Alan H. Bushell 32,009,928 4,149
Paul M. Cook 32,007,403 6,674
John W. Goddard 32,012,125 0
Jules Haimovitz 32,011,452 673
John A. Rollwagen 32,011,813 312
Barry E. Taylor 32,011,813 312
David F. Zucker 32,008,595 312
2. To approve an amendment to the 1995 Stock Plan to increase the
number of shares of Common Stock reserved for issuance by
3,300,000 shares.
For: 28,007,317 Against: 5,500,760 Abstained: 0
3. To approve an amendment to our Certificate of Incorporation to
authorize 2,000,000 shares on non-voting Series D-1 Preferred
Stock and 2,000,000 shares of non-voting Class B Common Stock.
COMMON: For: 15,745,352 Against: 0 Abstained: 650
PREFERRED: For: 17,760,773 Against: 0 Abstained: 1,302
SERIES A,
27
<PAGE>
SERIES B,
SERIES C&
SERIES D: For: 13,248,952 Against: 0 Abstained: 0
4. To approve an Amended and Restated Certificate of Incorporation
effective upon the closing of our Initial Public Offering.
COMMON: For: 14,275,352 Against: 1,470,000 Abstained: 650
PREFERRED: For: 17,736,773 Against: 24,000 Abstained: 1,302
SERIES A,
SERIES B,
SERIES C&
SERIES D: For: 13,224,952 Against: 24,000 Abstained: 0
5. To approve the Amended and Restated Bylaws effective upon the closing
of our Initial Public Offering.
COMMON: For: 14,275,146 Against: 1,470,000 Abstained: 856
PREFERRED:
SERIES A,
SERIES B,
SERIES C&
SERIES D: For: 13,224,952 Against: 24,000 Abstained: 0
6. To approve the 2000 Employee Stock Purchase Plan with 750,000 shares
of Common Stock reserved for issuance, effective upon the closing of
our Initial Public Offering.
For: 32,013,387 Against: 1,494,361 Abstained: 0
7. To approve the 2000 Stock Plan with 3,000,000 shares of Common Stock
reserved for issuance.
For: 32,013,716 Against: 1,494,361 Abstained: 0
8. To ratify the appointment of KPMG LLC as our independent auditors for
the fiscal year ending June 30, 2001.
For: 32,013,716 Against: 1,494,361 Abstained: 0
28
<PAGE>
Item 6. Exhibits and Reports on Form 8-K:
a. Exhibits.
27.1 Financial Data Schedule
b. Reports on Form 8-K.
No reports on Form 8-K were filed with the Securities and
Exchange Commission during the quarter ended September 30,
2000.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
DIVA SYSTEMS CORPORATION
By: /s/ WILLIAM M. SCHARNINGHAUSEN
---------------------------------------
William M. Scharninghausen
Senior Vice President, Finance and
Administration, and Chief Financial
Officer
Dated: November 14, 2000
30
