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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 0-21409
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CELLNET DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2951096
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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)
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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 May 13, 1999, 43,028,595 shares of the Registrant's Common Stock,
$0.001 par value, were issued and outstanding.
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TABLE OF CONTENTS
INDEX
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PAGE
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PART I. FINANCIAL INFORMATION.............................................................................. 3
Item 1. Consolidated Financial Statements (Unaudited)................................................. 3
Condensed Consolidated Balance Sheets--As of March 31, 1999 and December 31, 1998............. 3
Condensed Consolidated Statements of Operations--Three Months Ended March 31, 1999 and 1998... 4
Condensed Consolidated Statements of Cash Flows--Three Months Ended March 31, 1999 and 1998... 5
Notes to Condensed Consolidated Financial Statements.......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................... 35
PART II. OTHER INFORMATION................................................................................. 37
Item 1. Legal Proceedings............................................................................. 37
Item 2. Changes in Securities......................................................................... 37
Item 3. Defaults upon Senior Securities............................................................... 37
Item 4. Submission of Matters to a Vote of Security Holders........................................... 37
Item 5. Other Information............................................................................. 37
Item 6. Exhibits and Reports on Form 8-K.............................................................. 37
SIGNATURE.................................................................................................. 38
EXHIBIT INDEX.............................................................................................. 39
</TABLE>
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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>
MARCH 31, DECEMBER 31,
1999 1998
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................. $ 28,242 $ 35,505
Short-term investments................................................................ 26,524 50,728
Accounts receivable-trade............................................................. 5,896 5,022
Accounts receivable-other............................................................. 3,046 2,442
Prepaid expenses and other............................................................ 2,818 1,358
----------- ------------
Total current assets................................................................ 66,526 95,055
Networks-net............................................................................ 194,802 176,090
Network components and inventory........................................................ 28,696 32,616
Restricted cash......................................................................... 16,288 17,984
Property-net............................................................................ 15,496 16,499
Debt issuance costs and other net....................................................... 5,615 5,818
----------- ------------
Total assets........................................................................ $ 327,423 $ 344,062
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable...................................................................... $ 10,008 $ 11,703
Accrued compensation and related benefits............................................. 5,527 4,970
Accrued liabilities................................................................... 4,798 4,168
Current portion of capital lease obligations.......................................... 657 691
----------- ------------
Total current liabilities........................................................... 20,990 21,532
Senior notes............................................................................ 330,004 316,709
Revolving credit agreements............................................................. 39,350 31,350
Deferred revenue........................................................................ 5,257 5,339
Capital lease obligations............................................................... 326 437
Commitments and contingencies (Note 4).................................................. -- --
Mandatorily redeemable preferred securities of subsidiary holding solely Company
preferred stock....................................................................... 106,273 106,191
Stockholders' 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,
1999: 42,880,966; 1998: 42,494,406.................................................. 211,823 211,672
Notes receivable from sale of common stock............................................ (547) (640)
Warrants.............................................................................. 74,545 74,545
Accumulated deficit................................................................... (460,605) (423,085)
Net unrealized gain on short-term investments......................................... 7 12
----------- ------------
Total stockholders' deficit......................................................... (174,777) (137,496)
----------- ------------
Total liabilities and stockholders' deficit............................................. $ 327,423 $ 344,062
----------- ------------
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</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
MARCH 31,
----------------------
1999 1998
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Revenues:
Network service revenues............................................................. $ 4,262 $ 1,971
Product revenues..................................................................... 225 166
License fees and other revenues...................................................... 449 132
---------- ----------
Total revenues..................................................................... 4,936 2,269
---------- ----------
Costs and expenses:
Cost of network operations........................................................... 6,838 5,145
Cost of product and other revenues................................................... 412 84
Research and development............................................................. 6,783 7,024
Marketing and sales.................................................................. 2,690 3,051
General and administrative........................................................... 3,741 3,624
Depreciation and amortization........................................................ 6,627 4,179
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Total costs and expenses........................................................... 27,091 23,107
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Loss from operations................................................................... (22,155) (20,838)
Equity in net loss of unconsolidated affiliate......................................... (1,055) (351)
Other income (expense):
Interest income...................................................................... 1,127 1,934
Interest expense, net of capitalized interest........................................ (13,559) (10,782)
Other-net............................................................................ 129 (179)
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Total other income (expense)....................................................... (12,303) (9,027)
---------- ----------
Loss before provision for income taxes and dividends and accretion on preferred
securities........................................................................... (35,513) (30,216)
Provision for income taxes............................................................. 1 --
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Loss before dividends and accretion on preferred securities............................ (35,514) (30,216)
Dividends and accretion on preferred securities of subsidiary.......................... (2,006) --
---------- ----------
Net loss applicable to common stockholders............................................. $ (37,520) $ (30,216)
---------- ----------
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Basic and diluted net loss per share................................................... $ (0.88) $ (0.73)
---------- ----------
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Shares used in computing net loss per share............................................ 42,462 41,139
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
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CELLNET DATA SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 1998
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss applicable to common stockholders............................................... $ (37,520) $ (30,216)
Adjustments to reconcile net loss applicable to common stockholders to net cash used for
operating activities:
Depreciation and amortization.......................................................... 6,627 4,179
Accretion on senior notes, net of capitalized interest................................. 12,683 10,652
Accretion on preferred securities...................................................... 82 --
Amortization of debt issuance costs.................................................... 138 101
Equity in net loss of unconsolidated affiliate......................................... 1,055 351
Other.................................................................................. (229) 276
Changes in:
Accounts receivable-trade............................................................ (874) (557)
Accounts receivable-other............................................................ (604) (1,378)
Prepaid expenses and other........................................................... (1,460) (50)
Accounts payable..................................................................... (1,695) 2,432
Accrued compensation and related benefits............................................ 557 1,311
Accrued liabilities and deferred revenues............................................ 548 (25)
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Net cash used for operating activities............................................. (20,692) (12,924)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Networks................................................................................. (22,602) (19,123)
Network components and inventory......................................................... 3,920 (3,461)
Purchase of property..................................................................... (1,080) (1,648)
Investment in unconsolidated affiliates.................................................. (1,055) (833)
Purchase of short-term investments....................................................... (6,946) (25,509)
Proceeds from sales and maturities of short-term investments............................. 31,145 24,699
Proceeds from maturity of restricted cash................................................ 1,925 --
Other assets............................................................................. 65 (58)
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Net cash provided by (used for) investing activities................................... 5,372 (25,933)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit agreements................................................ 8,000 --
Repayment of capital lease obligations................................................... (187) (187)
Proceeds from sale of common stock, net of repurchases................................... 151 38
Collection of notes receivable from sale of common stock................................. 93 --
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Net cash provided by (used for) financing activities................................... 8,057 (149)
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NET DECREASE IN CASH AND CASH EQUIVALENTS.................................................. (7,263) (39,006)
CASH AND CASH EQUIVALENTS, Beginning of period............................................. 35,505 111,112
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CASH AND CASH EQUIVALENTS, End of period................................................... $ 28,242 $ 72,106
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SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases............................................. $ 42 $ 350
Capitalization of interest into networks................................................. $ 612 $ 627
Change in unrealized gain on short-term investments...................................... $ (5) $ (2)
Repurchase of unvested common stock and cancellation of related notes receivable......... $ -- $ 8
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest................................................................... $ 707 $ 26
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
FOR THE THREE MONTHS ENDED MARCH 31, 1999
1. BASIS OF PRESENTATION
In the opinion of management, these unaudited condensed consolidated
financial statements include all adjustments, consisting only of normal
recurring adjustments and accruals the Company considers necessary for a fair
presentation of the Company's financial position as of March 31, 1999 and the
results of operations and cash flows for the three months ended March 31, 1999
and 1998. This unaudited interim information should be read in conjunction with
the audited consolidated financial statements of CellNet Data Systems, Inc. and
the notes thereto for the year ended December 31, 1998. Operating results for
the three months ended March 31, 1999 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1999.
In 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 $37,525,000 and $30,218,000 for the
three months ended March 31, 1999 and 1998. The comprehensive net loss differs
from the net loss applicable to common stockholders by the net unrealized loss
on short-term investments.
In 1998, the Company adopted SFAS 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.
The Company operates in one reportable segment: the design, development and
operation of its CellNet wireless data communication system to provide automated
network meter reading and other services to the utility industry. The Company
operates exclusively in the United States.
In June 1998, the Financial Accounting Standards Board issued 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. SFAS 133 is
effective for quarters of fiscal years beginning after June 15, 1999. The
Company has not fully assessed the implications of this new standard.
2. NET LOSS PER SHARE
Basic EPS for the periods 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 was computed 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.
3. CREDIT AGREEMENTS
REVOLVING CREDIT AGREEMENTS
In November 1998, CellNet Data Services (KC), Inc. and CellNet Data Services
(SL), Inc. ("CellNet KC" and "CellNet SL", respectively, or the "Borrowers"
collectively), wholly-owned subsidiaries of the Company, each entered into a
reducing revolving credit agreement (the "Agreements") with a group of banks.
The Agreements provide for borrowings of up to $15,000,000 and $60,000,000 for
CellNet KC and CellNet SL, respectively and expire in December 2007. At March
31, 1999, outstanding borrowings under the Agreements for CellNet KC and CellNet
SL were $12,600,000 and $26,750,000, respectively. The
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Agreements provide for quarterly reductions in the availability of borrowings
commencing 2001 through the remaining term of the Agreement. In addition,
borrowings outstanding under the Agreements are subject to mandatory prepayment
(i) with the proceeds of certain asset sales and (ii) on an annual basis up to
12.5% of the Borrowers Excess Cash Flow (as defined in the Agreements.)
The Borrowers pay an annual commitment fee which fluctuates based on the
Borrower's Leverage Ratio (as defined in the Agreements) on the unused portion
of their available borrowings.
The Agreements contain covenants which limit the ability of the Borrowers to
incur additional indebtedness, create liens, pay dividends or make
distributions, consolidate, merge or sell all or substantially all of their
assets, guarantee obligations of other entities, or enter into transactions with
affiliates. Additionally, the Agreements require the Borrowers to maintain
compliance with certain operating and financial covenants, including minimum
revenue, minimum operating cash flow, maximum capital expenditures, leverage
ratio, pro forma debt service ratio and an interest coverage ratio. Borrowings
under the Agreements are secured by the Borrower's assets, contracts and leases.
At March 31, 1999, the Borrowers were in compliance with the above covenants.
The Agreements bear interest at rates, which are at the Borrower's option,
based upon (i) the higher of Prime Rate or the Federal Funds Rate plus 0.5% (the
"Base Rate") plus a variable margin or (ii) the Eurodollar rate plus a variable
margin. The margin fluctuates based on the Borrower's Leverage Ratio from 0.125%
to 1.5% on CellNet KC's Base Rate and 0.5% to 1.875% on CellNet SL's Base Rate
and 1.125% to 2.5% on CellNet KC's Eurodollar rate and 1.5% to 2.875% on CellNet
SL's Eurodollar rate. The weighted average interest rates at March 31, 1999 were
7.625% and 8.0% for CellNet KC and CellNet SL, respectively. As of March 31,
1999, outstanding borrowings for CellNet KC mature as follows: 2003, $1,163,000;
thereafter, $11,437,000. As of March 31, 1999, outstanding borrowings for
CellNet SL mature beginning in 2006 through 2007.
The Agreements require the Borrowers to enter into Interest Hedge Agreements
(as defined) to reduce the impact of changes in the variable interest rates on
borrowings under the Agreements. The Agreements require the Borrowers to hedge
not less than 33% of the outstanding principal amount of total outstanding
borrowings under the Agreements. At March 31, 1999, CellNet KC and CellNet SL
each had an interest rate swap agreement outstanding with a commercial bank with
total notional principal amounts of $6,000,000 and $24,000,000, respectively.
The interest rate swap agreements effectively exchange the Borrowers' interest
rate exposure on $6,000,000 of CellNet KC's and $24,000,000 of CellNet SL's
outstanding borrowings to fixed rates of 8.255%, and 8.63%, respectively. The
interest rate swaps mature on March 11, 2002. The Company is exposed to credit
loss in the event of nonperformance by the other party to the interest rate swap
agreements. However, the Company does not anticipate nonperformance by the
counterparty.
CUSTOMER LINE OF CREDIT
CellNet Data Services (SE), Inc. ("CellNet SE"), a wholly-owned subsidiary
of the Company, entered into a term loan agreement ("Term Loan") with one of its
customers. The Term Loan provides for borrowings of up to $40,000,000. The Term
Loan provides for up to one drawdown per month, bears interest at 6.5% per annum
and is secured by CellNet SE's assets, including contracts and leases. The Term
Loan documents contain covenants which limit the ability of CellNet SE to incur
additional indebtedness, create liens, pay dividends or make distributions,
consolidate, merge or sell all or substantially all of their assets, guarantee
obligations of other entities, or enter into transactions with affiliates. The
drawdowns are payable on the fifth anniversary of the initial drawdown. Interest
on the drawdowns is payable quarterly, beginning with the first calendar quarter
after the initial drawdown. There have been no drawdowns as of March 31, 1999.
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4. COMMITMENTS AND CONTINGENCIES
In October 1996, Itron, one of the Company's competitors, filed a complaint
against the Company in the Federal District Court in Minnesota alleging that the
Company infringes an Itron patent which was issued in September 1996. Itron is
seeking a judgment for damages, attorneys fees and injunctive relief. On January
28, 1999, the Court ruled in favor of the Company that, as a matter of law, the
Company's system did not infringe the Itron patent. The Court also ruled in
favor of Itron that the Itron patent was valid against certain prior art. These
rulings are subject to possible appeal by either or both of the parties. The
Company has not yet determined its course of action in this regard. The Company
believes that the ultimate outcome of the lawsuit is not expected to have a
material adverse effect on the Company's operating results, financial condition
and cash flows.
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 the Company's U.S. Patent No.
4,783,623. The Company sought an injunction, damages and other relief. On
November 2, 1998, the Court ruled that Itron's patent does not infringe upon the
Company's Patent No. 4,783,623. The Company recently filed its notice of appeal
in this action.
The consolidated complaint of Jere Settle and Karen Zully v. John M. Seidl,
et al., No. 398464, filed in the Superior Court of California for the County of
San Mateo, is a purported class action on behalf of the Company's stockholders
against the Company, certain of its officers and directors and underwriters of
the Company's initial public offering seeking unspecified damages and rescission
for alleged liability under various provisions of the federal securities law and
California state law. The plaintiffs alleged generally that the Prospectus and
Registration Statement dated September 26, 1996, pursuant to which the Company
issued 5,000,000 shares of common stock to the public, contained materially
misleading statements and/or omissions in that the Company was obligated to
disclose, but failed to disclose, that a patent conflict with Itron, Inc. was
likely to ensue. The complaint was dismissed on February 9, 1998, without leave
to amend. Plaintiffs filed an appeal in the California Court of Appeal, which is
pending. In the opinion of the Company, the ultimate outcome of the appeal is
not expected to have a material adverse effect on the Company's operating
results, financial condition and cash flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS SECTION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, INFORMATION ABOUT THE COMPANY'S
EXPECTED WIRELESS DATA NETWORK DEPLOYMENTS AND OPERATIONS, ITS STRATEGY FOR
MARKETING AND DEPLOYING SUCH NETWORKS AND RELATED FINANCING ACTIVITIES, ITS
EXPECTED REVENUES, EXPENSES AND CAPITAL EXPENDITURES AND ITS ASSESSMENT OF
POTENTIAL YEAR 2000 ISSUES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THE RESULTS ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF
CERTAIN FACTORS SET FORTH IN "RISK FACTORS" AND ELSEWHERE IN THIS REPORT.
OVERVIEW
CellNet intends to deploy and operate a series of wireless data
communications networks pursuant to services agreements with utilities and other
parties including new power market participants to earn recurring revenues by
providing network meter reading services and to use the networks to support a
variety of non-utility applications. CellNet employs two basic strategies in the
deployment of its networks-- saturation deployments for providing network meter
reading services to existing utilities, and broad deployments for providing
network meter reading services to other parties including new power market
participants. Under CellNet's saturation deployment strategy, CellNet builds out
its wide area network and local area network concurrently in order to cover
virtually 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 CellNet's broad deployment
strategy, CellNet first deploys its
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wide area network 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 CellNet's services and/or to concentrate their marketing
efforts. As contracts for the provision of network meter reading services are
obtained, CellNet builds out its local area network on an incremental basis as
necessary to service those customers or for advanced coverage of certain areas.
Both the local area network and wide area network 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, CellNet is also able to offer (i) network meter reading
services directly to energy consumers, to the extent that the information is not
being made available to them by their own utility or energy service provider,
(ii) network meter reading services which monitor sub-meters for industrial and
commercial customers which desire to monitor the energy consumption of
particular heating, ventilation and air conditioning systems, individual
manufacturing processes or pieces of equipment and individual departments, and
(iii) 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.
CellNet's business strategy has affected and will continue to affect its
financial condition and results of operations as follows:
COMPOSITION OF REVENUES
CellNet derives substantially all of its revenues from fees earned under
services agreements related to its wireless communications networks. Under
CellNet's existing services agreements with utilities, CellNet receives monthly
network meter reading services 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 CellNet's future revenues will depend upon its
ability to obtain additional services agreements with utilities and other
parties including new power market participants and upon CellNet'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
CellNet does not enter into any additional services agreements or other
arrangements. As a result, CellNet expects that its revenues will not grow
smoothly over time, but will increase unevenly as CellNet 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 "Risk Factors That May Affect Future Operating
Performance--CellNet's Future Revenues are Uncertain; --CellNet's Success
Depends Upon its Entering into Additional Services Contracts; and --CellNet
Expects its Operating Results to Significantly Fluctuate."
UNCERTAINTY OF MARKET ACCEPTANCE
CellNet'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 network meter reading services to be
provided thereunder. CellNet's existing revenues principally arise from
established utilities. During the first three months of 1999, approximately 96%
of CellNet's revenues were derived from its contracts with Kansas City Power &
Light ("KC Power & Light"), AmerenUE, Northern States Power Company ("N. States
Power") and Puget Sound Energy, Inc. ("Puget Sound Energy"). During 1998, 92% of
CellNet's revenues were derived from its contracts with KC Power & Light,
AmerenUE and N.
9
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States Power. The utility industry is historically characterized by long
purchasing cycles and cautious decision making, and purchases of CellNet'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
CellNet'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, CellNet
believes that implementation of utility deregulation will ultimately accelerate
the utility decision-making process. CellNet believes that it will enter into
additional services contracts with other utilities and other parties including
new power market participants, as well as expand its contracts with current
network customers; however, if CellNet'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, CellNet is seeking
opportunities to provide its network meter reading services to other parties
including new power market participants. CellNet believes it is well positioned
to offer competitive advantages to established utilities and other parties
including new power market participants. CellNet has entered into several
contracts with new power market participants and others for the provision of
network meter reading services. However there can be no assurance that CellNet
will be able to enter into contracts covering a sufficient number of meters to
recoup its costs of deployment, on terms favorable to CellNet, or at all.
CellNet 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. For these reasons, CellNet's ability to obtain
financing for the capital expenditures associated with these contracts may be
limited, although CellNet 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 CellNet, reducing CellNet's costs. CellNet 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. CellNet 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 CellNet will be successful in such marketing
efforts, or that the new power market participants or other parties will be
successful in capturing any significant share of the energy service market.
CellNet's long-term business plan contemplates the generation of a
significant percentage of future revenues from non-utility services. CellNet
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. CellNet currently has no services contracts which
provide for the implementation of such services, and CellNet has not yet
deployed such services on a commercial scale. In addition, unless CellNet is
successful in deploying its wireless networks in targeted service areas, CellNet
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
CellNet 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 network meter reading data obtained. CellNet 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 CellNet's
capital investments and expenses incurred to deploy such network for several
years. As of March 31, 1999, CellNet had approximately 4,019,000 meters under
long-term contracts, plus 313,000 meters under a memorandum of understanding and
a potential 500,000 meters under an agreement with C3 Communications, of which
approximately 2,152,000 meters were in revenue service. As additional segments
of CellNet's networks are
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installed and used by its customers for billing purposes, CellNet expects to
realize a corresponding increase in its network service revenues. However, if
CellNet 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
CellNet 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. CellNet has incurred substantial operating losses since its inception
and, as of March 31, 1999, had an accumulated deficit of $460.6 million. CellNet
does not expect significant revenues relative to anticipated operating costs
during 1999 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. CellNet does not expect positive
cash flow after capital expenditures from its network meter reading services
operations for several years. CellNet 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 "Risk Factors That May Affect Future Operating
Performance--History and Continuation of Operating Losses" and "--Risks
Associated with CellNet's Substantial Debt and its Ability to Service the Debt;
CellNet's Need for Substantial Future Capital."
INTEREST INCOME
CellNet has earned substantial amounts of interest income on short-term
investments of the proceeds of its financing activities. CellNet expects to
utilize substantially all of its cash, cash equivalents and short-term
investments in deploying its wireless communications networks, in continuing
research and development activities related thereto, in related selling and
marketing activities and for general and administrative purposes. As such funds
are expended, interest income is expected to decrease.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
REVENUES
Revenues for the three months ended March 31, 1999 and 1998 were $4.9
million and $2.3 million, respectively. During the three months ended March 31,
1999, AmerenUE, KC Power & Light, N. States Power and Puget Sound Energy
accounted for approximately 43%, 21%, 20% and 12% of CellNet's revenues,
respectively. During the first three months of 1998, AmerenUE, KC Power & Light
and N. States Power accounted for approximately 50%, 34% and 10% of CellNet's
revenues, respectively. The increase in revenues from period-to-period resulted
primarily from increases in network service revenues, consistent with the
increase in the number of installed, revenue-generating meters. CellNet's
network service revenues for the three months ended March 31, 1999 and 1998 were
$4.3 million and $2.0 million, respectively.
CellNet 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
network meter reading services provided. Revenues are expected to increase as
CellNet continues to install its networks, the networks or portions thereof
become operational, and its clients begin billing their own customers or begin
using the network meter reading services provided. The Company expects to have
product sales associated with certain network meter reading deployments. Such
sales could be material to CellNet's revenues, although no assurance can be
given in this regard. Due primarily to the
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nature, amount and timing of revenues received to date, no meaningful
period-to-period comparisons can be made. Revenues received during the three
month ended March 31, 1999 and 1998, respectively, are not reliable indicators
of revenues that might be expected in the future.
COST OF REVENUES
For the three months ended March 31, 1999 and 1998, cost of revenues
primarily consisted of network operations costs. Cost of revenues was $7.3
million and $5.2 million for the three months ended March 31, 1999 and 1998,
respectively. The increase in cost of revenues from period-to-period was driven
by increasing costs of providing network services to support the roll-out of new
and existing networks. Cost of network operations consists of labor costs and
associated costs necessary for network monitoring operations, network deployment
management and customer training. Cost of network operations also includes the
increased installation, applications and radio frequency engineering staff to
support anticipated additional utility contracts. Network operations do not
currently generate a profit as CellNet has not yet achieved a scale of services
sufficient to cover network costs. CellNet will incur significant increasing
costs primarily attributable to network operation and depreciation. Once a
network has been fully installed, costs associated with generating network
revenues will consist primarily of maintaining a monitoring center for such
network, network depreciation and miscellaneous maintenance and operating
expenses.
OPERATING EXPENSES
Operating expenses, consisting of research and development, marketing and
sales, general and administrative costs and depreciation and amortization
expenses, were $19.8 million and $17.9 million for the three months ended March
31, 1999 and 1998, respectively. The increase in operating expenses on a
period-to-period basis is attributable to the CellNet's rapid growth and to
increasing general and administrative expenditures and increasing depreciation
and amortization expenditures, partially offset by decreased research and
development and marketing and sales expenditures. CellNet expects to moderately
reduce its spending on research and development activities during 1999.
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
CellNet's expected growth. Depreciation and amortization expense is expected to
grow as a result of increased additions to networks, property and leasehold
improvements.
RESEARCH AND DEVELOPMENT
Research and development expenses are attributable largely to continuing
system software, firmware and equipment developments costs, prototype testing,
personnel costs, consulting fees and supplies. Research and development costs
are expensed as incurred. CellNet's networks include certain software
applications which are integral to their operation. The costs to develop such
software have not been capitalized as CellNet 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 $6.8 million and $7.0 million for the
three months ended March 31, 1999 and 1998, respectively, net of technology
migration expenses reimbursable by BCN Data Systems, L.L.C. ("BCN") of $245,000
for the three months ended March 31, 1998. No expenses were reimbursable by BCN
in the three months ended March 31, 1999. The moderate decrease in research and
development spending in 1999 over 1998 primarily reflects slight reductions in
CellNet's engineering staff. CellNet expects that research and development
expenses will continue to decrease moderately in the near term.
MARKETING AND SALES
Marketing and sales expenses consist principally of personnel costs,
including commissions paid to sales and marketing personnel, travel,
advertising, trade show and other promotional costs. Marketing and
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sales expenses were $2.7 million and $3.1 million for three months ended March
31, 1999 and 1998 respectively. These expenses have decreased period-to-period
due to a reduction in expenditures for CellNet's advertising programs. CellNet
expects marketing and sales expenses to increase moderately in the remainder of
1999, as CellNet continues its efforts to sign new service agreements.
GENERAL AND ADMINISTRATIVE
General and administrative expenses include compensation paid to general
management, administrative personnel costs, travel and communications and other
general administrative expenses, including fees for professional services.
General and administrative expenses for the three months ended March 31, 1999
and 1998 were $3.7 million and $3.6 million, respectively. The increase in these
expenses in 1999 over 1998 resulted from an increase in expenditures for certain
professional services. CellNet expects general and administrative expenses to
increase over time in line with expected growth.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $6.6 million and $4.2 million for
the three months ended March 31, 1999 and 1998, respectively. Depreciation and
amortization expense is attributable to CellNet's networks, including both
equipment manufactured by CellNet 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, property and leasehold
improvements period-over-period.
EQUITY IN LOSS OF UNCONSOLIDATED AFFILIATE
CellNet accounts for its investment in BCN, which began operations in 1997,
using the equity method. In the three months ended March 31, 1999 and 1998,
CellNet recognized $1.1 million and $351,000 as its share of BCN's losses,
respectively. CellNet expects to recognize increased losses in the future from
its share of BCN's losses.
INTEREST INCOME AND EXPENSE
Prior to June 1995, CellNet funded its liquidity needs primarily from the
issuance of equity securities. In June and November 1995, CellNet issued and
sold a total of $325.0 million aggregate principal amount at maturity of
CellNet'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.
On October 2, 1996, CellNet completed an initial public offering (the
"Initial Public Offering") in which it sold 5,000,000 shares of its Common Stock
at an offering price of $20 per share for aggregate net proceeds of $92.2
million after deducting underwriting discounts and commissions and offering
expenses payable by CellNet. In connection with the Initial Public Offering,
CellNet also received $1.2 million in proceeds from the cash exercise of the
1995 Warrants (the "Warrant Exercise") to purchase 495,918 shares of CellNet's
Common Stock. In addition, on October 2, 1996, CellNet completed certain direct
placements (the "Direct Placements") in which it sold 1,579,404 shares of its
Common Stock for proceeds of approximately $28.0 million.
In September 1997, CellNet issued and sold a total of approximately $654.1
million aggregate principal amount at maturity of 14% Senior Notes due 2007 (the
"1997 Notes") and warrants (the "1997 Warrants") 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 1997 Warrants was
issued in exchange for all of CellNet's 1995 Notes.
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In May 1998, a new subsidiary of CellNet, CellNet Funding, LLC ("Funding")
completed an offering of Exchangeable Preferred Securities Mandatorily
Redeemable 2010 (the "Preferred Securities") for proceeds net of issuance costs
of $106.0 million. The restricted cash at March 31, 1999 of approximately $16.3
million includes the proceeds of the offering which are designated for the
payment of cash dividends on the Preferred Securities through June 1, 2001.
Funding invested the restricted cash in U.S. Treasury strips ("Treasury Strips")
which was placed in escrow upon the closing of the offering of the Preferred
Securities.
In November 1998, two wholly-owned subsidiaries of CellNet each entered into
a revolving line of credit agreement ("the Revolving Credit Agreements") with a
group of banks, which provide for borrowings of $60.0 million and $15.0 million,
respectively, through December 31, 2007, at which time the Revolving Credit
Agreements expire. Borrowings are secured by the wholly-owned subsidiaries'
assets, contracts and leases. Borrowings bear interest at the wholly-owned
subsidiaries' option at various rates based on the lead bank's prime rate, or
margins above the Federal Funds rate or the London Interbank Offer Rate (LIBOR).
The wholly-owned subsidiaries pay a commitment fee on the unused portion of
their available borrowings under their respective Revolving Credit Agreements.
The Revolving Credit Agreements require the the wholly-owned subsidiaries to
enter into Interest Hedge Agreements (as defined) to reduce the impact of
changes in the variable interest rates on borrowings. The Revolving Credit
Agreements require the Borrowers to hedge not less than 33% of the outstanding
principal amount of their total outstanding borrowings. At March 31, 1999, the
wholly-owned subsidiaries each had an interest rate swap agreement outstanding
with a commercial bank with total notional principal amounts of $6,000,000 and
$24,000,000, respectively. The interest rate swap agreements effectively
exchange the wholly-owned subsidiaries' interest rate exposure on $6,000,000 and
$24,000,000 of outstanding borrowings to fixed rates of 8.255%, and 8.63%,
respectively. The interest rate swaps mature on March 11, 2002. CellNet is
exposed to credit loss in the event of nonperformance by the other party to the
interest rate swap agreements. However, CellNet does not anticipate
nonperformance by the counterparty.
CellNet has earned interest income on the invested proceeds from these
financings. CellNet 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 the increased accretion of a larger original issue discount balance
from the issuance of the 1997 Notes, and from interest and commitment fees
incurred from the Revolving Credit Agreements and Interest Hedge Agreements.
Interest income has been and will continue to be received by CellNet from
the short-term investment of proceeds from the issuance of equity and debt
securities pending the use of such proceeds by CellNet for capital expenditures
and operating and other expenses. Interest income is expected to be variable
over time as proceeds from the issue and sale of additional equity and debt
securities are received and as funds are used by CellNet in its business.
Interest income was $1.1 million and $1.9 million for the three months ended
March 31, 1999 and 1998, respectively.
No interest on the 1997 Notes is payable prior to April 1, 2003. Thereafter,
until maturity on October 1, 2007, 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 CellNet's interest expense includes such
accretion. Interest expense on the Revolving Credit Agreements is generally
payable quarterly or upon the maturity date of the advance if less than 90 days.
Commitment fees on the unused portion of the Revolving Credit Agreements are
payable quarterly. Interest under the Interest Hedge Agreements is received and
paid quarterly. Interest expense, net of capitalized interest, increased to
$13.6 million from $10.8 million for the three months ended March 31, 1999 over
the 1998 period, primarily resulting from increases in the accretion on the
senior notes and interest incurred on the Revolving Credit Agreements.
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PROVISION FOR INCOME TAXES
CellNet has not provided for or paid federal income taxes due to CellNet's
net losses. A nominal provision has been recorded for various state minimum
income and franchise taxes.
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $289.0 million and $149.0 million available to offset future
federal and state taxable income, respectively. Such federal carryforwards
expire in 2001 through 2013. Such state carryforwards expire in 1999 through
2013. 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. Based upon CellNet's history of operating
losses and the expiration dates of the loss carryforwards, CellNet has recorded
a valuation allowance to the full extent of its net deferred tax assets.
DIVIDENDS AND ACCRETION ON PREFERRED SECURITIES OF SUBSIDIARY
The net proceeds from the placement of the Preferred Securities in May 1998,
after offering costs, was $106.0 million and will fully accrete to the face
value of $110.0 million on June 1, 2010. The dividend is paid quarterly in
arrears each March 1, June 1, September 1 and December 1, and commenced
September 1, 1998. Dividend expense for the three months ended March 31, 1999
was $1.9 million. Accretion of the Preferred Securities for the three months
ended March 31, 1999 was $82,000.
IMPACT OF THE YEAR 2000
Many currently installed computer systems, software products and electronic
products are coded to accept only two-digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, during 1999 CellNet,
its suppliers and customers and its potential suppliers and customers, may need
to upgrade, repair or replace certain equipment computer systems or software to
ensure that its operations will not be adversely impacted by system failures
related to "Year 2000" noncompliance.
CellNet is in the process of conducting an internal and external review of
all of its systems and contacting all material software and other suppliers to
determine any major areas of exposure of its systems to Year 2000 issues. As a
result of the internal review to date, CellNet believes that its wireless data
networks, through which it provides network meter reading and other services to
its customers, are or will be Year 2000 compliant by January 1, 2000. As a
result of the external review to date, CellNet believes that its material
suppliers will be Year 2000 compliant by the year 2000.
To date, CellNet has spent an immaterial amount and does not expect to spend
a material amount to review and remedy Year 2000 compliance problems. Although
CellNet believes that its wireless data networks, through which it provides
network meter reading and other services to its customers, are or will be Year
2000 compliant, failure to provide Year 2000 compliant business solutions to its
customers or to receive such business solutions from its suppliers could result
in liability to CellNet or otherwise have a material adverse effect on CellNet's
business, operating results, financial condition, cash flows and its ability to
service its indebtedness. Furthermore, CellNet believes that the purchasing
patterns of customers and potential customers may be affected by Year 2000
issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase products and services such as those
offered by CellNet, which could result in a material adverse effect on CellNet's
business, operating results, financial condition, cash flows and its ability to
services its indebtedness. See "Risk Factors That May Affect Future Operating
Performance--Risks Associated with Year 2000 Compliance."
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LIQUIDITY AND CAPITAL RESOURCES
CellNet 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, CellNet 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 three months ended March 31, 1999 and 1998, net cash used for
CellNet's operating activities totaled $20.7 million, and $12.9 million,
respectively. Net cash used for operating activities resulted primarily from
cash used to fund net operating losses.
In the three months ended March 31, 1999 and 1998, net cash provided by
(used for) CellNet's investing activities totaled $5.4 million, and ($25.9)
million, respectively. CellNet's investing activities consisted primarily of
purchases of network components and inventory, the construction and installation
of networks, purchases of property and equipment and purchases, sales and
maturities of short-term investments. In the first three months of 1999, net
proceeds from the sale and maturities of short-term investments were $24.2
million and were used to fund operating activities. In 1998 purchases of
short-term investments exceeded proceeds from the sale and maturities of
short-term investments by $810,000.
In the first three months of 1999 and 1998, net cash provided by (used for)
CellNet's financing activities totaled $8.1 million and ($149,000),
respectively. Cash provided in 1999 resulted primarily from an additional $8.0
million in borrowings under the Agreements.
As of March 31, 1999, CellNet had cash, cash equivalents and short-term
investments totaling $54.8 million. As of December 31, 1998, CellNet had cash,
cash equivalents and short-term investments totaling $86.2 million. The decrease
of $31.4 million during the first three months of 1999 resulted from operating
costs and the development and construction of CellNet's wireless communications
networks, offset by proceeds from the Agreements of $8.0 million.
Deployments of CellNet's wireless communications networks will require
substantial additional capital. CellNet is budgeted to make approximately $99.3
million in capital expenditures in 1999 for saturation deployment network
installations. In addition, CellNet anticipates that it may make modest
additional capital expenditures relating to the installation of its broad
deployment network in California. The exact amount of such expenditures will
depend, in part, upon the amount of network meter reading and other services
contracted for. CellNet 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.
CellNet 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 CellNet obtains new services agreements or enters into other
arrangements for the installation of its networks, and that CellNet will require
significant amounts of additional capital from external sources. Sources of
additional capital for CellNet 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. CellNet expects that a substantial portion of its future
financing will be at the subsidiary level on a project basis. CellNet 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. CellNet
expects that the recurring revenue stream from long-term services contracts and
other arrangements will support the amortization of debt raised for
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the project involved, however no assurance can be given that this will occur.
CellNet expects that operating activities will require the consumption of a
substantial amount of cash resources for the next several years.
CellNet believes that existing cash, cash equivalents, short-term
investments, anticipated interest income, other revenues and expected sources of
project financing of approximately $120 million will be sufficient to meet its
cash requirements through March 2000. CellNet intends to raise a substantial
amount of capital in 1999 and expects that it will continue to require
substantial amounts of additional capital in the future. The extent of
additional financing will depend on the success of CellNet's business. CellNet
expects to incur significant operating losses and to generate increasingly
negative net cash flow during the next several years while it develops and
installs its network communications systems. There can be no assurance that
additional financing will be available to CellNet or, if available, that it can
be obtained on terms acceptable to CellNet and within the limitations contained
in the Indenture or that may be contained in any additional financing
arrangements. The Indenture governing the 1997 Notes contained certain covenants
that limit CellNet'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 of all of CellNet's development and
expansion plans and expenditures, which could limit the ability of CellNet to
meet its debt service requirements and could have a material adverse effect on
its business and on the value of the Common Stock. See "Risk Factors That May
Affect Future Operating Performance--Risks Associated with Year 2000
Compliance."
RISK FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
CELLNET DEPENDS ON THE UTILITY INDUSTRY FOR ACCEPTANCE OF THE CELLNET SYSTEM
CellNet offers automated meter reading services and data generated from such
services to utilities, new power market participants and utility customers.
CellNet contracts with these parties to establish wireless data networks for
automated meter reading and the automated distribution of data. CellNet's
success will be almost entirely dependent upon whether or not these parties (a)
sign additional contracts with CellNet for network meter reading and other
services or (b) otherwise allow CellNet to install wireless data networks for
servicing a substantial number of endpoint monitoring devices including utility
meters.
The automation of utility meter reading and data distribution is a
relatively new and rapidly changing market. CellNet believes that, as the
utility industry becomes more competitive through various deregulation and
privatization initiatives, there will be an increased need for more accurate,
timely and efficient collection of consumption and other operating data. This
will ultimately accelerate the adoption of automated meter reading, data
collection and data distribution systems and techniques. However, this is
entirely dependent upon decisions made by utilities, other utility industry
participants and utility customers over whom CellNet has no control. CellNet
cannot accurately predict the size of this market or its potential growth.
The CellNet system is one possible solution for automated meter reading and
data distribution. It has not been adopted as an industry standard and it may
not be adopted on a broad scale. Competing systems have been and likely will
continue to be selected by utilities and other potential clients. In the event
utilities, other utility industry participants and utility customers do not
adopt CellNet's technology or do so less rapidly than expected by CellNet,
CellNet's future financial results, including its ability to service its
indebtedness and achieve positive cash flow or profitability, will be materially
and adversely affected.
Participants in the utility industry have historically been cautious and
deliberate in making decisions concerning the adoption of new technology. This
process, which can take up to several years to complete, may include the
formation of evaluation committees, a review of different technical options,
technology trials, equipment testing and certification, performance and cost
justifications, regulatory review, one or more requests for vendor quotes and
proposals, budgetary approvals and other steps. Although deregulation and
privatization initiatives may ultimately accelerate the adoption of CellNet's
technology, the timing and extent of such adoption cannot be predicted. Only a
limited number of utilities have made a
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commitment to purchase CellNet's services to date. If CellNet does not enter
into additional services contracts or enter into contracts on terms favorable to
CellNet, CellNet's business, operating results, financial condition, cash flows
and its ability to service its indebtedness will be materially and adversely
affected.
CellNet expects to install networks to support a "saturation deployment"
strategy (where the network is intended to cover all or a substantial portion of
the meters in a utility's designated service area pursuant to contract with that
utility). CellNet also expects to install networks to support a "broad
deployment" strategy (where the network is installed incrementally to cover
service areas where the largest consumers of energy or other utility services
are located and where CellNet expects to be able, over time, to secure an
adequate number of service contracts with non-utility clients, such as
independent marketers and utility customers, to justify network installation and
operation). Although broad deployment networks are deployed incrementally to
meet anticipated service requirements and to mitigate financial risks, CellNet
expects that such networks will be installed before a sufficient number of
service contracts are in hand to generate revenues adequate enough to cover the
costs of network construction and associated operating costs.
CellNet's business, operating results, financial condition, cash flows and
its ability to service its indebtedness will be materially and adversely
affected if any of the following occur:
- CellNet cannot successfully market its services to utility industry
participants;
- CellNet's clients do not capture a significant portion of the utility
market;
- CellNet is unable to enter into contracts covering a sufficient number of
meters to recoup its costs of deployment and operation or to enter into
contracts on terms favorable to CellNet; or
- CellNet is unable to obtain financing for the construction and operation
of such networks.
CELLNET'S FUTURE REVENUES ARE UNCERTAIN
The timing and amount of future revenues will depend almost entirely upon
(a) CellNet's ability to obtain new services agreements with established
utilities and other utility industry participants and (b) the successful
deployment and operation of CellNet's wireless data networks. CellNet expects
that utilities and other parties will sign new services contracts for saturation
or broad deployments on an irregular basis. CellNet expects that the
installation of each saturation deployment network will require two to four
years after a services contract has been signed. Service revenues from both
types of such networks are not expected to exceed CellNet's capital investments
and expenses incurred to deploy and operate such networks for several years.
CellNet will not begin to receive recurring revenues under a services contract
until portions of the network become operational, which, for saturation
deployments, is expected to occur at least six months after the execution of the
applicable services contract. Although CellNet begins to incur capital
expenditures for the construction of networks used in broad deployments, it does
not begin to receive recurring revenues until portions of the network are
operating. Delays or difficulties in the network installation process may
materially and adversely affect CellNet's results of operations. The cost of
network deployments will vary based 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,
costs of governmental approvals and fees, local labor rates and other economic
factors.
CELLNET'S SUCCESS DEPENDS UPON ITS ENTERING INTO ADDITIONAL SERVICES CONTRACTS
CellNet currently derives almost all of its revenues from long-term services
contracts with a limited number of established utilities. During 1998,
approximately 92% of the Company's revenues were derived from its contracts with
AmerenUE, KC Power & Light and N. States Power and, during the first three
months of 1999, 96% of the Company's revenues were derived from its contracts
with AmerenUE, KC
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Power & Light, N. States Power and Puget Sound Energy. CellNet will not generate
sufficient cash flow to service its indebtedness or achieve profitability unless
it enters into additional services contracts covering a significant number of
additional meters. If CellNet does not successfully complete commercial
deployments of the CellNet system under current services contracts or obtain
enough additional services contracts on satisfactory terms for network
deployments in a sufficient number of locations, CellNet will not achieve
adequate cash flow to service its indebtedness or achieve positive cash flow or
profitability. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
CELLNET EXPECTS ITS OPERATING RESULTS TO SIGNIFICANTLY FLUCTUATE
CellNet's operating results will fluctuate significantly in the future due
to a variety of factors, some of which are outside of CellNet's control,
including the following factors:
- the rate at which established utilities, other utility industry
participants and utility customers enter into new services contracts;
- general economic conditions and 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 CellNet or its competitors and the mix
of services sold; and
- pricing changes and new service introductions by CellNet and its
competitors and prices charged by suppliers.
In response to a changing competitive environment, CellNet 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 CellNet's business, operating results, financial condition,
cash flows and its ability to service its indebtedness. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CELLNET DEPENDS ON NON-UTILITY APPLICATIONS
CellNet is planning to generate a significant percentage of future revenues
from non-utility services as part of its long-term business plan. Potential
non-utility applications of CellNet's systems include home security, remote
status monitoring of vending machines, office equipment and parking meters and
other equipment, as well as remote control of traffic lights. If CellNet is
unable to generate significant revenue from such additional non-utility
services, CellNet's ability to service its indebtedness and to achieve
profitability will be materially and adversely affected. While CellNet is
working with industry leaders to develop such non-utility applications, there is
no guarantee that CellNet will successfully develop or commercially introduce of
any such services. CellNet does not currently have any contracts to deploy non-
utility services on a commercial scale. In addition, unless CellNet is
successful in deploying its wireless networks in targeted service areas, CellNet
may not be able to offer any such services in these areas or may be able to
offer these services only on a limited basis.
CELLNET DEPENDS ON FORMING AND MAINTAINING BUSINESS RELATIONSHIPS TO ACHIEVE
MARKET PENETRATION
CellNet must form relationships with leading companies in order to expand
existing markets and enter new markets. CellNet is currently investing, and
plans to continue to invest, significant resources to develop these
relationships. CellNet 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. If CellNet cannot develop additional relationships
with such companies, maintain existing relationships or achieve the purpose
underlying such existing relationships or successfully discourage such companies
from forming competing arrangements, CellNet's business, operating results,
financial condition, cash flows and its ability to service its indebtedness
could be materially and adversely affected.
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RISKS ASSOCIATED WITH CELLNET'S SUBSTANTIAL DEBT AND ITS ABILITY TO SERVICE THE
DEBT; CELLNET'S NEED FOR SUBSTANTIAL FUTURE CAPITAL
CellNet has substantial outstanding indebtedness, including $654.1 million
in aggregate principal amount at maturity of its 14% Senior Discount Notes due
2007 (the "1997 Notes"). CellNet 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 CellNet, completed
its offering of Preferred Securities, which will fully accrete to a face value
of $110.0 million on June 1, 2010. The Preferred Securities bear a cumulative
dividend at the rate of 7% per annum. Funding has purchased Treasury Strips
sufficient in amount to pay cash dividends on the Preferred Securities through
June 1, 2001 and has deposited the Treasury Strips in escrow with the Escrow
Agent for the benefit of the holders of the Preferred Securities. Funding is
required to pay quarterly dividends in cash on the Preferred Securities through
June 1, 2001, and thereafter, in cash or shares of CellNet 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. CellNet has
issued Preferred Stock to Funding (the "CellNet Preferred Stock") and provided
the holders of the Preferred Securities certain guarantees of payment of
dividends, distributions, and redemptions.
In November 1998, two wholly-owned subsidiaries of CellNet each entered into
the Revolving Credit Agreements with a group of banks, which provide for
borrowings of $60.0 million and $15.0 million, respectively, through December
31, 2007, at which time the Revolving Credit Agreements expire. Borrowings are
secured by the wholly-owned subsidiaries' assets, contracts and leases.
Borrowings bear interest at the wholly-owned subsidiaries' option at various
rates based on the lead bank's prime rate, or margins above the Federal Funds
rate or LIBOR. At December 31, 1998, the wholly-owned subsidiaries had
outstanding advances totaling $31.4 million.
CellNet intends to incur substantial additional indebtedness to finance
operations and to install networks. As a result, CellNet will have a substantial
debt balance and related debt service obligations. CellNet's capital
expenditures will increase significantly if new services contracts are signed,
and CellNet expects that its cash flow, in part due to increased capital
expenditures, will be negative until such time as revenues exceed increased
capital and operating costs. The ability of CellNet to meet its debt service
requirements will depend upon achieving significant and sustained growth in
CellNet's cash flow, which will be affected by a number of factors, including
CellNet's success in implementing its business strategy, prevailing economic
conditions and financial, business and other factors, certain of which are
beyond CellNet's control. CellNet's ability to generate such cash flow is
subject to a number of risks and contingencies, including the following:
- CellNet may not obtain a sufficient number of new services contracts on
terms favorable to CellNet;
- network installations may not be completed on a timely basis;
- revenues may not be generated quickly enough to meet CellNet's operating
costs and debt service obligations;
- the operating and/or capital costs associated with the installation and
maintenance of CellNet's networks could be higher than projected;
- CellNet's wireless systems could experience performance problems; and
- the adoption of CellNet's services could be less widespread than
anticipated.
Accordingly, CellNet's operations may not generate positive cash flow or
become profitable on a timely basis, or at all. CellNet or its subsidiaries may
not have sufficient resources to meet their debt service obligations. If CellNet
is unable to generate sufficient cash flow or obtain sufficient liquidity to
service its indebtedness, CellNet will have to take actions which could
materially and adversely affect CellNet's business such as to reduce or delay
planned capital expenditures, sell assets, restructure or
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refinance its indebtedness or seek additional equity capital. CellNet may not be
able to affect these strategies on satisfactory terms, if at all, and these
strategies may yield insufficient proceeds to make the required payments on any
of CellNet's indebtedness. In particular, there is a risk that CellNet 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, CellNet's then
performance and financial position and CellNet's projected high levels of
indebtedness. Such inability to refinance the 1997 Notes could result in
cross-defaults under other indebtedness and may limit CellNet'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 level of CellNet's indebtedness could materially and
adversely affect, among other things:
- CellNet's ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, and other general corporate
purposes;
- CellNet's cash flow, if any, to the extent that it cannot be used in
CellNet's business and must be dedicated to the payment of principal and
interest on its indebtedness; and
- CellNet's ability to withstand economic downturns and competitive
pressures and to respond flexibly to changing business and economic
conditions.
CellNet will require substantial additional funds for the development,
commercial deployment and expansion of its networks, and for funding operating
losses. As of March 31, 1999, the Company had $54.8 million in cash, cash
equivalents and short-term investments. The Company intends to raise a
substantial amount of additional capital in 1999 and expects that it will
continue to require substantial amounts of additional capital in the future.
Depending upon the number and timing of any new services agreements and upon the
associated network deployment costs and schedules, CellNet may require
additional equity or debt financing earlier than estimated in order to fund its
working capital and other requirements. Additional financing may not be
available when required or, if available, it may not be on terms satisfactory to
CellNet. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
In the event that CellNet is unable to generate sufficient cash flow and is
otherwise unable to obtain funds necessary to meet required payments on its
indebtedness, CellNet 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 CellNet.
HISTORY AND CONTINUATION OF OPERATING LOSSES
CellNet has incurred substantial and increasing operating losses since
inception. As of March 31, 1999, the Company had an accumulated deficit of
$460.6 million, primarily resulting from expenses incurred in the development of
the Company's wireless data communications system, marketing of the Company's
NMR, distribution automation and other services, the installation of its
wireless data communications networks and the payment of other normal operating
costs.
CellNet does not expect to generate significant revenues relative to its
anticipated operating costs during 1999 and expects to incur substantial and
increasing operating losses and negative net cash flow after capital
expenditures for the foreseeable future. CellNet 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. CellNet's network service revenues from a particular network are
expected to lag significantly behind network installation expenses until such
network is substantially complete. If CellNet is able to deploy additional
networks, the losses created by this lag in revenues are expected to increase
until the
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revenues from the installed networks overtake the costs associated with the
deployment and operation of such additional networks. Accordingly, CellNet
expects that operating activities will require the consumption of substantial
cash resources for the next several years. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
SUBSTANTIAL AND INCREASING COMPETITION
Electronics, communications and utility product companies are beginning to
develop various wireless network meter reading systems as a result of the
deregulation of the electric utility industry and the potential market for other
applications once a common infrastructure is in place. A number of these systems
currently compete, and others may in the future compete, with the CellNet
system. Deregulation will likely cause competition to increase. CellNet believes
that at this time its most significant direct competitor in the marketplace is
Itron, an established manufacturer and seller of hand-held and drive-by
automated meter reading equipment for utilities. Itron is currently providing to
customers its Genesis-TM- system, a wireless radio network marketed as similar
to CellNet's for meter reading purposes.
There are other potential alternative solutions to CellNet's network meter
reading services including traditional wireless solutions. Mtel has announced
that it intends to adapt its technology to carry data from local area networks
operated by third parties who would offer residential services similar to
network meter reading some time in 1999, with the development of endpoint radios
and network management capabilities being left to other independent companies.
Whisper Communications now offers its True 2 Way-TM- fixed-based radio frequency
architecture communications technology for automated meter reading and other
services and has several trials and one deployment underway. Metricom, a
provider primarily of subscriber-based, wireless data communications for users
of portable and desktop computers, is currently involved in the automated meter
reading market through trials with Whisper Communications. Schlumberger is
working with a number of companies including CellNet, to conduct pilot trials of
utility network automation systems. Other wireless communications providers who
have entered the market for utility and commercial data services include
cellular control channel companies such as Cellemetry and Aeris Communications.
These companies offer low bandwidth services that compete with some of CellNet's
metering applications. Several companies are offering telephone-based network
automated meter reading services or equipment. Among these are Teldata, Inc. and
American Innovations. Bell South Wireless (formerly, Ram Mobile Data) offers
data services that may compete with a variety of CellNet's data services.
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 CellNet
although they have not yet done so. Communications or technology companies may
also seek to adapt new or existing technology to serve this market.
Many of CellNet's present and potential future competitors have
substantially greater financial, marketing, technical and manufacturing
resources, name recognition and experience than CellNet. CellNet'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 CellNet. While CellNet
believes its technology, including its software, is widely regarded as
competitive at the present time, CellNet's competitors may successfully develop
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 CellNet'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 CellNet achieves significant success it could draw additional
competitors into the market. Providers of wireless services may in the future
choose to enter CellNet's markets. Such existing and future competition could
materially and adversely affect the pricing for CellNet's services and CellNet's
ability to sign new services contracts and maintain existing agreements.
Competition for services relating to non-utility applications may be more
intense than
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competition for network meter reading services, and additional competitors may
emerge as CellNet continues to develop non-utility applications. CellNet may be
unable to compete successfully against current and future competitors, and any
failure to do so would have a material adverse effect on CellNet's business,
operating results, financial condition, cash flows and its ability to service
its indebtedness.
RISKS ASSOCIATED WITH TECHNOLOGICAL PERFORMANCE AND BUILD-OUT OF THE SYSTEM;
RAPID TECHNOLOGICAL CHANGE AND UNCERTAINTY
CellNet's initial target market is the monitoring, control and automation of
utilities' electric, gas and water meters and distribution networks. Unforeseen
problems may occur with respect to CellNet's technology, products or services,
and CellNet may not successfully complete the development and commercial
implementation of its technology on a wide scale. CellNet must continue to
expand and upgrade its ability to implement successfully its wireless networks.
CellNet may not be able to develop successfully a full range of endpoint
devices.
CellNet's future success will also depend, in part, on its ability to
enhance its existing hardware, software and wireless communications technology.
Significant technological advances occur rapidly and frequently in the
telecommunications industry. The advent of computer-linked electronic networks,
fiber optic transmission, advanced data digitization technology, cellular and
satellite communications capabilities, specialized mobile radio services and PCS
and other commercial mobile radio services have radically expanded
communications capabilities and market opportunities. Future advances may render
CellNet's technology obsolete or less cost effective than competitive systems or
erode CellNet's market position. Many companies from diverse industries are
seeking solutions for the transmission of data over traditional communications
media, including radio and paging, as well as more recently developed media such
as cellular and PCS-based networks. Competitors may be capable of offering
significant cost savings or other benefits to CellNet's customers. Consequently,
CellNet may be unable to offer competitive services or obtain appropriate new
technologies on a timely basis or on satisfactory terms. CellNet's future
performance will also depend significantly on its ability to respond to future
regulatory changes.
CellNet must make continued substantial investments to develop its
technology. CellNet has encountered product development delays in the past
affecting both software and hardware components of its system.
CELLNET DEPENDS ON ITS ACCESS TO RADIO FREQUENCY SPECTRUM, WHICH MAY BE AFFECTED
BY REGULATION BY THE FCC
CellNet attempts to obtain exclusive usage of licensed bandwidth and/or
secure its own licenses in compliance with FCC regulations in order to ensure
the ability to deliver wireless data services on a wide scale. These licenses,
referred to as spectrum licenses, are required by the FCC for the wireless
transmission of data over a specific radio frequency. CellNet has obtained
spectrum licenses in many of the largest Metropolitan Statistical Areas and
Consolidated Metropolitan Statistical Areas in the United States. As of March
31, 1999, the Company had acquired a total of 156 spectrum licenses in 54 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 CellNet's wireless based data
services or CellNet 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 CellNet. CellNet could also be unable to obtain
frequency in certain areas. Any of these circumstances could have a material
adverse impact on CellNet's future ability to provide its network services and
on CellNet's business, operating results, financial condition, cash flows and
its ability to service its indebtedness.
CellNet's network equipment uses radio spectrum and, as such, is subject to
regulation by the FCC. CellNet's network equipment uses both licensed spectrum
allocated for multiple address radio system operations in the 928/952 MHz band
and unlicensed spectrum in the 902-928 MHz band. As the amount of
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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. CellNet 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. CellNet plans to use these provisions of the FCC's rules to expand its
network system.
The FCC requires that a minimum configuration of an multiple address radio
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 multiple
address radio system frequencies. The eighteen-month deadline may be extended
upon a showing of good cause, but the FCC may not grant any such extension.
CellNet 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 CellNet's equipment utilizing the 902-928
MHz band, although the equipment must be certified by CellNet and the FCC as
being compliant with certain FCC restrictions on radio frequency emissions
designed to protect licensed services from objectionable interference. While
CellNet 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 CellNet's business, operating results, financial
condition, cash flows and its ability to service its indebtedness. The FCC's
rules 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.
The FCC's rules expressly recognize the rights of such unlicensed services to
operate under certain delineated operating parameters even if the potential for
interference to the licensed operations exists. The Company's systems will
operate within those specified parameters. The Commission is currently issuing
new LMS licenses by competitive bidding for the 902-928 MHz band; these new
licenses, when issued, will authorize operation of LMS systems in virtually all
areas of the nation which are not currently served by an LMS system. While the
Company believes that the FCC's rules are adequate to provide interference
protection for its systems, the authorization of additional LMS licenses may
materially and adversely impact the Company's operations in any given location.
While CellNet intends to offer alternate market services over its private,
internal network, some of those services may include the use of CellNet's
network for private carrier service offerings. CellNet'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 multiple address
radio system frequencies on which CellNet 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,
CellNet may be required to restructure such offering or to utilize other
frequencies for the purpose of providing such service. CellNet may not be able
to gain access to such other frequencies. Future interpretation of regulations
by the FCC or changes in the regulation of CellNet's industry by the FCC or
other regulatory bodies or legislation by Congress could have a material adverse
effect on CellNet's business, operating results, financial condition, cash flows
and its ability to service its indebtedness.
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 the following:
- the restriction on future licenses in the 928/952/956 MHz band (in which
CellNet now operates its wide area network) to systems exclusively used
for private internal purposes;
- the prohibition on future licensing in this band for systems which provide
subscriber-based services;
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- the designation of the 932/941 and 928/959 MHz bands for licensees
offering subscriber-based services;
- 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;
- the use of competitive bidding to award licenses for subscriber-based
services;
- the grandfathering and protection from interference of existing licensees,
but only to the extent of their current service areas;
- 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
- for incumbent and new licensees, liberalizing some of the technical and
operational restrictions on the use of the licensed channels.
These proposals have received substantial public comment from a wide range
of industry sectors currently utilizing the multiple address radio system
channels, including extensive comments from CellNet. CellNet has urged, in
particular, that there should not be any restrictions imposed on the use of the
928/952 MHz bands in which CellNet has developed its network facilities that
would unreasonably limit CellNet's ability to provide its current and
anticipated utility and non-utility service offerings. CellNet 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.
CellNet has also supported many of the proposed changes that will make the use
of the band more technically efficient, although CellNet 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.
CellNet's positions have substantial support in the record, although the effort
to retain the status quo eligibility for the 928/952 MHz band has been opposed
by representatives of the utility and transportation industries who would prefer
to limit the use of this band solely to private internal networks and to
prohibit any private carrier or subscriber-based service offerings.
In August 1997, the FCC's authority to utilize competitive bidding as a
licensing mechanism was amended and expanded by Congress in the Budget Act of
1997. Under this recent enactment, the FCC must use competitive bidding
procedures to choose between any mutually exclusive applications, except where
the radio frequency spectrum is being used for public radio safety services.
Congress included a very broad definition of "public radio safety services," to
include private internal radio services used by state and local governments and
non-governmental entities, including emergency road services provided by not-
for-profit organizations that are used to protect the safety of life, health, or
property and that are not made commercially available to the public. As a
result, licensed systems that protect the safety of life, health, or property
and are not made commercially available to the public are not subject to
licensing by FCC auctions.
The new auction legislation occurred after the Notice of Proposed Rulemaking
in WT Docket 97-81 and will, in CellNet'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. CellNet is unable to determine how the new auction legislation will
affect the proposals in that proceeding, whether CellNet's use of multiple
address radio system 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 CellNet
currently operates from circumstances in which mutual exclusivity between
applicants for the same license, requiring the use of auctions, is likely to
exist. It is expected that the FCC will act in WT Docket 97-81 to issue new
proposals consistent with the new auction legislation. However the Company is
unable to predict what those proposals will be or whether they will be favorable
to the Company's interest. Given the uncertainty surrounding the future
regulations governing the
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licensing of the MAS channels, it is possible that some or all of the Company's
uses of the MAS channels would be determined to restrict the ability to acquire
additional licenses in the 928/952 MHz band, thereby requiring the Company to
develop equipment capable of operating in one of the other MAS bands. It is also
possible that the Company may be required to obtain any future channels in the
928/952 MHz band or in any other MAS band for which the Company desires a
license from the FCC only through a competitive bidding assignment process.
Although CellNet believes that additional licensed frequency will be generally
available to it as required, the cost associated with acquiring such licensed
frequency as well as CellNet's operating costs could increase, perhaps
substantially, and CellNet could experience substantial delays in adapting its
networks if new 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 CellNet's business, operating results, financial condition, cash flows and
its ability to service its indebtedness.
In connection with the foregoing, the FCC has temporarily suspended
acceptance of multiple address radio system 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 multiple address radio system
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 CellNet's pending applications for licenses in
the 928/952 MHz band have been or are being processed in due course. In
addition, CellNet's applications for the assignment of licenses held by others
have been processed during the processing suspension. At the request of CellNet,
the FCC has determined that CellNet's current use of the multiple address radio
system spectrum constitutes the use as a private, internal network, and so
CellNet's applications for new licenses, and for major modifications to existing
licenses, are being processed in due course. CellNet's future uses of the
multiple address radio system spectrum may not similarly qualify as a use in a
private, internal network. The FCC may change or expand its freeze on the
processing of applications to recognize the impact of the new auction
legislation described above. In either case, CellNet's ability to obtain new
licenses could be materially and adversely affected, with similar consequences
on CellNet's ability to service areas where it has not yet acquired adequate
frequencies.
Finally, when CellNet acquires licenses assigned to other applicants, or
utilizes licenses issued in the past, CellNet is required to modify its licenses
to reflect more advanced technological parameters now utilized by CellNet and
its systems. CellNet has developed such amendments with the approval of the
FCC's staff and has received and anticipates continuing to receive timely grant
of all required modifications. However, a particular modification may not be
granted timely to CellNet's introduction of service on a particular license, and
the failure to obtain the required license modifications could have a material
adverse effect on CellNet's ability to serve areas covered by such unmodified
licenses.
RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION
CellNet is offering its network meter reading services in international
markets through BCN, its international joint venture with Bechtel Enterprises,
Inc. CellNet does not expect to generate material revenues from BCN's operations
during 1999. CellNet 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,
including the proceeds from necessary financings, are not adequate to offset the
expense of establishing and maintaining these international activities,
CellNet's business, operating results, financial condition, cash flows and its
ability to service its indebtedness could be materially and adversely affected.
International demand for CellNet or BCN's services and systems may not
materialize, and where present, is likely to vary by country, based on many
factors including:
- the degree of regulation in a given country;
- competitive factors;
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- demand for services;
- labor costs;
- the availability of spectrum and the costs of spectrum acquisition; and
- political and economic conditions.
In addition, CellNet may not be able to develop and implement localized
versions of its network meter reading system without significant effort and cost
due to many factors, including the differing standards among utilities on a
country-by-country basis. To date, CellNet has extremely limited experience in
developing a localized version of its wireless data communications system for
foreign markets. CellNet believes BCN's ability to establish business alliances
in each international market will be critical to its success. If BCN is
unsuccessful in developing, marketing and implementing its system in
international markets or in establishing successful business alliances for these
markets, BCN's future international operations could be materially and adversely
affected and, consequently, CellNet's business, operating results, financial
condition, cash flows and its ability to service its indebtedness could be
materially and adversely affected. In addition, there are certain risks inherent
in doing business internationally, any of which could materially and adversely
affect BCN's potential international operations, including:
- changes in regulatory requirements, import/export restrictions, tariffs
and non-tariff trade barriers;
- the ability to obtain financing for the construction and operation of
networks;
- difficulties in staffing and managing foreign operations;
- longer payment cycles and problems in collecting accounts receivable;
- political conditions;
- fluctuations in currency exchange rates;
- potentially adverse tax consequences;
- legal and economic factors; and
- the ability to protect CellNet's intellectual property.
One or more of such factors could have a material adverse effect on BCN's
future international operations and, consequently, on CellNet's business,
operating results, financial condition, cash flows and its ability to service
its indebtedness.
CellNet's strategy of pursuing international markets through BCN may involve
additional partners in particular countries. While BCN anticipates having a
majority interest and control over the Board of Directors of entities through
which business is carried out in foreign countries, in the event that this does
not occur, BCN may not have control over the operations and assets of such
entities. In any business venture in which CellNet or BCN may determine to
participate, there is a risk that the other venture partner may at any time have
economic, business or legal interests or goals that are inconsistent with those
of CellNet or BCN or that such partner will not impose the same or similar
accounting and financial controls as CellNet or BCN. The risk is also present
that a partner may be unable to meet its economic or other obligations and that
CellNet or BCN may be required to fulfill those obligations. Furthermore, the
entity's structure or the laws of a foreign country may limit or substantially
tax the amount of funds that can be transferred to CellNet or BCN.
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RISKS ASSOCIATED WITH A GROWING BUSINESS
CellNet's recent growth has placed, and is expected to continue to place, a
significant strain on its managerial, operational and financial resources.
CellNet's ability to manage growth effectively will require it to continue to
implement and improve its operational and financial systems and to expand or
manage its employee base. CellNet's growth may require the addition of new
management personnel and the development of additional expertise by existing
management personnel. CellNet may be unable to effectively manage the expansion
of its operations. In addition, CellNet's systems, procedures or controls may be
inadequate to support CellNet's operations or Company management may be unable
to exploit opportunities for CellNet's services. An inability to manage growth,
if any, could have a material adverse effect on CellNet's business, operating
results, financial condition, cash flows and its ability to service its
indebtedness.
CELLNET RELIES ON KEY PERSONNEL
The success of CellNet is substantially dependent on its key management and
technical personnel, the loss of one or more of whom could materially and
adversely affect CellNet's business. Substantially all of CellNet's employees
and officers are employed on an at-will basis. Presently, CellNet does not
maintain a "key man" life insurance policy on any of its executives or
employees. CellNet'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 CellNet may be unable
to attract or retain highly qualified technical and managerial personnel in the
future. If CellNet is unable to attract and retain the necessary technical and
managerial personnel, CellNet's business, operating results, financial
condition, cash flows and its ability to service its indebtedness could be
materially and adversely affected.
RISKS ASSOCIATED WITH THE UNCERTAINTY OF PROTECTION OF COPYRIGHTS, PATENTS AND
PROPRIETARY RIGHTS
CellNet relies on a combination of trade secret protection, copyright,
patent, trademark and confidentiality agreements and licensing arrangements to
establish and protect its proprietary rights. CellNet'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 CellNet has obtained and applied for
patents, and intends to file other applications for patents covering its
products and processes, additional patents may not be issued or, if issued, may
not provide adequate protection for CellNet's proprietary rights. In addition,
any patents issued to CellNet or licensed by CellNet may be challenged,
invalidated or circumvented, and the patent rights may not adequately protect
CellNet's intellectual property rights.
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 CellNet's products or
approach. Despite its efforts, CellNet may not be able to safeguard and maintain
these proprietary rights, and CellNet's competitors may independently develop
and patent technologies that are substantially equivalent or superior to
CellNet's technologies. Participants in the wireless industry, including
competitors of CellNet, 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. The issuance of third-party patents could require CellNet 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
CellNet to significant liabilities, require disputed rights to be licensed or
restrict CellNet's ability to use such technology. CellNet also relies to a
substantial degree upon unpatented trade secrets. Others, including CellNet's
competitors, may independently develop or otherwise acquire substantially
equivalent trade secrets. In addition, whether or not additional patents are
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<PAGE>
issued to CellNet, others may receive patents which contain claims applicable to
products or processes developed by CellNet. If any such claims were to be
upheld, CellNet would require licenses. Such licenses may not be available on
acceptable terms, if at all. In addition, CellNet could incur substantial costs
in defending against suits brought against it by others for infringement of
intellectual property rights or in prosecuting suits which CellNet might bring
against other parties to protect its intellectual property rights. From time to
time CellNet receives inquiries with respect to the coverage of its intellectual
property rights, and inquiries could develop into litigation.
In October 1996, Itron, one of CellNet's competitors, filed a complaint
against CellNet in the Federal District Court in Minnesota, alleging that
CellNet infringed an Itron patent which was issued in September 1996. Itron
sought a judgment for damages, attorneys' fees and injunctive relief. On January
28, 1999, the Court ruled in favor of CellNet that, as a matter of law,
CellNet's system did not infringe the Itron patent. The Court also ruled in
favor of Itron that the Itron patent was valid against certain prior art. These
rulings are subject to possible appeal by either or both of the parties. CellNet
has not yet determined its course of action in this regard. CellNet believes
that the ultimate outcome of the lawsuit is not expected to have a material
adverse effect on CellNet's business, operating results, financial condition and
cash flows.
CELLNET DEPENDS ON THIRD-PARTY MANUFACTURERS AND FACES RISKS ASSOCIATED WITH
COMPONENT SHORTAGES
CellNet relies and will continue to rely on outside parties to manufacture
most of its network equipment such as radio devices and printed circuit boards.
As CellNet signs additional services contracts, third party manufacturers must
significantly ramp-up the amount of manufacturing to be undertaken for CellNet
in order to enable CellNet to meet its contractual commitments. These
manufacturers may not be able to meet CellNet's manufacturing needs in a
satisfactory and timely manner. In addition, CellNet may be unable to obtain
additional manufacturers when and if needed. Although CellNet believes
alternative manufacturers are available, if CellNet is unable to develop
alternative suppliers quickly or cost-effectively, CellNet's ability to
manufacture and install systems could be impaired which would materially and
adversely affect CellNet's business, operating results, financial condition,
cash flows and its ability to service its indebtedness. CellNet'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 CellNet believes that
these manufacturers would have an economic incentive to perform such
manufacturing for CellNet, the quality, amount and timing of resources to be
devoted to these activities are not within the control of CellNet, and
manufacturing problems may 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 CellNet's business, operating
results, financial condition, cash flows and its ability to service its
indebtedness.
CellNet purchases certain subassemblies, components and network equipment
from single sources or from a limited number of sources. 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. CellNet's reliance on such
components and on a limited number of vendors and subcontractors involves
certain risks, including the possibility of shortages and reduced control over
delivery schedules, manufacturing capability, quality and cost. Some components
relied upon may have an excessive failure rate or inferior capabilities. A
significant price increase or interruption in supply from one or more of such
suppliers could have a material adverse effect on CellNet's business, operating
results, financial condition, cash flows and its ability to service its
indebtedness. Although CellNet believes alternative suppliers of subassemblies,
components and network equipment are available, the inability of CellNet to
develop alternative sources quickly or cost-effectively could materially impair
its ability to manufacture, install and maintain systems. Lead times can be as
long
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<PAGE>
as a year for certain components, which may require CellNet 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 other utility industry
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. Similar situations could also arise in
connection with network deployments for gas and water meters.
RISKS OF SYSTEM FAILURES, DELAYS AND INADEQUACIES
The performance, reliability and availability of CellNet's wireless data
networks are critical to CellNet's reputation and ability to attract and retain
customers and earn revenues from network meter reading services as well as
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 whether caused by an act of God or not could result in a loss of
revenue and, if sustained or repeated, could reduce the attractiveness of
CellNet's services for future utilities or other customers. The occurrence of
any of the foregoing could have a material adverse effect on CellNet's business,
operating results, financial condition and cash flows and its ability to service
its indebtedness.
RISK OF POSSIBLE TERMINATION OF CONTRACTS
CellNet 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 or
in the event of CellNet fails to meet in material respects the agreed network
meter reading and other performance standards on a consistent basis over agreed
time periods, subject to certain rights to cure any such failure. Each of
CellNet'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. In many instances, 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 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, CellNet may
incur substantial losses. In addition, CellNet's contracts with other utility
market participants will generally have shorter terms than CellNet's existing
utility contracts.
CellNet's current contracts with new power market participants generally
have terms of one to five years, compared to terms of ten to twenty years
generally with utilities. Since a network's service revenues are not expected to
exceed CellNet's capital investments to deploy such network for several years,
the termination or cancellation of one or more significant services contracts
would have a material adverse effect on CellNet's business, operating results,
financial condition, cash flows and its ability to service its indebtedness.
RISKS ASSOCIATED WITH YEAR 2000 COMPLIANCE
Many currently installed computer systems, software products and electronic
products are coded to accept only two-digit entries in the date code field.
These date code fields will need to accept four digit
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entries to distinguish 21st century dates from 20th century dates. As a result,
during 1999 CellNet, its suppliers and customers and its potential suppliers and
customers, may need to upgrade, repair or replace certain equipment computer
systems or software to ensure that its operations will not be adversely impacted
by system failures related to "Year 2000" noncompliance.
CellNet is in the process of conducting an internal and external review of
all of its systems and contacting all material software and other suppliers to
determine any major areas of exposure of its systems to Year 2000 issues. As a
result of the internal review to date, CellNet believes that its wireless data
networks, through which it provides network meter reading and other services to
its customers, are or will be Year 2000 compliant by January 1, 2000. As a
result of the external review to date, CellNet believes that its material
suppliers will be Year 2000 compliant by the year 2000.
To date, CellNet has spent an immaterial amount and does not expect to spend
a material amount to review and remedy Year 2000 compliance problems. Although
CellNet believes that its wireless data networks, through which it provides
network meter reading and other services to its customers, are or will be Year
2000 compliant, failure to provide Year 2000 compliant business solutions to its
customers or to receive such business solutions from its suppliers could result
in liability to CellNet or otherwise have a material adverse effect on CellNet's
business, operating results, financial condition, cash flows and its ability to
service its indebtedness. Furthermore, CellNet believes that the purchasing
patterns of customers and potential customers may be affected by Year 2000
issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase products and services such as those
offered by CellNet, which could result in a material adverse effect on CellNet's
business, operating results, financial condition, cash flows and its ability to
services its indebtedness. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Impact of the Year 2000."
CELLNET IS BOUND BY ITS SHAREHOLDERS' AGREEMENT
Under the terms of a Shareholders' Agreement among CellNet and certain
stockholders of CellNet (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), CellNet is obligated to nominate for
election representatives of certain stockholders as directors at each meeting of
CellNet'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 CellNet than they would otherwise have and to provide
certain stockholders with, among other things, certain registration, first
refusal, co-sale and other rights.
RISKS ASSOCIATED WITH LITIGATION
In October 1996, Itron, one of CellNet's competitors, filed a complaint
against CellNet in the Federal District Court in Minnesota alleging that CellNet
infringes an Itron patent which was issued in September 1996. Itron is seeking a
judgment for damages, attorneys fees and injunctive relief. On January 28, 1999,
the Court ruled in favor of CellNet that, as a matter of law, CellNet's system
did not infringe the Itron patent. The Court also ruled in favor of Itron that
the Itron patent was valid against certain prior art. These rulings are subject
to possible appeal by either or both of the parties. CellNet has not yet
determined its course of action in this regard. CellNet believes that the
ultimate outcome of the lawsuit is not expected to have a material adverse
effect on CellNet's business, operating results, financial condition and cash
flows.
In April 1997, CellNet 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. CellNet sought an injunction,
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damages and other relief. On November 2, 1998, the Court ruled that Itron's
patent does not infringe upon CellNet's Patent No. 4,783,623. CellNet recently
filed its notice of appeal in this action.
The consolidated complaint of Jere Settle and Karen Zully v. John M. Seidl,
et al., No. 398464, filed in the Superior Court of California for the County of
San Mateo, is a purported class action on behalf of CellNet's stockholders
against CellNet, certain of its officers and directors and underwriters of
CellNet's initial public offering seeking unspecified damages and rescission for
alleged liability under various provisions of the federal securities law and
California state law. The plaintiffs alleged generally that the Prospectus and
Registration Statement dated September 26, 1996, pursuant to which CellNet
issued 5,000,000 shares of common stock to the public, contained materially
misleading statements and/or omissions in that CellNet was obligated to
disclose, but failed to disclose, that a patent conflict with Itron, Inc. was
likely to ensue. The complaint was dismissed on February 9, 1998, without leave
to amend. Plaintiffs filed an appeal in the California Court of Appeal, which is
pending. In the opinion of CellNet, the ultimate outcome of the appeal is not
expected to have a material adverse effect on CellNet's business, operating
results, financial condition and cash flows.
CELLNET'S COMMON STOCK PRICE IS VOLATILE
The trading price of CellNet's common stock has been highly volatile since
CellNet's initial public offering and is likely to continue to be subject to
wide fluctuations in response to a variety of factors, including:
- quarterly variations in operating results;
- signing new services contracts or securing new customers;
- consolidations in the industry;
- technological innovations or the introduction of new products by CellNet
or its competitors;
- developments in patents or other intellectual property rights;
- general conditions in the network meter reading services industry and
other industries in which CellNet's services are provided;
- comments or recommendations issued by analysts who follow CellNet and its
competitors; and
- general economic and market conditions.
In addition, in some future period CellNet's operating results could be
below the expectations of public market analysts and investors. In such event,
the price of CellNet's common stock could be materially and adversely affected.
Additionally, the stock market in general, and the market for technology stocks
in particular, have recently experienced extreme price and volume fluctuations
that are not related to the operating performance of particular companies. These
broad market fluctuations could have a significant impact on the market price of
the common stock and the Preferred Securities.
CELLNET HAS DECLARED NO DIVIDENDS ON COMMON STOCK AND IS RESTRICTED FROM DOING
SO IN THE FUTURE
CellNet has not declared or paid any dividends on its common stock since its
inception. CellNet 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, CellNet's existing financing arrangements
restrict the payment of any dividends on the common stock.
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RISKS ASSOCIATED WITH A SUBSTANTIAL PORTION OF SHARES ELIGIBLE FOR FUTURE SALE
A substantial portion of CellNet's common stock is presently eligible for
immediate sale in the public market subject, in the case of certain shares, to
the limitations of Rules 144, 144(k) or 701 under the Securities Act. In
addition, the holders of a significant number of such shares of common stock are
entitled to certain registration rights with respect to such shares and the
number of shares sold in the public market could increase substantially upon
exercise of such registration rights.
RISKS RELATED TO PREFERRED SECURITIES OF FUNDING
In May 1998, Funding, a wholly-owned finance subsidiary of CellNet,
completed an offering of Preferred Securities which will fully accrete to a face
value of $110.0 million on June 1, 2010. The Preferred Securities bear a
cumulative dividend at the rate of 7% per annum. Funding has purchased Treasury
Strips sufficient in amount to pay cash dividends on the Preferred Securities
through June 1, 2001 and has deposited the Treasury Strips in escrow with the
Escrow Agent for the benefit of the holders of the Preferred Securities. Funding
is required to pay quarterly dividends in cash on the Preferred Securities
through June 1, 2001, and thereafter, in cash or shares of CellNet common stock,
at the option of Funding. Dividend payments of $1.9 million were made during the
three months ended March 31, 1999. 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. CellNet 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 Reports on Form 10-K and Form 10-Q and other filings by Funding
with the Securities and Exchange Commission.
RISKS ASSOCIATED WITH CELLNET'S ANTI-TAKEOVER PROVISIONS
On November 24, 1998 (the "Rights Dividend Declaration Date"), the Board of
Directors of CellNet adopted a Stockholder Rights Plan (the "Rights Plan") and
declared a dividend of one Preferred Share Purchase Right (a "Right") for each
outstanding share of common stock. The dividend was paid to stockholders of
record on December 21, 1998 (the "Record Date"). In addition, one Right will be
issued with each share of common stock that becomes outstanding between the
Record Date and the earlier to occur of the Distribution Date (as defined below)
and the Expiration Date (as defined below). This includes common stock that is
issued upon conversion of securities convertible into common stock such as stock
options, warrants, and the Preferred Securities.
The Distribution Date will occur, if at all, on the earlier of (a) the close
of business on the tenth (10th) day after a person or group acquires beneficial
ownership of fifteen percent (15%) or more of CellNet's common stock (including
common stock issuable upon conversion or exchange of any convertible
securities), and (b) the close of business on the tenth (10th) business day
after a person or group announces a tender or exchange offer, the consummation
of which would result in ownership by a person or group of fifteen percent (15%)
or more of CellNet's common stock (including common stock issuable upon
conversion or exchange of any convertible securities).
The Rights may not be exercised prior to the Distribution Date. Following
the Distribution Date, each Right will entitle the holder to purchase for $50.00
(the "Exercise Price") one one-thousandth (1/1000) of a share of CellNet's
Series A Participating Preferred Stock, $0.001 par value per share (the
"Preferred Stock") subject to certain adjustments in both price and number of
shares.
If a person or group acquires beneficial ownership of fifteen percent (15%)
or more of CellNet's common stock (including common stock issuable upon
conversion or exchange of any convertible securities) (an "Acquiring Person"),
then each Right (other than Rights owned by an Acquiring Person or its
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affiliates) will entitle the holder thereof to purchase, for the Exercise Price,
a number of shares of CellNet's common stock having a then current market value
of twice the Exercise Price.
If, after an Acquiring Person acquires beneficial ownership of fifteen
percent (15%) or more of CellNet's common stock (including common stock issuable
upon conversion or exchange of any convertible securities), (a) CellNet merges
into another entity, (b) an acquiring entity merges into CellNet, or (c) CellNet
sells more than fifty percent (50%) of its assets or earning power, then each
Right (other than Rights owned by an Acquiring Person or its affiliates) will
entitle the holder thereof to purchase, for the Exercise Price, a number of
shares of the common stock of the person or entity engaging in the transaction
having a then current market value of twice the Exercise Price.
At any time after an Acquiring Person acquires beneficial ownership of
fifteen percent (15%) or more of CellNet's common stock (including common stock
issuable upon conversion or exchange of any convertible securities) and prior to
the acquisition by the Acquiring Person of fifty percent (50%) of CellNet's
common stock (including common stock issuable upon conversion or exchange of any
convertible securities), the Board of Directors may exchange the Rights (other
than Rights owned by the Acquiring Person or its affiliates), in whole or in
part, for shares of CellNet's common stock at an exchange ratio of one (1) share
of common stock per Right (subject to certain adjustments).
The Rights are redeemable at CellNet's option (with the approval of the
Board of Directors) at any time prior to the close of business on the day (prior
to the Expiration Date) of a public announcement that an Acquiring Person has
acquired beneficial ownership of fifteen percent (15%) or more of CellNet's
common stock (including common stock issuable upon conversion or exchange of any
convertible securities). Upon exercise of CellNet's option to redeem the Rights,
holders will be entitled to receive a redemption payment of $0.001 per Right
(subject to certain adjustments) payable in cash or in shares of CellNet's
common stock.
The Rights expire (the "Expiration Date") on the earliest of (a) November
24, 2008, (b) the consummation of any of the following transactions: (i) CellNet
merges into another entity, (ii) an acquiring entity merges into CellNet, or
(iii) CellNet sells more than fifty percent (50%) of its assets or earning
power, (c) the effective date of a redemption of the Rights determined by the
Board of Directors, and (d) the time at which the Board of Directors orders an
exchange of the Rights.
Under certain circumstances, Rights beneficially owned by an Acquiring
Person or an affiliate or associate of an Acquiring Person and any subsequent
holder of such Rights may become null and void. The Rights have no voting
rights. The Rights have the benefits of certain customary anti-dilution
provisions.
The foregoing is a summary of certain principal terms of the Rights Plan and
is qualified in its entirety by reference to the terms of the Rights Agreement
pursuant to which the Rights have been issued. A copy has been filed with the
Securities and Exchange Commission on Form 8-A dated December 9, 1998.
The Rights Plan was adopted to provide protection to CellNet's stockholders
in the event of an unsolicited attempt to acquire CellNet on terms that are not
in the stockholders' best interests. The Rights Plan does not prevent an
acquisition of CellNet, impact CellNet's ability to negotiate a transaction on
mutually agreeable terms, or limit CellNet's flexibility in responding to
offers. The Rights Plan is designed to prevent the use of coercive and/or
abusive takeover techniques and to encourage any potential acquiror to negotiate
directly with the Board of Directors for the benefit of all stockholders. The
Rights Plan is also designed to afford the Board of Directors adequate time
within which to consider any takeover proposal and, if appropriate, to explore
alternatives. In addition, the Rights Plan is intended to provide increased
assurance that a potential acquiror would pay an appropriate control premium in
connection with any acquisition of CellNet. Nevertheless, the Rights Plan could
be utilized, under certain circumstances, as a method of discouraging, delaying
or preventing a change of control of CellNet.
CellNet is authorized to issue additional shares of undesignated preferred
stock. The Board of Directors has the authority, without further action by the
stockholders, to issue such stock in one or more
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series, to fix the rights, preferences, privileges and restrictions thereof. The
issuance of such stock may also have the effect of delaying, deferring or
preventing a change in control of CellNet, may discourage bids for CellNet's
common stock at a premium over its market price and may materially and adversely
affect the market price of and the voting and other rights of the holders of
common stock. In addition, CellNet 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 CellNet.
Furthermore, upon a change of control, the holders of CellNet's outstanding 1997
Notes are entitled, at their option, to be repaid in cash. Such provisions may
have the effect of delaying or preventing changes in control or management of
CellNet. All of these factors could materially and adversely affect the price of
CellNet's common stock and the Preferred Securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SHORT-TERM INVESTMENTS AND RESTRICTED CASH
CellNet maintains a short-term investment portfolio primarily consisting of
certificates of deposit and corporate debt securities with maturities less than
one year and auction rate preferred stock with maturities greater than ten
years. These available-for-sale securities are subject to interest rate risk and
will rise and fall in value if the market interest rate changes.
CellNet's restricted cash balances are invested in fixed income Treasury
Securities having staggered maturities matching dividend payment dates of the
Redeemable Preferred Securities. Accordingly, changes in market interest rates
have no effect on CellNet's operating results, financial condition and cash
flows.
As of March 31, 1999, the following table provides information about
CellNet's investment portfolio and restricted cash, and presents principal cash
flows and related weighted average interest rates by expected maturity dates (in
thousands).
<TABLE>
<CAPTION>
YEAR OF MATURITY TOTAL DUE
--------------------------------------------------------- AT FAIR
1999 2000 2001 2002 2003 THEREAFTER MATURITY VALUE
--------- --------- --------- ----- ----- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cash and Cash Equivalents..... $ 28,295 -- -- -- -- -- $ 28,295 $ 28,242
Average Interest Rate....... 4.6% -- -- -- -- --
Certificates of Deposit....... $ 8,000 -- -- -- -- -- $ 8,000 $ 8,006
Interest Rate............... 5.7% -- -- -- -- --
Corporate Debt Securities..... $ 8,545 -- -- -- -- -- $ 8,545 $ 8,518
Average Interest Rate....... 5.3% -- -- -- -- --
Auction-rate Preferred
Stock....................... -- -- -- -- -- $ 10,000 $ 10,000 $ 10,000
Average Interest Rate....... -- -- -- -- -- 4.9%
Restricted Cash--Fixed Rate... $ 5,781 $ 7,700 $ 3,850 -- -- -- $ 17,331 $ 16,413
Interest Rate............... 5.5% 5.6% 5.6% -- -- --
</TABLE>
SENIOR NOTES, REVOLVING CREDIT AGREEMENTS AND MANDATORILY REDEEMABLE PREFERRED
SECURITIES
CellNet uses senior notes, revolving credit agreements and mandatorily
redeemable preferred securities to finance its operations. These on-balance
sheet financial instruments, to the extent they provide for variable rates of
interest expose CellNet to interest rate risk, with the primary interest rate
risk exposure resulting from changes in LIBOR or the prime rate which are used
to determine the interest rates that are applicable to borrowings under
revolving credit agreements with two wholly-owned subsidiaries of CellNet. The
revolving credit agreements require the subsidiaries to partially hedge the
interest rate exposure using off-balance sheet derivative financial instruments.
CellNet uses off-balance sheet derivative financial instruments, including
interest rate swaps, to partially hedge interest rate exposure associated with
on-balance sheet financial instruments. All of CellNet's derivative financial
instrument transactions are entered into for non-trading purposes. The terms and
characteristics of the derivative financial instruments
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are matched with the existing on-balance sheet instruments and do not constitute
speculative or leveraged positions independent of these exposures.
The information below summarizes CellNet's financial instruments exposed to
market risks associated with fluctuations in interest rates as of March 31,
1999. To the extent CellNet's financial instruments expose CellNet to interest
rate risk, they are presented within each market risk category in the table
below. The table presents principal cash flows and related interest rates by
year of maturity for CellNet's senior notes, revolving credit agreements,
mandatorily redeemable preferred securities and interest rate swaps in effect at
March 31, 1999 and, in the case of the senior notes and mandatorily redeemable
preferred securities, exclude the potential exercise of the relevant redemption
features (in thousands).
<TABLE>
<CAPTION>
YEAR OF MATURITY TOTAL
----------------------------------------------------------- DUE AT
1999 2000 2001 2002 2003 THEREAFTER MATURITY FAIR VALUE
----- ----- ----- --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Senior Notes--Fixed Rate...... -- -- -- -- -- $ 654,133 $ 654,133 $ 209,323
Interest Rate............... -- -- -- -- -- 14.0%
Mandatorily Redeemable
Preferred Securities--Fixed
Rate...................... -- -- -- -- -- $ 110,000 $ 110,000 $ 60,500
Interest Rate............... -- -- -- -- -- 7.0%
Revolving Credit
Agreements--Variable Rate... -- -- -- -- $ 1,163 $ 38,187 $ 39,350 $ 39,350
Average Interest Rate....... -- -- -- -- 7.6% 7.9%
Interest Rate Swaps--Variable
to Fixed Rate............... -- -- -- $ 30,000 -- -- $ 30,000 $ (150)
Average Pay Rate............ -- -- -- 5.6% -- --
Average Receive Rate........ -- -- -- 5.0% -- --
</TABLE>
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See above, "Management's Discussion and Analysis--Risk Factors that May
Affect Future Operating Results--Litigation."
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
Exhibit 27.1 Financial Data Schedule
(B) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed during the quarter ended March 31,
1999.
37
<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: May 17, 1999 By: /s/ PAUL G. MANCA
-----------------------------------------
Paul G. Manca
VICE PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
</TABLE>
38
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT TITLE
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
39
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 28,242
<SECURITIES> 26,524
<RECEIVABLES> 8,942
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 66,526
<PP&E> 258,741
<DEPRECIATION> (48,443)
<TOTAL-ASSETS> 327,423
<CURRENT-LIABILITIES> (20,990)
<BONDS> (330,004)
(106,273)
0
<COMMON> (211,823)
<OTHER-SE> (74,005)
<TOTAL-LIABILITY-AND-EQUITY> (327,423)
<SALES> 225
<TOTAL-REVENUES> 4,936
<CGS> (348)
<TOTAL-COSTS> (6,902)
<OTHER-EXPENSES> (19,841)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (13,559)
<INCOME-PRETAX> (35,513)
<INCOME-TAX> (1)
<INCOME-CONTINUING> (35,514)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (37,520)
<EPS-PRIMARY> (0.88)
<EPS-DILUTED> (0.88)
</TABLE>
