<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
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
incorporation or organization) Identification 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 July 31, 1999, there were 173,372,135 shares of Common Stock
outstanding.
<PAGE> 2
GENERAL INSTRUMENT CORPORATION
INDEX TO FORM 10-Q
PAGES
-----
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statement of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7-15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 16-23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 24-25
ITEM 4. Submission of Matters to a Vote of Security Holders 26
ITEM 6. Exhibits and Reports on Form 8-K 27
SIGNATURE 28
<PAGE> 3
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
(UNAUDITED)
JUNE 30, DECEMBER 31,
1999 1998
----------- -----------
<S> <C> <C>
Assets
Cash and cash equivalents $ 364,961 $ 148,675
Short-term investments 86,191 4,865
Accounts receivable, less allowance for doubtful accounts of $1,807 and $3,833, respectively
(includes accounts receivable from related party of $60,764 and $81,075, respectively) 297,450 340,039
Inventories 235,269 281,451
Deferred income taxes 58,115 100,274
Other current assets 14,103 15,399
----------- -----------
Total current assets 1,056,089 890,703
Property, plant and equipment, net 234,113 237,131
Intangibles, less accumulated amortization of $104,543 and $97,630, respectively 490,911 497,696
Goodwill, less accumulated amortization of $129,380 and $122,110, respectively 448,086 455,466
Deferred income taxes 2,083 1,999
Investments and other assets 123,732 104,765
----------- -----------
TOTAL ASSETS $ 2,355,014 $ 2,187,760
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 216,208 $ 267,565
Other accrued liabilities 173,677 186,113
----------- -----------
Total current liabilities 389,885 453,678
Deferred income taxes 15,659 15,913
Other non-current liabilities 66,798 67,998
----------- -----------
Total liabilities 472,342 537,589
----------- -----------
Commitments and contingencies (See Note 5)
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; 180,894,275 and
173,393,275 shares issued, respectively 1,809 1,734
Additional paid-in capital 1,950,688 1,742,824
Note receivable from stockholder (36,136) (40,615)
Retained earnings 113,169 36,214
Accumulated other comprehensive income, net of taxes of $26,348 and $1,020, respectively 41,912 2,845
----------- -----------
2,071,442 1,743,002
Less - Treasury Stock, at cost, 7,632,327 and 4,619,069 shares, respectively (188,770) (92,831)
----------- -----------
Total stockholders' equity 1,882,672 1,650,171
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,355,014 $ 2,187,760
=========== ===========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited - In thousands, except per share information)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET SALES $ 527,030 $ 488,505 $ 1,046,091 $ 905,425
Cost of sales 368,872 347,384 749,887 671,316
----------- ----------- ----------- -----------
GROSS PROFIT 158,158 141,121 296,204 234,109
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Selling, general and administrative 39,881 45,883 90,798 101,768
Research and development 41,905 42,266 82,890 158,169
Goodwill amortization 3,699 3,562 7,281 7,123
----------- ----------- ----------- -----------
Total operating expenses 85,485 91,711 180,969 267,060
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) 72,673 49,410 115,235 (32,951)
Other expense - net (including equity interest in Partnership losses
of $5,995, $6,562, $11,605 and $17,852, respectively) (128) (796) (1,154) (9,804)
Interest income (expense) - net 4,386 (284) 8,069 (1,264)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 76,931 48,330 122,150 (44,019)
(Provision) benefit for income taxes (28,464) (18,367) (45,195) 14,090
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 48,467 $ 29,963 $ 76,955 $ (29,929)
=========== =========== =========== ===========
Earnings (Loss) Per Share - Basic $ 0.28 $ 0.20 $ 0.44 $ (0.20)
=========== =========== =========== ===========
Earnings (Loss) Per Share - Diluted $ 0.26 $ 0.19 $ 0.41 $ (0.20)
=========== =========== =========== ===========
Weighted-Average Shares Outstanding - Basic 173,081 151,226 174,137 150,450
Weighted-Average Shares Outstanding - Diluted 188,231 160,863 188,861 150,450
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED - IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL
COMMON STOCK PAID-IN FROM
SHARES AMOUNT CAPITAL STOCKHOLDER
------- ------- ----------- ---------
<S> <C> <C> <C> <C>
Balance, January 1, 1999 173,393 $ 1,734 $ 1,742,824 $ (40,615)
Net income -- -- -- --
Other comprehensive income, net-of-tax:
Unrealized gains on available-for-sale
securities -- -- -- --
Foreign currency translation adjustments -- -- -- --
Comprehensive income
Treasury stock purchases (5,300 shares) -- -- -- --
Exercise of stock options and related tax
benefit (2,287 shares issued from Treasury) -- -- 3,991 --
Issuances of shares 7,501 75 187,425 --
Payment of note receivable from stockholder -- -- -- 4,479
Warrant costs related to customer purchases -- -- 16,448 --
------- ------- ----------- ---------
BALANCE, JUNE 30, 1999 180,894 $ 1,809 $ 1,950,688 $ (36,136)
======= ======= =========== =========
</TABLE>
<TABLE>
<CAPTION>
NOTE ACCUMULATED
RECEIVABLE OTHER TOTAL
RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS'
EARNINGS INCOME, NET STOCK EQUITY
--------- --------- --------- -----------
<S> <C> <C> <C> <C>
Balance, January 1, 1999 $ 36,214 $ 2,845 $ (92,831) $ 1,650,171
Net income 76,955 -- -- 76,955
Other comprehensive income, net-of-tax:
Unrealized gains on available-for-sale
securities -- 39,617 -- 39,617
Foreign currency translation adjustments -- (550) -- (550)
-----------
Comprehensive income 116,022
Treasury stock purchases (5,300 shares) -- -- (148,400) (148,400)
Exercise of stock options and related tax
benefit (2,287 shares issued from Treasury) -- -- 52,461 56,452
Issuances of shares -- -- -- 187,500
Payment of note receivable from stockholder -- -- -- 4,479
Warrant costs related to customer purchases -- -- -- 16,448
--------- --------- --------- -----------
BALANCE, JUNE 30, 1999 $ 113,169 $ 41,912 $(188,770) $ 1,882,672
========= ========= ========= ===========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
GENERAL INSTRUMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Operating Activities:
Net income (loss) $ 76,955 $ (29,929)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 43,424 38,661
Warrant costs related to customer purchases 16,448 11,646
Gain on sales of short-term investments (12,098) (4,529)
Losses from asset sales and write-downs, net 10,715 6,714
Loss from equity investment 11,605 17,852
Changes in assets and liabilities:
Accounts receivable 42,590 13,103
Inventories 40,082 13,133
Prepaid expenses and other current assets 5,621 2,427
Deferred income taxes 16,490 (28,031)
Non-current assets 3,992 (436)
Accounts payable and other accrued liabilities (43,730) (1,458)
Other non-current liabilities (1,200) (3,206)
Other (579) (901)
--------- ---------
Net cash provided by operating activities 210,315 35,046
--------- ---------
INVESTING ACTIVITIES:
Additions to property, plant and equipment (30,800) (40,091)
Investments in other assets (55,623) (1,995)
Proceeds from sales of short-term investments 12,426 4,529
--------- ---------
Net cash used in investing activities (73,997) (37,557)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from stock option exercises 36,389 50,140
Proceeds from issuance of shares 187,500 --
Purchase of treasury shares (148,400) --
Payment of note receivable from stockholder 4,479 --
--------- ---------
Net cash provided by financing activities 79,968 50,140
--------- ---------
Change in cash and cash equivalents 216,286 47,629
Cash and cash equivalents, beginning of period 148,675 35,225
--------- ---------
Cash and cash equivalents, end of period $ 364,961 $ 82,854
========= =========
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
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 provider of integrated
and interactive broadband access solutions and, with its strategic partners and
customers, is advancing the convergence of the Internet, telecommunications and
video entertainment industries. The Company is the world's leading supplier of
digital and analog set-top terminals and 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 provider of digital
satellite television systems for programmers, direct-to-home ("DTH") satellite
networks and private networks for business communications. Through its limited
partnership interest in Next Level Communications L.P. (the "Partnership") (see
Note 10), the Company provides next-generation broadband access solutions for
local telephone companies with the Partnership's NLevel(3)(R) Switched Digital
Access System ("NLevel(3)").
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 "Distribution"). 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 the Company. The consolidated balance sheet as of June 30, 1999,
the consolidated statements of operations for the three and six months ended
June 30, 1999 and 1998, the consolidated statement of stockholders' equity for
the six months ended June 30, 1999 and the consolidated statements of cash flows
for the six months ended June 30, 1999 and 1998 of the Company are unaudited and
reflect all adjustments of a normal, recurring nature (except for those charges
disclosed in Notes 7, 8 and 10) 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 statements
should be read in conjunction with the accounting policies and notes to the
consolidated financial statements included in the Company's 1998 Annual Report
on Form 10-K.
3. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C>
Raw materials $104,384 $103,807
Work in process 24,814 19,236
Finished goods 106,071 158,408
-------- --------
$235,269 $281,451
======== ========
</TABLE>
7
<PAGE> 8
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
4. INVESTMENTS
At June 30, 1999 and December 31, 1998, all of the Company's marketable
equity securities were classified as available-for-sale. Proceeds and the
related realized gains from the sale of available-for-sale securities for the
three and six months ended June 30, 1999 were $7 million and $12 million,
respectively. Proceeds and the related realized gains from the sales of
available-for-sale securities for the three and six months ended June 30, 1998
were $2 million and $5 million, respectively. Realized gains were determined
using the securities' cost. Short-term investments consisted of the following at
June 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------------------------------ -------------------------------
GROSS GROSS
FAIR UNREALIZED COST FAIR UNREALIZED COST
VALUE GAINS BASIS VALUE GAINS BASIS
----- ----- ----- ----- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Marketable Equity Securities $86,191 $68,810 $17,381 $4,865 $ 3,865 $ 1,000
======= ======= ======= ====== ======= =======
</TABLE>
5. COMMITMENTS AND CONTINGENCIES
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
Distribution, by allegedly making false and misleading statements and failing to
disclose material facts about the Distributing Company's planned shipments in
1995 of its CFT2200 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
Distribution, 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 certain 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' motion 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. In November 1998, the defendants filed an answer to the derivative
action, denying liability. On January 21, 1999, the plaintiffs in the class
actions filed their motion for class certification, including the defendants'
opposition. The Company intends to vigorously contest these actions.
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 an amended complaint,
which contains 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 November, 1998,
the defendants filed an answer to the remaining parts of the amended complaint,
denying liability. The Company intends to vigorously contest this action.
8
<PAGE> 9
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
In connection with the Distribution, the Company has agreed to indemnify
General Semiconductor with respect to 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 moved to dismiss the remaining counts of the complaint.
That motion was denied on March 31, 1999 and defendants' answer was filed on
June 25, 1999. On July 30, 1999, defendants filed a motion seeking
reconsideration of the denial of their motion to dismiss. The Company intends to
vigorously contest this action.
On March 5, 1998, an action entitled DSC Communications Corporation and DSC
Technologies Corporation v. Next Level Communications L.P., KK Manager, L.L.C.,
General Instrument Corporation and Spencer Trask & Co., Inc. was filed in the
Superior Court of the State of Delaware in and for New Castle County (the
"Delaware Action"). In that action, DSC Communications Corporation and DSC
Technologies Corporation (collectively, "DSC") alleged that in connection with
the formation of the Partnership and the transfer to it of NLC's switched
digital video technology, the Partnership and KK Manager, L.L.C. misappropriated
DSC's trade secrets; that the Company improperly disclosed trade secrets when it
conveyed such technology to the Partnership; and that Spencer Trask & Co., Inc.
conspired to misappropriate DSC's trade secrets. The plaintiffs sought actual
damages for the defendants' purported unjust enrichment, disgorgement of
consideration, exemplary damages and attorney's fees, all in unspecified
amounts. In April 1998, the Company and the other defendants filed an action in
the United States District Court for the Eastern District of Texas, requesting
that the federal court preliminarily and permanently enjoin DSC from prosecuting
the Delaware Action because by pursuing such action, DSC effectively was trying
to circumvent and relitigate the Texas federal court's November 1997 judgment in
a previous lawsuit involving DSC, pursuant to which NLC had paid over $140
million. On May 14, 1998, the Texas court granted a preliminary injunction
preventing DSC from proceeding with the Delaware Action. That injunction order
was appealed to the United States Court of Appeals for the Fifth Circuit. On
June 21, 1999, the Fifth Circuit affirmed the Texas federal court's grant of the
preliminary injunction. On July 15, 1999, the Texas federal court granted the
Delaware defendants' motion for summary judgment and issued its final judgment
permanently enjoining DSC from prosecuting and continuing the Delaware Action.
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 (as specified below). The first
part of a bifurcated arbitration proceeding, relating to the Company's advanced
analog products, began on March 22, 1999 before an arbitration panel of the
American Arbitration Association in San Francisco, California. Oral arguments to
the panel by the Company and StarSight were concluded on May 23, 1999. The
Company and StarSight have submitted post-hearing filings to the arbitration
panel, and the Company now expects to receive a decision from the panel toward
the end of the third quarter or in the fourth quarter of 1999. At the
arbitration proceeding, StarSight identified purported damages arising from the
sale by the Company of advanced analog set top boxes containing a native
electronic program guide. StarSight alleged that it is entitled to collect $52
million to $177 million in compensatory damages and an unspecified amount of
punitive damages. The Company has denied liability and presented evidence
disputing both StarSight's damages theories and amounts in the event that
liability were to be found. A separate hearing relating to certain of the
Company's digital set top boxes and satellite products is currently scheduled
for mid-September, 1999. The Company continues to vigorously contest this
action.
On November 30, 1998, an action entitled Gemstar Development Corporation
and Index Systems, Inc. v. General Instrument Corporation was filed in the
United States District Court for the Northern District of California. The
complaint alleges infringement by the Company of two U.S. patents allegedly
covering electronic program guides. The complaint seeks unspecified damages and
an injunction. The plaintiffs sought to consolidate discovery for this action
with other program guide related patent infringement actions pending against
Pioneer Electronics Corp., Scientific-Atlanta, Inc., and
9
<PAGE> 10
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
Prevue Networks, Inc. On April 26, 1999, the Judicial Panel on Multidistrict
Litigation ordered the transfer of this action to the Northern District of
Georgia for consolidated pretrial proceedings with the Pioneer Electronics Corp.
and Scientific-Atlanta, Inc. actions. The Company denies that it infringes the
subject patents and intends to vigorously defend this action.
6. 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. 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 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 in comparison to net interest expense
of greater than 5 to 1; and (iii) maintenance of a leverage ratio comparing
total indebtedness to EBITDA 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 is expected to have a
significant effect on the Company's ability to operate, and as of June 30, 1999,
the Company was in compliance with all financial and operating covenants under
the Credit Agreement. At June 30, 1999, the Company had available credit of $500
million under the Credit Agreement. The Company had approximately $106 million
of letters of credit outstanding at June 30, 1999.
7. RESTRUCTURINGS
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 also
decided to close its corporate office and move from Chicago, Illinois to
Horsham, Pennsylvania, which was completed during the first quarter of 1998.
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. As a result of the above actions, the
Company recorded a pre-tax charge of $36 million during the fourth quarter of
1997.
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 selling,
general and administrative ("SG&A") expense and $1 million as research and
development ("R&D") expense.
On April 29, 1999, PRIMESTAR, Inc. ("PRIMESTAR") announced that it had
completed the previously announced sale of its direct broadcast satellite
("DBS") medium-power business and assets to Hughes Electronics Corporation
("Hughes"). Sales to PRIMESTAR accounted for 11% of the Company's sales in 1998.
The Company currently expects future PRIMESTAR purchases of medium-power
equipment from the Company to be insignificant. Further, as a result of the
previously announced purchase by Hughes of PRIMESTAR's rights to acquire certain
high-power satellite assets, the Company does not expect to supply any
high-power equipment to PRIMESTAR. In the first quarter of 1999, in connection
with the announcement of the PRIMESTAR developments, the Company evaluated its
overhead structure and has taken steps to further consolidate its San Diego,
California and Horsham, Pennsylvania operations, including reducing headcount by
approximately 200. The Company recorded a pre-tax charge of approximately $15
million during the first quarter of 1999 which primarily included $6 million for
severance costs, $6 million for the write-down of PRIMESTAR
10
<PAGE> 11
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
related inventory to its lower of cost or market, $2 million for the write-down
of fixed assets used to manufacture PRIMESTAR products to their estimated fair
values and $1 million of facility costs. Of these charges, $8 million were
recorded as cost of sales and $7 million were recorded as SG&A expense.
The following tabular reconciliation summarizes the restructuring activity
from January 1, 1998 through June 30, 1999:
<TABLE>
<CAPTION>
BALANCE AT 1998 BALANCE AT 1999 BALANCE AT
---------------------- ---------------------
JANUARY 1, AMOUNTS DECEMBER 31, AMOUNTS JUNE 30,
1998 ADDITIONS UTILIZED 1998 ADDITIONS UTILIZED 1999
----------- ---------- ----------- ------------- ---------- ---------- -----------
(in millions)
<S> <C> <C> <C> <C> <C> <C> <C>
Inventory (1) $-- $-- $-- $-- $ 6.1 $(2.1) $ 4.0
Property, Plant &
Equipment (1) 7.8 4.6 (12.4) -- 2.2 -- 2.2
Facility Costs 10.5 3.3 (10.0) 3.8 0.8 (0.7) 3.9
Severance 19.9 7.6 (26.7) 0.8 5.7 (3.1) 3.4
===== ===== ===== ===== ===== ===== =====
Total $38.2 $15.5 $(49.1) $ 4.6 $14.8 $(5.9) $13.5
===== ===== ===== ===== ===== ===== =====
</TABLE>
(1) These charges represent a direct reduction to the inventory and
property, plant and equipment balances to reflect the identified
impaired assets at their lower of cost or market and fair values,
respectively. The amounts utilized reflect the disposition of such
identified impaired assets.
8. 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, shutdown expenses and legal fees. The above charges
totaled $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 expense-net," related to costs
incurred by the Partnership, which the Company accounts for under the equity
method. Such costs are primarily related to a $5 million litigation settlement
and compensation expense related to key executives of an acquired company.
The following tabular reconciliation summarizes the other charge activity
discussed above:
<TABLE>
<CAPTION>
BALANCE AT 1998 BALANCE AT 1999 BALANCE AT
------------------------ ------------
JANUARY 1, AMOUNTS DECEMBER 31, AMOUNTS JUNE 30,
1998 ADDITIONS UTILIZED 1998 UTILIZED 1999
------------ ----------- ------------ ------------- ------------ -------------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Inventory (1) $43.3 $15.0 $(43.3) $15.0 $(4.5) $10.5
Property, Plant &
Equipment (1) 8.4 -- (1.1) 7.3 (7.3) --
Professional Fees &
Other Costs 3.2 10.1 (13.3) -- -- --
Partnership Related --
Costs -- 8.4 (8.4) -- -- --
===== ===== ===== ===== ===== =====
Total $54.9 $33.5 $(66.1) $22.3 $(11.8) $10.5
===== ===== ===== ===== ===== =====
</TABLE>
(1) These charges represent a direct reduction to the inventory and
property, plant and equipment balances to reflect these assets at
their lower of cost or market and fair values, respectively. The
amounts utilized reflect the disposition of such identified assets.
11
<PAGE> 12
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
9. OTHER EXPENSE - NET
Other expense-net for the three and six months ended June 30, 1999 primarily
includes $6 million and $12 million, respectively, related to the Company's
share of the Partnership losses, offset by $7 million and $12 million,
respectively, related to gains on the sales of short-term investments. Other
expense-net for the three and six months ended June 30, 1998 primarily reflects
$7 million and $18 million, respectively, related to the Company's share of the
Partnership losses, including the Company's share of a $5 million litigation
settlement and compensation expense related to key executives of an acquired
company, partially offset by $2 million and $5 million, respectively, related to
gains on the sales of short-term investments and $5 million for both periods
related to proceeds received from the settlement of an insurance claim.
10. 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 a
newly formed limited partnership (the "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 June 30, 1999. 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 operating general partner's interest in the Partnership.
Net assets transferred to the Partnership at formation of $45 million primarily
included property, plant and equipment, inventories and accounts receivable
partially offset by accounts payable and accrued expenses.
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.
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 R&D expense during the
quarter ended June 30, 1998 to fully reserve for the Note concurrent with the
funding. The proceeds of the Note are being utilized to fund the R&D activities
of the Partnership to develop the aforementioned telecommunication technology
for widespread commercial deployment. During 1998, the Company agreed to make
additional equity investments in the Partnership, aggregating $50 million,
beginning in November 1998, to fund the Partnership's growth and assist the
Partnership in meeting its forecasted working capital requirements. The Company
completed these equity investments in the second quarter of 1999.
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 R&D activities will be offset
against the $75 million reserve discussed above. For the three and six months
ended June 30, 1999, the Company's share of the Partnership's losses was $6
million and $12 million, respectively, (net of the Company's share of R&D
expenses of $11 million and $21 million, respectively). For the three and six
months ended June 30, 1998, the Company's share of the Partnership's losses was
$7 million and $18 million, respectively, (net of the Company's share of R&D
expenses of $10 million and $19 million, respectively). The Company has
eliminated its interest income from the Note against its share of the
Partnership's related interest expense on the Note. The Company's net equity
investment in the Partnership was $58 million at June 30, 1999.
12
<PAGE> 13
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
The following unaudited summarized financial information is provided for the
Partnership for the three and six months ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------------- ----------------------------------
1999 1998 1999 1998
-------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net sales $ 9,413 $ 3,090 $18,190 $ 5,829
Gross profit (loss) 878 (806) 1,450 (1,922)
Loss before income taxes (19,740) (20,748) (38,797) (45,058)
Net cash used in operating activities (5,054) (23,758) (24,099) (38,423)
</TABLE>
11. RELATED PARTY TRANSACTIONS
The Company entered into an Asset Purchase Agreement with two affiliates of
Tele-Communications, Inc. ("TCI"), which was consummated on July 17, 1998,
pursuant to which the Company acquired from TCI, in exchange for 21.4 million
shares of the Company's Common Stock, certain assets consisting primarily of a
license to certain intellectual property which will enable the Company to
conduct authorization services. Following the merger of a wholly-owned
subsidiary of AT&T Corp. with and into TCI, Liberty Media Corporation, a
wholly-owned subsidiary of TCI, became the beneficial owner of such 21.4 million
shares of the Company's Common Stock.
AT&T is a significant customer of the Company. Sales to AT&T (TCI prior to
its merger with AT&T) represented 30% and 31% of total Company sales for the six
months ended June 30, 1999 and the year ended December 31, 1998, respectively.
Management believes the transactions with AT&T are at arms length and are under
terms no less favorable to the Company than those with other customers. At June
30, 1999 and December 31, 1998 accounts receivable from AT&T (TCI prior to its
merger into AT&T) totaled $61 million and $81 million, respectively.
In April 1999, the Company repurchased 5.3 million shares of its Common
Stock from two partnerships affiliated with Forstmann Little & Co., a greater
than 10% stockholder at such time, for $148 million.
13
<PAGE> 14
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
12. SEGMENT INFORMATION
Selected information regarding the Company's reportable segments follows:
<TABLE>
<CAPTION>
SATELLITE
BROADBAND AND BROADCAST
NETWORKS NETWORK TOTAL
SYSTEMS SYSTEMS UNALLOCATED COMPANY
-------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 1999
- --------------------------------
Net sales $ 470,997 $ 56,033 $ -- $ 527,030
Operating income (loss) 76,485 6,069 (9,881) (b) 72,673
Other expense - net (128)
Interest income - net 4,386
Income before income taxes 76,931
Segment assets (a) 633,536 121,851 11,445 (c) 766,832
THREE MONTHS ENDED JUNE 30, 1998
- --------------------------------
Net sales $ 380,481 $ 108,024 $ -- $ 488,505
Operating income (loss) 55,639 12,409 (18,638) (b) 49,410
Other expense - net (796)
Interest expense - net (284)
Income before income taxes 48,330
Segment assets (a) 580,464 215,379 15,106 (c) 810,949
SIX MONTHS ENDED JUNE 30, 1999
- --------------------------------
Net sales $ 906,186 $ 139,905 $ -- $ 1,046,091
Operating income (loss) 128,979 17,546 (31,290) (b) 115,235
Other expense - net (1,154)
Interest income - net 8,069
Income before income taxes 122,150
SIX MONTHS ENDED JUNE 30, 1998
- --------------------------------
Net sales $ 690,615 $ 214,810 $ -- $ 905,425
Operating income (loss) 94,045 17,666 (144,662) (b) (32,951)
Other expense - net (9,804)
Interest expense - net (1,264)
Loss before income taxes (44,019)
</TABLE>
(a) Segment assets include accounts receivable, inventories and property,
plant and equipment. Other balance sheet items are not allocated to the
segments.
(b) Primarily reflects unallocated amounts, including (i) goodwill
amortization of $4 million and $7 million for the three and six months
ended June 30, 1999, respectively, and $4 million and $7 million for
the three and six months ended June 30, 1998, respectively, and (ii)
restructuring and other charges of $15 million for the six months ended
June 30, 1999 and $115 million for the six months ended June 30, 1998,
(see Notes 7 and 8). The remaining reconciling amounts reflect
unallocated selling, general and administrative expenses and other
overhead costs.
(c) Primarily reflects unallocated accounts receivable of $2 million and
$20 million at June 30, 1999 and 1998, respectively, and certain
unallocated property, plant and equipment balances of $16 million at
June 30, 1999 and 1998, offset by write-downs related to restructuring
and other charges not allocated to the segments for internal management
reporting purposes.
14
<PAGE> 15
GENERAL INSTRUMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, UNLESS OTHERWISE NOTED)
13. OTHER INFORMATION
Earnings (Loss) Per Share. For the three months ended June 30, 1999, the
calculation of diluted weighted-average shares outstanding included the dilutive
effects of stock options and warrants of 3,968 shares and 11,182 shares,
respectively. For the six months ended June 30, 1999, the calculation of diluted
weighted-average shares outstanding included the dilutive effects of stock
options and warrants of 3,976 shares and 10,748 shares, respectively. For the
three months ended June 30, 1998, the calculation of diluted weighted-average
shares outstanding included the dilutive effects of stock options and warrants
of 2,756 shares and 6,881 shares, respectively. Since the computation of diluted
loss per share is anti-dilutive for the six months ended June 30, 1998, the
amounts reported for basic and diluted loss per share are the same.
License Amortization. Intangible assets consist primarily of a license,
which is being amortized 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 and such deployment is expected to rise
significantly during the 20-year 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 denominator of which is
the expected revenues from the license during its 20-year term. Under the
Company's method, amortization for the three and six months ended June 30, 1999
was approximately $0.8 million and $1.7 million, respectively, and accumulated
amortization as of June 30, 1999 was approximately $2.3 million.
Comprehensive Income (Loss). Total comprehensive income was $89 million and
$116 million for the three and six months ended June 30, 1999, respectively. For
the three and six months ended June 30, 1998, total comprehensive income was $34
million and total comprehensive loss was $33 million, respectively.
New Accounting Pronouncements Not Yet Adopted. Statement of Financial
Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and
Hedging Activities" was issued in June 1998 and, as amended by SFAS No. 137
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of SFAS Statement No. 133" in June 1999, is effective for fiscal
years beginning after June 15, 2000. 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.
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NET SALES
Net sales for the three months ended June 30, 1999 were $527 million, an
increase of $38 million, or 8%, over net sales of $489 million for the three
months ended June 30, 1998. Net sales for the six months ended June 30, 1999
were $1,046 million compared to $905 million for the six months ended June 30,
1998, an increase of $141 million, or 16%. The increases in net sales for the
three and six month periods reflect higher sales of digital cable systems,
transmission and high speed data products, partially offset by lower sales of
analog cable and satellite products. Analog and digital products represented 39%
and 61%, respectively, of total sales for the six months ended June 30, 1999.
Analog and digital products each represented approximately 50% of total sales
for the six months ended June 30, 1998.
Worldwide broadband sales (consisting of digital and analog cable and
wireless television systems, transmission network systems and high speed data
products) of $471 million and $906 million for the three and six months ended
June 30, 1999, respectively, increased $91 million, or 24%, and $216 million, or
31%, respectively, from the comparable 1998 periods, primarily as a result of
increased U.S. sales volume of digital cable terminals and headends,
transmission product sales and high speed data product sales, partially offset
by lower sales of analog cable systems. These sales reflect the commitment of
cable television operators to deploy interactive digital systems in order to
offer advanced entertainment, interactive services and Internet access to their
customers. During the three months ended June 30, 1999 and 1998, broadband sales
in the U.S. were 83%, combined U.S. and Canadian sales were 87% and 84%,
respectively, and all other international sales were 13% and 16%, respectively,
of total worldwide broadband sales. For the six months ended June 30, 1999 and
1998, broadband sales in the U.S. were 85% and 82%, respectively, combined U.S.
and Canadian sales were 89% and 84%, respectively, and all other international
sales were 11% and 16%, respectively, of total worldwide broadband sales. The
decrease in international sales from the first half of 1998 was experienced
primarily in the Latin American region and international sales are not expected
to return to historical levels in the near-term.
Worldwide satellite sales of $56 million and $140 million for the three and
six months ended June 30, 1999, respectively, decreased $52 million, or 48%, and
$75 million, or 35%, respectively, from the comparable 1998 period, primarily as
a result of lower sales to PRIMESTAR, Inc. ("PRIMESTAR"), as described further
below. During the three months ended June 30, 1999 and 1998, satellite sales in
the U.S. were 58% and 96%, respectively, combined U.S. and Canadian sales were
82% and 96%, respectively, and all other international sales were 18% and 4%,
respectively, of total worldwide satellite sales. For the six months ended June
30, 1999 and 1998, satellite sales in the U.S. were 70% and 95%, respectively,
combined U.S. and Canadian sales were 89% and 98%, respectively, and all other
international sales were 11% and 2%, respectively, of total worldwide satellite
sales. The increase in international satellite sales was experienced in the
Latin American region.
AT&T (TCI prior to its merger with AT&T) accounted for approximately 30% of
the Company's consolidated net sales for the six months ended June 30, 1999. For
the year ended December 31, 1998, TCI and PRIMESTAR represented approximately
31% and 11%, respectively, of total Company sales.
On April 29, 1999, PRIMESTAR, Inc. ("PRIMESTAR") announced that it had
completed the previously announced sale of its direct broadcast satellite
("DBS") medium-power business and assets to Hughes Electronics Corporation
("Hughes"). The Company currently expects future PRIMESTAR purchases of
medium-power equipment from the Company to be insignificant. Further, as a
result of the previously announced purchase by Hughes of PRIMESTAR's rights to
acquire certain high-power satellite assets, the Company does not expect to
supply any high-power equipment to PRIMESTAR.
GROSS PROFIT
Gross profit was $158 million and $296 million for the three and six months
ended June 30, 1999, respectively, compared to $141 million and $234 million for
the three and six months ended June 30, 1998, respectively. Gross profit was 30%
and 28% of sales for the three and six months ended June 30, 1999, respectively,
compared to 29% and 26% of sales for the comparable 1998 periods. Gross profit
for the three and six months ended June 30, 1999 included a $6 million gain
related to the favorable resolution of certain duty matters. Gross profit for
the six months ended June 30, 1999 also included $8 million of restructuring
charges (see Note 7 and "Restructurings" below) recorded in the first quarter of
1999, primarily related to the write-down of PRIMESTAR related inventory to its
lower of cost or market and the write-down of fixed assets used to manufacture
PRIMESTAR products to their estimated fair values. Gross profit for
16
<PAGE> 17
the six months ended June 30, 1998 included $9 million of restructuring charges
(see Note 7 and "Restructurings" below) and $18 million of other charges (see
Note 8 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.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general & administrative ("SG&A") expense was $40 million and $91
million for the three and six months ended June 30, 1999, respectively,
compared to $46 million and $102 million for the three and six months ended
June 30, 1998, respectively. SG&A expense decreased as a percentage of sales to
8% and 9% for the three and six months ended June 30, 1999, respectively, from
9% and 11% for the three and six months ended June 30, 1998, respectively. SG&A
for the six months ended June 30, 1999 included $7 million of restructuring
charges (see Note 7 and "Restructurings" below) recorded in the first
quarter of 1999, primarily related to severance costs recorded in connection
with the announcement of the PRIMESTAR developments. These restructuring
activities have driven the reductions of ongoing SG&A expense. SG&A for the six
months ended June 30, 1998 included $6 million of restructuring charges (see
Note 7 and "Restructurings" below) and $7 million of other charges (see Note 8
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.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expense was $42 million and $83 million for
the three and six months ended June 30, 1999, respectively, compared to $42
million and $158 million, respectively, for the comparable 1998 periods. R&D
expense for the six months ended June 30, 1998 included a $75 million charge to
fully reserve the Partnership Note (see Note 10). Proceeds of the Partnership
Note are being utilized by the Partnership to fund research and development
activities 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. The Company's R&D
spending in 1999 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.
OTHER EXPENSE--NET
Other expense-net was $0.1 million and $1 million for the three and six
months ended June 30, 1999, respectively, and $1 million and $10 million for the
three and six months ended June 30, 1998, respectively. Other expense decreased
in the first half of 1999 from the comparable 1998 period primarily due to a
reduction in the Partnership's losses (see Note 10) and additional gains on the
sales of short-term investments. Other expense-net for the three and six months
ended June 30, 1999 primarily includes $6 million and $12 million, respectively,
related to the Company's share of the Partnership losses, offset by $7 million
and $12 million, respectively, related to gains on the sales of short-term
investments. Other expense-net for the three and six months ended June 30, 1998
primarily reflects $7 million and $18 million, respectively, related to the
Company's share of the Partnership losses, including the Company's share of a $5
million litigation settlement and compensation expense related to key executives
of an acquired company, partially offset by $2 million and $5 million,
respectively, related to gains on the sales of short-term investments and $5
million for both periods related to proceeds received from the settlement of an
insurance claim.
INTEREST INCOME (EXPENSE)--NET
Net interest income was $4 million and $8 million for the three and six
months ended June 30, 1999, respectively, compared to net interest expense of
$0.3 million and $1 million for the three and six months ended June 30, 1998,
respectively. The increases in interest income reflect the higher average cash
balances and debt free position during the three and six months ended June 30,
1999.
INCOME TAXES
The Company recorded a provision for income taxes of $28 million and $45
million for the three and six months ended June 30, 1999, respectively, and a
provision for income taxes of $18 million and a benefit for income taxes of $14
million, respectively, for the comparable 1998 periods. Excluding any
restructuring and other charges recorded during
17
<PAGE> 18
these periods, the effective tax rate was approximately 37% for the three and
six months ended June 30, 1999 and 38% for the three and six months ended June
30, 1998.
RESTRUCTURINGS
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 also
decided to close its corporate office and move from Chicago, Illinois to
Horsham, Pennsylvania, which was completed during the first quarter of 1998.
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. As a result of the above actions, the Company recorded a pre-tax
charge of $36 million during the fourth quarter of 1997 (see Note 7). These
restructuring costs provided cost savings in certain satellite production
processes; however, declining demand for certain satellite products has
substantially offset the 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 (see
Note 7). Of these charges, $9 million were recorded as cost of sales, $6 million
as SG&A expense and $1 million as R&D expense.
In the first quarter of 1999, in connection with the announcement of the
PRIMESTAR developments, the Company evaluated its overhead structure and has
taken steps to further consolidate its San Diego, California and Horsham,
Pennsylvania operations, including reducing headcount by approximately 200. The
Company recorded a pre-tax charge of approximately $15 million during the first
quarter of 1999 which primarily included $6 million for severance costs, $6
million for the write-down of PRIMESTAR related inventory to its lower of cost
or market, $2 million for the write-down of fixed assets used to manufacture
PRIMESTAR products to their estimated fair values and $1 million of facility
costs (see Note 7). Of these charges, $8 million were recorded as cost of sales
and $7 million were recorded as SG&A expense.
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, shutdown expenses and legal fees. The above charges
totaled $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 expense-net," related to costs
incurred by the Partnership, which the Company accounts for under the equity
method. Such costs are primarily related to a $5 million litigation settlement
and compensation expense related to key executives of an acquired company (see
Note 8).
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended June 30, 1999 and 1998, cash provided by operations
was $210 million and $35 million, respectively. Cash provided by operations in
the first half of 1999 primarily represents net income excluding non-cash
charges and reductions in accounts receivable and inventory balances. Cash
provided by operations in the first half of 1998 primarily reflects net income
excluding non-cash charges cash generated by the broadband and satellite
businesses, partially offset by the funding provided to the Partnership related
to its R&D activities and payments related to the restructuring.
At June 30, 1999, working capital (current assets less current liabilities)
was $666 million compared to $437 million at December 31, 1998. The Company
believes that working capital levels are appropriate to support the growth of
the
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<PAGE> 19
business; however, there can be no assurance that future industry-specific
developments or general economic trends will not alter the Company's working
capital requirements.
During the six months ended June 30, 1999 and 1998, the Company invested $31
million and $40 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 $70 million. The Company's R&D expenditures
were $83 million and $158 million (including the $75 million funding related to
the Partnership's R&D activities) during the first half of 1999 and 1998,
respectively. The Company expects total R&D expenditures to approximate $170
million for the year ending December 31, 1999.
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 in comparison to net interest expense of greater than 5 to
1; and (iii) maintenance of a leverage ratio comparing total indebtedness to
EBITDA of less than 3 to 1. None of the restrictions contained in the Credit
Agreement is expected to have a significant effect on the Company's ability to
operate. As of June 30, 1999, the Company was in compliance with all financial
and operating covenants contained in the Credit Agreement and had available
credit of $500 million.
In April 1999, the Company repurchased 5.3 million shares of its Common
Stock from two partnerships affiliated with Forstmann Little & Co. for $148
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 10).
The Partnership is a leading provider of next-generation integrated full
service digital loop carrier and fiber-to-the-curb systems that deliver
telephony, video and data for local telephone companies. The Partnership's
product, NLevel(3)(R), is designed to permit the cost effective delivery of a
suite of standard and advanced telephony services over twisted pair networks,
including high-speed data/Internet, distance learning, video services as well as
basic telephone services, to the home from a single access platform. The
Partnership has incurred net losses since inception and expects to continue to
operate at a loss through the year 2000 as the market for its products develops.
In order to position its products for mass commercial deployment, the
Partnership expects that product development efforts will continue to require
substantial investments. As such, during 1998, the Company agreed to make
additional equity investments in the Partnership, aggregating $50 million,
beginning in November 1998, to fund the Partnership's growth and assist the
Partnership in meeting its forecasted working capital requirements. The Company
completed these equity investments in the second quarter of 1999. The Company
accounts for its investment in the Partnership using the equity method and
records such investment in other assets. As of June 30, 1999, the Company
believes its recorded investment in the Partnership is recoverable. Based on the
Partnership's current cash flow projections for 1999, additional capital will be
required in the latter part of 1999 to fund its operations. The Partnership has
several alternatives to obtain the required capital, including additional equity
contributions from its partners, private placement financing and/or an initial
public offering.
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 and capital expenditures. There can be no assurance, however, that
future industry-
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<PAGE> 20
specific developments or general economic trends will not adversely affect the
Company's operations or its ability to meet its cash requirements.
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
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 1998 and have remained at these levels during 1999. There can
be no assurance that international sales will increase to historical levels in
the near future.
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.
READINESS FOR YEAR 2000
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 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.
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<PAGE> 21
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 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
developed a comprehensive Year 2000 test plan and test methodologies for the
testing of its products, as well as third-party products. 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 yet to be Completed" and "Testing not Required." The
creation of these six categories has assisted 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 identifies available upgrades, as well as the contemplated
completion date of testing and remediation for such products. In addition, the
Company has provided detailed, customer-specific inventory information to major
customers on a product-by-product basis in order to further assist such
customers with their own Year 2000 compliance programs. In furtherance of
providing information about its Year 2000 testing and remediation program, the
Company has disclosed its test plan and methodologies to certain of its
customers, strategic vendors and business partners. The Company is also
participating in industry-wide joint system testing efforts and has participated
in industry-wide forums with the Federal Communications Commission in order to
facilitate awareness in the industry of Year 2000 Issues.
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 and the Company's own internal testing, the Company
believes that 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. In conjunction with the
Company's review of internal IT systems, the Company engaged an outside
consulting firm with Year 2000 consulting experience to perform an assessment of
the Company's processes and test methodologies and to benchmark such plans and
methodologies against the practices of other companies. Based on these benchmark
comparisons, certain recommendations were made related to the test plans. The
Company is currently addressing these recommendations. 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 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 products and systems.
The Company has prioritized its testing and remediation work, focusing on
products which the Company believes are more likely to be impacted by Year 2000
Issues. The Company has completed the testing and remediation (as necessary) of
the majority of its products in accordance with its adopted test plans and
methodologies and is diligently working to complete testing and remediation (if
necessary) of the remainder of its products (except for end of life products) by
the end of the third quarter of 1999. As of June 30, 1999, the Company estimates
that it has completed approximately 95% of the Year 2000 readiness analysis
required for its Advanced Network Systems, Digital Network Systems and
Transmission Network Systems products. As of June 30, 1999, the Company
estimates that it has completed approximately 80% 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 (if necessary) is currently
anticipated to be completed during the fourth quarter of 1999. The Company has
completed testing and remediation of substantially all of its IT and non IT
internal systems, with the exception of certain minor systems which the Company
expects to complete by the end of the third quarter of 1999.
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<PAGE> 22
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 June 30, 1999, 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 is currently focused on obtaining Year 2000
Certifications or assurances from approximately 50 of these suppliers. The
Company anticipates that this evaluation will be on-going through the remainder
of 1999. To date, no significant problems have been discovered.
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 June 30, 1999, the Company has spent
approximately $2.5 million 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 used for Year 2000 remediation was less than 3% and is
expected to represent less than 3% of the IT budget for 1999. 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 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
The Company is evaluating the need for certain contingency plans 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. For example,
the Company is in the process of developing plans and procedures for its
customer service division to assist customers with the transition through the
Year 2000. Part of this plan will include processes and procedures recently used
by the Company in connection with a program to upgrade a substantial number of
analog addressable controllers to solve a date rollover issue prior to the year
1999. The Company is also evaluating the need for increasing inventory levels of
key components of its manufactured products. Since the Company's Year 2000
compliance program is ongoing, its ultimate scope, as well as the consideration
of additional 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
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<PAGE> 23
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 capital 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 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 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 June 30, 1999, a hypothetical 10% fluctuation in the exchange rate
of foreign currencies applicable to the Company, principally the new Taiwan
dollar, would result in a net $4 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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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
Distribution, by allegedly making false and misleading statements and failing to
disclose material facts about the Distributing Company's planned shipments in
1995 of its CFT2200 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
Distribution, 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 certain 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' motion 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. In November 1998, the defendants filed an answer to the derivative
action, denying liability. On January 21, 1999, the plaintiffs in the class
actions filed their motion for class certification, including the defendants'
opposition. The Company intends to vigorously contest these actions.
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 an amended complaint,
which contains 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 November, 1998,
the defendants filed an answer to the remaining parts of the amended complaint,
denying liability. The Company intends to vigorously contest this action.
In connection with the Distribution, the Company has agreed to indemnify
General Semiconductor with respect to 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 moved to dismiss the remaining counts of the complaint.
That motion was denied on March 31, 1999 and defendants' answer was filed on
June 25, 1999. On July 30, 1999, defendants filed a motion seeking
reconsideration of the denial of their motion to dismiss. The Company intends to
vigorously contest this action.
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On March 5, 1998, an action entitled DSC Communications Corporation and DSC
Technologies Corporation v. Next Level Communications L.P., KK Manager, L.L.C.,
General Instrument Corporation and Spencer Trask & Co., Inc. was filed in the
Superior Court of the State of Delaware in and for New Castle County (the
"Delaware Action"). In that action, DSC Communications Corporation and DSC
Technologies Corporation (collectively, "DSC") alleged that in connection with
the formation of the Partnership and the transfer to it of NLC's switched
digital video technology, the Partnership and KK Manager, L.L.C. misappropriated
DSC's trade secrets; that the Company improperly disclosed trade secrets when it
conveyed such technology to the Partnership; and that Spencer Trask & Co., Inc.
conspired to misappropriate DSC's trade secrets. The plaintiffs sought actual
damages for the defendants' purported unjust enrichment, disgorgement of
consideration, exemplary damages and attorney's fees, all in unspecified
amounts. In April 1998, the Company and the other defendants filed an action in
the United States District Court for the Eastern District of Texas, requesting
that the federal court preliminarily and permanently enjoin DSC from prosecuting
the Delaware Action because by pursuing such action, DSC effectively was trying
to circumvent and relitigate the Texas federal court's November 1997 judgment in
a previous lawsuit involving DSC, pursuant to which NLC had paid over $140
million. On May 14, 1998, the Texas court granted a preliminary injunction
preventing DSC from proceeding with the Delaware Action. That injunction order
was appealed to the United States Court of Appeals for the Fifth Circuit. On
June 21, 1999, the Fifth Circuit affirmed the Texas federal court's grant of the
preliminary injunction. On July 15, 1999, the Texas federal court granted the
Delaware defendants' motion for summary judgment and issued its final judgment
permanently enjoining DSC from prosecuting and continuing the Delaware Action.
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 (as specified below). The first
part of a bifurcated arbitration proceeding, relating to the Company's advanced
analog products, began on March 22, 1999 before an arbitration panel of the
American Arbitration Association in San Francisco, California. Oral arguments to
the panel by the Company and StarSight were concluded on May 23, 1999. The
Company and StarSight have submitted post-hearing filings to the arbitration
panel, and the Company now expects to receive a decision from the panel toward
the end of the third quarter or in the fourth quarter of 1999. At the
arbitration proceeding, StarSight identified purported damages arising from the
sale by the Company of advanced analog set top boxes containing a native
electronic program guide. StarSight alleged that it is entitled to collect $52
million to $177 million in compensatory damages and an unspecified amount of
punitive damages. The Company has denied liability and presented evidence
disputing both StarSight's damages theories and amounts in the event that
liability were to be found. A separate hearing relating to certain of the
Company's digital set top boxes and satellite products is currently scheduled
for mid-September, 1999. The Company continues to vigorously contest this
action.
On November 30, 1998, an action entitled Gemstar Development Corporation
and Index Systems, Inc. v. General Instrument Corporation was filed in the
United States District Court for the Northern District of California. The
complaint alleges infringement by the Company of two U.S. patents allegedly
covering electronic program guides. The complaint seeks unspecified damages and
an injunction. The plaintiffs sought to consolidate discovery for this action
with other program guide related patent infringement actions pending against
Pioneer Electronics Corp., Scientific-Atlanta, Inc., and Prevue Networks, Inc.
On April 26, 1999, the Judicial Panel on Multidistrict Litigation ordered the
transfer of this action to the Northern District of Georgia for consolidated
pretrial proceedings with the Pioneer Electronics Corp. and Scientific-Atlanta,
Inc. actions. The Company denies that it infringes the subject patents and
intends to vigorously defend this action.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were voted upon at the Annual Meeting of
Stockholders of General Instrument Corporation held in Philadelphia,
Pennsylvania on May 25, 1999:
(a) On the election of the following nominees as Class II directors of the
Company for terms ending at the 2002 Annual Meeting of Stockholders:
<TABLE>
<CAPTION>
NUMBER OF VOTES
---------------
For Withheld
--- --------
<S> <C> <C>
John Seely Brown 157,057,874 664,607
Frank M. Drendel 157,053,466 669,015
Lynn Forester 157,049,800 672,681
</TABLE>
(b) To approve the General Instrument Corporation 1999 Long-Term Incentive Plan:
<TABLE>
<CAPTION>
NUMBER OF VOTES
---------------
For Against Abstentions Broker Non-Votes
--- ------- ----------- ----------------
<S> <C> <C> <C>
115,585,554 27,182,061 410,286 33,986,356
</TABLE>
(c) To ratify the appointment by the Board of Directors of the Company of
Deloitte & Touche LLP as independent auditor for the Company for the 1999
fiscal year:
<TABLE>
<CAPTION>
NUMBER OF VOTES
---------------
For Against Abstentions
--- ------- -----------
<S> <C> <C>
157,227,332 224,491 270,658
</TABLE>
26
<PAGE> 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.1*+ General Instrument Corporation 1999 Long-Term Incentive Plan
Exhibit 27 Financial Data Schedule
Exhibit 99 Forward-Looking Information
* Incorporated herein by reference to Annex A of the Company's Definitive
Proxy Statement on Schedule 14A filed with the SEC on April 14, 1999
(SEC File Number 001-12925)
+ Management contract or compensatory plan
(b) Reports on Form 8-K
The Company filed on April 2, 1999 a Current Report on Form 8-K dated July
31, 1998, including in Item 7 of such report the following financial
statements related to an acquisition of certain assets: (i) Hits Access and
Control Division Combined Financial Statements as of and for the years ended
December 31, 1997 and 1996 and as of and for the six months ended June 30,
1998 and 1997; and (ii) Unaudited Pro Forma Consolidated Financial
Statements of the Company to reflect the acquisition of certain assets of
the Hits Access and Control Division.
The Company filed a Current Report on Form 8-K dated April 5, 1999,
reporting in Item 5 of such report the signing of a definitive agreement to
repurchase 5.3 million shares of the Company's common stock from two
partnerships affiliated with Forstmann Little & Co for an aggregate cash
purchase price of $148,400,000.
27
<PAGE> 28
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.
GENERAL INSTRUMENT CORPORATION
/s/ Marc E. Rothman
--------------- -------------------
Marc E. Rothman
Vice President, Financial
Planning & Controller
(Signing both in his
capacity as Vice President
on behalf of the Registrant
and as chief accounting
officer of the Registrant)
August 12, 1999
- -----------------------
Date
28
<PAGE> 29
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION
Exhibit 10.1*+ General Instrument Corporation 1999 Long-Term Incentive Plan
Exhibit 27 Financial Data Schedule
Exhibit 99 Forward-Looking Information
* Incorporated herein by reference to Annex A of the Company's Definitive
Proxy Statement on Schedule 14A filed with the SEC on April 14, 1999 (SEC
File Number 001-12925)
+ Management contract or compensatory plan
29
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF GENERAL INSTRUMENT CORPORATION AS OF AND FOR THE SIX
MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 364,961
<SECURITIES> 86,191
<RECEIVABLES> 299,257
<ALLOWANCES> (1,807)
<INVENTORY> 235,269
<CURRENT-ASSETS> 1,056,089
<PP&E> 534,901
<DEPRECIATION> (300,788)
<TOTAL-ASSETS> 2,355,014
<CURRENT-LIABILITIES> 389,885
<BONDS> 0
0
0
<COMMON> 1,809
<OTHER-SE> 1,880,863
<TOTAL-LIABILITY-AND-EQUITY> 2,355,014
<SALES> 1,046,091
<TOTAL-REVENUES> 1,046,091
<CGS> 749,887
<TOTAL-COSTS> 749,887
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,089
<INCOME-PRETAX> 122,150
<INCOME-TAX> (45,195)
<INCOME-CONTINUING> 76,955
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 76,955
<EPS-BASIC> 0.44
<EPS-DILUTED> 0.41
</TABLE>
<PAGE> 1
EXHIBIT 99
GENERAL INSTRUMENT CORPORATION
EXHIBIT 99 -- FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. The Company's Form 10-K, the Company's
Annual Report to Stockholders, any Form 10-Q or Form 8-K of the Company, or any
other oral or written statements made by or on behalf of the Company, may
include forward-looking statements which reflect the Company's current views
with respect to future events and financial performance. 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," and "scheduled" and similar expressions. These
forward-looking statements are subject to certain uncertainties and other
factors that could cause actual results to differ materially from such
statements. 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 undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
The actual results of the Company may differ significantly from the results
discussed in forward-looking statements. Factors that might cause such a
difference include, but are not limited to, uncertainties relating to general
political, economic and competitive conditions in the United States and other
markets where the Company operates; 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
capital 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; authoritative generally accepted accounting principles or policy
changes from such standard-setting bodies as the Financial Accounting Standards
Board and the Securities Exchange Commission; and the factors as set forth
below.
FACTORS RELATING TO THE DISTRIBUTION
In a transaction that was consummated on July 28, 1997, the former General
Instrument Corporation (the "Distributing Company") (i) transferred all the
assets and liabilities relating to the manufacture and sale of broadband
communications products used in the cable television, satellite, and
telecommunications industries to the Company (which was then named "NextLevel
Systems, Inc." and was a wholly-owned subsidiary of the Distributing Company)
and transferred 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") and (ii) then distributed all of the outstanding
shares of capital stock of each of the Company and CommScope to its stockholders
on a pro rata basis as a dividend (the "Distribution"). Immediately following
the Distribution, the Distributing Company changed its corporate name to
"General Semiconductor, Inc." ("General Semiconductor"). Effective February 2,
1998, the Company changed its corporate name from "NextLevel Systems, Inc." to
"General Instrument Corporation."
The Distribution Agreement, dated as of June 12, 1997, among the Company,
CommScope and the Distributing Company (the "Distribution Agreement") and
certain other agreements executed in connection with the Distribution
(collectively, the "Ancillary Agreements") allocate among the Company,
CommScope, and General Semiconductor and their respective subsidiaries
responsibility for various indebtedness, liabilities and obligations. It is
possible that a court would disregard this contractual allocation of
indebtedness, liabilities and obligations among the parties and require the
Company or its subsidiaries to assume responsibility for obligations allocated
to another party, particularly if such other party were to refuse or was unable
to pay or perform any of its allocated obligations.
Pursuant to the Distribution Agreement and certain of the Ancillary
Agreements, the Company has agreed to indemnify the other parties (and certain
related persons) from and after consummation of the Distribution with respect to
certain indebtedness, liabilities and obligations, which indemnification
obligations could be significant.
Although the Distributing Company has received a favorable ruling from the
Internal Revenue Service, if the Distribution were not to qualify as a tax free
spin-off (either because of the nature of the Distribution or because of events
occurring after the Distribution) under Section 355 of the Internal Revenue Code
of 1986, as amended, then, in
<PAGE> 2
general, a corporate tax would be payable by the consolidated group of which the
Distributing Company was the common parent based upon the difference between the
fair market value of the stock distributed and the Distributing Company's
adjusted basis in such stock. The corporate level tax would be payable by
General Semiconductor and could substantially exceed the net worth of General
Semiconductor. However, under certain circumstances, the Company and CommScope
have agreed to indemnify General Semiconductor for such tax liability. In
addition, under the consolidated return rules, each member of the consolidated
group (including the Company and CommScope) is severally liable for such tax
liability.
DEPENDENCE OF THE COMPANY ON THE CABLE TELEVISION INDUSTRY AND
CABLE TELEVISION CAPITAL SPENDING
The majority of the Company's revenues come from sales of systems and
equipment to the cable television industry. Demand for these products depends
primarily on capital spending by cable television system operators for
constructing, rebuilding or upgrading their systems. The amount of this capital
spending, and, therefore the Company's sales and profitability, may be affected
by a variety of factors, including general economic conditions, the continuing
trend of cable system consolidation within the industry, the financial condition
of domestic cable television system operators and their access to financing,
competition from direct-to-home ("DTH"), satellite, wireless television
providers and telephone companies offering video programming, technological
developments that impact the deployment of equipment and new legislation and
regulations affecting the equipment used by cable television system operators
and their customers. There can be no assurance that cable television capital
spending will increase from historical levels or that existing levels of cable
television capital spending will be maintained.
Although the domestic cable television industry is comprised of thousands of
cable systems, a small number of large cable television multiple systems
operators ("MSOs") own a majority of cable television systems. As a result, a
relatively small number of customers has historically accounted for a large
portion of the Company's revenues, and this trend is expected to continue. Sales
to the Company's single largest customer represented 30% and 31% of total
Company sales for the six months ended June 30, 1999 and the year ended December
31, 1998, respectively. For the same periods, the Company's top five MSO
customers accounted for 52% and 54%, respectively, of the Company's total sales.
Because a small number of MSOs account for a majority of the Company's revenues,
the Company's future success will depend on its ability to develop and maintain
relationships with these companies. The loss of business from a significant MSO
could have a material adverse effect on the business of the Company. Because
significant consolidation is occurring among cable television operators, the
risk to the Company from the concentration of its customer base is increasing.
THE IMPACT OF REGULATION AND GOVERNMENT ACTION
In recent years, cable television capital spending has been affected by new
legislation and regulation, on the federal, state and local level, and many
aspects of such regulation are currently the subject of judicial proceedings and
administrative or legislative proposals. During 1993 and 1994, the Federal
Communications Commission (the "FCC") adopted rules under the Cable Television
Consumer Protection and Competition Act of 1992 (the "1992 Cable Act"),
regulating rates that cable television operators may charge for lower tiers of
service and generally not regulating the rates for higher tiers of service. In
1996, the Telecommunications Act of 1996 (the "Telecom Act") was enacted to
eliminate certain governmental barriers to competition among local and long
distance telephone, cable television, broadcasting and wireless services. The
FCC is continuing its implementation of the Telecom Act which, when fully
implemented, may significantly impact the communications industry and alter
federal, state and local laws and regulations regarding the provision of cable
and telephony services. Among other things, the Telecom Act eliminates
substantially all restrictions on the entry of telephone companies and certain
public utilities into the cable television business. Telephone companies may now
enter the cable television business as traditional cable operators, as common
carrier conduits for programming supplied by others, as operators of wireless
distribution systems, or as hybrid common carrier/cable operator providers of
programming on so-called "open video systems." The economic impact of the 1992
Cable Act, the Telecom Act and the rules thereunder on the cable television
industry and the Company is still uncertain.
On June 24, 1998, the FCC released a Report and Order entitled In the Matter
of Implementation of Section 304 of the Telecommunications Act of 1996 -
Commercial Availability of Navigation Devices (the "Retail Sales Order"), which
promulgates rules providing for the commercial availability of navigation
devices, including set-top devices and other consumer equipment, used to receive
video signals and other services from multichannel video programming
distributors ("MVPDs"), including cable television system operators. The Retail
Sales Order mandates that (i) subscribers have a right to attach any compatible
navigation device to an MVPD system regardless of its
<PAGE> 3
source and (ii) service providers are prohibited from taking actions which would
prevent navigation devices that do not perform conditional access functions from
being made available by retailers, manufacturers, or other affiliated vendors.
To accomplish subscribers' right to attach, the FCC has ordered that (i) MVPDs
must provide technical information concerning interface parameters necessary to
permit navigation devices to operate with their systems; (ii) MVPDs must
separate out security functions from non-security functions by July 1, 2000; and
(iii) after January 1, 2005, MVPDs may not provide new navigation devices for
sale, lease or use that perform both conditional access functions and other
functions in a single integrated device.
Unless modified or overturned, the Retail Sales Order will require set-top
device manufacturers, such as the Company, to develop a separate security module
to be available for sale to other manufacturers who want to build set-top
devices, as well as ultimately prevent the Company from offering set-top devices
in which the security and non-security functions are integrated. In addition,
the Retail Sales Order may require the Company to offer its set-top devices
through retail distribution channels, an area in which the Company has limited
experience. The competitive impact of the Retail Sales Order is still uncertain,
and there can be no assurance that the Company will be able to compete
successfully with other consumer electronics manufacturers interested in
manufacturing set-top devices, many of which have greater resources and retail
sales experience than the Company.
There can be no assurance that future legislation, regulations or government
action will not have a material adverse effect on the operations and financial
condition of the Company.
TELECOMMUNICATIONS INDUSTRY COMPETITION AND TECHNOLOGICAL CHANGES AFFECTING THE
COMPANY
The Company will be significantly affected by the competition among cable
television system operators, satellite television providers and telephone
companies to provide video, voice and data/Internet services. In particular,
although cable television operators have historically provided television
services to the majority of U.S. households, DTH satellite television has
attracted a growing number of subscribers and the regional telephone companies
have begun to offer competing cable and wireless cable services. This
competitive environment is characterized by rapid technological changes,
particularly with respect to developments in digital compression and broadband
access technology.
The Company believes that, as a result of its development of new products
based on emerging technologies and the diversity of its product offerings, it is
well positioned to supply each of the cable, satellite and telephone markets.
The future success of the Company, however, will be dependent on its ability to
market and deploy these new products successfully and to continue to develop and
timely exploit new technologies and market opportunities both in the United
States and internationally. There can be no assurance that the Company will be
able to continue to successfully introduce new products and technologies, that
it will be able to deploy them successfully on a large-scale basis or that its
technologies and products will achieve significant market acceptance. The future
success of the Company will also be dependent on the ability of cable and
satellite television operators to successfully market the services provided by
the Company's advanced digital terminals to their customers. Further, there can
be no assurance that the development of products using new technologies or the
increased deployment of new products will not have an adverse impact on sales by
the Company of certain of its other products. For example, sales of analog cable
products have been impacted by a shift to digital deployment in North America.
INTELLECTUAL PROPERTY
Because the Company's products are based on complex, rapidly-developing
technologies, the Company has been, and could in the future be, made a party to
litigation regarding intellectual property matters. The Company has from time to
time been notified of allegations that it may be infringing certain patents and
other intellectual property rights of others. The adverse resolution of any
third party infringement claim could subject the Company to substantial
liabilities and could require the Company to refrain from manufacturing or
selling certain products. In addition, the costs incurred in intellectual
property litigation can be substantial, regardless of the outcome. It may be
necessary or desirable in the future to obtain licenses relating to one or more
products or relating to current or future technologies, and there can be no
assurance that the Company will be able to obtain these licenses or other rights
or obtain such licenses or rights on commercially reasonable terms.
<PAGE> 4
COMPETITION
The Company's products compete with those of a substantial number of foreign
and domestic companies, some with greater resources, financial or otherwise,
than the Company, and the rapid technological changes occurring in the Company's
markets are expected to lead to the entry of new competitors. The Company's
ability to anticipate technological changes and to introduce enhanced products
on a timely basis will be a significant factor in the Company's ability to
expand and remain competitive. Existing competitors' actions and new entrants
may have an adverse impact on the Company's sales and profitability. For a
discussion of competitive factors in regards to retail consumer electronic
manufacturers see "The Impact of Regulation and Government Action". The Company
believes that it enjoys a strong competitive position because of its large
installed cable television equipment base, its strong relationships with the
major cable television system operators, its technological leadership and new
product development capabilities, and the likely need for compatibility of new
technologies with currently installed systems. However, the focus by several
industry groups and the Federal government on uniform standards for
interoperability of devices will likely increase competition for the Company's
products by enabling competitors to develop systems compatible with, or that are
alternatives to, the Company's products.
INTERNATIONAL OPERATIONS; FOREIGN CURRENCY RISKS
U.S. broadband system designs and equipment are being employed in
international markets, where cable television penetration is low. In addition,
the Company is developing new products to address international market
opportunities. However, the impact of the economic crises in Asia and Latin
America has significantly affected the Company's results in these markets. There
can be no assurance that international markets will rebound to historical levels
or that such markets will continue to develop or that the Company will receive
additional contracts to supply systems and equipment in international markets.
International exports of certain of the Company's products require export
licenses issued by the U.S. Department of Commerce prior to shipment in
accordance with export control regulations. The Company has made a voluntary
disclosure to the U.S Department of Commerce with respect to several violations
by the Company of these export control regulations. While the Company does not
expect these violations to have a material adverse effect on the Company's
operations or financial condition, there can be no assurance that these
violations will not result in the imposition of sanctions or restrictions on the
Company.
A significant portion of the Company's products are manufactured or
assembled in Taiwan and Mexico. In addition, the Company's operations are
expanding into new international markets. These foreign operations are subject
to the usual risks inherent in situating operations abroad, including risks with
respect to currency exchange rates, economic and political destabilization,
restrictive actions by foreign governments, nationalizations, the laws and
policies of the United States affecting trade, foreign investment and loans, and
foreign tax laws. The Company's cost-competitive status relative to other
competitors could be adversely affected if the New Taiwan dollar, Mexican peso
or another relevant currency appreciates relative to the U.S. dollar because
this appreciation will make the Company's products manufactured and assembled in
Taiwan or Mexico more expensive when priced in U.S. Dollars.
YEAR 2000 READINESS
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 be exposed to risks from third parties with
whom the Company interacts who fail to adequately address their own Year 2000
issues.
There can be no assurance that the Company will be successful in its efforts
to address all of its 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 condition.
<PAGE> 5
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 condition.
For example, the failure of certain of the Company's principal suppliers to have
Year 2000 compliant internal 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 Year 2000 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.
ENVIRONMENT
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 financial condition.
The Company's present and past facilities have been in operation for many
years, and over that time in the course of those operations, such facilities
have used substances which are or might be considered hazardous, and the Company
has generated and disposed of wastes which are or might be considered hazardous.
Therefore, it is possible that additional environmental issues may arise in the
future, which the Company cannot now predict.
