<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q/A
(AMENDMENT NO. 1)
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 001-12925
------------------------
GENERAL INSTRUMENT CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-4134221
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
101 TOURNAMENT DRIVE, HORSHAM, PENNSYLVANIA, 19044
(Address of principal executive offices)
(Zip Code)
(215) 323-1000
(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 October 31, 1998, there were 167,391,015 shares of Common Stock
outstanding.
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<PAGE>
EXPLANATORY NOTE
This Form 10-Q/A ("Amendment No. 1") hereby amends, and replaces in their
entirety, Items 1, 2 and 3 of the Company's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1998 (the "Form 10-Q"), as set forth
below. The information contained herein has not been updated or revised to
reflect changes in the Company's business, or events occurring after November
16, 1998, the date on which the Form 10-Q was originally filed.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Cash and cash equivalents........................................................... $ 116,037 $ 35,225
Short-term investments.............................................................. 4,081 30,346
Accounts receivable, less allowance for doubtful accounts of $3,449 and $3,566,
respectively (includes related party amounts of $83,046 at September 30, 1998).... 315,755 343,625
Inventories......................................................................... 261,488 288,078
Deferred income taxes............................................................... 134,004 105,582
Other current assets................................................................ 16,389 21,862
------------- ------------
Total current assets............................................................ 847,754 824,718
Property, plant and equipment, net.................................................. 232,704 236,821
Intangibles, less accumulated amortization of $94,519 and $86,333, respectively..... 500,807 82,546
Excess of cost over fair value of net assets acquired, less accumulated amortization
of $118,480 and $108,123, respectively............................................ 453,856 471,186
Deferred income taxes............................................................... -- 5,634
Investments and other assets........................................................ 80,153 54,448
------------- ------------
TOTAL ASSETS........................................................................ $ 2,115,274 $1,675,353
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable.................................................................... $ 219,861 $ 200,817
Other accrued liabilities........................................................... 214,059 188,250
------------- ------------
Total current liabilities....................................................... 433,920 389,067
Deferred income taxes............................................................... 3,844 5,745
Other non-current liabilities....................................................... 64,656 65,730
------------- ------------
Total liabilities............................................................... 502,420 460,542
------------- ------------
Commitments and contingencies (See Note 7)
Stockholders' Equity:
Preferred Stock, $.01 par value; 20,000,000 shares authorized; no shares issued..... -- --
Common Stock, $.01 par value; 400,000,000 shares authorized; 173,393,275 and
148,358,188 shares issued at September 30, 1998 and December 31, 1997,
respectively...................................................................... 1,734 1,484
Additional paid-in capital.......................................................... 1,739,240 1,213,566
Note receivable from stockholder.................................................... (43,320) --
Accumulated deficit................................................................. (9,756) (19,236)
Accumulated other comprehensive income, net of taxes of $713 and $11,347,
respectively...................................................................... 2,368 18,999
------------- ------------
1,690,266 1,214,813
Less--Treasury Stock, at cost, 3,747,724 and 4,309 shares, respectively, of Common
Stock............................................................................. (77,412) (2)
------------- ------------
Total stockholders' equity.......................................................... 1,612,854 1,214,811
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......................................... $ 2,115,274 $1,675,353
------------- ------------
------------- ------------
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED--IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
NET SALES.................................................... $ 518,196 $ 464,582 $ 1,423,621 $ 1,323,013
Cost of sales................................................ 365,333 331,141 1,036,649 958,441
---------- ---------- ------------ ------------
GROSS PROFIT................................................. 152,863 133,441 386,972 364,572
---------- ---------- ------------ ------------
OPERATING EXPENSES:
Selling, general and adminstrative......................... 46,237 45,316 148,005 139,958
Research and development................................... 42,227 47,867 200,396 148,542
Amortization of excess of cost over fair value of net
assets acquired.......................................... 3,562 3,698 10,685 10,816
---------- ---------- ------------ ------------
Total operating expenses................................. 92,026 96,881 359,086 299,316
---------- ---------- ------------ ------------
OPERATING INCOME............................................. 60,837 36,560 27,886 65,256
Other income (expense)--net (including equity interest in
Partnership losses of $4,940 and $22,793 for the three and
nine months ended September 30, 1998)...................... 1,291 3,717 (8,513) 1,864
Interest income (expense)--net............................... 1,389 (829) 125 (14,340)
---------- ---------- ------------ ------------
INCOME BEFORE INCOME TAXES................................... 63,517 39,448 19,498 52,780
Provision for income taxes................................... (24,108) (14,990) (10,018) (22,955)
---------- ---------- ------------ ------------
NET INCOME................................................... $ 39,409 $ 24,458 $ 9,480 $ 29,825
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Earnings Per Share--Basic.................................... $ 0.23 $ 0.17 $ 0.06 $ 0.20
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Earnings Per Share--Diluted.................................. $ 0.22 $ 0.16 $ 0.06 $ 0.20
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Weighted-Average Shares Outstanding--Basic................... 168,932 147,499 156,679 147,426
Weighted-Average Shares Outstanding--Diluted................. 179,068 149,491 165,164 149,416
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENT OF STOCKHODLERS' EQUITY
(UNAUDITED--IN THOUSANDS)
<TABLE>
<CAPTION>
NOTE ACCUMULATED
COMMON STOCK ADDITIONAL RECEIVABLE OTHER COMMON
---------------------- PAID-IN FROM ACCUMULATED COMPREHENSIVE STOCK IN
SHARES AMOUNT CAPITAL STOCKHOLDER DEFICIT INCOME TREASURY
--------- ----------- ----------- ----------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1,
1998.................... 148,358 $ 1,484 $1,213,566 $ -- $ (19,236) $ 18,999 $ (2)
Net income................ 9,480
Exercise of stock options
and related tax
benefit................. 3,679 37 64,630 79
Issuance of stock in
connection with
acquisition............. 21,356 213 442,923 (43,320)
Warrant costs related to
customer purchases...... 18,121
Net change in
investments............. (16,631)
Treasury stock
purchases............... (77,489)
--------- ----------- ----------- ----------- ------------ --------------- -----------
BALANCE, SEPTEMBER 30,
1998.................... 173,393 $ 1,734 $1,739,240 $ (43,320) $ (9,756) $ 2,368 $ (77,412)
--------- ----------- ----------- ----------- ------------ --------------- -----------
--------- ----------- ----------- ----------- ------------ --------------- -----------
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
------------
<S> <C>
BALANCE, JANUARY 1,
1998.................... $1,214,811
Net income................ 9,480
Exercise of stock options
and related tax
benefit................. 64,746
Issuance of stock in
connection with
acquisition............. 399,816
Warrant costs related to
customer purchases...... 18,121
Net change in
investments............. (16,631)
Treasury stock
purchases............... (77,489)
------------
BALANCE, SEPTEMBER 30,
1998.................... $1,612,854
------------
------------
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED--IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
<S> <C> <C>
1998 1997
---------- ----------
Operating Activities:
Net income.............................................................................. $ 9,480 $ 29,825
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization......................................................... 60,146 67,000
Warrant costs related to customer purchases........................................... 18,121 --
Gain on sale of short-term investment................................................. (11,429) (4,829)
Losses from asset sales and write-downs, net.......................................... 8,858 --
Loss from equity investments.......................................................... 22,793 --
Changes in assets and liabilities:
Accounts receivable................................................................. 17,856 57,105
Inventories......................................................................... 12,676 (41,358)
Prepaid expenses and other current assets........................................... 360 30
Deferred income taxes............................................................... (43,771) 13,697
Non-current assets.................................................................. 1,225 (1,573)
Accounts payable and other accrued liabilities...................................... 50,739 4,731
Other non-current liabilities....................................................... (1,074) 792
Other................................................................................. (899) 767
---------- ----------
Net cash provided by operating activities................................................. 145,081 126,187
---------- ----------
Investing Activities:
Additions to property, plant and equipment............................................ (58,963) (56,437)
Investments in other assets........................................................... (7,995) (32,635)
Acquisitions, net of cash acquired.................................................... -- (6,980)
Proceeds from sale of short-term investment........................................... 11,429 4,829
---------- ----------
Net cash used in investing activities..................................................... (55,529) (91,223)
---------- ----------
Financing Activities:
Transfers from Distributing Company................................................... -- 125,310
Proceeds from stock option exercises.................................................. 55,844 2,319
Purchase of treasury shares........................................................... (64,584) --
Other................................................................................. -- (566)
---------- ----------
Net cash provided by (used in) financing activities....................................... (8,740) 127,063
---------- ----------
Change in cash and cash equivalents....................................................... 80,812 162,027
Cash and cash equivalents, beginning of period............................................ 35,225 --
---------- ----------
Cash and cash equivalents, end of period.................................................. $ 116,037 $ 162,027
---------- ----------
---------- ----------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, unless otherwise noted)
1. COMPANY BACKGROUND
General Instrument Corporation ("General Instrument" or the "Company"),
formerly NextLevel Systems, Inc., is a leading worldwide supplier of systems and
components for high-performance networks, delivering video, voice and
Internet/data services to the cable, satellite and telephony markets. General
Instrument is the world leader in digital and analog set-top systems for wired
and wireless cable television networks, as well as hybrid fiber/coaxial network
transmission systems used by cable television operators and is a leading
provider of digital satellite systems for programmers, direct-to-home satellite
network providers and private networks for business communications. Through its
limited partnership interest in Next Level Communications, L.P. (the
"Partnership")(see Note 12), the Company provides telephone network solutions
through the Partnership's NLevel(3)(R) Switched Digital Access system.
The Company was formerly the Communications Business of the former General
Instrument Corporation (the "Distributing Company"). In a transaction that was
consummated on July 28, 1997, the Distributing Company (i) transferred all the
assets and liabilities, at the Distributing Company's historical cost, relating
to the manufacture and sale of broadband communications products used in the
cable television, satellite, and telecommunications industries to the Company
(then a wholly-owned subsidiary of the Distributing Company) and all the assets
and liabilities relating to the manufacture and sale of coaxial, fiber optic and
other electric cable used in the cable television, satellite and other
industries to its wholly-owned subsidiary CommScope, Inc. ("CommScope"), at the
Distributing Company's historical cost, and (ii) distributed all of its
outstanding shares of capital stock of each of the Company and CommScope to its
stockholders on a pro rata basis as a dividend. Approximately 147.3 million
shares of the Company's common stock, par value $.01 per share (the "Common
Stock"), based on a ratio of one for one, were distributed to the Distributing
Company's stockholders of record on July 25, 1997 (the "Communications
Distribution"). On July 28, 1997, approximately 49.1 million shares of CommScope
common stock, based on a ratio of one for three, were distributed to the
Company's stockholders of record on that date (the "CommScope Distribution" and,
together with the Communications Distribution, the "Distributions"). On July 28,
1997, the Company and CommScope began operating as independent entities with
publicly traded common stock, and the Distributing Company retained no ownership
interest in either the Company or CommScope. Additionally, immediately following
the Communications Distribution, the Distributing Company was renamed General
Semiconductor, Inc. ("General Semiconductor") and effected a one for four
reverse stock split.
2. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements reflect the
results of operations, financial position, changes in stockholders' equity and
cash flows of General Instrument. The consolidated balance sheet as of September
30, 1998, the consolidated statements of operations for the three and nine
months ended September 30, 1998 and 1997, the consolidated statement of
stockholders' equity for the nine months ended September 30, 1998 and the
consolidated statements of cash flows for the nine months ended September 30,
1998 and 1997 of General Instrument are unaudited and reflect all adjustments of
a normal recurring nature (except for those charges disclosed in Notes 7, 11, 12
and 15) which are, in the opinion of management, necessary for a fair
presentation of the interim period financial statements. The results of
operations for the interim period are not necessarily indicative of the results
of operations to be expected for the full year.
The consolidated statements of operations for the nine months ended
September 30, 1997 include an allocation of general corporate expenses from the
Distributing Company. In the opinion of management, general corporate
administrative expenses have been allocated to the Company on a reasonable and
6
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
2. BASIS OF PRESENTATION (CONTINUED)
consistent basis by management of the Distributing Company using estimates of
the relative efforts provided to the Company by the Distributing Company.
However, it is not practicable to determine the actual costs that would have
been incurred if the Company operated on a stand alone basis; accordingly, such
allocation may not necessarily be indicative of the level of expenses which
would have been incurred had the Company been operating as a separate stand
alone entity during the periods prior to the Distributions.
Prior to the Distributions, the Company participated in the Distributing
Company's cash management program, and the accompanying consolidated statements
of operations for the three and nine months ended September 30, 1997 include an
allocation of net interest expense from the Distributing Company. To the extent
the Company generated positive cash, such amounts were remitted to the
Distributing Company. To the extent the Company experienced temporary cash needs
for working capital purposes or capital expenditures, such funds were
historically provided by the Distributing Company. Net interest expense has been
allocated based upon the Company's net assets as a percentage of the total net
assets of the Distributing Company. The allocations were made consistently in
each period, and management believes the allocations are reasonable. However,
these interest costs would not necessarily be indicative of what the actual
costs would have been had the Company operated as a separate, stand-alone
entity. Subsequent to the Distributions, the Company is responsible for all cash
management functions using its own resources or purchased services and is
responsible for the costs associated with operating as a public company.
Prior to the Distributions, the Company's financial results included the
costs incurred under the Distributing Company's pension and postretirement
benefit plans for employees and retirees of the Company. Subsequent to the
Distributions, the Company's financial results include the costs incurred under
the Company's own pension and postretirement benefit plans. The provision for
income taxes for the periods prior to the Distributions was based on the
Company's expected annual effective tax rate calculated assuming the Company had
filed separate tax returns under its then existing structure. For the three and
nine months ended September 30, 1998, income taxes were computed based upon the
expected annual effective tax rate.
The financial information included herein, related to the periods prior to
the Distributions, may not necessarily reflect the consolidated results of
operations, financial position and cash flows of the Company since the Company
was not a separate stand-alone entity.
3. PRO FORMA FINANCIAL INFORMATION
The unaudited pro forma consolidated statements of operations presented
below give effect to the Distributions as if they had occurred on January 1,
1997. The unaudited pro forma statements of operations set forth below do not
purport to represent what the Company's operations actually would have been had
the Distributions occurred on January 1, 1997 or to project the Company's
operating results for any future period.
The unaudited pro forma information has been prepared utilizing the
historical consolidated statements of operations of the Company which were
adjusted to reflect: (i) an additional $3.6 million of selling, general and
administrative costs for the nine months ended September 30, 1997 to eliminate
the allocation of corporate expenses to CommScope and General Semiconductor, as
such costs subsequent to
7
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
3. PRO FORMA FINANCIAL INFORMATION (CONTINUED)
the Distributions were no longer allocable and were expected to be incurred by
the Company in the future; and (ii) a net debt level of $100 million at January
1, 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1997
------------------- ------------------
<S> <C> <C>
Net sales................................................................ $ 464,582 $ 1,323,013
Cost of sales............................................................ 331,141 958,441
-------- ------------------
Gross profit............................................................. 133,441 364,572
Operating expenses:
Selling, general and administrative.................................... 45,316 143,558
Research and development............................................... 47,867 148,542
Amortization of excess of cost over fair value of net assets
acquired............................................................. 3,698 10,816
-------- ------------------
Total operating expenses................................................. 96,881 302,916
-------- ------------------
Operating income......................................................... 36,560 61,656
Other income--net........................................................ 3,717 1,864
Interest income (expense)--net......................................... 299 (3,499)
-------- ------------------
Income before income taxes............................................... 40,576 60,021
Provision for income taxes............................................... (15,421) (25,808)
-------- ------------------
Net income............................................................... $ 25,155 $ 34,213
-------- ------------------
-------- ------------------
Weighted-average shares outstanding--basic............................... 147,499 147,426
Weighted-average shares outstanding--diluted............................. 149,491 149,416
Earnings per share--basic and diluted.................................... $ 0.17 $ 0.23
-------- ------------------
-------- ------------------
</TABLE>
4. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
Raw materials.............................................................. $ 97,443 $ 111,148
Work in process............................................................ 20,736 19,676
Finished goods............................................................. 143,309 157,254
-------- --------
Total inventories.......................................................... $ 261,488 $ 288,078
-------- --------
-------- --------
</TABLE>
5. INVESTMENTS
At September 30, 1998 and December 31, 1997, all of the Company's marketable
equity securities were classified as "available-for-sale." Proceeds and the
related realized gains from the sales of available-for-sale securities for the
three and nine months ended September 30, 1998 were $7 million and $11 million,
respectively. Proceeds and the related realized gains from the sales of
available-for-sale securities for the three and nine months ended September 30,
1997 were $5 million. Realized gains were determined
8
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
5. INVESTMENTS (CONTINUED)
using the securities' cost. Short-term investments consisted of the following at
September 30, 1998 and December 31, 1997.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
---------------------------------------------- ----------------------------------------------
GROSS GROSS GROSS GROSS
FAIR UNREALIZED UNREALIZED COST FAIR UNREALIZED UNREALIZED COST
VALUE GAINS LOSSES BASIS VALUE GAINS LOSSES BASIS
--------- ----------- ----------- --------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Marketable Equity
Securities........... $ 4,081 $ 3,268 $ (187) $ 1,000 $ 30,346 $ 30,346 $ -- $ --
--------- ----------- ----- --------- --------- ----------- ----------- ---------
--------- ----------- ----- --------- --------- ----------- ----------- ---------
</TABLE>
6. ASSET PURCHASE
On June 17, 1998, the Company entered into an Asset Purchase Agreement (the
"Agreement") with two affiliates of Tele-Communications, Inc., TCIVG-GIC, Inc.
("TCIVG") and NDTC Technology, Inc. ("NDTC Technology" and, collectively with
TCIVG, "TCI") pursuant to which the Company agreed to acquire from TCIVG, in
exchange for 21.4 million unregistered shares of the Company's Common Stock,
certain assets, a license to certain intellectual property from NDTC Technology
which will enable the Company to conduct authorization services and future cash
consideration as discussed below. The shares issued to TCI are restricted in
that they are not registered and are not transferrable to any unrelated party
other than in the event of a change of control of the Company for a period of
three years following their date of issuance. The Company's provision of
services under the aforementioned license is intended to provide the cable
industry with a secure access control platform to support widespread deployment
of digital terminals and related systems and applications. On July 17, 1998 the
transaction was consummated. The Agreement provides the Company with minimum
revenue guarantees from TCI over the first nine years from the date of closing.
The Company has contracted with NDTC Technology for certain support services
during the first nine years following the date of closing, with renewable
one-year terms. The Agreement gives the Company the right to license the
technology for a period of 20 years. As mentioned above, the Agreement contains
a provision for TCIVG to pay the Company $50 million over the first five years
from the date of closing in equal monthly installments which represents a
reduction of purchase price. The present value of the $50 million note
receivable was recorded as a reduction of stockholders' equity. The net purchase
price of $400 million was allocated to the license and the assets acquired based
on their respective estimated fair values. The fair value of assets acquired
includes property, plant and equipment of $2 million, deferred tax liabilities
of $30 million and a license of $428 million. The Company computed the purchase
price by multiplying the number of shares issued by the per share trading price
of the stock reduced by a 10% discount to reflect the restrictions associated
with the unregistered shares, and adjusted such resulting amount to reflect the
$50 million reduction in purchase price discussed above. The Company is
amortizing the cost of the License over its 20-year term based on the expected
revenue stream. The revenue earned from the license is solely dependent on the
Company's deployment of digital terminals. Such deployment is expected to rise
significantly during the 20-year license term as supported by industry data and
the Company's contractual obligations with customers. The Company expects
revenues resulting from such deployments, which are calculated based on
estimated monthly fees times the estimated subscriber base, to rise from
approximately $2.5 million in 1998 to approximately $44 million by 2002 to
approximately $70 million by 2007 to approximately $80 million per annum during
the last seven years of the 20-year license term. The Company believes the
expected revenue stream is a reliable measure of the future benefit of the
License both in the aggregate and in terms of the periods to which such benefit
will be realized. Accordingly, the Company believes this method of amortization
is a more appropriate method than straight-line. At each reporting date, the
Company's method of amortization requires the determination of a fraction, the
numerator of which is the actual revenues for the period and the
9
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
6. ASSET PURCHASE (CONTINUED)
denominator of which is the expected revenues from the License during its
20-year term. This method results in any variation from original estimates being
recognized in the current period in a manner consistent with a
units-of-production method of depreciation. Under the Company's method,
amortization for the period from July 17, 1998 to September 30, 1998 was
approximately $0.3 million.
7. COMMITMENTS AND CONTINGENCIES
The Company is either a plaintiff or a defendant in several pending legal
matters. In addition, the Company is subject to various federal, state, local
and foreign laws and regulations governing the use, discharge and disposal of
hazardous materials. The Company's manufacturing facilities are believed to be
in substantial compliance with current laws and regulations. Compliance with
current laws and regulations has not had, and is not expected to have, a
material adverse effect on the Company's consolidated financial statements.
On May 5, 1998, the action entitled BroadBand Technologies, Inc. v. General
Instrument Corp., pending in the United States District Court for the Eastern
District of North Carolina, was dismissed with prejudice. In addition, on May 4,
1998, the action entitled Next Level Communications v. BroadBand Technologies,
Inc., was dismissed with prejudice. These dismissals were entered pursuant to a
settlement agreement under which, among other things, the Partnership has paid
BroadBand Technologies ("BBT") $5 million and BBT and the Partnership have
entered into a perpetual cross-license of patents applied for or issued
currently or during the next five years. At the time of the formation of the
Partnership (see Note 12), the Company, as limited partner, and Spencer Trask,
as general partner, estimated that no liability existed with respect to the BBT
litigation. Further, the Partnership indemnified the Company with respect to
this litigation because such litigation was directly related and attributable to
the technology transferred to the Partnership.
A securities class action is presently pending in the United States District
Court for the Northern District of Illinois, Eastern Division, In re General
Instrument Corporation Securities Litigation. This action, which consolidates
numerous class action complaints filed in various courts between October 10 and
October 27, 1995, is brought by plaintiffs, on their own behalf and as
representatives of a class of purchasers of the Distributing Company's common
stock during the period March 21, 1995 through October 18, 1995. The complaint
alleges that the Distributing Company and certain of its officers and directors,
as well as Forstmann Little & Co. and certain related entities, violated the
federal securities laws, namely, Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), prior to the
Distributions, by allegedly making false and misleading statements and failing
to disclose material facts about the Distributing Company's planned shipments in
1995 of its CFT 2200 and DigiCipher(R) products. Also pending in the same court,
under the same name, is a derivative action brought on behalf of the
Distributing Company. The derivative action alleges that, prior to the
Distributions, the members of the Distributing Company's Board of Directors,
several of its officers and Forstmann Little & Co. and related entities have
breached their fiduciary duties by reason of the matter complained of in the
class action and the defendants' alleged use of material non-public information
to sell shares of the Distributing Company's stock for personal gain. Both
actions seek unspecified damages and attorneys' fees and costs. The court
granted the defendants' motions to dismiss the original complaints in both of
these actions, but allowed the plaintiffs in each action an opportunity to file
amended complaints. Amended complaints were filed on November 7, 1997. The
defendants answered the amended consolidated complaint in the class actions,
denying liability, and filed a renewed motion to dismiss the derivative action.
On September 22, 1998, defendants' motion to dismiss the derivative action was
denied.
10
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
An action entitled BKP Partners, L.P. v. General Instrument Corp. was
brought in February 1996 by certain holders of preferred stock of Next Level
Communications ("NLC"), which merged into a subsidiary of the Distributing
Company in September 1995. The action was originally filed in the Northern
District of California and was subsequently transferred to the Northern District
of Illinois. The plaintiffs allege that the defendants violated federal
securities laws by making misrepresentations and omissions and breached
fiduciary duties to NLC in connection with the acquisition of NLC by the
Distributing Company. Plaintiffs seek, among other things, unspecified
compensatory and punitive damages and attorneys' fees and costs. On September
23, 1997, the district court dismissed the complaint, without prejudice, and the
plaintiffs were given until November 7, 1997 to amend their complaint. On
November 7, 1997, plaintiffs served the defendants with amended complaints,
which contain allegations substantially similar to those in the original
complaint. The defendants filed a motion to dismiss parts of the amended
complaint and answered the balance of the amended complaint, denying liability.
On September 22, 1998, the district court dismissed with prejudice the portion
of the complaint alleging violations of Section 14(a) of the Exchange Act, and
denied the remainder of the defendants' motion to dismiss.
In connection with the Distributions, the Company has agreed to indemnify
General Semiconductor in respect of its obligations, if any, arising out of or
in connection with the matters discussed in the preceding two paragraphs.
On February 19, 1998, a consolidated securities class action complaint
entitled In re NextLevel Systems, Inc. Securities Litigation was filed in the
United States District Court for the Northern District of Illinois, Eastern
Division, naming the Company and certain former officers and directors as
defendants. The complaint was filed on behalf of stockholders who purchased or
otherwise acquired stock of the Company between July 25, 1997 and October 15,
1997. The complaint alleged that the defendants violated Sections 11 and 15 of
the Securities Act of 1933, as amended (the "Securities Act"), and Sections
10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder by making false
and misleading statements about the Company's business, finances and future
prospects. The complaint seeks damages in an unspecified amount. On April 9,
1998, the plaintiffs voluntarily dismissed their Securities Act claims. On May
5, 1998, the defendants served upon the plaintiffs a motion to dismiss the
remaining counts of the complaint.
On March 5, 1998, an action entitled DSC Communications Corporation v. Next
Level Communications, L.P. was filed in the Superior Court of the State of
Delaware in and for New Castle County. DSC alleges that the defendants have
misappropriated trade secrets relating to a switched digital video product, and
that the defendants have conspired to misappropriate the trade secrets. The
plaintiffs seek monetary and exemplary damages in an unspecified amount and
attorneys' fees. On May 14, 1998, the United States District Court for the
Eastern District of Texas issued a preliminary injunction preventing DSC from
proceeding with this litigation. DSC has filed a notice of appeal of that order.
On July 6, 1998, the defendants filed a motion for summary judgment with the
district court requesting a permanent injunction preventing DSC from proceeding
with this litigation.
In May 1997, StarSight Telecast, Inc. ("StarSight") filed a Demand for
Arbitration against the Company alleging that the Company breached the terms of
a license agreement with StarSight by (a) developing a competing product that
wrongfully incorporates StarSight's technology and inventions claimed within a
certain StarSight patent, (b) failing to promote and market the StarSight
product as required by the license agreement, and (c) wrongfully using
StarSight's technical information, confidential information and StarSight's
graphical user interface in breach of the license agreement. StarSight is
seeking injunctive relief as well as damages in an unspecified amount. The
Company has denied StarSight's allegations and is vigorously defending the
arbitration action. The arbitration proceeding is scheduled to
11
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
begin in March 1999 before an arbitration panel of the American Arbitration
Association in San Francisco, California.
While the ultimate outcome of the matters described above cannot be
determined, the Company intends to vigorously contest these actions and
management does not believe that the final disposition of these matters will
have a material adverse effect on the Company's consolidated financial
statements.
8. EARNINGS PER SHARE AND PRO FORMA EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding. Diluted earnings per share
is computed by dividing net income by the weighted-average number of common
shares outstanding adjusted for the dilutive effect of stock options and
warrants (unless inclusion of such common stock equivalents would be
anti-dilutive). The dilutive effects of options and warrants of 10,136 and 8,485
shares for the three and nine months ended September 30, 1998, respectively,
were computed using the treasury stock method.
Prior to the Distributions, the Company did not have its own capital
structure, and pro forma per share information has been presented for the three
and nine months ended September 30, 1997. The pro forma weighted-average number
of shares outstanding used in the pro forma per share calculation for the three
and nine months ended September 30, 1997 equaled the number of common shares
issued and common equivalent shares existing on the date of the Distributions
plus the actual share activity during the period subsequent to the
Distributions.
9. LONG-TERM DEBT
In July 1997, the Company entered into a bank credit agreement (the "Credit
Agreement") which provides a $600 million unsecured revolving credit facility
and matures on December 31, 2002. The Credit Agreement permits the Company to
choose between two interest rate options: an Adjusted Base Rate (as defined in
the Credit Agreement), which is based on the highest of (i) the rate of interest
publicly announced by The Chase Manhattan Bank as its prime rate, (ii) 1% per
annum above the secondary market rate for three-month certificates of deposit
and (iii) the federal funds effective rate from time to time plus 0.5%, and a
Eurodollar rate (LIBOR) plus a margin which varies based on certain performance
criteria (between 15.5 and 43.75 additional basis points). The Company is also
able to set interest rates through a competitive bid procedure. In addition, the
Credit Agreement requires the Company to pay a facility fee of between 7 and
18.75 basis points on the total loan commitment. The Credit Agreement contains
financial and operating covenants, including limitations on guarantee
obligations, liens and sale of assets, and requires the maintenance of certain
financial ratios. Significant financial ratios include (i) maintenance of
consolidated net worth above $600 million adjusted for 50% of cumulative
positive quarterly net income subsequent to June 30, 1997; (ii) maintenance of
an interest coverage ratio based on EBITDA (excluding $203 million of charges
incurred in 1997 and 1998) in comparison to net interest expense of greater than
5 to 1; and (iii) maintenance of a leverage ratio comparing total indebtedness
to EBITDA (excluding $203 million of charges incurred in 1997 and 1998) of less
than 3 to 1. In addition, under the Credit Agreement, certain changes in control
of the Company would result in an event of default, and the lenders under the
Credit Agreement could declare all outstanding borrowings under the Credit
Agreement immediately due and payable. None of the restrictions contained in the
Credit Agreement are expected to have a significant effect on the Company's
ability to operate. As of September 30, 1998, the Company was in compliance with
all financial and operating covenants under the Credit Agreement. At September
30, 1998, the Company had available credit of $500 million under the Credit
Agreement. The Company had approximately $109 million of letters of credit
outstanding at September 30, 1998.
12
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
10. OTHER INCOME (EXPENSE)-NET
Other income (expense)-net for the three and nine months ended September 30,
1998 primarily includes $5 million and $23 million, respectively, related to the
Company's share of the Partnership losses, including certain charges described
in Note 15 related to the Partnership, offset by $7 million and $11 million,
respectively, related to gains on the sale of a portion of the Company's
investment in Ciena Corporation and $5 million for the nine months ended
September 30, 1998 related to proceeds received from the settlement of an
insurance claim.
Other income-net for the three months ended September 30, 1997 primarily
reflects gains from the sale of a portion of the Company's investment in Ciena
Corporation.
11. RESTRUCTURINGS
In connection with the Distributions (see Note 1), during the nine months
ended September 30, 1997, the Company recorded pre-tax charges to cost of sales
of $18 million for employee costs related to dividing the Distributing Company's
Taiwan operations between the Company and General Semiconductor. Further, the
Company recorded a charge of $6 million to SG&A expense for legal and other
professional fees incurred in connection with the Distributions. These charges
were fully paid as of March 31, 1998.
In the fourth quarter of 1997, with the change in senior management, the
Company undertook an effort to assess the future viability of its satellite
business. As the satellite business had been in a state of decline, management
of the Company made a decision to streamline the cost structure of its San
Diego-based satellite business by reducing this unit's headcount by 225. In
conjunction with the assessment of the satellite business, the Company also made
a strategic decision with respect to its worldwide consolidated manufacturing
operations that resulted in the closure of its Puerto Rico satellite TV
manufacturing facility, which manufactured receivers used in the private
network, commercial and consumer satellite markets for the reception of analog
and digital television signals, and reduced headcount by 1,100. The Company has
not experienced reduced revenues as a result of the closure of this
manufacturing facility since the products previously manufactured at this
location are currently being manufactured by subcontractors in the U.S. and
continue to be sold by the Company. The Company also decided to close its
corporate office and move from Chicago, Illinois to Horsham, Pennsylvania. The
closure of the Chicago corporate office was completed during the first quarter
of 1998. As a result of the above actions, the Company recorded a pre-tax charge
of $36 million during the fourth quarter of 1997, which included $15 million for
severance and other employee separation costs, $11 million for costs associated
with the closure of the facilities and $10 million related to the write-off of
fixed assets at these facilities. Of these charges, $21 million were recorded as
cost of sales, $14 million as SG&A expense and $1 million as research and
development expense. Substantially all of the fourth quarter severance and other
employee separation costs have been paid. Costs associated with the closure of
facilities ("Facility Costs") include vacated long-term leases which are payable
through the end of the lease terms which extend through the year 2008. The fixed
assets are expected to be disposed of by the end of 1998 and none are being
utilized in the Company's operations.
As part of the restructuring plan, the Company recorded an additional $16
million of pre-tax charges in the first quarter of 1998 which primarily included
$8 million for severance and other employee separation costs, $3 million of
facility exit costs, including the early termination of a leased facility which
the Company decided to close in the quarter ended March 31, 1998, and $5 million
related to the write-down of fixed assets to their estimated fair values. Of
these charges, $9 million were recorded as cost of sales, $6 million as SG&A and
$1 million as research and development expense. Through September 30,
13
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
11. RESTRUCTURINGS (CONTINUED)
1998, the Company has made severance and other restructuring related payments of
$8 million related to these first quarter 1998 charges. Substantially all of the
remaining severance and other employee separation costs are expected to be paid
during 1998 and the fixed assets are expected to be disposed of by the end of
1998.
The following tabular reconciliation summarizes the restructuring activity
from January 1, 1997 through September 30, 1998:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
JANUARY 1, AMOUNTS DECEMBER 31, AMOUNTS
1997 ADDITIONS UTILIZED 1997 ADDITIONS UTILIZED
------------- ----------- ----------- --------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
(IN MILLIONS)
Property, Plant & Equipment(1)........ $ 0.9 $ 10.4 $ (3.5) $ 7.8 $ 4.6 $ (3.7)
Facility Costs........................ 3.0 11.2 (3.7) 10.5 3.3 (8.3)
Severance............................. -- 32.7 (12.8) 19.9 7.6 (24.9)
Professional Fees..................... -- 6.0 (6.0) -- -- --
--- ----- ----------- ----- ----- -----------
Total................................. $ 3.9 $ 60.3 $ (26.0) $ 38.2 $ 15.5 $ (36.9)
--- ----- ----------- ----- ----- -----------
--- ----- ----------- ----- ----- -----------
<CAPTION>
BALANCE AT
SEPTEMBER 30,
1998
---------------
<S> <C>
Property, Plant & Equipment(1)........ $ 8.7
Facility Costs........................ 5.5
Severance............................. 2.6
Professional Fees..................... --
-----
Total................................. $ 16.8
-----
-----
</TABLE>
- ------------------------------
(1) The amount provided represents a direct reduction to the property, plant and
equipment balance to reflect the identified impaired assets at their fair
value. The amounts utilized reflect the disposition of such identified
impaired assets.
12. THE PARTNERSHIP
In January 1998, the Company transferred at historical cost the net assets,
the underlying NLC technology, and the management and workforce of NLC to the
newly formed Partnership in exchange for approximately an 89% limited
partnership interest (subject to additional dilution). Such transaction was
accounted for at historical cost. The limited partnership interest is included
in "investments and other assets" in the accompanying consolidated balance sheet
at September 30, 1998. The operating general partner, which was formed by
Spencer Trask & Co., an unrelated third party, has acquired approximately an 11%
interest in the Partnership and has the potential to acquire up to an additional
11% in the future. The Company does not have the option to acquire the remaining
interest in the Partnership. Net assets transferred to the Partnership of $45
million primarily included property, plant and equipment, inventories and
accounts receivable partially offset by accounts payable and accrued expenses.
The Company's net equity investment in the Partnership was $22 million at
September 30, 1998.
Pursuant to the Partnership agreement, the operating general partner
controls the Partnership and is responsible for developing the business plan and
infrastructure necessary to position the Partnership as a stand-alone company.
The Company, as the limited partner, has certain protective rights, including
the right to approve an alteration of the legal structure of the Partnership,
the sale of the Partnership's principal assets, the sale of the Partnership and
a change in the limited partner's financial interests in the Partnership. The
Company can not remove the general partner, except for cause; however, it has
the right to approve a change in the general partner. Since the operating
general partner controls the day-to-day operations of the Partnership and has
the ability to make decisions typical of a controlling party, including the
execution of agreements on all material matters affecting the Partnership's
business, the Partnership's operating results have not been consolidated with
the operating results of the Company subsequent to the January 1998 transfer.
14
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
12. THE PARTNERSHIP (CONTINUED)
The technology transferred to the Partnership related to in-process research
and development, which was originally purchased by the Company in connection
with the acquisition of NLC in September 1995, for the design and marketing of a
highly innovative next-generation telecommunication broadband access system for
the delivery of telephony, video and data from a telephone company central
office to the home. The in-process technology, at the date of the 1995
acquisition and at the date of the transfer to NLC, had not reached
technological feasibility and had no alternative future use. The Company does
not expect widespread commercial deployment of this technology until the latter
part of 1999 or early in 2000, however, there can be no assurance that the
development activities currently being undertaken will result in successful
commercial deployment.
In addition, in January 1998, the Company advanced $75 million to the
Partnership in exchange for an 8% debt instrument (the "Note"), and the Note
contains normal creditor security rights, including a prohibition against
incurring amounts of indebtedness for borrowed money in excess of $10 million.
Since the repayment of the Note is solely dependent upon the results of the
Partnership's research and development activities and the commercial success of
its product development, the Company recorded a charge to research and
development expense during the quarter ended March 31, 1998 to fully reserve for
the Note concurrent with the funding. The proceeds of the Note are being
utilized to fund the research and development activities of the Partnership
through 1999 to develop the aforementioned telecommunication technology for
widespread commercial deployment. The Company will make an additional $50
million equity investment in the Partnership beginning in November 1998 to fund
the Partnership's growth and assist the Partnership in meeting its forecasted
working capital requirements.
The Company is accounting for its interest in the Partnership as an
investment under the equity method of accounting. Further, the Company's share
of the Partnership's losses related to future research and development
activities will be offset against the $75 million reserve discussed above. For
the three and nine months ended September 30, 1998, the Company's share of the
Partnership's losses was $5 million and $23 million, respectively, (net of the
Company's share of research and development expenses of $11 million and $31
million, respectively). The Company has eliminated its interest income from the
Note against the Partnership's related interest expense on the Note. The
following summarized financial information is provided for the Partnership for
the three and nine months ended September 30, 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------- ------------------
<S> <C> <C>
Net sales..................................................... $ 14,601 $ 20,430
Gross profit.................................................. (497) (2,421)
Loss before income taxes...................................... (19,127) (64,186)
Operating cash flow........................................... (15,746) (56,535)
</TABLE>
13. RELATED PARTY TRANSACTIONS
In connection with the asset purchase from TCI which was consummated on July
17, 1998, described in Note 6, TCI obtained approximately a 12% ownership
interest in the Company. TCI is also a significant customer of the Company.
Sales to TCI represented 36% and 28% of total Company sales for the three and
nine months ended September 30, 1998, respectively. Management believes the
transactions with TCI are at arms length and are under terms no less favorable
to the Company than those with other customers. At September 30, 1998 accounts
receivable from TCI totaled $83 million.
15
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
14. COMPREHENSIVE INCOME (LOSS)
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This
statement requires that an enterprise report the change in its net assets during
the period from nonowner sources. Since this statement only requires additional
disclosures, it had no impact on the Company's consolidated financial position
or cash flows. For the three and nine months ended September 30, 1998 and 1997,
other comprehensive income comprised unrealized gains and losses on investments.
Comprehensive income is summarized below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Net income........................................................... $ 39,409 $ 24,458 $ 9,480 $ 29,825
Other comprehensive income (loss).................................... (13,162) (2,078) (16,631) 16,409
--------- --------- ---------- ---------
Total comprehensive income (loss).................................... $ 26,247 $ 22,380 $ (7,151) $ 46,234
--------- --------- ---------- ---------
--------- --------- ---------- ---------
</TABLE>
15. OTHER CHARGES
The Company incurred certain other pre-tax charges during the first quarter
of 1998 primarily related to management's decision to close a satellite
manufacturing facility due to reduced demand for the products manufactured by
that facility. Concurrent with this decision, the Company determined that the
carrying value of the inventory would not be recoverable and accordingly, the
Company wrote down the inventory to its lower of cost or market. In addition,
the Company incurred moving costs associated with relocating certain fixed
assets to other facilities, shut down expenses and legal fees. The above charges
totalled $25 million, of which, $18 million are included in cost of sales and $7
million are included in SG&A expense. In addition, the Company incurred $8
million of charges, which are included in "other income (expense)--net," related
to costs incurred by the Partnership, which the Company accounts for under the
equity method. Such costs are primarily related to the BBT litigation settlement
(see Note 7) and compensation expense related to key executives of an acquired
company. The balance of these reserves was $15 million at September 30, 1998 and
relates primarily to inventory, which the Company expects to be disposed of by
the end of the first quarter of 1999.
16. WARRANT COSTS
In December 1997, the Company entered into agreements to supply an aggregate
of 15 million of its two-way, interactive digital cable terminals to nine of the
leading North American cable television multiple system operators ("MSOs") over
a three to five year period. In connection with these legally binding supply
agreements, the Company issued warrants to purchase approximately 29 million
shares of the Company's Common Stock. Warrants aggregating 7.2, 7.3 and 14.2
million issued to the MSOs will vest and become exercisable on December 31,
1998, 1999, and 2000, respectively, provided that in each of those years each
such MSO fulfills its obligation to purchase a threshold number of digital
terminals from the Company. Each warrant is exercisable for one share of Common
Stock for a period of 18 months after it vests at an exercise price of $14.25
for each share of Common Stock. If, in any year, the Company fails to deliver
the threshold number of digital terminals for such year, through no fault of the
MSO, the total number of such MSOs warrants will vest for that year. If, in any
year, an MSO fails to purchase the threshold number of terminals for such year,
through no fault of the Company, no warrants for such year will vest, and the
MSO shall be subject to legal proceedings and damages relating to such failure.
The
16
<PAGE>
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
16. WARRANT COSTS (CONTINUED)
Company believes that the magnitude of such damages would be substantial. The
weighted-average per share fair value of the warrants granted during 1997
approximated $3.50 using the Black-Scholes pricing model with the following
weighted average assumptions: a risk-free interest rate of 6.08%; an expected
volatility of 35%; an expected dividend yield of 0%; and expected holding
periods ranging from 2.5 to 4.5 years. The value of the warrants is being
expensed to cost of sales based upon actual units shipped to the MSOs in a year
in relation to the total threshold number of units required to be purchased by
the MSOs in such year. During the three and nine months ended September 30,
1998, the Company recorded $6.5 million and $18.1 million to cost of sales
related to these warrants.
17. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
SEGMENT REPORTING--In June 1997, SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," was issued and is effective for
fiscal periods beginning after December 15, 1997. SFAS No. 131 establishes
standards for the reporting of information about operating segments, including
related disclosures about products and services, geographic areas and major
customers, and requires the reporting of selected information about operating
segments in interim financial statements. The Company is currently evaluating
the disclosure requirements of this statement and will include the necessary
disclosures in the year-end financial statements as required in the initial year
of adoption.
PENSION AND OTHER POSTRETIREMENT DISCLOSURES,--In February 1998, the FASB
issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits--an amendment of FASB Statements No. 87, 88 and 106."
This statement, which is effective for fiscal years beginning after December 15,
1997, requires revised disclosures about pension and other postretirement
benefit plans.
Since the above two statements only revise financial statement disclosures,
their adoption will not have any impact on the Company's consolidated financial
position, results of operations or cash flows.
DERIVATIVE AND HEDGE ACCOUNTING --In June 1998, SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," was issued and is effective
for fiscal years beginning after June 15, 1999. SFAS No. 133 requires that all
derivative instruments be measured at fair value and recognized in the balance
sheet as either assets or liabilities. The Company is currently evaluating the
impact this pronouncement will have on its consolidated financial statements.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
NET SALES
Net sales for the three months ended September 30, 1998 ("Third Quarter
1998") were $518 million compared to $465 million for the three months ended
September 30, 1997 ("Third Quarter 1997"), an increase of $53 million, or 11%.
Net sales for the nine months ended September 30, 1998 were $1,424 million
compared to $1,323 million for the nine months ended September 30, 1997, an
increase of $101 million, or 8%. The increases in net sales for the three and
nine month periods primarily reflect increased sales of digital cable systems,
partially offset by lower sales of analog cable terminals and a decline in
international sales. Analog and digital products represented approximately 46%
and 54%, respectively, of total sales of the Company for the nine months ended
September 30, 1998, compared to approximately 60% and 40%, respectively, for the
nine months ended September 30, 1997.
Worldwide broadband sales (consisting of digital and analog cable and
wireless television systems and network transmission systems) of $411 million
and $1,100 million for Third Quarter 1998 and for the nine months ended
September 30, 1998, respectively, increased $76 million, or 23%, and $147
million, or 15%, respectively, from the comparable 1997 periods primarily as a
result of increased U.S sales volume of digital cable terminals and headends,
partially offset by the decline in sales of analog cable network systems. These
sales reflect the increasing commitment of cable television operators to deploy
state-of-the-art interactive digital systems in order to offer advanced
entertainment, interactive services and Internet access to their customers.
During the Third Quarter 1998 and Third Quarter 1997, broadband net sales in the
U.S. were 88% and 73%, respectively, combined U.S. and Canadian sales were 89%
and 77%, respectively, and all other international sales were 11% and 23%,
respectively, of total worldwide broadband sales. For the nine months ended
September 30, 1998 and 1997, broadband net sales in the U.S. were 85% and 70%,
respectively, combined U.S. and Canadian sales were 86% and 74%, respectively,
and all other international sales were 14% and 26%, respectively, of total
worldwide broadband sales.
Worldwide satellite sales of $107 million and $323 million for Third Quarter
1998 and the nine months ended September 30, 1998, respectively, decreased $20
million, or 16%, and $44 million, or 12%, respectively, from the comparable 1997
periods primarily as a result of lower private and commercial network sales in
international markets. During the Third Quarter 1998 and Third Quarter 1997,
satellite net sales in the U.S. were 84% and 80%, respectively, combined U.S.
and Canadian sales were 99% and 87%, respectively, and all other international
sales were 1% and 13%, respectively, of total worldwide satellite sales. For the
nine months ended September 30, 1998 and 1997, satellite net sales in the U.S.
were 91% and 79%, respectively, combined U.S. and Canadian sales were 98% and
86%, respectively, and all other international sales were 2% and 14%,
respectively, of total worldwide satellite sales.
In February 1998, the Company entered into an agreement with PRIMESTAR,
pursuant to which the Company will manufacture integrated receiver decoders for
PRIMESTAR's planned high power retail and wholesale service. Offering a
high-power service may enable PRIMESTAR to provide expanded channel capacity and
smaller receiving dishes to its subscribers. In October 1998, PRIMESTAR
announced the termination of its agreement with American Sky Broadcasting LLC
(ASkyB) with respect to PRIMESTAR's proposed acquisition of ASkyB's assets
including a high power orbital slot. While PRIMESTAR is attempting to secure use
of another high power orbital slot, there can be no assurance that PRIMESTAR
will be able to secure another high power orbital slot, and accordingly, there
can be no assurance that the Company will realize the benefits of its agreement
with PRIMESTAR.
The decrease in broadband and satellite international sales during the 1998
periods was experienced in all international regions. The largest decreases in
sales during the nine months ended September 30, 1998 were experienced in the
Asia/Pacific and Latin American regions and there can be no assurance that
international sales will return to 1997 levels in the near term.
18
<PAGE>
TCI and Time Warner, including affiliates, each represented approximately
14% of the revenues of the Company for the year ended December 31, 1997. For the
nine months ended September 30, 1998, TCI and PRIMESTAR accounted for
approximately 28% and 13% of total Company sales, respectively.
GROSS PROFIT
Gross profit of $153 million and $387 million for Third Quarter 1998 and the
nine months ended September 30, 1998, respectively, increased $20 million, or
15%, and $22 million, or 6%, respectively, from the comparable 1997 periods.
Gross profit was 30% and 27% of sales for Third Quarter 1998 and the nine months
ended September 30, 1998, respectively, compared to 29% and 28%, respectively,
for the comparable 1997 periods. Gross profit for the nine months ended
September 30, 1998 included $9 million of restructuring charges (see Note 11 and
"Restructurings" below) and $18 million of other charges (see Note 15 and "Other
Charges" below) recorded in the first quarter of 1998, primarily related to
severance and other employee separation costs, costs associated with the closure
of various facilities, the write-down of fixed assets to their estimated fair
values and the write-down of inventories to their lower of cost or market. Gross
profit for the nine months ended September 30, 1997 included $18 million of
charges for employee costs related to dividing the Distributing Company's Taiwan
operations between the Company and General Semiconductor. Gross profit increases
primarily reflect increased sales levels as well as product cost reductions,
driven primarily by chip integration and productivity improvements at the
Company's Taiwan manufacturing facility.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general & administrative ("SG&A") expense was $46 million and $148
million for the Third Quarter 1998 and the nine months ended September 30, 1998,
respectively, compared to $45 million and $140 million, respectively, for the
comparable 1997 periods. SG&A expense as a percentage of sales was 9% and 10%
for the Third Quarter 1998 and the nine months ended September 30, 1998,
respectively, and 10% and 11%, respectively, for the 1997 periods. SG&A spending
for the nine months ended September 30, 1998 included $6 million of
restructuring charges (see Note 11 and "Restructurings" below) and $7 million of
other charges (see Note 15 and "Other Charges" below) recorded in the first
quarter of 1998, primarily related to severance and other employee separation
costs, costs associated with the closure of various facilities, including moving
costs, and costs associated with changing the Company's corporate name. SG&A
spending for the nine months ended September 30, 1997 included $6 million of
charges primarily for legal and other professional fees directly related to the
Communications Distribution (see Note 1). SG&A spending for the 1997 periods
also included SG&A expenses related to NLC.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expense was $42 million and $200 million
for the Third Quarter 1998 and nine months ended September 30, 1998,
respectively, compared to $48 million and $149 million, respectively, for the
comparable 1997 periods. R&D expense for the nine months ended September 30,
1998 included a $75 million charge to fully reserve the Partnership Note (see
Note 12). Proceeds of the Partnership Note are being utilized by the Partnership
to fund research and development activities through 1999 to develop, for
widespread commercial deployment, the next-generation telecommunications
technology for the delivery of telephony, video, and data from the telephone
company central office to the home. Such widespread deployment is not expected
until the latter part of 1999 or early in 2000; however, there can be no
assurance that the development activities currently being undertaken will result
in successful commercial deployment. R&D spending in 1998 is focused on new
product opportunities, including advanced digital services, high-speed internet
and data systems, and next generation transmission network systems. In addition,
the Company is incurring R&D expense to develop analog and digital products for
international markets, reduce costs and expand the features of its digital cable
and satellite systems.
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PURCHASED IN-PROCESS TECHNOLOGY
In connection with the acquisition of NLC in September 1995, the Company
recorded a pre-tax charge of $140 million for purchased in-process technology.
Through December 1997, the Company incurred approximately $50 million to develop
this technology for commercial deployment. In January 1998, such technology was
transferred to the Partnership (see Note 12).
OTHER INCOME (EXPENSE)--NET
Net other income of $1 million and net other expense of $9 million for the
Third Quarter 1998 and the nine months ended September 30, 1998, respectively,
compared with net other income of $4 million and $2 million, respectively, for
the comparable 1997 periods. Other expense increased during the nine months
ended September 30, 1998 from the comparable 1997 period primarily due to the
Company's equity interest in the Partnership's loss (see Notes 10 and 12), which
includes the BBT litigation settlement (see Note 7) and compensation expense
related to key executives of an acquired company, partially offset by larger
gains on the sale of a portion of the Company's investment in Ciena Corporation
and the settlement of an insurance claim.
INTEREST INCOME (EXPENSE)--NET
Net interest expense for the three and nine months ended September 30, 1997
includes an allocation of interest expense from the Distributing Company, which
was allocated based upon the Company's net assets as a percentage of the total
net assets of the Distributing Company for the period prior to the date of the
Communications Distribution. Net interest expense allocated to the Company was
$2 million and $15 million for the Third Quarter 1997 and for the nine months
ended September 30, 1997, respectively. Subsequent to July 25, 1997, the date of
the Communications Distribution, net interest represents actual net interest
expense incurred by the Company.
Pro forma interest expense for the Third Quarter 1997 and the nine months
ended September 30, 1997 includes a reduction of interest expense of $1 million
and $11 million, respectively, to reflect an assumed net debt level of $100
million at January 1, 1997.
INCOME TAXES
Through the date of the Distributions, income taxes were determined as if
the Company had filed separate tax returns under its existing structure for the
periods presented. Accordingly, future tax rates could vary from the historical
effective tax rates depending on the Company's future tax elections. The Company
recorded a provision for income taxes of $24 million and $10 million for the
Third Quarter 1998 and the nine months ended September 30, 1998, respectively,
and a provision for income taxes of $15 million and $23 million, respectively,
for the comparable 1997 periods based upon the expected annual effective tax
rate. Excluding the restructuring and other charges recorded during the nine
months ended September 30, 1998 and the restructuring charges recorded during
the three and nine months ended September 30, 1997, the effective tax rate for
each period was approximately 38%.
RESTRUCTURINGS
In connection with the Distributions (see Note 1), during the nine months
ended September 30, 1997, the Company recorded pre-tax charges to cost of sales
of $18 million for employee costs related to dividing the Distributing Company's
Taiwan operations between the Company and General Semiconductor. Further, the
Company recorded a charge of $6 million to SG&A expense for legal and other
professional fees incurred in connection with the Distributions. These charges
were fully paid as of March 31, 1998. These charges did not result in the
reduction of future expenses; therefore, they have not had and are not expected
to have a significant impact on the Company's results of operations and cash
flows.
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In the fourth quarter of 1997, with the change in senior management, the
Company undertook an effort to assess the future viability of its satellite
business. As the satellite business had been in a state of decline, management
of the Company made a decision to streamline the cost structure of its San
Diego-based satellite business by reducing this unit's headcount by 225. In
conjunction with the assessment of the satellite business, the Company also made
a strategic decision with respect to its worldwide consolidated manufacturing
operations that resulted in the closure of its Puerto Rico satellite TV
manufacturing facility, which manufactured receivers used in the private
network, commercial and consumer satellite markets for the reception of analog
and digital television signals, and reduced headcount by 1,100. The Company does
not expect reduced revenues as a result of the closure of this manufacturing
facility since the products previously manufactured at this location will be
manufactured by subcontractors in the U.S. and will continue to be sold by the
Company. The Company also decided to close its corporate office and move from
Chicago, Illinois to Horsham, Pennsylvania. The closure of the Chicago corporate
office was completed during the first quarter of 1998. As a result of the above
actions, the Company recorded a pre-tax charge of $36 million during the fourth
quarter of 1997, which included $15 million for severance and other employee
separation costs, $11 million for costs associated with the closure of the
facilities and $10 million related to the write-off of fixed assets at these
facilities. Of these charges, $21 million were recorded as cost of sales, $14
million as SG&A expense and $1 million as research and development expense.
Substantially all of the fourth quarter severance and other employee separation
costs have been paid. Costs associated with the closure of facilities include
vacated long-term leases which are payable through the end of the lease terms
which extend through the year 2008. The fixed assets are expected to be disposed
of by the end of 1998 and none are being utilized in the Company's operations.
These restructuring costs are expected to provide cost savings in certain
satellite production processes; however, declining demand for certain satellite
products will substantially offset the expected cost reductions.
As part of the restructuring plan, the Company recorded an additional $16
million of pre-tax charges in the first quarter of 1998 which primarily included
$8 million for severance and other employee separation costs, $3 million of
facility exit costs, including the early termination of a leased facility which
the Company decided to close in the quarter ended March 31, 1998, and $5 million
related to the write-down of fixed assets to their estimated fair values. Of
these charges, $9 million were recorded as cost of sales, $6 million as SG&A and
$1 million as research and development expense. Through September 30,
1998, the Company has made severance and other restructuring related payments of
$8 million related to these first quarter 1998 charges. Substantially all of the
remaining severance and other employee separation costs are expected to be paid
during 1998 and the fixed assets are expected to be disposed of by the end of
1998.
OTHER CHARGES
The Company incurred certain other pre-tax charges during the first quarter
of 1998 primarily related to management's decision to close a satellite
manufacturing facility due to reduced demand for the products manufactured by
that facility. Concurrent with this decision, the Company determined that the
carrying value of the inventory would not be recoverable and accordingly, the
Company wrote down the inventory to its lower of cost or market. In addition,
the Company incurred moving costs associated with relocating certain fixed
assets to other facilities, shut down expenses and legal fees. The above charges
totalled $25 million, of which, $18 million are included in cost of sales and $7
million are included in SG&A expense. In addition, the Company incurred $8
million of charges, which are included in "other income (expense)--net," related
to costs incurred by the Partnership, which the Company accounts for under the
equity method. Such costs are primarily related to the BBT litigation settlement
(see Note 7) and compensation expense related to key executives of an acquired
company. The balance of these reserves was $15 million at September 30, 1998 and
relates primarily to inventory.
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LIQUIDITY AND CAPITAL RESOURCES
Prior to the Distributions, the Company participated in the Distributing
Company's cash management program. To the extent the Company generated positive
cash, such amounts were remitted to the Distributing Company. To the extent the
Company experienced temporary cash needs for working capital purposes or capital
expenditures, such funds were historically provided by the Distributing Company.
At the date of the Distributions, $125 million of cash was transferred to the
Company.
For the nine months ended September 30, 1998 and 1997, cash provided by
operations was $145 million and $126 million, respectively. Cash provided by
operations during the nine months ended September 30, 1998 primarily reflects
cash generated from operations, partially offset by the funding provided to the
Partnership related to its R&D activities and payments related to the
restructuring. Cash provided by operations during the nine months ended
September 30, 1997 primarily represents cash generated by the broadband
business, partially offset by increased inventory levels to support business
growth.
At September 30, 1998 and December 31, 1997, working capital (current assets
less current liabilities) was $414 million and $436 million, respectively. The
Company believes that working capital levels are adequate to support the growth
of the digital business, however, there can be no assurance that future
industry-specific developments or general economic trends will not continue to
alter the Company's working capital requirements.
During the nine months ended September 30, 1998 and 1997, the Company
invested $59 million and $56 million, respectively, in equipment and facilities.
The Company expects to continue to expand its capacity to meet increased current
and anticipated future demands for digital products, with capital expenditures
for the year expected to approximate $100 million. The Company's R&D
expenditures were $200 million (including the $75 million funding related to the
Partnership's R&D activities) and $149 million during the first nine months of
1998 and the first nine months of 1997, respectively. The Company expects total
R&D expenditures to approximate $245 million (including the $75 million funding
related to the Partnership) for the year ending December 31, 1998.
The Company has a bank credit agreement (the "Credit Agreement") which
provides a $600 million unsecured revolving credit facility and matures on
December 31, 2002. The Credit Agreement permits the Company to choose between
two competitive interest rate options. The Credit Agreement contains financial
and operating covenants, including limitations on guarantee obligations, liens
and the sale of assets, and requires the maintenance of certain financial
ratios. Significant financial ratios include (i) maintenance of consolidated net
worth above $600 million adjusted for 50% of cumulative positive quarterly net
income subsequent to June 30, 1997; (ii) maintenance of an interest coverage
ratio based on EBITDA (excluding $203 million of charges incurred in 1997 and
1998) in comparison to net interest expense of greater than 5 to 1; and (iii)
maintenance of a leverage ratio comparing total indebtedness to EBITDA
(excluding $203 million of charges incurred in 1997 and 1998) of less than 3 to
1. None of the restrictions contained in the Credit Agreement are expected to
have a significant effect on the Company's ability to operate. As of September
30, 1998, the Company was in compliance with all financial and operating
covenants contained in the Credit Agreement and had available credit of $500
million.
On September 9, 1998, the Company announced a share repurchase program
authorizing the Company to repurchase up to 10 million shares of its outstanding
Common Stock. Through September 30, 1998, the Company had repurchased 3.7
million shares at a cost of $77.5 million, of which $12.9 million was paid in
October 1998. As of October 31, 1998, the Company had repurchased a total of 6.3
million shares at a cost of $126.3 million.
On July 17, 1998, the Company consummated a transaction with TCI, pursuant
to which the Company acquired, in exchange for 21.4 million shares of the
Company's Common Stock, certain assets, a license to certain intellectual
property, which will enable the Company to conduct authorization services
intended to
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provide the cable industry with a secure access control platform to support
widespread deployment of digital terminals and related systems and applications,
and a $50 million non-interest bearing note receivable. The net purchase price
of $400 million was allocated primarily to the license acquired (see Note 6).
In January 1998, the Company announced that, subject to the completion of
definitive agreements, Sony Corporation of America will purchase 7.5 million new
shares of common stock of the Company for $188 million.
In January 1998, the Company transferred the net assets, principally
technology, and the management and workforce of NLC to a newly formed limited
partnership in exchange for approximately an 89% (subject to additional
dilution) limited partnership interest. The technology transferred to the
Partnership related to in-process research and development for the design and
marketing of a highly innovative next-generation telecommunication broadband
access system for the delivery of telephony, video and data from a telephone
company central office to the home. Additionally, the Company advanced to the
Partnership $75 million, utilizing available operating funds and borrowings
under its Credit Agreement, in exchange for the Note. Since the repayment of the
Note is solely dependent upon the results of the Partnership's research and
development activities and the commercial success of its product development,
the Company recorded a charge to fully reserve for the Note concurrent with the
funding (see Note 12). The Company will make an additional $50 million equity
investment in the Partnership, beginning in November 1998, to fund the
Partnership's growth and assist the Partnership in meeting its forecasted
working capital requirements.
The Company's management assesses its liquidity in terms of its overall
ability to obtain cash to support its ongoing business levels and to fund its
growth objectives. The Company's principal sources of liquidity both on a
short-term and long-term basis are cash flows provided by operations and
borrowings under the Credit Agreement. The Company believes that based upon its
analysis of its consolidated financial position and its expected operating cash
flows from future operations, along with available funding under the Credit
Agreement, cash flows will be adequate to fund operations, research and
development, capital expenditures, strategic investments and share repurchases.
There can be no assurance, however, that future industry-specific developments
or general economic trends will not adversely affect the Company's operations or
its ability to meet its cash requirements.
NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
SEGMENT REPORTING --In June 1997, SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," was issued and is effective for
fiscal periods beginning after December 15, 1997. SFAS No. 131 establishes
standards for the reporting of information about operating segments, including
related disclosures about products and services, geographic areas and major
customers, and requires the reporting of selected information about operating
segments in interim financial statements. The Company is currently evaluating
the disclosure requirements of this statement and will include the necessary
disclosures in the year-end financial statements as required in the initial year
of adoption.
PENSION AND OTHER POSTRETIREMENT DISCLOSURES --In February 1998, the FASB
issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits--an amendment of FASB Statements No. 87, 88 and 106."
This statement, which is effective for fiscal years beginning after December 15,
1997, requires revised disclosures about pension and other postretirement
benefit plans.
Since the above two statements only revise financial statement disclosures,
their adoption will not have any impact on the Company's consolidated financial
position, results of operations or cash flows.
DERIVATIVE AND HEDGE ACCOUNTING --In June 1998, SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," was issued and is effective
for fiscal years beginning after June 15, 1999. SFAS No. 133 requires that all
derivative instruments be measured at fair value and recognized in the
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balance sheet as either assets or liabilities. The Company is currently
evaluating the impact this pronouncement will have on its consolidated financial
statements.
NEW TECHNOLOGIES
The Company operates in a dynamic and competitive environment in which its
success will be dependent upon numerous factors, including its ability to
continue to develop appropriate technologies and successfully implement
applications based on those technologies. In this regard, the Company has made
significant investments to develop advanced systems and equipment for the cable
and satellite television, Internet/data delivery and local telephone access
markets. Additionally, the future success of the Company will be dependent on
the ability of the cable and satellite television operators to successfully
market the services provided by the Company's advanced digital terminals to
their customers. Furthermore, as a result of the higher costs of initial
production, digital products presently being shipped carry lower margins than
the Company's mature analog products.
Management of the Company expects cable television operators in the United
States and abroad to continue to purchase analog products to upgrade their basic
networks and to develop, using U.S. architecture and systems, international
markets where cable penetration is low and demand for entertainment programming
is growing. However, management expects that demand in North America for its
basic analog cable products will continue to decline.
As the Company continues to introduce new products and technologies and such
technologies gain market acceptance, there can be no assurance that sales of
products based on new technologies will not affect the Company's product sales
mix and/or will not have an adverse impact on sales of certain of the Company's
other products. For example, sales of analog cable products have been impacted
by a shift to digital deployment in North America.
INTERNATIONAL MARKETS
Management of the Company believes that additional growth for the Company
will come from international markets, although the Company's international sales
decreased during the first nine months of 1998 in comparison to the prior year,
and there can be no assurance that international sales will increase to 1997
levels in the near future. In order to support the Company's international
product and marketing strategies, it is currently expected that the Company will
add operations in foreign markets in the following areas, among others: customer
service, sales, finance, product warehousing and expansion of manufacturing
capacity at existing facilities. Although no assurance can be given, management
expects that the expansion of international operations will not require
significant increased levels of capital expenditures.
EFFECT OF INFLATION
The Company continually attempts to minimize any effect of inflation on
earnings by controlling its operating costs and selling prices. During the past
few years, the rate of inflation has been low and has not had a material impact
on the Company's results of operations.
YEAR 2000 READINESS DISCLOSURE
The Company is preparing for the impact of the arrival of the Year 2000 on
its business, as well as on the businesses of its customers, suppliers and
business partners. The "Year 2000 Issue" is a term used to describe the problems
created by systems that are unable to accurately interpret dates after December
31, 1999. These problems are derived predominantly from the fact that many
software programs have historically categorized the "year" in a two-digit
format. The Year 2000 Issue creates potential risks for the Company, including
potential problems in the Company's products as well as in the Information
Technology ("IT") and non-IT systems that the Company uses in its business
operations. The Company may also
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be exposed to risks from third parties with whom the Company interacts who fail
to adequately address their own Year 2000 Issues.
THE COMPANY'S STATE OF READINESS
While the Company's Year 2000 efforts have been underway for several years,
the Company centralized its focus on addressing the Year 2000 Issue in 1998 by
forming a Year 2000 cross-functional project team of senior managers, chaired by
the Company's Vice President of Information Technology who reports directly to
the Company's Chief Executive Officer on this issue. The Audit Committee of the
Board of Directors is advised periodically on the status of the Company's Year
2000 compliance program.
The Year 2000 project team has developed a phased approach to identifying
and remediating Year 2000 Issues, with many of these phases overlapping with one
another or conducted simultaneously.
The first phase was to develop a corporate-wide, uniform strategy for
addressing the Year 2000 Issue and to assess the Company's current state of Year
2000 readiness. This included a review of all IT and non-IT systems, including
Company products and internal operating systems for potential Year 2000 Issues.
The Company completed this phase for the majority of its IT and non-IT systems
during the third quarter of 1998 with the balance of such systems expected to be
completed prior to the end of 1998. In addition, during this phase the Company
developed its Year 2000 Policy Statement which was released to the Company's
customers, suppliers and business partners.
The second phase of the Company's Year 2000 compliance program (begun
simultaneously with the first phase) was to define a Year 2000 "Compliance"
standard and to develop uniform test plans and test methodologies, building on
work already done by one of the Company's engineering groups. The Company
expects to engage an outside Year 2000 consultant to review the Company's test
plans and test methodologies for the testing of its products, as well as
third-party products, prior to the end of 1998. The Company has adopted the
following six compliance categories for its products: "Compliant," "Compliant
with Upgrade," "Compliant with Minor Issues," "Not Compliant or End of Life
Product," "Testing to be Completed" and "Testing not Required." The creation of
these six categories is expected to assist the Company in communicating with its
customers, suppliers and business partners regarding the Year 2000 status of the
Company's products.
To aid in communication with the Company's customers, suppliers and business
partners, the Company has developed an Internet web site that identifies the
current Year 2000 status for each of the Company's products in accordance with
the Company's Year 2000 compliance standard. The web site, which is updated
periodically, also includes available upgrades, as well as the contemplated
completion date of testing and remediation for such products. By January 1,
1999, detailed, customer-specific information is expected to be made available
to major customers on a product-by-product basis in order to further assist such
customers with their own Year 2000 compliance programs.
The Company has also undertaken a review of its internal IT and non-IT
systems to identify potential Year 2000 Issues. In 1996, the Company began the
process of implementing a uniform worldwide business and accounting information
system to improve internal reporting processes. The internal IT systems being
replaced include order entry systems, purchasing and inventory management
systems, and the Company's general financial systems. Based upon representations
from the manufacturer, this uniform information system is Year 2000 compliant.
The Company also has plans to identify and replace and/or upgrade legacy
business systems that are not Year 2000 compliant and are not part of the
uniform worldwide business and accounting information system. With respect to
non-IT systems, the Company is actively analyzing its in-line manufacturing
equipment in order to assess any Year 2000 issues. To date, no material problems
have been discovered, and the Company will continue to review, test and
remediate (if necessary) such equipment. The Company is also evaluating its
other critical non-IT facility and internal systems with date sensitive
operating controls for Year 2000 Issues. While the Company believes that most of
these systems
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will function without substantial Year 2000 compliance problems, the Company
will continue to review, test and remediate (if necessary) such systems.
The third phase of the Company's Year 2000 compliance program is the actual
testing and remediation (if necessary) of the Company's IT and non-IT products
and systems. The Company is currently testing its products in accordance with
its adopted test plans and anticipates that testing and remediation of most of
its products will be completed by the end of the first quarter of 1999. As of
September 30, 1998, the Company estimates that it has completed approximately
95% of the Year 2000 readiness analysis required for its Advanced Network
Systems products, approximately 75% of the Year 2000 readiness analysis required
for its Digital Network Systems products and approximately 95% of the Year 2000
readiness analysis required for its Transmission Network Systems products. As of
September 30, 1998, the Company estimates that it has completed approximately
40% of the Year 2000 readiness analysis for its Satellite and Broadcast Network
Systems products. For certain of the Company's satellite and broadcast products
and the Company's national authorization center, testing and remediation is
currently anticipated to be completed by the third quarter of 1999. It is
expected that the testing and remediation of the Company's IT and non-IT
internal systems will be completed by the end of the first quarter of 1999.
The Company is presently evaluating each of its principal suppliers, service
providers and other business partners to determine each of such party's Year
2000 status. The Company has developed a questionnaire and a Year 2000
certification for use with such third parties, and, as of October 31, 1998, the
Company had contacted approximately 300 vendors about their Year 2000
compliance, including many of the vendors that the Company has identified as
critical vendors. The Company anticipates that this evaluation will be on-going
through the remainder of 1998 and through 1999.
The Company is working jointly with customers, strategic vendors and
business partners to identify and resolve any Year 2000 issues that may impact
the Company. However, there can be no assurance that the companies with which
the Company does business will achieve a Year 2000 conversion in a timely
fashion, or that such failure to convert by another company will not have a
material adverse effect on the Company.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The total cost associated with the Company's Year 2000 remediation is not
expected to be material to the Company's financial condition or results of
operations. The estimated total cost of the Company's Year 2000 remediation is
not expected to exceed $5 million. Through September 30, 1998, the Company has
spent approximately $500,000 in connection with Year 2000 Issues. The cost of
implementing the uniform worldwide business and accounting information system
has not been included in this figure since the replacement of the previous
systems was not accelerated due to Year 2000 Issues. All Year 2000 expenditures
are made from the respective departments' budgets. The percentage of the IT
budget during 1998 expected to be used for Year 2000 remediation is less than
3%. No IT projects have been deferred due to Year 2000 efforts.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES
There can be no assurance that the Company will be completely successful in
its efforts to address Year 2000 Issues. If some of the Company's products are
not Year 2000 compliant, the Company could suffer lost sales or other negative
consequences, including, but not limited to, diversion of resources, damage to
the Company's reputation, increased service and warranty costs and litigation,
any of which could materially adversely affect the Company's business operations
or financial statements.
The Company is also dependent on third parties such as its customers,
suppliers, service providers and other business partners. If these or other
third parties fail to adequately address Year 2000 Issues, the Company could
experience a negative impact on its business operations or financial statements.
For example, the failure of certain of the Company's principal suppliers to have
Year 2000 compliant internal
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systems could impact the Company's ability to manufacture and/or ship its
products or to maintain adequate inventory levels for production.
THE COMPANY'S CONTINGENCY PLANS
Although the Company has not yet developed a comprehensive contingency plan
to address situations that may result if the Company or any of the third parties
upon which the Company is dependent is unable to achieve Year 2000 readiness,
the Company's Year 2000 compliance program is ongoing and its ultimate scope, as
well as the consideration of contingency plans, will continue to be evaluated as
new information becomes available.
YEAR 2000 FORWARD-LOOKING STATEMENTS
The foregoing Year 2000 discussion contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which the Company expects to complete certain actions, are based on management's
best current estimates, which were derived utilizing numerous assumptions about
future events, including the continued availability of certain resources,
representations received from third parties and other factors. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to, the ability to
identify and remediate all relevant IT and non-IT systems, results of Year 2000
testing, adequate resolution of Year 2000 Issues by businesses and other third
parties who are service providers, suppliers or customers of the Company,
unanticipated system costs, the adequacy of and ability to develop and implement
contingency plans and similar uncertainties. The "forward-looking statements"
made in the foregoing Year 2000 discussion speak only as of the date on which
such statements are made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events.
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Management's Discussion and
Analysis of Financial Condition and Results of Operations and other sections of
this Form 10-Q may include forward-looking statements concerning, among other
things, the Company's prospects, developments and business strategies. These
forward-looking statements are identified by their use of such terms and phrases
as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects,"
"expect," "expected," "project," "projects," "projected," "projections,"
"plans," "anticipates," "anticipated," "should," "designed to," "foreseeable
future," "believe," "believes," "subject to" and "scheduled." These
forward-looking statements are subject to certain uncertainties and other
factors that could cause actual results to differ materially from such
statements. These risks include, but are not limited to, uncertainties relating
to general political and economic conditions, uncertainties relating to
government and regulatory policies, uncertainties relating to customer plans and
commitments, the Company's dependence on the cable television industry and cable
television spending, Year 2000 readiness, the pricing and availability of
equipment, materials and inventories, technological developments, the
competitive environment in which the Company operates, changes in the financial
markets relating to the Company's capital structure and cost of capital, the
uncertainties inherent in international operations and foreign currency
fluctuations and authoritative generally accepted accounting principles or
policy changes from such standard-setting bodies as the Financial Accounting
Standards Board and the Securities and Exchange Commission. Reference is made to
Exhibit 99 in this Form 10-Q for a further discussion of such factors. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date the statement was made. The Company
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undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A significant portion of the Company's products are manufactured or
assembled in Taiwan and Mexico. These foreign operations are subject to market
risk changes with respect to currency exchange rate fluctuations, which could
impact the Company's consolidated financial statements. The Company monitors its
underlying exchange rate exposures on an ongoing basis and continues to
implement selective hedging strategies to reduce the market risks from changes
in exchange rates. On a selective basis, the Company enters into contracts to
limit the currency exposure of monetary assets and liabilities, contractual and
other firm commitments denominated in foreign currencies and limit the currency
exposure of anticipated, but not yet committed, transactions expected to be
denominated in foreign currencies. The use of these derivative financial
instruments allows the Company to reduce its overall exposure to exchange rate
movements since the gains and losses on these contracts substantially offset
losses and gains on the assets, liabilities and transactions being hedged.
Foreign currency exchange contracts are sensitive to changes in exchange
rates. As of September 30, 1998, a hypothetical 10% fluctuation in the exchange
rate of foreign currencies applicable to the Company, principally the New Taiwan
and Canadian dollars, would result in a net $0.2 million gain or loss on the
contracts the Company has outstanding, which would offset the related net loss
or gain on the assets, liabilities and transactions being hedged.
28
<PAGE>
SIGNATURE
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.
<TABLE>
<S> <C> <C>
GENERAL INSTRUMENT CORPORATION
/s/ MARC E. ROTHMAN
-----------------------------------------
Marc E. Rothman
Vice President and Controller
</TABLE>
February 11, 1999
- -----------------
Date
29
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL
STATEMENTS OF GENERAL INSTRUMENT CORPORATION FOR THE NINE MONTHS ENDED SEPTEMBER
30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 116,037
<SECURITIES> 4,081
<RECEIVABLES> 319,204
<ALLOWANCES> (3,449)
<INVENTORY> 261,488
<CURRENT-ASSETS> 847,754
<PP&E> 505,270
<DEPRECIATION> (272,566)
<TOTAL-ASSETS> 2,115,274
<CURRENT-LIABILITIES> 433,920
<BONDS> 0
1,734
0
<COMMON> 0
<OTHER-SE> 1,611,120
<TOTAL-LIABILITY-AND-EQUITY> 2,115,274
<SALES> 1,423,621
<TOTAL-REVENUES> 1,423,621
<CGS> 1,036,649
<TOTAL-COSTS> 1,036,649
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 125
<INCOME-PRETAX> 19,498
<INCOME-TAX> (10,018)
<INCOME-CONTINUING> 9,480
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,480
<EPS-PRIMARY> 0.06
<EPS-DILUTED> 0.06
</TABLE>
