<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE PERIOD ENDED JUNE 30, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-21409
------------------------
CELLNET DATA SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
DELAWARE 94-2951096
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 SHOREWAY ROAD 94070
SAN CARLOS, CALIFORNIA
(Address of principal executive (Zip Code)
offices)
</TABLE>
(650) 508-6000
(Registrant's Telephone Number, Including Area Code)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(a) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of July 31, 1997, 41,577,229 shares of the Registrant's Common Stock,
$0.001 par value, were issued and outstanding.
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<PAGE>
CELLNET DATA SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
-------------
<C> <S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements--Condensed Consolidated Financial Statements (unaudited)................... 1
(a) Condensed Consolidated Balance Sheets--As of June 30, 1997 and December 31, 1996..... 1
(b) Condensed Consolidated Statements of Operations--Three months ended June 30, 1997 and
June 30, 1996 and Six months ended June 30, 1997 and June 30, 1996................. 2
(c) Condensed Consolidated Statements of Cash Flows--Six months ended June 30, 1997 and
June 30, 1996...................................................................... 3
(d) Notes to Condensed Consolidated Financial Statements................................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 6
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 24
Item 2. Changes in Securities........................................................................... 25
Item 3. Defaults Upon Senior Securities................................................................. 25
Item 4. Submission of Matters to a Vote of Security Holders............................................. 25
Item 5. Other Information............................................................................... 25
Item 6. Exhibits and Reports on Form 8-K................................................................ 25
SIGNATURES.................................................................................................. 26
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 88,633 $ 124,232
Short-term investments.............................................................. 29,300 54,643
Accounts receivable--trade.......................................................... 1,393 850
Accounts receivable--other.......................................................... 3,597 1,264
Prepaid expenses and other.......................................................... 2,087 1,124
----------- ------------
Total current assets.............................................................. 125,010 182,113
Network components and inventory...................................................... 15,095 11,211
Networks in progress--net............................................................. 70,184 48,426
Property--net......................................................................... 14,275 12,236
Investment in unconsolidated affiliate................................................ -- --
Debt issuance and other costs--net.................................................... 5,274 5,565
----------- ------------
Total assets...................................................................... $ 229,838 $ 259,551
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Accounts payable.................................................................... 9,750 $ 8,133
Accrued compensation and related benefits........................................... 2,210 2,371
Accrued liabilities................................................................. 1,221 950
Current portion of capital lease obligations........................................ 336 308
----------- ------------
Total current liabilities......................................................... 13,517 11,762
----------- ------------
Senior discount notes--13%.......................................................... 220,832 207,178
----------- ------------
Capital lease obligations--net...................................................... 499 366
----------- ------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 3)
Stockholders' (deficit) equity:
Preferred stock--$.001 par value; 15,000,000 shares authorized;
shares outstanding, 1996: none; 1997: none........................................ -- --
Common stock--$.001 par value; 100,000,000 shares authorized;
shares outstanding, 1996: 38,537,517; 1997: 41,541,384............................ 209,348 205,793
Notes receivable from sale of common stock.......................................... (718) (814)
Warrants............................................................................ 1 2,984
Accumulated deficit................................................................. (213,641) (167,715)
Net unrealized loss on short-term investments....................................... 0 (3)
----------- ------------
Total stockholders' (deficit) equity.............................................. (5,010) 40,245
----------- ------------
Total liabilities and stockholders' (deficit) equity.................................. $ 229,838 $ 259,551
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to condensed consolidated financial statements
1
<PAGE>
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Network service revenues........................................ $ 1,254 $ 170 $ 2,113 $ 244
Product sales................................................... 235 57 299 127
Other revenues.................................................. 25 24 81 49
---------- ---------- ---------- ----------
Total revenues................................................ 1,514 251 2,493 420
---------- ---------- ---------- ----------
Costs and expenses:
Cost of network operations...................................... 3,933 1,668 7,498 2,920
Cost of product sales........................................... 259 44 337 109
Research and development........................................ 6,652 6,134 13,048 11,820
Marketing and sales............................................. 1,930 1,557 3,669 2,866
General and administrative...................................... 4,642 2,710 9,069 4,930
Depreciation and amortization................................... 2,674 1,292 5,139 2,183
---------- ---------- ---------- ----------
Total costs and expenses...................................... 20,090 13,405 38,760 24,828
---------- ---------- ---------- ----------
Loss from operations.............................................. (18,576) (13,154) (36,267) (24,408)
Equity in income (loss) of unconsolidated affiliate............... (981) (1,339)
Other income (expense):
Interest income................................................. 1,947 1,553 4,238 3,458
Interest expense................................................ (6,248) (5,554) (12,559) (11,264)
Other--net...................................................... (64) (91) 2 (97)
---------- ---------- ---------- ----------
Total other income (expense)...................................... (4,365) (4,092) (8,319) (7,903)
---------- ---------- ---------- ----------
Net loss before income taxes...................................... (23,922) (17,246) (45,925) (32,311)
Provision for income taxes........................................ 1 1 2
---------- ---------- ---------- ----------
Net loss.......................................................... $ (23,922) $ (17,247) $ (45,926) $ (32,313)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
PRO FORMA NET LOSS PER SHARE...................................... $ (0.60) $ (0.55) $ (1.16) $ (1.03)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
SHARES USED IN COMPUTING PER SHARE AMOUNTS........................ 39,913 31,277 39,214 31,217
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements
2
<PAGE>
CELLNET DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30,
-----------------------
1997 1996
---------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................................... $ (45,926) $ (32,313)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization........................................................ 5,139 2,257
Accretion on 13% senior discount notes............................................... 12,184 12,192
Amortization of debt issuance costs.................................................. 310 298
Loss (gain) on disposition of property................................................. (15)
Changes in:
Accounts receivable--trade........................................................... (543) 214
Accounts receivable--other........................................................... (2,333)
Prepaid expenses and other........................................................... (963) 54
Accounts payable..................................................................... 1,617 (912)
Accrued compensation and related benefits............................................ (161) (618)
Accrued liabilities.................................................................. 271 9
---------- -----------
Net cash used for operating activities............................................. (30,405) (18,834)
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Network components and inventory....................................................... (3,884) (905)
Purchase of property................................................................... (5,085) (3,478)
Networks in progress................................................................... (22,029) (17,482)
Other assets........................................................................... (19) --
Purchase of short-term investments..................................................... (13,789) (263,980)
Proceeds from sales and maturities of short-term investments........................... 39,134 327,522
---------- -----------
Net cash (used) provided for investing activities.................................... (5,672) 41,677
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash paid for debt issuance costs...................................................... -- --
Repayment of capital lease obligations................................................. (190) (160)
Proceeds from sale of preferred stock.................................................. -- 1
Proceeds from sale of common stock..................................................... 572 28
Collection of note receivable from sale of common stock................................ 96
---------- -----------
Net cash (used) provided by financing activities..................................... 478 (131)
---------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS.................................................... (35,599) 22,712
CASH AND CASH EQUIVALENTS, Beginning of period........................................... 124,232 48,018
---------- -----------
CASH AND CASH EQUIVALENTS, End of period................................................. $ 88,633 $ 70,730
---------- -----------
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases........................................... $ 351 $ 133
Capitalization of interest into networks in progress................................... $ 1,470 $
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest............................................... $ 53 $ 56
Cash paid for income taxes............................................................. $ 1 $ 2
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION.
In the opinion of management, these unaudited condensed consolidated
financial statements include all adjustments, consisting only of normal
recurring adjustments and accruals the Company considers necessary for a fair
presentation of the Company's financial position as of June 30, 1997, and the
results of operations and cash flows for the six months ended June 30, 1997 and
1996. This unaudited interim information should be read in conjunction with the
audited consolidated financial statements of CellNet Data Systems, Inc. and the
notes thereto for the year ended December 31, 1996. Operating results for the
six months ended June 30, 1997 are not necessarily indicative of the results
that may be expected for the year ended December 31, 1997.
Investment in affiliate is accounted for using the equity method. Income or
loss of affiliate is based upon the Company's beneficial interest (50%).
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, EARNINGS PER SHARE (SFAS 128). The
Company is required to adopt SFAS 128 in the fourth quarter of fiscal 1997 and
will restate at that time earnings per share (EPS) data for prior periods to
conform with SFAS 128. Earlier application is not permitted. The Company has
determined that adoption of SFAS 128 will not have a material effect on losses
per share which have been previously reported.
In June 1997, the Financial Accounting Standards Board adopted Statements of
Financial Accounting Standards No. 130 (REPORTING COMPREHENSIVE INCOME), which
requires that an enterprise report, by major components and as a single total,
the change in its net assets during the period from nonowner sources; and No.
131 (DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION), which
establishes annual and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services, geographic areas,
and major customers. Adoption of these statements will not impact the Company's
consolidated financial position, results or operations or cash flows. Both
statements are effective for fiscal years beginning after December 15, 1997,
with earlier application permitted.
2. NET LOSS PER SHARE.
Net loss per share is computed using the weighted average number of common
and common equivalent shares outstanding during the year ended December 31,
1996, and six months ended June 30, 1997. For the six months ended June 30,
1996, common equivalent shares include all outstanding preferred stock and
warrants that were converted in connection with the initial public offering
completed October 2, 1996, even when the effect is anti-dilutive.
3. COMMITMENTS AND CONTINGENCIES.
The industry in which the Company operates is characterized by frequent
litigation regarding patent and other intellectual property rights. The Company
is a party to three such claims. Although the ultimate outcome of these matters
is not presently determinable, management believes that the resolution of these
matters will not have a material adverse effect on the Company's financial
position or results of operations.
Although the Company has been granted federal registration of its "CellNet"
trademark, in January 1995, Century Telephone Enterprises, Inc. (Century
Telephone) filed a petition for cancellation in an attempt to challenge such
registration. The matter is currently pending before the Trademark Trial and
Appeal Board of the U.S. Patent and Trademark Office. CellNet and Century
Telephone are the sole parties in the action. If such challenge were successful,
the Company could lose its registration and could be required to adopt a new
trademark and possibly a new or modified corporate name. CellNet could
4
<PAGE>
CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. COMMITMENTS AND CONTINGENCIES. (CONTINUED)
encounter similar challenges in the future. While the requirement to adopt a new
trademark or new or modified corporate name could involve a significant expense
and could result in the loss of any goodwill and name recognition associated
with the Company's current trademark and corporate name, the Company does not
believe this would have a long-term material adverse impact on its results of
operations or financial condition.
In October 1996, Itron, Inc., one of the Company's competitors, filed a
complaint against the Company in the Federal District Court in Minnesota
alleging that the Company infringes an Itron patent which was issued in
September 1996. Itron is seeking a judgment for damages, attorneys fees and
injunctive relief. The Company believes, based on its current information, that
the Company's products do not infringe any valid claim in the Itron patent, and
in the Company's opinion, the ultimate outcome of the lawsuit is not expected to
have a material adverse effect on its results of operations or financial
condition.
On October 31, 1996, a complaint SETTLE V. SEIDL, ET AL., No. 398464, was
filed in the Superior Court of California for the County of San Mateo against
the Company, certain of its officers and directors and underwriters of the
Company's Initial Public Offering. The complaint, which is a purported class
action filed on behalf of those purchasing the Company's stock from the period
beginning on September 26, 1996 and ending on October 31, 1996, seeks
unspecified damages and rescission for alleged liability under various
provisions of the federal securities laws and California state law. Plaintiff
alleges that the Prospectus and Registration statement dated September 26, 1996,
pursuant to which the Company issued 5,000,000 shares of Common Stock to the
public, contained materially misleading statements and/or omissions in that
defendants were obligated to disclose, but failed to disclose, that a patent
conflict with Itron, Inc. was likely to ensue. On November 8 and 13, 1996, two
additional complaints, KAREN ZULLY V. CELLNET DATA SYSTEMS, INC., ET AL., No.
398551 and HOWARD FIENMAN AND GERALD SLAPSOWITZ V. CELLNET DATA SYSTEMS, INC.,
ET AL., No. 398560, were filed in the Superior Court of California for the
County of San Mateo. These cases are essentially similar in nature to the SETTLE
case. The Court has ordered consolidation of the SETTLE and ZULLY actions. The
Company expects that the FIENMAN action will be consolidated with the SETTLE and
ZULLY actions before trial. The Company believes that the allegations in these
complaints are without merit and intends to defend these actions vigorously. The
Company has filed demurrers seeking dismissal of these complaints. The motions
are currently under submission before the Special Master assigned by the Court
to hear certain pre-trial matters. In the Company's opinion, the ultimate
outcome of these lawsuits is not expected to have a material adverse effect on
its results of operations or financial condition.
In April 1997, the Company filed a patent infringement suit against Itron,
Inc. in the Federal District Court for the Northern District of California
claiming that Itron's use of its electronic meter reading Encoder Receiver
Transmitter (ERT-Registered Trademark-) device infringes CellNet's U.S. Patent
No. 4,783,623. The Company seeks an injunction, damages and other relief.
5
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS CONTAINS TREND ANALYSIS AND OTHER FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THAT INVOLVE
RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SET
FORTH IN SUCH FORWARD-LOOKING STATEMENTS AS A RESULT OF THE FACTORS SET FORTH
UNDER "FACTORS THAT MAY AFFECT FUTURE OPERATING PERFORMANCE" AND OTHER RISKS
DETAILED FROM TIME TO TIME IN THE COMPANY'S REPORTS FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION.
OVERVIEW
The Company intends to deploy and operate a series of wireless data
communications networks pursuant to long-term contracts with utility company
customers and to earn recurring revenues by providing network meter reading
("NMR") services to the utilities and using the network to support a variety of
non-utility applications. The Company may also provide NMR services pursuant to
(i) contracts and deployments with non-regulated third party entities (such as
system operators, power exchanges, power marketers, brokers, aggregators and
scheduling coordinators), (ii) broad, selective network deployments with
utilities and others aimed at serving the meter reading requirements of
high-value commercial and industrial customers (in addition to saturation
network deployments aimed at providing meter reading services for all meters
within a utility's service area), with other customers to be added over time,
(iii) contracts of shorter duration than those the Company has previously
entered into, and (iv) joint ventures or alliances with utilities and others to
form, own and/or operate metering companies or to provide metering services. The
Company's business strategy has affected and will continue to affect its
financial condition and results of operations as follows:
COMPOSITION OF REVENUES. The Company derives substantially all of its
revenues from fees earned under services agreements related to its wireless
communications networks. Under the Company's existing services agreements with
Kansas City Power & Light Company ("KCPL"), Union Electric Company ("UE"),
Northern States Power Company ("NSP"), Pacific Gas & Electric Company ("PG&E")
and Puget Sound Power & Light Company ("Puget"), the Company receives monthly
NMR service fees based on the number of endpoint devices that are in revenue
service during the applicable month and are being billed to customers.
UNEVEN REVENUE GROWTH. The timing and amount of the Company's future
revenues will depend upon its ability to obtain additional services agreements
with utilities and other customers and upon the Company's ability to deploy and
operate successfully its wireless communications networks. New services
agreements are expected to be obtained on an irregular basis, and there may be
prolonged periods during which the Company does not enter into any additional
services agreements and other arrangements. As a result, the Company expects
that its revenues will not grow smoothly over time, but will increase unevenly
as the Company enters into new services agreements and other commercial
relationships, and may decrease sharply in the event that any of its existing
services agreements are terminated or not renewed. See "Factors That May Affect
Future Operating Performance--Uncertainty of Future Revenues; Need for
Additional Services Contracts; and Fluctuating Operating Results."
UNCERTAINTY OF UTILITY MARKET ACCEPTANCE. The Company's future revenues
will depend on the number of energy or other companies signing new services
agreements with CellNet. During 1996, approximately 90% of the Company's
revenues were derived from contracts with KCPL and UE. The utility industry is
generally characterized by long purchasing cycles and cautious decision making,
and purchases of the Company's services are, to a substantial extent, deferrable
in the event that utilities seek to limit capital expenditures or decide to
defer such purchases for other reasons. Only a limited number of utilities have
made a commitment to purchase the Company's services to date. The Company
believes that it will enter into additional services contracts with other
utilities; however, if the Company's services do not gain
6
<PAGE>
widespread industry acceptance, its revenues would not increase significantly
after services contracts for existing network systems have been fully installed.
REVENUES LAG NETWORK DEPLOYMENT. The Company generally realizes network
service revenue under a services agreement with a utility only when a portion of
the network is installed and the utility has begun billing customers based upon
NMR data. The Company expects that its receipt of network service revenue will
lag the signing of the related services agreements by a minimum of six months
and that it will generally take two to four years to complete installation of a
network after each services agreement has been signed. A network's service
revenues are not expected to exceed the Company's capital investments and
expenses incurred to deploy such network for several years. As of June 30, 1997,
the Company had approximately 2,265,000 meters under long-term contracts, of
which approximately 580,000 meters were in revenue service. The Company signed
agreements with KCPL and UE in August 1994 and August 1995, respectively, and
did not receive its first revenue under the KCPL and UE services agreements
until September 1995 and May 1996, respectively. The Company has completed the
installation of its NMR network for KCPL and had installed approximately 378,000
meters on the network by the end of June 1997. The Company expects to add an
additional 37,000 meters to the KCPL network in the second half of 1997 and in
1998 which would be added to the total number of meters in revenue service upon
acceptance by KCPL for billing purposes. The remaining meters (approximately
5,000) under contract with KCPL may be automated or read manually. As of the end
of June 1997, the Company completed the on-line deployment of approximately
324,000 meters to the UE network and expects substantially to complete the UE
network in 1998. The Company began the installation of both the NSP and Puget
networks in August 1996 and began receiving revenue from Puget in January 1997.
The Company began the installation of the PG&E network in December 1996 and had
installed approximately 23,000 meters as of the end of June 1997. PG&E has
acknowledged that the data collection, cost savings, customer service and other
tests of the demonstration network have been met and has agreed with the Company
to build out the network to approximately 30,000 meters. As additional segments
of the Company's networks are installed and used by its utility clients for
billing purposes, the Company expects to realize a corresponding increase in its
network service revenues. However, if the Company is able to deploy successfully
an increasing number of networks over the next few years, the operating losses
created by this lag in revenues, and negative cash flow resulting from such
operating losses and the capital expenditures expected to be required in
connection with the installation of such networks, are expected to widen for a
period of time and will continue until the operating cash flow from installed
networks exceeds the costs of deploying and operating additional networks.
IMPACT OF RAPID EXPANSION. CellNet will not typically invest the capital
necessary to deploy a wireless communications network prior to entering into a
long-term services agreement with a utility or other customer. However, during
its expansion phase, the Company will be required to invest significant amounts
of capital in its networks and to incur substantial and increasing sales and
marketing expenses before receiving any return on such expenditures through
network service revenues. The Company has incurred substantial operating losses
since its inception and, as of June 30, 1997, had an accumulated deficit of
$213.6 million. The Company does not expect significant revenues relative to
anticipated operating costs during 1997 and expects to incur substantial and
increasing operating losses and negative net cash flow after capital
expenditures for the foreseeable future as it expands its research and
development and marketing efforts and installs additional networks. The Company
does not expect positive cash flow after capital expenditures from its NMR
services operations for several years. The Company will require substantial
capital to fund cash flow deficits and capital expenditures for the foreseeable
future and expects to finance these requirements through significant additional
external financing. See "Factors That May Affect Future Operating
Performance--History and Continuation of Operating Losses" and "--Substantial
Leverage and Ability to Service Debt; Substantial Future Capital Needs."
7
<PAGE>
INTEREST INCOME. The Company has earned substantial amounts of interest
income on short-term investments of the proceeds of its financing activities.
The Company expects to utilize substantially all of its cash, cash equivalents
and short-term investments in deploying its wireless communications networks, in
continuing research and development activities related thereto, in related
selling and marketing activities and for general and administrative purposes. As
such funds are expended, interest income is expected to decrease.
RESULTS OF OPERATIONS
REVENUES
Revenues for the six months ended June 30, 1996 and 1997 were $0.4 million
and $2.5 million, respectively. The increase in revenues was principally due to
the increase in network service revenues. During the first six months of 1997,
KCPL and UE accounted for 52% and 34% of the Company's revenues, respectively.
During the first six months of 1996, KCPL and UE accounted for 73% and 4% of the
Company's revenues, respectively. The Company's NMR service revenues for the six
months ended June 30, 1996 and 1997 were $0.2 million and $2.0 million,
respectively. In connection with the purchase of $15.0 million of restricted
Common Stock by NSP concurrent with the Company's Initial Public Offering, the
Company placed shares in escrow (the "Escrow Shares") which will be released
upon entering into an NMR services agreement with Wisconsin Electric Power
Company ("WEPC") by December 1997. The fair value of these Escrow Shares will be
expensed as a sales discount over the term of the WEPC services agreement if
such services agreement is entered into.
The Company generally realizes service revenues under its services
agreements with utilities only when its networks or portions thereof are
successfully installed and operating and the utility commences billing its
customers based upon the NMR data obtained. Revenues are expected to increase as
the Company continues to install its networks, the networks or portions thereof
become operational, and utilities begin billing their customers based upon data
obtained over the CellNet system. Due primarily to the nature, amount and timing
of revenues received to date, no meaningful period-to-period comparisons can be
made. Revenues received during the six months ended June 30, 1996 and 1997 are
not reliable indicators of revenues that might be expected in the future.
COST OF REVENUES
Cost of revenues historically have consisted of the cost of product sales.
For the six months ended June 30, 1996 and 1997, cost of revenues primarily
consisted of network operations costs. Cost of revenues for the six months ended
June 30, 1996 and 1997 were $3.0 million and $7.8 million, respectively. The
increase in cost of revenues was driven by increasing costs of providing network
services, due primarily to growth in the number of employees and associated
costs necessary for network monitoring operations at customer sites and at the
Company's headquarters, network deployment management and customer training.
Costs of network services also include the increased installation, applications
and RF engineering staffing at the Company's headquarters to support anticipated
additional utility contracts. Network services do not currently generate a
profit as the Company has not yet achieved a scale of services sufficient to
cover network costs. The Company will incur significant and increasing costs
primarily attributable to network operation and depreciation. Once a network has
been fully installed, costs associated with generating network revenues will
consist primarily of maintaining a monitoring center for such network, network
depreciation and miscellaneous maintenance and operating expenses.
OPERATING EXPENSES
Operating expenses, consisting of research and development, marketing and
sales, general and administrative costs and depreciation and amortization
expenses, were $21.8 million and $30.9 million, respectively, for the six months
ended June 30, 1996 and 1997. The increase in operating expenses on a
8
<PAGE>
period to period basis is attributable to the Company's rapid growth and to
increasing research and development and marketing and sales expenditures. The
Company expects to continue to spend a significant portion of its resources on
research and development activities for the foreseeable future. Marketing and
sales and general and administrative costs are expected to increase in the
future as the Company seeks to sign new services agreements.
RESEARCH & DEVELOPMENT
Research and development expenses are attributable largely to continuing
system software, firmware and equipment development costs, prototype
manufacturing, testing, personnel costs, consulting fees, and supplies. Research
and development costs are expensed as incurred. The Company's networks include
certain software applications which are integral to their operation. The costs
to develop such software have not been capitalized as the Company believes its
software development is essentially completed when technological feasibility of
the software is established and/or development of the related network hardware
is complete. Research and development expenses for the six months ended June 30,
1996 and 1997 were $11.8 million and $13.0 million, respectively. Research and
development spending increases for the six months ended June 30, 1997 reflect
primarily additions to the Company's engineering staff. The Company expects that
research and development expenses will increase in the near term for additional
investments in research and development projects for the principal purposes of
increasing network functionality and performance and lowering networking costs,
and in connection with the establishment of international operations.
MARKETING & SALES
Marketing and sales expenses consist principally of compensation, including
commissions paid to sales and marketing personnel, travel, advertising, trade
show and other promotional costs. Marketing and sales expenses for the six
months ended June 30, 1996 and 1997 were $2.9 million and $3.7 million,
respectively. These expenses have increased due to the Company's accelerated
efforts to sign new services agreements. The Company expects marketing and sales
expenses to continue to increase in absolute dollars as the Company seeks to
enter into new services agreements and undertakes a significantly larger
advertising program.
GENERAL & ADMINISTRATIVE
General and administrative expenses include compensation paid to general
management and administrative personnel, home office expense, communications
charges, recruiting costs, travel, and communications and other general
administrative expenses, including fees for professional services. General and
administrative expenses for the six months ended June 30, 1996 and 1997 were
$4.9 million and $9.1 million, respectively. The Company expects general and
administrative expenses to continue to increase in absolute dollars as the
Company increases staffing and continues developing information systems to
support its planned growth. The Company will need to increase administrative
expenditures in the longer term to expand domestic and establish international
operations.
INTEREST INCOME AND EXPENSE
Prior to June 1995, the Company funded its liquidity needs primarily from
the issuance of equity securities. In June and November 1995, the Company issued
and sold a total of $325.0 million aggregate principal amount at maturity of the
Company's 13% Senior Discount Notes due 2005 (the "1995 Notes") and warrants
(the "Note Warrants") for proceeds, net of issuance costs, of $169.9 million. On
October 2, 1996, the Company completed its Initial Public Offering in which it
sold 5,000,000 shares of its Common Stock at an offering price of $20 per share
for net proceeds of $92.2 million after deducting underwriting discounts and
commissions and offering expenses payable by the Company. In connection with the
Initial Public Offering, the Company also received $1.2 million in proceeds from
the cash exercise of warrants (the "Warrant Exercise") to purchase securities
converted into 495,918 shares of its Common Stock. In
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addition, on October 2, 1996, the Company completed certain direct placements
(the "Direct Placements") in which it sold 1,579,404 shares of its Common Stock
for proceeds of $28.0 million. Accordingly, the Company has earned interest
income on the invested proceeds from the 1995 Notes, the Note Warrants, the
Initial Public Offering, the Warrant Exercise and the Direct Placements. The
Company has also incurred significant interest expense from the amortization of
the original issue discount on the 1995 Notes.
Interest income has been and will continue to be received by the Company
from the short-term investment of proceeds from the issuance of equity and debt
securities pending the use of such proceeds by the Company for capital
expenditures and operating and other expenses. Interest income is expected to be
highly variable over time as proceeds from the issue and sale of additional
equity and debt securities are received and as funds are used by the Company in
its business. Interest income for the six months ended June 30, 1996 and 1997
were $3.5 million and $4.2 million, respectively.
No interest on the 1995 Notes is payable prior to December 15, 2000.
Thereafter until maturity in June 2005, interest on the 1995 Notes will be
payable semi-annually in arrears on each December 15 and June 15. The carrying
amount of the 1995 Notes accretes from the date of issue and the Company's
interest expense includes such accretion. Interest expense for periods prior to
June 1995 was attributable primarily to capital leases. Interest expense for the
six months ended June 30, 1996 and 1997 were $11.3 million and $12.6 million,
respectively.
PROVISION FOR INCOME TAXES
The Company has not provided for or paid federal income taxes due to the
Company's net losses. A nominal provision has been recorded for various state
minimum income and franchise taxes.
As of December 31, 1996, the Company had net operating loss carryforwards of
approximately $127.9 million and $71.9 million available to offset future
federal and state taxable income, respectively. The extent to which the loss
carryforwards can be used to offset future taxable income may be limited,
depending on the extent of ownership changes within any three-year period as
provided in the Tax Reform Act of 1986 and the California Conformity Act of
1987. Such state carryforwards will expire between 1997 and 2011. Such federal
carryforwards will expire between 2001 and 2011. Equity issuances in April 1991
and the Initial Public Offering in 1996 triggered such limitations on loss
carryforwards. As of December 31, 1996, approximately $108.0 million of net
operating losses remain limited to an annual usage of approximately $36.4
million for federal tax purposes. Based upon the Company's history of operating
losses and the expiration dates of the loss carryforwards, the Company has
recorded a valuation allowance to the full extent of its net deferred tax
assets.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires significant amounts of capital for research and
development in connection with the development of its proprietary wireless
communications network and related products and services, for investments in the
installation and testing of such networks and for related sales and marketing
and general and administrative expenses. Historically, the Company has satisfied
its liquidity requirements primarily through external financings, including
private placements of equity and debt securities and interest income derived
from the investment of the proceeds of its financing activities.
In the first six months of 1996 and 1997, net cash used in the Company's
operating activities totaled $18.8 million and $30.4 million, respectively. Net
cash used in operating activities resulted primarily from cash used to fund net
operating losses.
As of June 30, 1997, the Company had cash, cash equivalents and short-term
investments totaling $117.9 million. As of December 31, 1996, the Company had
cash, cash equivalents, and short-term investments totaling $178.9 million. The
decline of $61.0 million from December 31, 1996 was due
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primarily to operating costs and the development and construction of the
Company's wireless communications networks.
The 1995 Notes were issued at a substantial discount from their aggregate
principal amount at maturity of $325.0 million. Although interest is not payable
on the 1995 Notes prior to December 15, 2000, the carrying amount of such
indebtedness will increase as the original issue discount is amortized through
maturity in June 2005. Beginning June 15, 2000, the 1995 Notes will bear
interest, payable semi-annually, at a rate of 13% per annum, with payments
commencing December 15, 2000. No principal payments on the 1995 Notes are due
prior to maturity in June 2005.
In the first six months of 1996 and 1997, net cash provided (used) by
investing activities was $41.7 million and ($5.7) million, respectively. The
Company's investing activities consisted primarily of purchases of network
components and inventory, the construction and installation of networks,
purchases of property and equipment, and purchases, sales and maturities of
short-term investments. The $41.7 million of net cash provided by investing
activities in the first six months of 1997 was largely attributable to proceeds
from the sale of short-term investments. These proceeds exceed investments in
short-term instruments as the Company used the proceeds of short-term
investments to fund its operating activities. The Company shortened the maturity
of its portfolio of short-term investments to less than 90 days, which are
classified, accordingly, as cash equivalents.
Deployments of the Company's wireless communications networks will require
substantial additional capital. In addition, funds will be required for further
enhancements to the system software, firmware, hardware and other equipment to
increase the speed, capacity and functionality of the system, to enhance system
productivity over time and to expand the scope of utility and other network
information services that may be offered on the CellNet system. The Company
currently estimates that funds required for such capital expenditures for the
construction of networks presently under contract will be approximately $21.3
million for the last six months of 1997. The Company expects that cash used for
the construction and installation of networks and for the purchase of property
and equipment will increase substantially as and when the Company obtains new
services agreements or enters into other arrangements for the installation of
its networks, and that the Company will require significant amounts of
additional capital from external sources. Sources of additional capital for the
Company and its Subsidiaries may include project or conventional bank financing,
public and private offerings of debt and equity securities and revenues
generated from operating activities. To provide financing for installation of
the Company's network under its UE Services Agreement, the Company has received
a commitment from Toronto Dominion Bank for $25.0 million for a nine-year and
three-month secured revolving credit facility on conventional bank financing
terms. This commitment is subject to standard conditions including satisfactory
documentation. This facility is expected to require the Company's St. Louis
operations to meet certain revenue requirements and to limit the capital
expenditures and indebtedness of such operations. The Company expects that a
substantial portion of its future financing will be at the subsidiary level on a
project basis. The Company expects to obtain third party financing for the
construction of wireless networks, based on the projected cash flow expected to
be generated from such projects. The Company expects that the recurring revenue
stream from services contracts and other arrangements will support the
amortization of debt raised for the project involved. The Company does not
anticipate deriving any significant cash from such operations for several years.
The Company believes existing cash, cash equivalents and anticipated
interest income and other revenues, will be sufficient to meet its cash
requirements for at least the next 9 months using management's best estimates.
Thereafter, the Company expects that it will require substantial additional
capital. The extent of additional financing will depend on the success of the
Company's business. The Company expects to incur significant operating losses
and to generate increasingly negative net cash flow during the next several
years while it develops and installs its network communications systems. There
can be no assurance that additional financing will be available to the Company
or, if available, that it can be obtained on terms acceptable to the Company and
within the limitations on incurrence of indebtedness contained in the
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Indenture or that may be contained in any additional financing arrangements.
Failure to obtain such financing could result in the delay or abandonment of
some or all of the Company's development and expansion plans and expenditures,
which could limit the ability of the Company to meet its debt service
requirements and could have a material adverse effect on its business and on the
ability of the Company to meet its obligations. See "Factors That May Affect
Future Operating Performance-- Substantial Leverage and Ability to Service Debt;
Substantial Future Capital Needs."
FACTORS THAT MAY AFFECT FUTURE OPERATING PERFORMANCE
SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT; SUBSTANTIAL FUTURE CAPITAL
NEEDS
The Company has substantial outstanding indebtedness and must begin paying
cash interest on the aggregate accreted amount of $325 million of the 1995 Notes
on December 15, 2000. The Company intends to incur substantial additional
indebtedness, primarily in connection with installing future networks. As a
result, the Company will have substantial debt service obligations. The
Company's capital expenditures will increase significantly if new services
contracts are signed, and the Company expects that its cash flow taking into
account capital expenditures will be increasingly negative over the next several
years. The ability of the Company to meet its debt service requirements will
depend upon achieving significant and sustained growth in the Company's cash
flow, which will be affected by its success in implementing its business
strategy, prevailing economic conditions and financial, business and other
factors, certain of which are beyond the Company's control. The Company's
ability to generate such cash flow is subject to a number of risks and
contingencies. Included among these risks are: (i) the possibilities that the
Company may not obtain sufficient additional services agreements or complete
scheduled installations on a timely basis, (ii) revenues may not be generated
quickly enough to meet the Company's operating costs and debt service
obligations, (iii) the operating and/or capital costs associated with the
installation and maintenance of the network could be higher than projected, (iv)
the Company's wireless systems could experience performance problems, or (v)
adoption of the Company's system could be less widespread than anticipated.
Accordingly, there can be no assurance as to whether or when the Company's
operations will generate positive cash flow or become profitable or whether the
Company or its subsidiaries will at any time have sufficient resources to meet
their debt service obligations. If the Company is unable to generate sufficient
cash flow or obtain alternate liquidity to service its indebtedness, it will
have to reduce or delay planned capital expenditures, sell assets, restructure
or refinance its indebtedness or seek additional equity capital. There can be no
assurance that any of these strategies could be effected on satisfactory terms,
if at all, particularly in light of the Company's high levels of indebtedness.
In addition, the degree to which the Company is leveraged could have significant
consequences, including, but not limited to, the following: (i) the Company's
ability to obtain additional financing in the future for working capital,
capital expenditures, research and development, acquisitions, and other general
corporate purposes may be materially limited or impaired, (ii) a substantial
portion of the Company's cash flow from operations must be dedicated to the
payment of principal and interest on its indebtedness and therefore cannot be
used in the Company's business, and (iii) the Company's high degree of leverage
may make it more vulnerable to economic downturns, may limit its ability to
withstand competitive pressures and may reduce its flexibility in responding to
changing business and economic conditions.
The Company will require substantial additional funds for the development,
commercial deployment and expansion of its networks, as well as to fund
operating losses. As of June 30, 1997, the Company had $117.9 million in cash,
cash equivalents and short-term investments. The Company believes that its
existing cash, cash equivalents and short-term investments and anticipated
interest income and other revenues, will be sufficient to meet its cash
requirements for at least the next 9 months based on management's best
estimates. Thereafter, the Company expects that it will require substantial
additional capital. Depending upon the number and timing of any new services
agreements and upon the associated network deployment costs and schedules, the
Company may require additional equity or debt financing earlier than estimated
in order to fund its working capital and other requirements. Future financings
may be dilutive to existing stockholders. There can be no assurance that
additional financing will be available when required or, if
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available, that it will be on terms satisfactory to the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations Liquidity and Capital Resources."
Substantially all of the operations of the Company are and will be conducted
through subsidiaries. Nonetheless, the Company has incurred significant
indebtedness at the holding company level and intends to incur substantial
additional holding company indebtedness. The ability of the Company to service
such indebtedness will depend on the availability of income and cash flow from
its subsidiaries for distribution to the holding company. Such availability will
depend on a number of factors, including the terms of financing agreements
entered into by the Company's subsidiaries and restrictions arising under the
laws of the jurisdictions, which may be foreign jurisdictions, wherein those
subsidiaries conduct their businesses. The Company's subsidiaries are separate
and distinct legal entities and have no obligation, contingent or otherwise, to
pay any amounts due on the Company's indebtedness or to make any funds available
therefor, whether in the form of loans, dividends or otherwise. In addition, the
Company intends to pursue its international business through a joint venture
with Bechtel Enterprises, Inc. ("BEn"), and the joint venture structure may
limit the amount of funds permitted to be upstreamed to the Company. Any default
in the payment of its debt obligations could seriously impair the value of the
Common Stock.
In the event that the Company is unable to generate sufficient cash flow and
is otherwise unable to obtain funds necessary to meet required payments on its
indebtedness, the Company could be in default under the terms of the agreements
governing such indebtedness. In the event of such default, the holders of such
indebtedness would have certain enforcement rights, including the right to
accelerate such debt and the right to commence an involuntary bankruptcy
proceeding against the Company. In any such proceeding affecting any subsidiary
of the Company, the holders of such subsidiary's debt (including trade payables
and subordinated indebtedness) would be entitled to receive payment of their
claims prior to any distributions to the Company by such subsidiary. In
addition, any holders of secured indebtedness of the Company and its
subsidiaries would have certain rights to repossess, foreclose upon and sell the
assets securing such indebtedness. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
HISTORY AND CONTINUATION OF OPERATING LOSSES
The Company has incurred substantial and increasing operating losses since
inception. As of June 30, 1997, the Company had an accumulated deficit of $213.6
million, primarily resulting from expenses incurred in the development of the
Company's wireless data communications system, marketing of the Company's NMR,
distribution automation and other services, the installation of its wireless
data communications networks and the payment of other normal operating costs.
The Company does not expect significant revenues relative to anticipated
operating costs during 1997 and expects to incur substantial and increasing
operating losses and negative net cash flow after capital expenditures for the
foreseeable future as it expands its research and development and marketing
efforts and installs additional networks. The Company expects that its receipt
of network service revenues will lag the signing of the related services
agreements by a minimum of six months and that it will generally take two to
four years to complete installation of a network after each services agreement
has been signed. The Company's network service revenues from a particular
network are expected to lag significantly behind network installation expenses
until such network is substantially complete. If the Company is able to deploy
additional networks, the losses created by this lag in revenues are expected to
increase until the revenues from the installed networks overtake the costs
associated with the deployment and operation of such additional networks. The
Company does not expect positive cash flow after capital expenditures from its
NMR services operations for several years. A large portion of the Company's
limited revenues to date has been attributable to miscellaneous equipment sales
and development and other contract revenues that are largely non-recurring and
that the Company expects to decrease and remain at relatively insignificant
levels over the next few years. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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DEPENDENCE ON AND UNCERTAINTY OF UTILITY MARKET ACCEPTANCE
The Company's success will be almost entirely dependent on whether a
material number of utility or other companies sign services contracts with
CellNet or enter into other arrangements which allow CellNet to install its NMR
networks. During 1996, approximately 90% of the Company's revenues were derived
from contracts with KCPL and UE. Any decision by a utility to utilize the
Company's services will involve a significant organizational, technological and
financial commitment by such utility. The utility industry is generally
characterized by long purchasing cycles and cautious decision making. Utilities
typically go through numerous steps before making a final purchase decision.
These steps, which can take up to several years to complete, may include the
formation of a committee to evaluate the purchase, the review of different
technical options with vendors, performance and cost justifications, regulatory
review and the creation and issuance of requests for quotes and proposals, as
well as the utilities' normal budget approval process. Purchases of the
Company's services are, to a substantial extent, deferrable in the event that
utilities seek to reduce capital expenditures or decide to defer such purchases
for other reasons. Only a limited number of utilities have made a commitment to
purchase the Company's services to date, and there can be no assurance as to
when or if the Company will enter into additional services contracts or that any
such agreement would be on favorable terms to the Company.
Because automation of utility meter reading and distribution is a relatively
new and evolving market, it is difficult to predict the future growth rate and
size of this market. Utility companies are testing products from various
suppliers for various applications, and no industry standard has been broadly
adopted. The CellNet system is one possible solution for automated meter reading
and distribution automation. There can be no assurance that the Company will be
successful in achieving the large-scale adoption of its system. In the event
that the utility industry does not adopt the Company's technology, or does so
less rapidly than expected by the Company, the Company's future results,
including its ability to service its indebtedness and achieve profitability,
will be materially and adversely affected. In recent competitive bids, potential
utility customers have from time to time selected competing systems to perform
services offered by the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
UNCERTAINTY OF FUTURE REVENUES; NEED FOR ADDITIONAL SERVICES CONTRACTS AND
FLUCTUATING OPERATING RESULTS
The timing and amount of future revenues will depend almost entirely upon
the Company's ability to obtain new services agreements with utilities and other
parties and upon the successful deployment and operation of the Company's
wireless data communications networks. The signing of any new services contracts
is expected to occur on an irregular basis, if at all. The Company expects that
it will generally take two to four years to complete the installation of each
network after a services contract has been signed. Service revenues from such
networks are not expected to exceed the Company's capital investments and
expenses incurred to deploy and operate such network for several years. The
Company will not begin to receive recurring revenues under a services contract
until portions of the network become operational, which is expected to occur no
earlier than six months after installation begins. The Company's results of
operations may be adversely affected by delays or difficulties arising in the
network installation process. The cost of network deployments will be highly
variable and depend upon a wide variety of factors, including radio frequency
characteristics, the size of a service territory and density of endpoints within
such territory, the nature and sophistication of services being provided, local
labor rates and other economic factors.
CellNet currently derives almost all of its revenues from long-term services
contracts with a limited number of utilities. The Company will not generate
sufficient cash flow to service its indebtedness or achieve profitability unless
it enters into a significant number of additional services contracts. There can
be no assurance that the Company will complete commercial deployments of the
CellNet system under current utility contracts successfully or that it will
obtain enough additional contracts on satisfactory terms
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for network deployments in a sufficient number of locations to allow the Company
to achieve adequate cash flow to service its indebtedness or achieve
profitability. The Company's operating results will fluctuate significantly in
the future as a result of a variety of factors, some of which are outside of the
Company's control, including the rate at which utilities and other customers
enter into new services contracts, general economic conditions, economic
conditions in the utility industry, the effects of governmental regulations and
regulatory changes, capital expenditures and other costs relating to the
expansion of operations, the introduction of new services by the Company or its
competitors, the mix of services sold, pricing changes and new service
introductions by the Company and its competitors and prices charged by
suppliers. In response to a changing competitive environment, the Company may
elect from time to time to make certain pricing, service or marketing decisions
or enter into strategic alliances or investments that could have a material
adverse effect on the Company's business, results of operations, financial
condition and cash flow. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
UNCERTAINTY OF ACCEPTANCE OF AND DEPENDENCE ON OTHER APPLICATIONS
The Company's long-term business plan contemplates offering non-utility
application services. The Company believes its future ability to service its
indebtedness and to achieve profitability will be affected by its success in
generating substantial revenues from such additional services. The Company
currently has no services contracts which provide for the implementation of such
services, and the Company has not yet demonstrated an ability to deploy such
services on a commercial scale. In addition, unless utilities sign services
contracts that enable the Company to deploy its wireless networks in their
service areas, the Company may not be able to offer any such services in such
areas or may be able to offer these services only on a limited basis.
SUBSTANTIAL AND INCREASING COMPETITION
The emerging market for utility NMR systems, and the potential market for
other applications once a common infrastructure is in place, have led
electronics, communications and utility product companies to begin developing
various systems, some of which currently compete, and others of which may in the
future compete, with the CellNet system. The Company believes that its only
significant direct competitor in the marketplace at present is Itron, Inc.
("Itron"), an established supplier to the utility industry. Itron has announced
the development of its Genesis-TM- system, a radio network system similar to the
Company's, for meter reading purposes and is presently providing that system to
customers.
There may be many potential alternative solutions to the Company's NMR
services including traditional wireless solutions. SkyTel, a subsidiary of Mtel,
and Motorola are examples of companies whose technology might be adapted for NMR
and who may become direct competitors of the Company in the future. Whisper
Communications (formerly, a part of Diablo Research) now offers its True 2
Way-TM- fixed-base RF architecture communications technology for automated meter
reading and other services, and has several trials underway. Metricom, a
provider primarily of subscriber-based, wireless data communications for users
of portable and desktop computers, is currently involved in the AMR market
through trials with Whisper Communications. Schlumberger and Greenland are among
the companies that have conducted, or are in the process of conducting, pilot
trials of utility network automation systems. Several companies are offering
telephone-based network automated meter reading services or equipment. Among
these are International Teldata and American Innovations. Established suppliers
of equipment, services and technology to the utility industry such as Asea Brown
Boveri and General Electric could expand their current product and service
offerings so as to compete directly with the Company, although they have not yet
done so. Many of the Company's present and potential future competitors have
substantially greater financial, marketing, technical and manufacturing
resources, name recognition and experience than the Company. The Company's
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
development, promotion and sale of their products and services than the Company.
While CellNet believes its technology is widely regarded
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as competitive at the present time, there can be no assurance that the Company's
competitors will not succeed in developing products or technologies that are
better or more cost effective. In addition, current and potential competitors
may make strategic acquisitions or establish cooperative relationships among
themselves or with third parties that increase their ability to address the
needs of the Company's prospective customers. Accordingly, it is possible that
new competitors or alliances among current and new competitors may emerge and
rapidly gain significant market share. In addition, if the Company achieves
significant success it could draw additional competitors into the market.
Traditional providers of wireless services may in the future choose to enter the
Company's markets. Such existing and future competition could materially
adversely affect the pricing for the Company's services and the Company's
ability to sign long-term contracts and maintain existing agreements with
utilities. Competition for services relating to non-utility applications may be
more intense than competition for utility NMR services, and additional
competitors may emerge as the Company continues to develop non-utility
applications. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and any failure to do so
would have a material adverse effect on the Company's business, operating
results, financial condition and cash flow.
TECHNOLOGICAL PERFORMANCE AND BUILD-OUT OF THE SYSTEM; RAPID TECHNOLOGICAL
CHANGE AND UNCERTAINTY
The Company's initial target market is the monitoring, control and
automation of utility companies' electric, gas and water distribution networks.
There can be no assurance that unforeseen problems will not develop with respect
to the Company's technology, products or services, or that the Company will be
successful in completing the development and commercial implementation of its
technology on a wider scale. The Company must continue to expand and upgrade its
capabilities in connection with such commercial implementation, the success of
which cannot be assured. There can be no assurance that the Company will be able
to develop successfully a full range of endpoint devices required by utilities.
The Company must also continue to develop the hardware enhancements necessary to
utilize its system on a commercial basis with a variety of different gas and
water meters. The Company's future success will be materially adversely affected
if it is not successful or is significantly delayed in continuing technology
development and enhancement programs.
The Company's future success will also depend, in part, on its ability to
enhance its existing hardware, software and wireless communications technology.
The telecommunications industry has been characterized by rapid, significant
technological advances. The advent of computer-linked electronic networks, fiber
optic transmission, advanced data digitization technology, cellular and
satellite communications capabilities and personal communications systems
("PCS") have radically expanded communications capabilities and market
opportunities. Future advances may render the Company's technology obsolete or
less cost effective than competitive systems or erode the Company's market
position. Many companies from diverse industries are seeking solutions for the
transmission of data over traditional communications media, including radio, as
well as more recently developed media such as cellular and PCS-based networks.
Competitors may be capable of offering significant cost savings or other
benefits to the Company's customers, and there can be no assurance that the
Company will maintain competitive services or obtain appropriate new
technologies on a timely basis or on satisfactory terms.
The Company's necessary development efforts will require it to make
continued substantial investments. The Company has encountered product
development delays in the past affecting both software and hardware components
of its system.
ACCESS TO RADIO FREQUENCY ("RF") SPECTRUM; REGULATION BY THE FEDERAL
COMMUNICATIONS COMMISSION ("FCC")
The Company will attempt to obtain exclusive usage of licensed bandwidth
and/or secure its own licenses. CellNet licenses radio spectrum for its wireless
networks in the top 60 MSAs in the United States sufficient to support its
projected utility and non-utility applications with a margin for future growth.
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However, sufficient frequency spectrum may not be available to fully enable the
delivery of all or a part of the Company's wireless data communications services
or the Company may be required to find alternative frequencies. The cost of
obtaining such spectrum is currently difficult to estimate and may involve time
delays and/or increased cost to the Company. The Company could also be unable to
obtain frequency in certain areas. Any of these circumstances could have a
material adverse impact on the Company's future ability to provide its network
services and on the Company's business, operating results, financial condition
and cash flow.
The Company's network equipment uses radio spectrum and, as such, is subject
to regulation by the FCC. The Company's network equipment uses both licensed RF
spectrum allocated for multiple address system ("MAS") operations in the 928/952
MHz band and unlicensed spectrum in the 902-928 MHz band. In order to obtain a
license to operate the Company's network equipment in the 928/952 MHz band,
license applicants may need to obtain a waiver of various sections of the FCC's
rules. There can be no assurance that the Company will be able to obtain such
waivers on a timely basis or to obtain them at all. In addition, as the amount
of spectrum in the 928/952 MHz band is limited, issuance of these licenses is
contingent upon the availability of spectrum in the area(s) for which the
licenses are requested. The Company might not be able to obtain licenses to the
spectrum it needs in every area in which it has prospective customers. The FCC's
current rules, subject to a number of limited exceptions, permit third parties
such as CellNet to operate on spectrum licensed to utilities to provide other
services. The Company plans to use these provisions of the FCC's rules to expand
its network system.
The FCC requires that a minimum configuration of an MAS system be in
operation within eighteen months from the initial date of the grant of the
system authorization or risk forfeiture of the license for the MAS frequencies.
The eighteen-month deadline may be extended upon showing of good cause, but
there is no assurance that the FCC will grant any such extension. The Company is
responding to this requirement by selectively building out transmission capacity
in some areas where it does not yet have utility telecommunications services
contracts and may return licenses to the FCC in certain areas.
No license is needed to operate the Company's equipment utilizing the
902-928 MHz band, although the equipment must be certified by the Company and
the FCC as being compliant with certain FCC restrictions on radio frequency
emissions designed to protect licensed services from objectionable interference.
While the Company believes it has obtained all required certifications for its
products, the FCC could modify the limits imposed on such products or otherwise
impose new authorization requirements, and in either case, such changes could
have a material adverse impact on the Company's business. The FCC recently
completed a rulemaking proceeding designed to better accommodate the
cohabitation in the 902-928 MHz band of existing licensed services with newly
authorized and expanded uses of licensed systems, and existing and newly
designed unlicensed devices like those used by the Company. In this proceeding,
the FCC expressly recognized the rights of such unlicensed services to operate
under certain delineated operating parameters even if the potential for
interference to the licensed operations exists. The Company's systems will
operate within those specified parameters. The FCC is currently reviewing these
rules in response to numerous petitions for reconsideration and the agency could
modify those rules or to allow for other uses of this spectrum that might create
interference to the Company's systems, which could, in either case, have a
material adverse impact on the Company's business, operating results, financial
condition and cash flow.
The FCC's rules currently prohibit the use of the MAS frequencies on which
the Company is operating its systems for the provision of common carrier service
offerings. In the event that it is determined that a particular service offering
does not comply with the rules, the Company may be required to restructure such
offering or to utilize other frequencies for the purpose of providing such
service. There can be no assurance that the Company will gain access to such
other frequencies. Future interpretation of regulations by the FCC or changes in
the regulation of the Company's industry by the FCC or other regulatory bodies
or legislation by Congress could have a material adverse effect on the Company's
business, operating results, financial condition and cash flow.
17
<PAGE>
In February, 1997, the FCC published for public comment a Notice of Proposed
Rule Making in WT Docket No. 97-81 regarding the future licensing of frequencies
for use by Multiple Address Systems. The FCC has reached certain tentative
conclusions which, if adopted without any change, would result in (i) the
restriction on future licenses in the 928/952/956 MHz bands (in which the
Company now operates its wide area network) for systems exclusively used for
private internal purposes, and the prohibition on future licensing in this band
for systems which provide "subscriber-based" services, (ii) the designation of
the 932/941 and 928/959 MHz bands for licensees offering subscriber-based
services, (iii) the use of geographic licensing (using very large licensed
service areas) in lieu of site-by-site licensing for the bands designated for
subscriber-based services, (iv) the use of competitive bidding to award licenses
for subscriber-based services, (v) the grandfathering and protection from
interference of existing licensees, but only to the extent of their current
service areas, (vi) with respect to new geographic service area licensees,
liberalizing the time periods by which construction must be completed, but
imposing more burdensome construction requirements over the term of the license,
and (viii) for incumbent and new licensees, liberalizing some of the technical
and operational restrictions on the use of the license channels.
These proposals have engendered substantial public comment from a wide range
of industry sectors currently utilizing the MAS channels, including extensive
comments from the Company. The Company has urged, in particular, that there
should not be any restrictions imposed on the use of the 928/952 MHz bands in
which the Company has developed its network facilities that would unreasonably
limit the Company's ability to provide its current and anticipated utility and
non-utility service offerings. The Company has also urged that competitive
bidding and geographic licensing should not be the primary basis for awarding
licenses in this highly encumbered, heavily utilized band. The Company has also
supported many of the proposed changes that will make the use of the band more
technically efficient, although the Company has also opposed any use of the band
that would change its fundamental use for point-to-multipoint fixed operations,
and in particular, the use of the band for mobile operations. The Company's
positions have substantial support in the record, although the effort to retain
the status quo eligibility for the 928/952 MHz band has been opposed by
representatives of the utility and transportation industries who would prefer to
limit the use of this band solely to private internal networks and to prohibit
any private carrier or subscriber-based service offerings.
The Company is currently working with a coalition of interested parties,
including representatives of the utility and transportation industries, to
attempt to develop a compromise consensus proposal that would satisfy most of
the interested parties' concerns for presentation to the FCC in this proceeding.
However, the Company is unable to predict whether such a compromise can be
developed, or if it is developed, whether the Commission will view it favorably,
and if not, what form the final rules adopted in this proceeding will take.
Given the current proposal and the variety of comments submitted, it is possible
that some or all of the Company's uses of the MAS channels could be determined
to be the offering of private carrier or subscriber-based services, and that
future licenses for such offerings would be prohibited in the 928/952 MHz band
in which the Company currently operates, requiring the Company to develop
equipment capable of operating in one of the other MAS bands, and further
requiring the Company to obtain future licenses in a competitive bidding
process. Although the Company believes that additional licensed frequency will
be generally available to it as required, the cost associated with acquiring
such licensed frequency as well as the Company's operating costs could increase,
perhaps substantially, if the proposed rules were adopted. The adoption of new
rules, depending upon the form in which such rules are adopted, could have a
material adverse effect upon the Company's business, operating results,
financial condition and cash flow.
In connection with the foregoing, the FCC has temporarily suspended
acceptance of MAS applications for new licenses, major amendments, or major
modifications for the 928/959 MHz bands and applications to provide
subscriber-based services in the 928/952/956 MHz bands. This temporary
suspension does not affect applications for MAS licenses for private internal
purposes in the 928/952/956 MHz bands or applications for assignment of licenses
or transfer of control. Subject to certain limitations,
18
<PAGE>
pending applications at the time of the suspension will continue to be
processed. All of the Company's pending applications for licenses in the 928/952
MHz band have been or are being processed in due course. In addition, the
Company's applications for the assignment of licenses held by others have been
processed during the processing suspension. However, the FCC has tentatively
concluded that the Company's applications for licenses involve the offering of
subscriber-based services, and have therefore returned any applications newly
filed after the initiation of the processing suspension, precluding the Company
from obtaining any new licenses (other than through the assignment process)
while the processing suspension is in place. The Company has requested
reconsideration of this determination since the currently proposed uses of these
licenses constitutes, in the Company's view, a private, internal use network. If
the FCC does not change its tentative conclusion on this matter, the Company
will not be able to file any applications for new facilities until the
suspension is lifted, which is expected to occur when the proceedings in Docket
97-81 are concluded. This may adversely affect the Company's ability to service
areas where it has not yet acquired adequate frequencies.
MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL
The Company's recent growth has placed, and is expected to continue to
place, a significant strain on its managerial, operational and financial
resources. The Company's ability to manage growth effectively will require it to
continue to implement and improve its operational and financial systems and to
expand, and manage its employee base. These demands are expected to require the
addition of new management personnel and the development of additional expertise
by existing management personnel. There can be no assurance that the Company
will be able to effectively manage the expansion of its operations, that its
systems, procedures or controls will be adequate to support the Company's
operations or that Company management will be able to exploit opportunities for
the Company's services. An inability to manage growth, if any, could have a
material adverse effect on the Company's business, results of operations,
financial condition and cash flow.
The success of the Company is substantially dependent on its key management
and technical personnel, the loss of one or more of whom could adversely affect
the Company's business. All of the Company's employees and officers are employed
on an at-will basis. Presently, the Company does not maintain a "key man" life
insurance policy on any of its executives or employees. The Company's future
success also depends on its continuing ability to identify, hire, train and
retain other highly qualified technical and managerial personnel. Competition
for such personnel is intense, and there can be no assurance that the Company
will be able to attract or retain highly qualified technical and managerial
personnel in the future. An inability to attract and retain the necessary
technical and managerial personnel could have a material adverse effect on the
Company's business, operating results, financial condition and cash flow.
UNCERTAINTY OF PROTECTION OF COPYRIGHTS, PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of trade secret protection, copyright,
patent, trademark and confidentiality agreements and licensing arrangements to
establish and protect its proprietary rights. The Company's success will depend
in part on its ability to maintain copyright and patent protection for its
products, to preserve its trade secrets and to operate without infringing the
proprietary rights of third parties. While the Company has obtained and applied
for patents, and intends to file applications as appropriate for patents
covering its products and processes, there can be no assurance that additional
patents will be issued or, if issued, that the scope of any patent protection
will be significant, or that any patents issued to the Company or licensed by
the Company will not be challenged, invalidated or circumvented, or that the
rights granted thereunder will provide proprietary protection to the Company.
Since United States patent applications are maintained in secrecy until
patents are issued, and since publication of inventions in the technical or
patent literature tend to lag behind such inventions by several months, CellNet
cannot be certain that it was the first creator of inventions covered by its
issued patents or
19
<PAGE>
pending patent applications, that it was the first to file patent applications
for such inventions or that no patent conflict will exist with other products or
processes which could compete with the Company's products or approach. Despite
the Company's efforts to safeguard and maintain these proprietary rights, there
can be no assurance that the Company will be successful or that the Company's
competitors will not independently develop and patent technologies that are
substantially equivalent or superior to the Company's technologies. Participants
in the wireless industry, including competitors of the Company, typically seek
to obtain patents which will provide as broad a protection as possible for their
products and processes. There is a substantial backlog of patents at the United
States Patent and Trademark Office. It is uncertain whether any such third-party
patents will require the Company to alter its products or processes, obtain
licenses or cease certain activities. An adverse outcome with regard to a
third-party patent infringement claim could subject the Company to significant
liabilities, require disputed rights to be licensed or restrict the Company's
ability to use such technology. The Company also relies to a substantial degree
upon unpatented trade secrets, and no assurance can be given that others,
including the Company's competitors, will not independently develop or otherwise
acquire substantially equivalent trade secrets. In addition, whether or not
additional patents are issued to the Company, others may receive patents which
contain claims applicable to products or processes developed by the Company. If
any such claims were to be upheld, the Company would require licenses, and no
assurance can be given that licenses would be available on acceptable terms, if
at all. In addition, the Company could incur substantial costs in defending
against suits brought against it by others for infringement of intellectual
property rights or in prosecuting suits which the Company might bring against
other parties to protect its intellectual property rights. From time to time the
Company receives inquiries with respect to the coverage of its intellectual
property rights, and there can be no assurance that such inquiries will not
develop into litigation.
In October 1996, Itron, one of the Company's competitors, filed a complaint
against the Company in the Federal District Court in Minnesota, alleging that
the Company infringes an Itron patent which was issued in September 1996. Itron
is seeking a judgment for damages, attorneys' fees and injunctive relief. The
Company believes, based on information currently known, that the Company's
products do not infringe any valid claim in the Itron patent, and in the
Company's opinion, the ultimate outcome of the lawsuit is not expected to have a
material adverse effect on its results of operations or financial condition.
In April 1997, the Company filed a patent infringement suit against Itron in
the Federal District Court for the Northern District of California claiming that
Itron's use of its electronic meter reading Encoder Receiver Transmitter
(ERT-Registered Trademark-) device infringes CellNet's U.S. Patent No.
4,783,623. The Company seeks an injunction, damages and other relief.
Although the Company has been granted federal registration of its "CellNet"
trademark, another company has filed a petition for cancellation in an attempt
to challenge such registration which, if successful, would mean the Company
could lose its registration and be required to adopt a new trademark and
possibly a new or modified corporate name. CellNet could encounter similar
challenges to its trademark and corporate name in the future. While the
requirement to adopt a new trademark or new or modified corporate name could
involve a significant expense and could result in the loss of any goodwill and
name recognition associated with the Company's current trademark and corporate
name, the Company does not believe this would have a long-term material adverse
impact on its results of operations or financial condition.
DEPENDENCE ON THIRD-PARTY MANUFACTURERS; EXPOSURE TO COMPONENT SHORTAGES
The Company relies and will continue to rely on outside parties to
manufacture a majority of its network equipment such as radio devices and
printed circuit boards. As the Company signs additional services contracts,
there will be a significant ramp-up in the amount of manufacturing by third
parties in order to enable the Company to meet its contractual commitments.
There can be no assurance that these manufacturers will be able to meet the
Company's manufacturing needs in a satisfactory and timely manner or that the
Company can obtain additional manufacturers when and if needed. Although the
20
<PAGE>
Company believes alternative manufacturers are available, an inability of the
Company to develop alternative suppliers quickly or cost-effectively could
materially impair its ability to manufacture and install systems. The Company's
reliance on third-party manufacturers involves a number of additional risks,
including the absence of guaranteed capacity and reduced control over delivery
schedules, quality assurance, production yields and costs. Although the Company
believes that these manufacturers would have an economic incentive to perform
such manufacturing for the Company, the quality, amount and timing of resources
to be devoted to these activities is not within the control of the Company, and
there can be no assurance that manufacturing problems will not occur in the
future. A significant price increase, a quality control problem, an interruption
in supply from one or more of such manufacturers or the inability to obtain
additional manufacturers when and if needed could have a material adverse effect
on the Company's business, operating results, financial condition and cash flow.
Certain of the Company's subassemblies, components and network equipment are
procured from single sources and others are procured only from a limited number
of sources. In addition, CellNet may be affected by general shortages of certain
components, such as surface mounted integrated circuits and memory chips. There
have been shortages of such materials generally in the marketplace from time to
time in the past. The Company's reliance on such components and on a limited
number of vendors and subcontractors involves certain risks, including the
possibility of shortages and reduced control over delivery schedules,
manufacturing capability, quality and cost. A significant price increase or
interruption in supply from one or more of such suppliers could have a material
adverse effect on the Company's business, operating results, financial condition
and cash flow. Although the Company believes alternative suppliers of
sub-assemblies, components and network equipment are available, the inability of
the Company to develop alternative sources quickly or cost-effectively could
materially impair its ability to manufacture and install systems. Lead times can
be as long as a year for certain components, which may require the Company to
use working capital to purchase inventory significantly in advance of receiving
any revenues.
A significant number of new meters are required to initiate meter retrofit
and replacement in connection with each network deployment and to replace
existing meters in the field which are found to be obsolete, worn out or
otherwise unsuitable for retrofit and redeployment. Any increase in the number
of deployments would result in an increase in the number of new meters ordered
by utilities over and above those ordered on account of normal growth and
replacement within their service areas. To the extent that electric meter
manufacturers are unable or unwilling to increase production in line with such
increase in demand, temporarily or over a longer term, deployments may be
delayed or postponed, with the result that revenues from such deployments will
be likewise delayed or postponed.
DEPENDENCE ON BUSINESSES ALLIANCES
A key element of the Company's business strategy is the formation of
corporate alliances with leading companies. The Company is currently investing,
and plans to continue to invest, significant resources to develop these
relationships. The Company believes that its success in penetrating markets for
non-utility applications of its network will depend in large part on its ability
to maintain these relationships and to cultivate additional or alternative
relationships. There can be no assurance that the Company will be able to
develop additional corporate alliances with such companies, that existing
relationships will continue or be successful in achieving their purposes or that
such companies will not form competing arrangements.
POSSIBLE TERMINATION OF CONTRACTS
The Company expects that substantially all of its future revenues will be
provided pursuant to services contracts with utility companies and other
parties. These contracts will generally be subject to cancellation or
termination in certain circumstances in the event of a material and continuing
failure on CellNet's part to meet agreed NMR performance standards on a
consistent basis over agreed time periods, subject to certain rights to cure any
such failure. Each of the Company's existing services contracts also provides
for
21
<PAGE>
termination of such contracts by the respective utility without cause in less
than ten years, subject to certain reimbursement provisions. Such contracts also
provide that CellNet will be required to compensate such utilities for the use
of its system for non-utility applications. In the event that a services
contract is terminated by a utility, the Company would incur substantial losses.
A network's service revenues are not expected to exceed the Company's capital
investments to deploy such network for several years. Termination or
cancellation of one or more utility services contracts would have a material
adverse effect on the Company's business, results of operations, financial
condition and cash flow.
RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION
The Company plans to expand into international markets and has begun initial
marketing efforts. The Company does not anticipate that it will have any
material international operations for at least the next 12 months. The Company
anticipates that it will incur significant expenses in connection with the
establishment of international operations. If revenues generated by
international activities are not adequate to offset the expense of establishing
and maintaining these activities, the Company's business, operating results,
financial condition and cash flow could be materially adversely affected.
International demand for the Company's services and systems is expected to vary
by country, based on such factors as the regulatory environment, electric power
generating capacity and demand, labor costs and other political and economic
conditions. To date, the Company has no experience in developing a localized
version of its wireless data communications system for foreign markets. The
Company believes its ability to establish business alliances in each
international market will be critical to its success. There can be no assurance
that the Company will be able to successfully develop, market and implement its
system in international markets or establish successful business alliances for
these markets. In addition, there are certain risks inherent in doing business
internationally, such as unexpected changes in regulatory requirements, export
restrictions, tariffs and other trade barriers, difficulties in staffing and
managing foreign operations, longer payment cycles, problems in collecting
accounts receivable, political instability, fluctuations in currency exchange
rates and potentially adverse tax consequences, any of which could adversely
impact the Company's potential international operations. There can be no
assurance that one or more of such factors will not have a material adverse
effect on the Company's future international operations and, consequently, on
its business, operating results, financial condition and cash flow.
The Company's strategy is to pursue international markets through a joint
venture with BEn which could involve additional partners in a local operating
project entity in a particular country. The Company may not have a majority
interest or control of the board of directors of any such local operating
project entity. In any such joint venture in which the Company may determine to
participate, there is a risk that the other joint venture partner may at any
time have economic, business or legal interests or goals that are inconsistent
with those of the joint venture or the Company or that such partner will not
impose the same or similar accounting and financial controls as the Company. The
risk is also present that a joint venture partner may be unable to meet its
economic or other obligations and that the Company may be required to fulfill
those obligations. In addition, in any joint venture in which the Company does
not have a majority interest, the Company may not have control over the
operations or assets of such joint venture.
VOLATILITY OF STOCK PRICE
The trading price of the Company's Common Stock has been highly volatile at
relatively low trading volumes since the Company's Initial Public Offering and
has been and is likely to continue to be subject to wide fluctuations in
response to a variety of factors, including quarterly variations in operating
results, the signing of services contracts, new customers, consolidations in the
industry, technological innovations or new products by the Company or its
competitors, developments in patents or other intellectual property rights,
general conditions in the NMR services industry, revised earnings estimates,
comments or recommendations issued by analysts who follow the Company, its
competitors or the NMR services industry and general economic and market
conditions. In addition, it is possible that in some future period
22
<PAGE>
the Company's operating results may be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
could be materially adversely affected. Additionally, the stock market in
general, and the market for technology stocks in particular, have experienced
extreme price volatility in recent years. Volatility in price and volume has had
a substantial effect on the market prices of many technology companies for
reasons unrelated or disproportionate to the operating performance of such
companies. These broad market fluctuations could have a significant impact on
the market price of the Common Stock.
NO DIVIDENDS; DIVIDEND RESTRICTIONS
The Company has not declared or paid any dividends on its capital stock
since its inception. The Company currently anticipates that it will retain all
of its future earnings, if any, for use in the operation and expansion of its
business and does not anticipate paying any cash dividends in the foreseeable
future. In addition, the Company's existing financing arrangements restrict the
payment of any dividends.
23
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The industry in which the Company operates is characterized by frequent
litigation regarding patent and other intellectual property rights. The Company
is a party to three such claims. Although the ultimate outcome of these matters
is not presently determinable, management believes that the resolution of these
matters will not have a material adverse effect on the Company's financial
position or results of operations.
Although the Company has been granted federal registration of its "CellNet"
trademark, in January 1995, Century Telephone Enterprises, Inc. (Century
Telephone) filed a petition for cancellation in an attempt to challenge such
registration. The matter is currently pending before the Trademark Trial and
Appeal Board of the U.S. Patent and Trademark Office. CellNet and Century
Telephone are the sole parties in the action. If such challenge were successful,
the Company could lose its registration and could be required to adopt a new
trademark and possibly a new or modified corporate name. CellNet could encounter
similar challenges in the future. While the requirement to adopt a new trademark
or new or modified corporate name could involve a significant expense and could
result in the loss of any goodwill and name recognition associated with the
Company's current trademark and corporate name, the Company does not believe
this would have a long-term material adverse impact on its results of operations
or financial condition.
In October 1996, Itron, Inc., one of the Company's competitors, filed a
complaint against the Company in the Federal District Court in Minnesota
alleging that the Company infringes an Itron patent which was issued in
September 1996. Itron is seeking a judgment for damages, attorneys fees and
injunctive relief. The Company believes, based on its current information, that
the Company's products do not infringe any valid claim in the Itron patent, and
in the Company's opinion, the ultimate outcome of the lawsuit is not expected to
have a material adverse effect on its results of operations or financial
condition.
On October 31, 1996, a complaint SETTLE V. SEIDL, ET AL., No. 398464, was
filed in the Superior Court of California for the County of San Mateo against
the Company, certain of its officers and directors and underwriters of the
Company's Initial Public Offering. The complaint, which is a purported class
action filed on behalf of those purchasing the Company's stock from the period
beginning on September 26, 1996 and ending on October 31, 1996, seeks
unspecified damages and rescission for alleged liability under various
provisions of the federal securities laws and California state law. Plaintiff
alleges that the Prospectus and Registration statement dated September 26, 1996,
pursuant to which the Company issued 5,000,000 shares of Common Stock to the
public, contained materially misleading statements and/or omissions in that
defendants were obligated to disclose, but failed to disclose, that a patent
conflict with Itron, Inc. was likely to ensue. On November 8 and 13, 1996, two
additional complaints, KAREN ZULLY V. CELLNET DATA SYSTEMS, INC., ET AL., No.
398551 and HOWARD FIENMAN AND GERALD SLAPSOWITZ V. CELLNET DATA SYSTEMS, INC.,
ET AL., No. 398560, were filed in the Superior Court of California for the
County of San Mateo. These cases are essentially similar in nature to the SETTLE
case. The Court has ordered consolidation of the SETTLE and ZULLY actions. The
Company expects that the FIENMAN action will be consolidated with the SETTLE and
ZULLY actions before trial. The Company believes that the allegations in these
complaints are without merit and intends to defend these actions vigorously. The
Company has filed demurrers seeking dismissals of these complaints. The motions
are currently under submission before the Special Master assigned by the Court
to hear certain pre-trial matters. In the Company's opinion, the ultimate
outcome of these lawsuits is not expected to have a material adverse effect on
its results of operations or financial condition.
In April 1997, the Company filed a patent infringement suit against Itron,
Inc. in the Federal District Court for the Northern District of California
claiming that Itron's use of its electronic meter reading Encoder Receiver
Transmitter (EAT-Registered Trademark-) device infringes CellNet's U.S. Patent
No. 4,783,623. The Company seeks an injunction, damages and other relief.
24
<PAGE>
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 24, 1997, at the Company's annual stockholders' meeting, a quorum
of stockholders of the Company approved the following proposals: (1) election of
the following persons as Directors of the Company: Paul M. Cook, Neal M.
Douglas, William C. Edwards, William Hart, Brian Kwait, Nancy E. Pfund, Henry B.
Sargent and John M. Seidl; and (2) ratification of the appointment of Deloitte &
Touche LLP as the Company's independent auditors.
<TABLE>
<S> <C> <C>
Proposal 1. Election of Directors: Paul M. Cook, Neal M. Douglas, William C. Edwards,
William Hart, Brian Kwait, Nancy C. Pfund, Henry B. Sargent and John M. Seidl
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
FOR 26,704,828
WITHHELD/AGAINST 18,170
EXCEPTIONS/ABSTAIN 359,976
------------
Total 27,082,974
</TABLE>
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
<S> <C> <C>
Paul M. Cook 27,062,704 20,270
Neal M. Douglas 27,061,728 21,245
William C. Edwards 27,062,804 20,170
William Hart 26,706,728 376,246
Brian Kwait 27,060,828 22,146
Nancy E. Pfund 27,060,128 22,846
Henry B. Sargent 27,061,728 21,246
John M. Seidl 27,060,128 22,846
</TABLE>
<TABLE>
<S> <C> <C>
Proposal 2. Ratification of the appointment of Deloitte & Touche LLP as the Company's
independent auditors
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
FOR 27,062,436
WITHHELD/AGAINST 5,620
EXCEPTIONS/ABSTAIN 14,918
------------
Total 27,082,974
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
10.1 1997 Bonus Plan
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule
b. Reports on Form 8-K
</TABLE>
There have been no reports on Form 8-K filed during the quarter ended June
30, 1997.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLNET DATA SYSTEMS, INC.
Date: August 13, 1997 By: /s/ PAUL G. MANCA
------------------------------------------
Paul G. Manca
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
26
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
- ----------- ------------------------------------------------------------------------------------------------ ---------
<C> <S> <C>
10.1 1997 Bonus Plan.................................................................................
27.1 Financial Data Schedule.........................................................................
</TABLE>
27
<PAGE>
CELLNET DATA SYSTEMS, INC.
BONUS PLAN
1. PURPOSES OF THE PLAN. The purposes of the CellNet Data Systems, Inc. Bonus
Plan are to provide a financial incentive to employees to meet corporate and
individual goals, to help attract and retain key employees, and to enhance
the alignment between employee interests, shareholder interests and the
Corporation's success.
2. DEFINITIONS.
2.1. "TARGET AWARD LETTER" means the letter reflecting each
Participant's Target Award.
2.2. "BOARD" means the Board of Directors of the Corporation.
2.3. "COMMITTEE" means the Board or the Compensation Committee of the
Board.
2.4. "CORPORATION" means CellNet Data Systems, Inc., a Delaware
corporation, and each of its wholly-owned subsidiaries.
2.5. "MANAGEMENT" means those Officers of the Corporation designated by
the Committee to administer portions of the Plan.
2.6. "MINIMUM CORPORATION PERFORMANCE LEVEL" means actual Corporation
performance equal to fifty percent (50%) of the Committee-approved
Corporation Performance Level.
2.7. "PARTICIPANT" means an eligible employee of the Corporation
participating in the Plan during a Performance Period.
2.8. "PERFORMANCE LEVEL" means the level of performance required to
receive the full Target Award. Performance Levels are set for the Corporation
as a whole and for Participants individually.
2.9. "PERFORMANCE PERIOD" means the time period with respect to which an
award is earned and paid. Unless otherwise determined by the Committee, each
Performance Period under the Plan shall be an annual period that corresponds
with the fiscal year of the Corporation.
2.10. "PLAN" means this Bonus Plan.
2.11. "POOL" means the total amount designated by the Committee for
awards for a Performance Period.
2.12. "TARGET AWARD" means the award opportunity established pursuant
to Section 5 for each Participant for a Performance Period.
3. ADMINISTRATION OF THE PLAN.
<PAGE>
3.1. The Committee shall be responsible for the general administration
and interpretation of the Plan and for carrying out its provisions. The
Committee may delegate specific administrative tasks to Management or others
as appropriate for the proper administration of the Plan. The Committee shall
have such powers as may be necessary to discharge its duties hereunder,
including, without limitation, the power
(i) in its discretion to construe and interpret the terms of the Plan
and to determine eligibility, Target Awards and the amount, manner and time
of payment of any awards hereunder;
(ii) to prescribe forms and procedures for purposes of Plan
participation and distribution of awards; and
(iii) to adopt rules and regulations and to take such actions as it
deems necessary or desirable for the proper administration of the Plan.
3.2. Any rule or decision by the Committee that is not inconsistent
with the provisions of the Plan shall be conclusive and binding.
3.3. In the event of a significant corporate transaction or material
change in business conditions, the Committee, at its discretion, may make
such changes and adjustments to Target Awards, Performance Levels,
eligibility and the amount, time and manner of payment of awards or any other
provision of the Plan as the Committee may determine to be appropriate and in
furtherance of the Plan's purposes.
4. ELIGIBILITY. The employees eligible to participate in the Plan for a given
Performance Period shall be all regular full-time exempt employees of the
Corporation. The Chief Executive Officer shall determine the Participants for
each Performance Period.
5. AWARD OPPORTUNITY.
5.1. TARGET AWARD. The Committee shall establish Target Awards, the
Corporation Performance Level, the total amount of the Pool for the
Performance Period and the allocation of each Participant's Target Award
between Corporation Performance and Participant Performance Levels.
Management shall establish each Participant Performance Level.
5.2. TARGET AWARD LETTER. Each Target Award shall be communicated to
the Participant pursuant to Target Award Letter in such form as the Committee
shall approve. Target Award Letters shall be delivered to Participants as
soon as possible after the Target Awards are determined. The Target Award
Letter for each Participant shall specify the Target Award, the Participant
Performance Level and such terms and conditions as the Committee may specify.
6. PERFORMANCE MEASURES.
6.1. CORPORATION PERFORMANCE LEVEL. The Corporation Performance Level
shall be based on primary corporate performance measures, as determined by
the Committee.
<PAGE>
6.2. PARTICIPANT PERFORMANCE LEVEL. The Participant Performance Level
shall be based on the Participant's individual goals and objectives, as
determined by Management.
7. AWARD DETERMINATION.
7.1. CORPORATION PERFORMANCE. The actual payout for the Corporation
performance component of the Target Award shall range from zero for
Corporation performance below the Minimum Corporation Performance Level to
one hundred percent (100%) of the Target Award based upon exceptional
Corporation performance. The Corporation must achieve the Minimum Corporation
Performance Level before the Corporation performance component shall be paid.
The Corporation performance component may be reduced or eliminated at the
discretion of Management should a Participant not meet the Participant
Performance Level or other standards of acceptable performance or behavior.
7.2. PARTICIPANT PERFORMANCE. Each Performance Period, Management shall
review the Participant's performance based on the Participant Performance
Level and determine the actual payout for the Participant performance
component of the Target Award. The actual payout for the Participant
performance component of the Target Award may range from zero for
unsatisfactory performance to one hundred percent (100%) of the Participant
performance component of the Target Award for exceptional performance. If the
Corporation does not achieve the Minimum Corporation Performance Level,
Management may, at its discretion, reduce or not pay the individual
performance component of the Target Award.
8. AWARD PAYMENT.
8.1. FORM OF DISTRIBUTIONS. The Corporation shall distribute all awards
to the Participants in cash.
8.2. TIMING OF DISTRIBUTIONS. Subject to Section 7, the Corporation
shall distribute the respective award of each Participant to such
Participant, generally within sixty (60) days following the end of the
Performance Period.
9. TERM OF PLAN. The Plan shall apply first to the 1997 Performance Period.
The Plan shall continue until terminated under Section 10.
10. AMENDMENT AND TERMINATION OF THE PLAN. The Committee may amend, alter,
suspend or discontinue the Plan at any time, provided that, except as
contemplated in Section 3.3, no amendment, alteration, suspension or
discontinuation shall be made which would impair any payments to Participants
made prior to such amendment, alteration, suspension or discontinuation. At
no time before the actual distribution of funds to Participants under the
Plan shall any Participant accrue any vested interest or right whatsoever
under the Plan.
11. TERMINATION OF EMPLOYMENT.
11.1. In the event that a Participant's employment with the Corporation
terminates by reason of the Participant's retirement, total and permanent
disability or death, the Management
<PAGE>
may, in its discretion, pay to the Participant or the Participant's
representative, as the case may be, all or a portion of the Target Award for
the Performance Period in which such termination occurs.
11.2. No Target Award shall be paid to a Participant whose employment
terminates during a Performance Period except as provided in Section 11.1.
12. WITHHOLDING. Distributions pursuant to this Plan shall be subject to all
applicable federal, state and local withholding tax requirements.
13. EMPLOYMENT. This Plan does not constitute a contract of employment or
compensation or impose on either the Participant or the Corporation any
obligation to retain the Participant as an employee. This Plan does not
change the status of the Participant as an employee at will, the policies of
the Corporation regarding termination of employment nor guarantee further
continuing participation in the Plan.
14. SUCCESSORS. The provisions of this Plan shall inure to the benefit of and
be binding upon the successors, assigns, heirs, executors and administrators
of the parties hereto.
15. NONASSIGNMENT. The rights of a Participant under this Plan shall not be
assignable or transferable by the Participant except by will or the laws of
intestacy.
16. GOVERNING LAW. The Plan shall be governed by the laws of the State of
California.
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<PAGE>
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