<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998.
COMMISSION FILE NUMBER 0-21409
------------------------
CELLNET DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2951096
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
125 SHOREWAY ROAD 94070
SAN CARLOS, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(415) 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
filing requirements for the past 90 days. Yes /X/ No / /
As of April 1, 1998, 41,923,938 shares of the Registrant's Common Stock,
$0.001 par value, were issued and outstanding.
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<PAGE>
CELLNET DATA SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
-------------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--As of March 31, 1998 and December 31, 1997............... 3
Condensed Consolidated Statements of Operations--Three Months Ended March 31, 1998 and 1997..... 4
Condensed Consolidated Statements of Cash Flows--Three Months Ended March 31, 1998 and March 31,
1997............................................................................................ 5
Notes to Consolidated Financial Statements...................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 29
Item 2. Changes in Securities...................................................................... 29
Item 3. Defaults Upon Senior Securities............................................................ 29
Item 4. Submission of Matters to a Vote of Securities Holders...................................... 29
Item 5. Other Information.......................................................................... 30
Item 6. Exhibits and Reports on Form 8-K........................................................... 30
SIGNATURES.............................................................................................. 31
</TABLE>
2
<PAGE>
PART I.
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 72,106 $ 111,112
Short-term investments.............................................................. 37,754 36,946
Accounts receivable--trade.......................................................... 2,076 1,519
Accounts receivable--other.......................................................... 6,501 5,123
Prepaid expenses and other.......................................................... 2,110 2,060
----------- ------------
Total current assets.............................................................. 120,547 156,760
Network components and inventory...................................................... 27,686 24,225
Networks in progress--net............................................................. 109,965 92,308
Property--net......................................................................... 15,973 16,061
Debt issuance and other costs--net.................................................... 4,588 4,631
----------- ------------
Total assets...................................................................... $ 278,759 $ 293,985
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.................................................................... $ 14,138 $ 11,706
Accrued compensation and related benefits........................................... 3,500 2,189
Accrued liabilities................................................................. 2,185 2,655
Current portion of capital lease obligations........................................ 448 466
----------- ------------
Total current liabilities......................................................... 20,271 17,016
----------- ------------
Senior notes--14%..................................................................... 279,952 268,673
Deferred revenue...................................................................... 5,583 5,620
Capital lease obligations............................................................. 593 412
Commitments and Contingencies (Note 3)
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: 41,917,026; 1997: 41,845,475................................................ 210,302 209,996
Notes receivable from sale of common stock.......................................... (668) (676)
Warrants............................................................................ 74,546 74,546
Accumulated deficit................................................................. (311,815) (281,599)
Net unrealized loss on short-term investments....................................... (5) (3)
----------- ------------
Total stockholders' equity (deficit).............................................. (27,640) 2,264
----------- ------------
Total liabilities and stockholders' equity (deficit).................................. $ 278,759 $ 293,985
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Revenues:
Network service revenues................................................................ $ 1,971 $ 859
Product revenues........................................................................ 166 64
Other revenues.......................................................................... 132 56
---------- ----------
Total revenues........................................................................ 2,269 979
---------- ----------
Costs and expenses:
Cost of network operations.............................................................. 5,145 3,565
Cost of product and other revenues...................................................... 84 78
Research and development................................................................ 7,024 6,396
Marketing and sales..................................................................... 3,051 1,739
General and administrative.............................................................. 3,624 4,427
Depreciation and amortization........................................................... 4,179 2,465
---------- ----------
Total costs and expenses.............................................................. 23,107 18,670
---------- ----------
Loss from operations...................................................................... (20,838) (17,691)
Equity in loss of unconsolidated affiliate................................................ (351) (358)
Other income (expense):
Interest income......................................................................... 1,934 2,291
Interest expense, net of capitalized interest........................................... (10,782) (6,311)
Other--net.............................................................................. (179) 66
---------- ----------
Total other income (expense).............................................................. (9,027) (3,954)
---------- ----------
Loss before income taxes.................................................................. (30,216) (22,003)
Provision for income taxes................................................................ -- 1
---------- ----------
Net loss.................................................................................. $ (30,216) $ (22,004)
---------- ----------
---------- ----------
Basic and diluted earnings per share:
Net loss per share........................................................................ $ (0.73) $ (0.59)
---------- ----------
---------- ----------
Shares used in computing net loss per share............................................... 41,139 37,701
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................................................. $ (30,216) $ (22,004)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization.......................................................... 4,179 2,465
Accretion on senior notes.............................................................. 10,652 6,132
Amortization of debt issuance costs.................................................... 101 155
Equity in loss of unconsolidated affiliate............................................. 351 358
Other non-cash expenses................................................................ 276 --
Changes in:
Accounts receivable--trade........................................................... (557) (370)
Accounts receivable--other........................................................... (1,378) 114
Prepaid expenses and other........................................................... (50) (103)
Accounts payable..................................................................... 2,432 93
Accrued compensation and related benefits............................................ 1,311 315
Accrued liabilities and deferred revenue............................................. (25) (119)
--------- ---------
Net cash used for operating activities............................................. (12,924) (12,964)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Network components and inventory......................................................... (3,461) (2,894)
Purchase of property..................................................................... (1,648) (3,310)
Networks in progress..................................................................... (19,123) (9,107)
Investment in unconsolidated affiliate................................................... (833) (516)
Purchase of short-term investments....................................................... (25,509) (11,590)
Proceeds from sales and maturities of short-term investments............................. 24,699 31,934
Other assets............................................................................. (58) (10)
--------- ---------
Net cash provided by (used for) investing activities............................... (25,933) 4,507
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations................................................... (187) (78)
Proceeds from sale of common stock, net of repurchases................................... 38 57
Collection of note receivable from sale of common stock.................................. -- 96
--------- ---------
Net cash provided by (used for) financing activities............................... (149) 75
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS.................................................. (39,006) (8,382)
CASH AND CASH EQUIVALENTS, Beginning of period............................................. 111,112 124,232
--------- ---------
CASH AND CASH EQUIVALENTS, End of period................................................... $ 72,106 $ 115,850
--------- ---------
--------- ---------
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases............................................. $ 350 $ 23
Capitalization of interest into networks in progress..................................... $ 627 $ 586
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest................................................... $ 26 $ 22
Cash paid for income taxes............................................................... $ -- $ 1
Repurchase of unvested common stock and cancellation of related notes receivable......... $ 8 $ --
</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
March 31, 1998 and the results of operations and cash flows for the three months
ended March 31, 1998 and 1997. This unaudited interim information should be read
in conjunction with the audited consolidated financial statements of CellNet
Data Systems, Inc. and the notes thereto for the year ended December 31, 1997.
Operating results for the three months ended March 31, 1998 are not necessarily
indicative of the results that may be expected for the year ended December 31,
1998.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, REPORTING COMPREHENSIVE INCOME, which requires than 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 reconciliation of net loss to comprehensive net loss is as
follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Net loss.............................................................. $ (30,216) $ (22,004)
Other comprehensive loss--net unrealized gain (loss) on short-term
investments......................................................... (2) 3
---------- ----------
Total comprehensive loss.............................................. $ (30,218) $ (22,001)
---------- ----------
---------- ----------
</TABLE>
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 statement will not impact the Company's consolidated financial
position, results of operations or cash flows. The Company will adopt this
statement in its financial statements for the year ending December 31, 1998.
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 are excluded as they are antidilutive.
3. 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. 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
6
<PAGE>
CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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 was dismissed on February 9, 1998, without leave to amend. Counsel for
the plaintiffs in the SETTLE/ZULLY action have filed a notice of their intention
to appeal this dismissal to the California Court of Appeal. A second complaint,
also filed in the same Court, of HOWARD FIENMAN AND GERALD SLAPSOWITZ V. CELLNET
DATA SYSTEMS, INC., ET AL., No. 398560, was earlier voluntarily dismissed with
prejudice. These complaints, purported class actions filed 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, sought
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 defendants were obligated to disclose, but failed to disclose,
that a patent conflict with Itron was likely to ensue.
In 1995, Century Telephone Enterprises, Inc. ("Century Telephone") filed a
petition before the Trademark Trial and Appeal Board of the U.S. Patent and
Trademark Office for cancellation of the Company's "CellNet" trademark
registration. The parties have agreed to settle the matter under arrangements
whereby Century Telephone will withdraw its petition for cancellation and the
Company will purchase from Century Telephone their rights to the "CellNet"
trademark now registered in Century Telephone's name. The settlement is pending
execution of settlement documents.
7
<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 WITH REGARD TO THE
COMPANY'S EXPECTED WIRELESS DATA COMMUNICATIONS NETWORK DEPLOYMENTS AND
OPERATIONS, ITS STRATEGY FOR MARKETING AND DEPLOYING SUCH NETWORKS AND RELATED
FINANCING ACTIVITIES AND ITS EXPECTED REVENUES, EXPENSES AND CAPITAL
EXPENDITURES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS AND THE VARIATIONS MAY BE
MATERIAL. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS
ANTICIPATED IN THESE 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
communications 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
communications 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
communications networks for utility and non-utility applications. New services
agreements are expected to
8
<PAGE>
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"), and during the first three months of 1998, 94% 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 additional services. The Company currently has no services contracts
which provide for the implementation
9
<PAGE>
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 March 31, 1998, the Company had approximately
3,365,000 meters under long-term contracts, of which approximately 956,000
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 394,000 meters on the network
by March 31, 1998. The Company expects to add an additional 20,000 meters to the
KCPL network in 1998 which would be added to the total number of meters in
revenue service upon acceptance by KCPL for billing purposes. The remaining
6,000 meters under contract with KCPL may be automated or read manually. As of
March 31, 1998, the Company completed the on-line deployment of approximately
615,000 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. The Company has also successfully
completed a demonstration project with Pacific Gas & Electric Company ("PG&E")
in San Francisco pursuant to which the Company has installed a network that will
cover approximately 30,000 electric and gas meters. PG&E has acknowledged that
the data collection, cost savings, customer service and other objectives of the
demonstration network have been met. 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. 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, if the Company
is able to deploy successfully an increasing number of networks over the next
few years, the operating losses created by this lag in revenues, 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 March 31, 1998, had
an accumulated deficit of $311.8 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.
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."
10
<PAGE>
INTEREST INCOME. The Company has earned substantial amounts of interest
income on short-term investments of the proceeds of its financing activities.
The Company expects to utilize substantially all of its cash, cash equivalents
and short-term investments in deploying its wireless communications networks, in
continuing research and development activities related thereto, in related
selling and marketing activities and for general and administrative purposes. As
such funds are expended, interest income is expected to decrease.
RESULTS OF OPERATIONS
REVENUES
Revenues for the three months ended March 31, 1998 and 1997 were $2.3
million and $1.0 million, respectively. The increase in revenues was principally
due to the increases in network service revenues. During the three months ended
March 31, 1998, UE, KCPL and NSP accounted for approximately 50%, 34% and 10% of
the Company's revenues, respectively. During the first three months of 1997,
KCPL and UE accounted for 61% and 29% 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 which 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 three
months ended March 31, 1998 and 1997, respectively, are not reliable indicators
of revenues that might be expected in the future.
COST OF REVENUES
For the three months ended March 31, 1998 and 1997, cost of revenues
consisted primarily of network operations costs. Costs of revenues were $5.2
million and $3.6 million for the three months ended March 31, 1998 and 1997,
respectively. The increase in costs of revenues was driven by increasing costs
of providing network services, due primarily to growth in the number of
employees and associated costs necessary for network monitoring operations at
customer sites and at the Company's headquarters, network deployment management
and customer training. Costs of network services also include the increased
installation, applications and RF engineering staffing at the Company's
headquarters to support anticipated additional utility contracts. Network
services do not currently generate a profit as the Company has not yet achieved
a scale of services sufficient to cover network costs. The Company will incur
significant increasing costs primarily attributable to network operation and
depreciation. Once a network has been fully installed, costs associated with
generating network revenues will consist primarily of maintaining a monitoring
center for such network, network depreciation, and miscellaneous maintenance and
operating expenses.
OPERATING EXPENSES
Operating expenses, consisting of research and development, marketing and
sales, general and administrative costs and depreciation and amortization
expenses, were $17.9 million and $15.0 million for the three months ended March
31, 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 continue to spend a significant portion of its resources on research
and development activities for the foreseeable future. Marketing and sales costs
are expected to increase moderately over current levels as the Company continues
its efforts to sign new service agreements. General and administrative costs are
expected to increase over time in line with the Company's expected growth and
are expected to increase moderately for
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the next few years in connection with the planned installation of a new
corporate information system which has 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 $7.0 million and $6.4
million (net of expenses reimbursable by BCN Data Systems, L.L.C. ("BCN") of
$245,000 and $347,000 for technology migration costs), for the three months
ended March 31, 1998 and 1997, respectively. Research and development spending
increases in 1998 and 1997 reflect primarily additions to the Company's
engineering staff. The Company expects that research and development expenses
will increase moderately in the near term for additional investments in research
and development projects and in connection with the establishment of
international operations.
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 for the three months ended March 31, 1998 and 1997 were $3.1 million
and $1.7 million, respectively. These expenses have increased due to the
Company's accelerated efforts to sign new services agreements and a
significantly larger advertising program. The Company expects a moderate
increase in marketing and sales expenses over current levels as the Company
continues its efforts to sign new services agreements.
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 March 31, 1998
and 1997 were $3.6 million and $4.4 million, respectively. The decrease of
$803,000 in these expenses in 1998 over 1997 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.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $4.2 million and $2.5 million for
the three months ended March 31, 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. In the three months ended March 31, 1998 and
1997, the Company recognized $351,000 and $358,000 as its share of BCN's losses,
respectively. The Company expects to recognize increased losses in the future
from its share of BCN's losses as BCN expands its operations.
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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. 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 March 31, 1998 and 1997
was $1.9 million and $2.3 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 was $10.8 million and $6.3 million for the three
months ended March 31, 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.
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IMPACT OF THE YEAR 2000
The Company believes that its wireless data communications networks are Year
2000 compliant. In addition, the Company will require its third party vendors
and suppliers to be Year 2000 compliant. Accordingly, the Company expects that
the advent of the millennium will have no adverse effect on its network
operations. Certain of the Company's existing internal corporate information
systems require modification, upgrade or replacement in order to be Year 2000
compliant. Because these systems are becoming obsolete, the Company has decided
to replace them with a new corporate information system to be installed
commencing in the second quarter of 1998 and expects to complete installation in
advance of the year 2000. The Company expects to finance over several years most
of the costs involved in purchasing and installing the new corporate information
system, which are estimated at approximately $1.5 million for 1998 and totaled
$223,000 for the three months ended March 31, 1998.
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 three months of 1998 and 1997, net cash used in the Company's
operating activities totaled $12.9 million and $13.0 million, respectively. Net
cash used in operating activities resulted primarily from cash used to fund net
operating losses.
In the three months ended March 31, 1998 and 1997, net cash provided by
(used for) investing activities totaled ($25.9) million and $4.5 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 three months of 1997, net
proceeds from the sale and maturation of short-term investments of $20.3
million, respectively, were used to fund operating activities.
In the first three months of March 31, 1998 and 1997, net cash provided by
(used for) the Company's financing activities totaled ($149,000) and $75,000,
respectively.
As of March 31, 1998, the Company had cash, cash equivalents and short-term
investments totaling $109.9 million. As of December 31, 1997, the Company had
cash, cash equivalents and short-term investments totaling $148.1 million. The
decline of $38.2 million was due to operating costs and the development and
construction of the Company's wireless communications networks.
Deployments of the Company's wireless communications networks will require
substantial additional capital. The Company is committed to make approximately
$89.3 million in capital expenditures in 1998 for saturation deployment network
installations of which $13.9 million was expended by March 31, 1998. In
addition, the Company anticipates that it may spend as much as an additional
$37.0 million during 1998 in capital expenditures relating to the installation
of its broad deployment network in California, of which $5.2 million was
expended by March 31, 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
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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 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 ($35 million if the Company consummates a proposed
financing of convertible preferred stock to be issued by a subsidiary of the
Company pursuant to a Registration Statement on Form S-3 filed contemporaneously
herewith) 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 1998 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 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
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.
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."
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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 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
communications 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
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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 three months of 1998, 94% of the Company's
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 is working with industry leaders such as
Honeywell, Inc., Real Time Data, Inc., and Interactive Technologies, Inc. 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
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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.
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. 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 the 1997 Notes. 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 on the 1997 Notes.
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 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 March 31, 1998, the Company had $109.9 million in cash, cash
equivalents and short-term investments. The Company intends to raise a
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substantial amount of additional capital in 1998 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 March 31, 1998, the Company had an accumulated deficit of
$311.8 million, primarily resulting from expenses incurred in the development of
the Company's wireless data communications system, marketing of the Company's
NMR, distribution automation and other services, the installation of its
wireless data communications networks and the payment of other normal operating
costs.
The Company does not expect significant revenues relative to anticipated
operating costs during 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 its only significant direct competitor in the marketplace
at present is Itron, Inc. ("Itron"), an established manufacturer and seller of
hand-held and drive-by automated meter reading ("AMR") equipment for utilities.
Itron is currently providing to 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
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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. 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 International Teldata and American Innovations. Established
suppliers of equipment, services and technology to the utility industry such as
Asea Brown Boveri and General Electric could expand their current product and
service offerings so as to compete directly with the Company, although they have
not yet done so. Many of the Company's present and potential future competitors
have substantially greater financial, marketing, technical and manufacturing
resources, name recognition and experience than the Company. The Company's
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
development, promotion and sale of their products and services than the Company.
While CellNet believes its technology, 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. Traditional providers of wireless services may in the future choose to
enter the Company's markets. Such existing and future competition could
materially adversely affect the pricing for the Company's services and the
Company's ability to sign 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 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 must also continue to develop the hardware
enhancements necessary to utilize its system on a commercial basis with a
variety of different electric, gas and water meters. The Company's future
success will be materially adversely affected if it is not successful or is
significantly delayed in continuing technology development and enhancement
programs.
The Company's future success will also depend, in part, on its ability to
enhance its existing hardware, software and wireless communications technology.
The telecommunications industry has been characterized by rapid, significant
technological advances. The advent of computer-linked electronic networks, fiber
optic transmission, advanced data digitization technology, cellular and
satellite communications capabilities, specialized mobile radio services and
personal communications systems ("PCS") and other commercial mobile radio
services have radically expanded communications capabilities and market
opportunities.
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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 ("CSMAs") in the United States. As
of March 31, 1998, the Company had acquired a total of 87 spectrum licenses in
50 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 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
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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.
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 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 radiofrequency spectrum is being used for public radio safety services.
Congress included a very broad
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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.
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
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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 anticipates 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.
("BEn"). 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
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.
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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.
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
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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."
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 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.
See
Certain of the Company's subassemblies, components and network equipment are
procured from single sources and others are procured only from a limited number
of sources. In addition, CellNet may be affected by general shortages of certain
components, such as surface mounted integrated circuits and memory chips. There
have been shortages of such materials generally in the marketplace from time to
time in the past. The Company's reliance on such components and on a limited
number of vendors and subcontractors involves certain risks, including the
possibility of shortages and reduced control over delivery schedules,
manufacturing capability, quality and cost. A significant price increase or
interruption in supply from one or more of such suppliers could have a material
adverse effect on the Company's business, operating results, financial condition
and cash flow. Although the Company believes alternative suppliers of
sub-assemblies, components and network equipment are available, the inability of
the Company to develop alternative sources quickly or cost-effectively could
materially impair its ability to manufacture and install systems. Lead times can
be as long as a year for certain components, which may require the Company to
use working capital to purchase inventory significantly in advance of receiving
any revenues.
A significant number of new 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
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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.
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.
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 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."
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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 was dismissed on February 9, 1998, without leave to amend. Counsel for
the plaintiffs in the SETTLE/ZULLY action have filed a notice of their intention
to appeal this dismissal to the California Court of Appeal. A second complaint,
also filed in the same Court, of HOWARD FIENMAN AND GERALD SLAPSOWITZ V. CELLNET
DATA SYSTEMS, INC., ET AL., No. 398560, was earlier voluntarily dismissed with
prejudice. These complaints, purported class actions filed 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, sought
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 defendants were obligated to disclose, but failed to disclose,
that a patent conflict with Itron was likely to ensue.
In 1995, Century Telephone Enterprises, Inc. ("Century Telephone") filed a
petition before the Trademark Trial and Appeal Board of the U.S. Patent and
Trademark Office for cancellation of the Company's "CellNet" trademark
registration. The parties have agreed to settle the matter under arrangements
whereby Century Telephone will withdraw its petition for cancellation and the
Company will purchase from Century Telephone their rights to the "CellNet"
trademark now registered in Century Telephone's name. The settlement is pending
execution of settlement documents.
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 has been and is likely to
continue to be subject to wide fluctuations in response to a variety of factors,
including quarterly variations in operating results, the signing of services
contracts, new customers, consolidations in the industry, technological
innovations or new products by the Company or its competitors, developments in
patents or other intellectual property rights, general conditions in the NMR
services industry, revised earnings estimates, comments or recommendations
issued by analysts who follow the Company, its competitors or the NMR services
industry and general economic and market conditions. In addition, it is possible
that in some future period the Company's operating results may be below the
expectations of public market analysts and investors. In such event, the price
of the Company's Common Stock could be materially adversely affected.
Additionally, the stock market in general, and the market for technology stocks
in particular, have experienced extreme price volatility in recent years.
Volatility in price and volume has had a substantial effect on the market prices
of many technology companies for reasons unrelated or disproportionate to the
operating performance of such companies. These broad market fluctuations could
have a significant impact on the market price of the Common Stock.
NO DIVIDENDS 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.
28
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
CELLNET DATA SYSTEMS, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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
"Factors That May Affect Future Operating Results--Uncertainty of Protection of
Copyrights Patents and Proprietary Rights."
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 was dismissed on February 9, 1998, without leave to amend. Counsel for
the plaintiffs in the SETTLE/ZULLY action have filed a notice of their intention
to appeal this dismissal to the California Court of Appeal. A second complaint,
also filed in the same Court, of HOWARD FIENMAN AND GERALD SLAPSOWITZ V. CELLNET
DATA SYSTEMS, INC., ET AL., No. 398560, was earlier voluntarily dismissed with
prejudice. These complaints, purported class actions filed 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, sought
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 defendants were obligated to disclose, but failed to disclose,
that a patent conflict with Itron was likely to ensue.
In 1995, Century Telephone Enterprises, Inc. ("Century Telephone") filed a
petition before the Trademark Trial and Appeal Board of the U.S. Patent and
Trademark Office for cancellation of the Company's "CellNet" trademark
registration. The parties have agreed to settle the matter under arrangements
whereby Century Telephone will withdraw its petition for cancellation and the
Company will purchase from Century Telephone their rights to the "CellNet"
trademark now registered in Century Telephone's name. The settlement is pending
execution of settlement documents.
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.
29
<PAGE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
27.1 Financial Data Schedule
b. Reports on Form 8-K
There have been no reports on Form 8-K filed during the quarter ended
March 31, 1998.
30
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C> <C>
CELLNET DATA SYSTEMS, INC.
By: /s/ PAUL G. MANCA
-----------------------------------------
Paul G. Manca,
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
Date: April 22, 1998 OFFICER)
</TABLE>
31
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE
- ----------- -----
<S> <C> <C>
27.1 Financial Data Schedule...........................................................................
</TABLE>
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS
OF THE COMPANY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 72,106
<SECURITIES> 37,754
<RECEIVABLES> 8,577
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 120,547
<PP&E> 179,408
<DEPRECIATION> (25,784)
<TOTAL-ASSETS> 278,759
<CURRENT-LIABILITIES> (20,271)
<BONDS> (279,952)
0
0
<COMMON> (210,302)
<OTHER-SE> (73,873)
<TOTAL-LIABILITY-AND-EQUITY> (278,759)
<SALES> 166
<TOTAL-REVENUES> 2,269
<CGS> (84)
<TOTAL-COSTS> (5,229)
<OTHER-EXPENSES> (17,878)
<LOSS-PROVISION> (351)
<INTEREST-EXPENSE> (10,782)
<INCOME-PRETAX> (30,216)
<INCOME-TAX> 0
<INCOME-CONTINUING> (30,216)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (30,216)
<EPS-PRIMARY> (0.73)
<EPS-DILUTED> (0.73)
</TABLE>
