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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-21409
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CELLNET DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-2951096
(State or other jurisdiction (I.R.S. Employer Identification
of incorporation or Number)
organization)
</TABLE>
125 SHOREWAY ROAD
SAN CARLOS, CALIFORNIA 94070
(Address of principal executive offices, including zip code)
(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(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days. YES /X/ No / /
As of November 9, 1998, 42,342,711 shares of the Registrant's Common Stock,
$0.001 par value, were issued and outstanding.
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TABLE OF CONTENTS
INDEX
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
PART I. FINANCIAL INFORMATION............................................................................. 3
Item 1. Consolidated Financial Statements (Unaudited)............................................ 3
Condensed Consolidated Balance Sheets--As of September 30, 1998 and December 31, 1997.... 3
Condensed Consolidated Statements of Operations--Three Months Ended September 30, 1998
and 1997 and Nine Months Ended September 30, 1998 and 1997............................... 4
Condensed Consolidated Statements of Cash Flows--Nine Months Ended September 30, 1998 and
1997..................................................................................... 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................... 32
PART II. OTHER INFORMATION................................................................................ 33
Item 1. Legal Proceedings........................................................................ 33
Item 2. Changes in Securities.................................................................... 33
Item 3. Defaults upon Senior Securities.......................................................... 33
Item 4. Submission of Matters to a Vote of Security Holders...................................... 33
Item 5. Other Information........................................................................ 33
Item 6. Exhibits and Reports on Form 8-K......................................................... 33
SIGNATURE................................................................................................. 34
EXHIBIT INDEX............................................................................................. 35
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................................... $ 63,097 $ 111,112
Short-term investments............................................................ 43,577 36,946
Accounts receivable--trade........................................................ 3,293 1,519
Accounts receivable--other........................................................ 3,268 5,123
Prepaid expenses and other........................................................ 1,687 2,060
------------- ------------
Total current assets............................................................ 114,922 156,760
Network components and inventory.................................................... 33,388 24,225
Networks in progress--net........................................................... 155,055 92,308
Property--net....................................................................... 16,463 16,061
Investment in unconsolidated affiliate.............................................. 175 --
Restricted cash..................................................................... 19,649 --
Debt issuance costs and other--net.................................................. 4,634 4,631
------------- ------------
Total assets...................................................................... $ 344,286 $ 293,985
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.................................................................. $ 17,116 $ 11,706
Accrued compensation and related benefits......................................... 3,991 2,189
Accrued liabilities............................................................... 3,661 2,655
Current portion of capital lease obligations...................................... 603 466
------------- ------------
Total current liabilities....................................................... 25,371 17,016
Senior notes--14%................................................................... 303,949 268,673
Deferred revenue.................................................................... 5,420 5,620
Capital lease obligations........................................................... 588 412
Mandatorily redeemable preferred securities of subsidiary holding solely Company
preferred stock (Note 3).......................................................... 106,062 --
Commitments and contingencies (Note 4).............................................. -- --
Stockholders' equity (deficit):
Preferred stock--$.001 par value; 15,000,000 shares authorized; no shares
outstanding..................................................................... -- --
Common stock--$.001 par value; 100,000,000 shares authorized; shares outstanding,
1998: 42,324,813; 1997: 41,845,475.............................................. 211,111 209,996
Notes receivable from sale of common stock........................................ (640) (676)
Warrants.......................................................................... 74,545 74,546
Accumulated deficit............................................................... (382,155) (281,599)
Net unrealized gain (loss) on short-term investments.............................. 35 (3)
------------- ------------
Total stockholders' equity (deficit)............................................ (97,104) 2,264
------------- ------------
Total liabilities and stockholders' equity (deficit)................................ $ 344,286 $ 293,985
------------- ------------
------------- ------------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues:
Network service revenues......................................... $ 2,896 $ 1,338 $ 7,346 $ 3,451
Product revenues................................................. 144 67 552 366
Other revenues................................................... 457 128 728 209
--------- --------- ---------- ---------
Total revenues................................................. 3,497 1,533 8,626 4,026
--------- --------- ---------- ---------
Costs and expenses:
Cost of network operations....................................... 8,729 4,900 20,165 12,398
Cost of product and other revenues............................... 500 106 958 443
Research and development......................................... 7,115 5,717 22,613 18,765
Marketing and sales.............................................. 2,870 3,652 8,768 7,321
General and administrative....................................... 3,752 4,164 11,890 13,233
Depreciation and amortization.................................... 4,784 2,893 13,431 8,032
--------- --------- ---------- ---------
Total costs and expenses....................................... 27,750 21,432 77,825 60,192
--------- --------- ---------- ---------
Loss from operations............................................... (24,253) (19,899) (69,199) (56,166)
Equity in net loss of unconsolidated affiliate..................... (815) (670) (1,796) (2,009)
Other income (expense):
Interest income.................................................. 2,175 1,524 6,114 5,762
Interest expense, net of capitalized interest.................... (10,897) (6,124) (32,571) (18,683)
Other-net........................................................ 17 (39) (159) (37)
--------- --------- ---------- ---------
Total other income (expense)................................... (8,705) (4,639) (26,616) (12,958)
--------- --------- ---------- ---------
Loss before provision for income taxes, dividends and accretion on
preferred securities and extraordinary loss on early
extinguishment of 1995 Senior Notes.............................. (33,773) (25,208) (97,611) (71,133)
Provision for income taxes......................................... -- -- -- 1
--------- --------- ---------- ---------
Loss before dividends and accretion on preferred securities and
extraordinary loss on early extinguishment of 1995 Senior
Notes............................................................ (33,773) (25,208) (97,611) (71,134)
Dividends and accretion on preferred securities of subsidiary (Note
3)............................................................... (2,007) -- (2,945) --
--------- --------- ---------- ---------
Loss before extraordinary loss on early extinguishment of 1995
Senior Notes..................................................... (35,780) (25,208) (100,556) (71,134)
Extraordinary loss on early extinguishment of 1995 Senior Notes.... -- (11,417) -- (11,417)
--------- --------- ---------- ---------
Net loss applicable to common stockholders......................... $ (35,780) $ (36,625) $ (100,556) $ (82,551)
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Basic and diluted earnings per share:
Loss per share before extraordinary loss on early extinguishment of
1995 Senior Notes................................................ $ (0.86) $ (0.62) $ (2.43) $ (1.78)
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Net loss per share................................................. $ (0.86) $ (0.89) $ (2.43) $ (2.05)
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Shares used in computing net loss per share........................ 41,764 41,614 41,460 40,157
--------- --------- ---------- ---------
--------- --------- ---------- ---------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss applicable to common stockholders................................................. $(100,556) $ (82,551)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization............................................................ 13,431 8,032
Accretion on senior notes................................................................ 32,190 18,114
Accretion on preferred securities........................................................ 122 --
Write-off of remaining 1995 Senior Note debt issuance costs.............................. -- 4,791
Accelerated accretion on 1995 Senior Notes............................................... -- 3,127
1997 Senior Notes issued as non-cash consent fees........................................ -- 912
Amortization of debt issuance costs...................................................... 304 466
Equity in net loss of unconsolidated affiliate........................................... 1,796 2,009
Other non-cash income.................................................................... (398) --
Other non-cash expenses.................................................................. 276 --
Changes in:
Accounts receivable-trade.............................................................. (1,774) (685)
Accounts receivable-other.............................................................. 1,855 (2,252)
Prepaid expenses and other............................................................. 373 (1,026)
Accounts payable....................................................................... 5,410 1,141
Accrued compensation and related benefits.............................................. 1,802 1,598
Accrued liabilities and deferred revenues.............................................. 2,162 1,617
--------- ---------
Net cash used for operating activities............................................... (43,007) (44,707)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Network components and inventory........................................................... (9,163) (8,692)
Purchase of property....................................................................... (5,946) (7,761)
Networks in progress....................................................................... (66,714) (31,895)
Investment in unconsolidated affiliates.................................................... (3,327) (2,009)
Purchase of short-term investments......................................................... (95,400) (25,490)
Proceeds from sales and maturities of short-term investments............................... 88,807 49,836
Restriction of cash associated with Treasury Strips........................................ (21,433) --
Proceeds from maturity of restricted cash.................................................. 2,182 --
Other assets............................................................................... (307) (406)
--------- ---------
Net cash used for investing activities............................................... (111,301) (26,417)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred securities............................................. 105,940 --
Issuance of Senior Notes and warrants...................................................... -- 100,324
Debt issuance costs for Senior Notes....................................................... -- (3,514)
Repayment of capital lease obligations..................................................... (521) (321)
Proceeds from sale of common stock, net of repurchases..................................... 846 621
Collection of notes receivable from sale of common stock................................... 28 138
--------- ---------
Net cash provided by investing activities............................................ 106,293 97,248
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS......................................... (48,015) 26,124
CASH AND CASH EQUIVALENTS, Beginning of period............................................... 111,112 124,232
--------- ---------
CASH AND CASH EQUIVALENTS, End of period..................................................... $ 63,097 $ 150,356
--------- ---------
--------- ---------
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases............................................... $ 834 $ 557
Capitalization of interest into networks in progress....................................... $ 3,086 $ 2,739
Conversion of warrants to common stock..................................................... $ 1 $ --
Repurchase of unvested common stock and cancellation of related notes receivable........... $ 8 $ --
Change in unrealized gain (loss) in short-term investments................................. $ 38 $ (3)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest..................................................... $ 78 $ 89
Cash paid for income taxes................................................................. $ -- $ 1
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<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 September 30, 1998 and
the results of operations and cash flows for the three months and the nine
months ended September 30, 1998 and 1997. This unaudited interim information
should be read in conjunction with the audited consolidated financial statements
of the Company and the notes thereto for the year ended December 31, 1997.
Operating results for the three months and the nine months ending September 30,
1998 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1998.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, REPORTING COMPREHENSIVE INCOME, which requires that an
enterprise report, by major components and as a single total, the change in net
assets during the period from nonowner sources. Adoption of SFAS No. 130 did not
impact the Company's consolidated financial position, results of operations or
cash flows. The comprehensive net loss was $35,824,000 and $36,625,000 for the
three months ended September 30, 1998 and 1997. The comprehensive net loss was
$100,594,000 and $82,554,000 for the nine months ended September 30, 1998 and
1997, respectively. The comprehensive net loss differs from the net loss
applicable to common stockholders by the net unrealized gain (loss) on
short-term investments.
In June 1997, the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards 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 this standard will not impact the Company's consolidated financial
position, results of operations or cash flows. The Company will adopt this
standard in its financial statements for the year ending December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which defines derivatives, requires that all
derivatives be carried at fair value, and provides for hedging accounting when
certain conditions are met. This statement is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. Although the Company has not
fully assessed the implications of this new standard, the Company does not
believe adoption of this standard will have a material impact on the Company's
financial position or results of operations.
Certain reclassifications have been made to the 1997 amounts to conform to
the 1998 presentation.
2. NET LOSS PER SHARE
During December 1997, the Company adopted Statement of Financial Accounting
Standard No. 128 (SFAS 128), EARNINGS PER SHARE and, retroactively, restated
prior period earnings per share (EPS) for the change. SFAS 128 requires a dual
presentation of basic and diluted EPS. Basic EPS for the period presented is
computed by dividing net loss by the weighted average of common shares
outstanding (excluding shares subject to repurchase). Diluted EPS for all
periods presented is the same as basic EPS since all other potential dilutive
securities (common stock subject to repurchase, common stock options and
warrants and mandatorily redeemable preferred securities) are excluded as they
are antidilutive.
6
<PAGE>
CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
During May 1998, a new subsidiary of the Company, CellNet Funding, L.L.C.
("Funding") completed the sale of 7% Exchangeable Preferred Securities
Mandatorily Redeemable 2010 (the "Preferred Securities") for gross proceeds of
$110,000,000. Net proceeds from the offering, after offering costs, were
approximately $105,940,000. The recorded amount of the Preferred Securities will
fully accrete to the face value of $110,000,000 on June 1, 2010. The restricted
cash at September 30, 1998 of approximately $19,649,000 includes the proceeds of
the offering which are designated for the payment of cash dividends on the
Preferred Securities through June 1, 2001. Funding invested the restricted cash
in U.S. Treasury strips ("Treasury Strips") which were placed in escrow upon the
closing of the offering of the Preferred Securities. The Treasury Strips have
been pledged to The Bank of New York as escrow agent (the "Escrow Agent")
pursuant to an escrow agreement for the benefit of the holders of the Preferred
Securities. The Escrow Agent is required under the Escrow Agreement to release
from escrow amounts sufficient to pay quarterly dividends on the Preferred
Securities through September 1, 2001. The first dividend payment was made on
September 1, 1998 in the amount of $2,182,000.
The Preferred Securities consist of 4,400,000 exchangeable preferred
securities of Funding that bear a cumulative dividend at the rate of 7% per
annum. The dividend is paid quarterly in arrears each March 1, June 1, September
1 and December 1, and commenced September 1, 1998. The dividend is payable in
cash through June 1, 2001 and thereafter, by cash or shares of Company common
stock, at the option of Funding. The Preferred Securities are exchangeable at
any time prior to June 1, 2010, at the option of the holders, into Company
common stock, at a rate of 1.8328 shares of Company common stock per Preferred
Security, or $13.64 per share, subject to adjustment. On or prior to June 1,
2001, the Preferred Securities must be automatically exchanged for common stock
of the Company at an exchange price of $13.64 per share in the event the Current
Market Value (which is a formula as defined in the Written Action of the Manager
of Funding, the "Written Action") of the Company's common stock equals or
exceeds the following percentage of the exchange price, for at least 20 days of
any 30-day trading period during the 12 month period ending prior to June 1 of
the indicated year: 170% prior to June 1, 1999; 160% from June 1, 1999 through
June 1, 2000; and 150% from June 2, 2000 up to and prior to June 1, 2001. The
Preferred Securities are subject to mandatory redemption on June 1, 2010 at a
redemption price of 100% of the liquidation preference of the Preferred
Securities, plus accrued and unpaid dividends, if any. Funding may redeem, at
its option, the Preferred Securities, in whole or in part, at any time on or
after June 1, 2001 at certain redemption prices equal to a percentage of the
liquidation preference (set forth in the Written Action) which declines each
year until maturity of the Preferred Securities, together with accrued and
unpaid dividends, if any.
Pursuant to and to the extent set forth in the guarantee of the Preferred
Securities (the "Guarantee") by the Company for the benefit of the holders of
Preferred Securities, the Company has agreed to pay in full to the holders of
the Preferred Securities (except to the extent paid by Funding), as and when
due, regardless of any defense, right of set off or counterclaim which Funding
may have or assert, the following payments (the "Guarantee Payments"), without
duplication: (i) any accrued and unpaid distributions that are required to be
paid on the Preferred Securities, to the extent Funding has sufficient funds
legally available thereof, (ii) the redemption price, with respect to any
Preferred Securities called for redemption by Funding, to the extent Funding has
sufficient funds legally available therefor, and (iii) upon a voluntary or
involuntary dissolution, winding-up or termination of Funding, the lesser of (a)
the aggregate of the liquidation preference and all accrued and unpaid dividends
on the Preferred Securities to the date of payment to the extent Funding has
sufficient funds legally available therefor and (b) the amount of assets of
Funding remaining for distribution to holders of Preferred Securities upon the
liquidation of Funding.
7
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CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY (CONTINUED)
The Guarantee may also be subject to contractual restrictions under agreements
governing future indebtedness of the Company.
On May 19, 1998, after the investment in Treasury Strips, Funding applied
the remaining net proceeds from the offering of the Preferred Securities
together with other capital contributed by the Company to purchase $93,500,000
of the Company's Preferred Stock (the "CellNet Preferred Stock") which pays
dividends each March 1, June 1, September 1 and December 1 in additional shares
of CellNet Preferred Stock through June 1, 2001. Subsequent to June 1, 2001,
dividends are payable in cash or shares of common stock, at the option of the
Company. The CellNet Preferred Stock is exchangeable, at the option of Funding,
at any time prior to June 1, 2010 into shares of the Company's common stock at
an exchange rate based on the exchange rate of the Preferred Securities. The
CellNet Preferred Stock is subject to mandatory redemption on June 1, 2010.
The separate complete financial statements of Funding have not been included
herein because such disclosure is not considered to be material to the holders
of the Preferred Securities. For the period from May 13, 1998 (inception),
through September 30, 1998, the statement of operations of Funding included only
the preferred dividends paid or accrued, accretion of the Preferred Securities,
dividend income earned and accrued on the CellNet Preferred Stock and interest
income earned on the restricted cash. The balance sheet information for Funding
is as follows:
BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
(IN THOUSANDS)
<S> <C>
ASSETS:
Investment in CellNet Preferred Stock................................. $ 95,957
Restricted cash....................................................... 19,649
--------
Total assets........................................................ $ 115,606
--------
--------
LIABILITIES AND STOCKHOLDER'S EQUITY:
Accrued dividends..................................................... $ 642
Payable to Parent..................................................... 612
Mandatorily redeemable preferred securities........................... 106,062
STOCKHOLDER'S EQUITY:
Common limited liability security outstanding......................... 10
Additional paid-in capital............................................ 8,341
Accumulated deficit................................................... (61)
--------
Total stockholder's equity.......................................... 8,290
--------
Total liabilities and stockholder's equity............................ $ 115,606
--------
--------
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
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.
8
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CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
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 electric 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. See
"--Uncertainty of Protection of Copyrights Patents and Proprietary Rights." In
November 1998, the court granted Itron's motion for summary judgment, ruling
that Itron's products did not infringe the asserted claims in the Company's
patent. The Company intends to appeal the ruling.
The consolidated complaint of JERE SETTLE AND KAREN ZULLY V. JOHN M. SEIDL,
ET AL., No. 398464, filed in the Superior Court of California for the County of
San Mateo, is a purported class action on behalf of the Company's stockholders
against the Company, certain of its officers and directors and underwriters of
the Company's initial public offering seeking unspecified damages and rescission
for alleged liability under various provisions of the federal securities law and
California state law. The plaintiffs alleged generally 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 the Company was obligated to
disclose, but failed to disclose, that a patent conflict with Itron, Inc. was
likely to ensue. The complaint was dismissed on February 9, 1998, without leave
to amend. Plaintiffs subsequently filed notice of their intention to appeal the
decision, and on November 2, 1998, plaintiffs filed their appellate briefs in
the California Court of Appeal.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS SECTION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, INFORMATION ABOUT THE COMPANY'S
EXPECTED WIRELESS DATA NETWORK DEPLOYMENTS AND OPERATIONS, ITS STRATEGY FOR
MARKETING AND DEPLOYING SUCH NETWORKS AND RELATED FINANCING ACTIVITIES, ITS
EXPECTED REVENUES, EXPENSES AND CAPITAL EXPENDITURES AND ITS ASSESSMENT OF
POTENTIAL YEAR 2000 ISSUES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THE RESULTS ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF
CERTAIN FACTORS SET FORTH IN "RISK FACTORS" AND ELSEWHERE IN THIS REPORT.
OVERVIEW
The Company intends to deploy and operate a series of wireless data networks
pursuant to services agreements with utilities and other parties including new
power market participants to earn recurring revenues by providing network meter
reading (NMR) services and to use the networks to support a variety of
non-utility applications. The Company employs two basic strategies in the
deployment of its networks-- saturation deployments for providing NMR services
to existing utilities, and broad deployments for providing NMR services to other
parties including new power market participants. Under the Company's saturation
deployment strategy, the Company builds out its wide area network (WAN) and
local area network (LAN) concurrently in order to cover every meter in a
utility's designated service area. The saturation deployment strategy has proven
effective because it allows coverage of all of the energy consumers in those
service areas. Under the Company's broad deployment strategy, the Company first
deploys its WAN in service areas where the largest consumers of energy are
located and where energy consumers and other power market participants are most
likely to value the Company's services and/or to concentrate their marketing
efforts. As contracts for the provision of NMR services are obtained, the
Company builds out its LAN on an incremental basis as necessary to service those
customers or for advanced coverage of certain areas. Both the LAN and WAN can be
further expanded incrementally as additional business outside the existing
coverage areas is obtained. Broad deployment offers energy service providers who
lack the established utilities' designated geographical customer bases the
flexibility to build as they grow or to pursue particular market niches. It also
offers established utilities who are not yet prepared to commit their resources
to a long-term saturation deployment project the opportunity to cover a portion
of their customers initially and to increase coverage in their service areas
over time, potentially to all of their meters. By using networks deployed under
either strategy, the Company is also able (i) to offer NMR information metering
services directly to energy consumers, to the extent that the information
provided by such services is not being made available to them by their own
utility or energy service provider, (ii) to offer sub-metering NMR services to
industrial and commercial customers which desire to monitor the energy
consumption of particular heating, ventilating and air conditioning (HVAC)
system components, individual manufacturing processes or pieces of equipment or
individual departments, and (iii) to offer a range of non-utility wireless data
communication services for such applications as home security, remote status
monitoring of vending machines, office equipment and parking meters, and remote
control of traffic lights.
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
networks. Under the Company's existing services agreements with utilities, the
Company receives monthly NMR service fees based on the number of endpoint
devices that are in revenue service during the applicable month.
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 parties, including new power market participants, and
upon the Company's ability to deploy and operate successfully its wireless
10
<PAGE>
communications networks for utility and non-utility applications. 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 or 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 Results--Uncertainty of Future Revenues; Need for Additional Services
Contracts and Fluctuating Operating Results."
UNCERTAINTY OF MARKET ACCEPTANCE. The Company's future revenues will depend
on the number of new services agreements with established utilities and other
parties, including new power market participants, and on the amount of NMR
services to be provided thereunder. The Company's existing saturation contracts
are with established utilities. During 1997, approximately 88% of the Company's
revenues were derived from its contracts with Kansas City Power & Light Company
("KCPL") and AmerenUE ("UE"). During the first nine months of 1998, 92% of the
Company's revenues were derived from KCPL, UE and Northern States Power Company
("NSP"). The utility industry is historically 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. Although the uncertainty surrounding proposed
regulatory changes in some states may have caused, and may continue to cause,
additional delays in purchasing decisions by established utilities, the Company
believes that implementation of utility deregulation will ultimately accelerate
the utility decision-making process. The Company believes that it will enter
into additional services contracts with other utilities and other parties
including new power market participants; however, if the Company's services do
not gain widespread industry acceptance, its revenues would not increase
significantly after services contracts for existing network systems have been
fully installed.
With the advent of utility industry deregulation, the Company is seeking
opportunities to provide its NMR services to other parties, including new power
market participants. The Company believes it is well-positioned to offer
competitive advantages to established utilities and other parties including new
power market participants. The Company has entered into several contracts with
new power market participants and others for the provision of NMR services.
However there can be no assurance that the Company will be able to enter into
contracts covering a sufficient number of meters to recoup its costs of
deployment, on terms favorable to the Company, or at all. The Company also
anticipates that, under contracts with new power market participants, it would
build out its networks, at least in part, before the capacity is fully
committed. These contracts do not require that the participants provide any
minimum number of customers and, accordingly, the Company is dependent on the
participant's success in obtaining and retaining customers. For these reasons,
the Company's ability to obtain financing for the capital expenditures
associated with these contracts may be limited, although the Company also
believes that it will be able to defer a significant portion of the capital
expenditures by building out its networks incrementally as needed, and that the
new power market participants would lease or acquire the endpoints from the
Company, reducing the Company's costs. The Company also anticipates that its
contracts with new power market participants and other parties will be
shorter-term than those it has entered into with established utilities, and may
therefore not fully cover the costs of network build-out and associated
operating costs. The Company's current contracts generally have maximum terms of
up to five years, compared to terms of ten to twenty years with utilities. The
Company intends to reduce this risk by marketing its services to a wide range of
new power market participants and other parties, but there can be no assurance
that the Company will be successful in such marketing efforts, or that the new
power market participants will be successful in capturing any significant share
of the energy service market.
The Company's long-term business plan contemplates the generation of a
significant percentage of future revenues from non-utility 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
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additional services. The Company currently has no services contracts which
provide for the implementation of such services, and the Company has not yet
deployed such services on a commercial scale. In addition, unless the Company is
successful in deploying its wireless networks in targeted 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.
REVENUES LAG NETWORK DEPLOYMENT. The Company expects to realize network
service revenue under a services agreement with a utility or new power market
participant only when a portion of the network is installed and they have begun
billing their customers based upon the NMR data obtained. 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 September 30, 1998, the Company had
approximately 3,815,000 meters under long-term contracts, of which approximately
1,301,000 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 414,000 meters on the
network by September 30, 1998. The Company expects to add additional meters to
the KCPL network in 1998 and 1999 which would be added to the total number of
meters in revenue service upon acceptance by KCPL for billing purposes. In June
1998, the Company entered into a services contract to expand CellNet's NMR
network for UE by 450,000 meters. The total network for UE will provide coverage
for approximately 1,250,000 meters. As of September 30, 1998, the Company
completed the on-line deployment of approximately 761,000 meters to the UE
network. The Company began the installation of both the NSP and Puget Sound
Energy, Inc. ("PSE") networks in August 1996 and began receiving revenue from
PSE in January 1997. In October 1996, the Company began a demonstration project
with Pacific Gas & Electric Company ("PG&E") involving the installation of a
network that covers approximately 30,000 electric and gas meters. The project is
in the process of being concluded. In September 1997, the Company entered into a
services contract with Indianapolis Power & Light Company ("IP&L") for the
installation of its NMR network that will cover approximately 415,000 meters.
Installation of the initial portion of the IP&L network was completed in
November 1997 and IP&L has agreed to a roll-out of the balance of the network.
As additional segments of the Company's networks are installed and used by its
customers for billing purposes, the Company expects to realize a corresponding
increase in its network service revenues. However, there can be no guarantee
that the foregoing projects will be renewed at the end of their contractual time
periods, and even if they are renewed, there can be no guarantee that the
Company will derive significant revenues from such continuing projects. Also, if
the Company is able to successfully deploy an increasing number of networks over
the next few years, the operating losses created by this lag in revenues, the
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 the additional networks.
IMPACT OF RAPID EXPANSION. 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 September 30, 1998,
had an accumulated deficit of $382.2 million. The Company does not expect
significant revenues relative to anticipated operating costs during 1998 and
expects to incur substantial and increasing operating losses and negative net
cash flow after capital expenditures for the foreseeable future as it expands
and installs additional networks. The Company does not expect positive cash flow
after capital expenditures from its NMR services operations for several years.
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The Company will require substantial capital to fund operating 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 Results--History and Continuation
of Operating Losses" and "--Substantial Leverage and Ability to Service Debt;
Substantial Future Capital Needs."
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 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 FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND
1997
REVENUES.
Revenues for the three months ended September 30, 1998 and 1997 were $3.5
million and $1.5 million, respectively. The increase in revenues resulted
primarily from increases in network service revenues. During the three months
ended September 30, 1998, UE, KCPL and NSP accounted for approximately 47%, 28%
and 15% of the Company's revenues, respectively. For the three months ended
September 30, 1997, KCPL and UE accounted for approximately 50% and 44% of the
Company's revenues, respectively. Revenues for the nine months ended September
30, 1998 and 1997 were $8.6 million and $4.0 million, respectively. The increase
in revenues was principally due to the increases in network service revenues.
During the nine months ended September 30, 1998, UE, KCPL and NSP accounted for
approximately 50%, 31% and 11% of the Company's revenues, respectively. During
the first nine months of 1997, KCPL and UE accounted for 51% and 39% of the
Company's revenues, respectively.
The Company generally realizes service revenues under its services
agreements only when its networks or portions thereof are successfully installed
and operating and its clients begin billing their own customers or begin using
the NMR services provided. Revenues are expected to increase as the Company
continues to install its networks, the networks or portions thereof become
operational, and its clients begin billing their own customers or begin using
the NMR services provided. The Company expects to have product sales associated
with certain NMR deployments. These sales could be material to the Company's
revenues, although no assurance can be given in this regard. 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 nine
months ended September 30, 1998 and 1997, respectively, are not reliable
indicators of revenues that might be expected in the future.
COST OF REVENUES.
Costs of revenues were $9.2 million and $5.0 million for the three months
ended September 30, 1998 and 1997, respectively. Costs of revenues were $21.1
million and $12.8 million for the nine months ended September 30, 1998 and 1997,
respectively. For the three months and the nine months ended September 30, 1998
and 1997, cost of revenues consisted primarily of network operations costs. The
increase in costs of revenues was driven by increasing costs of providing
network services to support the roll-out of new and existing networks. Costs of
network operations consist of labor 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 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.
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OPERATING EXPENSES.
Operating expenses, consisting of research and development, marketing and
sales, general and administrative costs and depreciation and amortization
expenses, were $18.5 million and $16.4 million for the three months ended
September 30, 1998 and 1997, respectively. Operating expenses were $56.7 million
and $47.4 million for the nine months ended September 30, 1998 and 1997,
respectively. The increase in operating expenses on a 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
maintain its current level of spending on research and development activities
for the foreseeable future. Marketing and sales costs are expected to remain at
current levels. General and administrative costs are expected to increase over
time in line with the Company's expected growth and are expected to increase
moderately over the next few years in connection with the installation of a new
corporate information system which commenced in the second quarter of 1998.
RESEARCH AND 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 were $7.1 million and $5.7
million for the three months ended September 30, 1998 and 1997, respectively,
net of expenses reimbursable by BCN Data Systems, L.L.C. ("BCN") of $804,000 for
technology migration costs in the three months ended September 30, 1997. No
expenses were reimbursable by BCN in the three months ended September 30, 1998.
Research and development expenses were $22.6 million and $18.8 million, net of
expenses reimbursable by BCN of $245,000 and $2.5 million for technology
migration costs, for the nine months ended September 30, 1998 and 1997,
respectively. Research and development spending increases in 1998 and 1997
reflect primarily additions to the Company's engineering staff and the continued
expenditure for technology migration without a corresponding reimbursement by
BCN in 1998. The Company expects that research and development expenses will
remain at current levels in the near term.
MARKETING AND SALES.
Marketing and sales expenses consist principally of personnel costs,
including commissions paid to sales and marketing personnel, travel,
advertising, trade show and other promotional costs. Marketing and sales
expenses were $2.9 million and $3.7 million during the three months ended
September 30, 1998 and 1997, respectively. Marketing and sales expenses
decreased during the three months ended September 30, 1998 over the same period
in 1997 primarily resulting from the costs of a large advertising campaign in
the 1997 period which did not recur in the 1998 period. Marketing and sales
expenses for the nine months ended September 30, 1998 and 1997 were $8.8 million
and $7.3 million, respectively. The Company expects marketing and sales expenses
to remain at current levels in the near term.
GENERAL AND ADMINISTRATIVE.
General and administrative expenses include compensation paid to general
management, administrative personnel costs, travel and communications and other
general administrative expenses, including fees for professional services.
General and administrative expenses for the three months ended September 30,
1998 and 1997 were $3.8 million and $4.2 million, respectively. General and
administrative expenses for the nine months ended September 30, 1998 and 1997
were $11.9 million and $13.2 million, respectively. The decrease in these
expenses in the 1998 period over the 1997 period resulted from a reduction in
expenditures for certain employee compensation and professional fees. The
Company expects general and administrative expenses to increase over time in
line with expected growth.
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DEPRECIATION AND AMORTIZATION.
Depreciation and amortization expense was $4.8 million and $2.9 million for
the three months ended September 30, 1998 and 1997, respectively. Depreciation
and amortization expense was $13.4 million and $8.0 million for the nine months
ended September 30, 1998 and 1997, respectively. Depreciation and amortization
expense is attributable to the Company's networks in progress, including both
equipment manufactured by the Company and systems partially installed in the
field, property and leasehold improvements. Depreciation and amortization
expense has increased as a result of increased additions to networks in
progress, property and leasehold improvements period-over-period.
EQUITY IN LOSS OF UNCONSOLIDATED AFFILIATE.
The Company accounts for its investment in BCN, which began operations in
1997, using the equity method. For the three months ended September 30, 1998 and
1997, the Company recognized $815,000 and $670,000 as its share of BCN's losses,
respectively. In the nine months ended September 30, 1998 and 1997, the Company
recognized $1.8 million and $2.0 million as its share of BCN's losses,
respectively. The decrease in these expenses in the 1998 period over the 1997
period resulted from the continued expenditure by the Company for technology
migration without a corresponding reimbursement from BCN in 1998. The Company
expects to recognize increased losses in the future from its share of BCN's
losses as BCN expands its 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 Notes due 2005 (the "1995 Notes") and related warrants (the
"1995 Warrants") for proceeds, net of issuance costs, of $169.9 million. In
October 1996, the Company completed an initial public offering of its common
stock for aggregate net proceeds of $92.2 million. In connection with the
initial public offering, the Company also received $1.2 million in proceeds from
the cash exercise of warrants to purchase shares of the Company's common stock.
In addition, in October 1996, the Company completed certain private placements
of its common stock for net proceeds of approximately $28.0 million. In
September 1997, the Company issued and sold a total of approximately $654.1
million aggregate principal amount at maturity of the 1997 Notes and warrants
(including 1997 Notes and warrants issued in exchange for the 1995 Notes) for
proceeds, net of issuance costs, of $96.3 million. In connection with the
issuance of the 1997 Notes, $231.0 million of the issue price for the 1997 Notes
and warrants was issued in exchange for all of the Company's 1995 Notes. In May
1998, a new subsidiary of the Company, CellNet Funding L.L.C. ("Funding")
completed an offering of Exchangeable Preferred Securities Mandatorily
Redeemable 2010 (the "Preferred Securities") for proceeds net of issuance costs
of $105.9 million. The restricted cash at September 30, 1998 of approximately
$19.6 million includes the proceeds of the offering which are designated for the
payment of cash dividends on the Preferred Securities through June 1, 2001.
Funding invested the restricted cash in U.S. Treasury strips ("Treasury Strips")
which was placed in escrow upon the closing of the offering of the Preferred
Securities. The Company has earned interest income on the invested proceeds from
these financings. The Company has also incurred significant interest expense
from the amortization of the original issue discount on the 1995 Notes and the
1997 Notes. Interest expense will increase significantly in future periods as a
result of increased accretion of a larger original issue discount balance from
the issuance of the 1997 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 three months ended
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September 30, 1998 and 1997 was $2.2 million and $1.5 million, respectively.
Interest income for the nine months ended September 30, 1998 and 1997 was $6.1
million and $5.8 million, respectively.
No interest on the 1997 Notes is payable prior to April 1, 2003. Thereafter,
until maturity on October 1, 2007, any interest will be payable semi-annually in
arrears on each April 1 and October 1. The carrying amount of the 1997 Notes
accretes from the date of issue and the Company's interest expense includes such
accretion. Interest expense, net of capitalized interest, was $10.9 million and
$6.1 million for the three months ended September 30, 1998 and 1997. Interest
expense, net of capitalized interest, was $32.6 million and $18.7 million for
the nine months ended September 30, 1998 and 1997, 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, 1997, the Company had net operating loss carryforwards of
approximately $206.0 million and $56.0 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 1998 and 2012. Such federal
carryforwards will expire between 2001 and 2012. Equity issuances in April 1991
and the initial public offering in 1996 triggered such limitations on loss
carryforwards. As of December 31, 1997, approximately $70.0 million of net
operating losses remain limited to an annual usage of approximately $36.0
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.
DIVIDENDS AND ACCRETION ON PREFERRED SECURITIES OF SUBSIDIARY.
The Preferred Securities consist of 4.4 million exchangeable preferred
securities of Funding that bear a cumulative dividend at a rate of 7% per annum.
The dividend is paid quarterly in arrears each March 1, June 1, September 1 and
December 1, and commenced September 1, 1998. Dividend expense for the three
months and the nine months ended September 30, 1998 was $2.0 million and $2.8
million, respectively. The net proceeds from the placement of the Preferred
Securities, after offering costs, was $105.9 million and will fully accrete to
the face value of $110.0 million on June 1, 2010. Accreted interest expense for
the three months and the nine months ended September 30, 1998 was $28,000 and
$122,000, respectively.
IMPACT OF THE YEAR 2000.
The Company has assessed the scope of the risk of problems its computer
systems may have related to the Year 2000 and believes that its wireless data
networks are Year 2000 compliant. The Company will require its third party
network vendors and suppliers to be Year 2000 compliant. Accordingly, the
Company expects that the advent of the millennium will have no material adverse
effect on its network operations.
The Company's existing internal corporate information systems are not
adequate to support the Company's future plans and may not be Year 2000
compliant. Because these systems will not meet the Company's future needs, the
Company has decided to replace them with a new corporate information system
commencing in the second quarter of 1998 and expects to complete installation in
advance of the year 2000. The costs involved in purchasing and installing the
new corporate information system are estimated at approximately $1.5 million for
1998 and totaled $1.4 million for the nine months ended September 30, 1998.
In addition, the Company is in the process of inquiring of its vendors and
business partners about their progress in identifying and addressing problems
related to the year 2000. No assurance can be given that
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all of these third party systems will be Year 2000 compliant. Failure by the
Company and/or its vendors and business partners to complete Year 2000
compliance work in a timely manner could have a material adverse effect on
certain of the Company's operations.
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 nine months of 1998 and 1997, net cash used in the Company's
operating activities totaled $43.0 million and $44.7 million, respectively. Net
cash used in operating activities resulted primarily from cash used to fund net
operating losses.
In the nine months ended September 30, 1998 and 1997, net cash used for
investing activities totaled $111.3 million and $26.4 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.
In the first nine months of September 30, 1998 and 1997, net cash provided
by the Company's financing activities totaled $106.3 million and $97,000,
respectively. In May 1998, Funding, a new subsidiary of the Company, completed
an offering of the Preferred Securities for proceeds net of issuance costs of
$105.9 million.
As of September 30, 1998, the Company had cash, cash equivalents, short-term
investments and restricted cash totaling $126.3 million. As of December 31,
1997, the Company had cash, cash equivalents and short-term investments totaling
$148.1 million. The decrease of $21.8 million from December 31, 1997 resulted
from operating costs and the development and construction of the Company's
wireless communications networks, offset by proceeds related to the issuance of
the Preferred Securities.
Deployments of the Company's wireless communications networks will require
substantial additional capital. The Company is committed to make approximately
$77.5 million in capital expenditures in 1998 for saturation deployment network
installations of which $53.8 million was expended by September 30, 1998. In
addition, the Company anticipates that it may spend as much as an additional
$16.6 million during 1998 in capital expenditures relating to the installation
of its broad deployment network in California, of which $12.9 million was
expended by September 30, 1998. The exact amount of such expenditures will
depend, in part, upon the amount of NMR and other services contracted for. The
Company may make additional capital expenditures in connection with the
installation of new networks, the expansion of existing networks and/or an
acceleration in anticipated network installation schedules. In addition, funds
will be required for a number of purposes including, but not limited to, 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
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, including financing provided by utilities to
finance the construction of networks being built out primarily for them, public
and private offerings of debt and equity securities and cash generated from
operating activities. 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
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generated from such projects. The Company expects that the recurring revenue
stream from long-term services contracts and other arrangements will support the
amortization of debt raised for the project involved, however no assurance can
be given that this will occur. The Company does not anticipate deriving any
significant cash from such operations for several years.
The Company believes that existing cash, cash equivalents, anticipated
interest income, other revenues and expected sources of project financing of
approximately $90.0 million will be sufficient to meet its cash requirements for
at least the next 12 months. The Company requires and intends to raise a
substantial amount of capital in 1999 and expects that it will continue to
require substantial amounts of additional capital in the future. 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, including expected project 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 contained in the Indenture
or that may be contained in any additional financing arrangements. The Indenture
under which the 1997 Notes were issued contains certain covenants that limit the
Company's ability to incur additional indebtedness. Future financings may be
dilutive to existing stockholders. 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 value of the common stock.
RISK FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
DEPENDENCE ON AND UNCERTAINTY OF MARKET ACCEPTANCE.
The Company's success will be almost entirely dependent on whether
established utilities and other parties, including new power market
participants, sign services contracts with CellNet or enter into other
arrangements which allow CellNet to install NMR networks servicing a substantial
number of meters.
Because automation of utility meter reading and distribution is a relatively
new and evolving market and is likely to be significantly affected by
deregulation, it is difficult to predict the future growth rate and size of this
market. Utilities 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.
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 utilities or other
parties, including new power market participants, do not adopt the Company's
technology, or do so less rapidly than expected by the Company, the Company's
future results, including its ability to service its indebtedness and achieve
positive cash flow or profitability, will be materially and adversely affected.
In recent competitive bids, potential electric and gas utility customers and new
power market participants have selected competing systems to those offered by
the Company and potential utility customers and new power market participants,
from time to time may select competing services in the future. See
"--Substantial and Increasing Competition."
Any decision by an energy provider to utilize the Company's services will
involve significant organizational, technological and financial commitments. The
utility industry historically is characterized by long purchasing cycles and
cautious decision making. Utilities typically undergo 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. Although the uncertainty surrounding proposed regulatory
changes in some states may have caused, and may continue to cause, additional
delays in purchasing decisions by established utilities, the Company believes
that implementation of utility deregulation will ultimately accelerate the
utility decision-making process. Purchases of the Company's
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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, and there can be no assurance as to when or if
the Company will enter into additional services contracts or that any such
contracts would be on terms favorable to the Company.
With the advent of utility industry deregulation, the Company is seeking
opportunities to provide its NMR services to other parties, including new power
market participants. The Company believes it is well-positioned to offer
competitive advantages to established utilities and other parties, including new
power market participants. Although the Company has entered into several
contracts with new power market participants and other parties, there can be no
assurance that the Company will be able to enter into contracts covering a
sufficient number of meters to recoup its costs of deployment, on terms
favorable to the Company, or at all. The Company's ability to enter into
contracts with other parties, including new power market participants, depends,
in part, on the timing and type of deregulation in each state. The Company also
anticipates that under contracts with other parties, including new power market
participants, it would build out its networks, at least in part, before the
capacity was fully committed. For these reasons, the Company's ability to obtain
financing for the capital expenditures associated with these contracts may be
limited. The Company believes, however, that it will be able to defer a
significant portion of the required capital expenditures by building out its
networks incrementally as needed, and that the new power market participants and
other parties would lease or acquire the endpoints from the Company, reducing
the Company's costs. The Company also anticipates that its contracts with new
power market participants and other parties will be shorter-term than those it
has entered into with established utilities, and the revenues may therefore not
fully cover the costs of network build-out and associated operating costs. The
Company intends to reduce this risk by marketing its services to a wide range of
new power market participants and other parties, but there can be no assurance
that the Company will be successful in such marketing efforts, or that the new
power market participants and other parties will be successful in capturing any
significant share of the energy service market.
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 established
utilities and other parties including new power market participants and upon the
successful deployment and operation of the Company's wireless data networks. The
signing of any new services contracts for saturation or broad deployments is
expected to occur on an irregular basis. The Company expects that it will
generally take two to four years to complete the installation of each saturation
deployment network after a services contract has been signed. Service revenues
from both types of such networks are not expected to exceed the Company's
capital investments and expenses incurred to deploy and operate such networks
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 in saturation deployments no earlier than six months
after the execution of the applicable services contract. The Company begins to
incur capital expenditures for the construction of networks used in broad
deployments and does not begin to receive recurring revenues until portions of
the network become operational. 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, cost of
site leases, the nature and sophistication of services being provided, the cost
of spectrum acquisition, 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 established utilities. During 1997,
approximately 88% of the Company's revenues were derived from its contracts with
KCPL and UE and, during the first nine months of 1998, 92% of the Company's
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revenues were derived from its contracts with KCPL, UE and NSP. The Company will
not generate sufficient cash flow to service its indebtedness or achieve
profitability unless it enters into additional services contracts covering a
significant number of additional meters. There can be no assurance that the
Company will complete commercial deployments of the CellNet system under current
services contracts successfully or that it will obtain enough additional
services contracts on satisfactory terms for network deployments in a sufficient
number of locations to allow the Company to achieve adequate cash flow to
service its indebtedness or achieve positive cash flow or 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 established utilities and new power market
participants 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 relationships or investments that could result in a
material adverse effect on the Company's business, operating results, 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 the generation of a
significant percentage of future revenues from non-utility services. Potential
non-utility applications of the Company's systems include home security, remote
status monitoring of vending machines, office equipment and parking meters and
other equipment and remote control of traffic lights. The Company believes its
future ability to service its indebtedness and to achieve profitability will
depend, in part, upon its success in generating substantial revenues from such
additional services. The Company has been working with industry leaders to
develop such applications. However, there is no assurance any of these
activities will result in the successful development or commercial introduction
of any such services. The Company currently has no services contracts which
provide for the implementation of such services, and the Company has not yet
completed development or deployed any such services on a commercial scale. In
addition, unless the Company is successful in deploying its wireless networks in
targeted 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.
DEPENDENCE ON BUSINESS RELATIONSHIPS TO ACHIEVE MARKET PENETRATION.
A key element of the Company's business strategy is the formation of
corporate relationships 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 utility and 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 relationships with such
companies, that existing relationships will continue or be successful in
achieving their purposes or that such companies will not form competing
arrangements.
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SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT; SUBSTANTIAL FUTURE CAPITAL
NEEDS.
The Company has substantial outstanding indebtedness, including $654.1
million in aggregate principal amount at maturity of the 1997 Notes. The Company
will be required to pay cash interest on the 1997 Notes commencing April 1, 2003
and repay the 1997 Notes on October 1, 2007. In May 1998, Funding, a
wholly-owned finance subsidiary of the Company, completed an offering of
Preferred Securities which will fully accrete to a face value of $110.0 million
on June 1, 2010. The Preferred Securities bear a cumulative dividend at the rate
of 7% per annum. Funding has purchased Treasury Strips sufficient in amount to
pay cash dividends on the Preferred Securities through June 1, 2001 and has
deposited the Treasury Strips in escrow with the Escrow Agent for the benefit of
the holders of the Preferred Securities. Funding is required to pay quarterly
dividends in cash on the Preferred Securities through June 1, 2001, and
thereafter, in cash or shares of the Company common stock, at the option of
Funding. The Preferred Securities are subject to mandatory redemption on June 1,
2010 at a redemption price of 100% of the liquidation preference of the
Preferred Securities, plus accrued and unpaid dividends, if any. The Company has
provided the holders of the Preferred Securities certain guarantees of payment
of dividends, distributions, and redemptions.
CellNet intends to incur substantial additional indebtedness, primarily in
connection with installing future networks. As a result, CellNet 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, in part due to increased 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 a number
of factors, including 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 the possibilities that: (i) 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 services within a network 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 take actions such as 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, or that effecting any of these
strategies would yield sufficient proceeds to make the required payments on any
of the Company's indebtedness. In particular, there is a risk that the Company
would be unable, if needed, to refinance the 1997 Notes prior to the date cash
interest payments become due and payable on the 1997 Notes or at their maturity
date, given uncertainty about prevailing capital market conditions, the
Company's then performance and financial position and the Company's projected
high levels of indebtedness. Such inability to refinance the 1997 Notes could
result in cross-defaults under other indebtedness and may limit the Company's
ability to meet its obligations in respect of the CellNet Preferred Stock and
Funding's ability to meet its obligations in respect of the Preferred
Securities.
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) the
Company's cash flow, if any, cannot be used in the Company's business as a
substantial portion of the Company's cash flow from operations must
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be dedicated to the payment of principal and interest on its indebtedness, 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, and for funding operating
losses. As of September 30, 1998, the Company had $126.3 million in cash, cash
equivalents, short-term investments and restricted cash. The Company intends to
raise a substantial amount of additional capital in 1998 and 1999 and expects
that it will continue to require substantial amounts of additional capital in
the future. 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. There can be no assurance that
additional financing will be available when required or, if 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."
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 its 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.
HISTORY AND CONTINUATION OF OPERATING LOSSES.
The Company has incurred substantial and increasing operating losses since
inception. As of September 30, 1998, the Company had an accumulated deficit of
$382.2 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 to generate significant revenues relative to its
anticipated operating costs during 1998 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. Accordingly, the Company does not expect positive cash flow
after capital expenditures from its NMR services operations for several years.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
SUBSTANTIAL AND INCREASING COMPETITION.
The emerging market for utility NMR systems, the deregulation of the
electric utility industry 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. Deregulation will likely cause competition to increase. The
Company believes that at this time its only significant direct competitor in the
marketplace at present is Itron, Inc. ("Itron"), an established manufacturer and
seller of
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hand-held and drive-by automated meter reading ("AMR") equipment for utilities.
Itron has also offered its customers its Genesis-TM- system, a radio network
system similar to the Company's system, for meter reading purposes.
There may be many potential alternative solutions to the Company's NMR
services including traditional wireless solutions. Motorola is an example of a
company whose technology might be adapted for NMR and who might become a
competitor of the Company. Mtel has announced that it intends to adapt its
technology to offer residential services similar to NMR some time in 1999 over
its existing paging network, with the development of endpoint radios and network
management capabilities being left to other independent companies. Whisper
Communications (formerly, a part of Diablo Research) now offers its True 2
Way-TM- fixed-based radio frequency ("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. Other
wireless communications providers who have entered the market for utility and
commercial data services include cellular control channel companies such as
Cellemetry and Aeris Communications. These companies offer low bandwidth
services that compete with some of CellNet's metering applications. Bell South
Wireless (formerly Ram Mobile Data) offers data services that may compete with a
variety of CellNet data services. Schlumberger Industries, Inc. ("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 Teldata, Inc. 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, including its software, is widely
regarded as competitive at the present time, there can be no assurance that the
Company's competitors will not succeed in developing products, technologies or
software 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. 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 new services contracts and maintain existing agreements.
Competition for services relating to non-utility applications may be more
intense than competition for 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 utilities' electric, gas and water meters and 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
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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.
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, specialized mobile radio services and
personal communications systems ("PCS") and other commercial mobile radio
services 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 and
paging, 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 future
performance will also depend significantly on its ability to respond to future
regulatory changes.
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 attempts to obtain exclusive usage of licensed bandwidth and/or
secure its own licenses. The Company has focused its spectrum acquisition
strategy generally on the largest Metropolitan Statistical Areas ("MSAs") and
Consolidated Metropolitan Statistical Areas ("CMSAs") in the United States. As
of September 30, 1998, the Company had acquired a total of 149 spectrum licenses
in 53 of the top 60 MSAs/CMSAs. 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. 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 a showing of good cause, but
there is no assurance that the FCC will grant any such extension. The Company is
responding to this
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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, operating results,
financial condition and cash flow. 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. As
an outgrowth of this proceeding, the Commission will be conducting an auction of
the 902-928 MHz band for the Location and Monitoring Service ("LMS"), which will
auction off licenses covering the entire nation where incumbent licensees have
not been authorized. While the Company believes that the rules adopted in the
LMS proceeding are adequate to provide interference protection for its systems,
it cannot determine with certainty whether the authorization of additional LMS
licensees will adversely impact its operations in any given location.
While the Company intends to offer alternate market services over its
private, internal network, some of those services may include the use of the
Company's network for private carrier service offerings. The Company's offerings
would be structured to comply with FCC rules governing the offering of private
carrier services, and each such service offering would need to be reviewed
relative to these rules. 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 assurances 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.
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 band (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 (vii) for incumbent and new licensees, liberalizing some of the technical
and operational restrictions on the use of the licensed 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
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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.
In August 1997, the FCC's authority to utilize competitive bidding as a
licensing mechanism was amended and expanded by Congress in the Budget Act of
1997. Under this recent enactment, the FCC must use competitive bidding
procedures to choose between any mutually exclusive applications, except where
the radio frequency spectrum is being used for public radio safety services.
Congress included a very broad definition of "public radio safety services," to
include private internal radio services used by state and local governments and
non-governmental entities, including emergency road services provided by not-
for-profit organizations that are used to protect the safety of life, health, or
property and that are not made commercially available to the public. As a
result, licensed systems that protect the safety of life, health, or property
and are not made commercially available to the public are not subject to
licensing by FCC auctions.
The new auction legislation post-dates the Notice of Proposed Rulemaking in
WT Docket 97-81 and will, in the Company's view, require the FCC to review and
revise its proposals in that proceeding relating to the breadth of the auction
authority granted to the FCC, which no longer distinguishes between private
internal systems, and proposals relating to the grant of "subscriber based"
services. The Company is unable to determine how the new auction legislation
will affect the proposals in that proceeding, whether the Company's use of MAS
spectrum will subject its applications to the possibility of auctions or will,
instead, be considered a "public safety" use, or whether the Commission will
otherwise exempt the 928/952 MHz band in which the Company currently operates
from circumstances in which mutual exclusivity between applicants for the same
license, requiring the use of auctions, is likely to exist. Nor is the Company
able to determine when the FCC will act in WT Docket 97-81, either to issue new
proposals consistent with the new auction legislation or adopt new rules
consistent with the positions already established in the proceeding or a
combination thereof.
The Company is also 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 FCC 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, and
the Company could experience substantial delays in adapting its networks 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.
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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, 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. At the request of the Company, the FCC has determined that the
Company's current use of the MAS spectrum constitutes the use as a private,
internal network, and so the Company's applications for new licenses, and for
major modifications to existing licenses, are being processed in due course.
There is no assurance that the Company's future uses of the MAS spectrum will
similarly qualify as a use in a private, internal network, or the FCC will not
change or expand its freeze on the processing of applications to recognize the
impact of the new auction legislation described above. In either case, the
Company's ability to obtain new licenses could be materially adversely affected,
with similar consequences on the Company's ability to service areas where it has
not yet acquired adequate frequencies.
Finally, when the Company acquires licenses assigned to other applicants, or
utilizes licenses issued in the past, the Company is required to modify its
licenses to reflect more advanced technological parameters now utilized by the
Company and its systems. The Company has developed such amendments with the
approval of the FCC's staff and has received and anticipates continuing to
receive timely grant of all required modifications. There can be no assurance
that any particular modification will be granted timely to the Company's
introduction of service on a particular license, and the failure to obtain the
required license modifications could have a material adverse effect on the
Company's ability to serve areas covered by such unmodified licenses.
RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION.
The Company is pursuing international markets through BCN Data Systems
L.L.C. ("BCN"), its international joint venture with Bechtel Enterprises, Inc.
The Company does not expect to generate any revenues from its international
operations during 1998. The Company has incurred, and anticipates that it will
continue to incur, significant and increasing 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 may not materialize,
and where present, is likely to vary by country, based on such factors as the
regulatory environment, electric power generating capacity and demand, labor
costs, costs of spectrum acquisition and other political and economic
conditions. In addition, the Company may confront significant challenges in
developing and implementing localized versions of its NMR system due to many
factors including the differing standards among utilities on a country by
country basis. To date, the Company has extremely limited 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
27
<PAGE>
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 of pursuing international markets through BCN may
involve additional partners in local operating project entities in particular
countries. The Company or BCN 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 or BCN 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 BCN or that such partner will not impose the
same or similar accounting and financial controls as the Company or BCN. The
risk is also present that a joint venture partner may be unable to meet its
economic or other obligations and that the Company or BCN may be required to
fulfill those obligations. In addition, in any joint venture in which the
Company or BCN does not have a majority interest, the Company or BCN may not
have control over the operations or assets of such joint venture. Furthermore,
the joint venture structure may limit the amount of funds that can be upstreamed
to the Company or BCN.
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. Substantially 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.
28
<PAGE>
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 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 pending 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 the Company's business, operating results, financial
condition and cash flow. See "--Litigation" below.
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
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
29
<PAGE>
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. Some components relied upon may have
an excessive failure rate or inferior capabilities. 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
subassemblies, 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 electric 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 sudden or material
increase in the number of deployments would result in an increase in the number
of new electric meters ordered by electric utilities and new power market
participants 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.
RISK OF SYSTEM FAILURES, DELAYS AND INADEQUACIES.
The performance, reliability and availability of the Company's wireless data
networks are critical to the Company's reputation and ability to attract and
retain utilities and earn revenues from NMR services and other non-utility
applications. These wireless data networks are vulnerable to damage or
interruption from fire, flood, earthquakes, storms and other similar events. Any
system failure that causes interruption in the availability of network services
could result in a loss of revenue and, if sustained or repeated, could reduce
the attractiveness of the Company's services for future utilities or other
customers. The occurrence of any of the foregoing could have a material adverse
effect on the Company's business, operating results, financial condition and
cash flow.
POSSIBLE TERMINATION OF CONTRACTS.
The Company expects that a substantial portion of its future revenues will
be provided pursuant to services contracts of various kinds. 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 utility services contracts provides for 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. Future services contracts with utilities may
contain similar provisions. Contracts with new power market participants
generally allow for termination without cause by the new power market
participants on thirty days prior written notice except to the extent they have
already ordered services under the contract. In the event that such a services
contract is terminated, the Company may incur substantial losses. In addition,
the Company anticipates that any contracts with new power market participants
will generally have shorter terms than the Company's existing utility contracts.
30
<PAGE>
The Company's current contracts with new power market participants generally
have terms of one to five years, compared to terms of ten to twenty years with
utilities. 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 significant services contracts would have a material
adverse effect on the Company's business, results of operations, financial
condition and cash flow.
SHAREHOLDERS' AGREEMENT.
Under the terms of a Shareholders' Agreement among the Company and certain
stockholders of the Company (the "Shareholders' Agreement"), so long as certain
parties to the Shareholders' Agreement continue to hold not less than 700,000
shares of common stock (as such number is adjusted for stock splits,
consolidations or other similar events), the Company is obligated to nominate
for election representatives of certain stockholders as directors at each
meeting of the Company's stockholders at which a vote for directors will be
taken. The effect of the Shareholders' Agreement is to give certain stockholders
greater influence over the management of the Company than they would otherwise
have and to provide certain stockholders with, among other things, certain
registration, first refusal, co-sale and other rights.
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 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.
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 electric 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. See
"--Uncertainty of Protection of Copyrights Patents and Proprietary Rights." In
November 1998, the court granted Itron's motion for summary judgment, ruling
that Itron's products did not infringe the asserted claims in the Company's
patent. The Company intends to appeal the ruling.
The consolidated complaint of JERE SETTLE AND KAREN ZULLY V. JOHN M. SEIDL,
ET AL., No. 398464, filed in the Superior Court of California for the County of
San Mateo, is a purported class action on behalf of the Company's stockholders
against the Company, certain of its officers and directors and underwriters of
the Company's initial public offering seeking unspecified damages and rescission
for alleged liability under various provisions of the federal securities law and
California state law. The plaintiffs alleged generally 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 the Company was obligated to
disclose, but failed to disclose, that a patent conflict with Itron, Inc. was
likely to ensue. The complaint was dismissed on February 9, 1998, without leave
to amend. Plaintiffs subsequently filed notice of their intention to appeal the
decision, and on November 2, 1998, plaintiffs filed their appellate briefs in
the California Court of Appeal.
ABSENCE OF PUBLIC MARKET FOR THE CELLNET COMMON STOCK; VOLATILITY OF COMMON
STOCK PRICE.
The trading price of the Company's common stock has been highly volatile
since the Company's initial public offering 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
31
<PAGE>
addition, it is possible that in some future period 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 recently experienced extreme price and
volume fluctuations that are not related to the operating performance of
particular companies. These broad market fluctuations could have a significant
impact on the market price of the common stock and the Preferred Securities.
NO DIVIDENDS ON COMMON STOCK; DIVIDEND RESTRICTIONS.
The Company has not declared or paid any dividends on its common 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 on the common stock in the
foreseeable future. In addition, the Company's existing financing arrangements
restrict the payment of any dividends on the common stock.
POTENTIAL ADVERSE EFFECT OF SHARES ELIGIBLE FOR FUTURE SALE.
A substantial portion of the Company's common stock is presently eligible
for immediate sale in the public market subject, in the case of certain shares,
to the limitations of Rules 144, 144(k) or 701 under the Securities Act. In
addition, the holders of a significant number of such shares of common stock are
entitled to certain registration rights with respect to such shares and the
number of shares sold in the public market could increase substantially upon
exercise of such registration rights.
RISKS RELATED TO PREFERRED SECURITIES OF FUNDING.
In May 1998, Funding, a wholly-owned finance subsidiary of the Company,
completed an offering of Preferred Securities which will fully accrete to a face
value of $110.0 million on June 1, 2010. The Preferred Securities bear a
cumulative dividend at the rate of 7% per annum. Funding has purchased Treasury
Strips sufficient in amount to pay cash dividends on the Preferred Securities
through June 1, 2001 and has deposited the Treasury Strips in escrow with the
Escrow Agent for the benefit of the holders of the Preferred Securities. Funding
is required to pay quarterly dividends in cash on the Preferred Securities
through June 1, 2001, and thereafter, in cash or shares of the Company common
stock, at the option of Funding. The first dividend payment was made on
September 1, 1998 in the amount of $2.2 million. The Preferred Securities are
subject to mandatory redemption on June 1, 2010 at a redemption price of 100% of
the liquidation preference of the Preferred Securities, plus accrued and unpaid
dividends, if any. The Company has provided the holders of the Preferred
Securities certain guarantees of payment of dividends, distributions, and
redemptions. The Preferred Securities involve a high degree of risk, and
accordingly, reference must be made to the Risk Factors and other cautionary
statements set forth in the Registration Statement on Form S-3 in respect of the
Preferred Securities and in Funding's Report on Form 10-Q and other filings by
Funding with the Securities and Exchange Commission.
ANTI-TAKEOVER PROVISIONS.
The Board of Directors, without further shareholder approval, can issue
preferred shares with dividend, liquidation, conversion, voting, exchange or
other rights which could adversely affect the voting power or other rights of
the holders of the common stock. In the event of issuance, the preferred shares
could be utilized, under certain circumstances, as a method of discouraging,
delaying or preventing a change of control of CellNet. In addition, the Company
is, and will continue to be, subject to the anti-takeover provisions of the
Delaware General Corporation Law, which could have the effect of delaying or
preventing a change of control of the Company. Furthermore, upon a change of
control, the holders of substantially all of the Company's outstanding
indebtedness are entitled, at their option, to be repaid in chase and the
holders of CellNet's preferred stock may, at their option, require CellNet or
redeem their shares for cash. Such provisions may have the effect of delaying or
preventing changes in control or management of the Company. All of these factors
could materially adversely affect the price of the Company's common stock and
the Preferred Securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
32
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See above, "Management's Discussion and Analysis--Risk Factors that May
Affect Future Operating Results--Litigation".
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
- ----------- ----------------------------------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
(b) Reports of Form 8-K.
There were no reports on Form 8-K filed during the quarter ended September
30, 1998.
33
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C> <C>
CELLNET DATA SYSTEMS, INC.
DATE: November 12, 1998 By: /s/ PAUL G. MANCA
------------------------------------------
Paul G. Manca
VICE PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
</TABLE>
34
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 63,097
<SECURITIES> 43,577
<RECEIVABLES> 6,561
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 114,922
<PP&E> 239,985
<DEPRECIATION> (34,989)
<TOTAL-ASSETS> 344,286
<CURRENT-LIABILITIES> (25,371)
<BONDS> (303,949)
(106,062)
0
<COMMON> (211,111)
<OTHER-SE> (73,940)
<TOTAL-LIABILITY-AND-EQUITY> (344,286)
<SALES> 552
<TOTAL-REVENUES> 8,626
<CGS> (413)
<TOTAL-COSTS> (21,123)
<OTHER-EXPENSES> (56,702)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (32,571)
<INCOME-PRETAX> (97,611)
<INCOME-TAX> 0
<INCOME-CONTINUING> (97,611)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (100,556)
<EPS-PRIMARY> (2.43)
<EPS-DILUTED> (2.43)
</TABLE>
