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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-21409
------------------------
CELLNET DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-2951096
(State or other (I.R.S. Employer
jurisdiction of Identification
incorporation or Number)
organization)
</TABLE>
125 SHOREWAY ROAD
SAN CARLOS, CALIFORNIA 94070
(Address of principal executive offices, including zip code)
(650) 508-6000
(Registrant's Telephone Number, Including Area Code)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days.
YES /X/ NO / /
As of August 7, 1998, 42,201,426 shares of the Registrant's Common Stock,
$0.001 par value, were issued and outstanding.
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TABLE OF CONTENTS
INDEX
<TABLE>
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PAGE
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--As of June 30, 1998 and December 31, 1997....................... 3
Condensed Consolidated Statements of Operations--Three Months Ended June 30, 1998 and 1997 and Six
Months Ended June 30, 1998 and 1997................................................................... 4
Condensed Consolidated Statements of Cash Flows--Six Months Ended June 30, 1998 and June 30, 1997...... 5
Notes to Condensed Consolidated Financial Statements................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 32
PART II. OTHER INFORMATION................................................................................. 33
Item 1. Legal Proceedings................................................................................ 33
Item 2. Changes in Securities............................................................................ 33
Item 3. Defaults upon Senior Securities.................................................................. 33
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 33
Item 5. Other Information................................................................................ 34
Item 6. Exhibits and Reports on Form 8-K................................................................. 34
SIGNATURE.................................................................................................. 36
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
---------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 71,162 $ 111,112
Short-term investments............................................................... 79,264 36,946
Accounts receivable--trade........................................................... 2,706 1,519
Accounts receivable--other........................................................... 5,420 5,123
Prepaid expenses and other........................................................... 2,252 2,060
---------- ------------
Total current assets............................................................... 160,804 156,760
Network components and inventory....................................................... 26,943 24,225
Networks in progress--net.............................................................. 134,090 92,308
Property--net.......................................................................... 16,565 16,061
Investment in unconsolidated affiliate................................................. 218 --
Restricted cash........................................................................ 21,539 --
Debt issuance and other costs--net..................................................... 4,441 4,631
---------- ------------
Total assets....................................................................... $ 364,600 $ 293,985
---------- ------------
---------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable..................................................................... $ 16,385 $ 11,706
Accrued compensation and related benefits............................................ 2,464 2,189
Accrued liabilities.................................................................. 2,654 2,655
Current portion of capital lease obligations......................................... 627 466
---------- ------------
Total current liabilities.......................................................... 22,130 17,016
Senior notes--14%...................................................................... 291,704 268,673
Deferred revenue....................................................................... 5,501 5,620
Capital lease obligations.............................................................. 709 412
Mandatorily redeemable preferred securities of subsidiary holding solely Company
preferred stock (Note 3)............................................................. 105,979 --
Commitments and contingencies (Note 4)................................................. -- --
Stockholders' equity (deficit):
Preferred stock--$.001 par value; 15,000,000 shares authorized; no shares
outstanding.......................................................................... -- --
Common stock--$.001 par value; 100,000,000 shares authorized; shares outstanding, 1998:
42,193,012; 1997: 41,845,475......................................................... 211,056 209,996
Notes receivable from sale of common stock........................................... (640) (676)
Warrants............................................................................. 74,545 74,546
Accumulated deficit.................................................................. (346,375) (281,599)
Net unrealized loss on short-term investments........................................ (9) (3)
---------- ------------
Total stockholders' equity (deficit)............................................. (61,423) 2,264
---------- ------------
Total liabilities and stockholders' equity (deficit)................................. $ 364,600 $ 293,985
---------- ------------
---------- ------------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED JUNE
JUNE 30, 30,
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Network service revenues.......................................... $ 2,479 $ 1,254 $ 4,450 $ 2,113
Product revenues.................................................. 242 235 408 299
Other revenues.................................................... 139 25 271 81
---------- ---------- ---------- ----------
Total revenues.................................................. 2,860 1,514 5,129 2,493
---------- ---------- ---------- ----------
Costs and expenses:
Cost of network operations........................................ 6,291 3,933 11,436 7,498
Cost of product and other revenues................................ 374 259 458 337
Research and development.......................................... 8,474 6,652 15,498 13,048
Marketing and sales............................................... 2,847 1,930 5,898 3,669
General and administrative........................................ 4,514 4,642 8,138 9,069
Depreciation and amortization..................................... 4,468 2,674 8,647 5,139
---------- ---------- ---------- ----------
Total costs and expenses........................................ 26,968 20,090 50,075 38,760
---------- ---------- ---------- ----------
Loss from operations................................................ (24,108) (18,576) (44,946) (36,267)
Equity in net loss of unconsolidated affiliate...................... (630) (981) (981) (1,339)
Other income (expense):
Interest income................................................... 2,005 1,947 3,939 4,238
Interest expense, net of capitalized interest..................... (10,892) (6,248) (21,674) (12,559)
Other--net........................................................ 3 (64) (176) 2
---------- ---------- ---------- ----------
Total other income (expense).................................... (8,884) (4,365) (17,911) (8,319)
---------- ---------- ---------- ----------
Loss before provision for income taxes and dividends and accretion
on preferred securities........................................... (33,622) (23,922) (63,838) (45,925)
Provision for income taxes.......................................... -- -- -- 1
---------- ---------- ---------- ----------
Loss before dividends and accretion on preferred securities......... (33,622) (23,922) (63,838) (45,926)
Dividends and accretion on preferred securities of subsidiary (Note
3)................................................................ (938) -- (938) --
---------- ---------- ---------- ----------
Net loss applicable to common stockholders.......................... $ (34,560) $ (23,922) $ (64,776) $ (45,926)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic and diluted earnings per share:
Net loss per share.................................................. $ (0.83) $ (0.62) $ (1.57) $ (1.21)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Shares used in computing net loss per share......................... 41,469 38,734 41,305 38,218
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss applicable to common stockholders................................................ $ (64,776) $ (45,926)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization........................................................... 8,647 5,139
Accretion on senior notes............................................................... 21,418 12,184
Accretion on preferred securities....................................................... 39 --
Amortization of debt issuance costs..................................................... 202 310
Equity in net loss of unconsolidated affiliate.......................................... 981 1,339
Other non-cash expenses................................................................. 276 --
Changes in:
Accounts receivable--trade............................................................ (1,187) (543)
Accounts receivable--other............................................................ (297) (2,333)
Prepaid expenses and other............................................................ (192) (963)
Accounts payable...................................................................... 4,679 1,617
Accrued compensation and related benefits............................................. 275 (161)
Accrued liabilities and deferred revenues............................................. 1,236 74
--------- ---------
Net cash used for operating activities.............................................. (28,699) (29,263)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Network components and inventory.......................................................... (2,718) (3,884)
Purchase of property...................................................................... (3,927) (5,085)
Networks in progress...................................................................... (44,596) (22,029)
Investment in unconsolidated affiliates................................................... (2,555) (1,142)
Purchase of short-term investments........................................................ (79,842) (13,789)
Proceeds from sales and maturities of short-term investments.............................. 37,518 39,134
Increase in restricted cash............................................................... (21,403) --
Other assets.............................................................................. (148) (19)
--------- ---------
Net cash used for investing activities.................................................. (117,671) (6,814)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred securities............................................ 105,940 --
Repayment of capital lease obligations.................................................... (339) (190)
Proceeds from sale of common stock, net of repurchases.................................... 791 572
Collection of note receivable from sale of common stock................................... 28 96
--------- ---------
Net cash provided by investing activities............................................... 106,420 478
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS................................................... (39,950) (35,599)
CASH AND CASH EQUIVALENTS, Beginning of period.............................................. 111,112 124,232
--------- ---------
CASH AND CASH EQUIVALENTS, End of period.................................................... $ 71,162 $ 88,633
--------- ---------
--------- ---------
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases.............................................. $ 797 $ 351
Capitalization of interest into networks in progress...................................... $ 1,613 $ 1,470
Conversion of warrants to common stock.................................................... $ 1 $ --
Repurchase of unvested common stock and cancellation of related notes receivable.......... $ 8 $ --
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest.................................................... $ 47 $ 53
Cash paid for income taxes................................................................ $ -- $ 1
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In the opinion of management, these unaudited condensed consolidated
financial statements include all adjustments, consisting only of normal
recurring adjustments and accruals the Company considers necessary for a fair
presentation of the Company's financial position as of June 30, 1998 and the
results of operations and cash flows for the three months and the six months
ended June 30, 1998 and 1997. This unaudited interim information should be read
in conjunction with the audited consolidated financial statements of the Company
and the notes thereto for the year ended December 31, 1997. Operating results
for the three months and the six months ending June 30, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, REPORTING COMPREHENSIVE INCOME, which requires that an
enterprise report, by major components and as a single total, the change in net
assets during the period from nonowner sources. Adoption of SFAS No. 130 did not
impact the Company's consolidated financial position, results of operations or
cash flows. The comprehensive net loss was $34,564,000 and $23,922,000 for the
three months ended June 30, 1998 and 1997. The comprehensive net loss was
$64,782,000 and $45,923,000 for the six months ended June 30, 1998 and 1997,
respectively. The comprehensive net loss differs from the net loss applicable to
common stockholders by the net unrealized gain (loss) on short-term investments.
In June 1997, the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas and major customers.
Adoption of this standard will not impact the Company's consolidated financial
position, results of operations or cash flows. The Company will adopt this
standard in its financial statements for the year ending December 31, 1998.
In June 1998, the Financial Accounting Board issued Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which defines derivatives, requires that all derivatives be
carried at fair value, and provides for hedging accounting when certain
conditions are met. This statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. Although the Company has not fully
assessed the implications of this new standard, the Company does not believe
adoption of this standard will have a material impact on the Company's financial
position or results of operations.
Certain reclassifications have been made to the 1997 amounts to conform to
the 1998 presentation.
2. NET LOSS PER SHARE
During December 1997, the Company adopted Statement of Financial Accounting
Standard No. 128 (SFAS 128), EARNINGS PER SHARE and, retroactively, restated
prior period earnings per share (EPS) for the change. SFAS 128 requires a dual
presentation of basic and diluted EPS. Basic EPS for the period presented is
computed by dividing net loss by the weighted average of common shares
outstanding (excluding shares subject to repurchase). Diluted EPS for all
periods presented is the same as basic EPS since all other potential dilutive
securities (common stock subject to repurchase, common stock options and
warrants and mandatorily redeemable preferred securities) are excluded as they
are antidilutive.
6
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CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
During May 1998, a new subsidiary of the Company, CellNet Funding, L.L.C.
("Funding") completed the sale of 7% Exchangeable Preferred Securities
Mandatorily Redeemable 2010 (the "Preferred Securities") for gross proceeds of
$110,000,000. Net proceeds from the offering, after offering costs, were
approximately $105,940,000. The recorded amount of the Preferred Securities will
fully accrete to the face value of $110,000,000 on June 1, 2010. The restricted
cash at June 30, 1998 of approximately $21,539,000 includes the proceeds of the
offering which are designated for the payment of cash dividends on the Preferred
Securities through June 1, 2001. Funding invested the restricted cash in U.S.
Treasury strips ("Treasury Strips") which were placed in escrow upon the closing
of the offering of the Preferred Securities. The Treasury Strips have been
pledged to The Bank of New York as escrow agent (the "Escrow Agent") pursuant to
an escrow agreement for the benefit of the holders of the Preferred Securities.
The Escrow Agent is required under the Escrow Agreement to release from escrow
amounts sufficient to pay quarterly dividends on the Preferred Securities
through September 1, 2001.
The Preferred Securities consist of 4,400,000 exchangeable preferred
securities of Funding that bear a cumulative dividend at the rate of 7% per
annum. The dividend is paid quarterly in arrears each March 1, June 1, September
1 and December 1, commencing September 1, 1998. The dividend is payable in cash
through June 1, 2001 and thereafter, by cash or shares of Company common stock,
at the option of Funding. The Preferred Securities are exchangeable at any time
prior to June 1, 2010, at the option of the holders, into Company common stock,
at a rate of 1.8328 shares of Company common stock per Preferred Security, or
$13.64 per share, subject to adjustment. On or prior to June 1, 2001, the
Preferred Securities must be automatically exchanged for common stock of the
Company at an exchange price of $13.64 per share in the event the Current Market
Value (which is a formula as defined in the Written Action of the Manager of
Funding, the "Written Action") of the Company's common stock equals or exceeds
the following percentage of the exchange price, for at least 20 days of any
30-day trading period during the 12 month period ending prior to June 1 of the
indicated year: 170% prior to June 1, 1999; 160% from June 1, 1999 through June
1, 2000; and 150% from June 2, 2000 up to and prior to June 1, 2001. The
Preferred Securities are subject to mandatory redemption on June 1, 2010 at a
redemption price of 100% of the liquidation preference of the Preferred
Securities, plus accrued and unpaid dividends, if any. Funding may redeem, at
its option, the Preferred Securities, in whole or in part, at any time on or
after June 1, 2001 at certain redemption prices equal to a percentage of the
liquidation preference (set forth in the Written Action) which declines each
year until maturity of the Preferred Securities, together with accrued and
unpaid dividends, if any.
Pursuant to and to the extent set forth in the guarantee of the Preferred
Securities (the "Guarantee") by the Company for the benefit of the holders of
Preferred Securities, the Company has agreed to pay in full to the holders of
the Preferred Securities (except to the extent paid by Funding), as and when
due, regardless of any defense, right of set off or counterclaim which Funding
may have or assert, the following payments (the "Guarantee Payments"), without
duplication: (i) any accrued and unpaid distributions that are required to be
paid on the Preferred Securities, to the extent Funding has sufficient funds
legally available thereof, (ii) the redemption price, with respect to any
Preferred Securities called for redemption by Funding, to the extent Funding has
sufficient funds legally available therefor and (iii) upon a voluntary or
involuntary dissolution, winding-up or termination of Funding, the lesser of (a)
the aggregate of the liquidation preference and all accrued and unpaid dividends
on the Preferred Securities to the date of payment to the extent Funding has
sufficient funds legally available therefor and (b) the amount of assets of
Funding remaining for distribution to holders of Preferred Securities upon the
liquidation of Funding.
7
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CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY (CONTINUED)
The Guarantee may also be subject to contractual restrictions under agreements
governing future indebtedness of the Company.
On May 19, 1998, after the investment in Treasury Strips, Funding applied
the remaining net proceeds from the offering of the Preferred Securities
together with other capital contributed by the Company to purchase $93,500,000
of the Company's Preferred Stock (the "CellNet Preferred Stock") which pays
dividends each March 1, June 1, September 1 and December 1 in additional shares
of CellNet Preferred Stock through June 1, 2001. Subsequent to June 1, 2001,
dividends are payable in cash or shares of common stock, at the option of the
Company. The CellNet Preferred Stock is exchangeable, at the option of Funding,
at any time prior to June 1, 2010 into shares of the Company's common stock at
an exchange rate based on the exchange rate of the Preferred Securities. The
CellNet Preferred Stock is subject to mandatory redemption on June 1, 2010.
The separate complete financial statements of Funding have not been included
herein because such disclosure is not considered to be material to the holders
of the Preferred Securities. For the period from May 13, 1998 (inception),
through June 30, 1998, the statement of operations of Funding included only the
preferred dividends accrued, accretion of the Preferred Securities and interest
income earned on the restricted cash. The summarized balance sheet information
for Funding is as follows:
Summarized Balance Sheet Information
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------
(IN
THOUSANDS)
<S> <C>
ASSETS:
Investment in Parent Preferred Stock........................................... $ 93,500
Restricted cash................................................................ 21,539
-------------
Total assets................................................................. $ 115,039
-------------
-------------
LIABILITIES AND STOCKHOLDER'S DEFICIT
Accrued dividends.............................................................. $ 899
Payable to Parent.............................................................. 612
Mandatorily redeemable preferred securities.................................... 105,979
STOCKHOLDER'S DEFICIT:
Common limited liability security outstanding.................................. 10
Additional paid-in capital..................................................... 8,341
Accumulated deficit............................................................ (802)
-------------
Total stockholder's deficit.................................................. 7,549
-------------
Total liabilities and stockholder's deficit.................................... $ 115,039
-------------
-------------
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
In October 1996, Itron, Inc. ("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
8
<PAGE>
CELLNET DATA SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
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, HOWARD FIENMAN AND GERALD SAPSOWITZ 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 the 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.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS SECTION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, INFORMATION WITH REGARD TO THE
COMPANY'S EXPECTED WIRELESS DATA NETWORK DEPLOYMENTS AND OPERATIONS, ITS
STRATEGY FOR MARKETING AND DEPLOYING SUCH NETWORKS AND RELATED FINANCING
ACTIVITIES AND ITS EXPECTED REVENUES, EXPENSES AND CAPITAL EXPENDITURES AND ITS
ASSESSMENT OF POTENTIAL YEAR 2000 ISSUES. THE COMPANY'S ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THE RESULTS 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 networks
pursuant to services agreements with utilities and other parties including new
power market participants to earn recurring revenues by providing network meter
reading (NMR) services and to use the networks to support a variety of
non-utility applications. The Company employs two basic strategies in the
deployment of its networks-- saturation deployments for providing NMR services
to existing utilities, and broad deployments for providing NMR services to other
parties including new power market participants. Under the Company's saturation
deployment strategy, the Company builds out its wide area network (WAN) and
local area network (LAN) concurrently in order to cover every meter in a
utility's designated service area. The saturation deployment strategy has proven
effective because it allows coverage of all of the energy consumers in those
service areas. Under the Company's broad deployment strategy, the Company first
deploys its WAN in service areas where the largest consumers of energy are
located and where energy consumers and other power market participants are most
likely to value the Company's services and/or to concentrate their marketing
efforts. As contracts for the provision of NMR services are obtained, the
Company builds out its LAN on an incremental basis as necessary to service those
customers or for advanced coverage of certain areas. Both the LAN and WAN can be
further expanded incrementally as additional business outside the existing
coverage areas is obtained. Broad deployment offers energy service providers who
lack the established utilities' designated geographical customer bases the
flexibility to build as they grow or to pursue particular market niches. It also
offers established utilities who are not yet prepared to commit their resources
to a long-term saturation deployment project the opportunity to cover a portion
of their customers initially and to increase coverage in their service areas
over time, potentially to all of their meters. By using networks deployed under
either strategy, the Company is also able (i) to offer NMR information metering
services directly to energy consumers, to the extent that the information
provided by such services is not being made available to them by their own
utility or energy service provider, (ii) to offer sub-metering NMR services to
industrial and commercial customers which desire to monitor the energy
consumption of particular heating, ventilating and air conditioning (HVAC)
system components, individual manufacturing processes or pieces of equipment or
individual departments, and (iii) to offer a range of non-utility wireless data
communication services for such applications as home security, remote status
monitoring of vending machines, office equipment and parking meters, and remote
control of traffic lights.
The Company's business strategy has affected and will continue to affect its
financial condition and results of operations as follows:
COMPOSITION OF REVENUES. The Company derives substantially all of its
revenues from fees earned under services agreements related to its wireless
networks. Under the Company's existing services agreements with utilities, the
Company receives monthly NMR service fees based on the number of endpoint
devices that are in revenue service during the applicable month.
UNEVEN REVENUE GROWTH. The timing and amount of the Company's future
revenues will depend upon its ability to obtain additional services agreements
with utilities and other parties, including new
10
<PAGE>
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 be obtained on an
irregular basis, and there may be prolonged periods during which the Company
does not enter into any additional services agreements or other arrangements. As
a result, the Company expects that its revenues will not grow smoothly over
time, but will increase unevenly as the Company enters into new services
agreements and other commercial relationships, and may decrease sharply in the
event that any of its existing services agreements are terminated or not
renewed. See "Factors that may Affect Future Operating Results--Uncertainty of
Future Revenues; Need for Additional Services Contracts and Fluctuating
Operating Results."
UNCERTAINTY OF MARKET ACCEPTANCE. The Company's future revenues will depend
on the number of new services agreements with established utilities and other
parties, including new power market participants, and on the amount of NMR
services to be provided thereunder. The Company's existing saturation contracts
are with established utilities. During 1997, approximately 88% of the Company's
revenues were derived from its contracts with Kansas City Power & Light Company
("KCPL") and AmerenUE ("UE"). During the first six months of 1998, 85% of the
Company's revenues were derived from KCPL and UE. 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.
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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 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 June 30, 1998, the Company had approximately
3,815,000 meters under long-term contracts, of which approximately 1,055,000
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 409,000 meters on the network
by June 30, 1998. The Company expects to add additional meters to the KCPL
network in 1998 and 1999 which would be added to the total number of meters in
revenue service upon acceptance by KCPL for billing purposes. In June 1998, the
Company entered into a services contract to expand CellNet's NMR network for UE
by 450,000 meters. The total network for UE will provide coverage for
approximately 1,250,000 meters. As of June 30, 1998, the Company completed the
on-line deployment of approximately 711,000 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 covers 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. The project is now in the process of being concluded. In September 1997,
the Company entered into a services contract with Indianapolis Power & Light
Company ("IP&L") for the installation of its NMR network that will cover
approximately 415,000 meters. Installation of the initial portion of the IP&L
network was completed in November 1997 and IP&L has agreed to a roll-out of the
balance of the network. As additional segments of the Company's networks are
installed and used by its customers for billing purposes, the Company expects to
realize a corresponding increase in its network service revenues. However, 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 June 30, 1998, had
an accumulated deficit of $346.4 million. The Company does not expect
significant revenues relative to anticipated operating costs during 1998 and
expects to incur substantial and increasing operating losses and negative net
cash flow after capital expenditures for the foreseeable future as it expands
and installs additional networks. The Company does not expect positive cash flow
after capital expenditures from its NMR services operations for several years.
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The Company will require substantial capital to fund operating cash flow
deficits and capital expenditures for the foreseeable future and expects to
finance these requirements through significant additional external financing.
See "Factors that may Affect Future Operating Results--History and Continuation
of Operating Losses" and "--Substantial Leverage and Ability to Service Debt;
Substantial Future Capital Needs."
INTEREST INCOME. The Company has earned substantial amounts of interest
income on short-term investments of the proceeds of its financing activities.
The Company expects to utilize substantially all of its cash, cash equivalents
and short-term investments in deploying its wireless networks, in continuing
research and development activities related thereto, in related selling and
marketing activities and for general and administrative purposes. As such funds
are expended, interest income is expected to decrease.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997
REVENUES
Revenues for the three months ended June 30, 1998 and 1997 were $2.9 million
and $1.5 million, respectively. The increase in revenues was principally due to
increases in network service revenues. During the three months ended June 30,
1998, UE and KCPL accounted for approximately 53% and 31% of the Company's
revenues, respectively. For the three months ended June 30, 1997, KCPL and UE
accounted for approximately 45% and 40% of the Company's revenues, respectively.
Revenues for the six months ended June 30, 1998 and 1997 were $5.1 million and
$2.5 million, respectively. The increase in revenues was principally due to the
increases in network service revenues. During the six months ended June 30,
1998, UE and KCPL accounted for approximately 52% and 33% of the Company's
revenues, respectively. During the first six months of 1997, KCPL and UE
accounted for 52% and 34% 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 six
months ended June 30, 1998 and 1997, respectively, are not reliable indicators
of revenues that might be expected in the future.
COST OF REVENUES
Costs of revenues were $6.7 million and $4.2 million for the three months
ended June 30, 1998 and 1997, respectively. Costs of revenues were $11.9 million
and $7.8 million for the six months ended June 30, 1998 and 1997, respectively.
For the three months and the six months ended June 30, 1998 and 1997, cost of
revenues consisted primarily of network operations costs. The increase in costs
of revenues was driven by increasing costs of providing network services, 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.
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OPERATING EXPENSES
Operating expenses, consisting of research and development, marketing and
sales, general and administrative costs and depreciation and amortization
expenses were $20.3 million and $15.9 million for the three months ended June
30, 1998 and 1997, respectively. Operating expenses were $38.2 million and $30.9
million for the six months ended June 30, 1998 and 1997, respectively. The
increase in operating expenses on a period to period basis is attributable to
the Company's rapid growth and to increasing research and development, and
marketing and sales expenditures. The Company expects to 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 the next few years in connection with the installation
of a new corporate information system which commenced in the second quarter of
1998.
RESEARCH AND DEVELOPMENT
Research and development expenses are attributable largely to continuing
system software, firmware and equipment development costs, prototype
manufacturing, testing, personnel costs, consulting fees and supplies. Research
and development costs are expensed as incurred. The Company's networks include
certain software applications which are integral to their operation. The costs
to develop such software have not been capitalized as the Company believes its
software development is essentially completed when technological feasibility of
the software is established and/or development of the related network hardware
is complete. Research and development expenses were $8.5 million and $6.7
million for the three months ended June 30, 1998 and 1997, respectively, net of
expenses reimbursable by BCN Data Systems, L.L.C. ("BCN") of $259,000 for
technology migration costs in the three months ended June 30, 1997. No expenses
were reimbursable by BCN in the three months ended June 30, 1998. Research and
development expenses were $15.5 million and $13.0 million, net of expenses
reimbursable by BCN of $245,000 and $1,668,000 for technology migration costs,
for the six months ended June 30, 1998 and 1997, respectively. Research and
development spending increases in 1998 and 1997 reflect primarily additions to
the Company's engineering staff and the continued expenditure for technology
migration without a corresponding reimbursement by BCN in 1998. The Company
expects that research and development expenses will 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 were $2.8 million and $1.9 million during the three months ended June
30, 1998 and 1997, respectively. Marketing and sales expenses for the six months
ended June 30, 1998 and 1997 were $5.9 million and $3.7 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 June 30, 1998 and
1997 were $4.5 million and $4.6 million, respectively. General and
administrative expenses for the six months ended June 30, 1998 and 1997 were
$8.1 million and $9.1 million, respectively. The decrease in these expenses in
the 1998 period over the 1997 period resulted from a reduction in expenditures
for
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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 $4.5 million and $2.7 million for
the three months ended June 30, 1998 and 1997, respectively. Depreciation and
amortization expense was $8.6 million and $5.1 million for the six months ended
June 30, 1998 and 1997, respectively. Depreciation and amortization expense is
attributable to the Company's networks in progress, including both equipment
manufactured by the Company and systems partially installed in the field,
property and leasehold improvements. Depreciation and amortization expense has
increased as a result of increased additions to networks in progress, property
and leasehold improvements period-over-period.
EQUITY IN LOSS OF UNCONSOLIDATED AFFILIATE
The Company accounts for its investment in BCN, which began operations in
1997, using the equity method. For the three months ended June 30, 1998 and
1997, the Company recognized $630,000 and $981,000 as its share of BCN's losses,
respectively. In the six months ended June 30, 1998 and 1997, the Company
recognized $981,000 and $1.3 million as its share of BCN's losses, respectively.
The decrease in these expenses in the 1998 period over the 1997 period resulted
from the continued expenditure by the Company for technology migration without a
corresponding reimbursement from BCN in 1998. The Company expects to recognize
increased losses in the future from its share of BCN's losses as BCN expands its
operations.
INTEREST INCOME AND EXPENSE
Prior to June 1995, the Company funded its liquidity needs primarily from
the issuance of equity securities. In June and November 1995, the Company issued
and sold a total of $325.0 million aggregate principal amount at maturity of the
Company's 13% Senior Notes due 2005 (the "1995 Notes") and related warrants (the
"1995 Warrants") for proceeds, net of issuance costs, of $169.9 million. In
October 1996, the Company completed an initial public offering of its common
stock for aggregate net proceeds of $92.2 million. In connection with the
initial public offering, the Company also received $1.2 million in proceeds from
the cash exercise of warrants to purchase shares of the Company's common stock.
In addition, in October 1996, the Company completed certain private placements
of its common stock for net proceeds of approximately $28.0 million. In
September 1997, the Company issued and sold a total of approximately $654.1
million aggregate principal amount at maturity of the 1997 Notes and warrants
(including 1997 Notes and warrants issued in exchange for the 1995 Notes) for
proceeds, net of issuance costs, of $96.3 million. In connection with the
issuance of the 1997 Notes, $231.0 million of the issue price for the 1997 Notes
and warrants was issued in exchange for all of the Company's 1995 Notes. In May
1998, a new subsidiary of the Company, CellNet Funding L.L.C. ("Funding")
completed an offering of Exchangeable Preferred Securities Mandatorily
Redeemable 2010 (the "Preferred Securities") for proceeds net of issuance costs
of $105.9 million. The restricted cash at June 30, 1998 of approximately
$21,539,000 includes the proceeds of the offering which are designated for the
payment of cash dividends on the Preferred Securities through June 1, 2001.
Funding invested the restricted cash in U.S. Treasury strips ("Treasury Strips")
which was placed in escrow upon the closing of the offering of the Preferred
Securities. The Company has earned interest income on the invested proceeds from
these financings. The Company has also incurred significant interest expense
from the amortization of the original issue discount on the 1995 Notes and the
1997 Notes. Interest expense will increase significantly in future periods as a
result of increased accretion of a larger original issue discount balance from
the issuance of the 1997 Notes.
Interest income has been and will continue to be received by the Company
from the short-term investment of proceeds from the issuance of equity and debt
securities pending the use of such proceeds by the Company for capital
expenditures and operating and other expenses. Interest income is expected to be
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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 June 30, 1998 and 1997
was $2.0 million and $1.9 million, respectively. Interest income for the six
months ended June 30, 1998 and 1997 was $3.9 million and $4.2 million,
respectively.
No interest on the 1997 Notes is payable prior to April 1, 2003. Thereafter,
until maturity on October 1, 2007, any interest will be payable semi-annually in
arrears on each April 1 and October 1. The carrying amount of the 1997 Notes
accretes from the date of issue and the Company's interest expense includes such
accretion. Interest expense, net of capitalized interest, was $10.9 million and
$6.2 million for the three months ended June 30, 1998 and 1997. Interest
expense, net of capitalized interest, was $21.7 million and $12.6 million for
the six months ended June 30, 1998 and 1997, respectively.
PROVISION FOR INCOME TAXES
The Company has not provided for or paid federal income taxes due to the
Company's net losses. A nominal provision has been recorded for various state
minimum income and franchise taxes.
As of December 31, 1997, the Company had net operating loss carryforwards of
approximately $206.0 million and $56.0 million available to offset future
federal and state taxable income, respectively. The extent to which the loss
carryforwards can be used to offset future taxable income may be limited,
depending on the extent of ownership changes within any three-year period as
provided in the Tax Reform Act of 1986 and the California Conformity Act of
1987. Such state carryforwards will expire between 1998 and 2012. Such federal
carryforwards will expire between 2001 and 2012. Equity issuances in April 1991
and the initial public offering in 1996 triggered such limitations on loss
carryforwards. As of December 31, 1997, approximately $70.0 million of net
operating losses remain limited to an annual usage of approximately $36.0
million for federal tax purposes. Based upon the Company's history of operating
losses and the expiration dates of the loss carryforwards, the Company has
recorded a valuation allowance to the full extent of its net deferred tax
assets.
DIVIDENDS AND ACCRETION ON PREFERRED SECURITIES OF SUBSIDIARY
The Preferred Securities consist of 4.4 million exchangeable preferred
securities of Funding that bear a cumulative dividend at a rate of 7% per annum.
The dividend is paid quarterly in arrears each March 1, June 1, September 1 and
December 1, commencing September 1, 1998. Dividend expense for the three months
and the six months ended June 30, 1998 was $899,000. The net proceeds from the
placement of the Preferred Securities, after offering costs, was $105.9 million
and will fully accrete to the face value of $110.0 million on June 1, 2010.
Accreted interest expense for the three months and the six months ended June 30,
1998 was $39,000.
IMPACT OF THE YEAR 2000
The Company has assessed the scope of the risk of problems its computer
systems may have related to the Year 2000 and believes that its wireless data
networks are Year 2000 compliant. The Company will require its third party
network vendors and suppliers to be Year 2000 compliant. Accordingly, the
Company expects that the advent of the millennium will have no material adverse
effect on its network operations. 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
being 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 $820,000 for the six months ended June 30, 1998. In
addition, the Company is in the process of inquiring of its vendors and business
partners about their progress in identifying and addressing
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problems related to the year 2000. No assurance can be given that all of these
third party systems will be Year 2000 compliant.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires significant amounts of capital for research and
development in connection with the development of its proprietary wireless
communications network and related products and services, for investments in the
installation and testing of such networks and for related sales and marketing
and general and administrative expenses. Historically, the Company has satisfied
its liquidity requirements primarily through external financings, including
private placements of equity and debt securities and interest income derived
from the investment of the proceeds of its financing activities.
In the first six months of 1998 and 1997, net cash used in the Company's
operating activities totaled $28.7 million and $29.3 million, respectively. Net
cash used in operating activities resulted primarily from cash used to fund net
operating losses.
In the six months ended June 30, 1998 and 1997, net cash used for investing
activities totaled $117.7 million and $6.8 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 six months of June 30, 1998 and 1997, net cash provided by the
Company's financing activities totaled $106.4 million and $478,000,
respectively. In May 1998, Funding, a new subsidiary of the Company, completed
an offering of the Preferred Securities for proceeds net of issuance costs of
$105.9 million.
As of June 30, 1998, the Company had cash, cash equivalents, short-term
investments and restricted cash totaling $172.0 million. As of December 31,
1997, the Company had cash, cash equivalents and short-term investments totaling
$148.1 million. The increase of $23.9 million from December 31, 1997 resulted
from proceeds related to the issuance of the Preferred Securities, offset by
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
$88.6 million in capital expenditures in 1998 for saturation deployment network
installations of which $37.5 million was expended by June 30, 1998. In addition,
the Company anticipates that it may spend as much as an additional $34.8 million
during 1998 in capital expenditures relating to the installation of its broad
deployment network in California, of which $8.7 million was expended by June 30,
1998. The exact amount of such expenditures will depend, in part, upon the
amount of NMR and other services contracted for. The Company may make additional
capital expenditures in connection with the installation of new networks, the
expansion of existing networks and/or an acceleration in anticipated network
installation schedules. In addition, funds will be required for a number of
purposes including, but not limited to, further enhancements to the system
software, firmware, hardware and other equipment to increase the speed, capacity
and functionality of the system, to enhance system productivity over time and to
expand the scope of utility and other network information services that may be
offered on the CellNet system. The Company expects that cash used for the
construction and installation of networks and for the purchase of property and
equipment will increase substantially as and when the Company obtains new
services agreements or enters into other arrangements for the installation of
its networks, and that the Company will require significant amounts of
additional capital from external sources. Sources of additional capital for the
Company and its subsidiaries may include project or conventional bank financing,
including financing provided by utilities to finance the construction of
networks being built out primarily for them, public and private offerings of
debt and equity securities and cash generated from operating activities. The
Company expects that a substantial portion of its future financing will be at
the subsidiary level on a project basis. The Company expects to obtain third
party financing for the construction of wireless networks, based on the
projected cash flow expected to be generated from such projects. The Company
expects that the recurring revenue stream from long-term
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services contracts and other arrangements will support the amortization of debt
raised for the project involved, however no assurance can be given that this
will occur. The Company does not anticipate deriving any significant cash from
such operations for several years.
The Company believes that existing cash, cash equivalents, anticipated
interest income, other revenues and expected sources of project financing of
approximately $90.0 million will be sufficient to meet its cash requirements for
at least the next 12 months. The Company requires and intends to raise a
substantial amount of capital in 1998 and 1999 and expects that it will continue
to require substantial amounts of additional capital in the future. The extent
of additional financing will depend on the success of the Company's business.
The Company expects to incur significant operating losses and to generate
increasingly negative net cash flow during the next several years while it
develops and installs its network communications systems. There can be no
assurance that additional financing, including expected project financing, will
be available to the Company or, if available, that it can be obtained on terms
acceptable to the Company and within the limitations contained in the Indenture
or that may be contained in any additional financing arrangements. The Indenture
under which the 1997 Notes were issued contains certain covenants that limit the
Company's ability to incur additional indebtedness. Future financings may be
dilutive to existing stockholders. Failure to obtain such financing could result
in the delay or abandonment of some or all of the Company's development and
expansion plans and expenditures, which could limit the ability of the Company
to meet its debt service requirements and could have a material adverse effect
on its business and on the value of the common stock.
RISK FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
DEPENDENCE ON AND UNCERTAINTY OF MARKET ACCEPTANCE
The Company's success will be almost entirely dependent on whether
established utilities and other parties, including new power market
participants, sign services contracts with CellNet or enter into other
arrangements which allow CellNet to install NMR networks servicing a substantial
number of meters.
Because automation of utility meter reading and distribution is a relatively
new and evolving market and is likely to be significantly affected by
deregulation, it is difficult to predict the future growth rate and size of this
market. Utilities are testing products from various suppliers for various
applications, and no industry standard has been broadly adopted. The CellNet
system is one possible solution for automated meter reading and distribution.
There can be no assurance that the Company will be successful in achieving the
large-scale adoption of its system. In the event that the utilities or other
parties, including new power market participants, do not adopt the Company's
technology, or do so less rapidly than expected by the Company, the Company's
future results, including its ability to service its indebtedness and achieve
positive cash flow or profitability, will be materially and adversely affected.
In recent competitive bids, potential electric and gas utility customers and new
power market participants have selected competing systems to those offered by
the Company and potential utility customers and new power market participants,
from time to time may select competing services in the future. See
"--Substantial and Increasing Competition."
Any decision by an energy provider to utilize the Company's services will
involve significant organizational, technological and financial commitments. The
utility industry historically is characterized by long purchasing cycles and
cautious decision making. Utilities typically undergo numerous steps before
making a final purchase decision. These steps, which can take up to several
years to complete, may include the formation of a committee to evaluate the
purchase, the review of different technical options with vendors, performance
and cost justifications, regulatory review and the creation and issuance of
requests for quotes and proposals, as well as the utilities' normal budget
approval process. Although the uncertainty surrounding proposed regulatory
changes in some states may have caused, and may continue to cause, additional
delays in purchasing decisions by established utilities, the Company believes
that implementation of utility deregulation will ultimately accelerate the
utility decision-making process. Purchases of the Company's services are, to a
substantial extent, deferrable in the event that utilities seek to limit capital
expenditures
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or decide to defer such purchases for other reasons. Only a limited number of
utilities have made a commitment to purchase the Company's services to date, and
there can be no assurance as to when or if the Company will enter into
additional services contracts or that any such contracts would be on terms
favorable to the Company.
With the advent of utility industry deregulation, the Company is seeking
opportunities to provide its NMR services to other parties, including new power
market participants. The Company believes it is well-positioned to offer
competitive advantages to established utilities and other parties, including new
power market participants. Although the Company has entered into several
contracts with new power market participants and other parties, there can be no
assurance that the Company will be able to enter into contracts covering a
sufficient number of meters to recoup its costs of deployment, on terms
favorable to the Company, or at all. The Company's ability to enter into
contracts with other parties, including new power market participants, depends,
in part, on the timing and type of deregulation in each state. The Company also
anticipates that under contracts with other parties, including new power market
participants, it would build out its networks, at least in part, before the
capacity was fully committed. For these reasons, the Company's ability to obtain
financing for the capital expenditures associated with these contracts may be
limited. The Company believes, however, that it will be able to defer a
significant portion of the required capital expenditures by building out its
networks incrementally as needed, and that the new power market participants and
other parties would lease or acquire the endpoints from the Company, reducing
the Company's costs. The Company also anticipates that its contracts with new
power market participants and other parties will be shorter-term than those it
has entered into with established utilities, and the revenues may therefore not
fully cover the costs of network build-out and associated operating costs. The
Company intends to reduce this risk by marketing its services to a wide range of
new power market participants and other parties, but there can be no assurance
that the Company will be successful in such marketing efforts, or that the new
power market participants and other parties will be successful in capturing any
significant share of the energy service market.
UNCERTAINTY OF FUTURE REVENUES; NEED FOR ADDITIONAL SERVICES CONTRACTS AND
FLUCTUATING OPERATING RESULTS
The timing and amount of future revenues will depend almost entirely upon
the Company's ability to obtain new services agreements with established
utilities and other parties including new power market participants and upon the
successful deployment and operation of the Company's wireless data networks. The
signing of any new services contracts for saturation or broad deployments is
expected to occur on an irregular basis. The Company expects that it will
generally take two to four years to complete the installation of each saturation
deployment network after a services contract has been signed. Service revenues
from both types of such networks are not expected to exceed the Company's
capital investments and expenses incurred to deploy and operate such networks
for several years. The Company will not begin to receive recurring revenues
under a services contract until portions of the network become operational,
which is expected to occur in saturation deployments no earlier than six months
after the execution of the applicable services contract. The Company begins to
incur capital expenditures for the construction of networks used in broad
deployments and does not begin to receive recurring revenues until portions of
the network become operational. The Company's results of operations may be
adversely affected by delays or difficulties arising in the network installation
process. The cost of network deployments will be highly variable and depend upon
a wide variety of factors, including radio frequency characteristics, the size
of a service territory and density of endpoints within such territory, cost of
site leases, the nature and sophistication of services being provided, the cost
of spectrum acquisition, local labor rates and other economic factors.
CellNet currently derives almost all of its revenues from long-term services
contracts with a limited number of established utilities. During 1997,
approximately 88% of the Company's revenues were derived from its contracts with
KCPL and UE and, during the first six months of 1998, 85% of the Company's
revenues were derived from its contracts with KCPL and UE. The Company will not
generate sufficient
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cash flow to service its indebtedness or achieve profitability unless it enters
into additional services contracts covering a significant number of additional
meters. There can be no assurance that the Company will complete commercial
deployments of the CellNet system under current services contracts successfully
or that it will obtain enough additional services contracts on satisfactory
terms for network deployments in a sufficient number of locations to allow the
Company to achieve adequate cash flow to service its indebtedness or achieve
positive cash flow or profitability. The Company's operating results will
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside of the Company's control, including the rate at which
established utilities and new power market participants enter into new services
contracts, general economic conditions, economic conditions in the utility
industry, the effects of governmental regulations and regulatory changes,
capital expenditures and other costs relating to the expansion of operations,
the introduction of new services by the Company or its competitors, the mix of
services sold, pricing changes and new service introductions by the Company and
its competitors and prices charged by suppliers. In response to a changing
competitive environment, the Company may elect from time to time to make certain
pricing, service or marketing decisions or enter into strategic relationships or
investments that could result in a material adverse effect on the Company's
business, operating results, financial condition and cash flow. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
UNCERTAINTY OF ACCEPTANCE OF AND DEPENDENCE ON OTHER APPLICATIONS
The Company's long-term business plan contemplates the generation of a
significant percentage of future revenues from non-utility services. Potential
non-utility applications of the Company's systems include home security, remote
status monitoring of vending machines, office equipment and parking meters and
other equipment and remote control of traffic lights. The Company believes its
future ability to service its indebtedness and to achieve profitability will
depend, in part, upon its success in generating substantial revenues from such
additional services. The Company has been working with industry leaders to
develop such applications. However, there is no assurance any of these
activities will result in the successful development or commercial introduction
of any such services. The Company currently has no services contracts which
provide for the implementation of such services, and the Company has not yet
completed development or deployed any such services on a commercial scale. In
addition, unless the Company is successful in deploying its wireless networks in
targeted service areas, the Company may not be able to offer any such services
in such areas or may be able to offer these services only on a limited basis.
DEPENDENCE ON BUSINESS RELATIONSHIPS TO ACHIEVE MARKET PENETRATION
A key element of the Company's business strategy is the formation of
corporate relationships with leading companies. The Company is currently
investing, and plans to continue to invest, significant resources to develop
these relationships. The Company believes that its success in penetrating
markets for utility and non-utility applications of its network will depend in
large part on its ability to maintain these relationships and to cultivate
additional or alternative relationships. There can be no assurance that the
Company will be able to develop additional corporate relationships with such
companies, that existing relationships will continue or be successful in
achieving their purposes or that such companies will not form competing
arrangements.
SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT; SUBSTANTIAL FUTURE CAPITAL
NEEDS
The Company has substantial outstanding indebtedness, including $654.1
million in aggregate principal amount at maturity of the 1997 Notes. The Company
will be required to pay cash interest on the 1997 Notes commencing April 1, 2003
and repay the 1997 Notes on October 1, 2007. In May 1998, Funding, a
wholly-owned finance subsidiary of the Company, completed an offering of
Preferred Securities which will fully accrete to a face value of $110,000,000 on
June 1, 2010. The Preferred Securities bear a cumulative dividend at the rate of
7% per annum. Funding has purchased Treasury Strips sufficient in amount to pay
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cash dividends on the Preferred Securities through June 1, 2001 and has
deposited the Treasury Strips in escrow with the Escrow Agent for the benefit of
the holders of the Preferred Securities. Funding is required to pay quarterly
dividends in cash on the Preferred Securities through June 1, 2001, and
thereafter, in cash or shares of the Company common stock, at the option of
Funding. The Preferred Securities are subject to mandatory redemption on June 1,
2010 at a redemption price of 100% of the liquidation preference of the
Preferred Securities, plus accrued and unpaid dividends, if any. The Company has
provided the holders of the Preferred Securities certain guarantees of payment
of dividends, distributions, and redemptions. CellNet intends to incur
substantial additional indebtedness, primarily in connection with installing
future networks. As a result, CellNet will have substantial debt service
obligations. The Company's capital expenditures will increase significantly if
new services contracts are signed, and the Company expects that its cash flow,
in part due to increased capital expenditures, will be increasingly negative
over the next several years. The ability of the Company to meet its debt service
requirements will depend upon achieving significant and sustained growth in the
Company's cash flow, which will be affected by a number of factors, including
its success in implementing its business strategy, prevailing economic
conditions and financial, business and other factors, certain of which are
beyond the Company's control. The Company's ability to generate such cash flow
is subject to a number of risks and contingencies. Included among these risks
are the possibilities that: (i) the Company may not obtain sufficient additional
services agreements or complete scheduled installations on a timely basis, (ii)
revenues may not be generated quickly enough to meet the Company's operating
costs and debt service obligations, (iii) the operating and/or capital costs
associated with the installation and maintenance of the network could be higher
than projected, (iv) the Company's wireless systems could experience performance
problems, or (v) adoption of the Company's services within a network could be
less widespread than anticipated. Accordingly, there can be no assurance as to
whether or when the Company's operations will generate positive cash flow or
become profitable or whether the Company or its subsidiaries will at any time
have sufficient resources to meet their debt service obligations. If the Company
is unable to generate sufficient cash flow or obtain alternate liquidity to
service its indebtedness, it will have to take actions such as to reduce or
delay planned capital expenditures, sell assets, restructure or refinance its
indebtedness or seek additional equity capital. There can be no assurance that
any of these strategies could be effected on satisfactory terms, if at all, or
that effecting any of these strategies would yield sufficient proceeds to make
the required payments on any of the Company's indebtedness. In particular, there
is a risk that the Company would be unable, if needed, to refinance the 1997
Notes prior to the date cash interest payments become due and payable on the
1997 Notes or at their maturity date, given uncertainty about prevailing capital
market conditions, the Company's then performance and financial position and the
Company's projected high levels of indebtedness. Such inability to refinance the
1997 Notes could result in cross-defaults under other indebtedness and may limit
the Company's ability to meet its obligations in respect of the CellNet
Preferred Stock and Funding's ability to meet its obligations in respect of the
Preferred Securities.
In addition, the degree to which the Company is leveraged could have
significant consequences, including, but not limited to, the following: (i) the
Company's ability to obtain additional financing in the future for working
capital, capital expenditures, research and development, acquisitions, and other
general corporate purposes may be materially limited or impaired, (ii) the
Company's cash flow, if any, cannot be used in the Company's business as a
substantial portion of the Company's cash flow from operations must 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 June 30, 1998, the Company had $150.4 million in cash, cash
equivalents and short-term investments. The Company intends to raise a
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
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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 June 30, 1998, the Company had an accumulated deficit of $346.4
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 has also offered its customers its Genesis-TM- system, a radio network
system similar to the Company's system, for meter reading purposes.
There may be many potential alternative solutions to the Company's NMR
services including traditional wireless solutions. Motorola is an example of a
company whose technology might be adapted for NMR and who might become a
competitor of the Company. Mtel has announced that it intends to adapt its
technology to offer residential services similar to NMR some time in 1999 over
its existing paging network, with the development of endpoint radios and network
management capabilities being left to other independent companies. Whisper
Communications (formerly, a part of Diablo Research) now offers its True 2
Way-TM- fixed-based radio frequency ("RF") architecture communications
technology for automated meter reading and other services and has several trials
underway. Metricom, a provider primarily of
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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. 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
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capable of offering significant cost savings or other benefits to the Company's
customers, and there can be no assurance that the Company will maintain
competitive services or obtain appropriate new technologies on a timely basis or
on satisfactory terms. The Company's future performance will also depend
significantly on its ability to respond to future regulatory changes.
The Company's necessary development efforts will require it to make
continued substantial investments. The Company has encountered product
development delays in the past affecting both software and hardware components
of its system.
ACCESS TO RADIO FREQUENCY ("RF") SPECTRUM; REGULATION BY THE FEDERAL
COMMUNICATIONS COMMISSION ("FCC")
The Company attempts to obtain exclusive usage of licensed bandwidth and/or
secure its own licenses. The Company has focused its spectrum acquisition
strategy generally on the largest Metropolitan Statistical Areas ("MSAs") and
Consolidated Metropolitan Statistical Areas ("CMSAs") in the United States. As
of June 30, 1998, the Company had acquired a total of 101 spectrum licenses in
51 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 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.
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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 radio frequency spectrum is being used for public radio safety services.
Congress included a very broad definition of "public radio safety services," to
include private internal radio services used by state and local governments and
non-governmental entities, including emergency road services provided by
not-for-profit organizations that are used to protect the safety of life,
health, or property and that are not made commercially available to the public.
As a result, licensed systems that protect the safety of life, health, or
property and are not made commercially available to the public are not subject
to licensing by FCC auctions.
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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 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.
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RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION
The Company is pursuing international markets through BCN Data Systems
L.L.C. ("BCN"), its international joint venture with Bechtel Enterprises, Inc.
The Company does not expect to generate any revenues from its international
operations during 1998. The Company has incurred, and anticipates that it will
continue to incur, significant and increasing expenses in connection with the
establishment of international operations. If revenues generated by
international activities are not adequate to offset the expense of establishing
and maintaining these activities, the Company's business, operating results,
financial condition and cash flow could be materially adversely affected.
International demand for the Company's services and systems may not materialize,
and where present, is likely to vary by country, based on such factors as the
regulatory environment, electric power generating capacity and demand, labor
costs, costs of spectrum acquisition and other political and economic
conditions. In addition, the Company may confront significant challenges in
developing and implementing localized versions of its NMR system due to many
factors including the differing standards among utilities on a country by
country basis. To date, the Company has extremely limited experience in
developing a localized version of its wireless data communications system for
foreign markets. The Company believes its ability to establish business
alliances in each international market will be critical to its success. There
can be no assurance that the Company will be able to successfully develop,
market and implement its system in international markets or establish successful
business alliances for these markets. In addition, there are certain risks
inherent in doing business internationally, such as unexpected changes in
regulatory requirements, export restrictions, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, longer payment cycles,
problems in collecting accounts receivable, political instability, fluctuations
in currency exchange rates and potentially adverse tax consequences, any of
which could adversely impact the Company's potential international operations.
There can be no assurance that one or more of such factors will not have a
material adverse effect on the Company's future international operations and,
consequently, on its business, operating results, financial condition and cash
flow.
The Company's strategy of pursuing international markets through BCN may
involve additional partners in local operating project entities in particular
countries. The Company or BCN may not have a majority interest or control of the
board of directors of any such local operating project entity. In any such joint
venture in which the Company or BCN may determine to participate, there is a
risk that the other joint venture partner may at any time have economic,
business or legal interests or goals that are inconsistent with those of the
joint venture or the Company or BCN or that such partner will not impose the
same or similar accounting and financial controls as the Company or BCN. The
risk is also present that a joint venture partner may be unable to meet its
economic or other obligations and that the Company or BCN may be required to
fulfill those obligations. In addition, in any joint venture in which the
Company or BCN does not have a majority interest, the Company or BCN may not
have control over the operations or assets of such joint venture. Furthermore,
the joint venture structure may limit the amount of funds that can be upstreamed
to the Company or BCN.
MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL
The Company's recent growth has placed, and is expected to continue to
place, a significant strain on its managerial, operational and financial
resources. The Company's ability to manage growth effectively will require it to
continue to implement and improve its operational and financial systems and to
expand and manage its employee base. These demands are expected to require the
addition of new management personnel and the development of additional expertise
by existing management personnel. There can be no assurance that the Company
will be able to effectively manage the expansion of its operations, that its
systems, procedures or controls will be adequate to support the Company's
operations or that Company management will be able to exploit opportunities for
the Company's services. An inability to manage growth, if any, could have a
material adverse effect on the Company's business, results of operations,
financial condition and cash flow.
27
<PAGE>
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 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.
28
<PAGE>
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.
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
subassemblies, components and network equipment are available, the inability of
the Company to develop alternative sources quickly or cost-effectively could
materially impair its ability to manufacture and install systems. Lead times can
be as long as a year for certain components, which may require the Company to
use working capital to purchase inventory significantly in advance of receiving
any revenues.
A significant number of new electric meters are required to initiate meter
retrofit and replacement in connection with each network deployment and to
replace existing meters in the field which are found to be obsolete, worn out or
otherwise unsuitable for retrofit and redeployment. Any sudden or material
increase in the number of deployments would result in an increase in the number
of new electric meters ordered by electric utilities and new power market
participants over and above those ordered on account of normal growth and
replacement within their service areas. To the extent that electric meter
manufacturers are unable or unwilling to increase production in line with such
increase in demand, temporarily or over a longer term, deployments may be
delayed or postponed, with the result that revenues from such deployments will
be likewise delayed or postponed.
29
<PAGE>
RISK OF SYSTEM FAILURES, DELAYS AND INADEQUACIES
The performance, reliability and availability of the Company's wireless data
networks are critical to the Company's reputation and ability to attract and
retain utilities and earn revenues from NMR services and other non-utility
applications. These wireless data networks are vulnerable to damage or
interruption from fire, flood, earthquakes, storms and other similar events. Any
system failure that causes interruption in the availability of network services
could result in a loss of revenue and, if sustained or repeated, could reduce
the attractiveness of the Company's services for future utilities or other
customers. The occurrence of any of the foregoing could have a material adverse
effect on the Company's business, operating results, financial condition and
cash flow.
POSSIBLE TERMINATION OF CONTRACTS
The Company expects that a substantial portion of its future revenues will
be provided pursuant to services contracts of various kinds. These contracts
will generally be subject to cancellation or termination in certain
circumstances in the event of a material and continuing failure on CellNet's
part to meet agreed NMR performance standards on a consistent basis over agreed
time periods, subject to certain rights to cure any such failure. Each of the
Company's existing utility services contracts provides for termination of such
contracts by the respective utility without cause in less than ten years,
subject to certain reimbursement provisions. Such contracts also provide that
CellNet will be required to compensate such utilities for the use of its system
for non-utility applications. Future services contracts with utilities may
contain similar provisions. Contracts with new power market participants
generally allow for termination without cause by the new power market
participants on thirty days prior written notice except to the extent they have
already ordered services under the contract. In the event that such a services
contract is terminated, the Company may incur substantial losses. In addition,
the Company anticipates that any contracts with new power market participants
will generally have shorter terms than the Company's existing utility contracts.
The Company's current contracts with new power market participants generally
have terms of one to five years, compared to terms of ten to twenty years with
utilities. A network's service revenues are not expected to exceed the Company's
capital investments to deploy such network for several years. Termination or
cancellation of one or more significant services contracts would have a material
adverse effect on the Company's business, results of operations, financial
condition and cash flow.
SHAREHOLDERS' AGREEMENT
Under the terms of a Shareholders' Agreement among the Company and certain
stockholders of the Company (the "Shareholders' Agreement"), so long as certain
parties to the Shareholders' Agreement continue to hold not less than 700,000
shares of common stock (as such number is adjusted for stock splits,
consolidations or other similar events), the Company is obligated to nominate
for election representatives of certain stockholders as directors at each
meeting of the Company's stockholders at which a vote for directors will be
taken. The effect of the Shareholders' Agreement is to give certain stockholders
greater influence over the management of the Company than they would otherwise
have and to provide certain stockholders with, among other things, certain
registration, first refusal, co-sale and other rights.
LITIGATION
In October 1996, Itron, one of the Company's competitors, filed a complaint
against the Company in the Federal District Court in Minnesota alleging that the
Company infringes an Itron patent which was issued in September 1996. Itron is
seeking a judgment for damages, attorneys fees and injunctive relief. The
Company believes, based on its current information, that the Company's products
do not infringe any valid claim in the Itron patent, and in the Company's
opinion, the ultimate outcome of the lawsuit is not expected to have a material
adverse effect on its results of operations or financial condition.
30
<PAGE>
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."
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, HOWARD FIENMAN AND GERALD SAPSOWITZ 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, Inc. was likely to ensue.
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 and the
Preferred Securities.
NO DIVIDENDS ON COMMON STOCK; DIVIDEND RESTRICTIONS
The Company has not declared or paid any dividends on its common stock since
its inception. The Company currently anticipates that it will retain all of its
future earnings, if any, for use in the operation and expansion of its business
and does not anticipate paying any cash dividends on the common stock in the
foreseeable future. In addition, the Company's existing financing arrangements
restrict the payment of any dividends on the common stock.
POTENTIAL ADVERSE EFFECT OF SHARES ELIGIBLE FOR FUTURE SALE
A substantial portion of the Company's common stock is presently eligible
for immediate sale in the public market subject, in the case of certain shares,
to the limitations of Rules 144, 144(k) or 701 under the Securities Act. In
addition, the holders of a significant number of such shares of common stock are
entitled to certain registration rights with respect to such shares and the
number of shares sold in the public market could increase substantially upon
exercise of such registration rights.
31
<PAGE>
RISKS RELATED TO PREFERRED SECURITIES OF FUNDING
In May 1998, Funding, a wholly-owned finance subsidiary of the Company,
completed an offering of Preferred Securities which will fully accrete to a face
value of $110,000,000 on June 1, 2010. The Preferred Securities bear a
cumulative dividend at the rate of 7% per annum. Funding has purchased Treasury
Strips sufficient in amount to pay cash dividends on the Preferred Securities
through June 1, 2001 and has deposited the Treasury Strips in escrow with the
Escrow Agent for the benefit of the holders of the Preferred Securities. Funding
is required to pay quarterly dividends in cash on the Preferred Securities
through June 1, 2001, and thereafter, in cash or shares of the Company common
stock, at the option of Funding. The Preferred Securities are subject to
mandatory redemption on June 1, 2010 at a redemption price of 100% of the
liquidation preference of the Preferred Securities, plus accrued and unpaid
dividends, if any. The Company has provided the holders of the Preferred
Securities certain guarantees of payment of dividends, distributions, and
redemptions. The Preferred Securities involve a high degree of risk, and
accordingly, reference must be made to the Risk Factors and other cautionary
statements set forth in the Registration Statement on Form S-3 in respect of the
Preferred Securities and in Funding's Report on Form 10-Q and other filings by
Funding with the Securities and Exchange Commission.
ANTI-TAKEOVER PROVISIONS
The Board of Directors, without further shareholder approval, can issue
preferred shares with dividend, liquidation, conversion, voting, exchange or
other rights which could adversely affect the voting power or other rights of
the holders of the common stock. In the event of issuance, the preferred shares
could be utilized, under certain circumstances, as a method of discouraging,
delaying or preventing a change of control of CellNet. In addition, the Company
is, and will continue to be, subject to the anti-takeover provisions of the
Delaware General Corporation Law, which could have the effect of delaying or
preventing a change of control of the Company. Furthermore, upon a change of
control, the holders of substantially all of the Company's outstanding
indebtedness are entitled, at their option, to be repaid in chase and the
holders of CellNet's preferred stock may, at their option, require CellNet or
redeem their shares for cash. Such provisions may have the effect of delaying or
preventing changes in control or management of the Company. All of these factors
could materially adversely affect the price of the Company's common stock and
the Preferred Securities.
ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
32
<PAGE>
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, HOWARD FIENMAN AND GERALD SAPSOWITZ 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 the 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.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 30, 1998, at the Company's annual stockholders' meeting, a quorum
of stockholders of the Company approved the following proposals: (1) election of
the following persons as Directors of the Company: Paul M. Cook, Neal M.
Douglas, E. Linn Draper, Jr., William C. Edwards, William Hart and John M.
Seidl; (2) approval of an amendment to the Company's 1994 Stock Plan to increase
the number of shares of common stock available for issuance thereunder by
2,500,000 shares; and (3) ratification of the appointment of Deloitte & Touche
LLP as the Company's independent auditors.
33
<PAGE>
Proposal 1. Election of Directors: Paul M. Cook, Neal M. Douglas, E. Linn
Draper, Jr., William C. Edwards, William Hart and John M. Seidl.
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD/AGAINST
- - -------------------------------------------------------------- ------------ ----------------
<S> <C> <C>
Paul M. Cook.................................................. 32,231,711 357,930
Neal M. Douglas............................................... 32,235,861 353,780
E. Linn Draper, Jr............................................ 31,971,409 618,232
William C. Edwards............................................ 32,225,011 364,630
William Hart.................................................. 32,235,861 353,780
John M. Seidl................................................. 32,229,622 360,019
</TABLE>
Proposal 2. Approval of Amendment to 1994 Stock Plan.
<TABLE>
<S> <C>
For............................................................. 23,474,655
Withheld/against................................................ 1,114,677
Exceptions/abstain.............................................. 71,392
Broker non vote................................................. 7,928,917
---------
Total....................................................... 32,589,641
</TABLE>
Proposal 3. Ratification of the appointment of Deloitte & Touche LLP as the
Company's independent auditors.
<TABLE>
<S> <C>
For............................................................. 32,500,039
Withheld/against................................................ 24,994
Exceptions/abstain.............................................. 64,608
---------
TOTAL....................................................... 32,589,641
---------
---------
</TABLE>
ITEM 5. OTHER INFORMATION
Proposals of shareholders of the Company that are intended to be presented
by such shareholders at the Company's 1999 Annual Meeting of Shareholders must
be received by the Company in writing in accordance with procedures outlined in
the Company's Bylaws by November 27, 1998. If such shareholders fail to comply
with the foregoing notice provision, then the chairman of the 1999 Annual
Meeting of Shareholders may refuse to acknowledge the proposal.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
- - ------------- -------------------------------------------------------------------
<C> <S>
4.1* Certificate of Formation of CellNet Funding, L.L.C. filed April 21,
1998 with the Secretary of State of the State of Delaware
4.2* Form of Amended and Restated Limited Liability Company Agreement of
CellNet Funding, L.L.C., dated as of April 1998.
4.3* Form of Guarantee Agreement, dated May 1998, between CellNet Data
Systems, Inc. and CellNet Funding, L.L.C..
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
- - ------------- -------------------------------------------------------------------
<C> <S>
4.4* Form of Escrow and Security Agreement, date May 1998, among CellNet
Data Systems, Inc. and CellNet Funding, L.L.C.
4.5* Form of Written Action of the Manager of CellNet Funding, L.L.C.,
dated as of May 1998, with respect to the terms of the 7%
Exchangeable Limited Liability Company Preferred Securities.
4.6* Form of Certificate of Designation, Rights and Preferences of the
Preferred Stock Mandatorily Redeemable 2010 of CellNet Data
Systems, Inc. filed May 1998 with the Secretary of State of the
State of Delaware.
4.7* Specimen Certificate representing shares of Preferred Stock of
CellNet Data Systems, Inc.
27.1 Financial Data Schedule
</TABLE>
- - ------------------------
* Incorporated by reference to the exhibit files with the Registration
Statement on Form S-3 by CellNet Data Systems, Inc. and CellNet Funding
L.L.C. (No. 333-50851)
(B) REPORTS OF FORM 8-K
There have been no reports on Form 8-K filed during the quarter ended June
30, 1998.
35
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C> <C>
CELLNET DATA SYSTEMS, INC.
Date: August 12, 1998 By: /s/ PAUL G. MANCA
-----------------------------------------
Paul G. Manca
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
</TABLE>
36
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
- - ------------- ----------------------------------------------------------------------------------------------
<C> <S> <C>
4.1 Certificate of Formation of CellNet Funding, L.L.C. filed April 21, 1998 with the Secretary of
State of the State of Delaware
4.2 Form of Amended and Restated Limited Liability Company Agreement of CellNet Funding, L.L.C.,
dated as of April 1998.
4.3 Form of Guarantee Agreement, dated May 1998, between CellNet Data Systems, Inc. and CellNet
Funding, L.L.C..
4.4 Form of Escrow and Security Agreement, date May 1998, among CellNet Data Systems, Inc. and
CellNet Funding, L.L.C..
4.5 Form of Written Action of the Manager of CellNet Funding, L.L.C., dated as of May 1998, with
respect to the terms of the 7% Exchangeable Limited Liability Company Preferred Securities.
4.6 Form of Certificate of Designation, Rights and Preferences of the Preferred Stock Mandatorily
Redeemable 2010 of CellNet Data Systems, Inc. filed May 1998 with the Secretary of State of
the State of Delaware.
4.7 Specimen Certificate representing shares of Preferred Stock of CellNet Data Systems, Inc.
27.1 Financial Data Schedule
</TABLE>
37
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 71,162
<SECURITIES> 79,264
<RECEIVABLES> 2,706
<ALLOWANCES> (25)
<INVENTORY> 0
<CURRENT-ASSETS> 160,804
<PP&E> 180,868
<DEPRECIATION> (30,213)
<TOTAL-ASSETS> 364,600
<CURRENT-LIABILITIES> (22,130)
<BONDS> (291,704)
(105,979)
0
<COMMON> (211,056)
<OTHER-SE> (74,805)
<TOTAL-LIABILITY-AND-EQUITY> (364,600)
<SALES> 408
<TOTAL-REVENUES> 5,129
<CGS> (458)
<TOTAL-COSTS> (11,894)
<OTHER-EXPENSES> (38,181)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (21,674)
<INCOME-PRETAX> (63,838)
<INCOME-TAX> 0
<INCOME-CONTINUING> (64,776)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (64,776)
<EPS-PRIMARY> (1.57)
<EPS-DILUTED> (1.57)
</TABLE>
