<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 24, 1998
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
---------------
TERAYON COMMUNICATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
---------------
DELAWARE 3661 77-0328533
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
---------------
2952 BUNKER HILL LANE
SANTA CLARA, CA 95054
(408) 727-4400
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
DR. ZAKI RAKIB
CHIEF EXECUTIVE OFFICER
TERAYON COMMUNICATION SYSTEMS, INC.
2952 BUNKER HILL LANE
SANTA CLARA, CA 95054
(408) 727-4400
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------
COPIES TO:
JAMES C. GAITHER NEIL WOLFF
KARYN R. SMITH YOICHIRO TAKU
PETER M. O. WONG BENJAMIN CHUN
COOLEY GODWARD LLP WILSON SONSINI GOODRICH & ROSATI
ONE MARITIME PLAZA PROFESSIONAL CORPORATION
20TH FLOOR 650 PAGE MILL ROAD
SAN FRANCISCO, CA 94111 PALO ALTO, CA 94304
(415) 693-2000 (650) 493-9300
---------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the Registration Statement becomes effective.
---------------
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
number for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
---------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
======================================================================================
PROPOSED PROPOSED
AMOUNT MAXIMUM MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE FEE
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$.001 per share....... 3,450,000 $29.594 $102,098,438 $28,384
======================================================================================
</TABLE>
(1) Includes 450,000 shares which the Underwriters have the option to purchase
to cover over-allotments, if any.
(2) Estimated solely for the purpose of computing the registration fee.
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(a)
================================================================================
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE +
+CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT +
+FILED WITH THE SECURITIES AND EXCHANGE COMMISSION BECOMES EFFECTIVE. THIS +
+PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES NOR DOES IT +
+SEEK OFFERS TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR +
+SALE IS NOT PERMITTED. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
DECEMBER 24, 1998
3,000,000 SHARES
[LOGO OF TERAYON APPEARS HERE]
COMMON STOCK
--------
Terayon Communication Systems, Inc. is offering 1,750,000 shares. The selling
stockholders identified in this prospectus are offering an additional 1,250,000
shares. Terayon will not receive any of the proceeds from the sale of shares by
the selling stockholders.
Terayon's Common Stock is traded on the Nasdaq National Market under the
symbol "TERN." On December 23, 1998, the last reported sale price for the
Common Stock on the Nasdaq National Market was $36.50 per share.
INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public offering price........................................ $ $
Underwriting discount........................................ $ $
Proceeds, before expenses, to Terayon........................ $ $
Proceeds, before expenses, to the selling stockholders....... $ $
</TABLE>
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
Terayon and certain selling stockholders have granted the underwriters the
right to purchase up to 450,000 additional shares at the public offering price
to cover any over-allotments.
-----------
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares against payment in Baltimore,
Maryland on , 1999.
BT ALEX. BROWN
HAMBRECHT & QUIST
LEHMAN BROTHERS
SALOMON SMITH BARNEY
, 1999
<PAGE>
TERAYON'S BROADBAND ROADMAP
GRAPHIC CONSISTING OF A DEPICTION OF THE FOLLOWING COMPONENTS OF BROADBAND
COMMUNICATIONS SOLUTIONS:
S-CDMA CABLE MODEM SYSTEM
STANDARDS-BASED DOCSIS MODEM SYSTEM
TECHNOLOGY LEADERSHIP
SET-TOP BOXES
IP AND CIRCUIT TELEPHONY
TeraComm, TeraLink, TeraPro, TeraView and Terayon are our trademarks. All
other trademarks or service marks appearing in this prospectus are the property
of their respective owners.
2
<PAGE>
[GATEFOLD]
TERAYON CABLE MODEM SYSTEMS:
BROADBAND INNOVATION
INTERNET CABLE HEADEND COAX OR HFC CORPORATE OFFICE
PRIVATE BACKBONE TERALINK GATEWAY COAX OR HFC TERAPRO CABLE MODEM
NETWORK
TERALINK MASTER COAX OR HFC SMALL BUSINESS
CONTROLLER
TERAVIEW ELEMENT RESIDENTIAL
MANAGEMENT SOFTWARE
[GRAPHIC DEPICTING THE COMPONENTS OF THE
TERACOMM SYSTEM AND POTENTIAL USERS OF THE SYSTEM]
CAPTIONS:
S-CDMA CORE TECHNOLOGY. Terayon's S-CDMA technology allows cable operators to
provide reliable, high capacity communications over more cable systems than
alternative broadband access technologies.
STANDARDS-BASED ROADMAP. Terayon has been selected by CableLabs to co-author
an enhanced version of the DOCSIS cable modem specification based in part on
Terayon's S-CDMA technology.
FLEXIBLE ARCHITECTURE. The Terayon system can be deployed on any cable
infrastructure, from pure coaxial systems to hybrid fiber/coax ("HFC") upgraded
systems, providing cable operators fast time to market for cost-effective
broadband access.
ECONOMIC ADVANTAGE. The Terayon system does not require costly cable
infrastructure upgrades, allowing cable operators to provide broadband access
services at low start-up costs. The system also supports tiered levels of
service, which provide additional revenue opportunities for cable operators.
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information and financial statements and notes thereto appearing elsewhere in
this prospectus. Except as otherwise specified, all information in this
prospectus assumes no exercise of the Underwriters' overallotment option.
This prospectus contains forward-looking statements. The outcome of the
events described in these forward-looking statements is subject to risks and
actual results could differ materially. The sections entitled "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" contain a discussion of some of the factors that
could contribute to those differences.
TERAYON
We develop, market and sell cable modem systems that enable cable operators
to cost-effectively deploy reliable two-way broadband access services. Our
TeraComm system is designed to enable cable operators to maximize the capacity
and reliability of broadband access services over any cable plant. This allows
cable operators to minimize time-consuming and costly network infrastructure
upgrades, achieve reduced time to market and provide a wide range of service
levels to residential and commercial end users. Cable operators using the
TeraComm system can provide additional revenue-generating services to end
users. This enables cable operators to compete effectively in the emerging
market for broadband access services.
In recent years, the volume of bandwidth intensive data, voice and video
traffic across the Internet, corporate intranets and other public networks has
increased dramatically. International Data Corporation estimates that the
number of Internet users will increase from approximately 69 million at the end
of 1997 to approximately 320 million by the end of 2002. IDC also estimates
that the number of home office households will increase from approximately 35
million at the end of 1997 to approximately 50 million by the end of 2002.
Although various technologies have emerged to address the need for broadband
access, the existing cable infrastructure currently provides the highest
available two-way transmission speeds and "always-on" availability. In
addition, the existing cable infrastructure currently passes more than 95% of
homes in the U.S. and a large number of small businesses.
The TeraComm system is based on our Synchronous Code Division Multiple Access
or "S-CDMA" technology. The TeraComm system is comprised of the TeraPro cable
modem, the TeraLink 1000 Master Controller, the TeraLink Gateway, and the
TeraView Element Management and Provisioning Software. Our S-CDMA technology
enables reliable two-way broadband communications over both pure coaxial and
hybrid fiber/coax cable infrastructure. It does this by maximizing resistance
to noise that interferes with data transmissions over previously unusable
frequency spectrum. In November 1998, CableLabs selected us to co-author an
enhanced version of the DOCSIS cable modem specifications based in part on our
S-CDMA technology.
Our objective is to be the leading provider of cable modem systems to cable
operators seeking to provide broadband access services to residential and
commercial end users. Key elements of our strategy include the following:
. supply leading cable operators worldwide;
. advance industry standards;
. extend technology leadership and achieve rapid time to market;
3
<PAGE>
. reduce manufacturing costs;
. provide superior customer service and support; and
. increase our presence in existing and new markets.
We sell our products to cable operators through direct sales forces in North
America, Latin America and Europe. We also distribute our products via
distributors and systems integrators. Companies currently using or distributing
our TeraComm system include Shaw Communications Inc., TCA Cable TV, Inc.,
Cablevision Systems, Inc., and Crossbeam Networks Corporation, a wholly owned
subsidiary of Sumitomo Corporation.
Our Company was incorporated in California in January 1993 and reincorporated
in Delaware in July 1998. References in the prospectus to "Terayon," "we,"
"our," "us" and the "Company" refer to Terayon Communication Systems, Inc., a
Delaware corporation, and its subsidiaries. Our executive offices are located
at 2952 Bunker Hill Lane, Santa Clara, California 95054 and our telephone
number is (408) 727-4400. Our Web site is located at www.terayon.com.
Information contained on our Web site does not constitute part of this
prospectus.
RECENT DEVELOPMENTS
. In November 1998, CableLabs selected us to co-author a detailed technical
specification for an enhanced version of the DOCSIS cable modem standard,
based in part on our S-CDMA technology.
. In October 1998, we began volume shipments of our cable modems in a new
single-board design that achieves improved gross margins.
4
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Shares offered by Terayon.................... 1,750,000 shares
Shares offered by the selling stockholders... 1,250,000 shares
Shares to be outstanding after the offering.. 18,122,598 shares(1)
Use of proceeds.............................. For general corporate purposes,
including capital expenditures
and research and development
Nasdaq National Market symbol................ TERN
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------- ------------------
1994 1995 1996 1997 1997 1998
------ ------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Revenues................ $ 140 $ -- $ -- $ 2,118 $ 755 $ 18,776
Cost of goods sold...... -- 676 -- 6,462 2,243 22,023
------ ------- -------- -------- -------- --------
Gross profit (loss)..... 140 (676) -- (4,344) (1,488) (3,247)
------ ------- -------- -------- -------- --------
Operating expenses:
Research and develop-
ment................. 235 2,028 8,020 11,319 8,581 7,702
Sales and marketing... 17 205 1,141 4,468 2,715 4,815
General and adminis-
trative.............. 84 825 1,789 2,546 1,715 2,095
------ ------- -------- -------- -------- --------
Total operating ex-
penses.............. 336 3,058 10,950 18,333 13,011 14,612
------ ------- -------- -------- -------- --------
Loss from operations.... (196) (3,734) (10,950) (22,677) (14,499) (17,859)
Net interest income..... -- 68 253 128 130 26
------ ------- -------- -------- -------- --------
Net loss................ (196) (3,666) (10,697) (22,549) (14,369) (17,833)
Series F convertible
preferred stock divi-
dend(2)................ -- -- -- -- -- (23,910)
------ ------- -------- -------- -------- --------
Net loss applicable to
common stockholders.... $ (196) $(3,666) $(10,697) $(22,549) $(14,369) $(41,743)
====== ======= ======== ======== ======== ========
Historical basic and
diluted net loss per
share applicable to
common
stockholders(3)........ $(0.10) $ (1.02) $ (2.64) $ (5.26) $ (3.39) $ (6.39)
====== ======= ======== ======== ======== ========
Shares used in computing
historical basic and
diluted net loss per
share applicable to
common
stockholders(3)........ 2,000 3,589 4,054 4,289 4,235 6,530
====== ======= ======== ======== ======== ========
Pro forma basic and
diluted net loss per
share applicable to
common
stockholders(3)........ $ (2.07) $ (3.21)
======== ========
Shares used in pro forma
basic and diluted net
loss per share
applicable to common
stockholders(3)........ 10,873 12,991
======== ========
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------
ACTUAL AS ADJUSTED(4)
-------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..... $ 32,584 $
Working capital....................................... 29,731
Total assets.......................................... 48,530
Long-term debt (less current portion)................. 12 12
Accumulated deficit................................... (78,906) (78,906)
Total stockholders' equity............................ $ 33,166 $
</TABLE>
- -------
(1) Based on number of shares outstanding on September 30, 1998. Excludes
2,862,524 shares of common stock reserved for issuance pursuant to our
employee benefit plans, under which options to purchase 2,685,840 shares
were outstanding as of September 30, 1998. Also excludes 3,019,191 shares
issuable upon exercise of outstanding warrants.
(2) See Note 9 of Notes to Consolidated Financial Statements for an explanation
of the convertible preferred stock dividend.
(3) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method employed to determine the number of shares used to compute
per share amounts.
(4) As adjusted reflects the estimated net proceeds from the sale of the
1,750,000 shares of common stock offered by Terayon in this offering, after
deducting the estimated underwriting discount and estimated offering
expenses. See "Use of Proceeds."
5
<PAGE>
RISK FACTORS
This offering involves a high degree of risk. You should carefully consider
the risks and uncertainties described below and the other information in this
prospectus before deciding whether to invest in shares of our common stock. If
any of the following risks actually occur, our business, financial condition
or operating results could be materially adversely affected. This could cause
the trading price of our common stock to decline, and you may lose part or all
of your investment.
This prospectus also contains certain forward-looking statements that
involve risks and uncertainties. These statements relate to our future plans,
objectives, expectations and intentions. These statements may be identified by
the use of words such as "expects," "anticipates," "intends," "plans" and
similar expressions. Our actual results could differ materially from those
discussed in these statements. Factors that could contribute to these
differences include those discussed below and elsewhere in this prospectus.
WE HAVE A LIMITED OPERATING HISTORY AND A HISTORY OF LOSSES.
We have a very limited operating history, and it is difficult to predict our
future operating results. We were incorporated in January 1993 and began
shipping products commercially in June 1997. We have only been shipping
products in volume since the first quarter of 1998. As of September 30, 1998,
we had an accumulated deficit of $78.9 million. We believe that we will
continue to experience net losses for the foreseeable future. Most of our
expenses are fixed in advance, and we generally are unable to reduce our
expenses significantly in the short term to compensate for any unexpected
delay or decrease in anticipated revenues. We expect to increase expense
levels in each of the next several quarters to support increased sales and
marketing and technical support costs. Any significant delay in our
anticipated revenues or commercialization of new products would have an
immediate adverse effect on our business, operating results and financial
condition. The revenue and profit potential of our business and our industry
are unproven. We have had negative gross margins since our inception, and any
future revenue growth may not result in positive gross margins or operating
profits in future periods.
OUR OPERATING RESULTS MAY FLUCTUATE.
Our quarterly revenues are likely to fluctuate significantly in the future
due to a number of factors, many of which are outside our control. Factors
that could affect our revenues include the following:
. variations in the timing of orders and shipments of our products;
. variations in the size of the orders by our customers;
. new product introductions by competitors;
. delays in introducing new products;
. delays of orders forecasted by our customers;
. delays by our customers in the completion of upgrades of cable
infrastructure;
. variations in capital spending budgets of cable operators; and
. delays in obtaining regulatory approval for commercial deployment of
cable modem systems.
Our expenses generally will vary from quarter to quarter depending on the
level of actual and anticipated business activities. Research and development
expenses will vary as we begin development of new products and as our
development programs move to wafer fabrication, which results in higher
engineering expenses.
We have a limited backlog of orders, and net sales for any future quarter
are difficult to predict. Supply, manufacturing or testing constraints could
result in delays in the delivery of our products. Any delay in the product
deployment schedule of one or more of the cable operators that we target would
6
<PAGE>
have an adverse effect on our operating results for a particular period. In
addition, due to the large dollar size of a typical transaction in comparison
to our total revenues, any delay in the closing of a transaction could have a
significant impact on our operating results for a particular period.
A variety of factors affect our gross margin, including the following:
. the sales mix of our products;
. the volume of products manufactured;
. the type of distribution channel through which we sell our products;
. the average selling prices or "ASPs" of our products; and
. the effectiveness of our cost reduction measures.
We anticipate that unit ASPs of our products will decline in the future. This
could cause a decrease in the gross margins for these products. In addition,
the maturity of TeraComm system deployments affects our gross margin. New
deployments of the TeraComm system involve the sale of headend equipment (which
has higher margins) and generally involve smaller quantities of product. New
deployments typically are sold at higher margins than the larger volume sales
of product associated with more mature deployments of the TeraComm system. The
sales mix of TeraLink 1000 Master Controllers, TeraLink Gateways and TeraPro
cable modems also affects our gross margin. The TeraPro cable modems have
significantly lower margins than the TeraLink 1000 Master Controller and
TeraLink Gateway headend products. We expect to achieve only nominal margins on
the TeraPro cable modems for the foreseeable future. Further, we expect that
sales of TeraPro cable modems will continue to constitute a significant portion
of our revenues for the foreseeable future.
WE ARE DEPENDENT ON A SMALL NUMBER OF CUSTOMERS.
Three customers accounted for approximately 73% of our revenues in 1997 and
three customers accounted for approximately 65% of our revenues in the first
nine months of 1998. Of our total revenues in 1997, Telegate Ltd. accounted for
approximately 30%, Sumitomo Corporation accounted for approximately 29% and NET
Brasil S.A. accounted for approximately 14%. Of our total revenues for the nine
months ended September 30, 1998, Shaw Communications Inc. accounted for
approximately 32%, Cablevision Systems, Inc. accounted for approximately 19%
and Sumitomo Corporation accounted for approximately 14%. We believe that a
substantial majority of our revenues will continue to be derived from sales to
a relatively small number of customers for the foreseeable future. In addition,
we believe that sales to these customers will be focused on a small number of
projects. The cable industry is undergoing significant consolidation in the
United States and internationally, and a limited number of cable operators
controls an increasing number of cable systems. As a result, our sales will be
largely dependent upon product acceptance by the leading cable operators. Ten
cable operators in the United States owned and operated facilities passing
approximately 74% of total homes passed in 1997. The timing and size of each
customer's order is critical to our operating results. Our major customers are
likely to have significant negotiating leverage and may attempt to change the
terms, including pricing, upon which we do business with them. These customers
also may require longer payment terms than we anticipate, which could require
us to raise additional capital to meet our working capital requirements. Our
success will depend on our cable modems being widely deployed and our ability
to sell to new customers.
THE SALES CYCLE FOR OUR PRODUCTS IS LENGTHY.
The sales cycle associated with our products typically is lengthy, often
lasting six months to a year. Our customers typically conduct significant
technical evaluations of competing technologies prior to the commitment of
capital and other resources. In addition, purchasing decisions may be delayed
because
7
<PAGE>
of our customers' internal budget approval procedures. Sales also generally are
subject to customer trials, which typically last three months. Because of the
lengthy sales cycle and the large size of customers' orders, if orders
forecasted for a specific customer for a particular quarter do not occur in
that quarter, our operating results for that quarter could be materially
adversely affected.
THERE ARE MANY RISKS ASSOCIATED WITH OUR PARTICIPATION IN CO-AUTHORING THE
DOCSIS 1.2 SPECIFICATION.
In November 1998, CableLabs selected us to co-author a technical
specification for DOCSIS 1.2, an enhanced version of the DOCSIS cable modem
standard based in part on our S-CDMA technology. Our agreement to co-author the
DOCSIS 1.2 specification will require us to contribute some aspects of our S-
CDMA technology to a royalty-free intellectual property pool. As a result, any
of our competitors who join the DOCSIS intellectual property pool will have
access to some aspects of our technology and will not be required to pay us any
royalties or other compensation. Further, some of our competitors have been
successful in reverse engineering the technology of other companies, and our
contribution to the DOCSIS 1.2 intellectual property pool would expose some
aspects of our technology to those competitors. If a competitor is able to
duplicate the functionality and capabilities of our technology, we could lose
all or some of the time-to-market advantage we might otherwise have.
CableLabs may select additional authors to contribute to the DOCSIS 1.2
proposal. Any vendors that participate in the drafting process, including us,
must contribute any of their technology that is essential to implement the
DOCSIS 1.2 specification to the DOCSIS intellectual property pool on a royalty-
free basis. If the DOCSIS Certification Board includes our proposal in the
DOCSIS 1.2 draft specification, it will then be made available for comment by
the organizations that participate in the DOCSIS specification process. The
DOCSIS Certification Board may decide not to proceed with our proposal.
Further, the comment process may take considerably longer than expected and may
delay the publication of a DOCSIS 1.2 standard, currently anticipated to occur
in 2000. If our draft proposal is not approved by the DOCSIS Certification
Board, we may not be able to develop DOCSIS 1.2-compliant cable modems in a
timely fashion or at all.
We believe the adoption of DOCSIS 1.2 will result in increased competition in
the North American cable modem market. This competition could come from
existing competitors or from new competitors who enter the market as a result
of the adoption of DOCSIS 1.2. This increased competition is likely to result
in lower ASPs of cable modem systems and likely will adversely affect our gross
margin. Because our competitors will be able to incorporate some aspects of our
technology into their products, our current customers may choose alternate
cable modem suppliers or choose to purchase DOCSIS 1.2-compliant cable modems
from multiple suppliers. We may be unable to produce DOCSIS 1.2-compliant cable
modems more quickly or at lower cost than our competitors. The inclusion of our
S-CDMA technology in DOCSIS 1.2 could result in increased competition for the
services of our existing employees who have experience with S-CDMA. The loss of
these employees to one or more competitors could adversely affect our business.
DOCSIS standards have not yet been accepted in Europe and Asia. Sales to
customers outside of the United States and Canada accounted for 78% of our
revenues in 1997 and 38% of our revenues in the first nine months of 1998. If
standards that are not compatible with DOCSIS standards ultimately achieve
widespread acceptance outside of the United States and Canada, we could be
required to redesign our products for use in those markets. Even if we were
able to successfully redesign our products, this would likely delay the
deployment of our products in markets outside of the United States and Canada.
WE NEED TO DEVELOP NEW PRODUCTS.
Our future success will depend in part on our ability to develop, introduce
and market new products in a timely manner. We must also respond to competitive
pressures, evolving industry standards and technological advances. Our current
products are not DOCSIS-compliant, and we do not
8
<PAGE>
expect to sell our DOCSIS 1.2-compliant products until 2000. As 2000
approaches, existing or potential customers may delay purchases of our current
cable modem system in order to purchase systems that comply with the DOCSIS 1.2
standard. In addition, potential new customers could decide to purchase DOCSIS
1.2-compliant products from one or more of our competitors rather than from us.
As a result, in the second half of 1999 and early 2000, our product sales may
be lower than we anticipate. As 2000 approaches, we may be required to reduce
the price of our current products for sales to existing customers. This would
have an adverse effect on our operating results and gross margin.
It is expected that the DOCSIS 1.2 specifications will be based upon both S-
CDMA and advanced TDMA technology. In that event, we will have to incorporate
advanced TDMA technology into our DOCSIS 1.2-compliant products. If we are
unable to do this effectively or in a timely manner, we will lose some or all
of the time-to-market advantage we might otherwise have had.
AVERAGE SELLING PRICES OF CABLE EQUIPMENT TYPICALLY DECREASE.
The cable equipment systems industry has been characterized by erosion of
average selling prices. We expect this to continue. This erosion is due to a
number of factors, including competition, rapid technological change and price
performance enhancements. The average selling prices for our products may be
lower than expected as a result of competitive pricing pressures, our
promotional programs and customers who negotiate price reductions in exchange
for longer term purchase commitments. We anticipate that ASPs and gross margins
for our products will decrease over product life cycles. In addition, we
believe that the widespread adoption of industry standards is likely to further
erode ASPs, particularly for cable modems. It is likely that the adoption of
industry standards will result in increased retail distribution of cable
modems, which could put further price pressure on our modems. Decreasing ASPs
could result in decreased revenue even if the number of units sold increases.
As a result, we may experience substantial period-to-period fluctuations in
future operating results due to ASP erosion. Therefore, we must continue to
develop and introduce on a timely basis next-generation products with enhanced
functionalities that can be sold at higher gross margins. Our failure to do
this could cause our revenues and gross margin to decline.
WE MUST ACHIEVE COST REDUCTIONS.
Certain of our competitors currently offer cable modems at prices lower than
ours. Market acceptance of our products will depend in part on reductions in
the unit cost of our products. We expect that as headend equipment becomes more
widely deployed, the price of cable modems and other products will decline. In
particular, we believe that the adoption of industry standards such as DOCSIS
will cause increased price competition for cable modems. However, we may be
unable to reduce the cost of our modems sufficiently to enable us to compete
with other cable modem suppliers. Our cost reduction efforts may not allow us
to keep pace with competitive pricing pressures or lead to improved gross
margins.
Many of our competitors are larger and manufacture products in significantly
greater quantities than we intend to for the foreseeable future. Consequently,
these competitors have more leverage in obtaining favorable pricing from
suppliers and manufacturers. In order to remain competitive, we must
significantly reduce the cost of manufacturing our cable modems through design
and engineering changes. We may not be successful in redesigning our products.
Even if we are successful, our redesign may be delayed or may contain
significant errors and product defects. In addition, any redesign may not
result in sufficient cost reductions to allow us to significantly reduce the
list price of our products or improve our gross margin. Reductions in our
manufacturing costs will require us to use more highly integrated components in
future products and may require us to enter into high volume or long-term
purchase or manufacturing agreements. Volume purchase or manufacturing
agreements may not be available on acceptable terms. We could incur expenses
without related revenues if we enter into a high
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volume or long-term purchase or manufacturing agreement and then decide that we
cannot use the products or services offered by such agreement.
WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE TO REMAIN COMPETITIVE.
The markets for our products are characterized by rapid technological change,
evolving industry standards, changes in end user requirements and frequent new
product introductions and enhancements. Our future success will depend upon our
ability to enhance our existing products and to develop and introduce new
products that achieve market acceptance. Cable operators may adopt alternative
technologies or they may deploy alternative services that are incompatible with
our products.
The demand for broadband access services has resulted in the development of
several competing modulation technologies. Our products utilize a modulation
technology known as Synchronous Code Division Multiple Access or "S-CDMA,"
while several of our competitors utilize modulation technologies known as Time
Division Multiple Access or "TDMA" and Frequency Division Multiple Access or
"FDMA." Our headend equipment and cable modem products currently are not
interoperable with the headend equipment and modems of other suppliers of
broadband access products. As a result, potential customers who wish to
purchase broadband access products from multiple suppliers may be reluctant to
purchase our products. Although our technology may be incorporated into a
future version of industry standards, we cannot be certain that major cable
operators will adopt these standards. Major cable operators may not adopt
products or technologies based on our current proprietary S-CDMA technology or
on any future industry standard S-CDMA technology. Further, major cable
operators may adopt products or standards technologies based on competing
modulation technologies. If competitors using other modulation technologies can
incorporate functionality and capabilities currently found in S-CDMA, the value
of our S-CDMA technology would be diminished.
CABLE MODEMS HAVE NOT ACHIEVED WIDESPREAD MARKET ACCEPTANCE AND MANY COMPETING
TECHNOLOGIES EXIST.
Our success will depend upon the widespread commercial acceptance of cable
modems by cable operators and end users of broadband access services. Cable
operators have only recently begun to deploy broadband access services based on
cable modem technology, and the market for these services is not fully
developed. We cannot accurately predict the future growth rate or the ultimate
size of the cable modem market. Potential users of our products may have
concerns regarding the security, reliability, cost, ease of installation and
use and capability of cable modems in general.
The general market for cable modems may be affected by the development of
alternative technologies that provide broadband access services. These include
the following:
. Digital Subscriber Line technologies known as "xDSL";
. Integrated Service Digital Network or "ISDN";
. data transmission over fiber optic cable;
. direct broadcast satellite;
. Local Multipoint Distribution Service; and
. Multichannel Multipoint Distribution Service.
Broadband access services based on some of these competing technologies are
already available and could significantly limit acceptance of cable modem-based
services.
WE NEED TO DEVELOP ADDITIONAL DISTRIBUTION CHANNELS.
We presently market our products to cable operators and systems integrators.
We believe that much of the North American cable modem market may shift to a
retail distribution model. Accordingly, we
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may need to redirect our future marketing efforts to sell our cable modems
directly to retail distributors and end users. This shift would require us to
establish new distribution channels for our products. We may be unable to
establish these additional distribution channels. If we do establish them, we
may be unable to hire the additional personnel necessary to foster and enhance
such distribution channels. In addition, if the cable modem market shifts to a
retail distribution model, we may not successfully establish a retail
distribution presence. To the extent that large consumer electronics companies
enter the cable modem market, their well-established retail distribution
capabilities would provide them with a significant competitive advantage.
WE MAY BE UNABLE TO MARKET EFFECTIVELY TO CABLE OPERATORS.
Our growth and future success will be substantially dependent upon our
ability to convince cable operators to adopt our technologies, purchase our
products and effectively market our products to end users. Cable operators are
likely to prefer purchasing products from established manufacturing companies
that can demonstrate the capability to supply large volumes of products on
short notice. In addition, many cable operators may be reluctant to adopt
technologies that have not gained acceptance among other cable operators. This
reluctance could result in lengthy product testing and acceptance cycles for
our products. Consequently, the impediments to our initial sales may be even
greater than those to later sales. No established distribution network in the
cable modem industry exists that would provide us with easy access to smaller
or geographically diverse cable operators. Therefore, our initial sales to
larger, more established cable operators are critical to our business. Although
we intend to establish strategic relationships with leading distributors
worldwide, we may not succeed in establishing these relationships. Even if we
do establish these relationships, the distributors may not succeed in marketing
our products to cable operators. Some of our competitors have already
established relationships with certain cable operators, such as Motorola Inc.'s
relationships with Tele-Communications, Inc. or "TCI," Time Warner Cable,
Comcast Corporation and Cox Communications, Inc. These established
relationships may further limit our ability to sell products to those cable
operators. We do not have long, well-established relationships with those cable
operators. If we were to sell our products to those cable operators, it would
likely not be based on long-term contracts and those customers would be able to
terminate their relationships with us at any time. In addition, one or more of
our current customers could cancel its relationship with us at any time.
WE ARE DEPENDENT ON CABLE OPERATORS AND OTHER SERVICE PROVIDERS.
We depend on cable operators to purchase our cable modem systems and to
provide our cable modems to end users. Cable operators have a limited amount of
available bandwidth over which they can offer robust data services, and they
may not choose to provide these data services to their customers. If cable
operators choose to provide these services, we also will depend upon them to
market these services to cable customers, to install our equipment and to
provide support to end users. In addition, we will be highly dependent on cable
operators to continue to maintain their cable infrastructure in a manner that
allows us to provide consistently high performance and reliable services. Our
success also will depend upon the acceptance of our products by other providers
of services to the cable industry, such as At Home Corporation's @Home Network
and Road Runner, a joint venture between MediaOne Group, Inc. and Time Warner
Cable.
WE ARE DEPENDENT ON THE CABLE INDUSTRY TO UPGRADE TO TWO-WAY CABLE
INFRASTRUCTURE.
Demand for our products will depend to a significant degree upon the
magnitude and timing of capital spending by cable operators for implementation
of access systems for data transmission over cable networks. This involves the
enabling of two-way transmission over existing coaxial cable networks and the
eventual upgrade to HFC in areas of higher penetration of data services. If
cable operators fail to complete these upgrades of their cable infrastructures
in a timely and satisfactory manner, the market for our products could be
limited. In addition, few businesses in the United States currently have cable
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access. Cable operators may not choose to upgrade existing residential cable
systems or to install new cable systems to serve business locations.
The success and future growth of our business will be subject to economic and
other factors affecting the cable television industry generally, particularly
its ability to finance substantial capital expenditures. Capital spending
levels in the cable industry in the United States have fluctuated significantly
in the past, and we believe that such fluctuations will occur in the future.
The capital spending patterns of cable operators are dependent on a variety of
factors, including the following:
. the availability of financing;
. cable operators' annual budget cycles, as well as the typical reduction
in upgrade projects during the winter months;
. the status of federal, local and foreign government regulation and
deregulation of the telecommunications industry;
. overall demand for cable services;
. competitive pressures (including the availability of alternative data
transmission and access technologies);
. discretionary consumer spending patterns; and
. general economic conditions.
In recent periods, the United States cable market has been characterized by
the acquisition of smaller and independent cable operators by large cable
operators. We cannot predict the effect, if any, that consolidation in the
United States cable industry will have on overall capital spending patterns by
cable operators. The effect on our business of further industry consolidation
also is uncertain.
WE HAVE LIMITED MANUFACTURING EXPERIENCE AND WE ARE DEPENDENT ON CONTRACT
MANUFACTURERS.
We have had limited experience manufacturing our products and we depend
heavily upon the manufacturing capabilities of Solectron Corporation, our
contract manufacturer. We only began shipping our products in volume in the
first quarter of 1998, and we may encounter difficulties as we increase the
volume of our manufacturing operations. Our limited operating history and the
early stage of the cable modem market make it difficult for us to accurately
forecast demand for our products. Our inability to accurately forecast the
actual demand for our products could result in supply, manufacturing or testing
capacity constraints. These constraints could result in delays in the delivery
of our products or the loss of existing or potential customers, either of which
could have a material adverse effect on our business, operating results or
financial condition. In addition, we had unconditional purchase obligations of
approximately $11.4 million as of September 30, 1998, primarily to Solectron,
to purchase minimum quantities of materials and components used to manufacture
our products. We must fulfill these obligations even if demand for our products
is lower than we anticipate.
WE ARE DEPENDENT ON KEY SUPPLIERS.
We manufacture all of our products using components or subassemblies procured
from third-party suppliers. Certain of these components are available from a
single source and others are available from limited sources. All of our sales
are from products containing one or more components that are available only
from single supply sources. In addition, some of the components are custom
parts produced to our specifications. For example, we currently rely on VLSI
Technology, Inc. to supply a custom ASIC that is used in our products. Other
components, such as the radio frequency tuner and some surface acoustic wave
filters, are procured from sole-source suppliers. Any interruption in the
operations of vendors of sole sourced parts could adversely affect our ability
to meet our scheduled product deliveries to customers. Delays in key component
or product deliveries may occur due to shortages resulting from a
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limited number of suppliers, the financial or other difficulties of such
suppliers or a limitation in component product availability. We are dependent
on semiconductor manufacturers and are affected by worldwide conditions in the
semiconductor market. If we are unable to obtain a sufficient supply of
components from our current sources, we could experience difficulties in
obtaining alternative sources or in altering product designs to use alternative
components. Resulting delays or reductions in product shipments could damage
customer relationships. Further, a significant increase in the price of one or
more of these components could have a material adverse effect on our gross
margin or operating results.
WE MUST TRANSITION TO NEW SEMICONDUCTOR PROCESS TECHNOLOGIES.
Our future success will depend in part upon our ability to develop products
that utilize new semiconductor process technologies. These technologies change
rapidly and require us to spend significant amounts on research and
development. We continuously evaluate the benefits of redesigning our
integrated circuits using smaller geometry process technologies to improve
performance and reduce costs. The transition of our products to integrated
circuits with increasingly smaller geometries will be important to our
competitive position. Other companies have experienced difficulty in migrating
to new semiconductor processes and, consequently, have suffered reduced yields,
delays in product deliveries and increased expense levels. Moreover, we depend
on our relationship with our third-party manufacturers to migrate to smaller
geometry processes successfully. We may be unable to migrate to new
semiconductor process technologies successfully or on a timely basis.
WE ARE DEPENDENT ON CONTRACT MANUFACTURERS TO ASSEMBLE AND TEST OUR PRODUCTS.
Most of our products are assembled and tested by Solectron using testing
equipment that we provide. As a result of our dependence on Solectron for
assembly and testing of our products, we do not directly control product
delivery schedules or product quality. Any product shortages or quality
assurance problems could increase the costs of manufacture, assembly or testing
of our products. In addition, as manufacturing volume increases, we will need
to procure and assemble additional testing equipment and provide it to
Solectron. The production and assembly of testing equipment typically requires
significant time. We could experience significant delays in the shipment of our
products if we are unable to provide this testing equipment to Solectron in a
timely manner.
THERE ARE MANY RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.
Sales to customers outside of the United States accounted for approximately
88% of our revenues in 1997 and approximately 70% of our revenues in the first
nine months of 1998. We expect sales to customers outside of the United States
to continue to represent a significant percentage of our revenues for the
foreseeable future. International sales are subject to a number of risks,
including the following:
. changes in foreign government regulations and communications standards;
. export license requirements, tariffs and taxes;
. other trade barriers;
. difficulty in collecting accounts receivable;
. difficulty in managing foreign operations; and
. political and economic instability.
If our customers are impacted by currency devaluations or general economic
crises, such as the economic crisis currently affecting many Asian and Latin
American economies, their ability to purchase our products could be materially
adversely affected. Payment cycles for international customers typically are
longer than those for customers in the United States. Foreign markets for our
products may develop more slowly than currently anticipated. Foreign countries
may decide not to construct cable infrastructure or may prohibit, terminate or
delay the construction of new cable plants for a variety of
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reasons. These reasons include environmental issues, economic downturns, the
availability of favorable pricing for other communications services or the
availability and cost of related equipment. Any action like this by foreign
countries would reduce the market for our products.
We anticipate that our foreign sales generally will be invoiced in U.S.
dollars, and we currently do not plan to engage in foreign currency hedging
transactions. However, as we commence and expand our international operations,
we may be paid in foreign currencies and exposure to losses in foreign currency
transactions may increase. We may choose to limit our exposure by the purchase
of forward foreign exchange contracts or through similar hedging strategies. No
currency hedging strategy can fully protect against exchange-related losses. In
addition, if the relative value of the U.S. dollar in comparison to the
currency of our foreign customers should increase, the resulting effective
price increase of our products to those foreign customers could result in
decreased sales.
WE MAY BE UNABLE TO PROVIDE ADEQUATE CUSTOMER SUPPORT.
Our ability to achieve our planned sales growth and retain current and future
customers will depend in part upon the quality of our customer support
operations. Our customers generally require significant support and training
with respect to the TeraComm system, particularly in the initial deployment and
implementation stage. To date, we have sold a limited number of products, and
our sales have been concentrated in a small number of customers. We have
limited experience with widespread deployment of our products to a diverse
customer base. We may not have adequate personnel to provide the levels of
support that our customers may require during initial product deployment or on
an ongoing basis. Our inability to provide sufficient support to our customers
could delay or prevent the successful deployment of our products. In addition,
our failure to provide adequate support could have an adverse impact on our
reputation and relationship with our customers and could prevent us from
gaining new customers.
OUR INDUSTRY IS HIGHLY COMPETITIVE WITH MANY ESTABLISHED COMPETITORS.
The market for broadband access systems is extremely competitive and is
characterized by rapid technological change. Our direct competitors in the
cable modem arena include Cisco Systems, Inc., Com21, Inc., General Instrument
Corporation, Hayes Corporation, Hybrid Networks, Inc., Matsushita Electric
Industrial Co., Ltd. (which markets products under the brand name "Panasonic"),
Motorola, Nortel Networks, Inc., Phasecom Inc., Thomson Consumer Electronics,
Inc. (which markets products under the brand name "RCA"), Samsung Corporation,
Scientific-Atlanta, Inc., Sony Corporation, 3Com Corporation, Toshiba
Corporation and Zenith Electronics Corporation. We also compete with companies
that develop integrated circuits for broadband access products, such as
Broadcom Corporation. As cable modem standards such as DOCSIS 1.2 are adopted,
other companies may enter the cable modem market. In addition, Com21, Hybrid,
Motorola and Nortel introduced cable modems before we did, and they have
established relationships and have worked with customers for a longer period of
time than we have. The principal competitive factors in our market include the
following:
. product performance, features and reliability;
. price;
. size and stability of operations;
. breadth of product line;
. sales and distribution capability;
. technical support and service;
. relationships with cable operators; and
. compliance with industry standards.
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Some of these factors are outside of our control. The existing conditions in
the broadband access market could change rapidly and significantly as a result
of technological changes. The development and market acceptance of alternative
technologies could decrease the demand for our products or render them
obsolete. Our competitors may introduce broadband access products that are less
costly, provide superior performance or achieve greater market acceptance than
our products.
We also sell products that compete with existing data access and transmission
systems utilizing the telecommunications networks, such as those of 3Com.
Additionally, our controller and headend system products face intense
competition from well-established companies such as Cisco, Nortel and 3Com.
Many of our current and potential competitors have significantly greater
financial, technical, marketing, distribution, customer support and other
resources, as well as greater name recognition and access to customers than we
do. The anticipated widespread adoption of DOCSIS is likely to cause increased
price competition in the North American market. The adoption of DOCSIS also
could result in lower sales of our headend products in the North American
market. Any increased price competition or reduction in sales of our headend
products would result in downward pressure on our gross margin. We cannot
accurately predict how the competitive pressures that we face will affect our
business.
OUR BUSINESS IS DEPENDENT ON THE INTERNET AND THE DEVELOPMENT OF THE INTERNET
INFRASTRUCTURE.
The commercial market for products designed for the Internet has only
recently begun to develop. Our success will depend in large part on increased
use of the Internet to increase the need for high speed broadband access
networks. Critical issues concerning the commercial use of the Internet remain
unresolved and are likely to affect the development of the market for our
products. These issues include security, reliability, cost, ease of access and
Quality of Service. The adoption of the Internet for commerce and
communications, particularly by enterprises that have historically relied upon
alternative means of commerce and communications, generally requires the
acceptance of a new method of conducting business and exchanging information.
In addition, we depend on the growth of the use of the Internet by businesses,
particularly for applications that utilize multimedia content and thus require
high bandwidth. The recent growth in the use of the Internet has caused
frequent periods of performance degradation. This has required the upgrade of
routers, telecommunications links and other components forming the
infrastructure of the Internet by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a whole could undermine the benefits of our
products. Potentially increased performance provided by our products and the
products of others ultimately is limited by and reliant upon the speed and
reliability of the Internet backbone itself. Consequently, the emergence and
growth of the market for our products will depend on improvements being made to
the entire Internet infrastructure to alleviate overloading and congestion.
OUR FAILURE TO MANAGE GROWTH COULD ADVERSELY AFFECT US.
The growth of our business has placed, and is expected to continue to place,
a significant strain on our limited personnel, management and other resources.
Our management, personnel, systems, procedures and controls may be inadequate
to support our existing and future operations. To manage any future growth
effectively, we will need to attract, train, motivate, manage and retain
employees successfully, to integrate new employees into our overall operations
and to continue to improve our operational, financial and management systems.
We have hired some key employees and officers only recently, including our
Chief Financial Officer and Vice President, Manufacturing Operations. As a
result, some members of our management team have worked together for a brief
time.
WE ARE DEPENDENT ON KEY PERSONNEL.
Due to the specialized nature of our business, we are highly dependent on the
continued service of, and on the ability to attract and retain qualified
engineering, sales, marketing and senior management
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personnel. The competition for this personnel is intense. The loss of any of
these persons, particularly our Chairman, President and Chief Technical
Officer, Shlomo Rakib, and our Chief Executive Officer, Zaki Rakib, would have
a material adverse effect on our business and operating results. In addition,
if we are unable to hire additional qualified personnel as needed, we may not
be able to adequately manage and complete our existing sales commitments and to
bid for and execute additional sales. Further, we must train and manage our
growing employee base, which is likely to require increased levels of
responsibility for both existing and new management personnel. Our current
management personnel and systems may be inadequate, and we may fail to
assimilate new employees successfully. Highly skilled employees with the
education and training that we require, especially employees with significant
experience and expertise in both data networking and radio frequency design,
are in high demand. We may not be able to continue to attract and retain the
qualified personnel necessary for the development of our business. We do not
have "key person" insurance coverage for the loss of any of our employees. Any
officer or employee of our company can terminate his or her relationship with
us at any time. None of our employees are bound by any noncompetition
agreements with us.
OUR BUSINESS IS SUBJECT TO THE RISKS OF PRODUCT RETURNS, PRODUCT LIABILITY AND
PRODUCT DEFECTS.
Products as complex as ours frequently contain undetected errors or failures,
especially when first introduced or when new versions are released. Despite
testing, errors may occur. The occurrence of errors could result in product
returns and other losses to our company or our customers. This occurrence also
could result in the loss of or delay in market acceptance of our products. Due
to the recent introduction of our products, we have limited experience with the
problems that could arise with this generation of products. Our purchase
agreements with our customers typically contain provisions designed to limit
our exposure to potential product liability claims. However, the limitation of
liability provision contained in our purchase agreements may not be effective
as a result of federal, state or local laws or ordinances or unfavorable
judicial decisions in the United States or other countries. We have not
experienced any product liability claims to date, but the sale and support of
our products entails the risk of such claims. In addition, any failure by our
products to properly perform could result in claims against us by our
customers. We maintain insurance to protect against certain claims associated
with the use of our products, but our insurance coverage may not adequately
cover any claim asserted against us. In addition, even claims that ultimately
are unsuccessful could result in our expenditure of funds in litigation and
management time and resources.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY
RIGHTS.
We rely on a combination of patent, trade secret, copyright and trademark
laws and contractual restrictions to establish and protect proprietary rights
in our products. Our pending patent applications may not be granted. Even if
they are granted, the claims covered by the patents may be reduced from those
included in our applications. Any patent might be subject to challenge in court
and, whether or not challenged, might not be broad enough to prevent third
parties from developing equivalent technologies or products. We have entered
into confidentiality and invention assignment agreements with our employees,
and we enter into non-disclosure agreements with some of our suppliers,
distributors and appropriate customers so as to limit access to and disclosure
of our proprietary information. These statutory and contractual arrangements
may not prove sufficient to prevent misappropriation of our technology or to
deter independent third-party development of similar technologies. In addition,
the laws of some foreign countries might not protect our products or
intellectual property rights to the same extent as do the laws of the United
States. Protection of our intellectual property might not be available in every
country in which our products might be manufactured, marketed or sold.
Upon the completion and acceptance of the DOCSIS 1.2 cable modem
specification that we co-author, we would contribute some aspects of our S-CDMA
technology to the DOCSIS 1.2 intellectual property pool. We would contribute
our technology pursuant to a proposed license agreement between
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us and CableLabs that we would execute at that time. Under the terms of the
proposed license agreement, we would grant to CableLabs a license for some
aspects of our S-CDMA technology that are essential for compliance to the
DOCSIS 1.2 cable modem standard. This license would allow CableLabs to utilize
and incorporate the licensed technology for the limited use of making and
selling products or systems that comply with the DOCSIS 1.2 cable modem
specification. As a party to the license agreement, we would have access to the
DOCSIS 1.2 intellectual property pool and would have the right to develop
products that comply with the DOCSIS 1.2 cable modem specification. As a
result, any of our competitors who join the DOCSIS intellectual property pool
will have access to some aspects of our technology and will not be required to
pay us any royalties or other compensation. Further, some of our competitors
have been successful in reverse engineering the technology of other companies,
and our contribution to the DOCSIS 1.2 intellectual property pool would expose
some aspects of our technology to those competitors. If a competitor is able to
duplicate the functionality and capabilities of our technology, we could lose
all or some of the time-to-market advantage we might otherwise have. CableLabs
may sublicense the DOCSIS 1.2 intellectual property pool if the sublicensee
complies with certain conditions. The sublicensee's rights to some of the
DOCSIS 1.2 intellectual property pool could be terminated if it sues certain
companies for infringement of any copyright, patent right or trade secret
misappropriation.
We expect that developers of cable modems increasingly will be subject to
infringement claims as the number of products and competitors in our industry
segment grows. We have received a letter from an individual claiming that our
technology infringes a patent held by the individual. We have reviewed the
allegations made by this individual and, after consulting with our patent
counsel, we do not believe that our technology infringes any valid claim of
this individual's patent. If the issue is submitted to a court, the court could
find that our products infringe the patent. In addition, this individual may
continue to assert infringement. If we are found to have infringed this
individual's patent, we could be subject to substantial damages and/or an
injunction preventing us from conducting our business. In addition, other third
parties may assert infringement claims against us in the future. An
infringement claim, whether meritorious or not, could be time-consuming, result
in costly litigation, cause product shipment delays or require us to enter into
royalty or licensing agreements. These royalty or licensing agreements may not
be available on terms acceptable to us or at all, which could have a material
adverse effect upon our business, operating results and financial condition.
Litigation also may be necessary to enforce our intellectual property rights.
OUR BUSINESS IS SUBJECT TO COMMUNICATIONS INDUSTRY REGULATIONS.
Our business and our customers are subject to varying degrees of federal,
state and local regulation. The jurisdiction of the Federal Communications
Commission extends to the communications industry, including our broadband
access products. The FCC has promulgated regulations that, among other things,
set installation and equipment standards for communications systems. Although
FCC regulations and other governmental regulations have not materially
restricted our operations to date, future regulations applicable to our
business or our customers could be adopted by the FCC or other regulatory
bodies. For example, FCC regulatory policies affecting the availability of
cable services and other terms on which cable companies conduct their business
may impede our penetration of certain markets. In addition, regulation of cable
television rates may affect the speed at which cable operators upgrade their
cable infrastructures to two-way HFC. In addition, the increasing demand for
communications systems has exerted pressure on regulatory bodies worldwide to
adopt new standards for such products and services. This process generally
involves extensive investigation of and deliberation over competing
technologies. The delays inherent in this governmental approval process have in
the past, and may in the future, cause the cancellation, postponement or
rescheduling of the installation of communications systems by our customers.
If other countries begin to regulate the cable modem industry more heavily or
introduce standards or specifications with which our products do not comply, we
will be unable to offer products in those countries until our products comply
with those standards or specifications. In addition, we may have to
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incur substantial costs to comply with those standards or specifications. For
instance, should the DAVIC standards for ATM-based digital video be established
internationally, we will need to conform our cable modems to compete. Further,
many countries do not have regulations for installation of cable modem systems
or for upgrading existing cable network systems to accommodate our products.
Whether we currently operate in such a country or enter into the market in a
country where no such regulations exist, new regulations could be proposed at
any time. The imposition of regulations like this could place limitations on
the country's cable operators' ability to upgrade to support our products.
Cable operators in these countries may not be able to comply with these
regulations, and compliance with these regulations may require a long, costly
process. For example, we experienced delays in product shipments to a customer
in Brazil due to delays in certain regulatory approvals in Brazil. Similar
delays could occur in other countries in which we market or plan to market our
products. In addition, our customers in certain parts of Asia, such as Japan,
are required to obtain licenses prior to selling our products, and delays in
obtaining such licenses could have an adverse impact on our ability to sell
products to these customers.
OUR BUSINESS IS SUBJECT TO OTHER REGULATORY APPROVALS AND CERTIFICATIONS.
In the United States, in addition to complying with FCC regulations, our
products are required to meet certain safety requirements. For example, we are
required to have our products certified by Underwriters Laboratory in order to
meet federal requirements relating to electrical appliances to be used inside
the home. Outside the United States, our products are subject to the regulatory
requirements of each country in which the products are manufactured or sold.
These requirements are likely to vary widely. We may not be able to obtain on a
timely basis or at all the regulatory approvals that may be required for the
manufacture, marketing and sale of our products. In addition to regulatory
compliance, some cable industry participants may require certification of
compatibility.
OUR BUSINESS COULD BE ADVERSELY IMPACTED BY YEAR 2000 COMPLIANCE ISSUES.
The Year 2000 issue is the result of computer programs written using two
digits rather than four to define the applicable year. Computer programs that
have this date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
We are heavily dependent upon the proper functioning of our own computer or
data-dependent systems. This includes, but is not limited to, our systems in
information, business, finance, operations, manufacturing and service. Any
failure or malfunctioning on the part of these or other systems could adversely
affect our business in ways that are not currently known, discernable,
quantifiable or otherwise anticipated by us.
We recently formed an internal task force to evaluate those areas of our
business that may be affected by the Year 2000 issue. The task force will
devise a plan for us to become Year 2000 compliant in a timely manner. Our plan
will include independent validation of our Year 2000 assessment procedures,
initiating formal communications with all of our significant suppliers, large
customers and development partners to determine the extent to which we are
vulnerable to those third parties' failure to remedy their own Year 2000
issues. We also will develop contingency plans to address situations that may
result if we are unable to achieve Year 2000 readiness of our critical
operations. We anticipate addressing the critical Year 2000 issues by mid-1999,
prior to any anticipated impacts on our operating systems. We expect that we
may address non-critical Year 2000 issues beyond the Year 2000.
To date, we have not incurred incremental material costs associated with our
efforts to become Year 2000 compliant, as the majority of the costs have
occurred as a result of normal upgrade procedures. Furthermore, we believe that
future costs associated with our Year 2000 compliance efforts will not be
material.
18
<PAGE>
We currently have only limited information on the Year 2000 compliance of key
suppliers and customers. The operations of our key suppliers and customers
could be adversely affected in the event they do not successfully and timely
achieve Year 2000 compliance. Our business and results of operations could
experience material adverse effects if our key suppliers were to experience
Year 2000 issues that caused them to delay manufacturing or shipment of key
components to us. In addition, our results of operations could be materially
adversely affected if any of our key customers encounter Year 2000 issues that
cause them to delay or cancel substantial purchase orders or delivery of our
product.
We may be unable to develop a plan to address the Year 2000 Issue in a timely
manner or to upgrade any or all of our major systems in accordance with our
plan. Even if we do make upgrades, they may not effectively address the Year
2000 issue. If required upgrades are not completed timely or are not
successful, we may be unable to conduct our business or manufacture our
products, which would have a material impact on our operations. The systems of
other companies on which our systems rely may not be timely converted. A
failure to convert by another company, or a conversion that is incompatible
with our systems would have a material adverse effect on our business. We
intend to, but have not yet established a contingency plan detailing actions
that will be taken in the event that the assessment of the Year 2000 issue is
not successfully completed on a timely basis.
WE ARE CONTROLLED BY CERTAIN STOCKHOLDERS AND MANAGEMENT.
Upon completion of this offering, our executive officers, directors and
principal stockholders and their affiliates will own approximately shares
or % of the outstanding shares of common stock ( % if the Underwriters'
over-allotment option is exercised in full). As a result, they may have the
ability to effectively control our company and direct our affairs and business,
including the election of directors and approval of significant corporate
transactions. This concentration of ownership also may have the effect of
delaying, deferring or preventing a change in control of our company and may
make some transactions more difficult or impossible without the support of
these such stockholders.
MANAGEMENT WILL HAVE BROAD DISCRETION OVER THE PROCEEDS OF THE OFFERING.
We currently have no specific plans for a significant portion of our net
proceeds from this offering. Consequently, our management will have the
discretion to allocate the net proceeds to uses that stockholders may not deem
desirable. We may not be able to yield a significant return on any investment
of the proceeds. Substantially all of our proceeds from the offering will be
invested in short-term, interest-bearing, investment grade securities
immediately following the offering.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to
a variety of factors, including the following:
. actual or anticipated variations in quarterly operating results;
. announcements of technological innovations;
. new products or services offered by us or our competitors;
. changes in financial estimates by securities analysts;
. conditions or trends in the broadband access services industry;
. changes in the economic performance and/or market valuations of
Internet, online service or broadband access service industries;
. changes in the economic performance and/or market valuations of other
Internet, online service or broadband access service companies;
. our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
. additions or departures of key personnel;
19
<PAGE>
. sales of common stock; and
. other events or factors that may be beyond our control.
In addition, the stock markets in general, and the Nasdaq National Market and
the market for broadband access services and technology companies in
particular, have experienced extreme price and volume fluctuations recently.
These fluctuations often have been unrelated or disproportionate to the
operating performance of these companies. The trading prices of many technology
companies' stocks are at or near historical highs and these trading prices and
multiples are substantially above historical levels. These trading prices and
multiples may not be sustained. These broad market and industry factors may
materially adversely affect the market price of our common stock, regardless of
our actual operating performance. In the past, following periods of volatility
in the market price of a company's securities, securities class action
litigation often has been instituted against that company. Litigation like
this, if instituted, could result in substantial costs and a diversion of
management's attention and resources.
SOME ANTI-TAKEOVER PROVISIONS MAY AFFECT THE PRICE OF OUR COMMON STOCK.
The Board of Directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the preferences, rights and privileges of
those shares without any further vote or action by the stockholders. The rights
of the holders of common stock may be adversely affected by the rights of the
holders of any preferred stock that may be issued in the future. Some
provisions of our certificate of incorporation and bylaws could have the effect
of making it more difficult for a third party to acquire a majority of the
outstanding voting stock of the Company. These include provisions that provide
for a classified Board of Directors, prohibit stockholders from taking action
by written consent and restrict the ability of stockholders to call special
meetings.
A SIGNIFICANT NUMBER OF SHARE ARE ELIGIBLE FOR SALE AND THEIR SALE COULD
DEPRESS OUR STOCK PRICE.
Sales of substantial amounts of our common stock (including shares issued
upon the exercise of outstanding options) in the public market after this
offering could adversely affect the market price of our common stock. These
sales also might make it more difficult for us to sell equity or equity-related
securities in the future at a time and price that we deem appropriate. Upon
completion of this offering, we will have outstanding 18,122,598 shares of
common stock (based upon shares outstanding as of September 30, 1998), assuming
no exercise of the Underwriters' over-allotment option and no exercise of
outstanding options after September 30, 1998. Of these shares, the 3,000,000
shares sold in this offering, together with the 3,000,000 shares sold in our
initial public offering in August 1998 are freely tradable. Of the remaining
12,122,598 shares, the following shares are eligible for sale in the public
market as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
---------------- ----------------------------------------
<S> <C>
December , 1998
February 14, 1999
90 days from the date of this prospectus
</TABLE>
WE MAY NEED TO RAISE ADDITIONAL CAPITAL.
We believe that the proceeds of this offering, together with our existing
capital resources, will be sufficient to meet our capital requirements for at
least the next 18 months. We expect to use our proceeds from this offering
primarily for research and development and to expand sales and marketing
activities. Our capital requirements depend on several factors, including the
rate of market acceptance of our products, the ability to expand our client
base and the growth of sales and marketing. If our capital requirements are
materially different from those currently planned, we may require additional
financing sooner than anticipated. If additional funds are raised through the
issuance of equity securities,
20
<PAGE>
the percentage ownership of our stockholders will be reduced and such
securities may have rights, preferences or privileges senior to those of our
common stock. Additional financing may not be available on favorable terms or
at all. If adequate funds are not available or are not available on acceptable
terms, we may be unable to develop or enhance our products and services, take
advantage of future opportunities or respond to competitive pressures.
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE NET TANGIBLE BOOK
VALUE OF THE STOCK YOU PURCHASE.
The assumed public offering price is substantially higher than the book value
per share of common stock. Purchasers of our common stock will incur immediate,
substantial dilution of $ per share in the net tangible book value of our
common stock from the assumed public offering price. Additional dilution will
occur upon the exercise of outstanding options and warrants.
21
<PAGE>
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
When used in this Prospectus, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include but are not limited to statements
under the captions "Risk Factors," "Use of Proceeds," "Management's Discussion
and Analysis of Financial Condition and Results of Operations," "Business" and
elsewhere in this Prospectus as to the timing of availability of products under
development; the Company's ability to commercialize new products; the
acceptance and performance of the Company's products; the inclusion of the
Company's S-CDMA technology in the DOCSIS 1.2 standard; the adoption of DOCSIS
1.2 as an industry standard; demand for broadband access services; the ability
of the Company to achieve cost reductions; the compliance of future products
with various industry standards, including DOCSIS 1.2; the Company's ability to
make sales to new customers; the Company's ability to develop, introduce and
market new products in a timely manner; the Company's ability to provide
sufficient customer support; the adequacy of capital resources; future
fluctuations in operating expenses; future capital expenditures; the
sufficiency of existing and potential cash resources and the use of the
proceeds of this offering are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. The cautionary
statements made in this Prospectus should be read as being applicable to all
related forward-looking statements wherever they appear in this Prospectus. The
Company assumes no obligation to update such forward-looking statements or to
update the reasons actual results could differ materially from those
anticipated in such forward-looking statements.
22
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,750,000 shares of
Common Stock offered by the Company, at an assumed public offering price of
$ per share, are estimated to be approximately $ ($ if the
Underwriters' over-allotment option is exercised in full), after deducting
underwriting discounts and commissions and estimated offering expenses payable
by the Company. The Company expects to use the net proceeds for general
corporate purposes, including capital expenditures and research and
development. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources." The amounts and
timing of the Company's actual expenditures will depend upon numerous factors,
including the status of the Company's product development and commercialization
efforts, the amount of cash generated by the Company's operations, competition
and sales and marketing activities. Pending application of the net proceeds as
described above, the Company intends to invest the net proceeds of the offering
in short-term, investment-grade, interest-bearing securities. The Company will
not receive proceeds from the sale of the common stock sold by the selling
stockholders. See "Principal and Selling Stockholders."
DIVIDEND POLICY
The Company has never paid any cash dividends on its capital stock. The
Company currently anticipates that it will retain earnings to support
operations and to finance the growth and development of the Company's business
and does not anticipate paying cash dividends for the foreseeable future. In
addition, the Company's credit agreement prohibits the payment of cash
dividends without the lender's written consent.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the Nasdaq National Market under the
Symbol "TERN." Public trading of the Common Stock commenced on August 18, 1998.
Prior to that, there was no public market for the Common Stock. The following
table sets forth, for the periods indicated, the high and low per share sale
prices of the Common Stock, as reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
1998 HIGH LOW
<S> <C> <C>
Third Quarter (from August 18, 1998).......................... $15.186 $7.000
Fourth Quarter (through December 23, 1998).................... $38.125 $9.250
</TABLE>
On December 23, 1998, the last reported sale price for the Common Stock, as
reported by the Nasdaq National Market, was $36.50. As of December 15, 1998,
the Company had 128 holders of record of the Common Stock.
23
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1998, (i) on an actual basis and (ii) as adjusted to reflect the
sale of 1,750,000 shares of Common Stock offered by the Company, at an assumed
public offering price of $ per share and the receipt of the estimated net
proceeds therefrom.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
---------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Current portion of long-term debt........................ $ 43 $ 43
======== ========
Long-term debt, less current portion..................... $ 12 $ 12
Stockholders' equity (1):
Preferred Stock, $.001 par value; 5,000,000 shares
authorized actual and as adjusted; no shares issued and
outstanding actual and as adjusted..................... -- --
Common Stock, $.001 par value; 30,000,000 shares
authorized actual and as adjusted; 16,372,598 shares
issued and outstanding actual; 18,122,598 shares issued
and outstanding as adjusted............................ 16
Additional paid in capital............................... 113,907
Accumulated deficit...................................... (78,906) (78,906)
Deferred compensation.................................... (1,829) (1,829)
Stockholders' notes receivable........................... (22) (22)
-------- --------
Total stockholders' equity............................. 33,166
-------- --------
Total capitalization................................... $ 33,178 $
======== ========
</TABLE>
- --------
(1) Excludes (i) approximately 2,685,840 shares issuable upon exercise of
options outstanding at a weighted average exercise price of $3.73 per
share, (ii) 3,019,191 shares issuable upon exercise of outstanding
warrants with a weighted average exercise price of $6.46 per share and
(iii) approximately 2,862,524 shares reserved under the Company's employee
benefit plans. See "Management--Employee Benefit Plans" and Note 9 of
Notes to Consolidated Financial Statements.
24
<PAGE>
DILUTION
The net tangible book value of the Company at September 30, 1998 was
approximately $33,166,000 or $2.026 per share. Net tangible book value per
share is determined by dividing the Company's tangible net worth (tangible
assets less liabilities) by the number of shares of Common Stock outstanding.
After giving effect to the sale by the Company of the 1,750,000 shares of
Common Stock offered hereby at an assumed public offering price of $ per
share, after deducting underwriting discounts and commissions and estimated
offering expenses, the net tangible book value of the Company as of September
30, 1998 would have been $ or $ per share. This represents an
immediate increase in net tangible book value of $ per share to existing
stockholders and an immediate dilution in net tangible book value of $
per share to new investors purchasing shares at the assumed public offering
price. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed public offering price per share.................... $
------
Net tangible book value per share as of September 30,
1998.................................................... $2.026
Increase per share attributable to this offering.........
------
Net tangible book value per share after offering...........
------
Dilution per share to new investors........................ $
======
</TABLE>
The following table sets forth, as of September 30, 1998, the difference
between the number of shares of Common Stock purchased from the Company, the
total consideration paid and the average price per share paid by the existing
stockholders and by the new investors at an assumed public offering price of
$ per share for shares purchased in this offering, before deducting
underwriting discounts and commissions and estimated offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED(1) TOTAL CONSIDERATION
------------------------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- --------------------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 16,372,598 90% $88,758,000 % $
New investors........... 1,750,000 10
------------- ------ ----------- ---
Total................. 18,122,598 100% $ 100%
============= ====== =========== ===
</TABLE>
- --------
(1) The foregoing computations assume no exercise of outstanding stock
options. As of September 30, 1998, options were outstanding to purchase
2,685,840 shares at a weighted average exercise price of $3.73 per share
and warrants were outstanding to purchase 3,019,161 shares at a weighted
average exercise price of $6.46 per share. To the extent that outstanding
options and warrants are exercised, there will be further dilution to new
investors. See "Management--Employee Benefit Plans" and Note 9 of Notes to
Consolidated Financial Statements.
25
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated statement of operations data for the years ended December
31, 1995, 1996 and 1997 and the consolidated balance sheet data as of December
31, 1996 and 1997, have been derived from the audited consolidated financial
statements of the Company included elsewhere in this Prospectus that have been
audited by Ernst & Young LLP, independent auditors. The consolidated statement
of operations data for the year ended December 31, 1994 and the consolidated
balance sheet data as of December 31, 1994 and 1995 have been derived from the
audited consolidated financial statements of the Company not included herein.
The consolidated statement of operations data for the period from January 20,
1993 (inception) to December 31, 1993 and the consolidated balance sheet data
at December 31, 1993 have been derived from unaudited financial statements of
the Company not included herein. The consolidated statement of operations data
for the nine months ended September 30, 1997 and 1998 and the consolidated
balance sheet data at September 30, 1998 are derived from unaudited financial
statements included elsewhere in this Prospectus and contain all adjustments,
consisting of normal recurring accruals, necessary for a fair presentation of
the financial position and results of operations for such periods. The results
of operations for the nine months ended September 30, 1998 are not necessarily
indicative of results to be expected for the full fiscal year. The data set
forth below should be read in conjunction with the consolidated financial
statements of the Company, including the notes thereto, and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PERIOD FROM NINE MONTHS
JANUARY 20, ENDED
1993 (INCEPTION) YEARS ENDED DECEMBER 31, SEPTEMBER 30,
TO DECEMBER 31, ------------------------------------- ------------------
1993 1994 1995 1996 1997 1997 1998
---------------- -------- ------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Revenues................ $ 128 $ 140 $ -- $ -- $ 2,118 $ 755 $ 18,776
Cost of goods sold...... -- -- 676 -- 6,462 2,243 22,023
------ -------- ------- -------- -------- -------- --------
Gross profit (loss)..... 128 140 (676) -- (4,344) (1,488) (3,247)
------ -------- ------- -------- -------- -------- --------
Operating expenses:
Research and
development........... 157 235 2,028 8,020 11,319 8,581 7,702
Sales and marketing.... -- 17 205 1,141 4,468 2,715 4,815
General and
administrative........ 26 84 825 1,789 2,546 1,715 2,095
------ -------- ------- -------- -------- -------- --------
Total operating
expenses.............. 183 336 3,058 10,950 18,333 13,011 14,612
------ -------- ------- -------- -------- -------- --------
Loss from operations.... (55) (196) (3,734) (10,950) (22,677) (14,499) (17,859)
Net interest income..... -- -- 68 253 128 130 26
------ -------- ------- -------- -------- -------- --------
Net loss................ (55) (196) (3,666) (10,697) (22,549) (14,369) (17,833)
Series F convertible
preferred stock
dividend(1)............ -- -- -- -- -- -- (23,910)
------ -------- ------- -------- -------- -------- --------
Net loss applicable to
common stockholders.... $ (55) $ (196) $(3,666) $(10,697) $(22,549) $(14,369) $(41,743)
====== ======== ======= ======== ======== ======== ========
Historical basic and
diluted net loss per
share applicable to
common
stockholders(2)........ $(0.03) $ (0.10) $ (1.02) $ (2.64) $ (5.26) $ (3.39) $ (6.39)
====== ======== ======= ======== ======== ======== ========
Shares used in computing
historical basic and
diluted net loss per
share applicable to
common
stockholders(2)........ 1,750 2,000 3,589 4,054 4,289 4,235 6,530
====== ======== ======= ======== ======== ======== ========
Pro forma basic and
diluted net loss per
share applicable to
common
stockholders(2)........ $ (2.07) $ (3.21)
======== ========
Shares used in pro forma
basic and diluted net
loss per share
applicable to common
stockholders(2)........ 10,873 12,991
======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------ SEPTEMBER 30,
1993 1994 1995 1996 1997 1998
-------- -------- -------- -------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE
SHEET DATA:
Cash, cash equivalents
and short-term
investments............ $ -- $ 27 $ 8,620 $ 12,864 $ 1,987 $ 32,584
Working capital
(deficit).............. 3 (492) 6,934 9,971 (4,847) 29,731
Total assets............ 3 435 10,202 15,978 8,778 48,530
Long-term debt (less
current portion)....... -- 98 439 1,255 44 12
Accumulated deficit..... (55) (251) (3,917) (14,614) (37,163) (78,906)
Total stockholders'
equity (net capital
deficiency)............ $ (6) $ (201) $ 7,955 $ 11,405 $ (1,174) $ 33,166
</TABLE>
- -------
(1) See Note 9 of Notes to Consolidated Financial Statements for an explanation
of the convertible preferred stock dividend.
(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method employed to determine the number of shares used to compute
per share amounts.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Company's Consolidated
Financial Statements and Notes included elsewhere in this Prospectus. The
discussion in this Prospectus contains forward-looking statements that involve
risks and uncertainties, such as statements of the Company's plans,
objectives, expectations and intentions. The cautionary statements made in
this Prospectus should be read as being applicable to all related forward-
looking statements wherever they appear in this Prospectus. The Company's
actual results could differ materially from those discussed here. Factors that
could cause or contribute to such differences include those discussed in "Risk
Factors," as well as those discussed elsewhere herein. See "Risk Factors" and
"Information Regarding Forward-Looking Statements."
OVERVIEW
Terayon develops, markets and sells cable modem systems based upon its S-
CDMA technology. Since its inception in January 1993, the Company has focused
on the development of its S-CDMA technology, as well as certain other core
technologies, to enable broadband transmission of data over cable networks.
The Company commenced the specifications and design of its first ASIC in
October 1994 and produced the first version of this ASIC in June 1996. The
Company concurrently developed an end-to-end broadband access system, the
TeraComm system, around the ASIC. During late 1996 and through 1997, the
Company commenced limited field trials of the TeraComm system with several
cable operators. In the first quarter of 1998, the Company commenced volume
shipments to a small number of cable operators. The Company recognized
revenues of $2.1 million in the year ended December 31, 1997 and $18.8 million
for the nine months ended September 30, 1998. The Company generally recognizes
product revenues upon shipment of products to customers. While the Company's
existing agreements do not contain price protection provisions and certain
return rights, future agreements may contain such provisions.
The Company sells its products both in the United States and internationally
and markets its products primarily to cable operators and distributors. To
date, a small number of customers has accounted for all of the Company's
sales. In 1997, sales to Telegate, Sumitomo and NET Brasil represented
approximately 30%, 29% and 14%, respectively, of the Company's revenues. In
the first nine months of 1998, sales to Shaw, Cablevision and Sumitomo
represented approximately 32%, 19% and 14%, respectively, of the Company's
revenues. The Company expects that sales to a limited number of customers will
continue to account for a substantial portion of the Company's sales for the
foreseeable future. If orders from significant customers are delayed,
cancelled or otherwise fail to occur in any particular period, or if any
significant customer delays payment or fails to pay, the Company could
experience significant operating losses in such period. As a result, the
Company expects to experience significant fluctuations in its operating
results on a quarterly and annual basis. See "Risk Factors--We Are Dependent
on a Small Number of Customers," "--We May Be Unable to Market Effectively to
Cable Operators" and "--We Are Dependent on the Cable Industry to Upgrade to
Two-Way Cable Infrastructure."
The market for broadband access products and services is intensely
competitive and is characterized by rapid technological change, new product
development and product obsolescence, evolving industry standards and
significant price erosion of products over time. The Company has experienced
and expects to continue to experience downward pressure on its unit ASPs. The
Company has had negative gross margins since inception. While the Company has
initiated cost reduction programs to offset pricing pressures on its products,
there can be no assurance that these cost reduction efforts will continue to
keep pace with competitive price pressures or lead to improved gross margin.
If the Company is unable to reduce costs efficiently, its gross margin and
profitability will continue to be adversely affected. The Company's gross
margin also is affected by the sales mix of TeraLink 1000 Master Controllers,
TeraLink
27
<PAGE>
Gateways and TeraPro cable modems, as the TeraPro modems have significantly
lower margins than the TeraLink 1000 Master Controllers and TeraLink Gateway
headend products. As a result, the Company's gross margin also is affected by
the maturity of TeraComm deployments in any quarter, because new deployments of
the TeraComm system involve the sale of headend equipment (which has higher
margins) and generally involve smaller quantities of product, which typically
are sold at higher margins than the larger volume sales of product associated
with more mature deployments of the TeraComm system. For the foreseeable
future, the Company expects negative or nominal margins on TeraPro cable modems
and expects that sales of TeraPro cable modems will continue to constitute a
significant portion of its revenues. As a result of these factors, the
Company's gross margins and operating results are likely to be adversely
affected in the near term. The Company's components are sold together as part
of an entire system, and the Company accordingly does not report revenue
derived from each component. In addition, because the relationship of each
component to the other components is likely to vary depending on the specific
arrangement with each of the Company's customers, the quantification of revenue
according to each component is not necessarily indicative of the percentage of
revenue that each component might represent in future quarters. See "Risk
Factors--Average Selling Prices of Cable Equipment Typically Decrease," "--We
Must Achieve Cost Reductions," "--Cable Modems Have Not Achieved Widespread
Market Acceptance and Many Competing Technologies Exist," "--We Have Limited
Manufacturing Experience and We Are Dependent on Contract Manufacturers" and
"--Our Industry is Highly Competitive with Many Established Competitors."
The Company's ability to generate revenues also depends on guaranteeing the
availability of supplies from its sole sources, increasing the manufacturing
and testing capacity of its products by a contractor while ensuring product
quality, and continuing deployment of its products by existing and new
customers. In the first quarter of 1998, the Company transitioned its
manufacturing operations from CMC California, Inc. ("CMC") to Solectron. The
Company recorded a charge of $1.3 million in the first quarter of 1998 relating
to the write-off of inventory as a result of transitioning manufacturing
operations to Solectron. A portion of the charge consisted of $750,000 of raw
material components that were deemed obsolete due to a design change in the
Company's bill of materials during the quarter ended March 31, 1998. The charge
also consisted of a $550,000 write down of parts repurchased from CMC and then
resold to Solectron, as Solectron could purchase the related parts at a lower
cost than the Company had valued the inventory. Therefore, the Company wrote
down the inventory to the lower of cost or market as part of selling the
inventory to Solectron. The Company currently tests and assembles the TeraLink
1000 Master Controller and the TeraLink Gateway headend equipment at its Santa
Clara facility. Finished TeraPro cable modems are drop shipped by Solectron to
Terayon customers. See "Risk Factors--We Have Limited Manufacturing Experience
and We Are Dependent on Contract Manufacturers."
The Company sustained net losses applicable to common stockholders of $3.7
million, $10.7 million, $22.5 million and $41.7 million for the years ended
December 31, 1995, 1996 and 1997 and for the nine months ended September 30,
1998, respectively. As a result, the Company had an accumulated deficit of
$78.9 million as of September 30, 1998. The Company's operating expenses are
based in part on its expectations of future sales, and the Company expects that
a significant portion of its expenses will be committed in advance of sales. As
a result, net income may be adversely affected by a reduction in sales if the
Company is unable to adjust expenses quickly in response to any decrease in
sales. The Company expects to increase significantly expenditures in technical
development, sales and marketing and manufacturing as it engages in activities
related to product enhancement, cost reduction and commercialization of new
products. Additionally, the Company expects to increase capital expenditures
and other operating expenses in order to support and expand the Company's
operations. The Company anticipates that it will spend approximately $4.0
million on capital expenditures and approximately $12.0 million on research and
development during the twelve months ended September 30, 1999. Anticipated
capital expenditures consist of purchases of additional test equipment to
support higher levels of production and computer hardware, software and
equipment for newly hired
28
<PAGE>
employees. The Company intends to use the proceeds from this offering to fund
such requirements. As a result of these anticipated increased operating
expenses, the Company expects to continue to incur losses for the foreseeable
future. There can be no assurance that the Company will achieve or sustain
profitability in the future. See "Risk Factors--We Have a Limited Operating
History and a History of Losses," "--Our Operating Results May Fluctuate" and
"--The Sales Cycle for Our Products is Lengthy."
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
Revenues. The Company's revenues increased from $755,000 for the nine months
ended September 30, 1997 to $18.8 million for the nine months ended September
30, 1998. Revenues consist primarily of sales of cable modems and headend
equipment to new and existing customers. The Company did not commence selling
its products until June 1997.
Cost of Goods Sold. Cost of goods sold consists of direct product costs as
well as the cost of the Company's manufacturing operations group, which cost
consists of assembly, test and quality assurance for products, warranty costs
and associated costs of personnel and equipment. For the nine months ended
September 30, 1997, the Company incurred $2.2 million in cost of goods sold,
which included the cost of the manufacturing group for the entire period as it
readied the Company's products for commercialization, compared to
$22.0 million for the nine months ended September 30, 1998, which included the
costs of the manufacturing group and a charge of $1.3 million relating to the
write-off of obsolete inventory and the transition of manufacturing operations
to Solectron.
Gross Loss. The Company incurred a gross loss of $1.5 million for the nine
months ended September 30, 1997 due to costs associated with the Company's
manufacturing operations group. The Company incurred a gross loss of $3.2
million for the nine months ended September 30, 1998, primarily due to an
increased volume of negative margin cable modems and a charge of $1.3 million
relating to the write-off of obsolete inventory and the transition of
manufacturing operations to Solectron.
In the third quarter of 1998, the Company completed manufacturing
qualification of a lower cost, single-board modem. The Company expects to
complete the transition to the cost-effective modem product in the fourth
quarter of 1998; however, the Company anticipates that decreases in the
average sales price of its cable modems will partially offset the benefits
obtained from the cost-reduced modem.
Research and Development. Research and development expenses consist
primarily of personnel costs, as well as design expenditures, equipment and
supplies required to develop and enhance the Company's products. Research and
development expenses decreased from $8.6 million in the nine months ended
September 30, 1997 to $7.7 million in the nine months ended September 30, 1998
as a result of timing of the Company's development projects. The Company
intends to continue to increase investment in research and development
programs in future periods for the purpose of enhancing current products,
reducing the cost of current products and developing new products.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries for sales, marketing and support personnel, and costs related to
tradeshows, consulting and travel. Sales and marketing expenses increased from
$2.7 million in the nine months ended September 30, 1997 to $4.8 million in
the nine months ended September 30, 1998, primarily due to increased payroll
costs related to additional sales and support personnel for commercial trials
and deployment of the Company's products. The Company expects sales and
marketing expenses to increase in the future as the Company expands its
customer base.
General and Administrative. General and administrative expenses primarily
consist of salary and benefits for administrative officers and support
personnel, travel expenses, legal, accounting and consulting fees. General and
administrative expenses increased from $1.7 million in the nine months
29
<PAGE>
ended September 30, 1997 to $2.1 million in the nine months ended September
30, 1998. The increase was primarily a result of the additional reporting
requirements imposed on the Company as a public company and increased
infrastructure to support expanded activities of the Company. The Company
expects that general and administrative expenses will continue to increase in
the near term as a result of these factors.
Net Interest Income. Net interest income was $130,000 in the nine months
ended September 30, 1997 compared to $26,000 for the nine months ended
September 30, 1998. The decrease primarily was a result of lower interest
income on lower average cash balances and higher interest expense on term debt
in the nine months ended September 30, 1998.
Series F Convertible Preferred Stock Dividend. The Company recorded a
dividend of $23.9 million in the nine months ended September 30, 1998,
representing the fair value of the warrant to purchase 3,000,000 shares of the
Company's common stock (the "Shaw Warrant") under EITF No. 96-13, "Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock." The Company's accounting conclusion with respect to the
Shaw Warrant issued in connection with the sale of $5.0 million of convertible
preferred stock to Shaw (the "Shaw Financing") is based on management's
conclusion that the sale of preferred stock was, in substance, a financing
transaction and not the issuance of equity instruments in exchange for goods
or services. When the Company issued $5.0 million of convertible preferred
stock and the Shaw Warrant on April 6, 1998, its singular objective was to
obtain sufficient liquidity to continue as a going concern. At the time of the
Shaw Financing, the Company's ability to continue as a going concern was in
serious doubt. At March 31, 1998, the Company had only $109,000 in cash, but
was using cash of approximately $1.0 million, net, per month in operations;
further, the Company had a deficit in working capital of $8.8 million.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
Revenues. The Company did not recognize any revenues from product sales in
1995 or 1996, as the Company did not commence selling its products until June
1997. The Company recognized product revenues of $1.6 million in 1997,
primarily due to sales of headend controllers and cable modems. A majority of
the products shipped during 1997 were for customer trial purposes. During
1997, the Company also recognized $480,000 of technology development revenues
pursuant to a technology development agreement (the "Development Agreement")
to provide telephony modules to a telecommunications systems manufacturer. The
Company does not expect significant revenues to be recognized pursuant to the
Development Agreement in the future.
Cost of Goods Sold. In 1995, the Company incurred $676,000 in cost of goods
sold as a result of technology development costs incurred pursuant to the
Development Agreement. The Company did not incur any cost of goods sold in
1996. The Company incurred $6.5 million in cost of goods sold in 1997,
reflecting the costs of the Company's manufacturing operations group for the
full year and direct product costs related to sales that occurred primarily in
the last six months of 1997.
Gross Loss. The Company incurred a gross loss of $676,000 in 1995 due to
technology development costs incurred pursuant to the Development Agreement.
The Company did not realize any gross profit or loss in 1996. The Company
incurred a gross loss of $4.3 million in 1997, primarily due to manufacturing
costs for the full year spread against revenues recognized primarily in the
last six months of 1997. The manufacturing costs incurred in the first six
months of 1997 consisted of pre-production activities related to preparation
for commercialization of the Company's products.
Research and Development. Research and development expenses increased from
$2.0 million in 1995 to $8.0 million in 1996, primarily due to increased
number of personnel and related labor costs and approximately $1.5 million of
prototype and non-recurring engineering costs related to the development
30
<PAGE>
of the Company's initial products. Research and development expenses increased
from $8.0 million in 1996 to $11.3 million in 1997 due to increased staffing
and associated engineering costs related to new and existing product
development.
Sales and Marketing. Sales and marketing expenses increased from $205,000 in
1995 to $1.1 million in 1996, primarily as a result of increased number of
personnel and related labor costs and costs related to promotional activities
and early trials of the Company's products. Sales and marketing expenses
increased from $1.1 million in 1996 to $4.5 million in 1997, primarily due to
increased payroll costs related to additional sales and support personnel for
commercial and market trials and the commercial launch of the Company's
products.
General and Administrative. General and administrative expenses increased
from $825,000 in 1995 to $1.8 million in 1996, primarily due to increased
hiring and higher legal and travel expenses related to preparations for the
commercial release of the Company's products. General and administrative
expenses increased from $1.8 million in 1996 to $2.5 million in 1997, due to
increased number of personnel and related payroll costs and higher legal and
executive travel expenses.
Net Interest Income. Net interest income increased from $68,000 in 1995 to
$253,000 in 1996, as a result of increased cash balances during 1996 resulting
from the Company's financing activities during those periods. Net interest
income decreased from $253,000 in 1996 to $128,000 in 1997, primarily as a
result of higher interest expense due to larger loan balances.
31
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth selected unaudited consolidated statement of
operations data for each of the three-month periods in the seven quarters ended
September 30, 1998. The data set forth below have been derived from unaudited
consolidated financial statements of the Company and have been prepared on the
same basis as the audited consolidated financial statements contained in this
Prospectus, and in the opinion of management, include all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
of such information for the periods presented. Such consolidated statement of
operations data should be read in conjunction with the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Prospectus. Results of
operations in any period should not be considered indicative of the results to
be expected in any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1998 1998 1998
--------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ 93 $ 662 $ 1,363 $ 2,444 $ 6,932 $ 9,400
Cost of goods sold...... 178 304 1,761 4,219 4,134 7,383 10,506
------- ------- ------- ------- ------- -------- -------
Gross loss............ (178) (211) (1,099) (2,856) (1,690) (451) (1,106)
------- ------- ------- ------- ------- -------- -------
Operating expenses:
Research and
development.......... 2,580 3,306 2,695 2,738 2,305 2,618 2,779
Sales and marketing... 529 994 1,192 1,753 1,140 1,829 1,846
General and
administrative....... 461 644 610 831 505 777 813
------- ------- ------- ------- ------- -------- -------
Total operating
expenses............ 3,570 4,944 4,497 5,322 3,950 5,224 5,438
------- ------- ------- ------- ------- -------- -------
Loss from operations.... (3,748) (5,155) (5,596) (8,178) (5,640) (5,675) (6,544)
Net interest income
(expense).............. 91 32 7 (2) (64) 32 58
------- ------- ------- ------- ------- -------- -------
Net loss................ (3,657) (5,123) (5,589) (8,180) (5,704) (5,643) (6,486)
Series F convertible
preferred stock
dividend............... -- -- -- -- -- (23,910) --
------- ------- ------- ------- ------- -------- -------
Net loss applicable to
common stockholders.... $(3,657) $(5,123) $(5,589) $(8,180) $(5,704) $(29,553) $(6,486)
======= ======= ======= ======= ======= ======== =======
</TABLE>
Revenues increased in each of the consecutive three month periods due to
commencement of commercial shipment of the Company's products in June 1997. The
Company experienced declining gross margins in the second half of 1997 as the
Company commenced sales of cable modems which, due to low volume production
quantities and resulting high manufacturing costs and per-unit overhead
allocations, were sold at negative margins. Revenues for the fourth quarter of
1997 include $480,000 of product development revenues related to the Company's
development of a telephony module for a telecommunications system manufacturer.
Gross margins fluctuated in the first three quarters of 1998 as a result of
changes in the volume of sales in a particular quarter, changes in unit
manufacturing costs and pricing arrangements with customers. Operating expenses
varied in the last four quarters ended September 30, 1998 due to the timing of
research and development projects and due to significant trade shows in the
fourth quarter of 1997 and the second quarter of 1998. Net loss applicable to
common stockholders increased in the second quarter of 1998 due to the
recording of a dividend charge of $23.9 million representing the fair value of
the Shaw Warrant.
The Company has experienced, and expects to continue to experience,
fluctuations in its operating results on a quarterly and an annual basis.
Historically, the Company's quarterly revenues have been unpredictable due to a
number of factors. Factors that have influenced and will continue to influence
the Company's operating results include: a long sales cycle for the Company's
products; competitive pricing pressures; the effects of extended payment terms,
promotional pricing, service, marketing or other terms offered to customers;
accuracy of customer forecasts of end user demand; personnel changes; quality
control of products sold; and regulatory changes or delays in obtaining
required regulatory approvals. For example, the Company's product shipments to
date to a
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<PAGE>
customer in Brazil have been significantly lower than anticipated, due to
delays in certain regulatory approvals in Brazil. There can be no assurance
that similar delays will not occur in other countries in which the Company is
marketing or plans to market its products. Any such delays would have an
adverse effect on the Company's operating results for a particular period.
Factors that may influence the Company's operating results in the future
include: the size and timing of customer orders and subsequent shipments;
customer order deferrals in anticipation of new products or technologies;
timing of product introductions or enhancements by the Company or its
competitors; market acceptance of new products; technological changes in the
cable, wireless and telecommunications industries; changes in the Company's
operating expenses; customers' capital spending; delays of orders by customers;
customers' delay in or failure to pay accounts receivable; and general economic
conditions. See "Risk Factors--Our Operating Results May Fluctuate."
INCOME TAXES
The Company has not generated any net income to date and therefore has not
accrued any income taxes since its inception. The Company accounts for income
taxes under Statement of Financial Accounting Standards No. 109. Realization of
deferred tax assets is dependent on future earnings, if any, the timing and
amount of which are uncertain. Accordingly, valuation allowances in amounts
equal to the net deferred tax assets as of December 31, 1997 and 1996 have been
established to reflect these uncertainties.
At December 31, 1997, the Company had federal and state net operating loss
carryforwards of $31.0 million and $15.0 million, respectively, and federal and
state tax credit carryforwards of $1.7 million and $1.2 million, respectively,
that will expire at various dates beginning in 1999 through 2012, if not
utilized. Utilization of net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended, and
similar state provisions. The annual limitation may result in the expiration of
net operating loss and tax credit carryforwards before full utilization.
STOCK-BASED COMPENSATION
With respect to certain stock option grants in 1997 and the first nine months
of 1998, the Company had recorded deferred compensation of $2.1 million as of
September 30, 1998. The Company amortized approximately $12,000 of the deferred
compensation in 1997 and $236,000 in the first nine months of 1998, and will
amortize the remainder over the related vesting period of the stock options.
See Note 9 of Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception through September 30, 1998 the Company met its liquidity
needs primarily through private sales of preferred stock for aggregate proceeds
of $52.7 million, before deduction of issuance costs, and an initial public
offering of 3,000,000 shares of common stock at a price of $13.00 per share,
which was completed in August 1998. The net proceeds from the offering were
approximately $35.1 million.
Since its inception, the Company has used cash in operating activities of
$47.5 million through September 30, 1998. Cash used in operating activities in
1995, 1996, 1997 and the first nine months of 1998 was $2.3 million, $9.4
million, $20.8 million and $15.0 million, respectively. In 1995, 1996 and the
first nine months of 1998, cash used in investing activities was $1.3 million,
$6.5 million and $3.8 million, respectively. Investment activities in 1995
consisted primarily of the purchase of hardware, software and test equipment
and in 1996 and the first nine months of 1998 consisted primarily of the
purchase of short-term investments. Cash provided by investing activities,
primarily from the sales of short-term investments, was $1.5 million in 1997.
33
<PAGE>
At September 30, 1998 the Company had approximately $29.6 million in cash and
cash equivalents, $2.9 million in short-term investments and a $5.0 million
revolving line of credit. Subsequent to September 30, 1998, the Company
increased the line of credit to $10.0 million.
As of September 30, 1998, the Company had approximately $11.4 million of
unconditional purchase obligations. The Company anticipates that it will pay
approximately $8.5 million of such obligations by December 31, 1998. The
Company intends to make these payments out of available working capital.
The Company believes that its cash balances, together with the proceeds of
this offering, will be sufficient to satisfy its cash requirements for at least
the next 18 months. There can be no assurance, however, that the Company will
not require additional financing prior to such time to fund its operations and
it may seek to raise such additional funds through the sale of public or
private equity or debt financing or from other sources. The sale of additional
equity or debt securities may result in additional dilution to the Company's
stockholders. There can be no assurance that any additional financing will be
available to the Company on acceptable terms, or at all, when required by the
Company. See "Risk Factors--We May Need to Raise Additional Capital."
YEAR 2000
The Year 2000 issue is the result of computer programs written using two
digits rather than four to define the applicable year (the "Year 2000 Issue").
Computer programs that have such date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000. This could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send
invoices or engage in similar normal business activities.
The Company is heavily dependent upon the proper functioning of its own
computer or data-dependent systems. This includes, but is not limited to, its
systems in information, business, finance, operations, manufacturing and
service. Any failure or malfunctioning on the part of these or other systems
could adversely affect the Company in ways that are not currently known,
discernible, quantifiable or otherwise anticipated by the Company.
The Company recently formed an internal task force to evaluate those areas of
the Company that may be affected by the Year 2000 Issue. The task force will
devise a plan for the Company to become Year 2000 compliant in a timely manner
(the "Plan"). The Plan will include independent validation of the Company's
Year 2000 assessment procedures, initiating formal communications with all of
its significant suppliers, large customers and development partners to
determine the extent to which the Company is vulnerable to those third parties'
failure to remedy their own Year 2000 issues and the development of contingency
plans to address situations that may result if the Company is unable to achieve
Year 2000 readiness of its critical operations. The Company anticipates
addressing the critical Year 2000 issues by mid-1999, prior to any anticipated
impacts on its operating systems. The Company expects that it may address non-
critical Year 2000 issues beyond the Year 2000.
To date, the Company has not incurred incremental material costs associated
with its efforts to become Year 2000 compliant, as the majority of the costs
have occurred as a result of normal upgrade procedures. Furthermore, the
Company believes that future costs associated with its Year 2000 compliance
efforts will not be material.
The Company currently has only limited information on the Year 2000
compliance of its key suppliers and customers. The operations of the Company's
key suppliers and customers could be adversely affected in the event they do
not successfully and timely achieve Year 2000 compliance. The Company's
business and results of operations could experience material adverse effects if
its key suppliers were to experience Year 2000 issues that caused them to delay
manufacturing or shipment of
34
<PAGE>
key components to the Company. In addition, the Company's results of
operations could be materially adversely affected if any of the Company's key
customers encounter Year 2000 issues that cause them to delay or cancel
substantial purchase orders or delivery of the Company's product.
There can be no assurance that the Company will be able to develop a plan to
address the Year 2000 Issue in a timely manner or to upgrade any or all of its
major systems in accordance with such plan. In addition, there can be no
assurance that any such upgrades will effectively address the Year 2000 Issue.
If required upgrades are not completed timely or are not successful, the
Company may be unable to conduct its business or manufacture its products,
which would have a material impact on the operations of the Company.
Furthermore, there can be no guarantee that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure
to convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
The Company intends to, but has not yet established a contingency plan
detailing actions that will be taken in the event that the assessment of the
Year 2000 Issue is not successfully completed on a timely basis.
RECENT FINANCIAL ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 130, Reporting Comprehensive Income. This statement requires
that all items that are to be required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This statement is effective for fiscal years beginning after
December 15, 1997, and has been adopted by the Company in 1998.
In June 1997, FASB issued Statement No. 131, Disclosures About Segments of
an Enterprise and Related Information. This statement replaces Statement No.
14, Financial Reporting for Segments of a Business Enterprise, and changes the
way public companies report segment information. This statement is effective
for fiscal years beginning after December 15, 1997 and will be adopted by the
Company for the year ended December 31, 1998.
35
<PAGE>
BUSINESS
OVERVIEW
Terayon develops, markets and sells cable modem systems that enable cable
operators to cost-effectively deploy reliable two-way broadband access
services. The Company's TeraComm system is designed to enable cable operators
to maximize the capacity and reliability of broadband access services over any
cable plant. This allows cable operators to minimize time-consuming and costly
network infrastructure upgrades, achieve reduced time to market and provide a
wide range of service levels to residential and commercial end users. Cable
operators using the TeraComm system are able to provide additional revenue-
generating services to end users, enabling cable operators to compete
effectively in the emerging market for broadband access services.
The Company's TeraComm system, comprised of the TeraPro cable modem, the
TeraLink 1000 Master Controller, the TeraLink Gateway and the TeraView Element
Management and Provisioning Software, is based on Terayon's S-CDMA technology.
S-CDMA technology enables reliable two-way broadband communications over both
pure coaxial and HFC cable infrastructure by maximizing resistance to noise
that interferes with data transmissions over previously unusable frequency
spectrum. In November 1998, Terayon was selected by CableLabs to co-author an
enhanced version of the DOCSIS cable modem specification based in part on the
Company's S-CDMA technology. See "--Technology."
INDUSTRY BACKGROUND
DEMAND FOR BROADBAND ACCESS
In recent years, the volume of bandwidth intensive data, voice and video
traffic across the Internet, corporate intranets and other public networks has
increased dramatically. This demand has been driven by the proliferation of
residential and commercial computer users that are accessing networks in a
variety of applications, including communications via the Internet, electronic
commerce and telecommuting. These applications often require the transmission
of large, multimedia-intensive files. IDC estimates that the number of Internet
users will increase from approximately 69 million at the end of 1997 to
approximately 320 million by the end of 2002. IDC also estimates that the
number of home office households will increase from approximately 35 million at
the end of 1997 to approximately 50 million by the end of 2002.
Despite significant advances in the performance of computer processors and
data backbone networks, high speed data transmission has been limited by the
existing local access network infrastructure (the local loop), which is not
optimized for distribution of data-intensive multimedia content. Users of dial-
up analog modems with maximum data rates of only 28.8 Kbps to 56 Kbps often
experience frustration, as they encounter frequent and lengthy delays or
complete failures in transmission. In response to the growing demand for
increased bandwidth, the communications industry has begun to deploy new
broadband access technologies that can deliver megabit per second ("Mbps") or
better performance to end users.
ADVANTAGES OF CABLE MODEMS OVER ALTERNATIVE BROADBAND ACCESS TECHNOLOGIES
As residential and commercial demand for faster Internet access continues to
grow, particularly for applications such as streaming audio and video, IP
telephony and interactive two-way video, service providers are investing in
enabling infrastructure and technologies. Various technologies have emerged to
address the need for broadband access. The leading technologies include ISDN,
ADSL and other xDSL technologies being marketed by telecommunications
companies, and cable infrastructure technologies such as cable modems being
marketed by cable operators. These digital technologies offer substantial
performance increases over traditional analog 56 Kbps dial-up modem
technologies.
36
<PAGE>
The following chart depicts the maximum available throughput of various
broadband access technologies:
COMPARISON OF ALTERNATIVE BROADBAND TECHNOLOGIES
<TABLE>
<CAPTION>
MAXIMUM
AVAILABLE THROUGHPUT
------------------------
TECHNOLOGY DESCRIPTION DOWNSTREAM UPSTREAM
- ----------------------------------------------------------------------------
<C> <S> <C> <C>
Cable Modems High speed digital technology over 27.0 to 36.0 2.0 to 14.0
HFC and pure coaxial systems Mbps Mbps
- ----------------------------------------------------------------------------
ADSL High speed digital technology over 1.5 to 6.1 640 Kbps
existing copper wire Mbps
- ----------------------------------------------------------------------------
ISDN High speed digital technology over 128 Kbps 128 Kbps
existing copper wire
- ----------------------------------------------------------------------------
Dial-up Digital-to-analog conversion 56 Kbps 33 Kbps
Analog Access utilizing existing copper wire
- ----------------------------------------------------------------------------
</TABLE>
Of the digital technologies, cable modems currently provide the highest
available two-way transmission speeds and their "always on" availability
eliminates the tedious and unreliable dial-up process of other technologies.
The existing cable infrastructure offers other important advantages over
alternative broadband architectures. Currently, the cable infrastructure passes
over 95% of homes in the United States and a large number of small businesses.
In addition, the cable infrastructure has the potential to offer a wide range
of broadband services, such as digital TV, Internet access and IP telephony.
Many cable operators have recognized the need to expand beyond broadcast and
video TV services to diversify their business and remain competitive. A growing
number of cable operators have already expanded their business to include data-
over-cable services through affiliations with service providers such as @Home
and Road Runner, and several cable operators are exploring voice-over-cable
services as well. Kinetic Strategies Inc. estimates that there will be over
500,000 North American homes with data-over-cable services at the end of 1998.
LIMITATIONS OF EXISTING CABLE INFRASTRUCTURE
Most cable networks were designed to provide one-way video broadcast from the
cable headend to subscribers. Data-over-cable and other two-way services
require cable operators to provide an upstream return path from subscribers to
the headend. Noise interferes with upstream signal transmissions, potentially
resulting in corrupted information or service outages. Common noise problems
are (i) "ingress noise," a relatively constant level of interference resulting
from home appliances and consumer electronics leaking noise into the cable
system through imperfections in the cable plant, such as faulty connections or
cracked cable shielding and (ii) "impulse noise," which is transient,
unpredictable interference that results from home appliances switching on and
off. Noise is a particular problem in the upstream return path because each
home's noise is aggregated into the headend. In addition, the 5 to 42 MHz
frequency spectrum reserved for subscriber-to-headend transmissions is highly
susceptible to ingress and impulse noise.
CABLE OPERATOR CHALLENGES IN DEPLOYING BROADBAND ACCESS SERVICES
In order to successfully exploit the opportunities offered by the increasing
demand for broadband access, cable operators face a number of challenges.
Cost-effectively manage system noise. Cable modems based on current-
generation TDMA technologies typically require a Signal-to-Noise Ratio ("SNR")
of 20dB or better for reliable operation. To respond to ingress noise, cable
operators using cable modems based on TDMA often must upgrade their networks to
an HFC architecture at substantial cost. An upgrade to an HFC system includes
replacing a
37
<PAGE>
substantial portion of the existing coaxial network with optical fiber,
replacing the headend transmission equipment with optical transmission systems
and providing additional interface layers between the optical fiber and the
coaxial connection into the home.
To further address ingress noise and attempt to prevent impulse noise
interference, cable operators must often completely rebuild their HFC network.
This entails dividing the network into smaller segments, to isolate noise and
therefore limit the aggregate noise arriving at the headend, as well as
replacing coaxial drops in the homes of subscribers for data services and
placing filters on non-subscriber homes. In addition, many TDMA-based systems
employ a frequency-agile scheme where the transmission system will shift
transmission to a pre-reserved backup channel if the primary channel is
affected by a noise event. Despite these expenditures, cable operators using
TDMA may still be required to increase routine maintenance procedures in order
to provide reliable service and to restrict two-way services to a limited
portion of the 5 to 42 MHz frequency spectrum where noise events are less
likely to occur. To reduce these costs and improve the quality of their
service, cable operators require new upstream transmission technologies that
address both ingress and impulse noise.
Minimize network capital equipment costs. Noise levels are directly related
to the number of homes passed by a network, regardless of the number of
subscribers on such network. As a result, the number of homes that can be
supported by a single TDMA-based headend is limited, even in the early phase
of deployment, when the number of subscribers may be very small. Cable
operators using TDMA technology are often required to deploy a large number of
headends to create a large service area "footprint." Minimizing initial
investments and attaining "pay-as-you-go" capability that allows revenues to
support incremental investment are vital to the ability of cable operators to
enter the broadband access market.
Time to market. As telecommunications operators move quickly to offer
broadband services, the Company believes that a cable operator's success in a
particular geographic market will be determined by being first to market with
broadband access services. Therefore, the Company believes that cable
operators will need the ability to accelerate cable modem deployments in order
to enhance their competitive position.
Ability to offer tiered services. The Company believes that cable operators
can benefit from having a network capable of offering tiered services that
allow them to maximize revenue from bandwidth allocated to those services. For
example, a residential end user who only utilizes e-mail or Internet access
may only be willing to pay a small premium over the cost of a dial-up
connection, while commercial end users may be willing to pay a substantial
premium for guaranteed bandwidth. In order to offer tiers of service with
varied access speeds and priority connections, cable operators need the
ability to assign a portion of shared bandwidth to individual end users.
Deploy industry standard technology. The Company believes that cable
operators strive to deploy cable modems based on technology that conforms to
industry standards. Because cable modems must be interoperable with the
headend controller equipment, the purchase of a headend that is based on
proprietary technology requires the purchase of cable modems for that headend
from the same supplier. Industry standard technology allows multiple suppliers
to offer similar products, enhancing competition and lowering equipment prices
for cable operators, simplifying the purchasing decision and reducing
interoperability problems.
To meet these challenges, cable operators require a highly reliable
broadband access solution that can be deployed rapidly at low initial costs,
that enables cable operators to maximize revenues from available bandwidth
capacity, and that scales as the number of broadband access subscribers
increases.
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THE TERAYON SOLUTION
The Company's TeraComm system is designed to enable cable operators to
maximize the capacity and reliability of broadband access services over any
cable plant. This allows cable operators to minimize time-consuming and costly
network infrastructure upgrades, achieve reduced time to market and provide a
wide range of service levels to residential and commercial end users. Cable
operators using the TeraComm system are able to provide additional revenue-
generating services to end users, enabling cable operators to compete
effectively in the emerging market for broadband access services.
The Terayon system provides important advantages for any cable plant. Under
any given noise condition, S-CDMA provides higher reliability and a higher
capacity upstream channel than can be provided by current TDMA technology. S-
CDMA's reliability and capacity advantages exist even in fully upgraded HFC
plants. These advantages are particularly important for providing advanced
services such as telephony. The Company's S-CDMA technology offers cable
operators the following advantages:
Minimize upfront cable infrastructure upgrades. Terayon's S-CDMA technology
operates at extremely low SNRs (-13dB), which enables Terayon's cable modems
to be deployed on pure coaxial or HFC-upgraded systems, with minimal initial
system upgrades. TDMA-based systems, which generally demand higher SNRs for
operation (20dB), often require costly system upgrades or complete rebuilds to
high quality HFC in order to support comparable broadband access services. S-
CDMA allows operators to more closely match their network upgrades with the
offering of additional revenue opportunities.
Reduce time to market. Activating two-way transmission by installing the
TeraComm system does not require the time-consuming network upgrades or
rebuilds usually required to support TDMA-based transmission equipment. As a
result, cable operators can accelerate cable modem deployment and reduce their
time to market with broadband access services, thereby enhancing their
competitive position.
Minimize initial headend capital equipment costs. By deploying the TeraComm
system, cable operators can minimize the initial capital expense for headend
equipment. The noise-resistant properties of S-CDMA allow more cable segments
to be aggregated to form a single shared upstream channel. These properties
provide cable operators with a cost-effective solution during initial stages
of deployment even with a limited number of users. As the number of users
increases, additional Terayon equipment can be installed for a smooth
transition to a larger scale network. For large deployments, the routed
architecture of Terayon's system will support a large number of headends,
enabling cable operators to effectively manage thousands of subscribers as a
single IP network with multiple logical sub-networks. In contrast, TDMA-based
systems support a smaller number of homes passed per headend due to
susceptibility to noise-related service problems.
Increase signal transmission reliability. Cable operators who plan to offer
broadband access services must demonstrate the ability to provide reliable and
continuous service. S-CDMA enables cable operators to maintain signal
transmission even in high noise environments. Further, S-CDMA's ability to
respond to sudden changes in plant conditions prevents even short service
outages, unlike alternative systems that utilize a frequency-agile scheme,
which can result in a loss of service.
Maximize spectrum usage. The TeraComm system is designed to operate
effectively in the lowest frequency ranges of the upstream spectrum, where
noise is too severe to allow the operation of TDMA-based systems. As a result,
cable operators who employ the TeraComm system can utilize more of the
existing upstream bandwidth than alternative broadband access technologies.
Generate additional revenue through tiered services. The high capacity and
dynamic bandwidth management capabilities of the TeraComm system are designed
to enable cable operators to offer a wide range of services at tiered prices.
Cable operators can emulate high margin commercial-service offerings
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such as T-1, frame-relay and leased lines in the same network as lower margin,
residential, Internet access.
Reduce ongoing cable infrastructure maintenance costs. Cable operators
utilizing the TeraComm system can capitalize on S-CDMA's noise-resistant
properties, which enable cable operators to operate plants in a wide range of
conditions, thus reducing ongoing maintenance costs and minimizing service
problems. For example, while all cable operators monitor their networks on a
regular basis, cable operators using TDMA-based systems are generally required
to take more frequent corrective action than cable operators using S-CDMA-based
systems to prevent normal "wear and tear" on the cable system from impacting
service.
STRATEGY
The Company's objective is to be the leading provider of cable modem systems
to cable operators seeking to provide broadband access services to residential
and commercial end users. Key elements of the Company's strategy are as
follows:
Supply leading cable operators worldwide. The Company's initial target market
is the ten largest cable companies in each major geographic area. In most
markets, a small number of large cable operators often provides services to a
majority of subscribers in a specific region and thus influences the purchase
decisions of smaller cable operators. In the United States, ten cable operators
together own and operate facilities passing approximately 74% of total homes
passed. To date, three of the largest North American cable operators,
Cablevision, Shaw and TCA Cable TV, Inc. are deploying the TeraComm system
commercially.
Advance industry standards. In November 1998, CableLabs selected the Company
to co-author an enhanced version of the DOCSIS cable modem specification based
in part on the Company's S-CDMA technology. This enhanced version of the DOCSIS
specification will be known as DOCSIS 1.2. In order to advance the
standardization of cable modem technology, the Company has agreed to contribute
some aspects of its S-CDMA technology to the DOCSIS intellectual property pool
upon completion and acceptance of a specification that includes the Company's
S-CDMA technology. The Company intends to develop future products that are
DOCSIS 1.2-compliant and is actively participating in the development of
additional industry standards.
Extend technology leadership and achieve rapid time to market. The Company
believes the inclusion of its S-CDMA technology in DOCSIS 1.2 would give it an
advantage over its competitors, who will have to adapt their products to be
DOCSIS 1.2-compliant. Terayon's team of engineers has extensive experience in
many areas of broadband access system design, including communication systems,
ASICs, data networking, radio frequency, software and hardware. The Company
intends to leverage its engineering capabilities to expand the features and
functionality of its S-CDMA technology. The Company will strive to use its
technical expertise to achieve a significant time-to-market advantage over
competing cable modem suppliers in offering advanced features, such as IP
telephony and videoconferencing. In addition, Terayon intends to apply S-CDMA
to additional applications such as wireless communications and LMDS.
Reduce manufacturing costs. A key component of Terayon's strategy is to
decrease the cost of manufacturing its products to improve its gross margins.
For example, the Company recently introduced a cable modem that uses a single-
board design, which has higher gross margins than its original dual-board cable
modem. The Company intends to engage in other cost-reduction efforts, including
the further integration of ASIC components, other design changes and the
potential use of a second contract manufacturer.
Provide superior customer service and support. Terayon believes that its
ability to provide consistent high quality service and support will be a key
factor in attracting and retaining customers. In
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addition to assigning a field applications engineer to each customer account,
the Company provides its customers with technical support and training through
customer support representatives and representatives of distributors. The
Company provides service and support to its customers 24 hours a day, 7 days a
week.
Increase presence in existing and new markets. Terayon believes that the
market for cable modem systems is global and it intends to increase its
presence in new and existing markets throughout North America, Europe, Asia
and Latin America. The Company currently sells its products in over 20
countries worldwide. In order to increase its market penetration and to
capitalize on new opportunities, Terayon plans to continue to expand its
sales, marketing and customer support capabilities through both direct sales
and marketing staff as well as relationships with distributors. The Company
believes that a physical presence in key customer locations provides an
important advantage in developing and maintaining new and existing customer
relationships.
TECHNOLOGY
Terayon's products are based on the Company's S-CDMA technology. S-CDMA,
like asynchronous CDMA technology commonly used in wireless communications, is
a form of spread spectrum technology, enabling the transmission of information
as a group of codes from multiple transmitters to a single headend receiver.
In spread spectrum systems, data is transmitted by spreading the information
across a range of frequencies and across a period of time, limiting the amount
of interference caused by foreign signals as compared to TDMA systems. In
asynchronous CDMA transmissions, the codes can arrive at the headend at
slightly different times, or "unaligned," which can result in interference
among the codes, creating inefficiency and requiring the use of signal
modulation techniques that sacrifice capacity in order to cancel the
interference. The Company has developed a technique to synchronize the arrival
of codes at the headend to eliminate the interference among the codes,
allowing the use of signal modulation techniques that do not sacrifice
capacity. As a result, the Company's S-CDMA technology provides better channel
efficiency (more bandwidth per Hertz) than asynchronous CDMA.
S-CDMA technology is integrated into a single ASIC chip, which implements
the physical ("PHY") layer and media access control ("MAC") layer
communication protocols in the TeraComm system. S-CDMA technology is the
primary differentiator between Terayon's cable modems and those of competitors
who use TDMA-based technology for the PHY and MAC layer protocols. S-CDMA
technology is designed to maximize resistance to noise, optimize use of
network capacity and provide cable operators with multiple revenue streams
through the ability to offer multiple Quality of Service levels.
Maximum noise resistance through spread spectrum and rate adaptive
technologies. Spread spectrum technology was originally designed for use by
the military to provide reliable and secure communications in harsh RF
environments. The RF environment is subject to a variety of noise sources that
can interfere with the transmission of data. In spread spectrum systems such
as the Company's S-CDMA technology, data is transmitted by spreading the
information across a range of frequencies and across a period of time,
allowing sufficient information reception for the data to be reconstructed by
the receiver. Data is encoded by transmitters in unique spreading codes that
allow multiple data streams to be received and decoded by the receiver
simultaneously. Therefore, noise events that are typically specific to a
particular frequency or a period of time do not significantly interfere with
transmission.
In addition to spread spectrum, S-CDMA incorporates other techniques,
including forward error correction and interleaving, that further enhance the
ability of S-CDMA to resist impulse and ingress noise. In extremely harsh
noise environments, S-CDMA incorporates a rate adaptive mode of operation that
changes modulation schemes, reducing capacity, but allowing continued reliable
transmission. This combination of techniques enables S-CDMA-based systems to
operate in SNR environments as low as 13dB at full capacity and as low as -
13dB in rate adaptive mode. In contrast, TDMA-based systems typically require
an SNR of at least 20dB for reliable operation.
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Optimal capacity utilization through synchronization. In asynchronous CDMA
systems, codes arriving at the receiver are unaligned. This causes mutual
interference between the codes, which forces the use of lower order modulation
schemes resulting in significantly reduced data capacity. S-CDMA minimizes
mutual interference by ensuring that codes are synchronized with each other
through ranging, power management and adaptive equalization. The process of
ranging guarantees time alignment by ensuring all codes arrive at the receiver
at the same time. Power management and adaptive equalization compensate for
variables such as temperature and changes in network topology. These
techniques allow S-CDMA to utilize higher order modulation schemes providing a
capacity of 14 Mbps in a 5 MHz channel in both the upstream and downstream
paths. This 14 Mbps capacity is divided into 144 data streams, each of which
is represented by a unique S-CDMA spreading code.
Efficient bandwidth management for multiple levels of Quality of
Service. The TeraComm system segments each 14 Mbps upstream and downstream
channel into 128 user data streams and 16 management and control data streams.
Separating user data from management and control ensures high channel
efficiency under heavy channel loading. Each of the 128 user data streams has
a continuous data payload capacity of 64 Kbps. The bandwidth manager software
residing in the system headend allocates data streams to cable modems
individually or in groups. Data streams can also be assigned on a permanent
basis, or can be multiplexed among multiple modems based on a fairness
algorithm in the bandwidth manager. This capability allows the TeraComm system
to provide a variety of Quality of Service levels. Constant Bit Rate ("CBR")
services can be provisioned in increments of 64 Kbps by continuous assignment
of data streams to a TeraPro cable modem. As a result, services such as leased
lines and T-1 circuits can be emulated. Unspecified Bit Rate ("UBR") services
can be supported by allowing modems to contend for data streams on an "as
requested" basis. Because all access requests and grants are communicated
through management streams, the impact on channel efficiency is minimized as
more modems contend for bandwidth. Both CBR and UBR services can co-exist on a
single channel enabling a cable operator to create multiple service levels and
maximize revenue from the available bandwidth capacity.
PRODUCTS
CURRENT PRODUCTS
The Company's TeraComm system enables cable operators to cost-effectively
deploy reliable two-way broadband access services. The TeraComm system is
comprised of the TeraPro cable modem, the TeraLink 1000 Master Controller, the
TeraLink Gateway and the TeraView Element Management and Provisioning
Software. The price of a TeraComm system depends upon a number of variables,
including a customer's basic cable system architecture, the type of routing
equipment a customer intends to use, the level and quality of service that a
cable operator desires to provide and the volume of products purchased by a
customer.
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The following diagram illustrates the TeraComm system:
[Diagram of the components of the TeraComm system]
THE TERACOMM SYSTEM
TeraPro Cable Modem. The TeraPro cable modem is a data communications device
installed in a subscriber's home or business. The TeraPro cable modem connects
to the subscriber's PC via a standard 10BaseT Ethernet connector and to the
cable network via a standard coaxial cable connector. The TeraPro cable modem
automatically configures itself without user intervention, thus minimizing
modem installation time. In addition, the configuration software for the
TeraPro cable modem is downloaded remotely, allowing centralized software
upgrades directly from the headend management system. In October 1998, the
Company began volume shipments of its cable modems in a new single-board
design.
The TeraPro cable modem delivers full two-way communication over the cable
network, with data rates of up to 14 Mbps per 5 MHz channel in both the
upstream and the downstream direction. The TeraPro cable modem operates at
full capacity at an SNR as low as 13dB, and gradually adjusts throughput to
provide transmission at an SNR as low as -13dB. This feature will permit the
TeraPro cable modem to operate across any portion of the 5 to 42 MHz upstream
RF spectrum.
TeraLink 1000 Master Controller. The TeraLink 1000 Master Controller is a
data channel controller and multiplexer located at the cable headend system or
distribution hub. The TeraLink 1000 Master Controller provides control,
management and data transport functions for TeraPro cable modems connected to
the cable network. It offers dynamic bandwidth management, high-speed traffic
concentration, access control to data networking resources, and data service
quality and integrity.
The TeraLink 1000 Master Controller is a single channel, rack-mountable
controller that supports up to 2,000 cable modems per channel. Additional
TeraLink 1000 Master Controllers can be added to scale service as performance
and subscriber needs grow. The TeraLink 1000 Master Controller, with the
TeraLink Gateway, provides a 100 BaseT interface for direct connectivity to a
private backbone or any vendor's router or switch. Alternatively, the TeraLink
1000 Master Controller, with its built-in ATM OC-3 interface, can be connected
via an ATM switch, or directly to Cisco's 7500 series routers.
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TeraLink Gateway. The TeraLink Gateway is a rack-mountable edge concentrator
providing end-user clients with broadband access to a remote IP backbone
(e.g., Internet) as well as efficient communication between modems. The
TeraLink Gateway includes an ATM OC-3 interface for connectivity to up to two
TeraLink 1000 Master Controllers or an ATM switch. It also provides a
10/100 BaseT Ethernet/Fast Ethernet auto-sense interface to a headend backbone
or any IP router including the Cisco Universal Broadband Router. The TeraLink
Gateway also includes a separate 10 BaseT interface, which may be connected to
a separate management network or the headend network. The TeraLink Gateway
supports up to 2,000 cable modems per RF channel when connected to a TeraLink
1000 Master Controller. When used with the TeraLink Gateway, the TeraPro cable
modems behave as an extension of the TeraLink Gateway, providing maximum
bandwidth and privacy.
TeraView Element Management and Provisioning Software. The TeraView Element
Management and Provisioning Software is a Windows 95 and Windows NT standards-
based software application installed at the headend system or the network
operations center. The TeraView software allows cable operators to configure,
control, monitor and maintain multiple channels of the TeraComm system.
PRODUCTS UNDER DEVELOPMENT
The Company currently is designing and developing a DOCSIS 1.2-compliant
system. In addition to a cable modem, this system will include a headend
controller, the Teralink 2000 Master Controller. These products are in the
early stages of development and the Company does not anticipate commercial
deployment of these products until 2000.
CUSTOMERS
The Company markets its products to cable operators that seek to provide
broadband access services to both residential and commercial end users. The
Company's initial target market consists of the ten largest cable companies in
each major geographic area. In most markets, a small number of large cable
operators often provides services to a majority of subscribers in a specific
region and thus influences the purchasing decisions of smaller cable
operators. In the United States, ten cable operators together own and operate
facilities passing approximately 74% of total homes passed. The Company
commenced volume shipments of its products in the first quarter of 1998. To
date, three of the largest North American cable operators, Cablevision, Shaw
and TCA, are deploying the TeraComm system commercially.
Selected examples of the range of customers and applications for which the
TeraComm system is being commercially deployed are as follows:
Cablevision. Cablevision is the fifth largest cable operator in the United
States, with cable infrastructure passing approximately 5.1 million homes,
primarily located in New York, New Jersey, Connecticut, Ohio and
Massachusetts. Cablevision is currently deploying Terayon's products in
systems located in Long Island, New York and areas of Connecticut for its
optimum high speed data service.
Shaw. Shaw is the third largest cable operator in Canada, with cable
infrastructure passing approximately 2.0 million homes. Shaw currently has the
largest cable modem deployment in Canada, with over 55,000 cable modem users.
Shaw has selected Terayon to supply cable modem systems for Shaw's @Home
service deployments in various cities throughout Canada.
Sumitomo. The Company has a distribution agreement with Sumitomo under which
its subsidiary, Crossbeam Networks Corporation ("Crossbeam") is distributing
the TeraComm system to several of Japan's leading cable operators, including
Jupiter Communications, a joint venture between Sumitomo and TCI
International. The TeraComm system's noise resistant properties are designed
to enable two-way broadband access over pure coaxial networks, which comprise
the majority of Japan's cable infrastructure.
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TCA. TCA is the 16th largest cable operator in the United States, with cable
infrastructure passing approximately 1.2 million homes, primarily in Texas,
Arkansas and Louisiana. TCA has deployed the TeraComm system in certain
metropolitan areas in Texas. TCA provides a tiered service offering, with
prices ranging from $49.95 per month for residential Internet access to
$184.95 per month for commercial Internet access.
Three customers accounted for approximately 73% of the Company's revenues in
1997 and for approximately 65% of the Company's revenues in the first nine
months of 1998. In 1997, sales to Telegate, Sumitomo and NET Brasil
represented approximately 30%, 29% and 14%, respectively, of the Company's
revenues. In the first nine months of 1998, sales to Shaw, Cablevision and
Sumitomo represented approximately 32%, 19% and 14%, respectively, of the
Company's revenues. The Company believes that a substantial majority of its
revenues will continue to be derived from sales to a relatively small number
of customers for the foreseeable future. In addition, the Company believes
that sales to these customers will be focused on a small number of projects.
See "Risk Factors--We Are Dependent on a Small Number of Customers."
RESEARCH AND DEVELOPMENT
The Company believes that its future success will depend on its ability to
enhance its existing products and to develop and introduce new products that
meet a wide range of evolving cable operator and end user needs. In addition,
to address competitive and pricing pressures, the Company expects that it will
have to reduce the unit cost of manufacturing its cable modems through design
and engineering changes. For example, in October 1998, the Company introduced
a single-board modem, which provides cost savings over its original dual-board
modem. There can be no assurance that the Company will be successful in
redesigning its products, that any such redesign will be made on a timely
basis and without introducing significant errors and product defects, or that
any such redesign, including the DOCSIS-compliant modem, would result in
sufficient cost reductions to allow the Company to significantly reduce the
list price of its products or improve its gross margin.
The Company also currently is designing and developing a DOCSIS 1.2-
compliant system, which will include a cable modem and an accompanying headend
controller, the TeraLink 2000 Master Controller. These products are in the
early stages of development and the Company does not anticipate commercial
deployment of these products until 2000. See "Risk Factors--There Are Many
Risks Associated with Our Participation in Co-Authoring the DOCSIS-1.2
Specification," "--We Need to Develop New Products," "--We Must Achieve Cost
Reductions" and "We Must Keep Pace with Rapid Technological Change to Remain
Competitive."
As of November 30, 1998, the Company had 57 employees engaged in research
and development. The Company's total research and development expenses for
1995, 1996 and 1997 and the first nine months of 1998 were $2.0 million, $8.0
million, $11.3 million and $7.7 million, respectively.
SALES AND MARKETING
Terayon has direct sales forces in North America, Latin America and Europe.
The Company also distributes its products via distributors and systems
integrators. Terayon has signed a distribution agreement with Sumitomo under
which Crossbeam is distributing the TeraComm system to several of Japan's
leading cable operators.
The Company markets its products directly to cable operators through its
sales force, key distribution and technology partners, as well as other
marketing vehicles such as industry press, trade shows and the World Wide Web.
Through its marketing efforts, the Company strives to educate cable operators
on the technological and business benefits of its system solution, as well as
the Company's ability to provide quality support and service to the customer.
Terayon participates in the major trade shows and industry events for the
cable industry in the United States and is expanding its presence in
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other markets through joint participation at local events with its
international sales and marketing partners. Industry referrals and reference
accounts are significant marketing tools developed and utilized by the
Company.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
The Company believes that its ability to consistently provide high quality
service and support will be a key factor in attracting and retaining
customers. The Technical Services and Support ("TSS") organization provides
support 24 hours a day, seven days per week. Prior to deployment of the
Company's systems, each cable operator's needs are assessed and proactive
solutions are implemented, including various levels of training, periodic
management and coordination meetings, and problem escalation procedures.
Terayon places a strong emphasis on technical training, both for cable
operators and systems integrators. Initial training is offered to cable
operators and systems integrators at no cost, both in Terayon's headquarters
in Santa Clara and on a cable operator's or system integrator's premises. At
November 30, 1998, the TSS organization consisted of 16 employees located in
North America, Europe, Latin America and Asia.
In addition, Terayon has developed sophisticated tools for remote diagnosis
and monitoring of the TeraComm systems deployed by cable operators. Such tools
enable the Company to monitor cable operators' installations of the TeraLink
1000 Master Controller and to proactively suggest solutions before problems
become noticeable to end users. The Company is developing a Web-based
knowledge system to provide cable operators with access to the latest
technical support information.
MANUFACTURING
The Company outsources the materials procurement, printed circuit board
assembly, and product assembly and testing to turnkey contract manufacturers.
Currently, the Company contracts with Solectron, located in Milpitas,
California, for the manufacture of the majority of its products. CMC, located
in Santa Clara, California, also manufactures certain of the Company's
products. The Company has a limited in-house manufacturing capability at its
headquarters in Santa Clara. This facility is currently used for the assembly
and final testing of TeraLink 1000 Master Controller and TeraLink Gateways,
pilot production of new modem designs, sample testing of products received
from volume modem manufacturers, developing the manufacturing process and
documentation for new products in preparation for outsourcing. The Company
also repairs products returned from customers with its in-house manufacturing
resources.
The Company's future success will depend in significant part on its ability
to obtain high volume manufacturing at low costs. As volume increases, the
Company plans to engage additional contract manufacturers, to procure
additional manufacturing facilities and equipment, to modify existing
inventory procedures, to substantially increase its personnel and to revise
its quality assurance and testing practices. There can be no assurance that
any of these efforts will be successful. As part of its efforts to reduce
costs, the Company began volume shipments in October 1998 of its single-board
cable modem, which has higher gross margins than the Company's original dual-
board cable modem. The Company anticipates that it will need to reduce further
the manufacturing costs of its cable modem and will continue to evaluate the
use of low cost third-party suppliers and manufacturers. See "Risk Factors--We
Must Achieve Cost Reductions" and "--We Have Limited Manufacturing Experience
and We Are Dependent on Contract Manufacturers."
Subcontractors supply the Company's contract manufacturers with both
standard components and subassemblies manufactured to the Company's
specifications. The Company is dependent upon certain key suppliers for a
number of the components for its products. For example, the Company currently
relies on VLSI Technology, Inc. for the Company's S-CDMA ASIC, which is used
in the Company's headend and cable modem products. In addition, all of the
Company's products contain one or more components that are currently only
available from a single source.
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COMPETITION
The market for broadband access systems is extremely competitive and is
characterized by rapid technological change. The Company's direct competitors
in the cable modem arena include Cisco, Com21, Hayes, Hybrid, Matsushita,
Motorola, Nortel, Phasecom, RCA, Samsung, Scientific-Atlanta, Sony, 3Com,
Toshiba and Zenith and there are many other potential market entrants. In
addition, Com21, Hybrid, Motorola and Nortel introduced cable modems prior to
the Company, and have established relationships and have worked with customers
for a longer period of time than the Company. The principal competitive factors
in this market include: product performance, features and reliability; price;
size and stability of operations; breadth of product line; sales and
distribution capability; technical support and service; relationships with
cable operators; standards compliance; and general industry and economic
conditions. Certain of these factors are outside of the Company's control. The
existing conditions in the broadband access market could change rapidly and
significantly as a result of technological changes, and the development and
market acceptance of alternative technologies could decrease the demand for the
Company's products or render them obsolete. There can be no assurance that
these companies and other competitors will not introduce broadband access
products that will be less costly or provide superior performance or achieve
greater market acceptance than the Company's products.
The Company sells products that also compete with existing data access and
transmission systems utilizing the telecommunications networks, such as those
of 3Com. Additionally, the Company's controller and headend system products
face intense competition from well-established companies such as Cisco, Nortel
and 3Com. Many of the Company's current and potential competitors have
significantly greater financial, technical, marketing, distribution, customer
support and other resources, as well as greater name recognition and access to
customers than the Company. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that the
competitive pressures faced by the Company will not have a material adverse
effect on its business, operating results and financial condition.
The market for cable modems may be impacted by the development of other
technologies that enable the provisioning of broadband access services.
Examples of such technologies include technologies that increase the efficiency
of digital transmission over telephone companies' existing copper
infrastructure, such as various xDSL, as well as ISDN. Similarly, broadband
access services may be deployed over a number of other media, including fiber
optic cable, DBS and other wireless technologies. Broadband access services
based on some of these competing technologies are already available and could
materially limit acceptance of cable modem-based services. The failure of
broadband access services based on cable modem technology to gain widespread
commercial acceptance by cable operators and end users of broadband access
services would have a material adverse effect on the Company's business,
operating results and financial condition. See "Risk Factors --Our Industry is
Highly Competitive with Many Established Competitors."
REGULATION
The Company and its customers are subject to varying degrees of federal,
state and local regulation. The jurisdiction of the FCC extends to the
communications industry, including broadband access products such as those of
the Company. The FCC has promulgated regulations that, among other things, set
installation and equipment standards for communications systems. Although FCC
regulations and other governmental regulations have not materially restricted
the Company's operations, there can be no assurance that future regulations
adopted by the FCC or other regulatory bodies will not have a material adverse
effect on the Company. Further, regulation of the Company's customers may
adversely impact the Company's business, operating results and financial
condition. For example, FCC regulatory policies affecting the availability of
cable services and other terms on which cable companies conduct their business,
may impede the Company's penetration of certain markets. In addition,
regulation of cable
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television rates may affect the speed at which cable operators upgrade their
cable infrastructures to two-way HFC. Changes in, or the failure by the Company
to comply with, applicable domestic and international regulations could have a
material adverse effect on the Company's business, operating results and
financial condition. In addition, the increasing demand for communications
systems has exerted pressure on regulatory bodies worldwide to adopt new
standards for such products and services, generally following extensive
investigation of and deliberation over competing technologies. The delays
inherent in this governmental approval process have in the past, and may in the
future, cause the cancellation, postponement or rescheduling of the
installation of communications systems by the Company's customers, which in
turn may have a material adverse effect on the sale of products by the Company
to such customers. For example, the Company experienced delays in product
shipments to a customer in Brazil due to delays in certain regulatory approvals
in Brazil, and there can be no assurance that similar delays will not occur in
other countries in which the Company markets or plans to market its products.
In addition, the Company's customers in certain parts of Asia, such as Japan,
are required to obtain licenses prior to selling the Company's products, and
delays in obtaining such licenses could have an adverse impact on the Company's
operating results. See "Risk Factors -- Our Business is Subject to
Communications Industry Regulations."
In the United States, in addition to complying with FCC regulations, the
Company's products are required to meet certain safety requirements. For
example, the Company is required to have its products certified by UL in order
to meet federal requirements relating to electrical appliances to be used
inside the home. Outside of the United States, the Company's products are
subject to the regulatory requirements of each country in which the products
are manufactured or sold. These requirements are likely to vary widely, and
there can be no assurance that the Company will be able to obtain on a timely
basis or at all such regulatory approvals as may be required for the
manufacture, marketing or sale of its products. Any delay in or failure to
obtain such approvals or meet such requirements could have a material adverse
effect on the Company's business, operating results and financial condition.
See "Risk Factors -- Our Business is Subject to Other Regulatory Approvals and
Certifications."
INTELLECTUAL PROPERTY
The Company relies on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect
proprietary rights in its products. The Company has four issued patents and ten
patent applications pending in the United States. The Company has seven patent
applications pending internationally. There can be no assurance that the
Company's patent applications will be granted or, if granted, that the claims
covered by the patents will not be reduced from those included in the Company's
applications. Any patent might be subject to challenge in court and, whether or
not challenged, might not be sufficiently broad to prevent third parties from
developing equivalent technologies or products. The Company has entered into
confidentiality and invention assignment agreements with its employees, and
enters into non-disclosure agreements with certain of its suppliers,
distributors and appropriate customers so as to limit access to and disclosure
of its proprietary information. There can be no assurance that these statutory
and contractual arrangements will prove sufficient to prevent misappropriation
of the Company's technology or to deter independent third-party development of
similar technologies.
Upon the completion and acceptance of the DOCSIS 1.2 cable modem
specification co-authored by the Company, the Company would contribute some
aspects of its S-CDMA technology to the DOCSIS 1.2 intellectual property pool.
The Company's technology would be contributed pursuant to a proposed license
agreement between the Company and CableLabs (the "License Agreement") to be
executed at that time. Under the terms of the License Agreement, the Company
would grant to CableLabs a license for some aspects of its S-CDMA technology
(the "Licensed Technology"). This license would allow CableLabs to utilize and
incorporate the Licensed Technology only for the limited use of making and
selling products or systems that comply with the DOCSIS 1.2 cable modem
specification. As a party to
48
<PAGE>
the License Agreement, the Company would have access to the DOCSIS 1.2
intellectual property pool and would have the right to develop products that
comply with the DOCSIS 1.2 cable modem specification.
CableLabs would have the right to sublicense the DOCSIS 1.2 intellectual
property on a royalty-free non-exclusive basis to other companies for the sole
purpose of allowing them to build products that are certified to be fully
compliant with DOCSIS 1.2 or its successor specifications. This sublicense
generally would be granted to any company that requested it, unless that
company were involved in an intellectual property dispute with another company
that was already a DOCSIS sublicensee.
CableLabs may sublicense the DOCSIS 1.2 intellectual property pool if the
sublicensee complies with certain conditions. Such sublicensee's rights to
certain of the DOCSIS 1.2 intellectual property may be terminated if it sues
certain companies on claims of infringement of any copyright, patent right or
trade secret misappropriation.
The Company expects that developers of cable modems will increasingly be
subject to infringement claims as the number of products and competitors in the
Company's industry segment grows. The Company has received a letter from an
individual claiming that the Company's technology infringes a patent held by
such individual. The Company has reviewed the allegations made by such
individual and, after consulting with its patent counsel, does not believe that
the Company's technology infringes any valid claim of such individual's patent.
There can be no assurance that, if the issue were to be submitted to a court,
such a court would not find that the Company's products infringe the patent,
nor that the individual will not continue to assert infringement. If the
Company is found to have infringed such individual's patent, the Company could
be subject to substantial damages and/or an injunction preventing it from
conducting its proposed business, and the Company's business could be
materially and adversely affected. In addition, there can be no assurance that
other third parties will not assert infringement claims against the Company in
the future. Any such claim, whether meritorious or not, could be time-
consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements may not be available on terms acceptable to the Company
or at all, which could have a material adverse effect upon the Company's
business, operating results and financial condition. Litigation also may be
necessary to enforce the Company's intellectual property rights. Any
infringement claim or other litigation against or by the Company could have a
material adverse effect on the Company's business, operating results and
financial condition.
The Company pursues the registration of its trademarks in the United States
and has applications pending to register several of its trademarks. However,
since the laws of certain foreign countries might not protect the Company's
products or intellectual property rights to the same extent as do the laws of
the United States, effective trademark, copyright, trade secret and patent
protection might not be available in every country in which the Company's
products might be manufactured, marketed or sold.
EMPLOYEES
As of November 30, 1998, Terayon had 129 employees, of which 57 were in the
engineering group, 30 were in marketing, sales and customer support, 21 were in
operations and 21 were in general and administrative functions. None of the
Company's employees is represented by a union. The Company believes that its
relations with its employees are good.
PROPERTIES
The Company leases an approximately 38,000 square foot facility located in
Santa Clara, California. The current lease for the Santa Clara facility expires
in March 2002. The Company has sales offices in
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Denver, Colorado; Atlanta, Georgia; Sao Paulo, Brazil; and Brussels, Belgium.
The Company believes that its existing facilities are adequate to meet its
needs for the immediate future and that future growth can be accommodated by
leasing additional or alternative space near its current facilities.
LEGAL PROCEEDINGS
The Company is not currently a party to any material legal proceedings.
50
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
Certain information regarding the Company's directors, executive officers and
key employees as of November 30, 1998 is set forth below.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
EXECUTIVE OFFICERS AND DIRECTORS
Dr. Zaki Rakib(1)............... 40 Chief Executive Officer and Director
Shlomo Rakib.................... 41 Chairman of the Board, President and
Chief Technical Officer
Ray M. Fritz.................... 53 Chief Financial Officer
Dennis J. Picker................ 50 Chief Operating Officer
Michael D'Avella................ 40 Director
Christopher J. Schaepe(1)(2).... 35 Director
Lewis Solomon(2)................ 65 Director
Mark A. Stevens(1).............. 38 Director
KEY EMPLOYEES
Brian Bentley................... 37 Vice President, Worldwide Sales
Gary W. Law..................... 43 Vice President, Marketing and Business
Development
Linda R. Palmor................. 43 Vice President, Finance
Gershon Schatzberg.............. 43 Vice President, Customer Satisfaction
W. Lee Stalcup.................. 58 Vice President, Manufacturing Operations
</TABLE>
- --------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Zaki Rakib co-founded Terayon in 1993 and has served as Chief Executive
Officer since January 1993 and as a director since February 1995. From January
1993 to July 1998, Dr. Rakib also served as Chief Financial Officer of the
Company. Prior to co-founding the Company, Dr. Rakib served as Director of
Engineering for Cadence Design Systems, an electronic design automation
software company, from 1990 to 1994. Prior to joining Cadence, Dr. Rakib was
Vice President of Engineering at Helios Software, which was acquired by Cadence
in 1990. Dr. Rakib holds B.S., M.S. and Ph.D. degrees in engineering from Ben-
Gurion University in Israel. Dr. Rakib is the brother of Shlomo Rakib, the
Company's Chairman of the Board, President and Chief Technical Officer.
Shlomo Rakib co-founded Terayon in 1993 and has served as Chairman of the
Board and President since January 1993 and as Chief Technical Officer since
February 1995. Prior to co-founding the Company, Mr. Rakib served as Chief
Engineer at PhaseCom, Inc., a communications products company, from 1981 to
1993, where he pioneered the development of data and telephony applications
over cable. Mr. Rakib is the inventor of several patented technologies in the
area of data and telephony applications over cable. Mr. Rakib holds a B.S.E.E.
degree from Technion University in Israel. Mr. Rakib is the brother of Zaki
Rakib, the Chief Executive Officer and a director of the Company.
Ray M. Fritz has served as the Company's Chief Financial Officer since July
1998. Prior to joining the Company, Mr. Fritz was Vice President of Finance and
Operations and Chief Financial Officer of GigaLabs Inc., a provider of high
performance input/output switching solutions, from December 1997 to July 1998.
From August 1994 until August 1997, Mr. Fritz was with Clarify, Inc., a
provider of front office automation systems, as its Vice President, Finance and
Operations and Chief Financial Officer. From May 1990 to August 1994, he served
as Director, Finance of Synopsys, Inc., an electronic design automation
company, and from April 1986 to May 1990, Mr. Fritz served as Vice President
and Controller of LSI Logic Corporation, a semiconductor company. Prior to
that, he held a variety of finance positions with Xerox Corporation, The Singer
Company and Shell Oil Company. Mr. Fritz holds a B.S. degree in
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<PAGE>
finance/business administration from Benedictine College, an M.B.A. degree
from Atlanta University and an M.S. degree in tax from Golden Gate University.
Dennis J. Picker has served as Chief Operating Officer since February 1998
and served as Vice President, Standards from October 1997 to February 1998 and
Vice President, Engineering from May 1996 to October 1997. From 1994 to April
1996, Mr. Picker was Director of the Cable Data Products Business Unit of
Motorola, Inc., an electronics company, and from 1992 to 1994, he was Senior
Director of Data Networking Products at Motorola. Mr. Picker holds a B.S.
degree in electrical engineering from the University of Pennsylvania and an
M.S. degree in electrical engineering from Northwestern University.
Michael D'Avella has served as a director of the Company since April 1998.
Mr. D'Avella is the Senior Vice President, Planning for Shaw Communications
Inc. ("Shaw"), a diversified communications company and a leading cable
operator in Canada. Mr. D'Avella has held a variety of senior management
positions at Shaw since 1991. Prior to that, he held positions with the
Canadian Cable Television Association and Telesat Canada. He is a director of
several privately held companies. Mr. D'Avella holds a B.A. degree in
economics and planning from the University of Toronto in Canada.
Christopher J. Schaepe has served as a director of the Company since March
1995. Mr. Schaepe is a General Partner of Weiss, Peck & Greer Venture
Partners, L.P., a technology-focused venture capital firm, which he joined in
1991. Previously, Mr. Schaepe served in corporate finance and capital markets
roles for three years at Goldman, Sachs & Company after his employment as a
software engineer at IBM Corporation. He is a director of Galileo Technology
Ltd., a communications semiconductor company, as well as several privately
held companies. Mr. Schaepe holds B.S. and M.S. degrees in computer science
from the Massachusetts Institute of Technology and an M.B.A. degree from
Stanford Business School.
Lewis Solomon has served as a director of the Company since March 1995. Mr.
Solomon has been a principal of G&L Investments, a consulting firm, since 1989
and currently serves as the Chairman of the Board of ICTV, Inc. From 1983 to
1988, he served as Executive Vice President at Alan Patricof Associates, a
venture capital firm focused on high technology, biotechnology and
communications industries. Prior to that, Mr. Solomon served in various
capacities with General Instrument Corp., most recently as Senior Vice
President. From April 1986 to January 1997, he served as Chairman of the Board
of Cybernetic Services, Inc., an LED systems manufacturer, which commenced a
Chapter 7 bankruptcy proceeding in April 1997. Mr. Solomon serves on the
boards of Anadigics, Inc., a manufacturer of integrated circuits; Anacomp,
Inc., a manufacturer of data storage systems; and Artesyn Technologies, Inc.,
a power supply and power converter supply company. Mr. Solomon also serves on
the boards of several privately held companies.
Mark A. Stevens has served as a director of the Company since March 1995.
Mr. Stevens has been a General Partner of Sequoia Capital, a venture capital
investment fund, since March 1993. Mr. Stevens currently serves on the Board
of Directors of Aspect Development, Inc., a client/server applications
software company, and several privately held companies. Prior to joining
Sequoia in 1989, he held technical sales and marketing positions at Intel
Corporation. Mr. Stevens holds a B.S.E.E. degree, a B.A. degree in economics
and an M.S. degree in computer engineering from the University of Southern
California and an M.B.A. degree from Harvard Business School.
Brian Bentley has served as Vice President, Worldwide Sales since February
1997. From 1995 to February 1997, he served as Director of TCI Sales for
Scientific-Atlanta, Inc., a telecommunications equipment supplier. Prior to
that, Mr. Bentley served as Vice President of MSO Sales for the Multimedia
Group of Motorola from January 1995 to November 1995, and as Vice President
and General Manager for the Optical Media Group of Antec Corporation, a fiber-
optic equipment manufacturer company, from 1992 to 1995. He holds a B.S.
degree in economics from Arizona State University.
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<PAGE>
Gary W. Law has served as Vice President, Marketing and Business Development
since March 1997. From August 1995 to March 1997, he was Vice President of
Marketing for the Networking Products Group of Adaptec, Inc., a hardware and
software manufacturer company. Prior to that, Mr. Law served as Director of
Market Development for Bay Networks, Inc. from 1989 to 1995 and held sales and
marketing management positions with Hewlett-Packard Company, an electronics
company and Ungermann-Bass Inc. between 1978 and 1988. He holds a B.S. degree
in engineering from the University of Texas.
Linda R. Palmor has served as Vice President, Finance since May 1997 and
served as Corporate Controller from February 1996 to May 1997. Prior to
joining the Company, Ms. Palmor served as the Corporate Controller of
Electronic Arts Inc., a multimedia software company, from 1995 to 1996 and
held financial positions with The Walt Disney Company, a media conglomerate,
from 1991 to 1995. Ms. Palmor is a certified public accountant and holds a
B.Sc. degree in biochemistry from Manchester University in the United Kingdom.
Gershon Schatzberg has served as the Company's Vice President, Customer
Satisfaction since April 1998 and served as Group Director of Technical
Support Services from August 1997 to April 1998. Prior to joining the Company,
he served as Director of Network Consulting for 3Com Corporation, a networking
hardware manufacturer company, running North American sales support operations
from 1996 to 1997. From 1989 to 1996, Mr. Schatzberg served as the President
and Vice President of Engineering for RAD Network Devices, Inc., a networking
and router manufacturer company. Prior to that, he held engineering positions
with various companies. Mr. Schatzberg holds a B.S.E.E. degree from Technion
University in Israel.
W. Lee Stalcup has served as the Company's Vice President, Manufacturing
Operations since May 1998. Prior to joining the Company, Mr. Stalcup was Vice
President of Operations for Magellan Systems Corporation, a global positioning
systems manufacturer, from October 1996 to May 1998. From May 1994 to October
1994, he served as Director of Operations at AST Research, Inc., a computer
and network server manufacturer, and from October 1994 to October 1996 he
served as its Vice President of Worldwide Materials. From 1990 to 1993,
Mr. Stalcup was Executive Vice President and Chief Operating Officer of
Vitalrel Microelectronics, a multi-chip module company.
The Company's Board of Directors (the "Board") currently is comprised of six
directors. Directors are elected by the stockholders at each annual meeting of
stockholders to serve until the next annual meeting of stockholders or until
their successors are duly elected and qualified. Pursuant to a voting
agreement, Messrs. Rakib, who together beneficially own 4,000,000 shares of
the Company's stock, have agreed to vote to elect a nominee of Shaw to the
Company's Board ("Shaw Nominee"), currently Mr. D'Avella, until such time as
Shaw owns less than 384,615 shares of the Company's stock. The Company also
has agreed with Shaw to use its best efforts to nominate a Shaw Nominee to the
Board until the earlier of December 31, 2000 or the date upon which Shaw no
longer holds at least 384,615 shares of the Company's stock. The Company's
Board is be divided into three classes, Class I, Class II and Class III, with
each class serving staggered three-year terms. The Class I directors,
currently Messrs. Solomon and Stevens, will stand for reelection or election
at the 1999 annual meeting of stockholders. The Class II directors, currently
Mr. D'Avella and Shlomo Rakib, will stand for reelection or election at the
2000 annual meeting of stockholders. The Class III directors, currently Mr.
Schaepe and Zaki Rakib, will stand for reelection or election at the 2001
annual meeting of stockholders.
ADVISORY BOARD
In early 1997, the Company established an Advisory Board, which consists of
representatives from the United States and international cable industries. The
Advisory Board currently consists of nine members: Steven Craddock, the Vice
President of New Media for Comcast Corporation; Michael D'Avella,
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<PAGE>
the Senior Vice President of Planning for Shaw and a member of the Company's
Board of Directors; David Fellows, the former Vice President of Technology for
MediaOne Group, Inc.; George Harte, the Director of Telecom Technology for
Rogers Communications Inc.; Wilt Hildenbrand, the Vice President of Technology
for Cablevision; Isao Momota, the President of Crossbeam; Richard Rexroat, the
Vice President, Engineering of TCI International; J.C. Sparkman, a former
Executive Vice President of TCI; and Arthur Steiner, the Director of Business
Development for NET Brasil.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to February 1998, the Company did not have a Compensation Committee of
the Board of Directors, and the entire Board participated in all compensation
decisions, except that Messrs. Rakib did not participate in decisions relating
to their respective compensation. In February 1998, the Board formed the
Company's Compensation Committee to review and recommend to the Board
compensation and benefits for the Company's executive officers and administer
the Company's stock purchase and stock option plans. Each of the Company's
directors, or an affiliated entity, holds securities of the Company. See
"Certain Transactions" and "Principal and Selling Stockholders."
BOARD COMMITTEES
The Audit Committee of the Board of Directors, currently consisting of
Messrs. Schaepe and Solomon, reviews the internal accounting procedures of the
Company and consults with and reviews the services provided by the Company's
independent auditors. The Compensation Committee of the Board of Directors
currently consists of Dr. Rakib and Messrs. Schaepe and Stevens. The
Compensation Committee reviews and recommends to the Board the compensation and
benefits for the Company's executive officers, except that Dr. Rakib does not
participate in decisions relating to his compensation. The Compensation
Committee also administers the issuance of stock options and other awards under
the Company's 1995 Stock Option Plan, 1997 Equity Incentive Plan, 1998 Employee
Stock Purchase Plan and 1998 Non-Employee Directors' Stock Option Plan. See "--
Employee Benefit Plans."
DIRECTOR COMPENSATION
Lewis Solomon receives $2,000 per month for his service as a member of the
Board. No other director of the Company receives cash for services provided as
a director. Certain directors have been granted options to purchase Common
Stock in the past, and options may be granted to directors of the Company in
the future. Mr. Stevens, Mr. D'Avella and entities affiliated with Weiss, Peck
and Greer L.L.C., of which Mr. Schaepe is a partner, have each received options
to purchase 30,000 shares of Common Stock at exercise prices of $1.25, $6.50
and $1.25 per share, respectively.
In June 1998, the Board adopted the 1998 Non-Employee Directors' Stock Option
Plan (the "Directors' Plan") to provide for the automatic grant of options to
purchase shares of Common Stock to non-employee directors of the Company who
are not employees of or consultants to the Company or of any affiliate of the
Company (a "Non-Employee Director"). The Directors' Plan is administered by the
Board, unless the Board delegates administration to a Committee comprised of
members of the Board. See "--Employee Benefit Plans--1998 Non-Employee
Directors' Stock Option Plan."
LIMITATION ON DIRECTORS' AND OFFICERS' LIABILITY
As permitted by Section 145 of the Delaware General Corporation Law, the
Bylaws of the Company provide that (i) the Company is required to indemnify its
directors and executive officers to the fullest extent permitted by the
Delaware General Corporation Law, (ii) the Company may, in its discretion,
indemnify other officers, employees and agents as set forth in the Delaware
General Corporation Law, (iii) to the fullest extent permitted by the Delaware
General Corporation Law, the Company is required to advance all expenses
incurred by its directors and executive officers in connection with a legal
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<PAGE>
proceeding (subject to certain exceptions), (iv) the rights conferred in the
Bylaws are not exclusive, (v) the Company is authorized to enter into
indemnification agreements with its directors, officers, employees and agents
and (vi) the Company may not retroactively amend the Bylaws provisions relating
to indemnity. The Company entered into agreements to indemnify its officers and
directors. A copy of the form of such indemnification has been filed as an
exhibit to the Registration Statement .
EXECUTIVE COMPENSATION
The following table sets forth the annualized compensation awarded or paid by
the Company during the fiscal year ended December 31, 1997 to the Company's
Chief Executive Officer and four other most highly compensated officers whose
annual salary and bonus exceeded $100,000 in fiscal 1997 (hereinafter, the
"Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
---------------------------------- ------------
SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING
POSITION YEAR SALARY($) BONUS($) COMPENSATION($) OPTIONS (#)
------------------ ---- --------- -------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Dr. Zaki Rakib............ 1997 150,000 12,500 -- --
Chief Executive Officer
and Chief Financial
Officer
Shlomo Rakib.............. 1997 150,000 12,500 -- --
President and Chief
Technical Officer
Gary Law.................. 1997 108,333 -- -- 115,000
Vice President, Marketing
and Business Development
Linda Palmor.............. 1997 108,306 10,000 -- 35,000
Vice President, Finance
Dennis Picker............. 1997 129,000 31,800 75,166(2) --
Vice President,
Standards(1)
</TABLE>
- --------
(1) Mr. Picker has served as Chief Operating Officer since February 1998.
(2) Consists of reimbursement to Mr. Picker for travel costs of which $35,140
was attributable to tax gross-up payments made by the Company.
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<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options made during the
fiscal year ended December 31, 1997 to each of the Named Executive Officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------
POTENTIAL REALIZABLE
PERCENTAGE OF VALUE AT ASSUMED
TOTAL OPTIONS ANNUAL RATES OF STOCK
GRANTED TO PRICE APPRECIATION
NUMBER OF SECURITIES EMPLOYEES IN FOR OPTION TERM (4)
UNDERLYING OPTIONS FISCAL YEAR EXERCISE PRICE EXPIRATION ----------------------
NAME GRANTED (#) (1) (%) (2) ($/SH) (3) DATE 5% ($) 10% ($)
---- -------------------- ------------- -------------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Dr. Zaki Rakib.......... -- -- -- -- -- --
Shlomo Rakib............ -- -- -- -- -- --
Gary Law................ 115,000 8.82% $1.25 03/25/07 $234,153 $372,850
Linda Palmor............ 35,000 2.68% $1.25 05/05/07 $ 71,264 $113,476
Dennis Picker........... -- -- -- -- -- --
</TABLE>
- --------
(1) Options generally vest at a rate 20% on the first anniversary of the
vesting commencement date and 1/48th each month thereafter. The term of
each option granted is generally the earlier of (i) ten years or (ii) 90
days after termination of the optionee's services to the Company. Options
are immediately exercisable; however, the unvested shares purchasable
under such options are subject to repurchase by the Company at the
original exercise price paid per share upon the optionee's cessation of
service prior to the vesting of such shares.
(2) Based on an aggregate of 1,304,050 options granted to employees,
consultants and directors, including the Named Executive Officers, of the
Company during the fiscal year ended December 31, 1997.
(3) The exercise price per share of each option was equal to the fair market
value of the Common Stock on the date of grant as determined by the Board
of Directors after consideration of a number of factors, including, but
not limited to, the development life cycle of the Company's products, the
Company's financial performance, market conditions, the price and
preferred rights and privileges of shares of equity securities sold to or
purchased by outside investors, and third-party appraisals.
(4) The potential realizable value is calculated based on the term of the
option at its time of grant (ten years). It is calculated assuming that
the fair market value of the Company's Common Stock on the date of grant
appreciates at the indicated annual rate compounded annually for the
entire term of the option and that the option is exercised and sold on the
last day of its term for the appreciated stock price.
AGGREGATE OPTION EXERCISES IN FISCAL 1997 AND DECEMBER 31, 1997 OPTION VALUES
There were no exercises of options by any Named Executive Officer in the
fiscal year ended December 31, 1997.
EMPLOYEE BENEFIT PLANS
1997 Equity Incentive Plan. The Company's 1997 Equity Incentive Plan (the
"1997 Plan") was adopted in March 1997 and amended in December 1997 and June
1998. An aggregate of 3,300,000 shares of Common Stock currently are
authorized for issuance under the 1997 Plan. However, each year on January 1,
starting with January 1, 1999, the aggregate number of shares of Common Stock
that are available for issuance under the 1997 Plan will automatically be
increased to that number of shares of Common Stock that is equal to 5% of the
Company's outstanding shares of Common Stock on such date.
The 1997 Plan provides for the grant of incentive stock options, as defined
under the Internal Revenue Code of 1986, as amended (the "Code"), to employees
(including officers and employee directors) and non-statutory stock options,
restricted stock purchase awards and stock bonuses to employees (including
officers and employee directors), directors and consultants of the Company and
its affiliates. The 1997 Plan is administered by the Compensation Committee,
which determines the
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<PAGE>
recipients and types of awards to be granted, including the exercise price,
number of shares subject to the award and the exercisability thereof.
The terms of options granted under the 1997 Plan may not exceed 10 years. The
Compensation Committee determines the exercise price of options granted under
the 1997 Plan. However, the exercise price for an incentive stock option cannot
be less than 100% of the fair market value of the Common Stock on the date of
the option grant, and the exercise price for a non-statutory stock option
cannot be less than 85% of the fair market value of the Common Stock on the
date of the option grant. Options granted under the 1997 Plan vest at the rate
specified in the option agreement. Generally, the right to exercise 20% of the
total number of shares granted vest 12 months after the date of option grant,
with the reminder vesting monthly over four years thereafter, such that an
option is fully vested on the fifth anniversary of the date of the option
grant. Generally, the optionee may not transfer a stock option other than by
will or the laws of descent or distribution. However, an optionee may designate
a beneficiary who may exercise the option in the event of the optionee's death
or disability. Unless the terms of an optionee's option agreement provide for
an earlier termination, in the event of the optionee's cessation of his or her
relationship with the Company due to death or disability, the optionee's
beneficiary may exercise any vested options up to 18 months and 12 months,
respectively, after the date of such cessation. If such optionee's relationship
with the Company ceases for any reason other than the optionee's death or
disability or termination for cause, the optionee may exercise any vested
options during the 30 days following such cessation.
No incentive stock option (and, prior to the Company's stock being publicly
traded, no non-statutory stock option) may be granted to any person who, at the
time of the grant, owns (or is deemed to own) stock possessing more than 10% of
the total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at lease 110% of the fair market value of
the stock subject to the option on the date of grant and the term of the option
does not exceed five years from the date of the grant. In addition, the
aggregate fair market value, determined at the time of grant, of the shares of
Common Stock with respect to which incentive stock options are exercisable for
the first time by an optionee during any calendar year (under the 1997 Plan and
all other stock plans of the Company and its affiliates) may not exceed
$100,000. Pursuant to Section 162(m) of the Code, no person may be granted
options under the 1997 Plan covering more than 500,000 shares of Common Stock
in any calendar year.
Shares subject to stock awards that have expired or otherwise terminated
without having been exercised in full again become available for the grant of
awards under the 1997 Plan. The Compensation Committee has the authority to
reprice outstanding options or to offer optionees the opportunity to replace
outstanding options with new options for the same or a different number of
shares. Both the original and new options will count toward the Code Section
162(m) limitations set forth above.
Restricted stock purchase awards granted under the 1997 Plan may be granted
pursuant to a repurchase option in favor of the Company in accordance with a
vesting schedule and at a price determined by the Compensation Committee. Stock
bonuses may be awarded in consideration of past services without a purchase
payment. Rights under a stock bonus or restricted stock bonus agreement
generally may not be transferred other than by will or the laws of descent and
distribution during such period as the stock awarded pursuant to such an
agreement remains subject to the agreement.
If there is any sale of all or substantially all of the Company's assets, any
merger or any consolidation in which the Company is not the surviving
corporation or a like transaction involving the Company, all outstanding awards
under the 1997 Plan either will be assumed or substituted for by any surviving
entity. If the surviving entity determines not to assume or substitute for such
awards, the vesting of stock awards held by persons still serving the Company
or its affiliate will be accelerated and such awards will terminate if not
exercised prior to the sale of assets, merger or consolidation.
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<PAGE>
As of December 15, 1998, 32,274 shares of Common Stock had been issued upon
the exercise of options granted under the 1997 Plan, options to purchase
1,434,828 shares of Common Stock were outstanding and 1,802,898 shares
remained available for future grant. The 1997 Plan will terminate in March
2007 unless terminated by the Board before then. As of November 30, 1998, no
stock awards or restricted stock had been granted under the 1997 Plan.
1995 Stock Option Plan. The Company also has a 1995 Stock Option Plan (the
"1995 Plan"). The 1995 Plan is administered by the Board, unless the Board
delegates administration to a committee comprised of members of the Board.
Under the 1995 Plan, stock options and awards may be granted to employees,
directors and consultants. Only employees may receive incentive stock options;
employees, directors and consultants may receive non-statutory stock options
and stock awards other than incentive stock options. The exercise price of
incentive stock options granted under the 1995 Plan must be at least equal to
the fair market value of the Common Stock on the date of grant, while the
exercise price of nonstatutory options must equal at least 85% of such market
value. Generally, the right to exercise 20% of the total number of shares
granted vest 12 months after the date of option grant, with the reminder
vesting monthly over four years thereafter, such that an option is fully
vested on the fifth anniversary of the date of the option grant. Options and
awards granted under the Plan must be exercised within ten years of the date
of grant. The other terms of the 1995 Plan are substantially similar to the
terms of the 1997 Plan.
As of December 15, 1998, 336,048 shares had been issued upon the exercise of
options under the 1995 Plan, 1,162,123 shares of Common Stock were subject to
outstanding options and 58,709 shares remained available for future grant. The
1995 Plan will terminate in March 2005 unless terminated by the Board of
Directors before then.
1998 Non-Employee Directors' Stock Option Plan. In June 1998, the Board
adopted the Directors' Plan to provide for the automatic grant of options to
purchase shares of Common Stock to non-employee directors of the Company who
are not employees of or consultants to the Company or of any affiliate of the
Company (a "Non-Employee Director"). The Directors' Plan is administered by
the Board, unless the Board delegates administration to a Committee comprised
of members of the Board.
The aggregate number of shares of Common Stock that may be issued pursuant
to options granted under the Directors' Plan is 200,000 shares. Pursuant to
the terms of the Directors' Plan, after August 1998, each person who is
elected or appointed for the first time to be a Non-Employee Director
automatically shall, upon the date of his or her initial election or
appointment to be a Non-Employee Director by the Board or stockholders of the
Company, be granted an option to purchase 30,000 shares of Common Stock. In
addition, on the day following each Annual Meeting of Stockholders of the
Company ("Annual Meeting"), commencing with the Annual Meeting in 1999, each
person who is then serving as a Non-Employee Director automatically shall be
granted an option to purchase 12,500 shares of Common Stock, which amount
shall be prorated for any Non-Employee Director who has not continuously
served as a Non-Employee Director for the 12-month period prior to the date of
such Annual Meeting. In addition, on the day following each Annual Meeting,
commencing with the Annual Meeting in 1999, each Non-Employee Director who is
then serving as a member of a committee of the Board of Directors
automatically shall be granted, for each such committee, an option to purchase
3,000 shares of Common Stock of the Company, which amount shall be prorated
for any Non-Employee Director who has not continuously served as a member of
such committee for the 12-month period prior to the date of such Annual
Meeting.
The exercise price of the options granted under the Directors' Plan will be
equal to the fair market value of the Common Stock on the date of grant. No
option granted under the Directors' Plan may be exercised after the expiration
of 10 years from the date it was granted. Options granted under the Directors'
Plan vest and become exercisable as to 33% of the shares on the first
anniversary of the date of grant and 1/36th of the shares monthly thereafter.
Options granted under the Directors' Plan generally
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<PAGE>
are non-transferable. However, an optionee may designate a beneficiary who may
exercise the option following the optionee's death. An optionee whose service
relationship with the Company or any affiliate (whether as a Non-Employee
Director of the Company or subsequently as an employee, director or consultant
of either the Company or an affiliate) ceases for any reason may exercise
vested options for the term provided in the option agreement (3 months
generally, 12 months in the event of disability and 18 months in the event of
death).
In the event of certain changes in control of the Company, all outstanding
awards under the Directors' Plan either will be assumed or substituted for by
any surviving entity. If the surviving entity determines not to assume or
substitute for such awards, the vesting and time during which such options may
be exercised shall be accelerated prior to such event and the options will
terminate if not exercised after such acceleration and at or prior to such
event. Unless terminated sooner by the Board of Directors, the Directors' Plan
will terminate in June 2008.
1998 Employee Stock Purchase Plan. In June 1998, the Company's Board of
Directors approved the 1998 Employee Stock Purchase Plan (the "Purchase
Plan"), covering an aggregate of 700,000 shares of Common Stock. The Purchase
Plan is intended to qualify as an employee stock purchase plan within the
meaning of Section 423 of the Code. Under the Purchase Plan, the Board of
Directors may authorize participation by eligible employees, including
officers, in periodic offerings following the adoption of the Purchase Plan.
The offering period for any offering will be no more than 27 months.
Under the Purchase Plan, employees are eligible to participate if they are
employed by the Company or an affiliate of the Company designated by the Board
of Directors and are employed at least 20 hours per week and five months per
year. Employees who participate in an offering will have the right to purchase
up to the number of shares of Common Stock purchasable with a percentage
designated by the Board of Directors, up to 15%, of an employee's earnings
withheld pursuant to the Purchase Plan and applied, on specified dates
determined by the Board of Directors, to the purchase of shares of Common
Stock. The price of Common Stock purchased under the Purchase Plan will be
equal to 85% of the lower of the fair market value of the Common Stock on the
commencement date of each offering period or the relevant purchase date.
Employees may end their participation in the offering at any time during the
offering period, and participation ends automatically on termination of
employment with the Company.
In the event of certain changes in control of the Company, the Company and
the Board of Directors have discretion to provide that each right to purchase
Common Stock will be assumed or an equivalent right will be substituted by the
successor corporation, or the Board may shorten the offering period and
provide for all sums collected by payroll deductions to be applied to purchase
stock immediately prior to the change in control. The Purchase Plan will
terminate at the Board's discretion or when all of the shares reserved for
issuance under the Purchase Plan have been issued.
As of December 15, 1998, 93 employees have the right to purchase shares of
Common Stock under the Purchase Plan.
401(k) Plan. The Company maintains the Terayon Corporation 401(k) Retirement
Plan (the "401(k) Plan") for eligible employees ("Participants"). A
Participant may contribute up to 15% of his or her total annual compensation
to the 401(k) Plan, or up to a statutorily prescribed annual limit, if less.
The annual limit for 1998 is $10,000. Each Participant is fully vested in his
or her deferred salary contributions. Participant contributions are held and
invested by the 401(k) Plan's trustee. The Company may make discretionary
contributions as a percentage of Participant contributions, subject to
established limits. To date, the Company has not made any contributions to the
401(k) Plan on behalf of the Participants. The 401(k) Plan is intended to
qualify under Section 401 of the Code, so that contributions by employees or
by the Company to the 401(k) Plan, and income earned on the 401(k) Plan
contributions, are not taxable to employees until withdrawn from the 401(k)
Plan, and so that contributions by the Company, if any, will be deductible by
the Company when made.
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<PAGE>
EMPLOYMENT AGREEMENTS
In February 1993, the Company entered into an employment agreement with
Shlomo Rakib to serve as President and Chairman of the Board of Directors. The
employment agreement is for a specified duration of seven years, but it is
terminable at will or without cause at any time upon written notice. In
February 1993, the Company also entered into an employment agreement with Zaki
Rakib to serve as Chief Executive Officer and Chief Financial Officer. The
employment agreement is not for a specified term and is terminable at will or
without cause at any time upon written notice. Both employment agreements
further provide that the Company's Board of Directors will set each executive's
salary in accordance with the payroll policies of the Company as constituted
from time to time.
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<PAGE>
CERTAIN TRANSACTIONS
In February 1993, the Company entered into an employment agreement with Zaki
Rakib, the Company's Chief Executive Officer and a director of the Company. Dr.
Rakib is the brother of Shlomo Rakib, the Company's Chairman of the Board,
President and Chief Technical Officer. See "Management -- Employment
Agreements."
In February 1993, the Company also entered into an employment agreement with
Shlomo Rakib, the Company's Chairman of the Board, President and Chief
Technical Officer. Mr. Rakib is the brother of Zaki Rakib, the Company's Chief
Executive Officer and a director of the Company. See "Management --Employment
Agreements."
In March 1996, the Company loaned Shlomo Rakib, the Company's Chairman of the
Board, President and Chief Technical Officer, $100,000 pursuant to an interest-
free promissory note, with the principal amount due in March 2001. The purpose
of the loan was to permit Mr. Rakib to purchase a residence. Pursuant to its
terms the note accelerated upon the completion of the Company's initial public
offering in October 1998, the Board approved an extension of the repayment of
such note until August 1999. The note is secured by 20,000 shares of Common
Stock held by Mr. Rakib.
In the nine months ended September 30, 1998, the Company sold products to
Shaw for an aggregate of approximately $6.0 million. In addition, in April
1998, the Company issued Shaw a warrant ("Common Stock Warrant") to purchase
3,000,000 shares of Common Stock at an exercise price of $6.50 per share in
connection with the issuance of 384,615 shares of Series F convertible
preferred stock. The exercise price of the Common Stock Warrant is equal to the
fair market value of the Company's Common Stock at the time the Common Stock
Warrant was granted, as determined by the Company's Board of Directors. The
Common Stock Warrant is exercisable by Shaw at any time prior to December 31,
2003. In addition, the Company issued to Shaw a warrant ("Anti-Dilution
Warrant") to purchase an indeterminate number of shares of Common Stock for an
aggregate price of $1.00. The Anti-Dilution Warrant is exercisable from time to
time when the Company issues certain new equity securities until the date upon
which Shaw ceases to own shares of the Company's Common Stock. As of
September 30, 1998, Shaw had the right to receive 19,191 shares pursuant to the
Anti-Dilution Warrant. Michael D'Avella, a director of the Company, is the
Senior Vice President of Planning for Shaw.
The Company has granted options to certain of its directors and executive
officers. See "Management -- Director Compensation."
In July 1998, the Company entered into indemnification agreements with its
directors and executive officers for the indemnification of and advancement of
expenses to such persons to the full extent permitted by law. The Company also
intends to execute such agreements with its future directors and executive
officers. See "Management -- Limitation on Directors' and Officers' Liability."
The Company believes that the terms of the transactions described above were
no less favorable to the Company than would have been obtained from an
unaffiliated third party. Any future transactions between the Company and any
of its officers, directors or principal stockholders will be on terms no less
favorable to the Company than could be obtained from unaffiliated third parties
and will be approved by a majority of the independent and disinterested members
of the Board of Directors.
Certain holders of Common Stock are entitled to certain registration rights
with respect to such Common Stock. See "Description of Capital Stock --
Registration Rights."
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of December 15, 1998, and
as adjusted to reflect the sale of the shares of Common Stock offered hereby by
(i) each of the Company's Named Executive Officers, (ii) each of the Company's
directors, (iii) each stockholder who is known by the Company to own
beneficially more than 5% of the Company's Common Stock, (iv) each stockholder
of the Company who is selling shares of Common Stock in this offering ("Selling
Stockholders") and (v) all current directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE OWNED AFTER THE
OFFERING (1) OFFERING (1)
------------------- -------------------
NUMBER
OF SHARES
BEING
BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ---------------- ------------ ------- --------- ------ -------
<S> <C> <C> <C> <C> <C>
Dr. Zaki Rakib (2)...... 2,000,000 12.2%
Shlomo Rakib (2)........ 2,000,000 12.2%
Entities associated with 1,461,300 8.9%
Weiss, Peck & Greer
(3)....................
555 California Street,
Suite 3130
San Francisco,
California 94104
Entities associated with 1,431,974 8.7%
Sequoia Capital (4)....
3000 Sand Hill Road
Suite 280, Building 4
Menlo Park, California
94025
Shaw Communications Inc. 576,923 3.5%
(5)....................
Christopher J. Schaepe 1,461,300 8.9%
(3)....................
Mark Stevens (4)(6)..... 1,440,260 7.9%
Lewis Solomon (7)....... 100,000 *
Michael D'Avella 612,923 3.7%
(5)(8).................
Gary Law (9)............ 120,000 *
Linda Palmor (10)....... 90,000 *
Dennis Picker (11)...... 240,000 1.4%
All directors and
executive officers as a
group (7 persons)
(12)................... 7,974,483 *
</TABLE>
- --------
* Less than 1%.
(1) Percentage of beneficial ownership is based on 16,410,853 shares of Common
Stock outstanding as of December 15, 1998.
(2) The address for Messrs. Rakib is c/o Terayon Communication Systems, Inc.,
2952 Bunker Hill Lane, Santa Clara, CA 95054.
(3) Includes 797,870 shares held by WPG Enterprise Fund II, L.P. 8,190 of
which are subject to a right of repurchase and 663,430 shares held by
Weiss, Peck & Greer Venture Associates III, L.P. 6,810 of which are
subject to a right of repurchase. Christopher J. Schaepe, a director of
the Company, is a General Partner of WPG Venture Partners III, L.P., a
general partner of the entities associated with Weiss, Peck & Greer. Mr.
Schaepe may be deemed to have a voting and investment power over the
shares held by the entities associated with Weiss, Peck & Greer. He
disclaims beneficial ownership of such shares except to the extent of his
pecuniary interest therein.
(4) Includes (i) 1,302,483 shares held by Sequoia Capital VI; (ii) 71,566
shares held by Sequoia Technology Partners VI; (iii) 53,431 shares held by
Sequoia XXIV; (iv) 2,296 shares held by Sequoia 1995; (v) 791 shares held
by Sequoia 1997; and (vi) 1,407 shares held by SQP 1997. Mark Stevens, a
director of the Company, is a General Partner of the entities associated
with Sequoia Capital.
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<PAGE>
Mr. Stevens may be deemed to have a voting and investment power over the
shares held by the entities associated with Sequoia Capital. He disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest therein.
(5) Does not include 3,019,191 shares issuable pursuant to warrants.
(6) Includes 14,999 shares subject to repurchase by the Company within 60 days
of December 15, 1998.
(7) Includes 20,000 shares issuable upon the early exercise of options vesting
through May 2000, 8,333 of which will be fully vested and no longer
subject to repurchase within 60 days of December 15, 1998.
(8) Includes 576,923 shares held by Shaw Communications Inc. Mr. D'Avella, a
director of the Company, is the Senior Vice President, Planning for Shaw.
Also includes 33,750 shares issuable upon the early exercise of options
vesting through April 2001. Mr. D'Avella may be deemed to have a voting
and investment power over the shares held by Shaw. He disclaims beneficial
ownership as to all shares held by Shaw.
(9) Includes 120,000 shares issuable upon the early exercise of options
vesting through May 2003, 44,083, of which will be fully vested and no
longer subject to repurchase within 60 days of December 15, 1998.
(10) Includes 90,000 shares issuable upon the early exercise of options vesting
through May 2003, 32,666 of which will be fully vested and no longer
subject to repurchase within 60 days of December 15, 1998.
(11) Includes 240,000 shares issuable upon the early exercise of options
vesting through May 2003, 110,000 of which will be fully vested and no
longer subject to repurchase within 60 days of December 15, 1998.
(12) Includes 413,750 shares issuable upon the early exercise of options
vesting through May 2003, 162,416 of which will be fully vested and no
longer subject to repurchase within 60 days of December 15, 1998.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 30,000,000 shares of
Common Stock, par value $0.001 per share, and 5,000,000 shares of Preferred
Stock, par value $0.001 per share ("Preferred Stock").
COMMON STOCK
As of December 15, 1998, there were 16,410,853 shares of Common Stock
outstanding held of record by 128 stockholders.
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Subject to
preferences that may be applicable to any outstanding shares of the Preferred
Stock, the holders of Common Stock are entitled to receive ratably such
dividends as may be declared by the Board of Directors out of funds legally
available therefor. See "Dividend Policy." In the event of a liquidation,
dissolution or winding up of the Company, holders of the Common Stock are
entitled to share ratably in all assets remaining after payment of liabilities
and the liquidation preferences of any outstanding shares of Preferred Stock.
Holders of Common Stock have no preemptive rights and no right to convert
their Common Stock into any other securities. There are no redemption or
sinking fund provisions applicable to the Common Stock. All outstanding shares
of Common Stock are, and all shares of Common Stock to be outstanding upon the
completion of this offering will be, fully paid and non-assessable.
PREFERRED STOCK
Pursuant to the Restated Certificate, the Board of Directors has the
authority, without further action by the stockholders, to issue up to
5,000,000 shares of Preferred Stock in one or more series and to fix the
designations, powers, preferences, privileges and relative participating,
optional or special rights and the qualifications, limitations or restrictions
thereof, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater
than the rights of the Common Stock. The Board of Directors, without
stockholder approval, can issue Preferred Stock with voting, conversion or
other rights that could adversely affect the voting power and other rights of
the holders of Common Stock. Preferred Stock could thus be issued quickly with
terms calculated to delay, defer or prevent a change in control of the Company
or make removal of management more difficult. Additionally, the issuance of
Preferred Stock may have the effect of decreasing the market price of the
Common Stock and may adversely affect the voting and other rights of the
holders of Common Stock. No shares of Preferred Stock currently are
outstanding and the Company has no current plans to issue any shares of the
Preferred Stock.
WARRANTS
In April 1998, the Company issued to Shaw the Common Stock Warrant, which
gives Shaw the right to purchase 3,000,000 shares of Common Stock at an
exercise price of $6.50 per share. The Common Stock Warrant is exercisable by
Shaw at any time prior to December 31, 2003. In addition, the Company issued
to Shaw the Anti-Dilution Warrant, which gives Shaw the right to purchase an
indeterminate number of shares of Common Stock for an aggregate price of
$1.00. The Anti-Dilution Warrant is exercisable from time to time when the
Company issues certain new equity securities until the date upon which Shaw
ceases to own shares of the Company's Common Stock. As of September 30, 1998,
Shaw had the right to receive 19,191 shares pursuant to the Anti-Dilution
Warrant.
REGISTRATION RIGHTS
Pursuant to an agreement between the Company and the holders (or their
permitted transferees) of approximately 8,084,033 shares of Common Stock and
of warrants to purchase 3,019,191 shares of
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<PAGE>
Common Stock ("Holders"), the Holders are entitled to certain rights with
respect to registration of such shares for sale in the public market. The
Holders are entitled to certain rights with respect to the registration of such
shares under the Securities Act. If the Company proposes to register its Common
Stock, subject to certain exceptions, under the Securities Act, the Holders are
entitled to notice of the registration and are entitled at the Company's
expense to include such shares therein, provided that the managing underwriters
have the right to limit the number of such shares included in the registration
or exclude such shares entirely. In addition, certain of the Holders may
require the Company, at the Company's expense, on no more than six occasions,
to file a registration statement under the Securities Act with respect to their
shares of Common Stock. Such rights may not be exercised until February 14,
1999. Further, certain Holders may require the Company at the Company's expense
on no more than four occasions, to register all or portion of their shares on
Form S-3 when such form becomes available to the Company, subject to certain
conditions and limitations. Such rights expire in August 2005.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF CHARTER DOCUMENTS AND DELAWARE LAW
Charter Documents
The Restated Certificate and Restated Bylaws include a number of provisions
that may have the effect of deterring hostile takeovers or delaying or
preventing changes in control or management of the Company. First, the Restated
Certificate provides that all stockholder action upon completion of this
offering must be effected at a duly called meeting of holders and not by a
consent in writing. Second, the Restated Bylaws provide that special meetings
of the holders may be called only by (i) the Chairman of the Board of
Directors, (ii) the Chief Executive Officer or (iii) Board of Directors
pursuant to a resolution adopted by a majority of the total number of
authorized directors. Third, the Certificate and the Bylaws provide for a
classified Board of Directors. The Certificate includes a provision requiring
cumulative voting for directors only if required by applicable California law.
Under cumulative voting, a minority stockholder holding a sufficient percentage
of a class of shares may be able to ensure the election of one or more
directors. As a result of the provisions of the Certificate and applicable
California and Delaware law, at any annual meeting whereby the Company had at
least 800 stockholders as of the end of the fiscal year prior to the record
date for such annual meeting, stockholders will not be able to cumulate votes
for directors. Finally, the Restated Bylaws establish procedures, including
advance notice procedures with regard to the nomination of candidates for
election as directors and stockholder proposals. These provisions of the
Restated Certificate and Restated Bylaws could discourage potential acquisition
proposals and could delay or prevent a change in control or management of the
Company. Such provisions also may have the effect of preventing changes in the
management of the Company. See "Risk Factors--Some Anti-Takeover Provisions May
Affect the Price of Our Common Stock."
Delaware Takeover Statute
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ("Section 203"). In general, Section 203 prohibits a
publicly held Delaware corporation, such as the Company shall become upon
completion of this offering, from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction pursuant to which the person became an interested stockholder,
unless the business combination is approved in a manner prescribed by Delaware
law. For purposes of Section 203, a "business combination" includes a merger,
asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an "interested stockholder" is a person who,
together with affiliates and associates, owns (or within three years prior, did
own) 15% or more of the corporation's voting stock.
TRANSFER AGENT AND REGISTRAR
Boston Equiserve is the transfer agent and registrar for the Company's Common
Stock.
65
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of this offering, the Company will have outstanding
18,160,853 shares of Common Stock, based on the number of shares of Common
Stock outstanding as of December 15, 1998, assuming (i) the issuance by the
Company of an aggregate of 1,750,000 shares of Common Stock, (ii) the exercise
of options, warrants or other obligations in connection with this offering
and (iii) no exercise of the Underwriters' over-allotment option to purchase
450,000 shares of Common Stock, except as otherwise noted. The 3,000,000 shares
sold in this offering will be freely tradable without restriction under the
Securities Act. Of the shares outstanding upon completion of the offering,
12,847,899 shares of Common Stock held by existing stockholders are restricted
securities in that they may be sold in the public market only if registered or
if they qualify for an exemption from registration under the Securities Act or
Rules 144, 144(k) or 701 or Regulation S as promulgated under the Securities
Act. Holders, including all officers and directors, of 9,128,554 shares of the
Company's Common Stock and an additional 5,713,768 shares issuable upon
exercise of warrants and options have agreed with the representatives of the
Underwriters, subject to certain exceptions, not to offer, pledge, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase, or
otherwise transfer or dispose of, directly or indirectly, any shares of Common
Stock or any securities convertible into or exercisable or exchangeable for
Common Stock (whether such shares or any such securities are then owned by such
person or are thereafter acquired directly from the Company), or to enter into
any swap or similar arrangement that transfers, in whole or in part, the
economic risks of ownership of the Common Stock, without the prior written
consent of BT Alex. Brown Incorporated for a period of 180 days after the date
of the Company's initial public offering on August 18, 1998, and holders of
shares of the Company's Common Stock and an additional shares issuable
upon exercise of warrants and vested options have agreed to the same sale
restrictions for a period of 90 days after the date of this Prospectus (the
"Lock-Up Agreements"). As a result of such contractual restrictions and the
provisions of Rule 144 or Regulation S, additional shares will be available for
sale in the public market, subject to presentation of evidence satisfactory to
the Company, including an opinion of counsel acceptable to the Company, that
such sales may be made without registration pursuant to the Securities Act as
follows: (i) 1,607,845 shares of Common Stock currently outstanding will be
available for sale into the public market following the effectiveness of this
Registration Statement; (ii) 10,408,352 shares of Common Stock currently
outstanding and 714,265 shares of Common Stock issuable upon exercise of
currently outstanding options will be eligible for sale on February 14, 1999;
(iii) shares of Common Stock currently outstanding and shares of Common
Stock issuable upon exercise of currently outstanding options will be eligible
for sale 91 days after the date of this Prospectus; and (iv) the remainder of
the restricted securities will be eligible for sale from time to time
thereafter upon expiration of their respective one-year holding periods.
In general, under Rule 144 as currently in effect, beginning 90 days after
the Company's initial public offering, any holder, including an affiliate of
the Company, of restricted securities as to which at least one year has elapsed
since the later of the date of the holder's acquisition of such shares from the
Company or from an affiliate, would be entitled within any three-month period
to sell a number of shares that does not exceed the greater of 1% of the then
outstanding shares of Common Stock (approximately 181,609 shares immediately
after the closing of this offering assuming no exercise of the Underwriters'
over-allotment option) or the average weekly trading volume of the Common Stock
on the Nasdaq National Market during the four calendar weeks preceding the date
on which notice of the sale is filed with the Commission. Sales under Rule 144
are subject to certain requirements relating to manner of sale, notice and
availability of current public information about the Company. However, a person
(or persons whose shares are aggregated) who is not deemed to have been an
affiliate of the Company at any time during the 90 days immediately preceding
the sale and who beneficially owns restricted securities is entitled to sell
such shares under Rule 144(k) without regard to the limitations described
above, provided that at least two years have elapsed since the later of the
date the shares were acquired from the Company or from an affiliate of the
Company. The foregoing is a summary of Rule 144 and is not intended to be a
complete description of that rule.
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<PAGE>
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its
employees, directors, officers, consultants or advisers prior to the closing of
the Company's initial public offering, pursuant to written compensatory benefit
plans or written contracts relating to the compensation of such persons. In
addition, the Commission has indicated that Rule 701 will apply to stock
options granted by the Company before the initial public offering, along with
the shares acquired upon exercise of such options. Securities issued in
reliance on Rule 701 are deemed to be restricted securities and, beginning 90
days after the date of the Company's initial public offering (unless subject to
the contractual restrictions described above), may be sold by persons other
than affiliates, subject only to the manner of sale provisions of Rule 144 and
by affiliates under Rule 144 without compliance with its one-year minimum
holding period requirements.
The Company has filed a registration statement on Form S-8 under the
Securities Act covering shares of Common Stock reserved for issuance under the
1995 Stock Option Plan, 1997 Equity Incentive Plan, 1998 Non-Employee Directors
Plan, 1998 Non-Employee Stock Purchase Plan and Non-Plan options. See
"Management--Employee Benefit Plans." Accordingly, shares registered under such
registration statement are, subject to limitations applicable to affiliates of
the Company, available for sale in the open market, unless such shares are
subject to vesting restrictions with the Company or other contractual lock-up
restrictions. As of December 15, 1998, an aggregate of 84,030 shares of Common
Stock had been issued upon exercise of options under the Company's option plans
subsequent to the Company's initial public offering, and options to purchase
additional shares of Common Stock were issued and outstanding. See
"Management--Employee Benefit Plans."
There can be no assurance that an active public market for the Common Stock
will continue after this offering or that the market price of the Common Stock
will not decline below the public offering price. Future sales of substantial
amounts of Common Stock in the public market could adversely affect market
prices prevailing from time to time. As described above, only a limited number
of shares will be available for sale shortly after this offering because of
certain contractual and legal restrictions on resale. Sales of substantial
amounts of Common Stock of the Company in the public market after the
restrictions lapse could adversely affect the prevailing market price and the
ability of the Company to raise equity capital in the future.
67
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement (the
"Underwriting Agreement"), the underwriters named below (the "Underwriters"),
through their Representatives, BT Alex. Brown Incorporated, Hambrecht & Quist
LLC, Lehman Brothers Inc. and Salomon Smith Barney Inc., have severally agreed
to purchase from the Company and the Selling Stockholders the following
respective number of shares of Common Stock at the assumed public offering
price less the underwriting discounts and commissions set forth on the cover
page of this Prospectus:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
BT Alex. Brown Incorporated........................................
Hambrecht & Quist LLC..............................................
Lehman Brothers Inc................................................
Salomon Smith Barney Inc. .........................................
---------
Total............................................................ 3,000,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all shares of the Common Stock offered hereby if any such shares are
purchased.
The Company and the Selling Stockholders have been advised by Representatives
that the Underwriters propose to offer the shares of Common Stock directly to
the public at the offering price set forth on the cover page of this Prospectus
and to certain dealers at such price less a concession not in excess of $ per
share. The Underwriters may allow, and such dealers may reallow, a concession
not in excess of $ per share to certain other dealers. After the public
offering of the shares, the offering price and other selling terms may be
changed by the Representatives.
The Company and certain Selling Stockholders have granted to the Underwriters
an option, exercisable no later than 30 days after the date of this Prospectus,
to purchase up to 450,000 additional shares of Common Stock at the public
offering price less the underwriting discounts and commissions set forth on the
cover page of this Prospectus. To the extent that the Underwriters exercise
such option, each of the Underwriters will have a firm commitment to purchase
approximately the same percentage of such additional shares as the number set
forth next to such Underwriter's name in the above table bears to the total
number of shares of Common Stock offered hereby, and the Company and certain
Selling Stockholders will be obligated, pursuant to the option, to sell such
shares to the Underwriters to the extent the option is exercised. The
Underwriters may exercise such option only to cover over-allotments made in
connection with the sale of Common Stock offered hereby. If purchased, the
Underwriters will offer such additional shares on the same terms as those on
which the 3,000,000 shares are being offered.
The following table summarizes the compensation to be paid to the
Underwriters by the Company and the Selling Stockholders, and the expenses
payable by the Company and the Selling Stockholders.
<TABLE>
<CAPTION>
TOTAL
-----------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
--------- -------------- --------------
<S> <C> <C> <C>
Underwriting Discounts and Commissions
paid by the Company.................. $ $ $
Underwriting Discounts and Commissions
paid by Selling Stockholders......... $ $ $
</TABLE>
68
<PAGE>
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.
The Company's officers, directors and certain stockholders have agreed not to
offer, sell or otherwise dispose of any shares of Common Stock for a period of
90 days after the date of this Prospectus without the prior written consent of
BT Alex. Brown Incorporated. Such consent may be given at any time without any
public notice. The Company has entered into a similar agreement, except that it
may issue, and grant option or warrants to purchase, shares of Common Stock or
any securities convertible into, exercisable for or exchangeable for shares of
Common Stock, pursuant to the exercise of outstanding options and warrants and
the Company's issuance of options and stock granted under the existing stock
purchase plans.
The Representatives have advised the Company that, pursuant to Regulation M
under the Securities Exchange Act of 1934, as amended, certain persons
participating in the offering may engage in transactions, including stabilizing
bids, syndicate covering transactions and the imposition of penalty bids, which
may have the effect of stabilizing or maintaining the market price of the
Common Stock at a level above that which might otherwise prevail in the open
market. A "stabilizing bid" is a bid for or the purchase of the Common Stock on
behalf of the Underwriters for the purpose of fixing or maintaining the price
of the Common Stock. A "syndicate covering transaction" is the bid for or the
purchase of the Common Stock on behalf of the Underwriters to reduce a short
position incurred by the Underwriters in connection with the offering. A
"penalty bid" is an arrangement permitting the Representatives to reclaim the
selling concession otherwise accruing to an Underwriter or syndicate member in
connection with the offering if the Common Stock originally sold by such
Underwriter or syndicate member is purchased by the Representatives in a
syndicate covering transaction and has therefore not been effectively placed by
such Underwriter or syndicate member. The Representatives have advised the
Company that such transactions may be effected on the Nasdaq National Market or
otherwise and, if commenced, may be discontinued at any time.
In connection with this offering, certain Underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in the Common Stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended. During the business day prior to
the pricing of the offering before the commencement of offers or sales of the
Common Stock. Passive market makers must comply with applicable volume and
price limitations and must be identified as such. In general, a passive market
maker must display its bid at a price not in excess of the highest independent
bid of such security; if all independent bids are lowered below the passive
market maker's bid, however, such bid must then be lowered when certain
purchase limits are exceeded.
The Representatives of the Underwriters have advised the Company that the
Underwriters do not intend to confirm orders to any account over which they
exercise discretionary authority.
The Company estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $600,000.
69
<PAGE>
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward llp ("Cooley Godward"), San Francisco, California.
Certain legal matters related to the offering will be passed upon for the
Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California. As of the date of this Prospectus, certain partners and
associates of Cooley Godward own through an investment partnership an aggregate
of 36,668 shares of Common Stock of the Company.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 1997 and 1996, and for each of the three
years in the period ended December 31, 1997, included in our Prospectus and
Registration Statement, as set forth in their report, which is included in our
Prospectus and Registration Statement, and are included in reliance on their
report, given on their authority as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission
("Commission"), Washington, D.C. 20549, a Registration Statement on Form S-1
under the Securities Act with respect to the shares of Common Stock offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and such Common Stock, reference is
made to the Registration Statement and to the exhibits and schedules filed
therewith. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in
each instance reference is made to the copy of such contract or other document
filed as an exhibit to the Registration Statement, each such statement being
qualified in all respects by such reference. A copy of the Registration
Statement may be inspected by anyone without charge at the Commission's
principal office in Washington, D.C., and copies of all or any part of the
Registration Statement may be obtained from the Public Reference Section of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of
certain fees prescribed by the Commission. The Commission also maintains a
World Wide Web site that contains reports, proxy and information statements and
other information regarding registrants, such as the Company, that file
electronically with the Commission. The address of the site is
http://www.sec.gov.
The Company intends to furnish to its stockholders annual reports containing
audited financial statements certified by an independent public accounting firm
and quarterly reports containing unaudited interim financial information for
each of the first three fiscal quarters of each fiscal year of the Company.
70
<PAGE>
GLOSSARY OF TECHNICAL TERMS
<TABLE>
<C> <S>
10BASET..................... Ethernet standard that applies to the physical
layer of the OSI Reference Model for 10 Mbps
Ethernet over two pairs of category 3, 4 or 5
Unshielded Twisted Pair (UTP) wire.
100BASET.................... An extension to the 10BaseT Ethernet network
access method which operates at 100 Mbps.
56 KBPS..................... Equivalent to a single high speed telephone
service line, capable of transmitting one voice
call or 56 Kbps of data.
ADSL........................ Asymmetric Digital Subscriber Line. A high speed
technology that enables the transfer of data
over existing copper line.
ANALOG...................... A form of transmission employing a continuous
electrical signal (rather than a pulsed or
digital system) that varies in frequency and
amplitude.
ASIC........................ Application specific integrated circuit.
ASYNCHRONOUS................ A form of concurrent input and output
communication transmission with no timing
relationship between the two signals. Slower-
speed asynchronous transmission requires start
and stop bits to avoid a dependency on timing
clocks (10 bits to send an 8-bit byte).
ATM......................... Asynchronous Transfer Mode. A fixed length 53-
byte packet-based transmission technology that
may be used to transmit data, voice and video
traffic; ATM utilizes cell switching.
BANDWIDTH................... A range of signal frequencies, measured in
cycles per second or Hertz (Hz). Also refers to
the speed at which data is transmitted, measured
in bits per second (bps).
BROADBAND ACCESS............ A transmission that has a bandwidth greater than
a voice-grade line of 3KHz, usually at
transmission speeds of greater than 1.5 Mbps
(T-1).
CBR......................... Constant bit rate. A Quality of Service class
specified when service is initiated.
CDMA........................ Code Division Multiple Access. An information
transmission technology that transmits
information from multiple sources across a fixed
frequency band by encoding each in a unique
transmission code.
COAXIAL CABLE............... A large capacity data transmission medium
consisting of insulated wires grouped together
inside an insulated cable. Used for broadband
communications networks and cable TV.
DAVLC....................... Digital Audio Video Interactive Council. A
European standards setting committee.
DBS......................... Direct Broadcast Satellite. A broadband
communications technology that broadcasts
digital television programming from satellites
directly to end-user dish antennas.
</TABLE>
G-1
<PAGE>
<TABLE>
<C> <S>
DOCSIS...................... Data Over Cable Service Interface Specification.
The cable modem specifications set by the MCNS
group of North American cable operators.
DOWNSTREAM.................. The data path from service provider to end user.
DSL......................... Digital Subscriber Line. Point-to-point public
network access technologies that allow multiple
forms of data, voice and video to be carried
over twisted-pair copper wire on the local loop
between a network service provider's central
office and the customer site at limited
distances.
FCC......................... Federal Communications Commission.
FDMA........................ Frequency Division Multiple Access. A
transmission technology that multiplexes
information from multiple sources onto discrete
carrier frequencies over fixed time intervals.
FREQUENCY................... The number of identical cycles per second,
measured in hertz, of a periodic oscillation or
wave in radio propagation.
HDSL........................ High Bit Rate Digital Subscriber Line. A
technology that enables high speed transmission
of data over copper wires.
HEADEND..................... The central distribution point in a cable
system. Typically serves tens to hundreds of
thousands of homes.
HERTZ OR HZ................. Cycles per second.
HFC......................... Hybrid Fiber/Coax. Upgraded cable plant, which
uses a combination of fiber optic cable in the
backbone and coaxial cable in the subscriber
feeder plant.
HOMES PASSED................ Homes physically passed by a cable network.
IEEE........................ Institute of Electrical and Electronics
Engineers, Inc.
ISDN........................ Integrated Services Digital Network. An
internationally accepted standard for voice,
data and signaling that makes all transmission
circuits end-to-end digital and defines a
standard out-of-band signaling system.
KBPS........................ Kilobits per second. Thousand bits per second.
LMDS........................ Local Multipoint Distribution Service. A
broadband wireless communications network that
uses millimeter wave frequencies around 28 to 38
GHz to transmit video and data to residences
over a cellular-like network at distances under
a few miles.
MBPS........................ Megabits per second. Millions of bits per
second.
MCNS........................ Multimedia Cable Network System. Industry
consortium that defines the technical
requirement for interoperability of high speed
cable modem and headend equipment.
</TABLE>
G-2
<PAGE>
<TABLE>
<C> <S>
MHZ......................... Megahertz. Millions of cycles per second.
MMDS........................ Multichannel Multipoint Distribution Service. A
broadband wireless communications network that
uses microwave frequencies around 2.5 GHz to
transmit video to residences at distances up to
tens of miles.
OC-3........................ A specification of transmission of data over
optical cable at 155 megabits per second.
QAM......................... Quadrature Amplitude Modulation. A digital
modulation technique commonly used in broadband
networks.
RF.......................... Radio Frequency. The range of electro-magnetic
frequencies above the audio range and below
visible light.
RF MODULATION............... The transmission of a signal through a carrier
frequency.
S-CDMA...................... Sychronous Code Division Multiple Access. An
enhancement of CDMA that synchronizes multiple
subscriber end-stations to the headend receiver
unit to achieve high channel capacity.
SNR......................... Signal-to-noise ratio.
SYNCHRONOUS................. A form of communication transmission with a
direct timing relationship between input and
output signals. The transmitter and receiver are
in sync and signals are sent at a fixed rate.
Information is sent in multibyte packets.
TDMA........................ Time Division Multiple Access. An information
transmission technology that multiplexes
information from multiple sources onto a single
frequency carrier signal over discrete time
intervals.
UBR......................... Unspecified Bit Rate. A Quality of Service class
that provides no guarantee of a fixed data rate,
or bandwidth to the user. Bandwidth is provided
on a best effort basis.
UL.......................... Underwriter's Laboratory. A United States
regulatory body responsible for certification of
safety standards.
UPSTREAM.................... The data path from the end user to the service
provider.
XDSL........................ Other Digital Subscriber Line. Generic
representation of entire family of Digital
Subscriber Line technology spanning data rates
from 128 Kbps to 52 Mbps depending on the
distance between the central office and the
subscriber.
</TABLE>
G-3
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................... F-2
Consolidated Balance Sheets........................................... F-3
Consolidated Statements of Operations................................. F-4
Consolidated Statements of Stockholders' Equity (Net Capital
Deficiency).......................................................... F-5
Consolidated Statements of Cash Flows................................. F-7
Notes to Consolidated Financial Statements............................ F-9
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Terayon Communication Systems, Inc.
We have audited the accompanying consolidated balance sheets of Terayon
Communication Systems, Inc. as of December 31, 1996 and 1997, and the related
consolidated statements of operations, stockholders' equity (net capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Terayon Communication Systems, Inc. at December 31, 1996 and 1997, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
San Jose, California
February 6, 1998,
except for Note 14, as to which
the date is July 8, 1998
F-2
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ SEPTEMBER 30,
1996 1997 1998
-------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................. $ 8,356 $ 1,569 $ 29,636
Short-term investments..................... 4,508 418 2,948
Accounts receivable, less allowance for
doubtful accounts of $20 in 1997 and $464
in 1998................................... -- 574 1,629
Accounts receivable from related parties... -- 362 3,057
Inventory.................................. -- 1,322 5,833
Other current assets....................... 299 690 1,850
-------- -------- --------
Total current assets......................... 13,163 4,935 44,953
Property and equipment, net.................. 2,572 3,615 3,349
Officer note receivable...................... 100 100 100
Other assets................................. 143 128 128
-------- -------- --------
Total assets................................. $ 15,978 $ 8,778 $ 48,530
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
Current liabilities:
Accounts payable........................... $ 682 $ 2,232 $ 9,875
Accrued payroll and related expenses....... 570 1,052 1,717
Other accrued liabilities.................. 450 1,526 3,587
Advance from related party................. -- 2,000 --
Deferred revenue........................... 425 95 --
Current portion of long-term debt.......... 917 2,812 --
Current portion of capital lease
obligations............................... 148 65 43
-------- -------- --------
Total current liabilities................ 3,192 9,782 15,222
Long-term debt............................... 1,150 -- --
Long-term portion of capital lease
obligations................................. 105 44 12
Deferred rent................................ 102 126 130
Other noncurrent liabilities................. 24 -- --
Commitments and contingencies
Redeemable common stock, $.001 par value:
Authorized shares--included in common stock
authorized
Issued and outstanding shares--10,000 in
1997 and none in 1998..................... -- 13 --
Redeemable common stockholder's note
receivable................................ -- (13) --
-------- -------- --------
Total redeemable common stock............ -- -- --
Stockholders' equity (net capital
deficiency):
Preferred stock, $.001 par value:
Authorized shares--5,000,000
Issued and outstanding shares--none........ -- -- --
Convertible preferred stock, $.001 par
value:
Authorized shares--10,399,097 in 1997 and
none in 1998
Issued and outstanding shares--6,322,174 in
1996, 7,131,161 in 1997 and none in 1998.. 25,989 35,807 --
Common stock, $.001 par value:
Authorized shares--30,000,000
Issued and outstanding shares--4,138,799 in
1996, 4,620,447 in 1997 and 16,372,598 in
1998...................................... 90 458 16
Additional paid in capital................. -- -- 113,907
Accumulated deficit........................ (14,614) (37,163) (78,906)
Deferred compensation...................... -- (216) (1,829)
Stockholders' notes receivable............. (60) (60) (22)
-------- -------- --------
Total stockholders' equity (net capital
deficiency)............................. 11,405 (1,174) 33,166
-------- -------- --------
Total liabilities and stockholders'
equity (net capital deficiency)......... $ 15,978 $ 8,778 $ 48,530
======== ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- ------------------
1995 1996 1997 1997 1998
------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES:
Product revenues............ $ -- $ -- $ 1,021 $ 671 $ 10,131
Related party product
revenues................... -- -- 617 84 8,645
Contract consulting and
technology development
revenues................... -- -- 480 -- --
------- -------- -------- -------- --------
Total revenues............ -- -- 2,118 755 18,776
COST OF GOODS SOLD:
Cost of product revenues.... -- -- 3,904 2,120 14,196
Cost of related party
product revenues........... -- -- 2,558 123 7,827
Cost of contract consulting
and technology development
revenues................... 676 -- -- -- --
------- -------- -------- -------- --------
Total cost of goods sold.. 676 -- 6,462 2,243 22,023
------- -------- -------- -------- --------
GROSS LOSS ................... (676) -- (4,344) (1,488) (3,247)
OPERATING EXPENSES:
Research and development.... 2,028 8,020 11,319 8,581 7,702
Sales and marketing......... 205 1,141 4,468 2,715 4,815
General and administrative.. 825 1,789 2,546 1,715 2,095
------- -------- -------- -------- --------
Total operating expenses.. 3,058 10,950 18,333 13,011 14,612
------- -------- -------- -------- --------
Loss from operations.......... (3,734) (10,950) (22,677) (14,499) (17,859)
Interest income............... 110 393 396 305 381
Interest expense.............. (42) (140) (268) (175) (355)
------- -------- -------- -------- --------
Net loss...................... (3,666) (10,697) (22,549) (14,369) (17,833)
Series F convertible preferred
stock dividend (Note 9)...... -- -- -- -- (23,910)
------- -------- -------- -------- --------
Net loss applicable to common
stockholders................. $(3,666) $(10,697) $(22,549) $(14,369) $(41,743)
======= ======== ======== ======== ========
Historical basic and diluted
net loss per share applicable
to common stockholders....... $ (1.02) $ (2.64) $ (5.26) $ (3.39) $ (6.39)
======= ======== ======== ======== ========
Shares used in computing
historical basic and diluted
net loss per share applicable
to common stockholders....... 3,589 4,054 4,289 4,235 6,530
======= ======== ======== ======== ========
Pro forma basic and diluted
net loss per share applicable
to common stockholders....... $ (2.07) $ (3.21)
======== ========
Shares used in computing pro
forma basic and diluted net
loss per share applicable to
common stockholders.......... 10,873 12,991
======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
TOTAL
CONVERTIBLE ADDI- STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK TIONAL ACCUMU- DEFERRED STOCKHOLDERS' EQUITY
---------------- ---------------- PAID IN LATED COMPEN- NOTES (NET CAPITAL
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SATION RECEIVABLE DEFICIENCY)
--------- ------ --------- ------ ------- ------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1994................... -- $ -- 2,000,000 $ 62 -- $ (251) $ -- $(13) $ (202)
Exercise of option to
purchase common stock.. -- -- 2,000,000 -- -- -- -- -- --
Net cash proceeds from
issuance of Series A
preferred stock........ 4,077,093 3,853 -- -- -- -- -- -- 3,853
Issuance of Series A
preferred stock for
notes receivable....... 85,000 81 -- -- -- -- -- (81) --
Net cash proceeds from
issuance of Series B
preferred stock........ 896,834 7,970 -- -- -- -- -- -- 7,970
Net loss applicable to
common stockholders and
comprehensive net loss
applicable to common
stockholders........... -- -- -- -- -- (3,666) -- -- (3,666)
--------- ------ --------- ------ --- ------- ---- ---- -------
BALANCE AT DECEMBER 31,
1995................... 5,058,927 11,904 4,000,000 62 -- (3,917) -- (94) 7,955
Net cash proceeds from
issuance of Series B-1
preferred stock........ 448,417 3,957 -- -- -- -- -- -- 3,957
Cash proceeds from
payment on a
shareholder note
receivable............. -- -- -- -- -- -- -- 34 34
Exercise of options for
cash to purchase common
stock.................. -- -- 106,219 11 -- -- -- -- 11
Issuance of common stock
for consulting
services............... -- -- 32,580 17 -- -- -- -- 17
Net cash proceeds from
issuance of Series C
preferred stock........ 814,830 10,128 -- -- -- -- -- -- 10,128
Net loss applicable to
common stockholders and
comprehensive net loss
applicable to common
stockholders........... -- -- -- -- -- (10,697) -- -- (10,697)
--------- ------ --------- ------ --- ------- ---- ---- -------
BALANCE AT DECEMBER 31,
1996................... 6,322,174 25,989 4,138,799 90 -- (14,614) -- (60) 11,405
Exercise of options for
cash to purchase common
stock.................. -- -- 481,648 140 -- -- -- -- 140
Net cash proceeds from
issuance of Series D
preferred stock........ 808,987 9,818 -- -- -- -- -- -- 9,818
Unearned compensation
related to stock
options................ -- -- -- 228 -- -- (228) -- --
Amortization of unearned
compensation........... -- -- -- -- -- -- 12 -- 12
Net loss applicable to
common stockholders and
comprehensive net loss
applicable to common
stockholders........... -- -- -- -- -- (22,549) -- -- (22,549)
--------- ------ --------- ------ --- ------- ---- ---- -------
BALANCE AT DECEMBER 31,
1997................... 7,131,161 35,807 4,620,447 458 -- (37,163) (216) (60) (1,174)
Net cash proceeds from
issuance of Series D
preferred stock
(unaudited)............ 114,089 1,454 -- -- -- -- -- -- 1,454
Conversion of advance
from related party to
Series D preferred
stock (unaudited)...... 153,846 2,000 -- -- -- -- -- -- 2,000
Net cash proceeds from
issuance of Series F
preferred stock and a
warrant (unaudited).... 384,615 844 -- 4,089 -- -- -- -- 4,933
Dividends on Series F
convertible preferred
stock (unaudited)...... -- -- -- 23,910 -- -- -- -- 23,910
Value of preferred stock
warrant issued to
Series D preferred
stockholder
(unaudited)............ -- 19 -- -- -- -- -- -- 19
Exercise of options for
cash to purchase common
stock (unaudited)...... -- -- 205,276 56 -- -- -- -- 56
Exercise of option for
note receivable to
purchase common stock
(unaudited)............ -- -- 24,375 9 -- -- -- (9) --
Value of common stock
warrant (unaudited).... -- -- -- 35 -- -- -- -- 35
</TABLE>
See accompanying notes.
F-5
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)--
(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
TOTAL
CONVERTIBLE ADDI- STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK TIONAL ACCUMU- DEFERRED STOCKHOLDERS' EQUITY
-------------------- ------------------- PAID IN LATED COMPEN- NOTES (NET CAPITAL
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SATION RECEIVABLE DEFICIENCY)
---------- -------- ---------- -------- -------- -------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cash proceeds from
payment on a
stockholder note
receivable
(unaudited)........ -- $ -- -- $ -- $ -- $ -- $ -- $ 47 $ 47
Unearned
compensation
related to stock
options
(unaudited)........ -- -- -- 1,849 -- -- (1,849) -- --
Amortization of
unearned
compensation
related to stock
options
(unaudited)........ -- -- -- -- -- -- 236 -- 236
Transfer to
additional paid in
capital as a result
of reincorporation
(unaudited)........ -- (40,116) -- (30,401) 70,517 -- -- -- --
Conversion of
preferred stock
into common stock
upon the initial
public offering
(unaudited)........ (7,783,711) (8) 7,783,711 8 -- -- -- -- --
Issuance of common
stock in connection
with the initial
public offering,
net of issuance
costs (unaudited).. -- -- 3,000,000 3 35,141 -- -- -- 35,144
Conversion of
redeemable
preferred stock to
common stock upon
the initial public
offering
(unaudited)........ -- -- 576,924 -- 7,500 -- -- -- 7,500
Conversion of
redeemable common
stock upon the
initial public
offering
(unaudited)........ -- -- 10,000 -- 13 -- -- -- 13
Exercise of common
stock warrant
(unaudited)........ -- -- 50,000 -- 500 -- -- -- 500
Issuance of common
stock in legal
settlement to an
employee
(unaudited)........ -- -- 13,000 -- 169 -- -- -- 169
Exercise of options
for cash to
purchase common
stock (unaudited).. -- -- 88,865 -- 67 -- -- -- 67
Net loss applicable
to common
stockholders and
comprehensive net
loss applicable to
common stockholders
(unaudited)........ -- -- -- -- -- (41,743) -- -- (41,743)
---------- -------- ---------- -------- -------- -------- ------- ---- --------
BALANCE AT SEPTEMBER
30, 1998
(UNAUDITED)........ -- $ -- 16,372,598 $ 16 $113,907 $(78,906) $(1,829) $(22) $ 33,166
========== ======== ========== ======== ======== ======== ======= ==== ========
</TABLE>
See accompanying notes.
F-6
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- ------------------
1995 1996 1997 1997 1998
------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss applicable to common
stockholders................. $(3,666) $(10,697) $(22,549) $(14,369) $(41,743)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization............... 203 830 1,563 1,086 1,487
Amortization of unearned
compensation related to
stock options.............. -- -- 12 5 236
Loss on disposal of fixed
assets..................... -- 20 -- -- --
Issuance of common stock for
consulting services........ -- 17 -- -- --
Value of common and
preferred stock warrants
issued..................... -- -- -- -- 54
Series F convertible
preferred stock dividend... -- -- -- -- 23,910
Changes in operating assets
and liabilities:
Accounts receivable........ -- -- (574) (755) (1,055)
Accounts receivable from
related party............. -- -- (362) -- (2,695)
Inventory.................. -- -- (1,322) (2,623) (4,511)
Other current assets....... (97) (177) (391) (362) (1,160)
Other assets............... (7) (118) 15 11 --
Accounts payable........... 518 8 1,550 4,170 7,643
Accrued payroll and related
expenses.................. 212 346 482 279 665
Other accrued liabilities.. 168 263 1,076 (36) 2,230
Deferred revenue........... 325 -- (330) 55 (95)
Deferred rent.............. -- 102 24 19 4
Other noncurrent
liabilities............... -- 24 (24) -- --
------- -------- -------- -------- --------
Net cash used in operating
activities................... (2,344) (9,382) (20,830) (12,520) (15,030)
INVESTING ACTIVITIES:
Purchases of short-term
investments.................. -- (6,863) (10,995) (10,594) (2,948)
Proceeds from sales and
maturities of short-term
investments.................. -- 2,355 15,085 9,254 418
Purchases of property and
equipment.................... (1,301) (1,892) (2,606) (2,507) (1,221)
Proceeds from sale of assets.. -- 42 -- -- --
Officer note receivable....... -- (100) -- -- --
------- -------- -------- -------- --------
Net cash provided by (used in)
investing activities......... (1,301) (6,458) 1,484 ( 3,847) (3,751)
</TABLE>
See accompanying notes.
F-7
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------- ----------------
1995 1996 1997 1997 1998
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
FINANCING ACTIVITIES:
Principal payments on capital
leases.......................... $ (82) $ (124) $ (144) $ (111) $ (54)
Principal payments on long-term
debt............................ (16) (273) (909) (718) (2,812)
Proceeds from long-term debt..... 513 1,843 1,654 1,328 --
Exercise of options and warrant
to purchase common stock........ -- 11 140 105 623
Advance from related party....... -- -- 2,000 2,000 --
Proceeds from issuance of
preferred stock................. 11,823 14,085 9,818 9,818 6,387
Proceeds from issuance of
redeemable preferred stock...... -- -- -- -- 7,500
Principal payments on redeemable
common stockholder and common
stockholder notes receivable.... -- 34 -- -- 60
Proceeds from issuance of common
stock........................... -- -- -- -- 35,144
------- ------- ------- ------- -------
Net cash provided by financing
activities................... 12,238 15,576 12,559 12,422 46,848
------- ------- ------- ------- -------
Net increase (decrease) in cash
and cash equivalents............ 8,593 (264) (6,787) (3,945) 28,067
Cash and cash equivalents at
beginning of period............. 27 8,620 8,356 8,356 1,569
------- ------- ------- ------- -------
Cash and cash equivalents at end
of period....................... $ 8,620 $ 8,356 $ 1,569 $ 4,411 $29,636
======= ======= ======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for interest........... $ 42 $ 140 $ 268 $ 175 $ 355
SUPPLEMENTAL NONCASH INVESTING
AND FINANCING ACTIVITIES:
Property and equipment acquired
under capital leases............ $ 176 $ 137 $ -- $ -- $ --
Maintenance agreement acquired
under capital lease............. $ 6 $ -- $ -- $ -- $ --
Issuance of convertible preferred
stock for stockholder note
receivable...................... $ 81 $ -- $ -- $ -- $ --
Sale of asset for decrease in
accounts payable................ $ 210 $ -- $ -- $ -- $ --
Issuance of common stock for
consulting services............. $ -- $ 17 $ -- $ -- $ --
Exercise of option for note
receivable to purchase
redeemable common stock......... $ -- $ -- $ 13 $ 13 $ --
Exercise of option for note
receivable to purchase common
stock........................... $ -- $ -- $ -- $ -- $ 9
Conversion of advance from
related party to Series D
preferred stock................. $ -- $ -- $ -- $ -- $ 2,000
Issuance of common stock in legal
settlement to an employee....... $ -- $ -- $ -- $ -- $ 169
Conversion of preferred stock to
common stock.................... $ -- $ -- $ -- $ -- $ 8
Conversion of redeemable
preferred stock to common stock
................................ $ -- $ -- $ -- $ -- $ 7,500
Conversion of redeemable common
stock to common stock .......... $ -- $ -- $ -- $ -- $ 13
</TABLE>
See accompanying notes.
F-8
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Terayon Communication Systems, Inc. (the Company) was incorporated under the
laws of the state of California on January 20, 1993 for the purpose of
developing, producing, and marketing broadband access system products. In
October 1997, the Company changed its legal name from Terayon Corporation. In
July 1998, the Company reincorporated in the State of Delaware. Through
December 31, 1996, the Company was active in product development, the
acquisition of equipment and facilities, and raising capital; accordingly, the
Company was in the development stage. The Company emerged from the development
stage during 1997.
Unaudited Interim Financial Information
The accompanying consolidated financial statements at September 30, 1998 and
for the nine months ended September 30, 1997 and 1998 are unaudited but include
all adjustments (consisting of normal recurring accruals) which, in the opinion
of management, are necessary for a fair statement of the financial position and
the operating results and cash flows for the interim date and periods
presented. Results for the interim period ended September 30, 1998 are not
necessarily indicative of results for the entire fiscal year or future periods.
Basis of Consolidation
The consolidated financial statements include the accounts of the Company and
its majority owned subsidiaries, Terayon Communication Systems Europe and
Terayon do Brasil. The minority interests in net losses of Terayon
Communication Systems Europe and Terayon do Brasil were not significant for all
periods presented. All material intercompany balances and transactions have
been eliminated.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain prior year balances have been restated to conform with current year
presentation.
Advertising Expenses
The Company accounts for advertising costs as expense in the period in which
they are incurred. Advertising expense for the years ended December 31, 1995,
1996 and 1997 and for the nine months ended September 30, 1997 and 1998 was not
significant.
Research and Development Costs
Research and development costs are charged to expense as incurred.
F-9
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months but less
than a year are classified as short-term investments. At December 31, 1996 and
1997, approximately 90% and 45%, respectively, of the Company's total cash and
short-term investment balance was placed on deposit with an affiliate of a
convertible preferred stockholder (none at September 30, 1998). Management
determines the appropriate classification of debt and equity securities at the
time of purchase and reevaluates such designation at the end of each period.
At December 31, 1996 and 1997 and at September 30, 1998, all of the Company's
investments in debt securities were classified as available-for-sale and were
obligations issued by U.S. government agencies or corporate commercial paper,
maturing within one year. The amortized cost, which approximated fair value, of
debt instruments classified as cash equivalents and short-term investments was
approximately $6,436,000 and $4,508,000, respectively, at December 31, 1996,
$99,000 and $418,000, respectively, at December 31, 1997, and $23,580,000 and
$2,948,000, respectively, at September 30, 1998. The amount of unrealized gains
or losses was not significant at December 31, 1996 or 1997 or September 30,
1998. The estimated fair values of cash equivalents and short-term investments
are based on quoted market prices. The amount of realized gains or losses for
the years ended December 31, 1995, 1996, and 1997, and for the nine months
ended September 30, 1997 and 1998 were not significant.
Concentrations of Credit Risk, Customer, Supplier, and Product
The Company operates in one business segment, the development and sale of
cable modem access products, which it sells primarily to customers within the
cable and communications industries, including related parties (see Note 13).
The Company performs ongoing credit evaluations of its customers and generally
requires no collateral. A relatively small number of customers and resellers
account for a significant percentage of the Company's revenues. The Company
expects that the sale of its products to a limited number of customers and
resellers may continue to account for a high percentage of revenues for the
foreseeable future.
Currently, the Company relies on single source suppliers of materials and
labor for the significant majority of its product inventory but is actively
pursuing additional supplier alternatives. As a result, should the Company's
current suppliers not produce and deliver inventory for the Company to sell on
a timely basis, operating results may be adversely impacted.
Substantially all of the Company's revenues have been attributable to sales
of the TeraLink and the TeraPro. These products are expected to account for a
significant part of the Company's revenues for the foreseeable future. As a
result, a decline in demand for or failure to achieve broad market acceptance
of the TeraLink or the TeraPro would adversely affect operating results.
In addition, market acceptance of the Company's products may be affected by
the emergence and evolution of industry standards. While the Company expects
its products to become compliant with industry standards, its inability to do
so may adversely affect operating results.
The Company invests its excess cash in debt instruments of the U.S. Treasury,
governmental agencies, and corporations with strong credit ratings. The Company
has established guidelines relative
F-10
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
to diversification and maturities that attempt to maintain safety and
liquidity. The Company has not experienced any significant losses on its cash
equivalents or short-term investments.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market. The
components of inventory are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Inventory:
Finished goods................................ $ 163 $4,331
Work-in-process............................... 366 646
Raw materials................................. 793 856
------ ------
$1,322 $5,833
====== ======
</TABLE>
During the nine months ended September 30, 1998 the Company was required to
purchase inventory components from its previous contract manufacturer that were
subsequently sold to its current contract manufacturer. As a result of the
transition to the Company's current contract manufacturer, the Company recorded
a charge of approximately $1,300,000. A portion of the charge consisted of
approximately $750,000 of raw material components that were deemed obsolete due
to a design change in the Company's bill of materials during the quarter ended
March 31, 1998. The charge also consisted of a write down of approximately
$550,000 for parts repurchased from the Company's previous contract
manufacturer and then resold to the Company's current contract manufacturer, as
the Company's current contract manufacturer could purchase the related parts at
a lower cost than the Company had valued the inventory. Therefore, the Company
wrote down the inventory to the lower of cost or market as part of selling the
inventory to its current contract manufacturer.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and
amortization. Property and equipment are depreciated for financial reporting
purposes using the straight-line method over the estimated useful lives of
three to five years. Leasehold improvements are amortized using the straight-
line method over the shorter of the useful lives of the assets or the terms of
the leases. The recoverability of the carrying amount of property and equipment
is assessed based on estimated future undiscounted cash flows and if an
impairment exists the charge to operations is measured as the excess of the
carrying amount over the fair value of the assets. Based upon this method of
assessing recoverability, no asset impairment existed for all periods
presented.
F-11
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
Property and equipment are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- SEPTEMBER 30,
1996 1997 1998
------- ------- -------------
<S> <C> <C> <C>
Software and computers...................... $ 2,516 $ 3,695 $ 4,074
Furniture and equipment..................... 1,064 2,421 3,219
Leasehold improvements...................... 19 89 133
------- ------- -------
$ 3,599 $ 6,205 $ 7,426
Accumulated depreciation and amortization... (1,027) (2,590) (4,077)
------- ------- -------
Property and equipment, net................. $ 2,572 $ 3,615 $ 3,349
======= ======= =======
</TABLE>
Revenue Recognition
Revenues related to product sales are generally recognized when the products
are shipped to the customer. The Company has also performed some research and
product development work under best efforts technology development agreements.
Due to technological risk factors, the costs of these agreements have been
expensed as incurred and are included in cost of goods sold for the year ended
December 31, 1995. Revenues are recognized when applicable customer milestones
have been met, including deliverables and, in any case, not in excess of the
amount that would be recognized using the percentage-of-completion method. The
Company met deliverables under an agreement in the fourth quarter of the year
ended December 31, 1997 and recognized the related revenue (see Note 3).
Warranty Reserves
Due to the recent introduction of the Company's products, the Company has
limited experience with warranty commitments that may arise with the current
generation of its products. The Company's products generally carry a one-year
warranty that includes factory and on-site repair services as needed for
replacement of parts. Estimated expenses for warranty obligations are accrued
as revenue is recognized. Reserve estimates are adjusted periodically to
reflect actual experience.
Stock-Based Compensation
As described in Note 9, the Company has elected to account for its employee
stock plans in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB Opinion No.25), and to adopt
the disclosure-only provisions as required under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
(FAS 123).
Net Loss Per Share and Unaudited Pro Forma Stockholders' Equity (Net Capital
Deficiency)
Historical basic and diluted net loss per share are computed using the
weighted average number of common shares outstanding. Options, warrants,
restricted stock and preferred stock were not included in the computation of
diluted net loss per share because the effect would be antidilutive.
Pro forma net loss per share has been computed as described above and also
gives effect, even if antidilutive, to common equivalent shares from preferred
stock that automatically converted upon the closing of the Company's initial
public offering (using the as-if-converted method).
F-12
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
A reconciliation of shares used in the calculation of historical and pro
forma basic and diluted net loss per share follows (in thousands, except per
share data):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- ------------------
1995 1996 1997 1997 1998
------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net loss...................... $(3,666) $(10,697) $(22,549) $(14,369) $(17,833)
Series F convertible preferred
stock dividend (Note 9)...... -- -- -- -- (23,910)
------- -------- -------- -------- --------
Net loss applicable to common
stockholders................. $(3,666) $(10,697) $(22,549) $(14,369) $(41,743)
======= ======== ======== ======== ========
Shares used in computing
historical basic and diluted
net loss per share applicable
to common stockholders....... 3,589 4,054 4,289 4,235 6,530
Historical basic and diluted
net loss per share applicable
to common stockholders....... $ (1.02) $ (2.64) $ (5.26) $ (3.39) $ (6.39)
======= ======== ======== ======== ========
Shares used in computing
historical basic and diluted
net loss per share applicable
to common stockholders....... 4,289 6,530
Adjustment to reflect the
effect of the assumed
conversion of weighted
average shares of convertible
preferred stock outstanding
applicable to common
stockholders................. 6,584 6,461
-------- --------
Shares used in computing pro
forma basic and diluted net
loss per share applicable to
common stockholders.......... 10,873 12,991
======== ========
Pro forma basic and diluted
net loss per share applicable
to common stockholders....... $ (2.07) $ (3.21)
======== ========
</TABLE>
Impact of Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 requires that all items required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. FAS 130 is effective for fiscal years beginning after
December 15, 1997 and has been adopted by the Company in 1998. The Company's
comprehensive net loss was the same as its net loss for the years ended
December 31, 1995, 1996 and 1997, and for the nine months ended September 30,
1997 and 1998.
In addition, during June 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" (FAS 131). FAS 131 replaces
Statement of Financial Accounting Standards No. 14, "Financial Reporting for
Segments of a Business Enterprise" and changes the way public companies report
segment
F-13
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
information. FAS 131 is effective for fiscal years beginning after December 15,
1997 and will be adopted by the Company for the year ended December 31, 1998.
2. OFFICER NOTE RECEIVABLE
In March 1996, the Company loaned an officer $100,000 pursuant to a
promissory note. The note does not bear interest, matures in March 2001, and is
full recourse, including being collateralized by 20,000 shares of the Company's
common stock.
3. DEFERRED REVENUE
On January 4, 1995, the Company entered into a Development and Production
Agreement with a telecommunications systems manufacturer (the Manufacturer),
whereby the Company agreed to develop an enabling technology for use with
certain manufacturer technology (the Product). Pursuant to the agreement, the
Manufacturer is obligated to purchase certain minimum quantities of the
Product, and the Company has agreed to provide the Product to the Manufacturer
on favorable pricing terms for a period of four years following completion of
the Product. In addition, the Company has agreed that for the first three
months following the completion of the Product, the Company will not sell the
Product to any third party for use in the carrying of voice-over coaxial
cables.
In accordance with the agreement, the Company will receive funding from the
Manufacturer totaling $1,000,000. These payments were originally received upon
the completion of certain milestones set forth in the agreement. As of December
31, 1997, approximately $480,000 of cash advances had been received under the
agreement. In the fourth quarter of the year ended December 31, 1997, the
Company delivered the Product under the agreement and recognized the $480,000
as revenue. In March 1998, the agreement was amended, and the Company is to
receive the remaining payments (in addition to normal Product billings) over a
certain number of future unit shipments to the Manufacturer.
4. COMMITMENTS
The Company leases its facility and certain equipment under operating leases.
The operating lease for the Company's facility expires in 2002. Rental expense
was approximately $114,000, $542,000, and $850,000 for the years ended December
31, 1995, 1996, and 1997, respectively, and approximately $447,000 and $559,000
for the nine months ended September 30, 1997 and September 30, 1998,
respectively. The Company signed a promissory note of approximately $59,000 in
connection with the initial security deposit for the facility. The note did not
bear interest and was paid in April 1997.
In March 1996, the Company subleased its former facilities to a third party
through December 1997. Sublease rental income was approximately $106,000 and
$122,000 for the years ended December 31, 1996 and 1997, respectively, and
approximately $109,000 for the nine months ended September 30, 1997. In October
1997, the master lease and underlying sublease for these facilities were
terminated concurrently.
The Company leases certain equipment under noncancelable lease agreements
that are accounted for as capital leases. Equipment under capital lease
arrangements and included in property and equipment aggregated approximately
$452,000 at December 31, 1996 and 1997 and September 30, 1998. Related
accumulated amortization was approximately $211,000, $337,000 and $374,000 at
December 31,
F-14
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
1996 and 1997, and September 30, 1998, respectively. Amortization expense
related to assets under capital leases is included in depreciation expense. In
addition, the capital leases are secured by the related equipment, and the
Company is required to maintain liability and property damage insurance.
Future minimum lease payments under noncancelable operating leases and
capital leases are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------- ---------------------
OPERATING CAPITAL OPERATING CAPITAL
LEASES LEASES LEASES LEASES
--------- ------- ---------- --------
<S> <C> <C> <C> <C>
1998.............................. $ 610 $ 80 $ 162 $ 15
1999.............................. 666 34 666 34
2000.............................. 688 11 688 11
2001.............................. 708 4 708 4
2002.............................. 178 -- 178 --
------ ---- ---------- -------
Total minimum payments............ $2,850 129 $ 2,402 64
====== ==========
Less amount representing
interest......................... 20 9
---- -------
109 55
Less current portion.............. 65 43
---- -------
$ 44 $ 12
==== =======
</TABLE>
Unconditional Purchase Obligations
The Company has unconditional purchase obligations to a few of its suppliers
that support the Company's ability to manufacture its products. The obligations
require the Company to purchase minimum quantities of the suppliers' products
at a specified price. At September 30, 1998, the Company had approximately
$11,400,000 of unconditional purchase obligations ($784,000 at December 31,
1997 and none at December 31, 1996).
5. DEBT OBLIGATIONS
In April 1997, the Company amended an existing credit agreement with a bank
to provide for a revolving line of credit up to $10,000,000 and four term loans
totaling $4,250,000. Borrowings under the revolving line of credit are limited
to the lesser of a) 80% of accounts receivable less than ninety days from the
invoice date or b) $10,000,000. Borrowings under the revolving line of credit
bear interest at the bank's prime rate plus 0.50% per annum (8.75% at December
31, 1996 and 9.0% at December 31, 1997). There were no borrowings under the
revolving line of credit at December 31, 1996 and 1997. The revolving line of
credit was terminated in August 1998.
Each term loan is subject to an interest rate calculated at the bank's prime
rate plus 1.50% per annum (9.75% at December 31, 1996 and 10.0% at December 31,
1997). The first term loan is payable in thirty monthly payments consisting of
six interest payments and twenty-four equal principal and interest payments
through May 1998. Borrowings under the first term loan of approximately
$303,000 and $85,000 were outstanding at December 31, 1996 and 1997,
respectively (none at September 30, 1998).
F-15
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
The second term loan is payable in forty monthly payments of four interest
payments and thirty-six equal principal and interest payments through October
1999. Borrowings under the second term loan of approximately $944,000 and
$611,000, were outstanding at December 31, 1996 and 1997, respectively (none at
September 30, 1998).
The third term loan is payable according to two separate payment schedules.
The first payment schedule includes thirty-six equal principal and interest
payments through November 1999. At December 31, 1996 and 1997, borrowings under
the first payment schedule were approximately $820,000 and $539,000,
respectively (none at September 30, 1998). The second payment schedule consists
of thirty-one payments of one interest payment and thirty equal principal and
interest payments through December 1999. At December 31, 1997, borrowings under
the second payment schedule were approximately $119,000 (none at December 31,
1996 and September 30, 1998).
The fourth term loan is payable in forty-one monthly payments of five
interest payments and thirty-six equal principal and interest payments through
November 2000. Borrowings under the fourth term loan of approximately
$1,458,000 were outstanding at December 31, 1997 (none at December 31, 1996 and
September 30, 1998).
Outstanding borrowings under the credit agreement are secured by all of the
Company's assets. The credit agreement contains affirmative and negative
covenants and will, among other things, require the Company to maintain minimum
levels of investable funds and liquid assets. The credit agreement also limits
the Company's ability to incur additional debt, to pay cash dividends, or to
purchase or sell certain assets. Finally, the agreement restricts the Company
to a maximum liability to tangible net worth ratio and prohibits certain
acquisitions, mergers, consolidations, or similar transactions. At December 31,
1997, the Company was out of compliance with certain covenants contained within
the credit agreement and therefore classified all outstanding borrowings as
short-term.
In August 1998, the Company entered into a new credit agreement with a bank
to provide a line of credit in an amount up to $5,000,000 based on a
combination of eligible accounts receivable and customer purchase orders. The
new credit agreement provides for interest at a rate equal to prime (8.5% at
September 30, 1998) and matures two years from the date of the agreement. At
September 30, 1998, there were no outstanding borrowings under this agreement.
Outstanding borrowings under the new credit agreement are secured by certain
Company assets. The new credit agreement contains affirmative and negative
covenants and requires, among other things, that the Company maintain its
primary banking relationship with the bank. The new credit agreement also
limits, among other things, the Company's ability to incur additional debt, to
pay cash dividends, or to purchase or sell certain assets. Finally, the
agreement restricts the Company to a minimum tangible net worth and prohibits
certain acquisitions, mergers, consolidations, or similar transactions without
the prior consent of the bank. At September 30, 1998, the Company was compliant
with all covenants contained within the new credit agreement.
The Company incurred interest expense related to the debt obligations of
approximately $18,000, $88,000, and $205,000 for the years ended December 31,
1995, 1996, and 1997, respectively and $162,000 and $256,000 for the nine
months ended September 30, 1997 and 1998, respectively.
F-16
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
6. CONTINGENCIES
During 1997, the Company placed a noncancelable purchase order (subject to
specific delivery date requirements) with a subcontract manufacturer. As
delivery of the initial shipments was delayed by the manufacturer, the Company
subsequently canceled the purchase order without the consent of the subcontract
manufacturer. The Company has received notification from the subcontract
manufacturer that the Company is obligated to make payment for materials and
services rendered under the terms of the purchase order. While management
believes that amounts recorded on its financial statements are adequate to
cover all related risks, the subcontract manufacturer has not agreed to a
settlement with the Company. Although the ultimate outcome of this matter
cannot be determined at this time, management does not believe that the outcome
will have a material adverse effect on the Company's financial position,
results of operations, and cash flows. However, based on future developments,
the Company's estimate of the outcome of these matters could change in the near
term.
The Company has also received a letter from an individual claiming that the
Company's technology infringes a patent held by such individual. The Company
has reviewed the allegations made by such individual, and management does not
believe that the outcome will have a material adverse effect on the Company's
financial position, results of operations, or cash flows.
In the normal course of business, the Company from time to time receives
inquiries with regard to various legal proceedings. In the opinion of
management, any liability resulting from these inquiries has been accrued and
will not have a material adverse effect on the Company's financial position or
results of operations.
7. INITIAL PUBLIC OFFERING
In August 1998, the Company completed its initial public offering and issued
3,000,000 shares of its common stock to the public at a price of $13.00 per
share. The Company received net proceeds of approximately $35.1 million in
cash. Upon the closing of the offering, all of the outstanding shares of
convertible preferred stock and redeemable convertible preferred stock
outstanding were converted into an aggregate of 8,360,635 shares of common
stock.
8. REDEEMABLE STOCK
In December 1997, the Company entered into a Series E redeemable convertible
preferred stock agreement ("the Agreement"). The Agreement calls for the
establishment of a $5,000,000 escrow account to fund the issuance of up to
333,334 shares of Series E redeemable convertible preferred stock ("the Stock")
for cash at $15.00 per share. The escrow account will release cash to the
Company as the Company reaches certain technological and customer base
milestones as defined under the Agreement. Upon the first closing, the Company
is also to issue a warrant to purchase up to an additional 33,334 shares of the
Stock at $15.00 per share. In the event the final closing of the Agreement does
not occur prior to the earlier of the (a) completion of the Company's initial
public offering of shares of its common stock and (b) December 31, 1998, then
any amount remaining in the escrow account will be returned to the Series E
stockholder.
In February 1998, the Company reached a milestone under the Series E
redeemable convertible preferred stock agreement and issued 100,000 shares of
Series E redeemable convertible preferred stock,
F-17
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
resulting in cash proceeds of approximately $1,500,000 to the Company. In
conjunction with this issuance, the Company issued a warrant to the Series E
stockholder to purchase 33,334 shares of the Company's redeemable convertible
preferred stock at $15.00 per share.
In June 1998, the Company and the Series E stockholder amended the Series E
redeemable convertible preferred stock agreement (the "Amendment"). The
Amendment calls for the cancellation of all Series E redeemable convertible
preferred stock outstanding with the $1,500,000 of proceeds from the
cancellation being applied toward the issuance of 115,385 shares of Series D
redeemable convertible preferred stock. In addition, all future milestones
under the Series E redeemable convertible preferred stock agreement were
canceled under the Amendment and 269,231 additional shares of Series D
redeemable convertible preferred stock were issued resulting in additional
proceeds of approximately $3,500,000. The Amendment also cancelled the warrant
for the purchase of 33,334 shares of Series E convertible preferred stock at
$15.00 per share and issued a warrant for the purchase of 38,462 shares of
Series D convertible preferred stock with an exercise price of $13.00 per
share. The warrant is immediately exercisable and expires on the earlier of the
effective date of the Company's initial public offering or June 11, 2003. The
Company has recorded an expense of $19,000 to reflect the value of this
warrant.
The Series D redeemable convertible preferred stockholder also has the option
to sell to the Company some or all of the 384,616 redeemable shares held by the
Series D redeemable convertible preferred stockholder (the "Put Right") any
time after July 1, 1998. The price paid by the Company to the Series D
redeemable convertible preferred stockholder for any shares purchased pursuant
to the Put Right is $13.00 per share. In the event of the exercise of the Put
Right, the Company will apply the total amount of the Put Right toward the
purchase of the Company's products. Any of the redeemable shares not sold back
to the Company by the Series D redeemable convertible preferred stockholder
will retain their Put Right until the Put Termination Date which is defined
under the Agreement as the earlier of (a) February 20, 1999 and (b) the
completion of the Company's initial public offering of shares of its common
stock. In addition, in the event that prior to the Put Termination Date either
(a) the completion of the Company's initial public offering of shares of its
common stock has not occurred or (b) an acquisition of at least ninety percent
of all of the Company's capital stock has not occurred, then the Series D
redeemable convertible preferred stockholder has the right to receive a cash
payment from the Company in an amount equal to ten percent of the aggregate
purchase price of the number of redeemable shares held by the Series D
redeemable convertible preferred stockholder as of the Put Termination Date.
In June 1998, the Company issued 192,308 shares of Series F redeemable
convertible preferred stock resulting in proceeds of approximately $2,500,000
to the Company. Series F redeemable convertible preferred stock also contains
an option that allows the Series F stockholder to sell some or all of the
redeemable shares back to the Company at a price of $13.00 per share any time
after June 1, 1999 to be used toward the purchase of the Company's products.
Any of the redeemable shares not sold back to the Company by the Series F
stockholder will retain the option until the completion of the Company's
initial public offering of shares of its common stock.
In September 1997, the Company issued common stock to an employee in return
for a full recourse note receivable for $13,000. The note bears an interest
rate of 5.81% per annum and is due in September 1998. Pursuant to the stock
purchase agreement, the employee has the option to sell some or all of his
shares to the Company on or after September 22, 1998 at a purchase price of
$13.00 per share (the "Put
F-18
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
Price"). Such option expires upon the earlier of (a) September 22, 2003 and (b)
the completion of the Company's initial public offering of shares of its common
stock. The Company expensed approximately $29,000 and $88,000 for the year
ended December 31, 1997 and the nine months ended September 30, 1998,
respectively, representing the difference between the note receivable's per
share price and the Put Price over the option's vesting period. The note
receivable was paid in full in January 1998.
9. STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
Convertible Preferred Stock
In April 1998, the Company's Board of Directors approved an increase in the
authorized number of shares of convertible preferred stock to 10,399,097
shares.
In April 1998, the Company issued 384,615 shares of Series F convertible
preferred stock and a warrant to purchase 3,000,000 shares of the Company's
common stock at an exercise price of $6.50 per share, resulting in cash
proceeds of approximately $5,000,000 to the Company. The warrant is exercisable
at any time prior to December 31, 2003. In addition, the Company issued a
warrant (the "Anti-Dilution Warrant") to purchase an indeterminate number of
shares of common stock for an aggregate price of $1.00. The Anti-Dilution
Warrant is exercisable when the Company issues certain new equity securities.
The Company has issued new equity securities that require the Company to issue
an additional 19,191 shares of common stock pursuant to the Anti-Dilution
Warrant.
The Company recorded a dividend of $23,910,000 for the quarter ended June 30,
1998, representing the fair value of the warrant to purchase 3,000,000 shares
of the Company's common stock (the "Shaw Warrant") under EITF No. 96-13,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock." The Company's accounting conclusion with
respect to the Shaw Warrant issued in connection with the sale of $5,000,000 of
convertible preferred stock (the "Shaw Financing") is based on management's
conclusion that the sale of preferred stock was, in substance, a financing
transaction and not the issuance of equity instruments in exchange for goods or
services. When the Company issued $5,000,000 of convertible preferred stock and
the Shaw Warrant on April 6, 1998, its singular objective was to obtain
sufficient liquidity to continue as a going concern. At the time of the Shaw
Financing, the Company's ability to continue as a going concern was in serious
doubt. At March 31, 1998, the Company had only $109,000 in cash, but was using
cash of approximately $1,000,000, net, per month in operations; further, the
Company had a deficit in working capital of $8,769,000.
In April 1998, a $2,000,000 advance received from a Series D preferred
stockholder in 1997 was converted into 153,846 shares of Series D convertible
preferred stock (see Note 13).
In June 1998, the Company also issued 114,089 shares of Series D convertible
preferred stock resulting in additional net proceeds of approximately
$1,454,000 to the Company.
F-19
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
The following is a summary of convertible preferred stock issued and
outstanding, including redeemable convertible preferred stock at December 31,
1996 and 1997:
<TABLE>
<CAPTION>
SHARES ISSUED AND
OUTSTANDING
-------------------------
SHARES DECEMBER 31, DECEMBER 31,
SERIES AUTHORIZED 1996 1997
------ ---------- ------------ ------------
<S> <C> <C> <C>
A..................................... 4,162,093 4,162,093 4,162,093
B..................................... 896,834 896,834 896,834
B-1................................... 448,417 448,417 448,417
C..................................... 814,830 814,830 814,830
D..................................... 1,500,000 -- 808,987
E..................................... 2,000,000 -- --
F..................................... 576,923 -- --
---------- --------- ---------
10,399,097 6,322,174 7,131,161
========== ========= =========
</TABLE>
Below are the rights and preferences of the preferred stock and redeemable
preferred stock before their conversion upon the closing of the initial public
offering in August 1998.
Convertible preferred stockholders and redeemable convertible preferred
stockholders have the same voting rights as common stockholders. In addition,
the Series A, B, B-1, C, D, E and F stockholders will vote as a single class.
In the event of any voluntary or involuntary liquidation of the Company, Series
A, B, B-1, C, D, E and F stockholders are entitled to a per share liquidation
preference of $0.9545, $8.92, up to $17.84, $12.50, up to $19.50, up to $22.50,
and up to $19.50, respectively, plus accrued dividends, if any. The holders of
Series A, B, B-1, C, D, E and F stock are entitled to per share noncumulative
dividends of $0.0764, $0.7136, $0.7136, $1.00, $1.04, $1.20 and $1.04 per
annum, respectively, when and if declared by the Board of Directors.
Each share of preferred stock and redeemable preferred stock is convertible
at the option of the holder into one share of common stock, subject to
adjustments for future dilution since the date of issuance. Preferred stock and
redeemable preferred stock are convertible into common stock at a rate
calculated by the quotient obtained by dividing the conversion rates by the
conversion prices. Conversion rates for Series A, B, B-1, C, D, and F
stockholders are $0.9545, $8.92, $8.92, $12.50, $13.00 and $13.00,
respectively. Conversion prices for Series A, B, B-1, C, D, and F stockholders
are $0.9545, $8.92, $8.92, $12.50, $13.00 and $13.00, respectively. Both
conversion rates and conversion prices are subject to proportionate increases
and decreases resulting from adjustments to conversion prices for stock
dividends and for combinations or subdivisions of common stock, adjustments for
reclassification and reorganization or adjustments for the sale of shares below
the conversion prices for Series C, Series D, and Series F redeemable preferred
and preferred stockholders.
Each share of Series A, B, and B-1 preferred stock automatically converts
into common stock at the then applicable conversion rate upon the earlier of
(a) the public offering of the Company's common stock with aggregate proceeds
in excess of $10,000,000 or (b) the date on which the Company obtains the
consent of at least two-thirds of the shares of Series A, B, and B-1
stockholders separately by class. Each share of Series C preferred stock
automatically converts at the earlier of (a) the public offering of the
Company's common stock at a per share price of $12.50 (b) the end of any
twenty-day period after a public offering of the Company's common stock during
which the closing sales price per share was at
F-20
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
least $12.50, or (c) the date on which the Company obtains the consent of at
least two-thirds of the shares of Series C stockholders, as applicable. Each
share of Series D preferred and redeemable preferred stock, Series E preferred
stock, and Series F preferred and redeemable preferred stock automatically
converts at the earlier of (a) the public offering of the Company's common
stock at a per share price of $13.00 or (b) the date on which the Company
obtains the consent of at least two-thirds of the shares of Series D, E and
Series F stockholders, as applicable. The Company has fully reserved shares of
common stock for issuance upon the conversion of the convertible preferred
stock and redeemable convertible preferred stock. In June 1998, the Company
obtained waivers from the holders of more than 66 2/3% of the Series C, Series
D and Series F preferred stock, eliminating the automatic conversion price of
$12.50, $13.00 and $13.00 per share, respectively, and instituted an automatic
conversion provision of aggregate proceeds in excess of $30,000,000 from the
Company's initial public offering.
Prior to undertaking an initial public offering of its securities or
initiating a sale of 50% or more of the Company's outstanding capital stock or
substantially all of the Company's assets to a third party, the Company must
provide written notice to one of the convertible preferred shareholders. The
investor then has the right to make the first offer to purchase the Company for
a period of up to thirty days from receipt of the Company's notice.
Common Stock Warrant
In June 1998, the Company issued a warrant to purchase 50,000 shares of the
Company's common stock at $10.00 per share. The warrant expires on the earlier
of the completion of the Company's initial public offering or December 1998.
The Company recorded an expense of $35,000 to reflect the value of the warrant
in the nine months ended September 30, 1998. The warrant was exercised in
August 1998.
Common Stock Reserved
Common stock reserved for issuance is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Convertible preferred stock..................... 7,131,161 --
Redeemable convertible preferred stock.......... -- --
Common stock options............................ 2,646,880 4,848,364
Convertible preferred stock option.............. 153,846 --
Redeemable convertible preferred stock in es-
crow........................................... 333,334 --
Common stock warrants........................... -- 3,019,191
Employee stock purchase plan.................... -- 700,000
---------- ---------
10,265,221 8,567,555
========== =========
</TABLE>
Stock-Based Compensation
In March 1995 and February 1997, the Board of Directors approved a stock
option plan and an equity incentive plan, respectively, that authorized the
grant of options to purchase shares of the Company's common stock. At December
31, 1997, the total authorized number of shares under the 1995
F-21
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
and 1997 plans was 2,114,747 and 1,050,000, respectively. The plans are
administered by the Board of Directors and provide for incentive stock options
or nonqualified stock options to be issued to employees, directors, and
consultants of the Company. Prices for incentive stock options may not be less
than the fair value of the common stock at the date of grant. Prices for
nonqualified stock options may not be less than 85% of the fair value of the
common stock at the date of grant. Options are immediately exercisable and vest
over a period not to exceed five years from the date of grant. Any unvested
stock issued is subject to repurchase by the Company at the original issuance
price upon termination of the option holder's employment. Unexercised options
expire ten years after the date of grant.
In March and July 1997, the Board of Directors authorized grants of common
stock options outside the Company's stock option plans. The options are for
70,000 shares of common stock and generally vest over a three-year period in
six equal installments occurring every six months. In May and June 1998, the
Board of Directors authorized additional grants of 70,000 shares of common
stock outside the Company's stock option plans.
In June 1998, the Company's Board of Directors authorized (i) the adoption of
the amended 1997 Equity Incentive Plan, pursuant to which 2,250,000 additional
shares (plus a number of shares equal to the difference between the number of
shares remaining available for grant and the number of shares equal to 5% of
the Company's outstanding common stock at each year end) of the Company's
common stock have been reserved for future issuance to selected employees,
directors and consultants, (ii) the adoption of the 1998 Non-Employee
Directors' Stock Option Plan, pursuant to which 200,000 shares of the Company's
common stock have been reserved for future issuance to non-employee directors
of the Company, and (iii) the adoption of the 1998 Employee Stock Purchase
Plan, pursuant to which 700,000 shares of the Company's common stock have been
reserved for future issuance to eligible employees.
During the year ended December 31, 1997 and the nine months ended September
30, 1998, the Company recorded aggregate deferred compensation of approximately
$228,000 and $1,849,000, respectively, representing the difference between the
grant price and the deemed fair value of the Company's common stock options
granted during these periods. The amortization of deferred compensation is
being charged to operations and is being amortized over the vesting period of
the options, which is typically five years. For the year ended December 31,
1997 and the nine months ended September 30, 1998, the amortized expense was
approximately $12,000 and $236,000, respectively.
F-22
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
The following is a summary of additional information with respect to the 1995
Stock Option Plan, the 1997 Equity Incentive Plan, the 1998 Non-Employee
Directors' Stock Option Plan and option grants made outside the plans:
<TABLE>
<CAPTION>
OPTIONS
OUTSTANDING
AND EXERCISABLE
-------------------
WEIGHTED
OPTIONS NUMBER AVERAGE
AVAILABLE OF EXERCISE
FOR GRANT SHARES PRICE
---------- --------- --------
<S> <C> <C> <C>
Options authorized on March 8, 1995.......... 1,414,747 -- $ --
Options granted.............................. (1,630,500) 1,630,500 $0.10
Options canceled............................. 396,000 (396,000) $0.03
---------- ---------
Balance at December 31, 1995................... 180,247 1,234,500 $0.10
Options authorized........................... 700,000 -- $ --
Options granted.............................. (988,500) 988,500 $0.51
Options exercised............................ -- (106,219) $0.10
Options canceled............................. 229,831 (229,831) $0.15
---------- ---------
Balance at December 31, 1996................... 121,578 1,886,950 $0.31
Options authorized........................... 1,120,000 -- $ --
Options granted.............................. (1,304,050) 1,304,050 $1.71
Options exercised............................ -- (481,648) $0.30
Options canceled............................. 372,168 (372,168) $0.56
---------- ---------
Balance at December 31, 1997................... 309,696 2,337,184 $1.05
Options authorized (unaudited)............... 2,520,000 -- --
Options granted (unaudited).................. (1,092,487) 1,092,487 $8.15
Options exercised (unaudited)................ -- (318,516) $0.41
Options canceled (unaudited)................. 425,315 (425,315) $2.79
---------- ---------
Balance at September 30, 1998 (unaudited)...... 2,162,524 2,685,840 $3.73
========== =========
</TABLE>
The following table summarizes information about stock options that were
outstanding and exercisable at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
-------------------------------------------
WEIGHTED AVERAGE
WEIGHTED REMAINING
NUMBER OF AVERAGE EXERCISE CONTRACTUAL LIFE
RANGE OF EXERCISE PRICES SHARES PRICE (IN YEARS)
------------------------ --------- ---------------- ----------------
<S> <C> <C> <C>
$0.10 - $0.50.............. 1,167,134 $0.34 8.13
$1.25 - $1.30.............. 974,800 $1.26 9.00
$3.00 - $5.00.............. 195,250 $4.26 9.90
---------
Total.................... 2,337,184 $1.05 8.64
=========
</TABLE>
F-23
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
In addition, the following table summarizes information about stock options
that were outstanding and exercisable at September 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
-------------------------------------------
WEIGHTED AVERAGE
WEIGHTED REMAINING
NUMBER OF AVERAGE EXERCISE CONTRACTUAL LIFE
RANGE OF EXERCISE PRICES SHARES PRICE (IN YEARS)
------------------------ --------- ---------------- ----------------
<S> <C> <C> <C>
$0.10 -- $0.50............. 792,857 $ 0.39 7.49
$1.25 -- $1.30............. 767,198 $ 1.25 8.50
$3.00 -- $5.00............. 160,750 $ 4.10 9.23
$6.50 -- $10.00............ 786,658 $ 7.35 9.68
$13.00..................... 178,377 $13.00 9.87
---------
Total.................... 2,685,840 $ 3.73 8.68
=========
</TABLE>
At December 31, 1997 and September 30, 1998, 103,050 and 130,550 shares,
respectively, of common stock outstanding were subject to repurchase by the
Company. Common stock subject to repurchase represents any unvested shares of
common stock held by an option holder which, upon termination of the option
holder's employment, may be repurchased by the Company. Such shares are subject
to repurchase at their original issuance price.
The Company has elected to follow APB Opinion No. 25 and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FAS
123 requires the use of option valuation models that were not developed for use
in valuing employee stock options. Under APB Opinion No. 25, when the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net loss is required under FAS 123 and is
calculated as if the Company had accounted for its employee stock options
granted during the years ended December 31, 1995, 1996 and 1997 under the fair
value method of FAS 123. The fair value for these options was estimated at the
date of grant using the minimum value method with the following weighted
average assumptions: risk-free interest rates of 5.34%, 6.22%, and 5.75% for
1995, 1996, and 1997, respectively; no dividend yield or volatility factors of
the expected market price of the Company's common stock; and a weighted average
expected life of the option of five years.
As discussed above, the option valuation models used under FAS 123 were
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected life of the option. Because the Company's employee stock options have
characteristics significantly different from those of traded options and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
F-24
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
plans consistent with the method of FAS 123, the Company's net loss and loss
per share would have been increased to the pro forma amounts indicated below
(in thousands, except per share data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Pro forma net loss............................ $(3,669) $(10,718) $(22,627)
======= ======== ========
Pro forma basic and diluted net loss per
share........................................ $ (1.02) $ (2.64) $ (5.28)
======= ======== ========
</TABLE>
The pro forma impact of options on the net loss for the years ended December
31, 1995, 1996, and 1997 is not representative of the effects on net income
(loss) for future years, as future years will include the effects of options
vesting as well as the impact of multiple years of stock option grants. The
full effect of FAS 123 will not be fully reflected until 1999.
The options' weighted average grant date fair value, which is the value
assigned to the options under FAS 123, was $0.02, $0.11, and $0.41 for options
granted during 1995, 1996, and 1997, respectively.
Stockholders' Notes Receivable
In February 1993, the Company issued common stock to a founder in return for
a full recourse note receivable for $12,500. The note bears an interest rate of
7.04% per annum and is due in February 1998.
During June and December 1995, two officers of the Company were provided cash
advances totaling $81,133 for the purpose of purchasing the Company's Series A
preferred stock. The underlying full recourse notes were paid in August 1996
and June 1998.
In January 1998, the Company issued common stock to an employee in exchange
for a full recourse note receivable for $9,375. The note bears interest at 5.7%
and is payable in three equal annual payments commencing in January 1999.
10. INCOME TAXES
Due to operating losses and the inability to recognize the benefits
therefrom, there is no provision for income taxes for the fiscal years ended
December 31, 1995, 1996, and 1997.
F-25
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets as of December 31, 1996 and 1997 are as
follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-----------------
1996 1997
------- --------
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforwards........................ $ 4,412 $ 11,323
Tax credit carryforwards................................ 293 2,531
Capitalized research and development.................... 912 1,373
Other, net.............................................. 439 1,158
------- --------
Total deferred tax assets............................. 6,056 16,385
Valuation allowance....................................... (6,056) (16,385)
------- --------
Net deferred tax assets $ -- $ --
======= ========
</TABLE>
Realization of deferred tax assets is dependent on future earnings, if any,
the timing and the amount of which are uncertain. Accordingly, a valuation
allowance, in an amount equal to the net deferred tax asset as of December 31,
1996 and 1997, has been established to reflect these uncertainties. The change
in the valuation allowance was a net increase of approximately $1,533,000,
$4,444,000, and $10,329,000 for the years ended December 31, 1995, 1996, and
1997, respectively.
As of December 31, 1997, the Company had federal and California net operating
loss carryforwards of approximately $31,000,000 and $15,000,000, respectively.
The Company also had federal and California research and development tax credit
carryforwards of approximately $1,700,000 and $1,200,000, respectively. The net
operating loss and credit carryforwards will expire at various dates beginning
in the years 1999 through 2012, if not utilized.
Utilization of net operating loss and tax credit carryforwards may be subject
to a substantial annual limitation due to the ownership change limitations
provided by the Internal Revenue Code of 1986, as amended, and similar state
provisions. The annual limitation may result in the expiration of net operating
loss and tax credit carryforwards before full utilization.
The reconciliation of income tax expense (benefit) attributable to continuing
operations computed at the U.S. federal statutory rates to income tax expense
(benefit) for the fiscal years ended December 31, 1995, 1996, and 1997 is as
follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Tax provision (benefit) at U.S. statutory
rate........................................ $ (1,258) $ (3,638) $ (7,667)
Loss for which no tax benefit is currently
recognizable................................ 1,258 3,638 7,667
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
</TABLE>
F-26
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
11. SIGNIFICANT CUSTOMER AND GEOGRAPHIC INFORMATION
Three of the Company's customers, Telegate Ltd., Sumitomo Corporation, and
Net Brasil S.A. accounted for 30%, 29%, and 14% of revenues, respectively, for
the year ended December 31, 1997. Shaw Communications, Inc., Cablevision
Systems Corporation and Sumitomo Corporation, accounted for 32%, 19% and 14% of
revenues for the nine months ended September 30, 1998, respectively. No other
customer accounted for more than 10% of revenues during these periods.
Total net export revenues to regions outside of the United States were
approximately $1,855,000 and $13,187,000 for the year ended December 31, 1997
and the nine months ended September 30, 1998, respectively. Revenues by
geographic region were as follows (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Revenues:
United States................................... $ 263 $ 5,589
Canada.......................................... 198 6,010
Asia............................................ 617 2,830
South America................................... 326 1,039
Europe and Israel............................... 714 3,308
------ -------
Total......................................... $2,118 $18,776
====== =======
</TABLE>
12. 401(K) PROFIT SHARING PLAN AND TRUST
During 1995, the Company adopted a 401(k) Profit Sharing Plan and Trust that
allows eligible employees to make contributions subject to certain limitations.
The Company may make discretionary contributions based on profitability as
determined by the Board of Directors. No amount was contributed by the Company
to the plan during the years ended December 31, 1995, 1996, and 1997 or for the
nine months ended September 30, 1997 and 1998.
13. RELATED PARTY TRANSACTIONS
During the year ended December 31, 1997, the Company recognized revenue of
approximately $617,000 in connection with product shipments made to a Series D
preferred stockholder. In addition, during the nine months ended September 30,
1998, the Company recognized revenue of approximately $2,635,000 and $6,010,000
in connection with product shipments made to a Series D preferred stockholder,
and a Series F redeemable preferred and preferred stockholder, respectively.
Accounts receivable from the related parties totaled approximately $362,000 and
$3,057,000 at December 31, 1997 and September 30, 1998, respectively.
In September 1997, the Company received $2,000,000 from a Series D preferred
stockholder in connection with a stock option agreement. As of December 31,
1997, the Company has recorded the amount received as an advance from the
related party. The stock option agreement allows for the purchase of 153,846
shares of Series D preferred stock for the $2,000,000, on or before April 30,
1998. In April 1998, the $2,000,000 advance was converted into 153,846 shares
of Series D convertible preferred stock.
F-27
<PAGE>
TERAYON COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION PERTAINING TO SEPTEMBER 30, 1998 AND THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1997 AND 1998 IS UNAUDITED)
14. DELAWARE REINCORPORATION
In June 1998, the Company's Board of Directors authorized the reincorporation
of the Company in Delaware and an increase in the authorized number of shares
of common stock from 20,000,000 shares to 35,000,000 shares. In July 1998, the
Company's shareholders approved the reincorporation and the increase in
authorized number of shares, and the reincorporation was effective as of July
8, 1998. The par value of the preferred and common stock is $.001 per share.
Subsequent to the initial public offering, the Company's Certificate of
Incorporation will be amended to authorize 5,000,000 shares of preferred stock
which the Board of Directors has the authority to fix or alter the designation,
powers, preferences and rights of the shares of each such series and
qualifications, limitations or restrictions to any unissued series of preferred
stock. The Company's reincorporation has been reflected in the consolidated
financial statements. The change resulted in the transfer of $40,116,000 from
convertible preferred stock and $30,401,000 from common stock to additional
paid in capital.
15. SUBSEQUENT EVENT--LINE OF CREDIT
In October 1998, the Company's existing line of credit was increased to $10.0
million and the interest rate was reduced to prime.
F-28
<PAGE>
[Inside Back Cover]
Graphic consisting of a depiction of the following:
Terayon's new single-board cable modem
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
YOU MAY RELY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AU-
THORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS
PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK
MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE
OF THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF
AN OFFER TO BUY THESE SHARES OF THE COMMON STOCK IN ANY CIRCUMSTANCES UNDER
WHICH THE OFFER OR SOLICITATION IS UNLAWFUL.
----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 6
Information Regarding Forward-Looking Statements......................... 22
Use of Proceeds.......................................................... 23
Dividend Policy.......................................................... 23
Price Range of Common Stock.............................................. 23
Capitalization........................................................... 24
Dilution................................................................. 25
Selected Consolidated Financial Data..................................... 26
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 27
Business................................................................. 36
Management............................................................... 51
Certain Transactions..................................................... 61
Principal and Selling Stockholders....................................... 62
Description of Capital Stock............................................. 64
Shares Eligible for Future Sale.......................................... 66
Underwriting............................................................. 68
Legal Matters............................................................ 70
Experts.................................................................. 70
Additional Information................................................... 70
Glossary................................................................. G-1
Index to Financial Statements............................................ F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3,000,000 SHARES
[LOGO OF TERAYON COMMUNICATION SYSTEMS]
COMMON STOCK
------------
PROSPECTUS
------------
BT ALEX. BROWN
HAMBRECHT & QUIST
LEHMAN BROTHERS
SALOMON SMITH BARNEY
, 1999
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the Registrant in connection with the
sale of the shares of Common Stock being registered. All the amounts shown are
estimates except for the registration fee, the NASD filing fee and the Nasdaq
National Market listing fee.
<TABLE>
<S> <C>
Registration fee................................................... $ 28,400
NASD filing fee.................................................... 10,800
Nasdaq National Market listing fee................................. 17,500
Blue sky qualification fee and expenses............................ 5,000
Printing and engraving expenses.................................... 150,000
Legal fees and expenses............................................ 175,000
Accounting fees and expenses....................................... 175,000
Transfer agent and registrar fees.................................. 5,000
Miscellaneous...................................................... 33,300
--------
Total............................................................ $600,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
As permitted by Section 145 of the Delaware General Corporation Law, the
Bylaws of the Company provide that (i) the Company is required to indemnify its
directors and executive officers to the fullest extent permitted by the
Delaware General Corporation Law, (ii) the Company may, in its discretion,
indemnify other officers, employees and agents as set forth in the Delaware
General Corporation Law, (iii) to the fullest extent permitted by the Delaware
General Corporation Law, the Company is required to advance all expenses
incurred by its directors and executive officers in connection with a legal
proceeding (subject to certain exceptions), (iv) the rights conferred in the
Bylaws are not exclusive, (v) the Company is authorized to enter into
indemnification agreements with its directors, officers, employees and agents
and (vi) the Company may not retroactively amend the Bylaws provisions relating
to indemnity.
The Company has entered into agreements with its directors and executive
officers that require the Company to indemnify such persons against expenses,
judgments, fines, settlements and other amounts that such person becomes
legally obligated to pay (including expenses of a derivative action) in
connection with any proceeding, whether actual or threatened, to which any such
person may be made a party by reason of the fact that such person is or was a
director or officer of the Company or any of its affiliated enterprises,
provided such person acted in good faith and in a manner such person reasonably
believed to be in or not opposed to the best interests of the Company. The
indemnification agreements also set forth certain procedures that will apply in
the event of a claim for indemnification thereunder.
The Underwriting Agreement filed as Exhibit 1.1 to this Registration
Statement provides for indemnification by the Underwriters of the Registrant
and its officers and directors for certain liabilities arising under the
Securities Act of 1933, as amended (the "Securities Act"), or otherwise.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since November 30, 1995, Registrant has sold and issued the following
unregistered securities:
(1) Between November 30, 1995 and December 1995, Registrant issued and sold
110,000 shares of Series A Preferred Stock to two private investors for an
aggregate purchase price of $104,995.00.
II-1
<PAGE>
(2) In December 1995, Registrant issued and sold 896,834 shares of Series B
Preferred Stock to Cisco Systems, Inc. for an aggregate purchase price of
$7,999,759.
(3) In February 1996, Registrant issued and sold 448,417 shares of Series B-1
Preferred Stock to Sierra Ventures for an aggregate purchase price of
$3,999,880.
(4) In April 1996, Registrant issued 32,580 shares of Common Stock valued at
$16,290 to a consultant in consideration of consulting services rendered.
(5) In December 1996, Registrant issued and sold 814,830 shares of Series C
Preferred Stock to 13 private investors for an aggregate purchase price of
$10,185,375.
(6) In September 1997, Registrant issued and sold 10,000 shares of Common
Stock to an employee for an aggregate offering price of $13,000.
(7) Between September 1997 and June 1998, Registrant issued and sold 1,461,538
shares of Series D Preferred Stock to 27 private investors for an
aggregate purchase price of $18,999,994, and issued warrants to purchase
an aggregate of 38,462 shares of Series D Preferred Stock at an exercise
price of $13.00 per share.
(8) In December 1997, Registrant issued 15,716 shares of Series D Preferred
Stock valued at $204,308 to an investment bank for services rendered as
the exclusive placement agent of the sale of Series D Preferred Stock.
(9) In April 1998, Registrant issued to Shaw Communications Inc. ("Shaw") an
aggregate of 384,615 shares of Series F Preferred Stock and a warrant to
purchase 3,000,000 shares of Common Stock at an exercise price of $6.50
per share and a warrant to purchase an indeterminate amount of Common
Stock for $1.00 upon the occurrence of certain events for an aggregate
purchase price of $5,000,000. In June 1998, Registrant issued Shaw an
aggregate of 192,308 shares of Series F Preferred Stock for an aggregate
purchase price of $2,499,999.
(10) In June 1998, the Company issued a warrant to TAL Financial Corporation to
purchase 50,000 shares of Common Stock at an exercise price of $10.00 per
share.
(11) In August 1998, the Company issued 13,000 shares of Common Stock valued at
$13.00 per share to a former employee.
(12) From November 30, 1995 to December 15, 1998, Registrant granted stock
options to a total of 171 employees, directors and consultants covering an
aggregate of 3,438,037 shares of Common Stock, at exercise prices varying
from $.10 to $13.00. Of such shares, 988,563 shares have been issued and
sold pursuant to the exercise of such options. Options to purchase
1,028,991 shares of Common Stock have been cancelled or have lapsed
without being exercised or otherwise have been cancelled.
Registrant claimed exemptions under the Securities Act from registration
under the Securities Act for the sale and issuance of securities in the
transaction described in paragraphs (1) through (11) by virtue of Section 4(2),
Regulation D promulgated thereunder as transactions not involving a public
offering. The purchasers in each case represented their intention to acquire
the securities for investment only and not with a view to the distribution
thereof. Appropriate legends are affixed to the stock certificates issued in
such transactions. All recipients either received adequate information about
the Registrant or had access, through employment or other relationships, to
such information.
The sales and issuances in the transactions described in paragraph (12) above
were deemed to be exempt from registration under the Securities Act by virtue
of Rule 701 promulgated thereunder, in that they were issued pursuant to a
written compensatory benefit plan, as provided by Rule 701.
II-2
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(A) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement.
3.1 Amended and Restated Certificate of Incorporation of the
Registrant.
3.2 Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2
of the Registrant's Registration Statement on Form S-1
("Registration Statement No. 333-56911")).
4.1 Reference is made to Exhibits 3.1 through 3.3.
4.2 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.2 of Registration Statement No. 333-56911).
4.3 Amended and Restated Information and Registration Rights Agreement
dated April 6, 1998. (Incorporated by reference to Exhibit 4.3 of
Registration Statement No. 333-56911).
5.1* Opinion of Cooley Godward llp.
10.1 Form of Indemnity Agreement between the Registrant and each of its
directors and officers. (Incorporated by reference to Exhibit 10.1
of Registration Statement No. 333-56911).
10.2 1995 Stock Option Plan, as amended on March 26, 1996. (Incorporated
by reference to Exhibit 10.2 of Registration Statement No. 333-
56911).
10.3 1997 Equity Incentive Plan, as amended on June 9, 1998.
(Incorporated by reference to Exhibit 10.3 of Registration
Statement No. 333-56911).
10.4 1998 Employee Stock Purchase Plan. (Incorporated by reference to
Exhibit 10.4 of Registration Statement No. 333-56911).
10.5 1998 Non-Employee Directors Stock Option Plan. (Incorporated by
reference to Exhibit 10.5 of Registration Statement No. 333-
56911).
10.6** Supply Agreement between the Registrant and ECI Telecom Ltd. dated
March 3, 1998. (Incorporated by reference to Exhibit 10.6 of
Registration Statement No. 333-56911).
10.7** Strategic Partnership and Distributorship Agreement between the
Registrant and Sumitomo Corporation dated December 4, 1996.
(Incorporated by reference to Exhibit 10.7 of Registration
Statement No. 333-56911).
10.8** Master Agreement between the Registrant and NET Brasil S.A. dated
June 30, 1997. (Incorporated by reference to Exhibit 10.8 of
Registration Statement No. 333-56911).
10.9 Resale and License Agreement between the Registrant and Digital
Equipment Corporation dated December 9, 1996. (Incorporated by
reference to Exhibit 10.9 of Registration Statement No. 333-
56911).
10.10 Lease Agreement dated January 23, 1996 between the Registrant and
Arrillaga Family Trust and Richard T. Peery Separate Property
Trust. (Incorporated by reference to Exhibit 10.10 of Registration
Statement No. 333-56911).
10.11 Employment Agreement between the Registrant and Zaki Rakib dated
February 1993. (Incorporated by reference to Exhibit 10.11 of
Registration Statement No. 333-56911).
10.12 Employment Agreement between the Registrant and Selim Rakib dated
February 1993. (Incorporated by reference to Exhibit 10.12 of
Registration Statement No. 333-56911).
10.13 Loan and Security Agreement dated August 10, 1998 between the
Company and Silicon Valley Bank and Schedule to Loan and Security
Agreement dated August 10, 1998 between the Company and Silicon
Valley Bank (Incorporated by reference to Exhibits 10.1 and 10.2
of the Registrant's Quarterly Report on Form 10-Q
(No. 000-24647)).
10.14 Streamline Facility Agreement dated October 30, 1998 between the
Company and Silicon Valley Bank.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -------------------------------------------------------------------
<C> <S>
10.15 Product Development Agreement between the Registrant and Cisco
Systems, Inc. dated July 22, 1996. (Incorporated by reference to
Exhibit 10.14 of Registration Statement No. 333-56911).
10.16 Promissory Note and Stock Pledge Agreement between the Registrant
and Shlomo Rakib dated March 6, 1996. (Incorporated by reference
to Exhibit 10.15 of Registration Statement No. 333-56911).
10.17 Stock Repurchase Agreement between the Registrant and Zaki Rakib
dated March 16, 1995. (Incorporated by reference to Exhibit 10.16
of Registration Statement No. 333-56911).
10.18 Stock Repurchase Agreement between the Registrant and Shlomo Rakib
dated March 16, 1995. (Incorporated by reference to Exhibit 10.17
of Registration Statement No. 333-56911).
10.19 Series A Preferred Stock Purchase Agreement between the Registrant
and Lewis Solomon dated June 16, 1995. (Incorporated by reference
to Exhibit 10.18 of Registration Statement No. 333-56911).
10.20 Promissory Note between the Registrant and Lewis Solomon dated June
16, 1997. (Incorporated by reference to Exhibit 10.19 of
Registration Statement No. 333-56911).
10.21 Stock Pledge Agreement between the Registrant and Lewis Solomon
dated June 16, 1997. (Incorporated by reference to Exhibit 10.20
of Registration Statement No. 333-56911).
10.22 Anti-Dilution Warrant to Purchase Shares of Common Stock dated
April 6, 1998 issued to Shaw Communications Inc. (Incorporated by
reference to Exhibit 10.21 of Registration Statement No. 333-
56911).
21.1 List of Subsidiaries. (Incorporated by reference to Exhibit 21.1 of
Registration Statement No. 333-56911).
23.1* Consent of Cooley Godward llp (included in Exhibit 5.1).
23.2 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (reference is made to page II-6).
</TABLE>
- --------
* To be supplied by amendment.
** Confidential treatment has been granted for portions of this document. The
information omitted pursuant to such confidential treatment order has been
filed separately with the Securities and Exchange Commission.
(B) FINANCIAL STATEMENT SCHEDULES.
Schedule II--Valuation and Qualifying Accounts
Schedules not listed above are omitted because they are not required, they
are not applicable or the information is already included in the consolidated
financial statements or notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide the Underwriters at
the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers, and controlling
persons of the Registrant pursuant to the provisions described in Item 14 or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than
II-4
<PAGE>
the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in the successful defense of
any action, suit, or proceeding) is asserted by such director, officer, or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Act, the information omitted from the form
of prospectus as filed as part of the registration statement in reliance upon
Rule 430A and contained in the form of prospectus filed by the Registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be deemed to be
part of the registration statement as of the time it was declared effective,
(2) for the purpose of determining any liability under the Act, each post-
effective amendment that contains a form of prospectus shall be deemed to be a
new registration statement relating to the securities offered therein, and this
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof, and (3) to remove from registration by means of a post-
effective amendment any of the securities being registered which remain unsold
at the termination of the offering.
II-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, REGISTRANT HAS
CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE COUNTY OF SANTA CLARA, STATE OF
CALIFORNIA, ON THE 23RD DAY OF DECEMBER, 1998.
TERAYON COMMUNICATION SYSTEMS, INC.
By /s/ Dr. Zaki Rakib
----------------------------------
DR. ZAKI RAKIB
CHIEF EXECUTIVE OFFICER AND
DIRECTOR
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Dr. Zaki
Rakib and Ray M. Fritz as his true and lawful attorney-in-fact and agent, each
acting alone, with full power of substitution and resubstitution, for him and
in his name, place and stead, in any and all capacities, to sign any or all
amendments) (including post-effective amendments) to this Registration
Statement on Form S-1, and to sign any registration statement filed under Rule
462 under the Securities Act of 1933 (including post-effective amendments)
thereto, and to file the same, with all exhibits thereto, and all documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorney-in-fact and agent, full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorney-in-fact
and agent, or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.
SIGNATURES TITLE DATE
/s/ Dr. Zaki Rakib Chief Executive December 23, 1998
- ------------------------------------- Officer and
DR. ZAKI RAKIB Director (Principal
Executive Officer)
/s/ Ray M. Fritz Chief Financial December 23, 1998
- ------------------------------------- Officer (Principal
RAY M. FRITZ Accounting and
Financial Officer)
/s/ Shlomo Rakib Chairman of the December 23, 1998
- ------------------------------------- Board of Directors
SHLOMO RAKIB
/s/ Michael D'Avella Director December 23, 1998
- -------------------------------------
MICHAEL D'AVELLA
/s/ Christopher J. Schaepe Director December 23, 1998
- -------------------------------------
CHRISTOPHER J. SCHAEPE
/s/ Lewis Solomon Director December 23, 1998
- -------------------------------------
LEWIS SOLOMON
/s/ Mark Stevens Director December 23, 1998
- -------------------------------------
MARK STEVENS
II-6
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT END
PERIOD EXPENSES WRITE-OFFS OF PERIOD
------------ ---------- ---------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Allowance for doubtful
accounts:
Year ended December 31,
1995...................... $-- $ -- $-- $ --
Year ended December 13,
1996...................... $-- $ -- $-- $ --
Year ended December 31,
1997...................... $-- $ 20 $-- $ 20
Nine months ended September
30, 1998 (unaudited)...... $20 $444 $-- $464
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
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<C> <S>
1.1 Form of Underwriting Agreement.
3.1 Amended and Restated Certificate of Incorporation of the
Registrant.
3.2 Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2
of the Registrant's Registration Statement on Form S-1
("Registration Statement No. 333-56911")).
4.1 Reference is made to Exhibits 3.1 through 3.3.
4.2 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.2 of Registration Statement No. 333-56911).
4.3 Amended and Restated Information and Registration Rights Agreement
dated April 6, 1998. (Incorporated by reference to Exhibit 4.3 of
Registration Statement No. 333-56911).
5.1* Opinion of Cooley Godward llp.
10.1 Form of Indemnity Agreement between the Registrant and each of its
directors and officers. (Incorporated by reference to Exhibit 10.1
of Registration Statement No. 333-56911).
10.2 1995 Stock Option Plan, as amended on March 26, 1996. (Incorporated
by reference to Exhibit 10.2 of Registration Statement No. 333-
56911).
10.3 1997 Equity Incentive Plan, as amended on June 9, 1998.
(Incorporated by reference to Exhibit 10.3 of Registration
Statement No. 333-56911).
10.4 1998 Employee Stock Purchase Plan. (Incorporated by reference to
Exhibit 10.4 of Registration Statement No. 333-56911).
10.5 1998 Non-Employee Directors Stock Option Plan. (Incorporated by
reference to Exhibit 10.5 of Registration Statement No. 333-
56911).
10.6** Supply Agreement between the Registrant and ECI Telecom Ltd. dated
March 3, 1998. (Incorporated by reference to Exhibit 10.6 of
Registration Statement No. 333-56911).
10.7** Strategic Partnership and Distributorship Agreement between the
Registrant and Sumitomo Corporation dated December 4, 1996.
(Incorporated by reference to Exhibit 10.7 of Registration
Statement No. 333-56911).
10.8** Master Agreement between the Registrant and NET Brasil S.A. dated
June 30, 1997. (Incorporated by reference to Exhibit 10.8 of
Registration Statement No. 333-56911).
10.9 Resale and License Agreement between the Registrant and Digital
Equipment Corporation dated December 9, 1996. (Incorporated by
reference to Exhibit 10.9 of Registration Statement No. 333-
56911).
10.10 Lease Agreement dated January 23, 1996 between the Registrant and
Arrillaga Family Trust and Richard T. Peery Separate Property
Trust. (Incorporated by reference to Exhibit 10.10 of Registration
Statement No. 333-56911).
10.11 Employment Agreement between the Registrant and Zaki Rakib dated
February 1993. (Incorporated by reference to Exhibit 10.11 of
Registration Statement No. 333-56911).
10.12 Employment Agreement between the Registrant and Selim Rakib dated
February 1993. (Incorporated by reference to Exhibit 10.12 of
Registration Statement No. 333-56911).
10.13 Loan and Security Agreement dated August 10, 1998 between the
Company and Silicon Valley Bank and Schedule to Loan and Security
Agreement dated August 10, 1998 between the Company and Silicon
Valley Bank (Incorporated by reference to Exhibits 10.1 and 10.2
of the Registrant's Quarterly Report on Form 10-Q
(No. 000-24647)).
10.14 Streamline Facility Agreement dated October 30, 1998 between the
Company and Silicon Valley Bank.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
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<C> <S>
10.15 Product Development Agreement between the Registrant and Cisco
Systems, Inc. dated July 22, 1996. (Incorporated by reference to
Exhibit 10.14 of Registration Statement No. 333-56911).
10.16 Promissory Note and Stock Pledge Agreement between the Registrant
and Shlomo Rakib dated March 6, 1996. (Incorporated by reference
to Exhibit 10.15 of Registration Statement No. 333-56911).
10.17 Stock Repurchase Agreement between the Registrant and Zaki Rakib
dated March 16, 1995. (Incorporated by reference to Exhibit 10.16
of Registration Statement No. 333-56911).
10.18 Stock Repurchase Agreement between the Registrant and Shlomo Rakib
dated March 16, 1995. (Incorporated by reference to Exhibit 10.17
of Registration Statement No. 333-56911).
10.19 Series A Preferred Stock Purchase Agreement between the Registrant
and Lewis Solomon dated June 16, 1995. (Incorporated by reference
to Exhibit 10.18 of Registration Statement No. 333-56911).
10.20 Promissory Note between the Registrant and Lewis Solomon dated June
16, 1997. (Incorporated by reference to Exhibit 10.19 of
Registration Statement No. 333-56911).
10.21 Stock Pledge Agreement between the Registrant and Lewis Solomon
dated June 16, 1997. (Incorporated by reference to Exhibit 10.20
of Registration Statement No. 333-56911).
10.22 Anti-Dilution Warrant to Purchase Shares of Common Stock dated
April 6, 1998 issued to Shaw Communications Inc. (Incorporated by
reference to Exhibit 10.21 of Registration Statement No. 333-
56911).
21.1 List of Subsidiaries. (Incorporated by reference to Exhibit 21.1 of
Registration Statement No. 333-56911).
23.1* Consent of Cooley Godward llp (included in Exhibit 5.1).
23.2 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (reference is made to page II-6).
</TABLE>
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* To be supplied by amendment.
** Confidential treatment has been granted for portions of this document. The
information omitted pursuant to such confidential treatment order has been
filed separately with the Securities and Exchange Commission.
<PAGE>
EXHIBIT 1.1
3,000,000 SHARES
TERAYON COMMUNICATION SYSTEMS, INC.
COMMON STOCK
($0.001 PAR VALUE)
UNDERWRITING AGREEMENT
----------------------
January ___, 1999
BT Alex. Brown Incorporated
Hambrecht & Quist LLC
Lehman Brothers Inc.
Salomon Smith Barney Inc.
As Representatives of the Several Underwriters
c/o BT Alex. Brown Incorporated
135 East Baltimore Street
Baltimore, Maryland 21202
Gentlemen:
Terayon Communication Systems, Inc., a Delaware corporation (the "Company")
and certain shareholders of the Company (the "Selling Shareholders"), propose to
sell to the several underwriters (the "Underwriters") named in Schedule I hereto
for whom you are acting as representatives (the "Representatives") an aggregate
of 3,000,000 shares of the Company's Common Stock, $0.001 par value (the "Firm
Shares"), of which 1,750,000 shares will be sold by the Company and 1,250,000
shares will be sold by Selling Shareholders. The respective amounts of the Firm
Shares to be so purchased by the several Underwriters are set forth opposite
their names in Schedule I hereto, and the respective amounts to be sold by the
Selling Shareholders are set forth opposite their names in Schedule II hereto.
The Company and the Selling Shareholders are sometimes referred to herein
collectively as the "Sellers." The Company and certain Selling Shareholders
also propose to sell at the Underwriters' option an aggregate of up to 450,000
additional shares of the Company's Common Stock (the "Option Shares") as set
forth below.
As the Representatives, you have advised the Company and the Selling
Shareholders (a) that you are authorized to enter into this Agreement on behalf
of the several Underwriters and (b) that the several Underwriters are willing,
acting severally and not jointly, to purchase the numbers of Firm
<PAGE>
Shares set forth opposite their respective names in Schedule I, plus their pro
rata portion of the Option Shares if you elect to exercise the over-allotment
option in whole or in part for the accounts of the several Underwriters. The
Firm Shares and the Option Shares (to the extent the aforementioned option is
exercised) are herein collectively called the "Shares."
In consideration of the mutual agreements contained herein and of the
interests of the parties in the transactions contemplated hereby, the parties
hereto agree as follows:
1. Representations and Warranties of the Company and Selling
---------------------------------------------------------
Shareholders.
------------
(a) The Company represents and warrants to each of the Underwriters as
follows:
(i) A registration statement on Form S-1 (File No. 333-_____)
with respect to the Shares has been prepared by the Company in conformity with
the requirements of the Securities Act of 1933, as amended (the "Act"), and the
Rules and Regulations (the "Rules and Regulations") of the Securities and
Exchange Commission (the "Commission") thereunder and has been filed with the
Commission. Copies of such registration statement, including any amendments
thereto, the preliminary prospectuses (meeting the requirements of the Rules and
Regulations) contained therein and the exhibits, financial statements and
schedules, as finally amended and revised, have heretofore been delivered by the
Company to you. Such registration statement, together with any registration
statement filed by the Company pursuant to Rule 462 (b) of the Act, herein
referred to as the "Registration Statement," which shall be deemed to include
all information omitted therefrom in reliance upon Rule 430A and contained in
the Prospectus referred to below, has become effective under the Act and no
post-effective amendment to the Registration Statement has been filed as of the
date of this Agreement. "Prospectus" means (i) the form of prospectus first
filed with the Commission pursuant to Rule 424(b) or (ii) the last preliminary
prospectus included in the Registration Statement filed prior to the time it
becomes effective or filed pursuant to Rule 424(a) under the Act that is
delivered by the Company to the Underwriters for delivery to purchasers of the
Shares, together with the term sheet or abbreviated term sheet filed with the
Commission pursuant to Rule 424(b)(7) under the Act. Each preliminary prospectus
included in the Registration Statement prior to the time it becomes effective is
herein referred to as a "Preliminary Prospectus." Any reference herein to the
Registration Statement, any Preliminary Prospectus or to the Prospectus shall be
deemed to refer to and include any supplements or amendments to any Prospectus
filed with the Commission after the date of filing of the Prospectus under Rules
424(b) or 430A and prior to the termination of the offering of the Shares by the
Underwriters.
(ii) The Company has been duly organized and is validly existing
as a corporation in good standing under the laws of the State of Delaware, with
corporate power and authority to own or lease its properties and conduct its
business as described in the Registration Statement. Each of the subsidiaries
of the Company as listed in Exhibit 21.1 to Item 16(a) of the Registration
Statement (collectively, the "Subsidiaries") has been duly organized and is
validly existing as a corporation or limited liability company, as applicable,
in good standing under the laws of the jurisdiction of its incorporation, with
corporate power and authority to lease its properties and
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<PAGE>
conduct its business as described in the Registration Statement. The
Subsidiaries are the only subsidiaries, direct or indirect, of the Company. The
Company and each of the Subsidiaries are duly qualified to transact business in
all jurisdictions in which the conduct of their business requires such
qualification, except where the failure to so qualify would not have a material
adverse effect on the earnings, business, management, properties, assets,
rights, prospects, results of operations or condition (financial or otherwise)
of the Company and its Subsidiaries, taken as a whole (a "Material Adverse
Effect"). All of the outstanding shares of capital stock of each of the
Subsidiaries have been duly authorized and validly issued and are fully paid and
non-assessable. The shares of capital stock of the Subsidiaries held by the
Company are owned by the Company free and clear of all liens, encumbrances,
equities and claims; and, to the Company's knowledge, no options, warrants or
other rights to purchase, agreements or other obligations to issue or other
rights to convert any obligations into shares of capital stock or ownership
interest in the Subsidiaries are outstanding.
(iii) The outstanding shares of Common Stock of the Company,
including all shares to be sold by the Selling Shareholders have been duly
authorized and validly issued and are fully paid and non-assessable and have
been issued in compliance with all applicable securities laws; the portion of
the Shares to be issued and sold by the Company has been duly authorized and
when issued and paid for as contemplated herein will be validly issued, fully
paid and non-assessable; and no preemptive rights of stockholders, or other
rights to subscribe to, exist with respect to any of the Shares or the issue and
sale thereof. Neither the filing of the Registration Statement nor the offering
or sale of the Shares as contemplated by this Agreement gives rise to any
rights, other than those which have been waived or satisfied, for or relating to
the registration of any shares of Common Stock. Cisco Systems, Inc., a
stockholder of the Company, has received the notice required pursuant to its
right of first offer to acquire the Company upon a public offering of the
Company and has not responded in writing within the required time period in
order to exercise such right.
(iv) The information set forth under the caption
"Capitalization" in the Prospectus is true and correct. All of the Shares
conform to the description thereof contained in the Registration Statement. The
form of certificates for the Shares conforms to the Delaware General Corporate
Law.
(v) The Commission has not issued an order preventing or
suspending the use of any Prospectus relating to the proposed offering of the
Shares nor instituted proceedings for that purpose. The Registration Statement
contains, and the Prospectus and any amendments or supplements thereto will
contain, all statements which are required to be stated therein by, and will
conform, to the requirements of the Act and the Rules and Regulations. The
Registration Statement and any amendment thereto did not and will not as of the
applicable effective date, contain any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary to
make the statements therein not misleading. The Prospectus and any amendments
and supplements thereto did not and will not, as of the date thereof, contain
any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
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<PAGE>
provided, however, that the Company makes no representations or warranties as to
information contained in or omitted from the Registration Statement or the
Prospectus, or any such amendment or supplement, in reliance upon, and in
conformity with, written information furnished to the Company by or on behalf of
any Underwriter through the Representatives, specifically for use in the
preparation thereof.
(vi) The consolidated financial statements of the Company,
together with related notes and schedules as set forth in the Registration
Statement, present fairly the financial position and the results of operations
and cash flows of the Company and the Subsidiaries, at the indicated dates and
for the indicated periods. Such financial statements and related schedules have
been prepared in accordance with generally accepted principles of accounting,
consistently applied throughout the periods involved, except as disclosed
herein, and all adjustments necessary for a fair presentation of results for
such periods have been made. The summary financial and statistical data
included in the Registration Statement present fairly the information shown
therein and such data have been compiled on a basis consistent with the
financial statements presented therein and the books and records of the Company.
The pro forma financial information included in the Registration Statement and
the Prospectus present fairly the information shown therein, have been prepared
in accordance with the Commission's rules and guidelines with respect to pro
forma financial statements, have been properly compiled on the pro forma bases
described therein, and, in the opinion of the Company, the assumptions used in
the preparation thereof are reasonable and the adjustments used therein are
appropriate to give effect to the transactions or circumstances referred to
therein.
(vii) Ernst & Young LLP, who have certified certain of the
financial statements filed with the Commission as part of the Registration
Statement, have advised the Company that they are independent public accountants
as required by the Act and the Rules and Regulations.
(viii) There is no action, suit, claim or proceeding pending or,
to the knowledge of the Company, threatened against the Company or any of the
Subsidiaries before any court or administrative agency or otherwise (i) which if
determined adversely to the Company or any of its Subsidiaries would have a
Material Adverse Effect or (ii) to prevent the consummation of the transactions
contemplated hereby, except as set forth in the Registration Statement.
(ix) The Company and the Subsidiaries have good and marketable
title to all of the properties and assets reflected in the financial statements
(or as described in the Registration Statement) hereinabove described, subject
to no lien, mortgage, pledge, charge or encumbrance of any kind except those
reflected in such financial statements (or as described in the Registration
Statement) or which are not material in amount. The Company and the
Subsidiaries occupy their leased properties under valid and binding leases
conforming in all material respects to the description thereof set forth in the
Registration Statement.
(x) The Company and the Subsidiaries have filed all federal,
state, local and foreign income tax returns which have been required to be filed
and have paid all taxes indicated
-4-
<PAGE>
by said returns and all assessments received by them or any of them to the
extent that such taxes have become due. All tax liabilities have been adequately
provided for in the consolidated financial statements of the Company, and the
Company does not know of any actual or proposed additional tax assessments.
(xi) Since the respective dates as of which information is given
in the Registration Statement, and except as disclosed in the Prospectus, there
has not been any Material Adverse Effect or any development that could
reasonably be expected to have a Material Adverse Effect, and there has not been
any material transaction entered into by the Company or the Subsidiaries, other
than transactions in the ordinary course of business. The Company and the
Subsidiaries have no material contingent obligations which are not disclosed in
the Company's consolidated financial statements included in the Registration
Statement.
(xii) Except as disclosed in the Prospectus, neither the Company
nor any of the Subsidiaries is or with the giving of notice or lapse of time or
both, will be, in violation of or in default under its charter or bylaws or
under any agreement, lease, contract, indenture or other instrument or
obligation to which it is a party or by which it, or any of its properties, is
bound and which violation or default would have a Material Adverse Effect. The
execution and delivery of this Agreement and the consummation of the
transactions herein contemplated and the fulfillment of the terms hereof will
not conflict with or result in a breach of any of the terms or provisions of, or
constitute a default under, any indenture, mortgage, deed of trust or other
agreement or instrument to which the Company or any Subsidiary is a party, or of
the charter or bylaws of the Company or any Subsidiary or any rule or regulation
applicable to the Company or any Subsidiary or any order of which the Company is
aware of any court or of any regulatory body or administrative agency or other
governmental body.
(xiii) Each approval, consent, order, authorization, designation,
declaration or filing by or with any regulatory, administrative or other
governmental body necessary in connection with the execution and delivery by the
Company of this Agreement and the consummation of the transactions herein
contemplated (except such additional steps as may be required by the Commission,
the National Association of Securities Dealers, Inc. (the "NASD") or such
additional steps as may be necessary to qualify the Shares for public offering
by the Underwriters under state securities or Blue Sky laws) has been obtained
or made and is in full force and effect. Except for the Shares, none of the
offerings by the Company of its securities before or during the Offering is part
of the Offering or part of a single plan of financing together with the
Offering.
(xiv) The Company and each of the Subsidiaries hold all material
licenses, certificates and permits from governmental authorities which are
necessary to the conduct of their respective businesses. Except as specifically
disclosed in the Prospectus, the Company and each of the Subsidiaries owns or
possesses adequate rights to use all trademarks, trade names, patents, patent
rights, mask works, copyrights, licenses, approvals and governmental
authorizations currently used in its business as now conducted and, to the
Company's knowledge, as proposed to be conducted;
-5-
<PAGE>
and, to the Company's knowledge, neither the Company nor any of the Subsidiaries
has infringed any trademark, trade name, patent, patent right, mask work,
copyright, license, trade secret or other similar right of others, and, except
as disclosed in the Prospectus, no written claim has been made against the
Company or any of the Subsidiaries regarding trademark, trade name, patent, mask
work, copyright, license, trade secret or other infringement which could have a
Material Adverse Effect. The Company knows of no material infringement by others
of any trademark, trade name, patent, patent right, mask work, copyright,
license, trade secret or other similar right owned by or licensed to the
Company.
(xv) The Company has not taken and will not take, directly or
indirectly, any action designed to or which might reasonably be expected to
cause or result in the stabilization or manipulation of the price of the shares
of Common Stock to facilitate the sale or resale of the Shares and the Company,
without investigation, is not aware of any such action by any of its affiliates.
The Company acknowledges that the Underwriters may engage in passive market
making transactions in the Shares on The NASDAQ Stock Market in accordance with
Rule 10b-6A under the Exchange Act.
(xvi) Neither the Company nor any Subsidiary is an "investment
company" within the meaning of such term under the Investment Company Act of
1940 and the rules and regulations of the Commission thereunder.
(xvii) The Company maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions are
executed in accordance with management's general or specific authorization; (ii)
transactions are recorded as necessary to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
maintain accountability for assets; (iii) access to assets is permitted only in
accordance with management's general or specific authorization; and (iv) the
recorded accountability for assets is compared with existing assets at
reasonable intervals and appropriate action is taken with respect to any
differences.
(xviii) The Company and each of its Subsidiaries carry, or are
covered by, insurance in such amounts and covering such risks as the Company
reasonably believes to be adequate for the conduct of their respective
businesses and the value of their respective properties and as the Company
reasonably believes to be customary for companies engaged in similar industries.
(xix) The Company is in compliance in all material respects with
all presently applicable provisions of the Employee Retirement Income Security
Act of 1974, as amended, including the regulations and published interpretations
thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred
with respect to any "pension plan" (as defined in ERISA) for which the Company
would have any liability; the Company has not incurred and does not expect to
incur liability under (i) Title IV of ERISA with respect to termination of, or
withdrawal from, any "pension plan" or (ii) Sections 412 or 4971 of the Internal
Revenue Code of 1986, as
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<PAGE>
amended, including the regulations and published interpretations thereunder (the
"Code"); and each "pension plan" for which the Company would have any liability
that is intended to be qualified under Section 401(a) of the Code is so
qualified in all material respects and nothing has occurred, whether by action
or by failure to act, which would cause the loss of such qualification.
(xx) The Company confirms as of the date hereof that it is in
compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198,
An Act Relating to Disclosure of Doing Business with Cuba.
- ---------------------------------------------------------
(xxi) Except as disclosed to the Underwriters, the Company is
not (nor did it permit any of its officers, directors, agents, representatives
or affiliates to) directly or indirectly, other than as described in the
Prospectus, taking any of the following actions: (A) solicit, entertain,
encourage, initiate or participate in any proposals, or conduct discussions with
or engage in negotiations, relating to, (B) provide information with respect to
it relating to, or otherwise cooperate with, facilitate or encourage any effort
or attempt with regard to, (C) enter into an agreement providing for, or (D)
make or authorize any statement, recommendation or solicitation in support of,
any possible acquisition of Company or any of the Subsidiaries (whether by
merger, purchase of assets, tender offer or otherwise), or any material portion
of its or their capital stock or assets or any equity interest in the Company or
any of the Subsidiaries.
(xxii) To the best of Company's knowledge, no labor disturbance
by the employees of the Company or any of the Subsidiaries exists or is
imminent. No collective bargaining agreement exists with any of the Company's
employees and, to the best of the Company's knowledge, no such agreement is
imminent.
(xxiii) The Common Stock has been approved for quotation on The
Nasdaq National Market, subject to official notice of issuance.
(xxiv) Neither the Company nor any of the Subsidiaries has at any
time during the last four (4) years (A) made any unlawful contribution to any
candidate for foreign office or failed to disclose fully any contribution in
violation of law, or (B) made any payment to any federal or state governmental
officer or official, or other person charged with similar public or quasi-public
duties, other than payments required or permitted by the laws of the United
States or any jurisdiction thereof.
(xxv) (A) Each of the Company and its Subsidiaries is in
compliance with all rules, laws and regulations relating to the use, treatment,
storage and disposal of toxic substances and protection of health or the
environment ("Environmental Laws") which are applicable to its respective
business, (B) neither the Company nor any of its Subsidiaries has received
notice from any governmental authority or third party of an asserted claim under
Environmental Laws, which claim is required to be disclosed in the Registration
Statement and the Prospectus and is not so disclosed, (C) to the Company's
knowledge, neither the Company nor any of its Subsidiaries will be required to
make future material capital expenditures to comply with existing Environmental
Laws,
-7-
<PAGE>
and (D) to the Company's knowledge, no property which is leased or occupied by
the Company or any of its Subsidiaries has been designated as a Superfund site
pursuant to the Comprehensive Response, Compensation, and Liability Act of 1980,
as amended (42 U.S.C. (S) 9601, et seq.), or otherwise designated as a
------
contaminated site under applicable state or local law.
(xxvi) There are no outstanding loans, advances (except normal
advances for business expenses in the ordinary course of business) or guarantees
of indebtedness by the Company or any of its Subsidiaries to or for the benefit
of any of the officers or directors of the Company or any of its Subsidiaries or
any of the members of the families of any of them, except as disclosed in the
Registration Statement and the Prospectus.
(b) Each of the Selling Shareholders severally represents and warrants
as follows:
(i) Such Selling Shareholder now has and at the Closing Date
and the Option Closing Date, as the case may be (as such dates are hereinafter
defined) will have good and marketable title to the Firm Shares and the Option
Shares to be sold by such Selling Shareholder, free and clear of any liens,
encumbrances, equities and claims, and full right, power and authority to effect
the sale and delivery of such Firm Shares and Option Shares; and upon the
delivery of, against payment for, such Firm Shares and Option Shares pursuant to
this Agreement, the Underwriters will acquire good and marketable title thereto,
free and clear of any liens, encumbrances, equities and claims.
(ii) Such Selling Shareholder has full right, power and
authority to execute and deliver this Agreement, the Power of Attorney, and the
Custodian Agreement referred to below and to perform its obligations under such
Agreements. The execution and delivery of this Agreement and the consummation by
such Selling Shareholder of the transactions herein contemplated and the
fulfillment by such Selling Shareholder of the terms hereof will not require any
consent, approval, authorization, or other order of any court, regulatory body,
administrative agency or other governmental body (except as may be required
under the Act, state securities laws or Blue Sky laws) and will not result in a
breach of any of the terms and provisions of, or constitute a default under,
organizational documents of such Selling Shareholder, if not an individual, or
any indenture, mortgage, deed of trust or other agreement or instrument to which
such Selling Shareholder is a party, or of any order, rule or regulation
applicable to such Selling Shareholder of any court or of any regulatory body or
administrative agency or other governmental body having jurisdiction.
(iii) Such Selling Shareholder has not taken and will not take,
directly or indirectly, any action designed to, or which has constituted, or
which might reasonably be expected to cause or result in the stabilization or
manipulation of the price of the Common Stock of the Company and, other than as
permitted by the Act, the Selling Shareholder will not distribute any prospectus
or other offering material in connection with the offering of the Shares.
(iv) Without having undertaken to determine independently the
accuracy or completeness of either the representations and warranties of the
Company contained herein or the
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<PAGE>
information contained in the Registration Statement, such Selling Shareholder
has no reason to believe that the representations and warranties of the Company
contained in this Section 1 are not true and correct, is familiar with the
Registration Statement and has no knowledge of any material fact, condition or
information not disclosed in the Registration Statement which has adversely
affected or may adversely affect the business of the Company or any of the
Subsidiaries; and the sale of the Firm Shares and the Option Shares by such
Selling Shareholder pursuant hereto is not prompted by any information
concerning the Company or any of the Subsidiaries which is not set forth in the
Registration Statement or the documents incorporated by reference therein. The
information pertaining to such Selling Shareholder under the caption "Selling
Shareholders" in the Prospectus is complete and accurate in all material
respects.
2. Purchase, Sale and Delivery of the Firm Shares.
----------------------------------------------
(a) On the basis of the representations, warranties and covenants
herein contained, and subject to the conditions herein set forth, the Sellers
agree to sell to the Underwriters and each Underwriter agrees, severally and not
jointly, to purchase, at a price of $_____ per share, the number of Firm Shares
set forth opposite the name of each Underwriter in Schedule I hereof, subject to
adjustments in accordance with Section 9 hereof. The number of Firm Shares to
be purchased by each Underwriter from each Seller shall be as nearly as
practicable in the same proportion to the total number of Firm Shares being sold
by each Seller as the number of Firm Shares being purchased by each Underwriter
bears to the total number of Firm Shares to be sold hereunder. The obligations
of the Company and of each of the Selling Shareholders shall be several and not
joint.
(b) Certificates in negotiable form for the total number of the Shares
to be sold hereunder by the Selling Shareholders have been placed in custody
with Boston Equiserre as custodian (the "Custodian") pursuant to the Custodian
Agreement executed by each Selling Shareholder for delivery of all Firm Shares
and any Option Shares to be sold hereunder by the Selling Shareholders. Each of
the Selling Shareholders specifically agrees that the Firm Shares and any Option
Shares represented by the certificates held in custody for the Selling
Shareholders under the Custodian Agreement are subject to the interests of the
Underwriters hereunder, that the arrangements made by the Selling Shareholders
for such custody are to that extent irrevocable, and that the obligations of the
Selling Shareholders hereunder shall not be terminable by any act or deed of the
Selling Shareholders (or by any other person, firm or corporation including the
Company, the Custodian or the Underwriters) or by operation of law (including
the death of an individual Selling Shareholder or the dissolution of a corporate
Selling Shareholder) or by the occurrence of any other event or events, except
as set forth in the Custodian Agreement. If any such event should occur prior
to the delivery to the Underwriters of the Firm Shares or the Option Shares
hereunder, certificates for the Firm Shares or the Option Shares, as the case
may be, shall be delivered by the Custodian in accordance with the terms and
conditions of this Agreement as if such event has not occurred. The Custodian
is authorized to receive and acknowledge receipt of the proceeds of sale of the
Shares held by it against delivery of such Shares.
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(c) Payment for the Firm Shares to be sold hereunder is to be made in
by wire transfer of immediately available funds to an account specified in
writing by the Company for the Firm Shares to be sold by it and to an account
designated by the custodian for the Firm Shares to be sold by the Selling
Shareholders, against delivery of certificates therefor to the Representatives
for the several accounts of the Underwriters. Such payment and delivery are to
be made through the facilities of the Depository Trust Company, New York, New
York, at 10:00 a.m., Baltimore time, (i) on the third business day after the
date of this Agreement, (ii) if this Agreement is executed and delivered after
4:30 p.m. Eastern time, on the fourth business day after the date of this
Agreement or (iii) at such other time and date not later than five business days
thereafter as you and the Company shall agree upon, such time and date being
herein referred to as the "Closing Date." (As used herein, "business day" means
a day on which the New York Stock Exchange is open for trading and on which
banks in New York are open for business and are not permitted by law or
executive order to be closed.) The certificates for the Firm Shares will be
delivered in such denominations and in such registrations as the Representatives
request in writing not later than the second full business day prior to the
Closing Date, and will be made available for inspection by the Representatives
at least one business day prior to the Closing Date.
(d) In addition, on the basis of the representations and warranties
herein contained and subject to the terms and conditions herein set forth, the
Company and certain Selling Shareholders listed on Schedule III hereto hereby
grant an option to the several Underwriters to purchase the Option Shares at the
price per share as set forth in the first paragraph of this Section 2. The
maximum number of Option Shares to be sold by the Company and the Selling
Shareholders is set forth opposite their respective names on Schedule III
hereto. The option granted hereby may be exercised in whole or in part by
giving written notice (i) at any time before the Closing Date and (ii) only once
thereafter within 30 days after the date of this Agreement, by you, as
Representatives of the several Underwriters, to the Company, the Attorney-in-
Fact, and the Custodian, setting forth the number of Option Shares as to which
the several Underwriters are exercising the option, the names and denominations
in which the Option Shares are to be registered and the time and date at which
such certificates are to be delivered. If the option granted hereby is
exercised in part, the respective number of Option Shares to be sold by the
Company and each of the Selling Shareholders listed in Schedule III hereto shall
be determined on a pro rata basis in accordance with the percentages set forth
opposite their names on Schedule II hereto, adjusted by you in such manner as to
avoid fractional shares. The time and date at which certificates for Option
Shares are to be delivered shall be determined by the Representatives but shall
not be earlier than three nor later than 10 full business days after the
exercise of such option, nor in any event prior to the Closing Date (such time
and date being herein referred to as the "Option Closing Date"). If the date of
exercise of the option is two or more business days before the Closing Date, the
notice of exercise shall set the Closing Date as the Option Closing Date. The
number of Option Shares to be purchased by each Underwriter shall be in the same
proportion to the total number of Option Shares being purchased as the number of
Firm Shares being purchased by such Underwriter bears to the total number of
Firm Shares being purchased, adjusted by you in such manner as to avoid
fractional shares. The option with respect to the Option Shares granted
hereunder may be exercised only to cover over-allotments in the sale of the Firm
Shares by the Underwriters. You, as Representatives of the several
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Underwriters, may cancel such option at any time prior to its expiration by
giving written notice of such cancellation to the Company. To the extent, if
any, that the option is exercised, payment for the Option Shares shall be made
on the Option Closing Date by wire transfer of immediately available funds to an
account specified in writing by the Company for the Option Shares to be sold by
it and to an account designated by the Custodian for Option Shares to be sold by
the Selling Shareholders against delivery of certificates therefor through the
facilities of the Depository Trust Company, New York, New York.
(e) If on the Closing Date or Option Closing Date, as the case may be,
any Selling Shareholder fails to sell the Firm Shares or Option Shares which
such Selling Shareholder has agreed to sell on such date as set forth in
Schedule II or Schedule III hereto, the Company agrees that it will sell or
arrange for the sale of that number of shares of Common Stock to the
Underwriters which represents Firm Shares or the Option Shares which such
Selling Shareholder has failed to so sell, as set forth in Schedule II or
Schedule III hereto, or such lesser number as may be requested by the
Representatives.
3. Offering by the Underwriters.
----------------------------
It is understood that the several Underwriters are to make a public
offering of the Firm Shares as soon as the Representatives deem it advisable to
do so. The Firm Shares are to be initially offered to the public at the initial
public offering price set forth in the Prospectus. The Representatives may from
time to time thereafter change the public offering price and other selling
terms. To the extent, if at all, that any Option Shares are purchased pursuant
to Section 2 hereof, the Underwriters will offer them to the public on the
foregoing terms.
It is further understood that you will act as the Representatives for
the Underwriters in the offering and sale of the Shares in accordance with a
Master Agreement Among Underwriters entered into by you and the several other
Underwriters.
4. Covenants of the Company and the Selling Shareholders.
-----------------------------------------------------
(a) The Company covenants and agrees with the several Underwriters
that:
(i) The Company will (A) use its best efforts to cause the
Registration Statement to become effective or, if the procedure in Rule 430A of
the Rules and Regulations is followed, to prepare and timely file with the
Commission under Rule 424(b) of the Rules and Regulations a Prospectus in a form
approved by the Representatives containing information previously omitted at the
time of effectiveness of the Registration Statement in reliance on Rule 430A of
the Rules and Regulations, (B) not file any amendment to the Registration
Statement or supplement to the Prospectus of which the Representatives shall not
previously have been advised and furnished with a copy or to which the
Representatives shall have reasonably objected in writing or which is not in
compliance with the Rules and Regulations and (C) file on a timely basis all
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reports and statements required to be filed by the Company with the Commission
subsequent to the date of the Prospectus and prior to the termination of the
offering of the Shares by the Underwriters.
(ii) The Company will advise the Representatives promptly (A)
when the Registration Statement or any post-effective amendment thereto shall
have become effective, (B) of any request of the Commission for amendment of the
Registration Statement or for supplement to the Prospectus or for any additional
information, and (C) of the issuance by the Commission of any stop order
suspending the effectiveness of the Registration Statement or the use of the
Prospectus or of the institution of any proceedings for that purpose. In the
event of the issuance of any stop order preventing or suspending the use of the
Prospectus, the Company will use its best efforts to obtain as soon as possible
the lifting thereof.
(iii) The Company will cooperate with the Representatives in
endeavoring to qualify the Shares for sale under the securities laws of such
jurisdictions as the Representatives may reasonably have designated in writing
and will make such applications, file such documents, and furnish such
information as may be reasonably required for that purpose, provided the Company
shall not be required to qualify as a foreign corporation or to file a general
consent to service of process in any jurisdiction where it is not now so
qualified or required to file such a consent. The Company will, from time to
time, prepare and file such statements, reports, and other documents, as are or
may be required to continue such qualifications in effect for so long a period
as the Representatives may reasonably request for distribution of the Shares.
(iv) The Company will deliver to, or upon the order of, the
Representatives, from time to time, as many copies of any Preliminary Prospectus
as the Representatives may reasonably request. The Company will deliver to, or
upon the order of, the Representatives during the period when delivery of a
Prospectus is required under the Act, as many copies of the Prospectus in final
form, or as thereafter amended or supplemented, as the Representatives may
reasonably request. The Company will deliver to the Representatives at or
before the Closing Date, four conformed copies of the Registration Statement and
all amendments thereto including all exhibits filed therewith, and will deliver
to the Representatives such additional number of copies of the Registration
Statement (including such number of copies of the exhibits filed therewith that
may reasonably be requested), and of all amendments thereto, as the
Representatives may reasonably request.
(v) The Company will comply with the Act and the Rules and
Regulations, and the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and the rules and regulations of the Commission thereunder, so as to
permit the completion of the distribution of the Shares as contemplated in this
Agreement and the Prospectus. If during the period in which a prospectus is
required by law to be delivered by an Underwriter or dealer, any event shall
occur as a result of which, in the judgment of the Company or in the reasonable
opinion of the Underwriters, it becomes necessary to amend or supplement the
Prospectus in order to make the statements therein, in the light of the
circumstances existing at the time the Prospectus is delivered to a purchaser,
not misleading, or, if it is necessary at any time to amend or supplement the
Prospectus
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to comply with any law, the Company promptly will prepare and file with the
Commission an appropriate amendment to the Registration Statement or supplement
to the Prospectus so that the Prospectus as so amended or supplemented will not,
in the light of the circumstances when it is so delivered, be misleading, or so
that the Prospectus will comply with the law.
(vi) The Company will make generally available to its
stockholders, as soon as it is practicable to do so, but in any event not later
than 15 months after the effective date of the Registration Statement, an
earnings statement (which need not be audited) in reasonable detail, covering a
period of at least 12 consecutive months beginning after the effective date of
the Registration Statement, which earnings statement shall satisfy the
requirements of Section 11(a) of the Act and Rule 158 of the Rules and
Regulations and will advise you in writing when such statement has been so made
available.
(vii) The Company will, for a period of five years from the
Closing Date, deliver to the Representatives copies of annual reports and copies
of all other documents, reports and information furnished by the Company to its
stockholders or filed with any securities exchange pursuant to the requirements
of such exchange or with the Commission pursuant to the Act or the Exchange Act.
The Company will deliver to the Representatives similar reports with respect to
significant subsidiaries, as that term is defined in the Rules and Regulations,
which are not consolidated in the Company's financial statements.
(viii) No offering, sale, short sale or other disposition of any
shares of Common Stock of the Company or other securities convertible into or
exchangeable or exercisable for shares of Common Stock or derivative of Common
Stock (or agreement for such) will be made for a period of 90 days after the
date of this Agreement, directly or indirectly, by the Company except with the
prior written consent of BT Alex. Brown Incorporated. The foregoing sentence
shall not apply to (A) the Shares to be sold to the Underwriters pursuant to
this Agreement, (B) shares of Common Stock issued by the Company upon the
exercise of options granted under the stock option plans of the Company (the
"Option Plans") or upon the exercise of warrants outstanding as of the date
hereof, (C) options to purchase Common Stock granted under the Option Plans and
(D) shares of Common Stock or options or warrants to purchase Common Stock
issued or granted in connection with equipment lease financing arrangements,
credit agreements or other commercial transactions or corporate strategic
partner transactions approved by the Company's Board of Directors.
(ix) Each officer and director (and entities affiliated with
directors) of the Company, and each Selling Shareholder and beneficial owner of
more than __% of the Company's Common Stock has agreed not to offer, sell, sell
short or otherwise dispose of any shares of Common Stock of the Company or other
capital stock of the Company, or any other securities convertible, exchangeable
or exercisable for Common Shares or derivative of Common Shares owned by such
person (or as to which such person has the right to direct the disposition of)
for a period of 90 days after the date of this Agreement, directly or
indirectly, except with the prior written consent of the Company or BT Alex.
Brown Incorporated ("Lockup Agreements").
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<PAGE>
(x) The Company shall apply the net proceeds of its sale of
the Shares as set forth in the Prospectus and shall file such reports with the
Commission with respect to the sale of the Shares and the application of the
proceeds therefrom as may be required in accordance with Rule 463 under the Act.
(xi) The Company shall not invest, or otherwise use the proceeds
received by the Company from its sale of the Shares in such a manner as would
require the Company or any of the Subsidiaries to register as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act").
(xii) The Company will maintain a transfer agent and, if
necessary under the jurisdiction of incorporation of the Company, a registrar
for the Common Stock.
(b) Each of the Selling Shareholders covenants and agrees with the
several Underwriters that:
(i) No offering, sale, short sale or other disposition of any
shares of Common Stock of the Company or other capital stock of the Company or
other securities convertible, exchangeable or exercisable for Common Stock or
derivative of Common Stock owned by the Selling Shareholder or request the
registration for the offer or sale of any of the foregoing (or as to which the
Selling Shareholder has the right to direct the disposition of) will be made for
a period of 90 days after the date of this Agreement, directly or indirectly, by
such Selling Shareholder otherwise than hereunder or with the prior written
consent of Alex. Brown & Sons Incorporated.
(ii) In order to document the Underwriters' compliance with the
reporting and withholding provisions of the Tax Equity and Fiscal Responsibility
Act of 1982 and the Interest and Dividend Tax Compliance Act of 1983 with
respect to the transactions herein contemplated, each of the Selling
Shareholders agrees to deliver to you prior to or at the Closing Date a properly
completed and executed United States Treasury Department Form W-8 or W-9 (or
other applicable form or statement specified by Treasury Department regulations
in lieu thereof).
(iii) Such Selling Shareholder will not take, directly or
indirectly, any action designed to cause or result in, or that has constituted
or might reasonably be expected to constitute, the stabilization or manipulation
of the price of any securities of the Company.
5. Costs and Expenses.
------------------
The Company will pay all costs, expenses and fees incident to the
performance of the obligations of the Sellers under this Agreement, including,
without limiting the generality of the foregoing, the following: accounting
fees of the Company; the fees and disbursements of counsel for the Company; the
cost of printing and delivering to, or as requested by, the Underwriters copies
of the Registration Statement, Preliminary Prospectuses, the Prospectus, this
Agreement, the Underwriters' Selling Memorandum, the Underwriters' Invitation
Letter, the Listing Application, the
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Blue Sky Survey and any supplements or amendments thereto; the filing fees of
the Commission; the filing fees and reasonable expenses (including legal fees
and disbursements) incident to securing any required review by the National
Association of Securities Dealers, Inc. (the "NASD") of the terms of the sale of
the Shares, not to exceed $6,000; the listing fee of the Nasdaq National Market;
and the expenses, including the fees and disbursements of counsel for the
Underwriters, incurred in connection with the qualification of the Shares under
state securities or Blue Sky laws. The Selling Shareholders have agreed with the
Company to reimburse the Company for a portion of such expenses. To the extent,
if at all, that any of the Selling Shareholders engage special legal counsel to
represent them in connection with this offering, the fees and expenses of such
counsel shall be borne by such Selling Shareholder, unless otherwise agreed
between the Company and such Selling Shareholder. Any transfer taxes imposed on
the sale of the Shares to the several Underwriters will be paid by the Sellers
pro rata. The Company agrees to pay all costs and expenses of the Underwriters,
including the reasonable fees and disbursements of counsel for the Underwriters,
incident to the offer and sale of directed shares of the Common Stock by the
Underwriters to employees and persons having business relationships with the
Company and its Subsidiaries, not to exceed $20,000. The Sellers shall not,
however, be required to pay for any of the Underwriters' expenses (other than
those related to qualification under NASD regulation and state securities or
Blue Sky laws) except that, if this Agreement shall not be consummated because
the conditions in Section 6 hereof are not satisfied, or because this Agreement
is terminated by the Representatives pursuant to Section 11 hereof, or by reason
of any failure, refusal or inability on the part of the Company or the Selling
Shareholders to perform any undertaking or satisfy any condition of this
Agreement or to comply with any of the terms hereof on their part to be
performed, unless such failure to satisfy said condition or to comply with said
terms be due to the default or omission of any Underwriter, then the Company
shall reimburse the several Underwriters for reasonable out-of-pocket expenses,
including fees and disbursements of counsel, reasonably incurred in connection
with investigating, marketing and proposing to market the Shares or in
contemplation of performing their obligations hereunder; but the Company and the
Selling Shareholders shall not in any event be liable to any of the several
Underwriters for damages on account of loss of anticipated profits from the sale
by them of the Shares.
6. Conditions of Obligations of the Underwriters.
---------------------------------------------
The several obligations of the Underwriters to purchase the Firm
Shares on the Closing Date and the Option Shares, if any, on the Option Closing
Date are subject to the accuracy, as of the Closing Date or the Option Closing
Date, as the case may be, of the representations and warranties of the Company
and the Selling Shareholders contained herein, and to the performance by the
Company and the Selling Shareholders of their covenants and obligations
hereunder and to the following additional conditions:
(a) The Registration Statement shall have become effective and any and
all filings required by Rule 424 and Rule 430A of the Rules and Regulations
shall have been made, and any request of the Commission for additional
information (to be included in the Registration Statement or otherwise) shall
have been disclosed to the Representatives and complied with to their reasonable
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satisfaction. No stop order suspending the effectiveness of the Registration
Statement, as amended from time to time, shall have been issued and no
proceedings for that purpose shall have been taken or threatened by the
Commission and no injunction, restraining order, or order of any nature by a
federal or state court of competent jurisdiction shall have been issued as of
the Closing Date which would reasonably be expected to prevent the issuance of
the Shares.
(b) The Representatives shall have received on the Closing Date or the
Option Closing Date, as the case may be, the opinion of Cooley Godward LLP,
counsel for the Company, dated the Closing Date or the Option Closing Date, as
the case may be, addressed to the Underwriters to the effect that:
(i) The Company has been duly organized and is validly
existing as a corporation in good standing under the laws of the State of
Delaware, with corporate power and authority to own or lease its properties and
conduct its business as described in the Registration Statement; to the best of
such counsel's knowledge, the Company is duly qualified to transact business in
all jurisdictions in which the conduct of its business requires such
qualification, except where the failure to so qualify would have a Material
Adverse Effect;
(ii) [Intentionally omitted.]
(iii) The Company had authorized and outstanding capital stock as
set forth under the caption "Capitalization" in the Prospectus as of the date
set forth therein; the authorized shares of the Company's Common Stock,
including the Shares to be sold by the Selling Shareholders have been duly
authorized; the outstanding shares of the Company's Common Stock have been duly
authorized and validly issued and are fully paid and non-assessable; all of the
Shares conform to the description thereof contained in the Prospectus under the
caption "Description of Capital Stock"; the certificates for the Shares in the
form filed as Exhibit 4.2 to the Registration Statement with the Commission, are
in due and proper form under Delaware law; the Firm Shares and the Option
Shares, if any, to be sold by the Company pursuant to this Agreement have been
duly authorized and will be validly issued, fully paid and non-assessable when
issued and paid for as contemplated by this Agreement; and to such counsel's
knowledge, no preemptive rights of stockholders exist with respect to any of the
Shares or the issue or sale thereof.
(iv) Except as described in or contemplated by the Prospectus,
to the knowledge of such counsel, (a) there are no outstanding securities of the
Company convertible or exchangeable into or evidencing the right to purchase or
subscribe for any shares of capital stock of the Company and (b) there are no
outstanding or authorized options, warrants or rights obligating the Company to
issue any shares of its capital stock or any securities convertible or
exchangeable into or evidencing the right to purchase or subscribe for any
shares of such stock; and except as described in the Prospectus, to the
knowledge of such counsel, no holder of any securities of the Company or any
other person has the right, which has not been satisfied or effectively waived,
to cause the Company to sell or otherwise issue to them, or to permit such
person to underwrite the sale of, any of the Shares or the right to have any
Common Shares or other securities of the Company included in the
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Registration Statement or the right, as a result of the filing of the
Registration Statement, to require registration under the Act of any shares of
Common Stock or other securities of the Company.
(v) The Registration Statement has become effective under the
Act and, to the best of the knowledge of such counsel, no stop order proceedings
with respect thereto have been instituted or are pending or threatened under the
Act.
(vi) The Registration Statement and the Prospectus comply as to
form in all material respects with the requirements of the Act and the
applicable rules and regulations thereunder (except that such counsel need
express no opinion as to the financial statements and schedules, related notes,
other financial data and statistical data derived therefrom included in the
Registration Statement and Prospectus).
(vii) The statements under the captions "Management -- Limitation
on Directors' and Officers' Liability," "Management -- Employee Benefit Plans,"
"Certain Transactions," "Description of Capital Stock," and "Shares Eligible for
Future Sale" in the Prospectus, insofar as such statements constitute a summary
of documents referred to therein or matters of law, summarize the information
called for with respect to such documents and matters to the extent required by
the Act and the Rules and Regulations.
(viii) Such counsel does not know of any contracts or documents
required to be filed as exhibits to the Registration Statement or described in
the Registration Statement or the Prospectus which are no so filed or described
as required, and such contracts and documents as are summarized in the
Registration Statement or the Prospectus are summarized to the extent required
by the Act and the Rules and Regulations.
(ix) Such counsel knows of no legal or governmental proceedings
pending or threatened against the Company or any of the Subsidiaries required
under the Act and the Rules and Regulations to be described in the Prospectus,
except as set forth in the Prospectus.
(x) The execution and delivery of this Agreement and the
consummation of the transactions herein contemplated do not and will not
conflict with or result in a breach of any of the terms or provisions of, or
constitute a default under, the Certificate of Incorporation or Bylaws of the
Company, or any agreement or instrument to which the Company or any of the
Subsidiaries is a party or by which the Company or any of the Subsidiaries may
be bound that was filed as an exhibit to the Registration Statement.
(xi) This Agreement has been duly authorized, executed and
delivered by the Company.
(xii) No approval, consent, order, authorization, designation,
declaration or filing by or with any regulatory, administrative or other
governmental body is necessary in connection with the execution and delivery
of this Agreement and the consummation of the transactions
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herein contemplated (other than as may be required by the NASD or as required by
State securities and Blue Sky laws as to which such counsel need express no
opinion) except such as have been obtained or made, specifying the same.
(xiii) The Company is not, and will not become, as a result of the
consummation of the transactions contemplated by this Agreement, and application
of the net proceeds therefrom as described in the Prospectus, required to
register as an investment company under the 1940 Act.
(xiv) This Agreement has been duly authorized, executed and
delivered on behalf of the Selling Shareholders.
(xv) Each Selling Shareholder has full legal right, power and
authority, and any approval required by law (other than as required by State
securities and Blue Sky laws as to which such counsel need express no opinion),
to sell, assign, transfer and deliver the portion of the Shares to be sold by
such Selling Shareholder.
(xvi) The Custodian Agreement and the Power of Attorney executed
and delivered by each Selling Shareholder is valid and binding.
(xvii) The Underwriters (assuming that they are bona fide
purchasers within the meaning of the Uniform Commercial Code) have acquired good
and marketable title to the Shares being sold by each Selling Shareholder on the
Closing Date, and the Option Closing Date, as the case may be, free and clear of
all liens, encumbrances, equities and claims.
In rendering such opinion, Cooley Godward LLP may rely as to matters
governed by the laws of states other than California, the corporate laws of
Delaware or federal securities laws on local counsel in such jurisdictions and
as to the matters set forth in subparagraphs (xiv), (xv), (xvi) and (xvii) on
opinions of other counsel representing the respective Selling Shareholders,
provided that in each case Cooley Godward LLP, shall state that they believe
that they and the Underwriters are justified in relying on such other counsel.
In addition to the matters set forth above, such opinion shall also state that
nothing has come to the attention of such counsel which leads them to believe
that (i) the Registration Statement, at the time it became effective under the
Act (but after giving effect to any modifications incorporated therein pursuant
to Rule 430A under the Act), contained an untrue statement of a material fact or
omitted to state a material fact required to be stated therein or necessary to
make the statements therein not misleading, and (ii) the Prospectus, on the date
it was filed pursuant to the Rules and Regulations and as of the Closing Date or
the Option Closing Date, as the case may be, contained an untrue statement of a
material fact or omitted to state a material fact necessary in order to make the
statements, in the light of the circumstances under which they are made, not
misleading (except that such counsel need express no view as to financial
statements and schedules, related notes, other financial data and statistical
data derived therefrom). With respect to such statement, check and
verification, Cooley Godward LLP may state that their belief is based upon the
procedures set forth therein, but is without independent check and verification.
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(c) The Underwriters shall have received on the Closing Date an
opinion of Falk & Fish, LLP, dated the Closing Date, with respect to certain
intellectual property matters, to the effect that:
(i) As to the patent applications such counsel has filed, the
Company owns all patent applications and patents which have issued therefrom
although the corporate name change has left the assignments from the inventors
to the Company by its prior name, described in the Registration Statement and
Prospectus as being owned by it or necessary for the conduct of its business,
and such counsel is not aware of any claim to the contrary or any challenge by
any other person to the rights of ownership in the Company with respect to the
foregoing.
(ii) Such counsel is not aware of any legal actions, claims or
proceedings pending or threatened against the Company alleging that the Company
is infringing or otherwise violating any patents or trade secrets owned by
others other than those identified in the Registration Statement and the
Prospectus.
(iii) Based upon a review of certain third party patent rights
owned by Unisys and not asserted by them but made known to such counsel, a
formal interpretation of the claims and discussions with scientific personnel of
the Company regarding application of the properly interpreted claims to the
technology of the Company, such counsel does not believe any claim of this
patent would be found in a correctly decided patent litigation to be infringed
by the activities of the Company in the manufacture, use or sale of any product
of the Company, the technologies employed by the Company or the method of their
use in any product of the Company, each as described in the Registration
Statement and Prospectus and as such are related to the Company's technologies
and products. Such counsel have been made aware of another pair of patents
owned by Scientific Atlanta which have not been asserted by them and which
relate to cable modem technology. Based upon some preliminary studies of the
prosecution history and discussions with company technical personnel, such
counsel believes there is no infringement of these patents. However, such
counsel has not as yet had time to do a formal claim interpretation and
infringement analysis, so such counsel has no final opinion on this matter.
(iv) Such counsel has reviewed the patent applications filed by
the Company and prepared by us, such applications have been properly prepared
and filed, are being diligently pursued by the Company, and the inventions
described in such applications are owned by the Company.
(v) Such counsel has reviewed the statements under the
captions "Risk Factors -- We May Not Be Able to Adequately Protect or Enforce
Our Intellectual Property Rights" and "Business--Intellectual Property" in the
Registration Statement and Prospectus, and, to the extent they constitute
matters of law or legal conclusions, these descriptions appear to be accurate
and fairly and completely present the intellectual property situation of the
Company with respect to patents that have actually been asserted or as to which
infringement has been claimed.
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(vi) Such counsel is aware of nothing that causes such counsel
to believe that, as of the date that the Registration Statement became effective
and as of the date of such opinion, the statements under the captions "Risk
Factors--We May Not be Able to Adequately Protect or Enforce Our Intellectual
Property Rights" and "Business--Intellectual Property" in the Registration
Statement and Prospectus contained or contains any untrue statement of a
material fact (other than understating the number of patent applications now
pending - there are now 7 pending U.S. patent applications and one PCT
application which has not yet entered the national stage, but if it does and if
the Company files in all the countries in which they filed a prior application,
there will be 14 pending foreign applications in January 1999 - there are
currently 7 pending foreign applications) or omitted or omits to state a
material fact necessary to make the statements made therein, in light of the
circumstances under which they were made, not misleading, (except that no
mention is made of the unasserted patents the situations of which have been
described above - if those facts are deemed material). There is never absolute
certainty about the validity, enforceability or infringement of a patent, and
the Registration Statement does a good job of accurately reflecting this
uncertainty. There are always challenges to the validity and/or enforceability
of patents in patent litigation and neither the Registration Statement nor this
opinion can possibly anticipate what they will be if litigation occurs.
(d) The Representatives shall have received from Wilson Sonsini
Goodrich & Rosati, P.C., counsel for the Underwriters, an opinion dated the
Closing Date or the Option Closing Date, as the case may be, substantially to
the effect specified in subparagraphs (v) and (vi) of Paragraph (b) of this
Section 6, and that the Company is a duly organized and validly existing
corporation under the laws of the State of Delaware. In addition to the matters
set forth above, such opinion shall also include a statement to the effect that
nothing has come to the attention of such counsel which leads them to believe
that (i) the Registration Statement at the time it became effective under the
Act (but after giving effect to any modifications incorporated therein pursuant
to Rule 430A under the Act) contained an untrue statement of a material fact or
omitted to state a material fact required to be stated therein or necessary to
make the statements therein not misleading, and (ii) the Prospectus on the date
it was filed pursuant to the Rules and Regulations and as of the Closing Date or
the Option Closing Date, as the case may be, contained an untrue statement of a
material fact or omitted to state a material fact, necessary in order to make
the statements, in the light of the circumstances under which they are made, not
misleading (except that such counsel need express no view as to financial
statements, related notes, schedules and other financial information or
statistical data derived therefrom therein). With respect to such statement,
Wilson Sonsini Goodrich & Rosati, P.C. may state that their belief is based upon
the procedures set forth therein, but is without independent check and
verification.
(e) The Representatives shall have received at or prior to the Closing
Date from Wilson Sonsini Goodrich & Rosati, P.C., a memorandum or summary, in
form and substance satisfactory to the Representatives, with respect to the
qualification for offering and sale by the Underwriters of the Shares under the
State securities or Blue Sky laws of such jurisdictions as the Representatives
may reasonably have designated to the Company.
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<PAGE>
(f) You shall have received, on each of the dates hereof, the Closing
Date and the Option Closing Date, as the case may be, a letter dated the date
hereof, the Closing Date or the Option Closing Date, as the case may be, in form
and substance satisfactory to you, of Ernst & Young LLP confirming that they are
independent public accountants within the meaning of the Act and the applicable
published Rules and Regulations thereunder and stating that in their opinion the
financial statements and schedules examined by them and included in the
Registration Statement comply in form in all material respects with the
applicable accounting requirements of the Act and the related published Rules
and Regulations; and containing such other statements and information as is
ordinarily included in accountants' "comfort letters" to Underwriters with
respect to the financial statements and certain financial and statistical
information contained in the Registration Statement and Prospectus.
(g) The Representatives shall have received on the Closing Date or the
Option Closing Date, as the case may be, a certificate or certificates of the
Chief Executive Officer and the Chief Financial Officer of the Company to the
effect that, as of the Closing Date or the Option Closing Date, as the case may
be, each of them severally represents as follows:
(i) The Registration Statement has become effective under the
Act and, to his knowledge, no stop order suspending the effectiveness of the
Registration Statement has been issued, and no proceedings for such purpose have
been taken or are, to his knowledge, contemplated by the Commission;
(ii) The representations and warranties of the Company contained
in Section 1 hereof are true and correct as of the Closing Date or the Option
Closing Date, as the case may be;
(iii) He has examined the Registration Statement and the
Prospectus and, in his opinion, as of the effective date of the Registration
Statement, the statements contained in the Registration Statement were true and
correct, and such Registration Statement and Prospectus did not omit to state a
material fact required to be stated therein or necessary in order to make the
statements therein not misleading, and since the effective date of the
Registration Statement, no event has occurred which should have been set forth
in a supplement to or an amendment of the Prospectus which has not been so set
forth in such supplement or amendment; and
(iv) Since the respective dates as of which information is given
in the Registration Statement and Prospectus, and except as disclosed therein,
there has not been any Material Adverse Effect or any development that could
reasonably be expected to have a Material Adverse Effect.
(h) The Representatives shall have received a certificate, dated as of
the Closing Date or Option Closing Date, as the case may be, signed by or on
behalf of each of the Selling Shareholders to the effect that the
representations and warranties of such Selling Shareholder in this Agreement are
true and correct, as if made at and as of such Closing Date or Option Closing
Date, as the case may be, and such Selling Shareholder has complied with all the
agreements and satisfied all
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<PAGE>
the conditions on his or its part to be performed or satisfied prior to such
Closing Date or Option Closing Date, as the case may be.
(i) The Company and the Selling Shareholders shall have furnished to
the Representatives such further certificates and documents confirming the
representations and warranties, covenants and conditions contained herein and
related matters as the Representatives may reasonably have requested.
(j) The Firm Shares and Option Shares, if any, shall have been
approved for listing on the Nasdaq National Market, subject to official notice
of issuance.
(k) The Lockup Agreements described in Section 4(a)(ix) shall be in
full force and effect as of the Closing Date.
The opinions and certificates mentioned in this Agreement shall be
deemed to be in compliance with the provisions hereof only if they are in all
material respects satisfactory to the Representatives and to Wilson Sonsini
Goodrich & Rosati, P.C., counsel for the Underwriters.
If any of the conditions hereinabove provided for in this Section 6
shall not have been fulfilled when and as required by this Agreement to be
fulfilled, the obligations of the Underwriters hereunder may be terminated by
the Representatives by notifying the Company and the Selling Shareholders of
such termination in writing or by telegram at or prior to the Closing Date or
the Option Closing Date, as the case may be.
In such event, the Selling Shareholders, the Company and the
Underwriters shall not be under any obligation to each other (except to the
extent provided in Sections 5 and 8 hereof).
7. Conditions of the Obligations of the Sellers.
--------------------------------------------
The obligations of the Sellers to sell and deliver the portion of the
Shares required to be delivered as and when specified in this Agreement are
subject to the conditions that at the Closing Date or the Option Closing Date,
as the case may be, no stop order suspending the effectiveness of the
Registration Statement shall have been issued and in effect or proceedings
therefor initiated or threatened.
8. Indemnification.
---------------
(a) The Company agrees to indemnify and hold harmless each Underwriter
and each person, if any, who controls any Underwriter within the meaning of the
Act, against any losses, claims, damages or liabilities to which such
Underwriter or any such controlling person may become subject under the Act or
otherwise, insofar as such losses, claims, damages or liabilities (or actions or
proceedings in respect thereof) arise out of or are based upon (i) any untrue
statement or alleged untrue statement of any material fact contained in the
Registration Statement or any amendment or
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<PAGE>
supplement thereto or the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading or (ii) any untrue statement or alleged untrue statement
of a material fact contained in the Preliminary Prospectus, the Prospectus or
any amendment or supplement thereto or the omission or alleged omission to state
therein any material fact required to be stated therein or necessary to make the
statements therein not misleading in light of the circumstances under which they
were made; and will reimburse each Underwriter and each such controlling person
upon demand for any legal or other expenses reasonably incurred by such
Underwriter or such controlling person in connection with investigating or
defending any such loss, claim, damage or liability, action or proceeding or in
responding to a subpoena or governmental inquiry related to the offering of the
Shares, whether or not such Underwriter or controlling person is a party to any
action or proceeding; provided, however, that the Company will not be liable in
any such case to the extent that any such loss, claim, damage or liability
arises out of or is based upon an untrue statement or alleged untrue statement,
or omission or alleged omission made in the Registration Statement, any
Preliminary Prospectus, the Prospectus or such amendment or supplement, in
reliance upon and in conformity with written information furnished to the
Company by or through the Representatives specifically for use in the
preparation thereof. This indemnity agreement will be in addition to any
liability which the Company may otherwise have.
(b) The Selling Shareholders agree to indemnify the Underwriters and
each person, if any, who controls any Underwriter within the meaning of the Act,
against any losses, claims, damages or liabilities to which such Underwriter or
controlling person may become subject under the Act or otherwise to the same
extent as indemnity is provided by the Company pursuant to Section 8(a) above.
In no event, however, shall the liability of any Selling Shareholder for
indemnification under this Section 8(a) exceed the proceeds received by such
Selling Shareholder from the Underwriters in the offering. This indemnity
obligation will be in addition to any liability which the Company may otherwise
have.
(c) Each Underwriter severally and not jointly will indemnify and hold
harmless the Company, each of its directors, each of its officers who have
signed the Registration Statement, the Selling Shareholders, and each person, if
any, who controls the Company or the Selling Shareholders within the meaning of
the Act, against any losses, claims, damages or liabilities to which the Company
or any such director, officer, Selling Shareholder or controlling person may
become subject under the Act or otherwise, insofar as such losses, claims,
damages or liabilities (or actions or proceedings in respect thereof) arise out
of or are based upon (i) any untrue statement or alleged untrue statement of any
material fact contained in the Registration Statement or any amendment or
supplement thereto or the omission or the alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading or (ii) any untrue statement or alleged untrue statement
of a material fact contained in the Preliminary Prospectus, the Prospectus or
any amendment or supplement thereto or the omission or alleged omission to state
therein any material fact required to be stated therein or necessary to make the
statements therein not misleading in light of the circumstances under which they
were made and will reimburse any legal or other expenses reasonably incurred by
the Company or any such director, officer, Selling Shareholder or controlling
person in connection with investigating or defending any
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<PAGE>
such loss, claim, damage, liability, action or proceeding; provided, however,
that each Underwriter will be liable in each case to the extent, but only to the
extent, that such untrue statement or alleged untrue statement or omission or
alleged omission has been made in the Registration Statement, any Preliminary
Prospectus, the Prospectus or such amendment or supplement, in reliance upon and
in conformity with written information furnished to the Company by or through
the Representatives specifically for use in the preparation thereof. This
indemnity agreement will be in addition to any liability which such Underwriter
may otherwise have.
(d) In case any proceeding (including any governmental investigation)
shall be instituted involving any person in respect of which indemnity may be
sought pursuant to this Section 8, such person (the "indemnified party") shall
promptly notify the person against whom such indemnity may be sought (the
"indemnifying party") in writing. No indemnification provided for in Section
8(a), (b) or (c) shall be available to any party who shall fail to give notice
as provided in this Section 8(d) if the party to whom notice was not given was
unaware of the proceeding to which such notice would have related and was
materially prejudiced by the failure to give such notice, but the failure to
give such notice shall not relieve the indemnifying party or parties from any
liability which it or they may have to the indemnified party for contribution or
otherwise than on account of the pro visions of Section 8(a), (b) or (c). In
case any such proceeding shall be brought against any indemnified party and it
shall notify the indemnifying party of the commencement thereof, the
indemnifying party shall be entitled to participate therein and, to the extent
that it shall wish, jointly with any other indemnifying party similarly
notified, to assume the defense thereof, with counsel reasonably satisfactory
to such indemnified party and the indemnifying party shall pay as incurred the
fees and disbursements of such counsel related to such proceeding. In any
such proceeding, any indemnified party shall have the right to retain its own
counsel at its own expense. Notwithstanding the fore going, the indemnifying
party shall pay as incurred (or within 30 days of presentation) the fees and
expenses of the counsel retained by the indemnified party in the event (i) the
indemnifying party and the indemnified party shall have mutually agreed to the
retention of such counsel, (ii) the named parties to any such proceeding
(including any impleaded parties) include both the indemnifying party and the
indemnified party and representation of both parties by the same counsel would
be inappropriate due to actual or potential differing interests between them
or (iii) the indemnifying party shall have failed to assume the defense and
employ counsel acceptable to the indemnified party within a reasonable period of
time after notice of commencement of the action. It is understood that the
indemnifying party shall not, in connection with any proceeding or related
proceedings in the same jurisdiction, be liable for the reasonable fees and
expenses of more than one separate firm for all such indemnified parties. Such
firm shall be designated in writing by you in the case of parties indemnified
pursuant to Section 8(a) or (b) and by the Company and the Selling Shareholders
in the case of parties indemnified pursuant to Section 8(c). The indemnifying
party shall not be liable for any settlement of any proceeding effected without
its written consent but if settled with such consent or if there be a final
judgment for the plaintiff, the indemnifying party agrees to indemnify the
indemnified party from and against any loss or liability by reason of such
settlement or judgment. In addition, the indemnifying party will not, without
the prior written consent of the indemnified party, settle or compromise or
consent to the entry of any judgment in any pending or threatened claim, action
or proceeding of which indemnification may be sought hereunder (whether or not
any
-24-
<PAGE>
indemnified party is an actual or potential party to such claim, action or
proceeding) unless such settlement, compromise or consent includes an
unconditional release of each indemnified party from all liability arising out
of such claim, action or proceeding.
(e) If the indemnification provided for in this Section 8 is
unavailable to or insufficient to hold harmless an indemnified party under
Section 8(a), (b) or (c) above in respect of any losses, claims, damages or
liabilities (or actions or proceedings in respect thereof) referred to therein,
then each indemnifying party shall contribute to the amount paid or payable by
such indemnified party as a result of such losses, claims, damages or
liabilities (or actions or proceedings in respect thereof) in such proportion as
is appropriate to reflect the relative benefits received by the indemnifying
party or parties on the one hand and the indemnified party or parties on the
other from the offering of the Shares. If, however, the allocation provided by
the immediately preceding sentence is not permitted by applicable law, then each
indemnifying party shall contribute to such amount paid or payable by such
indemnified party in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the indemnifying party or
parties on the one hand and the indemnified party or parties on the other in
connection with the statements or omissions which resulted in such losses,
claims, damages or liabilities (or actions or proceedings in respect thereof),
as well as any other relevant equitable considerations. The relative benefits
received by the Company and the Selling Shareholders on the one hand and the
Underwriters on the other shall be deemed to be in the same proportion as the
total net proceeds from the offering (before deducting expenses) received by the
Company and the Selling Shareholders bear to the total underwriting discounts
and commissions received by the Underwriters, in each case as set forth in the
table on the cover page of the Prospectus. The relative fault shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by the Company or the Selling
Shareholders on the one hand or the Underwriters on the other and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
The Company, the Selling Shareholders and the Underwriters agree that
it would not be just and equitable if contributions pursuant to this Section
8(e) were determined by pro rata allocation (even if the Underwriters were
treated as one entity for such purpose) or by any other method of allocation
which does not take account of the equitable considerations referred to above in
this Section 8(e). The amount paid or payable by an indemnified party as a
result of the losses, claims, damages or liabilities (or actions or proceedings
in respect thereof) referred to above in this Section 8(e) shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in connection with investigating or defending any such action or claim.
Notwithstanding the provisions of this subsection (e), (i) no Underwriter shall
be required to contribute any amount in excess of the underwriting discounts and
commissions applicable to the Shares purchased by such Underwriter, (ii) no
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation and (iii) no Selling Shareholder
shall be required to contribute any amount in excess of the proceeds received by
such Selling Shareholder from the
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<PAGE>
Underwriters in the offering. The Underwriters' obligations in this Section 8(e)
to contribute are several in proportion to their respective underwriting
obligations and not joint.
(f) In any proceeding relating to the Registration Statement, any
Preliminary Prospectus, the Prospectus or any supplement or amendment thereto,
each party against whom contribution may be sought under this Section 8 hereby
consents to the jurisdiction of any court having jurisdiction over any other
contributing party, agrees that process issuing from such court may be served
upon him or it by any other contributing party and consents to the service of
such process and agrees that any other contributing party may join him or it as
an additional defendant in any such proceeding in which such other contributing
party is a party.
(g) Any losses, claims, damages, liabilities or expenses for which an
indemnified party is entitled to indemnification or contribution under this
Section 8 shall be paid by the indemnifying party to the indemnified party as
such losses, claims, damages, liabilities or expenses are incurred. The
indemnity and contribution agreements contained in this Section 8 and the
representations and warranties of the Company set forth in this Agreement
shall remain operative and in full force and effect, regardless of (i) any
investigation made by or on behalf of any Underwriter or any person controlling
any Underwriter, the Company, its directors or officers or any persons
controlling the Company, (ii) acceptance of any Shares and payment therefor
hereunder, and (iii) any termination of this Agreement. A successor to any
Underwriter, or to the Company, its directors or officers, or any person
controlling the Company, shall be entitled to the benefits of the indemnity,
contribution and reimbursement agreements contained in this Section 8.
9. Default by Underwriters.
-----------------------
If on the Closing Date or the Option Closing Date, as the case may be,
any Underwriter shall fail to purchase and pay for the portion of the Shares
which such Underwriter has agreed to purchase and pay for on such date
(otherwise than by reason of any default on the part of the Company or a Selling
Shareholder), you, as Representatives of the Underwriters, shall use your
reasonable efforts to procure within 36 hours thereafter one or more of the
other Underwriters, or any others, to purchase from the Company and the Selling
Shareholders such amounts as may be agreed upon and upon the terms set forth
herein, the Firm Shares or Option Shares, as the case may be, which the
defaulting Underwriter or Underwriters failed to purchase. If during such 36
hours you, as such Representatives, shall not have procured such other
Underwriters, or any others, to purchase the Firm Shares or Option Shares, as
the case may be, agreed to be purchased by the defaulting Underwriter or
Underwriters, then (a) if the aggregate number of shares with respect to which
such default shall occur does not exceed 10% of the Firm Shares or Option
Shares, as the case may be, covered hereby, the other Underwriters shall be
obligated, severally, in proportion to the respective numbers of Firm Shares or
Option Shares, as the case may be, which they are obligated to purchase
hereunder, to purchase the Firm Shares or Option Shares, as the case may be,
which such defaulting Underwriter or Underwriters failed to purchase, or (b) if
the aggregate number of shares of Firm Shares or Option Shares, as the case may
be, with respect to which such default shall occur exceeds 10% of the Firm
Shares or Option Shares, as the case may be, covered hereby, the Company and the
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<PAGE>
Selling Shareholders or you as the Representatives of the Underwriters will have
the right, by written notice given within the next 36-hour period to the parties
to this Agreement, to terminate this Agreement without liability on the part of
the non-defaulting Underwriters or of the Company or of the Selling Shareholders
except to the extent provided in Section 8 hereof. In the event of a default by
any Underwriter or Underwriters, as set forth in this Section 9, the Closing
Date or Option Closing Date, as the case may be, may be postponed for such
period, not exceeding seven days, as you, as Representatives, may determine in
order that the required changes in the Registration Statement or in the
Prospectus or in any other documents or arrangements may be effected. The term
"Underwriter" includes any person substituted for a defaulting Underwriter. Any
action taken under this Section 9 shall not relieve any defaulting Underwriter
from liability in respect of any default of such Underwriter under this
Agreement.
10. Notices.
-------
All communications hereunder shall be in writing and, except as
otherwise provided herein, will be mailed, delivered, telecopied or telegraphed
and confirmed as follows: if to the Underwriters, to BT Alex. Brown
Incorporated, 101 California Street, 48th Floor, San Francisco, California
94111, Attention: Tony Meneghetti; with a copy to BT Alex. Brown Incorporated,
One Bankers Trust Plaza, 130 Liberty Street, New York, New York 10006,
Attention: General Counsel; if to the Company or the Selling Shareholders, to
Dr. Zaki Rakib
Chief Executive Officer
Terayon Communication Systems, Inc.
2952 Bunker Hill Lane
Santa Clara, CA 95054
with a copy to:
Cooley Godward LLP
One Maritime Plaza
20th Floor
San Francisco, CA 94111
Attn: James C. Gaither
11. Termination.
-----------
This Agreement may be terminated by you by notice to the Company and
the Selling Shareholders as follows:
(a) at any time prior to the Closing Date if any of the following has
occurred: (i) since the respective dates as of which information is given in the
Registration Statement and the Prospectus, any Material Adverse Effect has
occurred or is reasonably likely to occur, (ii) any out-
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<PAGE>
break or escalation of hostilities or declaration of war or national emergency
or other national or international calamity or crisis or change in economic or
political conditions if the effect of such outbreak, escalation, declaration,
emergency, calamity, crisis or change on the financial markets of the United
States would, in your reasonable judgment, make it impracticable to market the
Shares or to enforce contracts for the sale of the Shares, or (iii) suspension
of trading in securities generally on the New York Stock Exchange or the
American Stock Exchange or limitation on prices (other than limitations on hours
or numbers of days of trading) for securities on either such Exchange, (iv) the
enactment, publication, decree or other promulgation of any statute, regulation,
rule or order of any court or other governmental authority which in your opinion
is reasonably likely to have a Material Adverse Effect, (v) declaration of a
banking moratorium by United States or New York State authorities, (vi) any
downgrading in the rating of the Company's debt securities by any "nationally
recognized statistical rating organization" (as defined for purposes of Rule
436(g) under the Exchange Act); (vii) the suspension of trading of the Company's
Common Stock by the Commission on the Nasdaq National Market or (viii) the
taking of any action by any governmental body or agency in respect of its
monetary or fiscal affairs which in your reasonable opinion has a material
adverse effect on the securities markets in the United States; or
(b) as provided in Sections 6 and 9 of this Agreement.
12. Successors.
----------
This Agreement has been and is made solely for the benefit of the
Underwriters, the Company and the Selling Shareholders and their respective
successors, executors, administrators, heirs and assigns, the officers,
directors and controlling persons referred to herein, and no other person will
have any right or obligation hereunder. No purchaser of any of the Shares from
any Underwriter shall be deemed a successor or assign merely because of such
purchase.
13. Information Provided by Underwriters.
------------------------------------
The Company, the Selling Shareholders and the Underwriters acknowledge
and agree that the only information furnished or to be furnished by any
Underwriter to the Company for inclusion in any Prospectus or the Registration
Statement consists of the information set forth in the last paragraph on the
front cover page (insofar as such information relates to the Underwriters),
legends required by Item 502(d) of Regulation S-K under the Act and the
information under the caption "Underwriting" in the Prospectus.
14. Miscellaneous.
-------------
The reimbursement, indemnification and contribution agreements
contained in this Agreement and the representations, warranties and covenants in
this Agreement shall remain in full force and effect regardless of (a) any
termination of this Agreement, (b) any investigation made by or on behalf of
any Underwriter or controlling person thereof, or on behalf of the Company or
its directors or officers and (c) delivery of and payment for the Shares under
this Agreement.
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<PAGE>
This Agreement may be executed in two or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument.
This Agreement shall be governed by, and construed in accordance with,
the laws of the State of Maryland.
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<PAGE>
If the foregoing letter is in accordance with your understanding of our
agreement, please sign and return to us the enclosed duplicates hereof,
whereupon it will become a binding agreement among the Selling Shareholders, the
Company and the several Underwriters in accordance with its terms.
Very truly yours,
TERAYON COMMUNICATION SYSTEMS, INC.
By
------------------------------------------
Zaki Rakib
Chief Executive Officer
Selling Shareholders listed on Schedule II and III
By
------------------------------------------
The foregoing Underwriting Agreement
is hereby confirmed and accepted as
of the date first above written.
BT ALEX. BROWN INCORPORATED
HAMBRECHT & QUIST LLC
LEHMAN BROTHERS INC.
SALOMON SMITH BARNEY INC.
As Representatives of the several
Underwriters listed on Schedule I
By: BT Alex. Brown Incorporated
By:
------------------------------
Authorized Officer
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<PAGE>
SCHEDULE I
SCHEDULE OF UNDERWRITERS
NUMBER OF FIRM
SHARES TO BE
UNDERWRITER PURCHASED
- -----------------------------------------------------------------------------
BT Alex. Brown Incorporated...............................
Hambrecht & Quist LLC.....................................
Lehman Brothers Inc. .....................................
Salomon Smith Barney Inc. ................................
==============
Total Underwriters........................................ 3,000,000
<PAGE>
SCHEDULE II
SCHEDULE OF SELLING SHAREHOLDERS
NUMBER OF FIRM
SHARES
SELLING SHAREHOLDER TO BE SOLD
- -------------------------------------------------------------------------------
==============
Total 1,250,000
<PAGE>
SCHEDULE III
SCHEDULE OF OPTION SHARES
MAXIMUM NUMBER PERCENTAGE OF
OF OPTION SHARES TOTAL NUMBER OF
NAME OF SELLER TO BE SOLD OPTION SHARES
- ------------------------------------------------------------------------------
=============== ================
Total 100%
<PAGE>
STATE OF DELAWARE
SECRETARY OF STATE
DIVISION OF CORPORATIONS EXHIBIT 3.1
FILED 03:00 PM 08/21/1998
981329097 - 2908580
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
TERAYON COMMUNICATION SYSTEMS, INC.
TERAYON COMMUNICATION SYSTEMS, INC.,a corporation organized and existing
under the laws of the state of Delaware (the "Corporation") hereby certifies
that:
1. The name of this corporation is Terayon Communication Systems, Inc.
The Corporation was originally incorporated under the name Terayon Merger
Corporation.
2. The date of filing of the Corporation's original Certificate of
Incorporation was June 12, 1998.
3. The Amended and Restated Certificate of Incorporation of the
Corporation as provided in Exhibit A, hereto was duly adopted in accordance with
the provisions of Section 242 and Section 245 of the General Corporation Law of
the State of Delaware by the Board of Directors of the Corporation.
4. Pursuant to Section 245 of the Delaware General Corporation Law,
approval of the stockholders of the Corporation has been obtained.
5. The Amended and Restated Certificate of Incorporation so adopted
reads in full as set forth in Exhibit A attached hereto and is hereby
incorporated by reference.
IN WITNESS WHEREOF, the undersigned has signed this certificate the 21st
day of August, 1998, and hereby affirms and acknowledges under penalty of
perjury that the filing of this Amended and Restated Certificate of
Incorporation is the act and deed of Terayon Communications Systems, Inc.
TERAYON COMMUNICATION SYSTEMS INC.
By /s/ Zaki Rakib
--------------------------------
Zaki Rakib
Chief Executive Officer
<PAGE>
AMENDED AND RESTATED Exhibit A
CERTIFICATE OF INCORPORATION
OF
TERAYON COMMUNICATION SYSTEMS, INC.
I.
The name of this corporation is Terayon Communication Systems, Inc.
II.
The address of the registered office of the corporation in the State of
Delaware is 1013 Centre Road, City of Wilmington, 19805, County of New Castle
and the name of the registered agent of the corporation in the State of Delaware
at such address is Corporate Service Company.
III.
The purpose of this corporation is to engage in any lawful act or activity
for which a corporation may be organized under the General Corporation Law of
the State of Delaware.
IV.
This corporation is authorized to issue two classes of stock to be
designated, respectively, "Common Stock" and "Preferred Stock." The total number
of shares which the corporation is authorized to issue is Thirty-Five Million
(35,000,000) shares. Thirty Million (30,000,000) shares shall be Common Stock,
each having a par value of one tenth of one cent ($.001). Five Million
(5,000,000) shares shall be Preferred Stock, each having a par value of one
tenth of one cent ($.001).
The Preferred Stock may be issued from time to time in one or more series.
The Board of Directors is hereby authorized, by filing a certificate (a
"Preferred Stock Designation") pursuant to the Delaware General Corporation Law,
to fix or alter from time to time the designation, powers, preferences and
rights of the shares of each such series and the qualifications, limitations or
restrictions of any wholly unissued series of Preferred Stock, and to establish
from time to time the number of shares constituting any such series or any of
them; and to increase or decrease the number of shares of any series subsequent
to the issuance of shares of that series, but not below the number of shares of
such series then outstanding. In case the number of shares of any series shall
be decreased in accordance with the foregoing sentence, the shares constituting
such decrease shall resume the status that they had prior to the adoption of the
resolution originally fixing the number of shares of such series.
1
<PAGE>
EXHIBIT 10.14
Streamline Facility Agreement
October 30, 1998
Terayon Communication Systems, Inc.
2952 Bunker Hill Lane
Santa Clara, California 95054
Gentlemen:
Reference is made to the Loan and Security between you ("Borrower") and us
("Silicon") dated August 10, 1998 (as amended, the "Loan Agreement"). (This
letter agreement, the Loan Agreement, and all other written documents and
agreements between us are referred to herein collectively as the "Loan
Documents". Capitalized terms used but not defined in this agreement, shall
have the meanings set forth in the Loan Agreement.)
This will confirm our agreement that the following provisions shall apply,
effective on the date hereof:
1. Monthly Borrowing Base. Within 20 days after the end of each month,
-----------------------
if at the end of such month the outstanding Obligations exceed $3,000,000,
Borrower shall deliver to Silicon a Borrowing Base Certificate signed by the
Chief Executive Officer, President, Chief Financial Officer or Controller of
Borrower in substantially the form of Exhibit A hereto.
2. Daily Delivery of Proceeds of Receivables Not Required. Borrower
------------------------------------------------------
shall not be required to deliver the proceeds of Receivables to Silicon upon
receipt as provided in Section 4.4 of the Loan Agreement; provided that if any
Event of Default has occurred and is continuing, without limiting its other
rights and remedies, Silicon shall have the right to require that all proceeds
of all Receivables be delivered to Silicon upon receipt and in the form
received.
3. Changes to Reporting Requirements.
----------------------------------
(a) Daily delivery to Silicon of transaction reports, schedules and
assignments of Receivables, and schedules of collections, and delivery to
Silicon of copies of credit memos within two days after the date issued, as
called for by Section 4.3 of the Loan Agreement, will not be required.
(b) The first sentence of Section 4.6, which requires that Borrower
promptly notify Silicon of all disputes or claims relating to Receivables, is
replaced by the following: "Borrower shall promptly notify Silicon of all
returns and recoveries and of all disputes and claims, where the return,
recovery, dispute or claim involves more than $50,000".
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<PAGE>
(c) The following reporting requirements shall supersede and replace
those reporting requirements set forth in Section 6 of the Schedule to the Loan
Agreement. Borrower shall provide Silicon with the following, in such form as
Silicon shall specify:
(i) Monthly Receivable agings, aged by invoice date, within
twenty days after the end of each month if at the end of
such month the outstanding Obligations exceed $3,000,000.
(ii) Monthly accounts payable agings, aged by invoice date, and
outstanding or held check registers, if any, within twenty
days after the end of each month if at the end of such
month the outstanding Obligations exceed $3,000,000.
(iii) Quarterly Compliance Certificates, within fifty days after
the end of each fiscal quarter, in such form as Silicon
shall reasonably specify, signed by the Chief Financial
Officer of Borrower, certifying that as of the end of such
fiscal quarter Borrower was in full compliance with all of
the terms and conditions of this Agreement, and setting
forth calculations showing compliance with the financial
covenants set forth in this Agreement and such other
information as Silicon shall reasonably request,
including, without limitation, a statement that at the end
of such fiscal quarter there were no held checks.
(iv) Copies of all reports on Form 10-Q filed with the
Securities and Exchange Commission, within fifty (50) days
after the end of each fiscal quarter.
(v) Copies of all reports on Form 10-K filed with the
Securities and Exchange Commission, within ninety-five
(95) days after the end of each fiscal year.
4. Letters of Credit. Section 1.5 of the Loan Agreement is amended to
-----------------
read as follows:
"1.5 LETTERS OF CREDIT. At the request of Borrower, Silicon may, in
its sole discretion, issue or arrange for the issuance of letters of credit
for the account of Borrower, in each case in form and substance
satisfactory to Silicon in its sole discretion (collectively, "Letters of
Credit"). The aggregate face amount of all outstanding Letters of Credit
from time to time shall not exceed the amount shown on the Schedule (the
"Letter of Credit Sublimit"), and shall be reserved against Loans which
would otherwise be available hereunder. Borrower shall pay all bank
charges (including charges of Silicon) for the issuance of Letters of
Credit, together with such additional fee as Silicon's letter of credit
department shall charge in connection with the issuance of the Letters of
Credit. Any
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<PAGE>
payment by Silicon under or in connection with a Letter of Credit shall
constitute a Loan hereunder on the date such payment is made. Each Letter
of Credit shall have an expiry date no later than thirty days prior to the
Maturity Date. Borrower hereby agrees to indemnify, save, and hold Silicon
harmless from any loss, cost, expense, or liability, including payments
made by Silicon, expenses, and reasonable attorneys' fees incurred by
Silicon arising out of or in connection with any Letters of Credit.
Borrower agrees to be bound by the regulations and interpretations of the
issuer of any Letters of Credit guarantied by Silicon and opened for
Borrower's account or by Silicon's interpretations of any Letter of Credit
issued by Silicon for Borrower's account, and Borrower understands and
agrees that Silicon shall not be liable for any error, negligence, or
mistake, whether of omission or commission, in following Borrower's
instructions or those contained in the Letters of Credit or any
modifications, amendments, or supplements thereto. Borrower understands
that Letters of Credit may require Silicon to indemnify the issuing bank
for certain costs or liabilities arising out of claims by Borrower against
such issuing bank. Borrower hereby agrees to indemnify and hold Silicon
harmless with respect to any loss, cost, expense, or liability incurred by
Silicon under any Letter of Credit as a result of Silicon's indemnification
of any such issuing bank. The provisions of this Loan Agreement, as it
pertains to Letters of Credit, and any other present or future documents or
agreements between Borrower and Silicon relating to Letters of Credit are
cumulative."
5. Credit Limit. The Credit Limit (Section 1 of the Schedule to the Loan
------------
Agreement) is hereby amended to read as follows:
"1. CREDIT LIMIT
(Section 1.1): An amount not to exceed the lesser of:
(a) $10,000,000 at any one time outstanding (the "Maximum
Credit Limit") or,
(b) the sum of:
(i) 80% of Borrower's Eligible Receivables other than
Receivables backed by a letter of credit satisfactory
to Silicon, plus
----
(ii) 100% of Borrower's Eligible Receivables backed by a
letter of credit satisfactory to Silicon,
provided that subsection (b) above shall not apply unless
-------- ----
the outstanding Obligations exceed $3,000,000.
LETTER OF CREDIT SUBLIMIT
(Section 1.5): $2,000,000.
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<PAGE>
FOREIGN EXCHANGE
CONTRACT SUBLIMIT Up to $2,000,000 of the Credit Limit (the "Contract
Limit") may be utilized for spot and future foreign
exchange contracts (the "Exchange Contracts"). The
Credit Limit available at any time shall be reduced by
the following amounts (the "Foreign Exchange Reserve")
on each day (the "Determination Date"): (i) on all
outstanding Exchange Contracts on which delivery is to
be effected or settlement allowed more than two
business days from the Determination Date, 10% of the
gross amount of the Exchange Contracts; plus (ii) on
all outstanding Exchange Contracts on which delivery
is to be effected or settlement allowed within two
business days after the Determination Date, 100% of
the gross amount of the Exchange Contracts. In lieu of
the Foreign Exchange Reserve for 100% of the gross
amount of any Exchange Contract, Borrower may request
that Silicon debit Borrower's bank account with
Silicon for such amount, provided Borrower has
immediately available funds in such amount in its bank
account.
Silicon may, in its discretion, terminate the Exchange
Contracts at any time (a) that an Event of Default
occurs or (b) that there is not sufficient
availability under the Credit Limit and Borrower does
not have available funds in its bank account to
satisfy the Foreign Exchange Reserve. If either
Silicon or Borrower terminates the Exchange Contracts,
and without limitation of the FX Indemnity Provisions
(as defined below), Borrower agrees to reimburse
Silicon for any and all fees, costs and expenses
relating thereto or arising in connection therewith.
Borrower shall not permit the total gross amount of
all Exchange Contracts on which delivery is to be
effected and settlement allowed in any two business
day period to be more than $1,000,000 (the "Settlement
Limit"), nor shall Borrower permit the total gross
amount of all Exchange Contracts to which Borrower is
a party, outstanding at any one time, to exceed the
Contract Limit.
Notwithstanding the above, however, the amount which
may be settled in any two (2) business day period may,
in Silicon's sole discretion, be increased above the
Settlement Limit up to, but in no event to exceed, the
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<PAGE>
amount of the Contract Limit (the "Discretionary
Settlement Amount") under either of the following
circumstances (the "Discretionary Settlement
Circumstances"):
(i) if there is sufficient availability under the
Credit Limit in the amount of the Foreign Exchange
Reserve as of each Determination Date, and Silicon
in advance shall reserve the full amount of the
Foreign Exchange Reserve against the Credit Limit;
or
(ii) if there is insufficient availability under
the Credit Limit as to settlements within any two
(2) business day period, and if Silicon is able
to: (A) verify good funds overseas prior to
crediting Borrower's deposit account with Silicon
(in the case of Borrower's sale of foreign
currency); or (B) debit Borrower's deposit account
with Silicon prior to delivering foreign currency
overseas (in the case of Borrower's purchase of
foreign currency);
provided that it is expressly understood that
Silicon's willingness to adopt the Discretionary
Settlement Amount is a matter of Silicon's sole
discretion and the existence of any Discretionary
Settlement Circumstances in no way means or implies
that Silicon shall be obligated to permit Borrower to
exceed the Settlement Limit in any two business day
period.
In the case of Borrower's purchase of foreign
currency, Borrower shall instruct Silicon in advance
upon settlement either to treat the settlement amount
as an advance under the Credit Limit, or to debit
Borrower's account for the amount settled.
Borrower shall execute all standard form applications
and agreements of Silicon in connection with the
Exchange Contracts, and without limiting any of the
terms of such applications and agreements, Borrower
shall pay all standard fees and charges of Silicon in
connection with the Exchange Contracts.
Without limiting any of the other terms of this Loan
Agreement or any such standard form applications and
agreements of Silicon, Borrower agrees to indemnify
Silicon and hold it harmless, from and against any and
all
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<PAGE>
claims, debts, liabilities, demands, obligations,
actions, costs and expenses (including, without
limitation, attorneys' fees of counsel of Silicon's
choice), of every nature and description, which it may
sustain or incur, based upon, arising out of, or in
any way relating to any of the Exchange Contracts or
any transactions relating thereto or contemplated
thereby (collectively referred to as the "FX Indemnity
Provisions").
The Exchange Contracts shall have maturity dates no
later than the Maturity Date."
6. Interest Rate. The definition of the interest rate charged upon all
-------------
monetary Obligations, as set forth in Section 2 of the Schedule to the Loan
Agreement, is hereby amended to read as follows:
"A rate equal to the "Prime Rate" in effect from time to time.
Interest shall be calculated on the basis of a 360-day year for the actual
number of days elapsed. "Prime Rate" means the rate announced from time to
time by Silicon as its "prime rate;" it is a base rate upon which other
rates charged by Silicon are based, and it is not necessarily the best rate
available at Silicon. The interest rate applicable to the Obligations shall
change on each date there is a change in the Prime Rate."
7. Change in Maturity Date. The Maturity Date is hereby amended to be
-----------------------
364 days from the date of this letter agreement.
8. Financial Covenants. Borrower shall comply with all of the following
-------------------
covenants. Compliance shall be determined as of the end of each fiscal quarter.
(a) Tangible Net Worth. During the six-month period beginning with
------------------
the date of this letter agreement, Borrower shall maintain a Tangible Net Worth
of not less than $25,000,000. Beginning six months from the date of this letter
agreement, and continuing thereafter, Borrower shall maintain a Tangible Net
Worth of not less than $20,000,000. The foregoing supersedes and replaces the
Minimum Tangible Net Worth covenant set forth in Section 5 of the Schedule to
the Loan Agreement.
(b) Quick Ratio. Borrower shall maintain a ratio of quick assets of
-----------
current liabilities of at least 2.0 to 1.0. The term "quick assets" means, as
of any applicable date, Borrower's consolidated cash, cash equivalents, accounts
receivable and investments with maturities of fewer than 90 days, determined in
accordance with generally accepted accounting principles.
(c) Debt-Net Worth Ratio. Borrower shall maintain a ratio of total
--------------------
liabilities to tangible net worth of not more than 1.0 to 1.0.
This letter agreement, the Loan Agreement, and the other Loan Documents set
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<PAGE>
forth in full all of the representations and agreements of the parties with
respect to the subject matter hereof and supersede all prior discussions, oral
representations, oral agreements and oral understandings between the parties
with respect to the subject hereof. Except as herein expressly amended, all of
the terms and provisions of the Loan Agreement, and all other Loan Documents
shall continue in full force and effect and the same are hereby ratified and
confirmed.
If the foregoing correctly sets forth our agreement, please sign the
enclosed copy of this Agreement and return it to us.
Sincerely yours,
Silicon Valley Bank
By /s/ Timothy M. Walsh
----------------------------
Title VP
----------------------
Accepted and agreed:
Borrower:
TERAYON COMMUNICATION SYSTEMS,
INC.
By /s/ Ray M. Fritz
------------------------
President or Vice President
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<PAGE>
EXHIBIT A
BORROWING BASE CERTIFICATE
<TABLE>
<CAPTION>
Borrower: Terayon Communication Systems, Inc. Bank: Silicon Valley Bank
<S> <C> <C> <C>
ACCOUNTS RECEIVABLE
1. Accounts Receivable Book Value as of _____ $_______________ _
2. Additions (please explain on reverse) $_______________ _
3. TOTAL ACCOUNTS RECEIVABLE $_______________ _
ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication)
4. Amounts over 90 days due $_______________ _
5. Balance of 50% over 90 day accounts $_______________ _
6. Concentration Limits $_______________ _
7. Foreign Accounts $_______________ _
8. Governmental Accounts $_______________ _
9. Contra Accounts $_______________ _
10. Promotion or Demo Accounts $_______________ _
11. Intercompany/Employee Accounts $_______________ _
12. Other (please explain on reverse) $_______________ _
13. TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS $_______________ _
14. Eligible Accounts (#3 minus #13) $_______________ _
15. LOAN VALUE OF ACCOUNTS (_____% OF #14) $_______________ _
INVENTORY
16. Inventory Value as of _________ _ $_______________ _
17. LOAN VALUE OF INVENTORY (_____% OF #16) $_______________ _
BALANCES
18. Maximum Loan Amount $_______________ _
19. Total Funds Available [Lessor of #18 or (#15 plus #17)] $_______________ _
20. Present balance owing on Line of Credit $_______________ _
21. Outstanding under Sublimits ( ) $_______________ _
22. RESERVE POSITION (#19 minus #20 and #21) $_______________ _
</TABLE>
The undersigned represents and warrants that the foregoing is true, complete and
correct, and that the information reflected in this Borrowing Base Certificate
complies with the representations and warranties set forth in the Loan and
Security Agreement between the undersigned and Silicon Valley Bank.
COMMENTS:
====================================
BANK USE ONLY
Received By:______________
Date:______________
Reviewed By:______________
Complaints Status: Yes/No
====================================
Terayon Communication Systems, Inc.
By: /s/ Ray M. Fritz
______________________________
Authorized Signer
<PAGE>
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected
Consolidated Financial Data" and "Experts" and to the use of our report dated
February 6, 1998 (except Note 14, as to which the date is July 8, 1998) in the
Registration Statement (Form S-1) and related Prospectus of Terayon
Communication Systems, Inc. for the registration of 3,450,000 shares of its
common stock.
Our audits also included the financial statement schedule of Terayon
Communication Systems, Inc. for each of the three years in the period ended
December 31, 1997 listed in Item 16(b) of this Registration Statement. This
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
December 22, 1998
