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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________.
COMMISSION FILE NUMBER 000-22697
AT HOME CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0408542
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
425 BROADWAY STREET
REDWOOD CITY, CA 94063
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES,
INCLUDING ZIP CODE)
(650) 569-5000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
FORMER NAME, FORMER ADDRESS, AND FORMER YEAR, IF CHANGED SINCE LAST REPORT:
NOT APPLICABLE
------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [_]
THE NUMBER OF SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE,
OUTSTANDING AS OF OCTOBER 31, 1998: 102,379,650 SHARES OF SERIES A COMMON STOCK,
15,400,000 SHARES OF SERIES B COMMON STOCK, AND 4,219,415 SHARES OF SERIES K
COMMON STOCK.
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AT HOME CORPORATION
TABLE OF CONTENTS
<TABLE>
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Page
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PART I FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - September 30, 1998
and December 31, 1997............................................. 3
Condensed Consolidated Statements of Operations - Three and Nine
Months Ended September 30, 1998 and 1997.......................... 4
Condensed Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 1998 and 1997................................. 5
Notes to Condensed Consolidated Financial Statements............... 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 9
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk......... 25
PART II OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds.......................... 26
ITEM 5. Other Information.................................................. 26
ITEM 6. Exhibits and Reports on Form 8-K................................... 26
Signatures......................................................... 27
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AT HOME CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $105,131 $ 44,213
Short-term cash investments................................... 98,608 76,166
-------- --------
Total cash, cash equivalents and short-term cash investments.. 203,739 120,379
Accounts receivable........................................... 3,867 1,470
Accounts receivable - related parties......................... 4,069 672
Other current assets........................................... 3,459 2,919
-------- --------
Total current assets........................................... 215,134 125,440
Property, equipment and improvements, net...................... 44,243 33,061
Other assets................................................... 7,219 2,082
-------- --------
Total assets................................................... $266,596 $160,583
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 5,913 $ 2,409
Accounts payable - related parties............................ 2,623 2,108
Accrued compensation and related expenses..................... 1,009 798
Accrued transport costs....................................... 1,839 1,179
Deferred revenues............................................. 5,054 1,941
Other accrued liabilities..................................... 7,591 5,644
Current portion of capital lease obligations.................. 12,175 9,971
-------- --------
Total current liabilities..................................... 36,204 24,050
Capital lease obligations, less current portion................ 13,521 15,735
Other long-term liabilities.................................... -- 1,736
Commitments and contingencies
Stockholders' equity:
Preferred stock............................................... -- --
Common stock, $0.01 par value:
Authorized shares - 230,277,660
Issued and outstanding shares--
121,948,717 in 1998 and 118,603,220 in 1997................. 581,728 370,111
Notes receivable from stockholders............................ (25) (319)
Deferred compensation......................................... (3,634) (4,399)
Accumulated deficit............................................ (361,198) (246,331)
-------- --------
Total stockholders' equity.................................... 216,871 119,062
-------- --------
Total liabilities and stockholders' equity.................... $266,596 $160,583
======== ========
</TABLE>
See accompanying notes.
3
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AT HOME CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Revenues /(1)/........................... $ 13,815 $ 1,907 $ 28,808 $ 3,737
Costs and expenses /(2)/:
Operating costs......................... 12,256 6,203 30,969 15,368
Product development and engineering..... 4,588 3,137 12,052 8,411
Sales and marketing..................... 4,978 2,937 12,834 8,815
General and administrative.............. 3,112 2,861 8,911 7,521
Cost of distribution agreements......... -- -- 83,320 --
-------- -------- --------- --------
Total costs and expenses.............. 24,934 15,138 148,086 40,115
-------- -------- --------- --------
Loss from operations..................... (11,119) (13,231) (119,278) (36,378)
Interest income, net..................... 1,460 1,337 3,473 1,680
-------- -------- --------- --------
Net loss................................. $ (9,659) $(11,894) $(115,805) $(34,698)
======== ======== ========= ========
Basic and diluted net loss per share..... $ (0.08) $ (0.11) $ (1.02) $ (0.34)
======== ======== ========= ========
Shares used in per share calculations.... 115,073 107,106 113,089 101,191
======== ======== ========= ========
- ------------
/(1)/ Revenues from related parties..... $ 2,914 $ 739 $ 6,086 $ 2,087
======== ======= ========= ========
/(2)/ Depreciation and amortization
included in costs and expenses... $ 3,965 $ 2,412 $ 10,303 $ 6,115
======== ======= ========= ========
</TABLE>
See accompanying notes.
4
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AT HOME CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1998 1997
--------- --------
<S> <C> <C>
CASH USED IN OPERATING ACTIVITIES
Net loss..................................................... $(115,805) $(34,698)
Adjustments to reconcile net loss to cash used
in operating activities:
Amortization of deferred compensation..................... 765 804
Depreciation and amortization............................. 9,538 5,311
Cost of distribution agreements........................... 83,320 --
Changes in assets and liabilities:
Accounts receivable..................................... (5,794) (440)
Other assets............................................ (4,739) (1,794)
Accounts payable........................................ 4,019 (355)
Accrued compensation and related expenses............... 211 351
Deferred revenue........................................ 3,113 1,853
Other accrued liabilities............................... 2,607 4,680
Other long-term liabilities............................. (1,736) 104
--------- --------
Cash used in operating activities............................ (24,501) (24,184)
CASH USED IN INVESTING ACTIVITIES
Purchase of short-term cash investments...................... (86,055) (74,644)
Sales and maturities of short-term cash investments.......... 63,613 8,066
Purchase of property, equipment and improvements,
net of leases............................................... (11,751) (7,678)
--------- --------
Cash used in investing activities............................ (34,193) (74,256)
CASH PROVIDED BY FINANCING ACTIVITIES
Proceeds from issuance of convertible preferred stock........ -- 46,528
Proceeds from issuance of common stock....................... 128,297 99,919
Proceeds from capital lease financing........................ -- 5,630
Payments on capital lease obligations........................ (8,979) (4,477)
Repayment of notes receivable from stockholders.............. 294 177
--------- --------
Cash provided by financing activities........................ 119,612 147,777
--------- --------
Net increase in cash and cash equivalents.................... 60,918 49,337
Cash and cash equivalents, beginning of period............... 44,213 9,709
--------- --------
Cash and cash equivalents, end of period..................... $ 105,131 $ 59,046
========= ========
SUPPLEMENTAL DISCLOSURES
Interest paid................................................ $ 1,676 $ 579
========= ========
Acquisition of equipment under capital leases................ $ 8,969 $ 12,882
========= ========
Financing of acquisition of other assets..................... $ -- $ 1,299
========= ========
Notes receivable from stockholders issued in connection with
exercise of stock options and restricted stock purchases.... $ -- $ 342
========= ========
</TABLE>
See accompanying notes.
5
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AT HOME CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of At Home Corporation and its wholly owned subsidiaries
(collectively, the "Company"). These condensed financial statements do not
include all of the information and accompanying notes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation of financial position
and results of operations have been included in the condensed financial
statements. Operating results for the three and nine months ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
full year ending December 31, 1998. The interim financial statements should be
read in connection with the consolidated financial statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997 filed
with the Securities and Exchange Commission.
NOTE 2. BASIC AND DILUTED NET LOSS PER SHARE
Basic and diluted net loss per share are computed using the weighted average
number of common shares outstanding. The computation for the three and nine
months ended September 30, 1997 also gives pro forma effect to the conversion,
in connection with the Company's initial public offering in July 1997, of all
outstanding shares of Convertible Preferred Stock into shares of Common Stock.
In addition, the effect of the additional shares issued in the Company's public
stock offering on August 12, 1998 is reflected in the computations for the three
and nine months ended September 30, 1998. The effect of outstanding stock
options, warrants and Common Stock subject to repurchase is excluded from the
computation as their inclusion would be anti-dilutive.
The computation of basic and diluted net loss per share is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
1998 1997 1998 1997
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net loss................................ $ (9,659) $(11,894) $(115,805) $(34,698)
======== ======== ========= ========
Weighted average shares of common
stock outstanding...................... 115,073 11,854 113,089 5,939
Pro forma common equivalent shares
from convertible preferred stock....... -- 95,252 -- 95,252
-------- -------- --------- --------
Shares used in per
share calculations..................... 115,073 107,106 113,089 101,191
======== ======== ========= ========
Basic and diluted net
loss per share......................... $ (0.08) $ (0.11) $ (1.02) $ (0.34)
======== ======== ========= ========
</TABLE>
6
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NOTE 3. DEPRECIATION AND AMORTIZATION INCLUDED IN COSTS AND EXPENSES
The components of the Company's depreciation and amortization included in costs
and expenses are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Amortization of deferred compensation.. $ 255 $ 326 $ 765 $ 804
Depreciation and amortization.......... 3,710 2,086 9,538 5,311
-------- -------- --------- --------
$ 3,965 $ 2,412 $ 10,303 $ 6,115
======== ======== ========= ========
</TABLE>
NOTE 4. COMPREHENSIVE INCOME (LOSS)
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"), which
establishes new rules for the reporting and display of comprehensive income
(loss) and its components. The adoption of this Statement had no impact on the
Company's net loss or stockholders' equity. FAS 130 requires unrealized gains
and losses on the Company's available-for-sale securities to be included in
comprehensive loss.
The components of the Company's comprehensive loss are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net loss............................... $ (9,659) $(11,894) $(115,805) $(34,698)
Unrealized gain (loss) on investments.. (2,037) -- 938 --
-------- -------- --------- --------
Comprehensive loss..................... $(11,696) $(11,894) $(114,867) $(34,698)
======== ======== ========= ========
</TABLE>
NOTE 5. STOCKHOLDERS' EQUITY
Common Stock Warrants Issued to Cable Partners in Connection With Distribution
Agreements.
In October 1997, the Company entered into a contract with Cablevision Systems
Corporation ("Cablevision"), and its parent, CSC Parent Corporation ("CSC
Parent"), Comcast Corporation ("Comcast"), Cox Communications, Inc. ("Cox"),
Kleiner Perkins Caufield & Byers ("KPCB") and Tele-Communications, Inc. ("TCI")
(the "Cablevision Agreement"). Pursuant to the Cablevision Agreement,
Cablevision entered into a Master Distribution Agreement for the distribution of
the Company's @Home service on substantially the same terms and conditions as
such service is distributed by TCI, Comcast and Cox. Although Cablevision is
subject to certain exclusivity obligations that prohibit it from obtaining high-
speed (greater than 128 kilobits per second) residential consumer Internet
services from any source other than the Company, Cablevision is under no
obligation to upgrade its cable systems to two-way cable infrastructure and is
under no affirmative obligation to roll out, market, promote or carry any of the
Company's services. The exclusivity obligations in favor of the Company expire
in June 2002 and may be terminated sooner under certain circumstances. These
exclusivity obligations also are subject to exceptions that would permit
Cablevision to engage in certain activities which could compete, directly or
indirectly, with the activities of the Company. In connection with the
Cablevision Agreement, Cablevision was granted warrants to purchase up to
10,946,936 shares of the Company's Series A Common Stock at an exercise price of
$0.50 per share under certain conditions. A portion of the warrants are not
exercisable unless certain cable systems are transferred by TCI to Cablevision.
7
<PAGE>
In addition, in March 1998, the Company issued performance-based warrants to
Rogers Cablesystems Limited ("Rogers") and Shaw Cablesystems Ltd. ("Shaw") to
purchase up to 5,000,000 shares of Series A Common Stock at an exercise price of
$10.50 per share. These warrants will become exercisable if and when Rogers or
Shaw, as the case may be, meets certain performance milestones for homes passed,
subscribers and revenue.
In May and June 1998, the Company issued performance based warrants to purchase
an aggregate of up to 5,272,100 shares of Series A Common Stock at an exercise
price of $10.50 per share to certain new Cable Partners in connection with
distribution agreements entered into in the second quarter of 1998. In
addition, if one of these Cable Partners enters into a binding agreement to
acquire additional homes in the Los Angeles area during 1998, the Company will
issue additional warrants to purchase Series A Common Stock at an exercise price
of $10.50 per share. Beginning in March 1999, these warrants will become
exercisable on an annual basis based on the number of homes that those Cable
Partners upgrade to two-way or one-way HFC (for one Cable Partner) and two-way
HFC cable (for the other Cable Partners) and that are capable of accessing the
@Home service. In the event and to the extent such performance milestones are
met, the Company will incur non-cash charges to operations in future periods
based on the difference between the then fair market value of the Company's
Series A Common Stock and the exercise price of $10.50 per share.
As a result of these agreements, warrants to purchase 10,231,298 shares of
Series A Common Stock at $0.50 per share and 350,000 shares at $10.50 per share
were exercisable as of September 30, 1998. During the three months ended March
31, 1998, the Company recorded a non-cash charge to operations of $83.3 million
based on the fair value of such warrants to purchase 2,705,514 shares of Series
A Common Stock that became exercisable during the period as a result of the
transfer of certain TCI cable systems to Cablevision and the achievement of
certain performance milestones. Such charges are included in "cost of
distribution agreements" in the accompanying condensed consolidated statements
of operations. The remaining warrants will become exercisable if and when
additional specific TCI homes are transferred to Cablevision and if and when
certain performance milestones are achieved by Rogers or Shaw.
Public Offering of Common Stock
In August 1998, the Company completed a public stock offering, issuing 2,075,000
shares of its Common Stock to the public and 800,000 shares of its Common Stock
to TCI at a price of $46.125 per share. The Company received net proceeds of
approximately $126.0 million in cash.
Employee Stock Option and Purchase Plans
On May 13, 1998, the stockholders approved increases of 600,000 and 4,975,000
shares of Series A Common Stock reserved for issuance to participants in the
Employee Stock Purchase Plan and the 1997 Equity Incentive Plan, respectively.
NOTE 6. COMMITMENTS
In September 1997 and March 1998, the Company exercised its build-to-suit
options that require the landlord to build additional facilities on property
adjacent to the Company's headquarters. The build-to-suit options provide for
monthly rental payments, beginning upon the phased completion of the buildings.
Occupancy of the first phase is scheduled for the first half of 1999, which will
result in rental payments of approximately $412,000 per month. Additional
buildings are scheduled to be occupied early in the year 2000, which will result
in additional rental payments of approximately $412,000 per month.
NOTE 7. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("FAS 131"), which establishes reporting
standards regarding operating segments, products and services, geographic areas
and major customers. The disclosure required by FAS 131 will first be reflected
in the Company's consolidated financial statements for the year ending December
31, 1998.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and is subject to the safe harbors created
by those sections. These forward-looking statements are subject to significant
risks and uncertainties, including those identified in the section of this Form
10-Q entitled "Factors That May Affect Future Operating Results," in the
Company's 1997 Annual Report on Form 10-K filed with the SEC on March 31, 1998,
and in the Company's Form S-3 for its public stock offering filed with the
Securities and Exchange Commission ("SEC") on August 12, 1998, which may cause
actual results to differ materially from those discussed in such forward-looking
statements. Any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements. The Company undertakes no obligation to release publicly the results
of any revisions to these forward-looking statements that may be made to reflect
events or circumstances occurring subsequent to the filing of this Form 10-Q
with the SEC. Readers are urged to review and consider carefully the various
disclosures made by the Company in this report and in the Company's other
reports filed with the SEC that attempt to advise interested parties of the
risks and factors that may affect the Company's business.
GENERAL
The Company is the leading provider of broadband Internet services over the
cable television infrastructure to consumers. By virtue of its relationships
with 18 cable companies in North America and Europe, @Home has access to
approximately 58.7 million homes, which includes exclusive access to over 50% of
the households in the United States and Canada. @Home also provides broadband
Internet services to businesses over both the cable television infrastructure
and digital telecommunications lines.
The Company's primary offering, the @Home service, allows residential
subscribers to connect their personal computers via cable modems to a high-speed
Internet backbone network developed and managed by the Company. This service
enables subscribers to receive the "@Home Experience," which includes Internet
service over hybrid fiber-coaxial ("HFC") cable at peak transmission speeds over
100 times faster than typical dial-up connections, "always on" connection and
rich multimedia programming through its broadband Internet portal. The
technology foundation of the @Home Experience is the Company's scalable,
distributed, intelligent network architecture (the "@Home Broadband Network"), a
"parallel Internet" that optimizes traffic routing, improves security and
consistency of service, and facilitates end-to-end network management, enhancing
the Company's ability to address performance bottlenecks before they affect the
user experience.
The Company's @Media group has established the @Home launch screen (the "@Home
Portal") as the leading broadband Internet portal, providing a gateway to
compelling multimedia and electronic commerce offerings on the Internet. To
date, the @Home Experience has generated greater page views per subscriber than
are reported by the leading narrowband Internet portal companies. The @Media
group works with content providers to facilitate the creation of rich multimedia
broadband content delivered through the @Home Portal and to facilitate online
transactions and services for @Home subscribers. Multimedia content offerings
include on-demand video clips from partners such as Bloomberg, CNN Interactive
and the National Basketball Association, on-demand music and CD previews
provided by the Company's Tune-In service and low-latency multiplayer gaming
from SegaSoft. Electronic commerce partners include Amazon.com, the leading
online bookseller, BuyDirect.com, an online software distributor, and
Travelocity, a leading online travel site. The @Media group also sells
advertising on a cost per thousand impressions ("CPM") basis as well as on a
sponsorship basis. The Company had over 40 advertisers in the quarter ended
September 30, 1998, including Clorox, Disney, General Motors, Kraft, Procter &
Gamble, Toyota and Unilever.
For businesses, the Company's @Work services provide a platform for Internet,
intranet and extranet connectivity solutions and networked business applications
over both cable infrastructure and digital telecommunications lines. In order to
accelerate deployment of the @Work connectivity and hosting solutions into major
U.S. metropolitan areas, the Company has established strategic relationships
with Teleport Communications Group, Inc. ("TCG"), the country's largest
competitive local exchange carrier ("CLEC"), Northpoint Communications, Inc.
("Northpoint"), a provider of digital subscriber line ("DSL") services to
businesses, and Exodus Communications, Inc. ("Exodus"), a provider of Internet
hosting and network management services. By combining the Company's broadband
distributed network architecture with cable, telephone and technology
relationships, the @Work services provide a compelling
9
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platform for nationwide delivery of network-based business applications. The
Company has developed this platform at a low incremental cost by leveraging its
existing @Home Broadband Network investment. The Company currently provides
@Work services to more than 1,200 businesses.
The Company has entered into distribution arrangements for the @Home service
with 16 cable companies in North America whose cable systems pass approximately
57.3 million homes, including TCI, Cablevision, Comcast, Cox (together with TCI,
Cablevision and Comcast, the "Principal U.S. Cable Partners"), Rogers, Shaw,
Bresnan Communications Company ("Bresnan"), Century Communications Corp.
("Century"), Cogeco Cable, Inc. ("Cogeco"), Garden State Cable ("Garden State"),
Insight Communications ("Insight"), Jones Intercable, Inc. ("Jones"), Lenfest
Communications Inc. ("Lenfest"), Marcus Cable Operating Company, L.P.
("Marcus"), InterMedia Partners IV L.P. ("InterMedia") and Midcontinent Cable
Co. ("Midcontinent") (collectively, the "Cable Partners"). Some of these
distribution arrangements are subject to the completion of definitive
agreements. As of September 30, 1998, approximately 10.0 million of the homes
served by these Cable Partners were passed by upgraded two-way HFC cable, and
the Company believes that the Cable Partners will complete the upgrade of
systems passing a majority of their homes within five years. In order to shorten
time to market for cable operators, the Company provides a turnkey solution,
which includes not only a technology platform and a national brand, but also
ongoing marketing, customer service, billing and product development support.
The Company has launched the @Home service through its Cable Partners in
portions of 44 cities and communities and has approximately 210,000 subscribers
of which approximately 60% are located in the United States and 40% in Canada.
As part of its strategy to expand into international markets, the Company has
entered into agreements for the distribution of the @Home service by EDON Beheer
B.V. ("Edon") and Palet Kabelcom in the Netherlands. The Company entered into a
non-binding letter of intent with Intel to create a limited partnership whereby
Intel will invest $20 million in @Home Benelux, which operates under the trade
name @Home Nederland, to help speed the deployment of broadband services in the
Netherlands. The Company has also initiated distribution programs with leading
consumer electronics retailers and computer manufacturers, including CompUSA,
Inc. ("CompUSA"), Compaq Computer Corporation ("Compaq") and Dell Computer
Corporation ("Dell"), to facilitate the sale of the @Home service and cable
modems compliant with Data Over Cable Service Interface Specifications
("DOCSIS"). In addition, the Company is working with Cable Television
Laboratories, Inc. ("CableLabs") and TCIs National Digital Telecom Center
("NDTC") to develop advanced digital set-top boxes to provide broadband
Internet access via television sets and to accelerate transformation of the
Internet into a mass medium.
RECENT EVENTS
On June 24, 1998, TCI and AT&T Corp. ("AT&T") announced that they had signed a
definitive merger agreement pursuant to which AT&T will acquire TCI. AT&T has
announced that it currently intends to combine, following the merger, TCI's
cable, telecommunications and high-speed Internet businesses, including TCI's
controlling equity interest in the Company, with AT&T's consumer businesses to
form AT&T Consumer Services, which will provide a broad set of consumer
communications services, including local, long distance, wireless and
international communications, cable television and dial-up and high-speed
Internet access services under the AT&T brand name. In announcing the merger,
AT&T stated its intention to accelerate the upgrade of TCI's cable
infrastructure significantly, enabling AT&T to begin providing digital telephony
and data services to consumers by the end of 1999. AT&T and TCI anticipate that
the merger, which is subject to regulatory and stockholder approvals, will be
completed in the first half of 1999. In addition, in July 1998, AT&T acquired
TCG.
The Company believes that AT&T's acquisition of TCG and of TCI's cable,
telecommunications and high-speed Internet businesses may benefit the Company by
increasing the rate at which TCI's cable facilities will be upgraded to the two-
way HFC cable necessary to carry the Company's services, by allowing the Company
to utilize the strength of AT&T's brand in marketing the @Home service to
consumers and by increasing the potential for cooperation between the Company
and TCG. However, these benefits may not be realized. See "Factors That May
Affect Future Operating Results--AT&T Acquisition of TCI and TCG."
Effective October 2, 1997, the Company entered into a Letter Agreement and Term
Sheet with Cablevision, Comcast, Cox, TCI and KPCB (the "Cablevision
Agreement"). Pursuant to the Cablevision Agreement, Cablevision entered into a
Master Distribution Agreement for the distribution of the Company's @Home
service on substantially the same terms and conditions as such service is
distributed by TCI, Comcast and Cox. In connection with the Cablevision
Agreement, Cablevision was granted warrants to purchase up to 10,946,936 shares
of the Company's
10
<PAGE>
Series A Common Stock at an exercise price of $0.50 per share under certain
conditions. A portion of the warrants are not exercisable unless certain cable
systems are transferred by TCI to Cablevision.
In addition, in March 1998, the Company issued performance-based warrants to
Rogers and Shaw to purchase up to 5,000,000 shares of Series A Common Stock at
an exercise price of $10.50 per share. These warrants will become exercisable if
and when Rogers or Shaw, as the case may be, meet certain performance milestones
for homes passed, subscribers and revenue.
In May and June 1998, the Company agreed to issue performance based warrants to
purchase an aggregate of up to 5,272,100 shares of Series A Common Stock at an
exercise price of $10.50 per share to certain new Cable Partners in connection
with distribution agreements entered into in the second quarter of 1998. In
addition, if one of these Cable Partners enters into a binding agreement to
acquire additional homes in the Los Angeles area during 1998, the Company will
issue additional warrants to purchase Series A Common Stock at an exercise price
of $10.50 per share. Beginning in March 1999, these warrants will become
exercisable on an annual basis based on the number of homes that those Cable
Partners upgrade to two-way or one-way HFC (for one Cable Partner) and two-way
HFC cable (for the other Cable Partners) and that are capable of accessing the
@Home service. In the event and to the extent such performance milestones are
met, the Company may incur significant non-cash charges to operations in future
periods based on the difference between the then fair market value of the
Company's Series A Common Stock and the exercise price of $10.50 per share.
As a result of these agreements, warrants to purchase 10,231,298 shares of
Series A Common Stock at $0.50 per share and 350,000 shares at $10.50 a share
were exercisable as of September 30, 1998. During the three months ended March
31, 1998, the Company recorded a non-cash charge to operations of $83.3 million
based on the fair value of such warrants to purchase 2,705,514 shares of Series
A Common Stock that became exercisable during the period as a result of the
transfer of certain TCI cable systems to Cablevision and the achievement of
certain performance milestones. Such charges are included in "cost of
distribution agreements" in the accompanying condensed consolidated statements
of operations. The remaining warrants will become exercisable if and when
additional specific TCI homes are transferred to Cablevision and if and when
certain performance milestones are achieved by Rogers or Shaw, as the case may
be.
To the extent that any of the Cable Partners become eligible to exercise their
warrants, the Company's stockholders would experience additional dilution. The
Company also may issue additional stock, or warrants to purchase stock, at less
than fair market value in connection with its efforts to expand its distribution
of the @Home service to other cable operators.
As of September 30, 1998, the Company had expended approximately $187.2 million
on capital expenditures and operating costs and expenses to design, build and
maintain the @Home Broadband Network and the corporate infrastructure necessary
to support the roll-out and maintenance of the @Home and @Work services. The
Company currently intends to increase its capital expenditures as well as its
operating and sales and marketing expenditures in order to expand its network to
support additional expected subscribers in existing and future markets and to
provide the Company's services to a growing number of potential subscribers. To
the extent that cable modems are successfully marketed in the future through
retail and other mass-market channels, additional expenditures customary in this
channel could be incurred. As a result, the Company expects to continue to incur
additional substantial net losses for the foreseeable future. The Company has
incurred net losses from operations in each fiscal period since its inception
and, as of September 30, 1998, had an accumulated deficit of $105.3 million
(before the $255.9 million of charges recorded in the first quarter of 1998 and
the fourth quarter of 1997 in connection with the distribution agreements), and
an accumulated deficit of $361.2 million, including these charges.
The Company has received requests from the staff of the Securities and Exchange
Commission for additional information regarding the accounting for the non-cash
costs of its distribution agreement with Cablevision. The Company recorded non-
cash charges to operations of $172.6 million and $74.5 million in the fourth
quarter of 1997 and the first quarter of 1998, respectively, based on the fair
value of common stock warrants issued under the terms of the distribution
agreement. The Company cannot determine at this time the effect, if any, that
the outcome of this matter will have on its reported financial position or
results of operations.
11
<PAGE>
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
REVENUES 1998 CHANGE 1997 1998 CHANGE 1997
- -------- -------- ------ ------- -------- ------ -------
Revenues $ 13,815 624% $ 1,907 $ 28,808 671% $ 3,737
======== ======= ======== =======
Revenues. The Company's revenues consist of: monthly subscription fees for the
@Home residential service; @Work monthly access fees, product development
revenues, and installation charges; fees related to @Media content, advertising,
and e-commerce partnerships; fees for product development and customer support
activities provided to domestic cable system operators; and, management fees
related to the development of international operations. The Company recognizes
revenue during the period in which the services are provided.
Total revenues for the three months ended September 30, 1998 totaled $13.8
million, an increase of $11.9 million over revenues of $1.9 million for the
three months ended September 30, 1997. These additional revenues resulted from
substantial period over period growth in all three of the Company's business
units. For the @Home residential service, subscribers increased to approximately
210,000 at September 30, 1998 from 26,000 at September 30, 1997. The @Work
Internet service had over 1,250 installed accounts at September 30, 1998 as
compared to 200 at September 30, 1997. In addition, the @Media group had more
than 40 advertisers at September 30, 1998, more than double the number as of
December 31, 1997. For the period ended September 30, 1998 the @Home
residential service contributed approximately 50% of the revenues, the @Work
commercial business contributed approximately 40% and the @Media business
contributed approximately 10%. Certain revenues of the Company are derived from
other business services provided to certain Cable Partners that have an equity
investment in the Company. These related party revenues, which include product
development services and fees for customer support activities were approximately
21% and 39% of total revenues for the three months ended September 30, 1998 and
1997, respectively. Related party revenues are anticipated to continue to
decline as a percentage of total revenues in subsequent quarters.
Total revenues for the nine months ended September 30, 1998 totaled $28.8
million, an increase of $25.1 million over revenues of $3.7 million for the
nine months ended September 30, 1997. Each of the Company's business units
experienced significant revenue growth for the nine months ended September 30,
1998, when compared to same period in 1997, with revenues from @Work services
and the deployment of the @Home service in Canada making a significant
contribution for the first time. Related party revenues as a percentage of
total revenues were approximately 21% and 56% for the nine months ended
September 30, 1998 and 1997, respectively.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ------------------------------
COSTS AND EXPENSES 1998 CHANGE 1997 1998 CHANGE 1997
- ------------------ ------- ------ ------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Operating Costs $12,256 98% $ 6,203 $ 30,969 102% $15,368
Product Development
and Engineering 4,588 46% 3,137 12,052 43% 8,411
Sales and Marketing 4,978 70% 2,937 12,834 46% 8,815
General and Administrative 3,112 8% 2,861 8,911 18% 7,521
------- ------- -------- -------
Total Costs and Expenses Before
Costs of Distribution Agreements 24,934 65% 15,138 64,766 61% 40,115
Costs of Distribution Agreements -- N/A -- 83,320 N/A --
------- ------- -------- -------
Total Costs and Expenses $24,934 65% $15,138 $148,086 269% $40,115
======= ======= ======== =======
</TABLE>
Total Costs and Expenses. Total costs and expenses for the three months ended
September 30, 1998 were $24.9 million compared to $15.1 million for the
corresponding period of 1997. The period over period increase of $9.8
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<PAGE>
million was primarily a result of: operating costs associated with the expansion
and deployment of the @Home Broadband Network to support both @Home and @Work
services; customer service and operations investments; costs associated with
development work for domestic cable system operators; and costs associated with
the development of international operations. Total costs and expenses for the
quarter rose 65% period over period compared to revenue growth of 624%. The
Company believes continued expansion of operations as well as its network
infrastructure is critical to the achievement of its goals and anticipates that
costs and expenses will continue to increase significantly in each quarter for
the foreseeable future.
Total costs and expenses for the nine months ended September 30, 1998, before
the first quarter non-cash charge of $83.3 million related to the fair value of
common stock warrants issued to cable system operators in connection with
distribution agreements, increased to $64.8 million from $40.1 million for the
nine months ended September 30, 1997. Total costs and expenses for the nine
months rose 269% period over period compared to revenue growth of 671%.
Operating Costs. Operating costs are primarily related to providing services to
customers and maintaining the @Home Broadband Network, which includes the
functional areas of customer and technical support, regional data centers
("RDCs"), content programming, and @Home and @Work telecommunications costs.
Included in operating costs are salaries and related expenses for personnel,
telecommunication (transport) costs, and the depreciation, amortization and
maintenance of capital equipment.
For the three months ended September 30, 1998, operating costs grew 98% to $12.3
million from $6.2 million in the corresponding period of 1997. This increase
primarily resulted from: (i) expansion of the @Home Broadband Network,
including maintenance and depreciation of capital equipment, to support the
increase in @Home and @Work deployments; (ii) customer service operations,
especially the expansion of technical support and the investment in operations;
(iii) direct costs, including local transport and customer premise equipment, to
support the substantial revenue growth from @Work services; and (iv)
development of additional content programming resources. For the nine months
ended September 30, 1998, operating costs were $31.0 million, a 102% increase
over operating expenses of $15.4 million for the corresponding period of 1997.
These increases were primarily attributable to @Home Broadband Network costs,
direct costs to support the substantial revenue growth from @Work services, and
additional costs for customer service expansion and investments in operations.
During the remainder of 1998 and in 1999, operating costs are expected to
increase substantially in absolute dollars as the Company continues to expand
operations with existing Cable Partners and begins to deploy services with Cable
Partners that have only recently signed distribution agreements with the
Company. The Company expects to offer its services in approximately 22
additional markets in the fourth quarter of 1998, and will continue to make
investments in the @Home Broadband Network, computer systems to support the
growth in the Company's operations, and increased personnel and transport costs.
Product Development and Engineering. Product development and engineering
expenses consist primarily of salaries and related expenses for personnel, fees
to outside contractors and consultants, the allocated cost of facilities, and
the depreciation and amortization of capital equipment.
Product development and engineering expenses for the three months ended
September 30, 1998 and 1997 were $4.6 million and $3.1 million, respectively.
For the nine months ended September 30, 1998 and 1997, product development and
engineering expenses were $12.1 million and $8.4 million, respectively. For
both the three and nine months ended September 30, 1998, these higher levels of
expenses were attributable primarily to increases in personnel and related
expenses incurred in five areas: (i) the design, testing and deployment of
technologies related to the @Home Broadband Network; (ii) the development of
@Work services; (iii) the development of technologies for advanced digital set-
top box applications; (iv) the development of enabling platforms for the
creation and distribution of enhanced content; and (v) the development of
applications specifically designed to take advantage of the @Home Broadband
Network. Product development and engineering costs have been expensed as
incurred.
During the remainder of 1998 and in 1999, product development and engineering
expenses are expected to increase substantially due in part to the Company's
continued development of technologies related to advanced digital set-top box
applications and to the expansion of the @Home Broadband Network.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and promotional expenses. All three of the business units
of the Company, @Home, @Work and @Media, have sales organizations in place that
are partially compensated on a commission basis.
13
<PAGE>
Sales and marketing expenses for the three months ended September 1998 and 1997
were $5.0 million and $2.9 million, respectively. For the nine months ended
September 30, 1998 and 1997, sales and marketing expenses were $12.8 million and
$8.8 million, respectively. The increased period over period expenses were
incurred primarily in four areas: (i) local and regional sales and marketing
activities targeted at acquiring new subscribers, corporate accounts and cable
partners; (ii) the initiation of channel/retail sales programs; (iii) expansion
of the @Work sales force and related travel expenses; and (iv) @Media programs
designed to support revenue growth. The period over period expense growth was
significantly less than revenue growth, as the Company continued to benefit from
economies of scale and leveraging its Cable Partner affiliations.
Costs in this area are expected to increase throughout the remainder of 1998 and
into 1999 primarily due to continued investments in the @Work sales organization
as well as anticipated personnel and other costs required to increase the
Company's focus on national branding, national promotions and the initiation of
its retail sales efforts.
General and Administrative. General and administrative expenses consist
primarily of administrative and executive personnel costs, fees for professional
services and the costs of in-house systems and infrastructure to support the
operations of the Company.
General and administrative expenses for the three months ended September 30,
1998 and 1997 were $3.1 million and $2.9 million, respectively. For the nine
months ended September 30, 1998 and 1997, these expenses were $8.9 million and
$7.5 million, respectively. The increases in both the three and nine-month
periods were the result of: increased expenses associated with the Company's
international efforts; additions of personnel to support the operations of the
Company and their related costs; and additional expenses related to activities
and requirements of a public company.
Interest Income, Net. Interest income, net, represents interest earned by the
Company on its cash and short-term cash investments, less interest expense on
capital lease obligations. Interest income was $2.0 million and $1.7 million for
the three months ended September 30, 1998 and 1997, respectively. For the nine
months ended September 30, 1998 and 1997, interest income was $5.0 million and
$2.4 million, respectively. These increases were primarily due to the increased
cash balances available to invest resulting from the Company's initial public
offering in July 1997 and the Company's stock offering in August 1998.
Interest expense for the three months ended September 30, 1998 was $524,000 as
compared to $351,000 for the corresponding period of 1997. Interest expense for
the nine months ended September 30, 1998 was $1.5 million as compared to
$745,000 for the corresponding period of 1997. These increases were primarily
due to increases in capital lease obligations associated with the Company's
leasing of capital equipment.
Net Loss. The net loss for the three months ended September 30, 1998 was $9.7
million, as compared to $11.9 million for the corresponding period of 1997. The
decrease in net loss for the quarter of $2.2 million was primarily attributable
to revenues increasing faster than expenses and to the increase in net interest
income. The Company anticipates that the quarterly net loss, excluding potential
charges such as those relating to distribution agreements and other potential
performance-based warrant charges, will continue to decline during the fourth
quarter of 1998 as sequential revenues grow at a faster rate than sequential
expenses.
For the nine months ended September 30, 1998, the net loss, before the charge
for the fair value of common stock warrants issued to cable system operators in
connection with distribution agreements, was $36.0 million, as compared to $34.7
million for the corresponding period of 1997. Including the non-cash charge of
$83.3 million, the net loss for the nine months ended September 30, 1998 was
$115.8 million. This compares to a net loss of $34.7 million for the
corresponding period of 1997.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily through a
combination of private and public sales of equity securities and capital
equipment leases. At September 30, 1998, the principal source of liquidity for
the Company was $203.7 million of cash, cash equivalents and short-term cash
investments, as compared to $120.4 million at December 31, 1997. The Company
finances, and expects to continue financing, a substantial amount of its capital
equipment expenditures from a variety of sources, including direct vendor
leasing programs, third party commercial leasing arrangements and bank
financing.
In September 1997, the Company entered into a Term Loan Agreement (the "Term
Loan") with Silicon Valley Bank (the "Bank"). The Term Loan provides for
borrowings of up to $8.0 million to finance the acquisition of property,
14
<PAGE>
equipment and improvements, and to collateralize letters of credit. Any
borrowings under this Term Loan would bear interest at the Bank's prime rate. As
of September 30, 1998, there were no borrowings under this Term Loan although
there were outstanding letters of credit in the amount of $3.4 million related
to real property leases. Under the Term Loan, the Company is required to meet
certain financial covenants. As of September 30, 1998, the Company was in
compliance with all such covenants. In October 1998, an amendment ("Loan
Modification Agreement") was entered into by and between the Company and the
Bank. The terms of the Loan Modification Agreement allow for borrowings up to
$15.0 million under similar terms and conditions as the original agreement.
This agreement amends the maturity date to October 19, 2002.
Net cash used in operating activities for the nine months ended September 30,
1998 was $24.5 million, primarily as a result of the net loss of $115.8 million
before being partially offset by non-cash charges related to distribution
agreements of $83.3 million and depreciation and amortization of $9.5 million.
Net cash used in operating activities for the nine months ended September 30,
1997 was $24.2 million, primarily as a result of the net loss of $34.7 million,
partially offset by depreciation and amortization of $5.3 million.
Net cash used in investing activities for the nine months ended September 30,
1998 of $34.2 million was a result of purchases of short-term cash investments
of $86.1 million that were offset by sales and maturities of short-term cash
investments of $63.6 million and from cash purchases of property, equipment, and
improvements of $11.7 million. Net cash used in investing activities for the
nine months ended September 30, 1997 of $74.3 million was a result of purchases
of short-term cash investments of $74.7 million that were offset by sales and
maturities of short-term cash investments of $8.1 million and from cash
purchases of property, equipment, and improvements of $7.7 million. Gross
capital expenditures for equipment, software, furniture, leasehold improvements
and fixtures for the nine-month periods ended September 30, 1998 and 1997 were
$20.7 million and $20.6 million, respectively, of which $9.0 million and $12.9
million, respectively, were financed through capital leases.
Net cash provided by financing activities for the nine months ended September
30, 1998 was $119.6 million, resulting primarily from net proceeds of Series A
Common Stock sold in the Company's public stock offering of $126.0 million in
August 1998, partially offset by payments on capital lease obligations of $9.0
million. For the nine months ended September 30, 1997, cash provided by
financing activities was $147.8 million, resulting primarily from net proceeds
of $46.5 million from the sale of Series C Preferred Stock in April 1997 and net
proceeds from the Company's initial public offering in July 1997 of $99.9
million.
The Company believes that it has the financial resources needed to meet its
presently anticipated business requirements, including capital expenditure and
strategic operating programs, for at least the next 12 months. Nonetheless,
depending on market conditions, the Company may elect to sell additional equity
or debt securities or obtain additional credit facilities. Thereafter, if cash
generated by operations is insufficient to satisfy the Company's liquidity
requirements, the Company may need or elect, depending on market conditions, to
sell additional equity or debt securities or obtain additional credit
facilities. The sale of additional equity or convertible debt securities may
result in additional dilution to the Company's stockholders. There can be no
assurance that the Company will be able to raise any such capital on terms
acceptable to the Company or at all.
The Company is headquartered in facilities consisting of approximately 135,000
square feet in Redwood City, California, which the Company occupies under a 12-
year lease. In September 1997 and March 1998, the Company exercised its build-
to-suit options to require the landlord to build additional facilities of
approximately 360,000 square feet on adjacent property. The Company also has
another build-to-suit option to require the landlord to build an additional
facility of approximately 110,000 square feet on the adjacent property, subject
to certain conditions. All facilities constructed under the Company's build-to-
suit options will be subject to leases of up to 15 years in length, have base
rent determined in relation to construction costs and will include tenant
improvements paid for by the Company. The build-to-suit options that have been
exercised to date provide for monthly rental payments beginning upon the phased
completion of the buildings. Occupancy of the first phase is scheduled to occur
during the first half of 1999 and will result in increased rental payments of
approximately $412,000 per month. Occupancy of the second phase is scheduled to
occur early in the year 2000 and will result in additional rental payments of
approximately $412,000 per month. In addition to its build-to-suit options, the
Company has the right to purchase two of the buildings leased from the landlord
consisting of approximately 245,000 total square feet. The Company anticipates
that its existing facilities, together with the facilities the Company has the
right to have built, will be adequate to accommodate its growth for the
foreseeable future.
15
<PAGE>
IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes reporting standards
regarding operating segments, products and services, geographic areas and major
customers. The disclosure required by FAS 131 will first be reflected in the
consolidated financial statements for the year ending December 31, 1998.
IMPACT OF THE YEAR 2000 ISSUE
Year 2000 computer issues create certain risks for the Company, although the
Company believes that such risks are less significant than those faced by many
companies due to the fact the Company commenced operations in 1995. If the
Company's internal and network information systems do not correctly recognize
and process date information beyond the year 1999, there could be an adverse
impact on the Company's operations. To address these Year 2000 issues with its
internal and network systems, the Company has initiated a program to evaluate
its internal and network systems. The Company and its majority shareholder, TCI,
have initiated a comprehensive program (the "Program") to address Year 2000
readiness in its systems and with its customers' and suppliers' systems. The
Program has been designed to gather information regarding the Year 2000
compliance of products and services that are required by the Company to deploy
its residential and commercial Internet services. Under the Program, assessment
and remediation are proceeding in tandem and are intended to have the Company's
critical systems in Year 2000 compliance by June 30, 1999. These activities are
intended to encompass all major categories of systems in use by the Company,
including network management, customer service, and business operations. The
costs incurred to date related to the Program have not been material. The
Company currently expects that the total cost of its Year 2000 readiness Program
will not exceed $750,000 over the next fiscal year. The total cost estimate
does not include potential costs related to any customer or other claims or the
costs of internal software or hardware replaced in the normal course of
business. The total cost estimate is based on the current assessment of the
Company's Year 2000 readiness needs and is subject to change as the Program
proceeds.
As part of the normal course of its operations, the Company is currently in the
process of transitioning to or implementing new computer software for its
accounting, billing, network management, human resources, and other management
information systems. The Company is assessing and testing these systems for Year
2000 dependencies and will implement changes to such systems if necessary. The
successful implementation of these new systems is crucial to the efficient
operation of the Company's business. There can be no assurance that the Company
will implement its new systems in an efficient and timely manner or that the new
systems will be adequate to support the Company's operations. Problems with
installation or initial operation of the new systems could cause substantial
difficulties in operations planning, business management, and financial
reporting, which could have a material adverse effect on the Company's business,
financial condition and results of operations. The cost of bringing the
Company's new systems into Year 2000 compliance, if necessary, is not expected
to have a material effect on the Company's financial condition or results of
operations.
The Company has also initiated formal communications with many of its
significant suppliers to determine the extent to which the Company is vulnerable
to such suppliers' failure to remedy their own Year 2000 issue. The Company has
already received assurances of Year 2000 compliance from a number of those
suppliers. Most of the suppliers have no contractual obligations under existing
contracts with the Company to provide such information to the Company. The
Company is taking steps with respect to new supplier agreements to ensure that
the suppliers' products and internal systems are Year 2000 compliant.
While the Company currently expects that the Year 2000 issue will not pose
significant operational problems, delays in the implementation of new
information systems or a failure to fully identify all Year 2000 dependencies in
the Company's existing system and in the systems of its suppliers could have
material adverse consequences. Therefore, the Company is developing contingency
plans for continuing operations in the event such problems arise.
16
<PAGE>
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
UNPROVEN BUSINESS; NO ASSURANCE OF PROFITABILITY
The Company was incorporated in March 1995, commenced operations in August 1995,
and has incurred net losses from operations in each fiscal period since its
inception. As of September 30, 1998, the Company had an accumulated deficit of
$105.3 million (before the $255.9 million of charges recorded in the fourth
quarter of 1997 and first quarter of 1998 in connection with the distribution
agreements), and an accumulated deficit of $361.2 million, including the charges
relating to these agreements. In addition, the Company currently intends to
increase its capital expenditures and operating expenses in order to expand its
network to support additional expected subscribers in existing and future
markets, to support the continued roll-out of its @Work services and to market
and provide the Company's services to a growing number of potential subscribers.
As a result, the Company expects to incur additional substantial operating and
net losses for the foreseeable future. The profit potential of the Company's
business model is unproven. The @Home service was only available in portions of
44 geographic markets as of September 30, 1998 and may not achieve broad
consumer or commercial acceptance. Although approximately 1,600 organizations
have agreed to utilize @Work services as of September 30, 1998, @Work services
may not achieve broad commercial acceptance and the current rate of deployment
for @Work services may not be sustained. The Company has difficulty predicting
whether the pricing models for its Internet services will prove to be viable,
whether demand for its Internet services will materialize at the prices it
expects its Cable Partners to charge (for the @Home service) or the prices it or
the Cable Partners charge (for @Work services), or whether current or future
pricing levels will be sustainable. If such pricing levels are not achieved or
sustained or if the Company's services do not achieve or sustain broad market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected. There can be no assurance that the
Company will ever achieve favorable operating results or profitability.
SUBSCRIBER GROWTH RISKS FOR THE @HOME SERVICE
As of September 30, 1998, the Company had approximately 210,000 cable modem
subscribers. The Company's ability to increase the number of cable modem
subscribers to achieve its business plans and generate future revenues will be
dependent on a number of factors, many of which are beyond the Company's
control. These factors include, among others: (i) the rate at which the
Company's current and future Cable Partners upgrade their cable infrastructures;
(ii) the ability of the Company and its Cable Partners to coordinate timely and
effective marketing campaigns with the availability of such upgrades; (iii) the
success of the Cable Partners in marketing the @Home service to subscribers in
their local cable areas; (iv) the prices that the Cable Partners set for the
@Home service and its installation; (v) the speed at which the Cable Partners
can complete the installations required to initiate service for new subscribers;
(vi) the quality of customer and technical support provided by the Company and
its Cable Partners; and (vii) the quality of content on the @Home service. The
Company believes subscriber growth has been constrained, and will continue to be
constrained, by the cost and the amount of time required to install the @Home
service for each residential consumer. In addition, most of the Company's Cable
Partners are not obligated to upgrade their cable infrastructures or market the
@Home service. Moreover, the @Home service is currently priced at a premium to
many other online services, and large numbers of subscribers may not be willing
to pay a premium for the @Home service. Because of the foregoing factors, among
others, the Company's actual revenues or the rate at which it will add new
subscribers may differ from its forecasts. The Company may not be able to
increase its subscriber base in accordance with its internal forecasts or the
forecasts of industry analysts or to a level that meets the expectations of
investors. The rate at which subscribers have increased during the first three
quarters of 1998 should not be taken as indicative of the rate at which
subscribers may be expected to increase in the future. In particular, while the
Company has recently forecast that its number of subscribers could grow to over
300,000 by the end of 1998 from approximately 210,000 subscribers at September
30, 1998, the Company may not achieve this level of subscriber growth,
particularly given the risks set forth herein.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside the
Company's control. Factors that may affect the Company's quarterly operating
results
17
<PAGE>
attributable to its @Home service include: (i) the timing of the Company's Cable
Partners' upgrades of their cable infrastructures and roll-outs of the @Home
service; (ii) the rate at which customers subscribe to the Company's Internet
services and the prices subscribers pay for such services; (iii) subscriber
churn rates; (iv) changes in the revenue splits between the Company and its
Cable Partners; (v) the demand for Internet advertising and electronic commerce;
(vi) the effectiveness of the Cable Partners' marketing and other operations;
and (vii) potential competition with Cable Partners for advertising revenue.
Quarterly operating results attributable to the Company's @Work services are
dependent on: (i) the demand for, and level of acceptance of, the Company's
corporate Internet, intranet and extranet connectivity and telecommuting
solutions; (ii) the introduction of, demand for, and level of acceptance of, the
Company's value-added business applications; (iii) in part, the timing of the
Cable Partners' upgrades of their cable infrastructures; (iv) the effectiveness
of the Cable Partners' marketing and other operations; (v) competitive
pressures, including pricing pressure and the availability of competing
technologies, in the market for business Internet services; and (vi) the
creditworthiness of the Company's @Work customers. In addition, the Company's
quarterly operating results have been and may continue to be adversely affected
by significant charges associated with warrants issued to current and potential
Cable Partners in connection with distribution agreements. The Company's
quarterly sales and operating results are difficult to forecast even in the
short term. A significant portion of the Company's expenses are fixed in advance
based in large part on future revenue forecasts. If revenue is below
expectations in any given quarter, the adverse impact of the shortfall on the
Company's operating results may be magnified by the Company's inability to
adjust spending to compensate for the shortfall. Moreover, the Company's Cable
Partners have complete discretion regarding the pricing of the @Home service in
their territories, which could further impact the Company's ability to generate
sufficient revenue. A shortfall in actual as compared to estimated revenue could
have a material adverse effect on the Company's business, operating results and
financial condition.
DEPENDENCE ON CABLE PARTNERS TO UPGRADE TO TWO-WAY CABLE INFRASTRUCTURE
NECESSARY TO SUPPORT THE @HOME SERVICE; UNCERTAIN AVAILABILITY AND TIMING OF
UPGRADES
Transmission of the @Home service and certain @Work services over cable is
dependent on the availability of high-speed two-way HFC cable infrastructure.
However, only a small portion of existing cable plant in the United States and
in certain international markets has been upgraded to HFC cable, and even less
is capable of high-speed two-way transmission. The Company's Cable Partners have
announced and begun to implement major infrastructure investments in order to
deploy two-way HFC cable. However, cable system operators have limited
experience with these upgrades, and these investments have placed a significant
strain on the financial, managerial, operating and other resources of the Cable
Partners, most of which are already highly leveraged. Therefore, these
infrastructure investments have been, and the Company expects will continue to
be, subject to change, delay or cancellation. Although the Company's commercial
success depends on the successful and timely completion of these infrastructure
upgrades, most of the Cable Partners are under no obligation to the Company to
upgrade systems or to roll out, market or promote the Company's services. In
addition, most of the Cable Partners are not contractually required to achieve
any specific roll-out schedule. The failure of the Cable Partners to complete
these upgrades in a timely and satisfactory manner, or at all, would prevent the
Company from delivering high-performance Internet services and would have a
material adverse effect on the Company's business, operating results and
financial condition.
EXTENT OF CABLE PARTNERS OBLIGATION TO CARRY THE COMPANY'S SERVICES; LIMITATIONS
ON THEIR EXCLUSIVITY
Although the Company's Cable Partners are subject to certain exclusivity
obligations that prohibit them from obtaining high-speed (greater than 128 Kbps)
residential consumer Internet services from any source other than the Company
(the "Exclusivity Obligations"), most of the Cable Partners are under no
affirmative obligation to carry any of the Company's services. Such Exclusivity
Obligations of the Principal U.S. Cable Partners expire on June 4, 2002, and may
be terminated sooner under certain circumstances. Most Cable Partners'
Exclusivity Obligations are limited to high-speed residential Internet services
and do not extend to various "Excluded Services" that may be offered without the
Company. Moreover, "Excluded Services" include: (i) the provision of telephony
services; (ii) the provision of services that are primarily work-related (such
as @Work services); (iii) the provision of Internet services that do not use the
Cable Partners' cable television infrastructures; (iv) the provision of any
local Internet service that does not require use of an Internet backbone outside
a single metropolitan area; (v) the provision of services that are utilized
primarily to connect students to schools, colleges or universities; (vi) the
provision of Internet telephony, Internet video telephony or Internet video
conferencing; (vii) the provision of certain limited
18
<PAGE>
Internet services primarily intended for display on a television such as some
types of Internet-based digital set-top services; (viii) the provision of
certain Internet services that are primarily downstream services where the user
cannot send upstream commands in real-time; (ix) the provision of streaming
video services that include video segments longer than ten minutes in duration;
and (x) limited testing, trials and similar activities with respect to
businesses subject to the Exclusivity Obligations of less than six months. By
engaging in the Excluded Services, most U.S. Cable Partners can compete,
directly or indirectly, with the activities of the Company, including the
Company's @Work services.
CONTROL BY TCI; VETO POWER OF OTHER PRINCIPAL STOCKHOLDERS.
TCI controls approximately 72% of the voting power of the Company as of March
31, 1998. Therefore, TCI has the ability to control most significant matters
requiring stockholder approval, including the election of a majority of the
Company's directors, subject to certain supermajority approval rights held by
Comcast and Cox. In addition, the Company's Board of Directors, which is
controlled by TCI and certain of the Company's other Principal U.S. Cable
Partners, has the power, subject to directors' fiduciary duties, to change the
terms of distribution for the Company's Internet services to be more favorable
for the Company's Principal U.S. Cable Partners and less favorable for the
Company. See the Company's Registration Statement on Form S-1 (File No. 333-
27323), and exhibits thereto, which became effective on July 11, 1997 for
additional information on the rights of TCI and other Principal U.S. Cable
Partners.
AT&T ACQUISITION OF TCI AND TCG
On June 24, 1998, TCI and AT&T announced that they had signed a definitive
merger agreement pursuant to which AT&T will acquire TCI. Following the
acquisition of TCI by AT&T and therefore of TCI's equity interest in the
Company, AT&T will have the power to exercise control over the Company. AT&T
and TCI anticipate that the merger, which is subject to regulatory and
stockholder approvals, will be completed in the first half of 1999. In addition,
in July 1998, AT&T acquired TCG. While the Company believes that AT&T's
acquisition of TCI and TCG may benefit the Company by increasing the rate at
which TCI's cable facilities will be upgraded to the two-way HFC cable necessary
to carry the Company's services, by allowing the Company to utilize AT&T's brand
in marketing the @Home service to consumers and by increasing the potential for
cooperation between the Company and TCG, these benefits may not be realized and
the TCI acquisition may not be completed. Moreover, the Master Distribution
Agreement Term Sheet under which the Company's Principal U.S. Cable Partners
have agreed to the Exclusivity Obligations provides that upon a change of
control of TCI, either Cox or Comcast may terminate the Exclusivity Obligations
as to all Principal U.S. Cable Partners. For this purpose, a "change of control"
of TCI is defined to occur at such time as (i) any person (or group of persons
acting in concert), other than Bob Magness or John Malone or their descendants
or any stockholder that was a member of the controlling group of stockholders of
TCI as of June 4, 1996, owns stock representing more than 50% of the voting
power of TCI and (ii) as a result of acquiring such ownership, at any time prior
to the first anniversary of acquiring such ownership (the "Acquisition Date"),
the directors who were members of the Board of Directors of TCI as of the
Acquisition Date, plus any additional directors not designated by the acquiring
person who are approved by a majority of the directors who were directors on the
Acquisition Date, no longer constitute a majority of the entire board of
directors of TCI. If AT&T completes its proposed acquisition, it will acquire a
majority of the voting power of TCI and will therefore have the power to
preserve the Exclusivity Obligations. However, if AT&T chooses not to retain a
sufficient number of the directors of TCI who were in office prior to the
completion of the merger for at least one year after the Acquisition Date,
either Cox or Comcast would have the right to terminate the exclusivity
provisions applicable to the Principal U.S. Cable Partners, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
LIMITATIONS ON THE COMPANY'S ABILITY TO PROVIDE CERTAIN EXCLUDED SERVICES
The Company has agreed with its Principal U.S. Cable Partners (i) not to
directly or indirectly offer, provide, distribute, advertise, promote or market
(or carry or otherwise distribute advertising or promotions with respect to) any
streaming video transmissions that include video segments longer than ten
minutes in duration or any other Excluded Service to residences in the Exclusive
Territory (as defined below) of a Principal U.S. Cable Partner without its prior
written consent even if such Excluded Service has been integrated with the @Home
service in other areas and (ii) not to offer or provide Internet services other
than through the Cable infrastructure at data transmission
19
<PAGE>
speeds greater than 128 Kbps to residences in any geographic area served by the
cable systems of those Principal U.S. Cable Partners that remain in compliance
with their exclusivity provisions (the "Exclusive Territory") until the later of
June 4, 2002 and such time as the Principal U.S. Cable Partner is no longer in
compliance with the Exclusivity Obligations. No assurance can be given that the
Company will have access to the cable infrastructures of its Principal U.S.
Cable Partners for Excluded Services, and the Company must negotiate a separate
agreement with each of the Principal U.S. Cable Partners for each portion of
such services that the Company seeks to provide over their cable
infrastructures. Any such failure to obtain access, or competition from the
Company's Principal U.S. Cable Partners in providing Excluded Services, could
have a material adverse effect on the Company's business, operating results and
financial condition.
POTENTIAL DISPOSITION OF CABLE SYSTEMS BY PRINCIPAL U.S. CABLE PARTNERS
The Company's agreements with its Principal U.S. Cable Partners do not require
that they maintain a specified number of cable systems, subscribers or homes
passed in order to maintain their control over and equity ownership of the
Company. Therefore, these Principal U.S. Cable Partners may dispose of a
significant amount of their cable systems without requiring that such cable
systems remain subject to any exclusivity provisions. However, to the extent
that any Principal U.S. Cable Partner disposes of more than 20% of the number of
homes passed in its service areas as of June 4, 1996 (subject to certain
exceptions) without causing such transferred homes to remain exclusive to @Home,
then such Principal U.S. Cable Partner may be required to sell a proportionate
amount of its equity interest in the Company to the other Principal U.S. Cable
Partners at the fair market value thereof. TCI has completed the transfer or
sale of certain cable systems and has announced the proposed sale or transfer of
additional cable systems and is considering various plans and proposals that may
result in the disposition of other of its cable systems. Although TCI has
informed the Company that it is attempting to cause certain of such transferred
systems to remain subject to the Exclusivity Obligations, there can be no
assurance that these efforts will be successful. Such dispositions may have an
adverse effect upon the business, operating results and financial condition of
the Company if the transferred homes do not remain exclusive to the Company.
UNPROVEN NETWORK SCALABILITY, SPEED AND SECURITY
Due to the limited deployment of the Company's services, the ability of the
@Home Broadband Network to connect and manage a substantial number of online
subscribers at high transmission speeds is as yet unknown, and the Company faces
risks related to the @Home Broadband Network's ability to be scaled up to its
expected subscriber levels while maintaining superior performance. The @Home
Broadband Network may be unable to achieve or maintain a high speed of data
transmission, especially as the number of the Company's subscribers grows. The
Company's failure to achieve or maintain high-speed data transmission would
significantly reduce consumer demand for its services and have a material
adverse effect on its business, operating results and financial condition. In
addition, while the Company has taken steps to prevent users from sharing files
via the @Home service and to protect against "email spamming," public concerns
about security, privacy and reliability of the cable network, or actual problems
with the security, privacy or reliability of the Company's network, may inhibit
the acceptance of the Company's Internet services.
MANAGEMENT OF EXPANDED OPERATIONS; DEPENDENCE ON KEY PERSONNEL
The Company may not be able to successfully manage any future periods of rapid
growth or expansion, which could be expected to place a significant strain on
the Company's managerial, operating, financial and other resources. From time to
time, the Company and its Cable Partners have had difficulty managing network
operations and expansion of backbone capacity and providing adequate customer
service or efficient provisioning of new subscribers. A prolonged failure to
perform these functions successfully would have a material adverse effect on
subscriber growth and retention and would materially adversely affect the
Company's business, operating results and financial condition. The Company is
highly dependent upon the efforts of its senior management team, and the
Company's future performance will depend, in part, upon the ability of senior
management to manage growth effectively, which will require the Company: (i) to
implement additional management information systems capabilities; (ii) to
develop further its operating, administrative, financial and accounting systems
and controls; (iii) to maintain close coordination among engineering,
accounting, finance, marketing, sales and operations; and (iv) to hire and train
additional technical and marketing personnel. There is intense competition for
senior management, technical and marketing personnel in the areas of the
Company's activities. The loss of the services of any of the Company's senior
20
<PAGE>
management team or the failure to attract and retain additional key employees
could have a material adverse effect on the Company's business, operating
results and financial condition. The Company maintains no key-person life
insurance.
DEPENDENCE ON TWO-WAY CABLE MODEMS; NEW INDUSTRY STANDARD
Each of the Company's subscribers currently must obtain a cable modem from a
Cable Partner to access the @Home service. The North American cable industry has
recently adopted a set of interface standards known as DOCSIS for hardware and
software to support the delivery of data services over the cable infrastructure
utilizing interoperable cable modems. The Company believes that these
specifications, together with the recently executed non-binding distribution
agreement with CompUSA will facilitate the growth of the cable modem industry
and the availability of lower cost, interoperable cable modems through retail
channels. However, certain of the Company's Cable Partners have chosen to slow
the deployment of the @Home service until the commercial availability of
DOCSIS-compliant cable modems. The Company's subscriber growth could be
constrained and the Company's business, operating results and financial
condition could be materially adversely affected to the extent the Cable
Partners choose to slow the deployment of the @Home service further, as a
result of the timing of commercial availability of DOCSIS-compliant cable
modems or otherwise. Cable modems that are DOCSIS-compliant are not expected
to be available in significant quantities until 1999. Although multiple
vendors are expected to supply DOCSIS-compliant cable modems and their
constituent components, any Cable Partner's reliance on a single provider of
such modems or components could cause that Cable Partner to be unable to
generate expected subscriber growth for the @Home service in the event such
supplier does not provide the Cable Partner with a sufficient quantity of
DOCSIS-complaint modems to meet the Cable Partner's requirements.
COMPETITION
The markets for consumer and business Internet services and online content are
extremely competitive, and the Company expects that competition will intensify
in the future. The Company's most direct competitors in these markets are
unaffiliated cable companies, other providers of cable based Internet services,
national long-distance carriers, local exchange carriers, Internet service
providers ("ISPs"), online service providers ("OSPs") and Internet content
aggregators.
The Company's competitors in the cable-based services market are those
companies that have developed their own cable-based services and market those
services to unaffiliated cable system operators that are planning to deploy
data services. In particular, Time Warner Inc. ("Time Warner") and MediaOne
Group ("MediaOne") have deployed high-speed Internet access services over
their existing local HFC cable networks through their cable-based Internet
service, Road Runner, which features a variety of proprietary content from
Time Warner Publications. Time Warner's substantial libraries of multimedia
content could provide Road Runner with a significant competitive advantage. In
June 1998, Microsoft Corporation ("Microsoft") and Compaq each invested $212.5
million in Road Runner and announced that Microsoft will provide software for
the Road Runner service and that Compaq will produce cable-ready personal
computers to be used with the service. Time Warner and MediaOne plan to market
the Road Runner service through their own cable systems as well as to other
cable system operators nationwide.
Long distance inter-exchange carriers, such as AT&T, MCI Communications
Corporation ("MCI"), Sprint Corporation ("Sprint") and WorldCom, Inc.
("WorldCom"), have deployed large-scale Internet access networks and sell
connectivity to business and residential customers. The regional Bell operating
companies ("RBOCs") and other local exchange carriers have also entered this
field and are providing price competitive services. Many of these competitors
are offering (or may soon offer) technologies that will compete with some or all
of the Company's high-speed data service offerings. Such technologies include
Integrated Services Digital Network ("ISDN") and
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<PAGE>
Asymmetric Digital Subscriber Line ("ADSL"). In January 1998, Compaq, Intel
and Microsoft, other technology companies and numerous telecommunications
providers announced an initiative to develop a simplified version of ADSL,
referred to as "ADSL Lite," which reduces the complexity and expense of
installing Internet services based on ADSL. In October 1998, the International
Telecommunications Union adopted an ADSL Lite standard. Widespread commercial
acceptance of ADSL technologies could significantly reduce the potential
subscriber base for the Company's Internet services, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
The Company could also face substantial competition from its strategic partners.
In February 1997, TCG acquired CERFnet Services, Inc. ("CERFnet"), an Internet
service provider for business customers that competes with the Company's @Work
service. The Company's @Work business depends to a significant extent on its
agreement with TCG for local access telecommunications services. If TCG ceases
to cooperate with the Company, there could be an adverse effect on the Company's
@Work business. In July 1998, AT&T acquired TCG and in June 1998, AT&T announced
an agreement to acquire TCI, including TCI's controlling interest in the
Company. AT&T also operates a consumer Internet service known as AT&T WorldNet.
Now that it owns TCG, and if it completes its acquisition of TCI, AT&T could
take actions that benefit CERFnet, WorldNet or other services of AT&T to the
detriment of the Company. Moreover, as discussed above, AT&T's acquisition of
TCI could result in termination of the Exclusivity Obligations of the Company's
Principal U.S. Cable Partners. Any of these actions could have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company also competes with Internet service providers which provide basic
Internet access to residential consumers and businesses, generally using
existing telephone network infrastructures. While not offering the advantages
of broadband access, these services are widely available and inexpensive. In
addition, the Company competes with online service providers such as America
Online, Inc. ("America Online") that provide, over the Internet and on
proprietary online services, content and applications ranging from news and
sports to consumer videoconferencing. These services currently are designed
for broad consumer access over telecommunications-based transmission media,
which enables the provision of data services to the large group of consumers
who have personal computers with modems. Finally, the Company competes with
content aggregators and Internet portals that seek to capture audience flow by
providing ease-of-use and offering content that appeals to a broad audience.
Leading companies in this area include America Online, Yahoo! Inc. and Excite,
Inc.
Many of the Company's competitors and potential competitors have substantially
greater financial, technical and marketing resources, larger subscriber bases,
longer operating histories, greater name recognition and more established
relationships with advertisers and content and application providers than the
Company. Such competitors may be able to undertake more extensive marketing
campaigns, adopt more aggressive pricing policies and devote substantially more
resources to developing Internet services or online content than the Company.
The Company may not be able to compete successfully against current or future
competitors, and competitive pressures faced by the Company could materially
adversely affect the Company's business, operating results or financial
condition. Further, as a strategic response to changes in the competitive
environment, the Company and its Cable Partners may make certain pricing,
service or marketing decisions or enter into acquisitions or new ventures that
could have a material adverse effect on the Company's business, operating
results or financial condition.
RISKS ASSOCIATED WITH JOINT DEVELOPMENT EFFORT
The Company was selected by TCI to develop software and provide integration
services for TCI's next generation advanced digital set-top devices, pursuant to
a Software Development and Services Agreement between the Company and NDTC.
Although the Company believes this relationship could enable the Company to
expand its product line and market the @Home service to a broader audience of
consumers who do not regularly use a personal computer, the agreement does not
require that TCI deploy the @Home service on such set-top devices, and the
22
<PAGE>
Company cannot predict when such set-top devices will become commercially
available. In addition to the technological, financial and infrastructure
challenges TCI faces in deploying the new set-top devices, the success of this
development effort is subject to: (i) the technological and operational
challenges of providing and supporting email and other Internet services to set-
top device users; (ii) competition from alternative Internet service providers
and deployment technologies; and (iii) the degree to which consumers desire
Internet services, including email, on their televisions.
RISK OF SYSTEM FAILURE
The Company's operations are dependent upon its ability to support its highly
complex network infrastructure and avoid damage from fires, earthquakes, floods,
power losses, telecommunications failures and similar events. The occurrence of
a natural disaster or other unanticipated problem at the Company's Network
Operations Center or at a number of the Company's regional data centers could
cause interruptions in the services provided by the Company. Additionally,
failure of the Company's Cable Partners or companies from which the Company
obtains data transport services to provide the data communications capacity
required by the Company, as a result of natural disaster, operational disruption
or any other reason, could cause interruptions in the services provided by the
Company. Any damage or failure that causes interruptions in the Company's
operations could have a material adverse effect on the Company's business,
operating results and financial condition.
RISKS OF TECHNOLOGICAL CHANGE
The markets for consumer and business Internet access services and online
content are characterized by rapid technological developments, frequent new
product introductions and evolving industry standards. The emerging nature of
these products and services and their rapid evolution will require that the
Company continually improve the performance, features and reliability of its
network, Internet content and consumer and business services, particularly in
response to competitive offerings. The Company may not be successful in
responding quickly, cost effectively and sufficiently to these developments.
There may be a time-limited market opportunity for the Company's cable-based
consumer and business Internet services, and the Company may not be successful
in achieving widespread acceptance of its services before competitors offer
products and services with speed and performance similar to the Company's
current offerings. In addition, the widespread adoption of new Internet or
telecommuting technologies or standards, cable-based or otherwise, could require
substantial expenditures by the Company to modify or adapt its network, products
and services and could fundamentally affect the character, viability and
frequency of Internet-based advertising and content services, either of which
could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, new Internet or telecommuting
services or enhancements offered by the Company may contain design flaws or
other defects that could have a material adverse effect on the Company's
business, operating results and financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
A key component of the Company's strategy is expansion into international
markets. To date, the Company has developed relationships only with United
States, Canadian and Dutch cable system operators. The Company has extremely
limited experience in developing localized versions of its products and services
and in developing relationships with international cable system operators. The
Company may not be successful in expanding its product and service offerings
into foreign markets. In addition to the uncertainty regarding the Company's
ability to generate revenues from foreign operations and expand its
international presence, there are certain risks inherent in doing business on an
international level, such as: (i) regulatory requirements (including the
regulation of Internet access); (ii) legal uncertainty regarding liability for
information retrieved and replicated in foreign jurisdictions; (iii) export and
import restrictions; (iv) tariffs and other trade barriers; (v) difficulties in
staffing and managing foreign operations; (vi) longer payment cycles; (vii)
problems in collecting accounts receivable; (viii) fluctuations in currency
exchange rates; (ix) seasonal reductions in business activity during the summer
months in Europe and certain other parts of the world; and (x) potentially
adverse tax consequences, which could adversely affect the success of the
Company's future international operations. One or more of such factors could
have a material adverse effect on the Company's future international operations
and, consequently, on the Company's business, operating results and financial
condition.
23
<PAGE>
RISK OF FCC REGULATORY ACTION
In recent months, AOL, MindSpring Enterprises, Inc., the Consumers Union and
other parties have requested the Federal Communications Commission (the "FCC")
to require cable operators to provide ISPs and online service providers ("OSPs")
with equal access to the cable infrastructure. In the event that the FCC were
to require such third party access to the cable infrastructure, ISPs and OSPs
could potentially provide services over the cable infrastructure of the
Company's Cable Partners that compete with the services offered by the Company.
The third party access issue has been raised in two different FCC proceedings.
First, the issue has been linked to the FCC's review of an application to
transfer certain licenses filed in connection with AT&T's acquisition of TCI.
As part of the approval process, the FCC has the authority to place conditions
on the transfer, and one requested condition is to allow third party access to
the cable infrastructure. The FCC is not likely to make a decision on this
matter until early 1999.
Second, the FCC has been asked to review the third party access issue in
connection with its inquiry concerning the availability of advanced
telecommunications services pursuant to Section 706 of the Telecommunications
Act of 1996 (the "1996 Telecom Act"). On August 7, 1998, the FCC released a
Notice of Inquiry ("NOI") in order to begin that process. Numerous parties,
including the National Cable Trade Association ("NCTA"), the Company, and many
of the Cable Partners, have submitted comments in response to the NOI. The FCC
has 180 days from the date of its NOI to complete its inquiry, and a report is
not expected until February 1999.
The Company believes that the FCC should reject the demands for third party
access to the cable infrastructure for a number of reasons. First, requiring
cable operators to unbundle their plant will reduce their incentive to make the
significant investment that is required to upgrade their networks and roll-out
broadband services. Second, such regulatory action could have a "chilling
effect" on other emerging broadband satellite and wireless providers that also
must make sizable investments to offer facilities based broadband solutions.
Third, regulation is unnecessary as cable operators do not have a dominate
position in the Internet services market and do not limit access to AOL or other
Internet content. Fourth, it is doubtful that the FCC has the legal authority
to mandate such third party access under the 1996 Telecom Act or other existing
telecommunications laws.
Rogers and Shaw have informed the Company that, due to certain Canadian
regulations, they are required to provide access to their respective networks to
third-party ISPs. Although no third party currently uses Rogers' or Shaw's
networks for purposes of offering Internet services, these Canadian regulations
preclude the Company from having the sole right to access to these networks.
24
<PAGE>
DILUTION FROM CERTAIN TRANSACTIONS
The Company has entered into agreements with Cablevision, Rogers, Shaw and
certain other Cable Partners pursuant to which the Company has issued warrants
to purchase a total of 21,219,036 shares of Series A Common Stock. Under these
agreements, warrants to purchase 10,231,298 shares of Series A Common Stock at
$0.50 per share and 350,000 shares at $10.50 per share were exercisable as of
March 31, 1998. To the extent that Cablevision, Rogers, Shaw or certain other
Cable Partners become eligible to and exercise their warrants, the Company's
stockholders would experience substantial dilution. The Company also may issue
additional stock, or warrants to purchase the same, at less than fair market
value in connection with its efforts to expand its distribution of the @Home
service.
POSSIBLE VOLATILITY OF STOCK PRICE
The stock market has from time to time experienced significant price and volume
fluctuations. In addition, the market price of the shares of the Company's
Series A Common Stock, similar to the market prices of other Internet companies,
has been and is likely to be highly volatile. Factors such as fluctuations in
the Company's operating results, announcements of technological innovations or
new products by the Company or its competitors, regulatory actions, market
rumors, acquisitions in the telecommunications or cable industries and general
market conditions may have a significant effect on the market price of the
Company's Series A Common Stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
25
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Use of Proceeds from Sales of Registered Securities. The Company commenced its
Initial Public Offering ("IPO") on July 11, 1997 pursuant to a Registration
Statement on Form S-1 (File No. 333-27323). In the IPO the Company sold an
aggregate of 10,350,000 shares of its Series A Common Stock (including
1,350,000 shares sold pursuant to the exercise of the Underwriters' over-
allotment option) at an initial price of $10.50 per share. The IPO was closed
on July 16, 1997.
Aggregate proceeds from the IPO were $108,675,000, which included $14,175,000 in
aggregate proceeds due to the exercise of the underwriters' option to purchase
shares to cover over-allotments. The Company paid underwriters' discounts and
commissions of $7,607,250 and other expenses of approximately $1,300,000 in
connection with the IPO. The total expenses paid by the Company in the IPO were
$8,907,250, and the net proceeds to the Company in the IPO were $99,767,750. Of
the net proceeds, $7,303,000 has been used for purchases of property, equipment
and improvements, $6,153,000 for payments on capital lease obligations and the
remainder for working capital requirements of the Company, including $14,230,000
used to fund operating losses. None of the net proceeds of the Offering were
paid directly or indirectly to any director, officer, general partner of the
Company or their associates, persons owning 10 percent or more of any class of
equity securities of the Company, or an affiliate of the Company.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
See attached exhibit index.
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed during the quarter ended September 30,
1998.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AT HOME CORPORATION
(Registrant)
/s/ Kenneth A. Goldman
____________________________
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
(Duly Authorized Officer)
/s/ Robert A. Lerner
_____________________________
Corporate Controller
and Treasurer
(Principal Accounting Officer)
(Duly Authorized Officer)
NOVEMBER 16, 1998
27
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit Title
- -------------- -------------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 105,131
<SECURITIES> 98,608
<RECEIVABLES> 7,963
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 215,134
<PP&E> 63,433
<DEPRECIATION> 19,190
<TOTAL-ASSETS> 266,596
<CURRENT-LIABILITIES> 36,204
<BONDS> 13,521
0
0
<COMMON> 581,728
<OTHER-SE> (364,857)
<TOTAL-LIABILITY-AND-EQUITY> 266,596
<SALES> 0
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<INCOME-PRETAX> (115,805)
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<INCOME-CONTINUING> (115,805)
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<CHANGES> 0
<NET-INCOME> (115,805)
<EPS-PRIMARY> (1.02)
<EPS-DILUTED> (1.02)
</TABLE>
