<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------
FORM 10-Q
Mark One
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended June 30, 2000.
or
/_/ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period From To .
---------- ------------
Commission file number: 000-25755
WORLDGATE COMMUNICATIONS, INC.
-------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2866697
------------------------- ------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
3190 Tremont Avenue
Trevose, Pennsylvania 19053
----------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(215) 354-5100
-----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of July 31, 2000, there were 21,667,154 shares of common stock, par value
$.01 per share, outstanding.
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS AND SIX MONTHS
ENDED JUNE 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements and Supplementary Data ......................................Page 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............................................Page 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk .......................Page 11
PART II OTHER INFORMATION
Item 1. Legal Proceedings ................................................................Page 12
Item 2. Changes in Securities and Use of Proceeds ........................................Page 12
Item 4. Submission of Matters to a Vote of Security Holders ..............................Page 13
Item 5. Other Information.................................................................Page 13
Item 6. Exhibits and Reports on Form 8-K .................................................Page 14
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
(UNAUDITED)
------------------ ------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,795 $ 9,256
Short - term investments 39,078 66,414
Accounts receivable, less allowance for doubtful accounts of $500 at 5,766 3,248
June 30, 2000 and $150 at December 31, 1999
Inventory 10,506 5,600
Prepaid and other assets 1,126 1,738
------------------ ------------------
Total current assets 67,271 86,256
------------------ ------------------
Property and equipment 3,319 2,196
Less: accumulated depreciation and amortization (762) (402)
------------------ ------------------
Property and equipment, net 2,557 1,794
Prepaid expenses and deposits 1,144 1,120
Goodwill 3,550 0
================== ==================
Total assets $ 74,522 $ 89,170
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion, notes payable $ 742 $ 796
Current portion, capital leases 5 5
Notes payable - Shareholders DVA 1,332 0
Accounts payable 5,198 2,810
Accrued expenses 1,283 389
Accrued compensation and benefits 1,926 1,844
Other 30 30
------------------ ------------------
Total current liabilities 10,516 5,874
Notes payable 111 377
Capital leases 4 7
Other 240 255
------------------ ------------------
Total liabilities 10,871 6,513
------------------ ------------------
Stockholders' equity:
Class A Common Stock, $.01 par value, 50,000,000 shares authorized, 216 215
21,667,154 shares issued and outstanding at June 30, 2000 and
21,488,456 shares issued and outstanding at December 31, 1999
Additional paid-in capital 173,204 170,592
Warrant for Class A Common Stock 1,911 1,911
Accumulated deficit (110,902) (89,085)
Unearned stock-based compensation (778) (976)
------------------ ------------------
Total stockholders' equity 63,651 82,657
================== ==================
Total liabilities and stockholders' equity $ 74,522 $ 89,170
================== ==================
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------------- ------------------------------
2000 1999 2000 1999
--------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 3,576 $ 741 $ 5,150 $ 1,290
--------------- -------------- ------------- -------------
Costs and expenses:
Cost of revenues 5,249 3,950 9,177 5,783
Engineering and development (excluding depreciation and 3,552 2,434 8,429 4,764
amortization amounts of $53 and $26 for the three months
ended June 30, 2000 and 1999,respectively, and $85 and $48
for the six months ended June 30, 2000 and June 30, 1999,
respectively)
Sales and marketing (excluding depreciation and 3,695 1,893 6,428 3,248
amortization amounts of $60 and $29 for the three months
ended June 30, 2000 and 1999, respectively and $116 and $31
for the six months ended June 30, 2000 and June 30, 1999,
respectively)
General and administrative (excluding depreciation and 2,620 1,443 4,534 2,580
amortization amounts of $36 and $12 for the three months
ended June 30, 2000 and 1999, respectively and $62 and $23
for the six months ended June 30, 2000 and June 30, 1999,
respectively)
Depreciation and amortization 206 65 321 102
--------------- -------------- ------------- -------------
Total costs and expenses 15,322 9,785 28,889 16,477
--------------- -------------- ------------- -------------
Loss from operations (11,746) (9,044) (23,739) (15,187)
Interest and other income 783 986 1,964 1,024
Interest expense 21 76 42 169
--------------- -------------- ------------- -------------
Loss before extraordinary item (10,984) (8,134) (21,817) (14,332)
Extraordinary item - loss on early extinguishment
of debt 0 (1,019) 0 (1,019)
--------------- -------------- ------------- -------------
Net loss (10,984) (9,153) (21,817) (15,351)
Accretion on preferred stock 0 (364) 0 (2,475)
--------------- -------------- ------------- -------------
Net loss available to common stockholders $ (10,984) $ (9,517) $ (21,817) $ (17,826)
=============== ============== ============= =============
Net loss per common share (basic and diluted) *
Loss before extraordinary item $ (0.51) $ (0.44) $ (1.01) $ (1.18)
Extraordinary item 0 (0.05) 0 (0.07)
--------------- -------------- ------------- -------------
Net Loss $ (0.51) $ (0.49) $ (1.01) $ (1.25)
=============== ============== ============= =============
Weighted average common shares outstanding - basic and
diluted 21,589,700 19,313,383 21,558,314 14,235,304
=============== ============== ============= =============
</TABLE>
* For purposes of computing net loss per common share
amounts, loss before extraordinary item and net loss
have been reduced by the accretion on preferred
stock.
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------------
2000 1999
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (21,817) $ (15,351)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 263 102
Bad debt expense 350 0
Amortization of deferred compensation 198 198
Amortization of goodwill 58 0
Amortization of debt issue costs 0 108
Extraordinary loss on early extinguishment of debt 0 1,019
Changes in operating assets and liabilities:
Accounts receivable (2,562) (394)
Inventories (4,906) (2,219)
Prepaid and other assets 614 (1,086)
Accounts payable 2,383 (2,029)
Accrued expenses 795 1,921
Accrued compensation and benefits (28) (523)
Other (15) 268
---------------- ----------------
Net cash used in operating activities (24,667) (17,986)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (983) (609)
Proceeds from maturities of short-term investments, net 27,336 (85,810)
Net cash acquired - acquisition of DVA 63 0
Restricted cash 0 240
---------------- ----------------
Net cash provided by (used in) investing activities 26,416 (86,179)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 0 7,672
Proceeds from issuance of common stock 0 120,750
Proceeds from exercise of stock options 113 43
Stock issuance costs 0 (9,574)
Proceeds from notes payable 0 6,000
Debt issue costs 0 (530)
Repayments of capital leases and notes payable (323) (5,822)
---------------- ----------------
Net cash (used in) provided by financing activities (210) 118,539
---------------- ----------------
Net (decrease) increase in cash 1,539 14,374
Cash and cash equivalents, beginning of period 9,256 128
---------------- ----------------
Cash and cash equivalents, end of period $ 10,795 $ 14,502
================ ================
Noncash investing and financing activities:
Issuance of common stock for acquisition of business $ 2,500 0
Issuance of notes payable for acquisition of business $ 1,332 0
Accretion on preferred stock 0 $ 2,475
Issuance of warrants in connection with financing agreements 0 1,030
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
WORLDGATE COMMUNICATIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollar Amounts are in Thousands, Except per Share Amounts)
(unaudited)
1. Basis of Presentation.
The unaudited financial statements of WorldGate Communications, Inc. (the
"Company") for the three and six months ended June 30, 2000 and June 30, 1999
presented herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission for quarterly reports on
Form 10-Q. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. These financial statements should be read in conjunction with the
financial statements for the year ended December 31, 1999 and the notes thereto
included in the Company's Annual Report on Form 10-K.
The financial information in this Report reflects, in the opinion of
management, all adjustments of a normal recurring nature necessary to present
fairly the results for the interim period. Quarterly operating results are not
indicative of the results that may be expected for the year ending December 31,
2000.
2. Recent Accounting Pronouncements.
On April 3, 2000 the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) 44, "Accounting for Certain Transactions Involving
Stock Compensation - an Interpretation of APB 25." FIN 44 specifically answers
twenty-nine questions on the implementation of APB 25 that were derived from a
survey of members of the Emerging Issues Task Force (EITF) and the task force on
stock compensation. FIN 44 is effective July 1, 2000, but certain conclusions in
FIN 44 cover specific events that occur after December 15, 1998. To the extent
that FIN 44 covers events occurring during the period after December 15, 1998,
but before the effective date of July 1, 2000, the effects of applying FIN 44
are recognized on a prospective basis from July 1, 2000. Management is currently
evaluating the impact, if any, FIN 44 will have on the Company's financial
position and results of operation.
On June 26, 2000 the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101B which amends the implementation date of SAB
101, "Revenue Recognition" to the three month period ending December 31, 2000.
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. Management is currently assessing the impact,
if any, the SAB will have on the Company's financial position and results of
operations.
3. Inventories.
Inventories are summarized as follows:
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
------------------ --------------------
<S> <C> <C>
Raw Material $6,171 $3,046
Work in Progress 1,151 340
Finished Goods 3,184 2,214
------------------ --------------------
$10,506 $5,600
================== ====================
</TABLE>
Customers and vendors held $2,128 and $1,710 of the Company's finished
goods inventories at June 30, 2000 and December 31, 1999, respectively, for use
in system trials and product testing.
6
<PAGE>
4. Stockholders' Equity.
STOCK OPTION PLAN
On May 4, 2000, the Company's Board of Directors increased, subject to
stockholder approval, the number of shares of common stock issuable under the
Company's 1996 Stock Option Plan to 3,200,000 shares.
EARNINGS PER SHARE
The following table is a reconciliation of the computation of net loss per
common share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
----------------------------- ------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss available to common stockholders:
Loss before extraordinary item $ (10,984) $ (8,134) $ (21,817) $ (14,332)
Accretion on preferred stock 0 (364) 0 (2,475)
------------ ------------ ------------ ------------
Loss available to common stockholders* (10,984) (8,498) (21,817) (16,807)
Extraordinary item - loss on early extinguishment of debt 0 (1,019) 0 (1,019)
------------ ------------ ------------ ------------
Net Loss available to common stockholders* $ (10,984) $ (9,517) $ (21,817) $ (17,826)
============ ============ ============ ============
Basic and diluted net loss per common share**:
Weighted average shares outstanding 21,589,700 19,313,383 21,558,314 14,235,304
============ ============ ============ ============
Loss before extraordinary item per share - basic and
diluted $ (0.51) $ (0.44) $ (1.01) $ (1.18)
Extraordinary item - loss on early extinguishment of debt 0 (0.05) 0 (0.07
------------ ------------ ------------ ------------
Net loss per share - basic and diluted $ (0.51) $ (0.49) $ (1.01) $ (1.25)
============ ============ ============ ============
</TABLE>
* Loss and net loss available to common stockholders is the same for purposes of
calculating basic and diluted loss per common share
** Basic and diluted loss per common share are equal, since common stock
equivalents are not included, as inclusion of such shares would have an
antidilutive effect.
5. Related Party Transactions.
In 1997, the Company entered into an agreement with a cable operator who is
an investor. Revenues recognized from this investor were approximately $1,745
and $213, respectively, for the three months ended June 30, 2000 and June 30,
1999, and $2,411 and $644, respectively, for the six months ended June 30, 2000
and June 30, 1999. Accounts receivable from this investor amounted to
approximately $1,883 at June 30, 2000 and $738 at December 31, 1999.
In 1997 and 1998, the Company entered into agreements with four
stockholders to provide the Company with engineering and development support. As
a result of these agreements, the Company has expensed approximately $1,336 and
$1,338, respectively, for the three months ended June 30, 2000 and June 30, 1999
and $2,781 and $1,718, respectively, for the six months ended June 30, 2000 and
June 30, 1999. Accounts payable to these stockholders amounted to $1,138 and
$126 at June 30, 2000 and December 31, 1999, respectively. These stockholders
are suppliers of technology and components for the Company's products and
services. These agreements provide for licensing of technology, as well as
contracted services, including hardware and software development, product
testing and certification, and the creation and development of tools and systems
to facilitate the Company's engineering efforts. These agreements do not provide
for ongoing royalties, purchase provisions, nor for any requirement to provide
additional funding to the Company.
6. Digital Video Arts, Inc. Acquisition
On April 28, 2000, the Company completed the acquisition of Digital
Video Arts, Inc. ("DVA"), a Campbell, California based engineering services
operation providing out-sourced product development, with expertise in digital
television and 3D graphics. The acquisition was recorded under the purchase
method of accounting.
7
<PAGE>
The total purchase consideration of $3,977 consisted of approximately 119,000
shares of Common Stock with a value of $2,500, obligations totaling $1,332, and
acquisition costs of $145. The purchase consideration of the acquired assets and
assumed liabilities were allocated based on fair values as follows:
<TABLE>
<S> <C>
Assets acquired ........................ $ 582
Liabilities assumed .................... (213)
Goodwill ............................... 3,608
-------
Total purchase consideration ........... $ 3,977
=======
</TABLE>
In addition, the purchase agreement between the Company and DVA provides for the
payment of contingent consideration in shares of Common Stock in accordance with
a specified formula if certain criteria with respect to the retention of the
former management and employees of DVA are met over future periods ranging from
one to three years. Contingent consideration in shares of Common Stock up to a
maximum amount of $4,174 could be payable based on performance criteria
associated with the three years ended December 31, 2003. The projected
contingent consideration is not currently determinable. Goodwill associated with
the DVA acquisition will be amortized on a straight-line basis over ten years.
The pro forma results of operations for DVA for the three and six months ended
June 30, 2000 and 1999, were not significant.
7. Subsequent Events
On July 24, 2000, the Company entered into multi-year agreements with
four cable operators for the digital deployment of the Company's Internet on
EVERY TV service to a predetermined number of households. In addition to the
deployment agreements, the cable providers agreed to purchase an aggregate of
1,531,211 shares of the Company's common stock yielding aggregate gross
proceeds to the Company of $24,500. In addition, these same cable operators
can each earn warrants for the purchase of the Company's common stock. These
warrants are earned based on additional deployments of the Company's Internet
on EVERY TV service to the cable operators' digital cable subscribers.
Concurrently the Company formed a separate joint venture, TVGateway, LLC,
with the same four cable operators. The joint venture will license patented
Channel Hyperlinking and Ultra-Thin Client technology from the Company, which
can provide the back office infrastructure support necessary to implement
interactive advertising and programming for the cable operator's digital set-top
boxes. TVGateway will also license Application Launcher technology from the
Company that enables multiple applications to be easily interchanged in the
digital set-top box. The Company will provide certain administrative services to
the joint venture and will account for its investment in the joint venture under
the equity method.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
(Dollars Amounts are in Thousands, Except per Share Amounts)
FORWARD-LOOKING AND CAUTIONARY STATEMENTS.
We may from time to time make written or oral forward-looking statements,
including those contained in the foregoing Management's Discussion and Analysis
of Financial Condition and Results of Operations. In order to take advantage of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995, we are hereby identifying certain important factors which could cause our
actual results, performance or achievement to differ materially from those that
may be contained in or implied by any forward-looking statement made by or on
behalf of WorldGate. The factors, individually or in the aggregate, that could
cause such forward-looking statements not to be realized include, without
limitation, the following: (1) difficulty in developing and implementing
marketing and business plans, (2) continued losses, (3) industry competition
factors and other uncertainty that a market for the WORLDGATEsm Service will
develop, (4) challenges associated with cable operators (including, uncertainty
that they will offer the WORLDGATE Service, inability to predict the manner in
which they will market and price the WORLDGATE Service and existence of
potential conflicts of interests and contractual limitations impeding their
ability to offer the WORLDGATE Service), (5) challenges associated with cable
box manufacturers (including uncertainty that they will support our technology
in their cable boxes), (6) challenges with advertisers and television
programmers (including uncertainties that they will support our CHANNEL
HYPERLINKINGsm technology), (7) loss of any one of our largest customers, (8)
departure of one or more key persons and (9) other risks identified in filings
with the Securities and Exchange Commission. We caution you that the foregoing
list of important factors is not intended to be, and is not, exhaustive. We do
not undertake to update any forward-looking statement that may be made from time
to time by or on behalf of WorldGate.
Results of Operations:
Three and Six Months Ended June 30, 2000 and June 30, 1999
Revenues. Revenues increased from $741 for the three months ended June 30,
1999, to $3,576 for the three months ended June 30, 2000. Revenues also
increased from $1,290 for the six months ended June 30, 1999 to $5,150 for the
six months ended June 30, 2000. Substantially all revenues are attributable to
the increase in commercial deployments of WorldGate's interactive television
service and cable subscribers subscribing to the WorldGate Internet on EVERY TV
service. At June 30, 1999 there were 10 commercial deployments and approximately
7,300 participating subscribers. As of June 30, 2000 there were 16 commercial
deployments, with approximately 43,000 cable customers subscribing to the
WorldGate Service. For the three and six months ended June 30, 2000 revenues
were derived primarily from the delivery of headends, keyboards, and related
products and services.
Costs and Expenses.
Cost of Revenues. Cost of revenues consist primarily of product costs
related to initial trials, commercial deployments and WorldGate modules used by
the cable operators in deploying the WorldGate Service to be incorporated into
the set-top boxes. Cost of revenues for the three and six months ended June 30,
2000 were $5,249 and $9,177, respectively, or approximately 147% and 178% of
revenues, respectively, compared to the cost of revenues of $3,950 and $5,783,
respectively, or approximately 533% and 448% of revenues, respectively, for the
three and six months ended June 30, 1999. This reduction in cost of revenues as
a percent of revenues is primarily attributable to the Company's reduction of
unit costs, the reduced requirement for WorldGate to supply modules to be
incorporated into set-top box deliveries, and additional volume to cover
manufacturing overheads.
Engineering and Development. Engineering and development expenses
primarily consist of the cost of design, programming, testing, documentation and
support of the Company's hardware, software and services. Engineering and
development costs were $3,552 and $8,429, respectively, for the three and six
months ended June 30, 2000, an increase of approximately 46% and 77%,
respectively, when compared to $2,434 and $4,764, respectively, for the three
and six months ended June 30, 1999. The Company anticipates continued increases
in expenditures for staff and new and enhanced products, software and services.
9
<PAGE>
Sales and Marketing. Sales and marketing costs consist primarily of
compensation, attendance at conferences and trade shows, travel costs necessary
to cover a domestic and international customer market base, promotions and other
marketing programs substantially related to initial trial installations and
commercial deployments. For the three and six months ended June 30, 2000 sales
and marketing expenses were $3,695 and $6,428, respectively. This represented
increases of approximately 95% and 98%, respectively, when compared to sales and
marketing expenses of $1,893 and $3,248, respectively, for the three and six
months ended June 30, 1999. These increases were primarily the result of
additional trade show costs of approximately $500 together with increases in
marketing and promotional expenditures which the Company anticipates will
continue to increase with the anticipated growth in the number of new, and the
expansion of existing, commercial deployments. Increased expenditures are also
anticipated in the future for advertising and other trade promotional
activities.
General and Administrative. General and administrative expenses consist
primarily of expenditures for administration, office and facility operations,
finance and general management activities, including legal, accounting and other
professional fees. General and administrative expenses were $2,620 and $4,534,
respectively, for the three and six months ended June 30, 2000, an increase of
approximately 82% and 76%, respectively, when compared to expenses of $1,443 and
$2,580, respectively, for the same periods in 1999. This increase of $1,177 and
$1,954, respectively, was primarily due to $99 and $198, respectively, of
additional deferred compensation expense related to options previously granted,
facility operating costs of $86 and $507, respectively, associated with the
Company's relocation to a larger facility in June 1999, additional legal,
professional fees and insurance costs of $707 and $808, respectively, and $200
and $350, respectively, covering increases in our reserve for doubtful accounts.
The Company anticipates that general and administrative expenses will continue
to increase as the Company hires additional personnel to support its expected
growth.
Interest and Other Income and Interest Expense. Interest and other
income and interest expense consist of interest earned on cash and cash
equivalents and short-term investments, and interest expense on equipment
financing and short-term debt. Interest and other income decreased from $986 for
the three months ended June 30, 1999 to $783 for the three months ended June 30,
2000, and increased from $1,024 to $1,964 for the six months ended June 30, 1999
and June 30, 2000, respectively. During the three and six months ended June 30,
1999, the Company earned interest on an average cash balance of approximately
$83,000 and $42,000, respectively, and incurred interest expense related to its
$6,000 financing and $1,100 equipment financing facility. In comparison, during
the three and six months ended June 30, 2000 the Company earned interest on an
average cash balance of approximately $57,400 and $64,000, respectively, and
incurred interest expense related to its $1,100 equipment financing facility.
Extraordinary Loss. As a result of the early extinguishment in April
1999 of Notes issued by the Company in March 1999, the Company recognized a loss
of $1,019 during the second quarter of 1999, primarily related to the remaining
unamortized debt discount balance.
Income Taxes. The Company has incurred net operating losses since
inception and accordingly had no income taxes due and has not recorded any
income tax benefit for those losses.
Liquidity and Capital Resources.
As of June 30, 2000, the Company's primary source of liquidity
consisted of cash and debt instruments that are highly liquid, are of high
quality investment grade and have maturities of less than one year.
At June 30, 2000, the Company had cash and cash equivalents of $10,795
(in addition to $39,078 in short-term investments) as compared to $9,256 (in
addition to $66,414 in short-term investments) at December 31, 1999. Net cash
used in operations was $24,667 for the six months ended June 30, 2000, as
compared to $17,986 used for the same period in 1999. The increase in net cash
used for operations was primarily attributable to the Company's increased
expenditures in 2000, inventory increases in anticipation of future deliveries,
and higher accounts receivable balances due primarily to shipments late in the
second quarter.
Net cash for the six months ended June 30, 2000 was further reduced by
$210, reflecting the net impact of the Company's repayment of equipment
financing obligations which was partially offset by the proceeds from option
exercises. The Company's net use of cash for operating and financing activities
as well as capital expenditure requirements was offset by proceeds from the
maturity of short-term investments. In comparison, net
10
<PAGE>
cash provided from financing activities was $118,539 during the six months ended
June 30, 1999, primarily resulting from the Company's initial public offering in
April 1999, with net proceeds totaling $111,192. The Company reported net cash
used in investing activities during the six months ended June 30, 1999 of
$86,179 due primarily to investment of the IPO proceeds in short-term
investments.
In July 2000, the Company entered into agreements with four cable
operators regarding the digital deployment of the Company's Internet on EVERY TV
service. In connection with such agreements, the cable operators agreed, subject
to certain closing conditions, to purchase an aggregate of 1,531,211 shares of
the Company's common stock yielding aggregate gross proceeds to the Company of
$24,500. In addition, each cable operator can earn warrants to purchase shares
of the Company's common stock. The warrants are earned based on additional
deployments of the Company's Internet on EVERY TV service to the cable
operators' digital cable subscribers.
On April 3, 2000 the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) 44, "Accounting for Certain Transactions Involving
Stock Compensation - an Interpretation of APB 25." FIN 44 specifically answers
twenty-nine questions on the implementation of APB 25 that were derived from a
survey of members of the Emerging Issues Task Force (EITF) and the task force on
stock compensation. FIN 44 is effective July 1, 2000, but certain conclusions in
FIN 44 cover specific events that occur after December 15, 1998. To the extent
that FIN 44 covers events occurring during the period after December 15, 1998,
but before the effective date of July 1, 2000, the effects of applying the
Interpretation are recognized on a prospective basis from July 1, 2000.
Management is currently evaluating the impact, if any, FIN 44 will have on the
Company's financial position and results of operation.
On June 26, 2000 the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101B which amends the implementation date of SAB
101, "Revenue Recognition" to the three month period ending December 31, 2000.
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. Management is currently assessing the impact,
if any, the SAB will have on the Company's financial position and results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INTEREST RATE RISK. Our exposure to market risk related to changes in interest
rates relates primarily to our investment portfolio. We invest in instruments
that meet high credit quality standards, and we limit the amount of credit
exposure to any one issue, issuer and type of investment.
As of June 30, 2000, our cash and cash equivalents and short-term
investments were $49,873, most of which were debt securities having a maturity
of less than one year. Due to the average maturity and conservative nature of
our investment portfolio, management believes a sudden change in interest rates
would not have a material effect on the value of the portfolio. Management
estimates that had the average yield of our investments decreased by 100 basis
points, our interest income for the six months ended June 30, 2000 would have
decreased by approximately $313. This estimate assumes that the decrease
occurred on the first day of 2000 and reduced the yield of each investment
instrument by 100 basis points. The impact on our future interest income of
future changes in investment yields will depend largely on our total
investments.
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<PAGE>
PART II. OTHER INFORMATION
(Dollars Amounts are in Thousands, Except per Share Amounts)
ITEM 1. LEGAL PROCEEDINGS.
On May 11, 1998, Interactive Channel Technologies, Inc. and SMI
Holdings, Inc., subsidiaries of Source Media, Inc. ("Source"), filed a complaint
against us in the U.S. District Court for the District of Delaware, alleging
that the WorldGate Service infringes patents issued to Source. The complaint
seeks injunctive relief, as well as monetary damages and attorney fees. In our
answer filed on June 22, 1998, we have denied these allegations and further
asserted that the patents in suit were invalid. In addition we have filed
multiple counterclaims against Source asserting that Source misappropriated our
confidential information and trade secrets, and intentionally and tortiously
interfered with our existing and prospective business relationships, which
counterclaims Source has subsequently moved to dismiss. Source's motion was
subsequently denied and discovery is now proceeding.
On October 6, 1998, Advanced Interactive, Inc. ("AII") filed a
complaint in the U.S. District Court for the Northern District of Illinois,
Eastern Division, against Matsushita Electric Corporation, Matsushita Electric
Industrial Co. Ltd., Sharp Electronics Corp., Sharp Corp., Interactive Channel
Technologies, Thomson Consumer Electronics, Toshiba Consumer Products, Inc.,
Toshiba America, Inc., Toshiba Corporation, General Instrument Corporation,
Scientific-Atlanta, Inc., ATI Technologies, Inc., ADS Technologies, Inc.,
Gateway 2000, Inc., STB Systems, Inc., Hauppauge Computer Works, Inc., WebTV
Networks, Inc., and us, alleging that each of the above companies infringed a
patent issued to AII. The complaint seeks monetary damages and attorney fees. In
our answer filed on December 2, 1998, we denied these allegations and further
asserted that the patent in suit was invalid. Subsequently, the defendants have
filed a joint motion for partial summary adjudication of claim construction
issues. On February 27, 2000 the Court agreed with the claim construction
proposed by the defendants and granted defendant's joint motion for partial
summary judgement, and entered judgement accordingly. AII has filed an appeal.
In the opinion of management, the ultimate resolution of these matters
will not have a material effect on the consolidated financial position,
operations or cash flow of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
INITIAL PUBLIC OFFERING/USE OF PROCEEDS.
On April 15, 1999, the Company's Registration Statement on Form S-1
(Commission file number 333-71997) covering the initial public offering of
5,750,000 shares of our common stock at twenty one dollars ($21.00) per share
was declared effective.
The net proceeds of the offering to the Company (after deducting the
foregoing expenses associated with such offering) was $111,192. From the
effective date of the Registration Statement to June 30, 2000, the net proceeds
have been used for the following purposes:
<TABLE>
<S> <C>
Construction of plant, building and facilities $ 0
Purchase and installation of machinery and equipment 2,181
Purchase of real estate 0
Acquisition of other business (including transaction costs) 145
Repayment of indebtedness 6,486
Working capital 56,850
Temporary investments, including cash and cash equivalents 10,795
Other purposes (for which at least $100 has been used) including:
investments, including debt instruments of the United States Government
and its agencies and in high quality corporate issuers 34,735
--------
$111,192
========
</TABLE>
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<PAGE>
Except for compensation expenses, all of the foregoing payments were direct
or indirect payments to persons other than (i) directors, officers or their
associates; (ii) persons owning ten percent (10%) or more of the Company's
common stock; or (iii) affiliates of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. NONE
ITEM 5: OTHER INFORMATION
In April 2000, the Company acquired Digital Video Art, Inc. ("DVI"), based
in Campbell, California, pursuant to a merger agreement (the "Merger
Agreement"). DVI is a supplier of custom software engineering services. Its
primary business activities are product development, and the design and
integration of custom technology solutions. DVI also develops and maintains two
products for high-resolution CCD imaging.
In connection with the acquisition the Company will make payments totaling
up to an aggregate of approximately $8.0 million (the "Merger Consideration") to
Michael Bruno, the sole stockholder of DVI (the "DVI Stockholder"), and to
certain other individuals who held options to acquire shares of DVI (the "DVI
Optionholders"). The payments may be made in cash or in shares of the Company
common stock at the Company's option. The payments will be made over a period of
four years, with the first payment to the DVI Stockholder made in April 2000 and
the remaining payments made to the DVI Stockholder and the DVI Optionholders on
the first, second and third anniversaries of the closing.
The aggregate amount of the Merger Consideration is subject to adjustment
based upon the continued employment with the Company of the DVI Stockholder and
certain software engineers of DVI. If the DVI Stockholder or any DVI
Optionholder voluntarily terminates his employment with the Company or is
terminated for cause, he will forfeit his unpaid Merger consideration unless
certain conditions are met. In addition, the amount of the Merger Consideration
payable on the first anniversary will be reduced in the event that less than 15
of the software engineers employed by DVI prior to the acquisition remain
employed by the Company at such anniversary.
In the event that the Company issues shares of common stock as payment, the
recipients have been granted the right to demand registration of such shares.
Such demand must be received by the Company not less than sixty days prior to
the anniversary on which such consideration is payable. In addition, the Company
has registered for resale 119,047 shares of common stock issued to the DVI
Stockholder on Form S-3 (Registration No. 333-35936).
The Company has also provided the DVI Stockholder and the DVI Optionholders
with a guarantee that the recipient of the Company's common stock as
consideration for the acquisition will receive as proceeds from sales of shares
during the period that a registration statement remains effective, an amount not
less than the amount of consideration owed to such individual pursuant to the
Merger Agreement based on the share price immediately prior to the closing or
respective anniversary dates of the Merger Agreement, as applicable (the
"Guaranteed Consideration"). In the event that the aggregate amount of proceeds
received by the individual upon the sale of all of the registered shares is less
than the amount of the Guaranteed Consideration paid in registered shares
pursuant to the terms of the Merger Agreement, the Company will, at its
election, either (i) pay the individual cash or (ii) issue additional shares, in
an amount equal to the difference between the proceeds realized by the
individual from the sale of the shares registered on such registration statement
during the period that the registration statement remains effective and the
amount of the Guaranteed Consideration paid in registered shares pursuant to the
terms of the Merger Agreement. Shares registered on a registration statement,
but not sold during the period that the registration statement remains effective
will be valued at the fair market value of the shares on the date of their
issuance and such value shall be counted towards the guaranteed amount. The
guarantee applies only to shares sold by the DVI Stockholder or the DVI
Optionholders during the period that the registration statement remains
effective and terminates upon the withdrawal of the registration statement.
In the event that the DVI Stockholder or DVI Optionholders receive proceeds
from the sale of the securities registered on a registration statement during
the period that the registration statement remains effective which exceed the
amount of Merger Consideration then payable to such individual, the amount of
any future payments to such individual pursuant to the Merger Agreement shall be
reduced on a dollar for dollar basis.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit Number Description
-------------- ------------
27.1 Financial Data Schedules
(b) Reports on Form 8-K. None.
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.
Date: August 11, 2000
/s/ Hal M. Krisbergh
---------------------------------------
Hal M. Krisbergh
President and Chief Executive Officer
/s/ James V. Agnello
---------------------------------------
James V. Agnello
Vice President and Chief Financial Officer
14
