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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/3A
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AMENDMENT NO. 3
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-25826
HARMONIC INC.
(FORMERLY, HARMONIC LIGHTWAVES, INC.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 77-0201147
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
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549 BALTIC WAY
SUNNYVALE, CA 94089
(408) 542-2500
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
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 shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K/3A or any
amendment to this Form 10-K/3A. ________
Based on the closing sale price of the Common Stock on the NASDAQ National
Market System on March 1, 1999, the aggregate market value of the voting stock
held by non-affiliates of the Registrant was $85,570,254. Shares of Common Stock
held by each officer and director and by each person who owns 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The number of shares outstanding of the Registrant's Common Stock, $.001
par value, was 23,939,552 at March 1, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
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DOCUMENT LOCATION IN FORM 10-K/3A
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Portions of the Proxy Statement for the 1999 Annual Meeting Part III
of Stockholders (which will be filed with the Securities and
Exchange Commission within 120 days of the end of the fiscal
year ended December 31, 1998)
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The Board Compensation Committee Report and the Performance Graph to be
included with the 1999 Proxy Statement shall not be deemed to be "soliciting
material" or to be "filed" with the Commission or otherwise incorporated by
reference into this report.
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K/3A contains forward-looking statements that
involve risks and uncertainties. The statements contained herein that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, including without
limitation statements regarding Harmonic's expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements included in this
document or incorporated by reference herein are based on information available
to Harmonic on the date hereof, and Harmonic assumes no obligation to update any
such forward-looking statements. Harmonic's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth in "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors That
May Effect Future Results of Operations."
OVERVIEW
Harmonic designs, manufactures and markets digital and fiber optic systems
for delivering video, voice and data services over cable, satellite and wireless
networks. Our advanced solutions enable cable television and other network
operators to provide a range of broadcast and interactive broadband services
that include high-speed Internet access, telephony and video on demand. We offer
a broad range of fiber optic transmission and digital headend products for
hybrid fiber coax, satellite and wireless networks, and our acquisition of New
Media Communication Ltd. in January 1998 has allowed us to develop and expand
our product offerings to include high-speed data delivery software and hardware.
On March 23, 1999, Harmonic Lightwaves, Inc. announced the merger of its
subsidiary, Harmonic Inc. with and into Harmonic Lightwaves, Inc. pursuant to a
Certificate of Ownership and Amendment dated March 22, 1999. Pursuant to this
merger, Harmonic Lightwaves, Inc. changed its corporate name to Harmonic Inc.
INDUSTRY BACKGROUND
Demand for Broadband Access
The demand for broadband access has increased significantly in recent years
due in large part to the dramatic growth of the Internet, which has facilitated
commercial applications such as telecommuting and electronic commerce as well as
widespread use of the Web for communicating and accessing information. IDC
estimates that the number of devices that access the Internet worldwide will
increase from approximately 78 million at the end of 1997 to approximately 515
million by the end of 2002. Rapid growth in the number of Internet users and the
demand for more bandwidth-intensive video, voice and data content has strained
existing communications networks and created bottlenecks, especially in the
"last mile" of the communications infrastructure where homes connect to the
local network. Increasingly, individuals who experience the value of high-speed
Internet access from their work locations are demanding similar levels of speed
from their home or laptop connection. Access to the Internet over the last mile
using standard telephone dial-up connections, however, has been limited
generally to speeds of up to 56Kbps.
Competition and Deregulation
Increased demand for high-speed broadband access, combined with recent and
proposed regulatory reform, has spurred competition among communications service
providers worldwide to offer combinations of video, voice and data services.
Historically, U.S. long distance carriers and regional Bell operating companies,
or RBOCs, were generally limited to providing only telephony services in the
residential market. Cable television multiple system operators, or MSOs, also
were generally limited to providing video programming. As a result, neither the
RBOCs nor the cable operators had networks conducive to providing high-speed
data services to residential subscribers. The Telecommunications Act of 1996,
however, permitted cable operators, long-distance carriers and local exchange
carriers such as the RBOCs to enter each other's markets. As a
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result, AT&T has acquired TCI and announced plans to offer broadband and
interactive services, including telephony, on a broad scale over TCI's cable
systems in the next few years. Similarly, RBOCs are deploying various digital
subscriber line technologies, or xDSL, for high-speed data services over their
existing copper networks. A number of RBOCs also have deployed alternative
delivery systems such as hybrid fiber coax, or HFC, fiber to the curb and
wireless for data and video transmission. In certain major metropolitan areas,
new carriers have entered the market. For example, companies such as RCN and
21st Century are building state of the art HFC networks to compete with
incumbent RBOCs and cable operators.
Similar deregulation of telecommunications and broadcasting abroad has
fostered substantial growth and competition in many foreign communications
markets. The emergence of direct broadcast satellite, or DBS, systems
internationally and in the United States has subjected cable operators to
increasing competitive pressures. DBS systems offer consumers up to 200 channels
of digital video programming. In addition, operators in other countries with
more established DBS infrastructures are introducing data services to meet the
growing demand from residential and small business customers for Internet
access.
Response of the Cable Operators
To address increasing competition and demand for high-speed broadband
services, cable operators are introducing voice and data services in addition to
video. By offering bundled packages of broadband services, cable operators are
seeking to obtain a competitive advantage over telephone companies and DBS
providers and to create additional revenue streams.
In order to provide high-speed Internet access, cable operators are
beginning to deploy cable modems in a number of major metropolitan areas. Cable
modems provide significantly faster and easier access to the Internet than
traditional 28Kbps or 56Kbps telephone modems. Cable modems are frequently
offered in conjunction with Internet content services such as @Home or Road
Runner by cable operators, which seek to accelerate customer adoption by
providing a complete hardware and content package. The number of cable modem
subscribers in the U.S. at the end of 1998 was estimated to be approximately
500,000, compared to approximately 100,000 in 1997. Forecasts from Paul Kagan
Associates suggest that over five million cable modems will be deployed by 2001.
Similarly, cable operators are upgrading and rebuilding their networks to
offer digital video, which enables cable operators to provide more channels and
better picture quality. Paul Kagan Associates estimated that of the
approximately 65 million U.S. cable subscribers, approximately one million homes
would install digital set top boxes by the end of 1998 and approximately 7.7
million homes will install digital set top boxes by the end of 2000.
Additionally, the FCC has mandated that broadcasters convert to digital format
by 2006. Operators, nevertheless, will have to work with both analog and digital
video signals for many years.
As telephone carriers are planning to offer broadband voice, data and video
services, cable operators are also upgrading and building out their HFC network
architectures to provide telephony services. AT&T has set targets of 30% local
telephone market share in its initial deployments in TCI systems. In joint
venture agreements with partners such as Time Warner, AT&T has guaranteed
minimum levels of up to 25% telephony penetration within six years.
The ability of cable operators to deliver digital video, voice and
high-speed data services on a broad scale, however, is constrained by the
designs of their legacy networks. These networks, which pass more than 90% of
U.S. homes, were built initially for one-way broadcast analog television and
require substantial upgrades to make them capable of reliably supporting two-way
digital services, such as high-speed Internet access and telephony.
Development of the Cable System Network Architecture
The introduction and deployment of hybrid fiber coax network architectures
has significantly increased network capacity, quality and reliability. The
higher bandwidth of fiber can increase capacity to up to 110 analog channels.
Video compression technologies can further extend the capacity of cable
television systems to several hundred channels. However, to accommodate the
interactive nature of telephony and
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Internet services, these networks require installation of return path equipment
for the transmission of video, voice and data on the return path from the
subscriber to the headend. Additionally, the introduction of telephony service
will require the deployment of fiber closer to the subscriber and therefore
increase the amount of optical fiber and fiber optic equipment in an HFC
network. In order to reliably deliver telephony and data services for large
numbers of subscribers, optical fiber will need to serve approximately 50-home
groups, as opposed to the 500 to 1,000 home groups that are common in today's
networks.
In addition to upgrading and extending network infrastructure with fiber
optics, it will be necessary for cable operators to invest in new digital
headend equipment that can receive and process content from a variety of sources
in different formats and protocols. Interfaces to wired and wireless, analog and
digital, and local and remote sources will increase the complexity of local
headends. Moreover, the desire to tailor services to specific groups of
customers will require flexibility and ease of configuration at the local
network headend.
The Market Opportunity
The upgrade and extension of existing networks to facilitate high-speed
broadband video, voice and data services require substantial expenditure and the
replacement of significant portions of the transmission network. To date, cable
operators have been slow to upgrade their cable plants and network
infrastructure due to capital constraints and the need to achieve significant
economies of scale to justify such expenditures. Competitive pressures and the
desire to capture new revenue opportunities, however, have induced major cable
operators to focus on achieving economies of scale by increasing the size of
their cable systems. This has been accomplished largely through cable system
exchanges and the acquisition of smaller cable operators and independent
operators, many of which could not afford the significant costs necessary to
upgrade their systems. Having achieved a significant degree of consolidation,
many cable operators are now turning their attention to investment in new
infrastructure equipment.
As a result of growing demand for broadband services, development and
deployment of enabling technologies, significant regulatory change, rapidly
increasing competition and considerable industry consolidation, substantial new
investments in the cable industry are providing the capital necessary to
accelerate the upgrade of the cable infrastructure. Recent examples of this
increased investment activity include:
- In 1997, Microsoft invested $1 billion in Comcast;
- In 1998, Paul Allen acquired Charter Communications for $4.5 billion and
purchased a controlling interest in Marcus Cable for $2.8 billion;
- In 1999, AT&T completed the acquisition of TCI for approximately $60
billion and has entered into joint ventures with Time Warner and a number
of smaller cable operators.
As cable operators upgrade their networks to meet market demands, we
believe that increased recognition of the value of cable networks as a medium
for high-speed, interactive video, voice and data, their strategic access to
homes and the improved financial strength of cable operators represent a
significant market opportunity for broadband communications equipment vendors.
Moreover, we believe that these equipment vendors will also benefit from growth
in the services offered by wireless, satellite and other broadband service
providers.
THE HARMONIC SOLUTION
Harmonic develops, manufactures and markets digital and fiber optic systems
for delivering video, voice and data services over cable, wireless and satellite
networks. Our technical strengths in optics have allowed us to develop reliable,
highly integrated systems that enable cable operators to transport digital
video, a greater number of channels and a choice of programming packages over
their fiber optic networks. In addition, our advanced solutions enable cable and
other network operators to provide a range of broadcast and interactive
broadband services that include high-speed Internet access, telephony and video
on demand.
Fiber Optics Products. Our optical transmission products, node and return
path products, and element management hardware and software allow operators to
deliver traditional broadcast video services while
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supporting the roll-out of emerging interactive services and managing the fiber
network. Our new METROLink dense wave division multiplexing, or DWDM, solution
also allows cable operators to provide video, voice and data services directly
from the network headend to distributed nodes, thereby simplifying network
architecture and eliminating the need to install complex electronics in multiple
hubs, which significantly reduces the size of hubs and the associated building
and maintenance costs.
TRANsend Digital Headend System. Our digital TRANsend platform gives cable,
wireless and satellite service providers the flexibility to combine and
customize content from a variety of sources for seamless integration and
delivery of voice, video and data to different subscriber groups. The TRANsend
system leverages our expertise in combining and transporting Internet Protocol,
or IP, data together with digital video. In addition, the TRANsend platform is
designed to be compliant with established international digital video standards,
providing interoperability with equipment from other manufacturers, such as
set-top boxes.
CyberStream System. Our CyberStream product line, which we developed and
introduced in 1998 following our purchase of New Media Communication Ltd.,
provides a low cost, end to end hardware and software solution for high-speed
data delivery, primarily over satellite and wireless networks to residential and
business users. These products can support transmission rates of up to 48
Megabits per second.
Our products incorporate network management systems employing internally
developed hardware and software to monitor and control the network and increase
system availability. The "plug and play" design philosophy and network
management employed in our products further enhance ease of installation and
operation.
STRATEGY
The key elements of Harmonic's business strategy are as follows:
Develop New Products to Meet Cable Operators' Emerging Broadband Needs. We
will continue to develop products to assist cable operators in the introduction
of new broadband services and in the design of new network architectures. We
believe that the strength of our core technologies and the expertise of our
engineering and manufacturing personnel will contribute to the continued
development of products that address customer needs in both their transmission
networks and their headends. Our recently introduced DWDM and scaleable node
products, for example, illustrate our commitment to assisting our customers to
reliably and cost-effectively equip their networks for the deployment of new
services. Our digital headend products provide operators with the flexibility to
market services tailored to particular groups of subscribers. We will continue
to design and manufacture products to meet emerging and existing industry
standards to facilitate interoperability with other manufacturers' equipment.
Increase Penetration of Major Cable Operators. The five largest U.S. cable
operators, which serve a majority of domestic cable subscribers, have purchased
a significant amount of our products. We will continue to leverage our close
relationships with these and other cable operators to promote increased usage
and deployment of our products, particularly as they upgrade and expand their
networks through internal build-out or by acquisition of smaller systems. Our
sales force and technical personnel work closely with cable operators as part of
the sales process to ensure that our products meet cable operators' evolving
application needs and technical specifications. We have reorganized and intend
to expand our direct sales force to maintain close contact and further develop
our relationships with major cable operators.
Provide Highly Integrated Systems. We provide highly integrated systems
that allow network operators to manage increasingly complex networks and thereby
reduce maintenance and operating costs. To address cable operators' requirements
for comprehensive network and headend solutions, our products include a wide
range of forward and return path optical transmitters and receivers and a
growing portfolio of products for digital headends. We also incorporate network
management functions into all of our products, enabling operators to enhance
network reliability and optimize system performance. As operators introduce new
services over more complex networks, the need for integration and sophisticated
network management is becoming more critical. We also design "plug and play"
capabilities into our products, enabling them to be easily installed in an
existing network without complex and lengthy setup procedures.
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Provide Fiber Optic Products to Telephone Companies. As RBOCs begin to
upgrade and deploy networks to provide video programming, we seek to provide the
high performance transmission systems required for delivery of this service. For
example, we have deployed our transmitters and optical amplifiers at one RBOC.
Our products are enabling this RBOC to provide video services in addition to
voice and high-speed data in a fiber to the curb application. In order to
address the needs of telephone company customers, we intend to expand our sales
force to support sales to telephone companies or develop a strategic alliance
with one or more current suppliers of telephony transmission equipment. We
intend to develop closer working relationships with telephone companies as they
deploy broadband services.
Expand in Broadband Wireless and Satellite Markets. Through our acquisition
of New Media Communication Ltd. in January 1998, we have developed and now offer
our CyberStream high-speed, broadband data delivery hardware and software
products, which enable satellite and broadband wireless operators as well as
cable operators to offer high-speed Internet access and video distribution. In
addition, our TRANsend digital headend platform allows wireless and satellite
providers to combine content from a variety of sources for seamless integration
and delivery of digital video and high-speed data. We intend to expand our
presence in these emerging markets as wireless and satellite operators introduce
broadband services.
Increase Sales in International Markets. We currently supply products to a
number of large international customers, including cable operators in Canada,
Europe, Asia and Latin America. We intend to continue to supply complete network
and headend solutions to these and other operators in various international
markets. Although certain international markets are currently depressed, we
believe that many of the same factors which are driving the adoption of
broadband services in the U.S. are present in foreign markets and will, in time,
result in increasing opportunities for sales in these markets. Over the past
year we have added regional sales and support centers in Europe and Asia and we
intend to continue to expand our operations internationally to meet market
demands.
PRODUCTS
Harmonic designs, develops, manufactures and markets fiber optic
transmission and digital systems, comprised of three product families: fiber
optic products, TRANsend digital headend products and CyberStream data delivery
products. Our products employ internally developed hardware and software to
facilitate a high degree of system integration. The "plug and play" design
philosophy and network management employed in our products enhance ease of
installation and operation.
FIBER OPTIC PRODUCTS
We have applied our technical strengths in optics and electronics,
including expertise with lasers, modulators, and radio frequency technology, to
develop products which provide enhanced network reliability and allow broadband
service providers to deliver advanced services, including two-way interactive
services. We have provided the operator with end-to-end capability in the fiber
portion of the network.
Optical Transmission Systems
We offer MAXLink transmitters and optical amplifiers, PWRLink transmitters
and the METROLink system for a wide range of optical transmission requirements.
MAXLink Transmitters and Optical Amplifiers. The MAXLink transmitters and
optical amplifiers operate at a wavelength of 1550nm and serve long-haul
applications and fiber dense architectures that are beyond the capability of
1310nm transmitters. This system is suited to evolving cable networks employing
such features as redundant rings, hub interconnects and broadcast layer
transmission.
PWRLink Transmitters. The PWRLink series of optical transmitters
incorporates semiconductor lasers and provides optical transmission primarily
for use at a headend or hub for local distribution to optical nodes and for
narrowcasting, which is the transmission of programming to a select set of
subscribers.
METROLink System. Our METROLink system, the first DWDM system for the cable
industry, allows operators to expand the capacity of a single strand of fiber
and also to provide high-speed narrowcast services
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directly from the headend to nodes. This ability largely eliminates the need to
locate expensive electronic equipment in each network hub, which significantly
reduces the size of hubs and the associated building and equipment maintenance
costs. By increasing the downstream and upstream capacity of existing optical
fiber, METROLink also can eliminate the often significant expense associated
with laying additional fiber.
Optical Node Receivers, Return Path and Network Management Products
We offer a number of optical nodes, return path transmitters and return
path receivers to provide two-way transmission capability. In addition, we offer
network management hardware and software to enable the network operator to
monitor and control the entire transmission network.
PWRBlazer Optical Node Receivers. Our PWRBlazer optical node receivers
convert optical signals received from the transmitters into radio frequency
signals for transmission to the home via coaxial cable. We offer a variety of
receiver products for applications including indoor and outdoor use, all of
which can be fitted to support two-way traffic.
PWRBlazer Scaleable Optical Node. Our PWRBlazer scaleable optical node is a
receiver which can be easily adapted to handle increasing traffic over a fiber
network without major reconstruction. It is particularly suited to networks that
are expected to handle increasing demands for two-way services and can be
flexibly configured to support specific operator requirements.
Return Path Transmitters and Receivers. Our return path transmitters
support two-way transmission capabilities by sending video, voice and data
signals from the optical node to the headend. Signals originating at the home
can be sent via the coaxial cable to the optical node and then transmitted in
optical form to the headend by the return path transmitter. Our return path
receivers operate at the headend to receive return path optical transmission
from the return path transmitters.
NETWatch Management System. Our NETWatch management system consists of
transponders and network management software. The transponders operate in
broadband networks to capture measurement data. Harmonic's software enables the
broadband service operator to monitor and control the entire HFC transmission
network from a central office or remote locations. Our NETWatch software is
designed to be integrated into larger network management systems through the use
of simple network management protocol, or SNMP.
TRANSEND DIGITAL HEADEND PRODUCTS
Our TRANsend digital headend platform consists of a number of products for
encoding, compressing, multiplexing and modulating digital signals prior to
transmission over broadband networks. It also provides interfaces to incoming
and outgoing data streams and various protocols and formats.
Video Transport Platform. Our VTP houses configurable combinations of
application modules necessary to perform a variety of functions required at a
digital headend. It includes a bus system which routes data and control
information between the application modules under network management control.
Encoders. Our encoders convert analog and digital video and audio signals
to compressed digital format fully compliant with the MPEG-2 standard.
Integrated Receiver eXchange Modules. Our IRX modules receive a number of
individually encoded digital program streams originating from multiple sources.
Multiplexers. Our multiplexer module combines multiple MPEG-2 streams into
one transport stream as well as authorizing conditional access.
Modulators. Our modulators accept digital signals for modulation on to a
radio frequency carrier for transmission over a broadband network.
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CYBERSTREAM PRODUCTS
CyberStream System. This system enables Internet access and high-speed data
delivery primarily over satellite or wireless networks to residential and
business subscribers. It is capable of supporting transmission rates of up to 48
Megabits per second which enables applications such as video distribution and
distance learning. This system includes a headend data encoder, a network
management system and an end-user receiver card which is installed in either a
PC or our Enterprise1 product.
Enterprise1. The Enterprise1 is a network router, which interfaces the
CyberStream System with a local area network. It provides desktop broadband
access by linking high-speed cable, satellite or wireless networks directly to a
LAN.
ProCast. Our ProCast system is a software package that allows service
providers to distribute multimedia information to selected groups of end-users
at pre-authorized service levels.
CUSTOMERS
We sell our products to a variety of broadband communications network
operators. Set forth below is a representative list of our customers during
1998.
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Armstrong A provincial PTT in China
Charter Golden Channels
Comcast NTL
Cox Rogers
Jones Intercable Shaw
MediaOne Tele-2
RCN Telewest
TCI Videotron
Time-Warner
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Historically, the majority of our sales have been to relatively few
customers, and we expect this customer concentration to continue in the
foreseeable future. In 1998, sales to TCI accounted for 17% of net sales and
sales to a Chinese distributor accounted for 11% of net sales. In 1997, Capella
(our Canadian distributor) accounted for 17% of net sales. In 1996, sales to
Tratec (our former U.K. distributor), Capella, and ANTEC accounted for 15%, 15%,
and 13%, respectively, of net sales. No other customer accounted for more than
10% of our net sales in 1998, 1997 or 1996. The loss of a significant customer
or any reduction in orders by any significant customer, or our failure to
qualify our products with a significant cable operator could adversely affect
our business and operating results.
Sales to customers outside of the United States in 1998, 1997 and 1996
represented 43%, 59% and 57% of net sales, respectively. We expect international
sales to continue to account for a substantial portion of our net sales for the
foreseeable future. International sales are subject to a number of risks,
including changes in foreign government regulations and telecommunications
standards, import and export license requirements, tariffs, taxes and other
trade barriers, fluctuations in foreign currency exchange rates, difficulty in
collecting accounts receivable, difficulty in staffing and managing foreign
operations, managing distributor relations and political and economic
instability. In recent periods certain Asian and Latin American currencies have
devalued significantly in relation to the U.S. dollar. We continue to evaluate
the effect of recent developments in Asia and Latin America on our business, and
we cannot assure you that our sales will not be materially adversely affected by
such developments. We also cannot assure you that international markets will
continue to develop or that we will receive future orders to supply our products
in international markets at rates equal to or greater than those experienced in
recent periods. See "Risk Factors -- We depend on our international sales and
are subject to the risks associated with international operations."
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SALES AND MARKETING
We sell our products in the United States through our own direct sales
force which is organized geographically to support major network operators at
both the corporate level and in their individual systems. Our sales force is
supported by a highly qualified technical staff. Together, they work closely
with customers to design systems and develop technical proposals to optimize
system performance and economic benefits for the operators. The technical group
also assists customers with installation and post-sale support.
International sales are made primarily to distributors, which are generally
responsible for importing the products and providing installation and technical
support and service to customers in their territory. However, a small direct
sales force, based in Sunnyvale, California, and in Europe and Asia is
responsible for account management and providing high-level technical support
directly to customers as well as to distributors. Our technical group also
supports the international sales force.
Because of the cable industry's 24 hour programming requirements, we
provide round-the-clock technical support, both directly and through our
distributors. We provide training for our customers and distributors, as
required, both in our facilities and on-site.
Our marketing organization develops strategies for product lines and, in
conjunction with our sales force, identifies evolving technical and application
needs of customers so that our product development resources can be most
effectively and efficiently deployed to meet anticipated product requirements.
Our marketing organization is also responsible for setting price levels, demand
forecasting and general support of the sales force, particularly at major
accounts. We have many programs in place to heighten industry awareness of
Harmonic and our products, including participation in technical conferences,
publication of articles in industry journals and exhibiting at trade shows.
MANUFACTURING AND SUPPLIERS
Our manufacturing processes consist primarily of integration, final
assembly and test, performed by highly trained personnel employing
technologically advanced electronic equipment and proprietary test programs. The
manufacturing of our products and subassemblies is a complex process and we
cannot assure you that we will not experience production problems or
manufacturing delays in the future. Because we utilize our own manufacturing
facility for this production, and because such manufacturing capabilities are
not readily available from third parties, any interruption in operations could
materially and adversely affect our business and operating results.
We use third party contract manufacturers like Sanmina to assemble certain
standard parts for our products, including such items as printed circuit boards,
metal chassis and power supplies. We intend to subcontract an increasing number
of tasks to third parties in the future. Our increasing reliance on
subcontractors involves several risks, and we may not be able to obtain an
adequate supply of components, subassemblies and modules on a timely basis.
Some components, subassemblies and modules necessary for the manufacture
and integration of our products are obtained from a sole supplier or a limited
group of suppliers. In particular, we rely on Fujitsu as a major source of
lasers for our PWRLink and return path transmitters, for which there are limited
alternative suppliers. In addition, certain optical components used in our
METROLink and MAXLink products are currently available only from Uniphase
Corporation and JDS FITEL, which recently announced their intention to merge.
Although we have qualified alternative suppliers for lasers, in the event that
the supply of optical components is interrupted for any reason, products from
alternative suppliers are unlikely to be immediately available in sufficient
volume to meet our production needs. Further, sole suppliers are providing
certain key elements of our digital products. The reliance on sole or limited
suppliers, particularly foreign suppliers, involves several risks, including a
potential inability to obtain an adequate supply of required components or
subassemblies and reduced control over pricing, quality and timely delivery of
components. Although we attempt to minimize supply risks by holding safety
stocks and continuously evaluating other sources, any interruption in supply
could materially adversely affect our business and operating results. We do not
maintain long-term agreements with any of our suppliers. While we have been able
historically to obtain
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adequate supplies of components in a timely manner from our principal suppliers,
we cannot assure you that we will be able to obtain adequate supplies in the
future. Because the purchase of certain key components involves long lead times,
in the event of unanticipated increases in demand for our products, we could be
unable to manufacture certain products in a quantity sufficient to meet our
customers' demand. If we cannot obtain adequate deliveries of key components we
may not be able to ship products on a timely basis. Delays in shipment could
damage relationships with current and prospective customers and could harm our
business and operating results.
INTELLECTUAL PROPERTY
We currently hold 12 issued United States patents and 9 issued foreign
patents, and have a number of patent applications pending. Although we attempt
to protect our intellectual property rights through patents, trademarks,
copyrights, maintaining certain technology as trade secrets and other measures,
we cannot assure you that any patent, trademark, copyright or other intellectual
property right owned by us will not be invalidated, circumvented or challenged,
that such intellectual property right will provide competitive advantages to us
or that any of our pending or future patent applications will be issued with the
scope of the claims sought by us, if at all. We cannot assure you that others
will not develop technologies that are similar or superior to our technology,
duplicate our technology or design around the patents that we own. In addition,
effective patent, copyright and trade secret protection may be unavailable or
limited in certain foreign countries in which we do business or intend to do
business in the future.
We believe that the future success of our business will depend on our
ability to translate the technological expertise and innovation of our personnel
into new and enhanced products. We generally enter into confidentiality or
license agreements with our employees, consultants, vendors and customers as
needed, and generally limit access to and distribution of our proprietary
information. Nevertheless, we cannot assure you that the steps taken by us will
prevent misappropriation of our technology. In addition, we have taken in the
past, and may take in the future, legal action to enforce our patents and other
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could harm our business and
operating results.
In order to successfully develop and market our planned products for
digital headend applications, we may be required to enter into technology
development or licensing agreements with third parties. Although many companies
are often willing to enter into such technology development or licensing
agreements, we cannot assure you that such agreements will be negotiated on
terms acceptable to us, or at all. The failure to enter into technology
development or licensing agreements, when necessary, could limit our ability to
develop and market new products and could cause our business to suffer.
As is common in our industry, we have from time to time received
notification from other companies of intellectual property rights held by those
companies upon which our products may infringe. Any claim or litigation, with or
without merit, could be costly, time consuming and could result in a diversion
of management's attention, which could harm our business. If we were found to be
infringing on the intellectual property rights of any third party, we could be
subject to liabilities for such infringement, which could be material, and could
be required to seek licenses from other companies or to refrain from using,
manufacturing or selling certain products or using certain processes. Although
holders of patents and other intellectual property rights often offer licenses
to their patent or other intellectual property rights, no assurance can be given
that licenses would be offered, that the terms of any offered license would be
acceptable to us or that failure to obtain a license would not cause our
operating results to suffer.
BACKLOG
We schedule production of our systems based upon our backlog, informal
commitments from customers and sales projections. Our backlog consists of firm
purchase orders by customers for delivery within the next twelve months. At
December 31, 1998, order backlog amounted to $20.8 million, compared to $5.5
million at December 31, 1997. Anticipated orders from customers may fail to
materialize and delivery schedules may be
9
<PAGE> 11
deferred or canceled for a number of reasons, including reductions in capital
spending by cable television operators or changes in specific customer
requirements. In addition, due to weather-related seasonal factors and annual
capital spending budget cycles at many major end-users, our backlog at December
31, 1998 or any other date, is not necessarily indicative of actual sales for
any succeeding period.
COMPETITION
The markets for cable television equipment and other broadband
communications equipment are extremely competitive and characterized by rapid
technological change. The principal competitive factors in these markets include
product performance, reliability, price, breadth of product line, network
management capabilities, sales and distribution capability, technical support
and service and relationships with network operators. Certain of these factors
are outside of our control.
Our competitors for fiber optic transmission products include established
suppliers of cable television and telecommunications equipment such as ADC
Telecommunications, ANTEC, General Instrument, Philips and Scientific-Atlanta,
as well as a number of smaller, more specialized companies. For digital headend
products, our competitors include many of the same competitors as in fiber optic
transmission products, and a number of new competitors, including Divicom, a
division of C-Cube and Lucent Technologies. Competitors for CyberStream products
in the satellite and wireless market include Broadlogic, Echostar, Hybrid
Networks, SAGEM and Philips. Most of our competitors are substantially larger
and have greater financial, technical, marketing and other resources than we do.
Many of our larger competitors are in a better position to withstand any
significant reduction in capital spending by cable television operators and
other broadband service providers. In addition, many of our competitors have
more long-standing and established relationships with domestic and foreign cable
operators than we do.
RESEARCH AND DEVELOPMENT
We have historically devoted a significant amount of our resources to
research and development. Research and development expenses in 1998, 1997 and
1996 were $13.5 million, $11.7 million, and $9.2 million, respectively. We
expect that research and development expenses will continue to increase in the
future.
Our success in designing, developing, manufacturing and selling new or
enhanced products will depend on a variety of factors, including the
identification of market demand for new products, product selection, timely
implementation of product design and development, product performance, effective
manufacturing and assembly processes and sales and marketing. Because of the
complexity inherent in such research and development efforts, we cannot assure
you that we will successfully develop new products, or that new products
developed by us will achieve market acceptance. Our failure to successfully
develop and introduce new products could harm our business and operating
results.
EMPLOYEES
As of December 31, 1998, we employed a total of 293 people, including 101
in manufacturing operations, 82 in research and development, 77 in sales and
marketing and 33 in a general and administrative capacity. We also employ a
number of temporary employees and consultants on a contract basis. None of our
employees is represented by a labor union with respect to his or her employment
by Harmonic. We have not experienced any work stoppages and we consider our
relations with our employees to be good. Our future success will depend, in
part, upon our ability to attract and retain qualified personnel. Competition
for qualified personnel in the communications industry and in our immediate
geographic area is intense, and we cannot assure you that we will be successful
in retaining our key employees or that we will be able to attract skilled
personnel as we grow.
10
<PAGE> 12
EXECUTIVE OFFICERS
The following table sets forth certain information regarding the executive
officers of Harmonic and their ages as of March 1, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Anthony J. Ley............................ 60 Chairman of the Board of Directors,
President and Chief Executive Officer
Moshe Nazarathy........................... 47 Senior Vice President, General Manager
Israel R&D Center, Director
Robin N. Dickson.......................... 51 Chief Financial Officer
Michael Yost.............................. 55 Vice President, Operations
D. Colin Boyd............................. 47 Vice President, Sales (North America) and
Marketing
Israel Levi............................... 59 Vice President, Research and Development
</TABLE>
Anthony J. Ley has served as Harmonic's President and Chief Executive
Officer since November 1988. Mr. Ley was elected Chairman of the Board of
Directors in February 1995. From 1963 to 1987, Mr. Ley was employed at
Schlumberger, both in Europe and the United States, holding various senior
business management and research and development positions, most recently as
Vice President, Research and Engineering at Fairchild Semiconductor/Schlumberger
in Palo Alto, California. Mr. Ley holds an M.A. in mechanical sciences from the
University of Cambridge and an S.M.E.E. from the Massachusetts Institute of
Technology, is named as an inventor on 29 patents and is a Fellow of the I.E.E.
(U.K.) and a senior member of the I.E.E.E.
Moshe Nazarathy, a founder of Harmonic, has served as Senior Vice
President, General Manager of Israel R&D Center, since December 1993, as a
director of Harmonic since Harmonic's inception and as Vice President, Research,
from Harmonic's inception through December 1993. From 1985 to 1988, Dr.
Nazarathy was employed in the Photonics and Instruments Laboratory of
Hewlett-Packard Company, most recently serving as Principal Scientist from 1987
to 1988. From 1982 to 1984, Dr. Nazarathy held post-doctoral and adjunct
professor positions at Standard University. Dr. Nazarathy holds a B.S. and a
Ph.D. in electrical engineering from Technion-Israel Institute of Technology and
is named as an inventor on twelve patents.
Robin N. Dickson joined Harmonic in April 1992 as Chief Financial Officer.
From 1989 to March 1992, Mr. Dickson was corporate controller of Vitelic
Corporation, a semiconductor manufacturer. From 1976 to 1989, Mr. Dickson held
various positions at Raychem Corporation, a materials science company, including
regional financial officer of the Asia-Pacific Division of the International
Group. Mr. Dickson holds a Bachelor of Laws from the University of Edinburgh and
is a member of the Institute of Chartered Accountants of Scotland.
Michael Yost joined Harmonic in September 1991 as Vice President,
Operations. From 1983 until December 1990, Mr. Yost was employed at Vitalink
Communications, a satellite communications systems manufacturer, holding various
senior management positions, most recently as Vice President, Operations. Mr.
Yost holds a B.S. in management from San Jose State University.
D. Colin Boyd joined Harmonic in June 1998 as Vice President, Sales (North
America) and Marketing. From January 1997 to May 1998, Mr. Boyd was Vice
President of International Sales Operations, Satellite Networks Division at
General Instrument, a communications equipment manufacturer. Previously, Mr.
Boyd was employed at Scientific-Atlanta, a communications equipment
manufacturer, where he held the position of Director, Business Television and
Specialty Markets from December 1994 to December 1996 and the position of
Director, Domestic Product Line from November 1989 until December 1994. Mr. Boyd
holds an M.Sc. in Electrical Engineering from the University of British Columbia
and a B.Sc. in Electronics Engineering from Queen's University, Belfast,
Northern Ireland.
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<PAGE> 13
Israel Levi joined Harmonic in July 1989 and has served as Vice President,
Research and Development since May 1996. Between July 1989 and May 1996, Mr.
Levi held various product management and product development positions at
Harmonic. From 1988 to 1989, Mr. Levi served in product development at DSC, a
telecommunications systems company, and from 1984 to 1988, Mr. Levi served as
Director of CATV Products Division at Catel Communications, a telecommunications
equipment manufacturer. Mr. Levi holds an M.S. in Electrical Engineering from
Carleton University, Ottawa, Canada and a B.S. in Electrical Engineering from
Technion-Israel Institute of Technology.
ITEM 2. PROPERTIES
Our principal operations are located at our corporate headquarters in
Sunnyvale, California. The lease on our headquarters building, of approximately
110,000 square feet, expires in July 2006. We have subleased approximately
25,000 square feet of our headquarters through December 1999. We also have
several sales offices in the United States, sales and support centers in Europe
and Asia and two subsidiaries, New Media Communication Ltd., and a research and
development facility in Israel. We believe that our existing facilities will be
adequate to meet our needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which we are is a party
or to which any of our properties is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
(a) The Company's Common Stock has been quoted on the Nasdaq National
Market under the symbol HLIT since the Company's initial public offering on May
22, 1995. Prior to such time, there was no public market for the Common Stock of
the Company. The following table sets forth, for the periods indicated, the high
and low sales prices per share of the Common Stock (adjusted to reflect a
two-for-one stock split on October 14, 1999) as reported on the Nasdaq National
Market:
<TABLE>
<CAPTION>
HIGH LOW
------ -----
<S> <C> <C>
1997
First quarter............................................... $12.63 $6.38
Second quarter.............................................. $10.50 $5.63
Third quarter............................................... $10.63 $7.44
Fourth quarter.............................................. $ 8.25 $5.13
1998
First quarter............................................... $ 8.13 $5.31
Second quarter.............................................. $ 9.50 $6.06
Third quarter............................................... $ 9.00 $3.81
Fourth quarter.............................................. $ 9.44 $4.38
</TABLE>
(b) Holders of record: At March 1, 1999, there were approximately 111
stockholders of record of the Company's Common Stock.
(c) Dividends: The Company has never declared or paid any dividends on its
capital stock. The Company currently expects to retain future earnings, if any,
for the use in the operation and expansion of its business and does not
anticipate paying any cash dividends in the foreseeable future. The covenants
made by the Company under its existing line of credit prohibit the payment of
dividends.
12
<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales...................................... $ 83,857 $74,442 $60,894 $39,180 $ 18,224
Gross profit................................... 30,555 34,605 27,731 17,851 6,467
Income (loss) from operations(1)............... (21,943) 4,506 5,204 3,761 (2,189)
Net income (loss)(1)........................... (21,453) 4,929 5,918 4,121 (2,368)
Basic net income (loss) per share(2)(3)........ (0.92) 0.24 0.29 0.36 --
Diluted net income (loss) per share(2)(3)...... (0.92) 0.21 0.26 0.20 --
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents...................... $ 9,178 $13,670 $16,410 $22,126 $ 1,743
Working capital................................ 32,318 38,772 34,321 32,495 6,893
Total assets................................... 62,424 58,887 54,633 41,817 14,578
Long term debt, including current portion...... 577 -- -- -- 1,480
Mandatorily Redeemable Convertible Preferred
Stock........................................ -- -- -- -- 29,215
Stockholders' equity (deficit)................. 43,474 49,931 43,641 37,009 (20,717)
</TABLE>
- ---------------
(1) The 1998 loss from operations and net loss include a one-time charge of
$14.0 million for acquired in-process technology. See Note 2 of Notes to
Consolidated Financial Statements.
(2) Net loss per share data for periods prior to the commencement of public
trading of the company's Common Stock on May 22, 1995 have not been
presented as such presentation is not meaningful.
(3) See Note 5 to Consolidated Financial Statements for a discussion of the
shares used to compute net income (loss) per share. All per share amounts
have been retroactively adjusted to reflect the two-for-one stock split made
effective on October 14, 1999.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Harmonic designs, manufactures and markets digital fiber optic systems for
delivering video, voice and data services over cable, satellite and wireless
networks. Almost all of our sales have been derived directly or indirectly from
sales of fiber optic transmission systems to cable television operators. With
the introduction of our TRANsend digital headend products in 1997 and the
subsequent purchase of New Media Communication Ltd., we have broadened our
product offering to enable delivery of digital video, voice and data over
satellite and wireless networks in addition to cable systems.
To date, a substantial majority of Harmonic's net sales have been to
relatively few customers, and Harmonic expects this customer concentration to
continue in the foreseeable future. In 1998, sales to TCI accounted for 17% of
Harmonic's net sales and sales to a Chinese distributor accounted for 11% of
Harmonic's net sales. In 1997, sales to Capella, Harmonic's Canadian
distributor, accounted for 17% of Harmonic's net sales. In 1996, sales to
Tratec, Harmonic's former U.K. distributor, Capella and ANTEC accounted for 15%,
15% and 13%, respectively, of Harmonic's net sales.
Sales to customers outside of the United States in 1998, 1997 and 1996
represented 43%, 59% and 57% of net sales, respectively. International sales are
made primarily to distributors, which are generally responsible for importing
the products and providing installation and technical support and service to
customers within their territory. We expect international sales to continue to
account for a substantial portion of our net sales for the foreseeable future.
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<PAGE> 15
Harmonic's net sales in the second half of 1997 and the first quarter of
1998 were negatively affected by a slow-down in spending by cable television
operators in the U.S. and in foreign markets. The factors contributing to this
slow-down in capital spending included:
- consolidation and system exchanges by our domestic cable customers, which
generally have had the initial effect of delaying certain system
upgrades;
- uncertainty related to development of digital video and cable modem
industry standards;
- delays associated with the evaluation of new services and system
architectures by many cable television operators;
- emphasis on marketing and customer service strategies by some
international cable television operators instead of construction of
networks; and
- general economic conditions in international markets.
While Harmonic's net sales increased in the last three quarters of 1998
from the level achieved in the first quarter of 1998 due to increased spending
in the U.S. cable television industry, spending by international cable
television operators generally remained weak. Harmonic cannot predict when
international cable television spending will increase and whether U.S. cable
television spending will continue to grow. In addition, cable television capital
spending can be subject to the effects of seasonality, with fewer construction
and upgrade projects typically occurring in winter months and otherwise being
affected by inclement weather.
In 1998, 1997 and 1996, sales of optical transmitters accounted for
approximately 54%, 63%, and 71%, respectively, of net sales and sales of optical
node receivers, return path and network management products accounted for
approximately 35%, 37%, and 29%, respectively, of net sales. In 1998, TRANsend
and CyberStream digital products accounted for 11% of net sales. There were no
significant sales of digital products in 1997 or 1996.
Harmonic generally recognizes revenue upon shipment of product. Harmonic
does not provide for rights of return to end users or distributors. A provision
for the estimated cost of warranty is recorded at the time revenue is
recognized. To date, gross margins on sales of optical transmitter products have
been higher than sales of receiver and return path products. In addition, sales
made to customers outside of the United States have generally carried higher
gross margins. In 1999, we expect our gross margins to be below 1997 levels
principally due to anticipated softness in certain international markets,
continued pricing pressure, our expected mix of products sold and manufacturing
start-up costs associated with recent product introductions.
Harmonic often recognizes a substantial portion of its revenues in the last
month of the quarter. Harmonic establishes its expenditure levels for product
development and other operating expenses based on projected sales levels, and
expenses are relatively fixed in the short term. Accordingly, variations in
timing of sales can cause significant fluctuations in operating results. In
addition, because a significant portion of Harmonic's business is derived from
orders placed by a limited number of large customers, the timing of such orders
can also cause significant fluctuations in our operating results. Harmonic's
expenses for any given quarter are typically based on expected levels of future
sales and if sales are below expectations in any given quarter, the adverse
impact of the shortfall on operating results may be magnified by Harmonic's
inability to adjust spending to compensate for the shortfall. As a result of
these and other factors, Harmonic's operating results in one or more future
periods may fail to meet or exceed the expectations of securities analysts or
investors. In that event, the trading price of our common stock would likely
decline. See "Risk Factors -- Our operating results are likely to fluctuate
significantly and may fail to meet or exceed the expectations of securities
analysts or investors, causing our stock price to decline."
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<PAGE> 16
RESULTS OF OPERATIONS
Harmonic's historical consolidated statements of operations data for each
of the three years ended December 31, 1996, 1997 and 1998 as a percentage of net
sales, are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
--------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net sales................................................... 100% 100% 100%
Cost of sales............................................... 64 54 54
--- --- ---
Gross profit................................................ 36 46 46
Operating expenses
Research and development.................................. 16 16 15
Sales and marketing....................................... 21 18 16
General and administrative................................ 8 6 6
Acquired in-process technology............................ 17 -- --
--- --- ---
Total operating expenses.......................... 62 40 37
--- --- ---
Income (loss) from operations............................... (26) 6 9
Interest and other income, net.............................. -- 1 1
--- --- ---
Income (loss) before income taxes........................... (26) 7 10
Provision for income taxes.................................. -- -- --
--- --- ---
Net income (loss)........................................... (26)% 7% 10%
=== === ===
</TABLE>
Net Sales
Harmonic's net sales increased by 13% to $83.9 million in 1998 as compared
to $74.4 million in 1997. This growth in net sales was primarily attributable to
the sale of new products, including TRANsend digital headend products, METROLink
DWDM systems and PWRBlazer Scaleable Nodes, which began volume shipment during
the middle of 1998, as well as to an increase in spending by our domestic
customers in the second half of 1998. During 1998 domestic sales increased by
55%, principally due to increased shipments to TCI, while international sales
decreased by 17% due to continued weakness in many international markets. While
the increase in net sales was also due to nominally higher unit sales of
existing products, generally lower selling prices in the industry resulted in an
approximate ten percent decrease in existing product sales. Net sales increased
by 22% to $74.4 million in 1997 from $60.9 million in 1996. This growth in net
sales in 1997 was primarily attributable to higher unit sales of Harmonic's
receiver and return path products and sales of the 1550nm MAXLink transmission
system, which began shipment during the second quarter of 1996. These factors
were partially offset by lower unit sales of YAGLink transmitters due in part to
the increasing acceptance of 1550nm transmitters among cable operators for
broadcast transmission.
Gross Profit
Gross profit decreased to $30.6 million (36% of net sales) in 1998 from
$34.6 million (46% of net sales) in 1997. The decreases in gross profit and
gross margins were principally due to a lower percentage of international sales
resulting from reduced demand, a less favorable product mix which included a
lower percentage of transmitters, and pricing pressure for certain products due
to increased competition. In addition, gross profit and gross margins were
negatively impacted by start-up costs associated with new product introductions
and an increase of $1.2 million in inventory reserves for existing products
following the introduction of new products. Harmonic expects gross margins to
continue to be below 1997 levels in 1999 due to anticipated softness in certain
international markets, expected changes in product mix, pricing pressure for
certain products and manufacturing start-up costs associated with recent product
introductions. Gross profit increased to $34.6 million (46% of net sales) in
1997 from $27.7 million (46% of net sales) in 1996. The increase in gross profit
was principally due to higher unit sales volume and lower manufacturing costs,
particularly for Harmonic's MAXLink products, which commenced shipment during
the second quarter of
15
<PAGE> 17
1996, and improved margins on return path products resulting from product design
changes. These factors were partially offset by a less favorable product mix
which included lower sales of transmitters as a percentage of net sales, and
lower selling prices for certain products.
Research and Development
Research and development expenses increased to $13.5 million (16% of net
sales) in 1998 from $11.7 million (16% of net sales) in 1997. The increase in
research and development expenses in 1998 was primarily due to increased
headcount, particularly at Harmonic's subsidiary in Caesarea, Israel which is
continuing to develop Harmonic's TRANsend digital headend products, and to the
inclusion of NMC's research and development expenses starting in January 1998.
Research and development expenses increased to $11.7 million (16% of net sales)
in 1997 from $9.2 million (15% of net sales) in 1996. The increase in research
and development expenses in 1997 both in absolute dollars and as a percentage of
net sales was principally attributable to increased headcount and higher
prototype material costs in connection with the node and digital development
programs. Research and development expenses for 1998, 1997 and 1996 are net of
grants of approximately $346,000, $120,000 and $140,000, respectively. Harmonic
anticipates that research and development expenses will continue to increase in
absolute dollars, although they may vary as a percentage of net sales.
Sales and Marketing
Sales and marketing expenses increased to $18.2 million (21% of net sales)
in 1998 from $13.6 million (18% of net sales) in 1997. The increase in sales and
marketing expenses in 1998 both in absolute dollars and as a percentage of net
sales was primarily due to higher headcount and costs associated with expansion
and reorganization of the direct sales force, technical support and marketing
organizations, particularly to support the introduction of our new products.
This increase was due to expenses incurred in connection with the recruiting and
staffing for new international sales and technical support centers. In addition,
higher promotional expenses and the inclusion of NMC's sales and marketing
expenses starting in January 1998 contributed to the increase. Sales and
marketing expenses increased to $13.6 million (18% of net sales) in 1997 from
$9.8 million (16% of net sales) in 1996. The increase in sales and marketing
expenses in 1997 was primarily due to higher headcount associated with expansion
of the direct sales force, customer service and technical support organizations,
expenses associated with establishing international sales offices, and higher
promotional expenses. Harmonic expects that sales and marketing expenses will
continue to increase in absolute dollars, although they may vary as a percentage
of net sales.
General and Administrative
General and administrative expenses increased to $6.8 million (8% of net
sales) in 1998 from $4.8 million (6% of net sales) in 1997. The increase in
general and administrative expenses in 1998 was primarily due to the inclusion
of NMC's expenses starting in January 1998, as well as costs of supporting
Harmonic's growth in overall headcount, and the establishment of international
sales and support offices. General and administrative expenses increased to $4.8
million (6% of net sales) in 1997 from $3.5 million (6% of net sales) in 1996.
The increase in absolute expenses in 1997 was principally attributable to costs
of supporting Harmonic's growth in overall headcount and operations and
providing for a higher accounts receivable reserve. Harmonic expects to incur
higher levels of general and administrative expenses in the future, although
such expenses may vary as a percentage of net sales.
Acquired In-Process Technology
On January 5, 1998, Harmonic acquired NMC, a privately-held Israeli
development stage company with 15 employees, for $17.6 million in a
stock-for-stock transaction. Harmonic also assumed all outstanding stock options
of NMC. The transaction was accounted for as a purchase and, accordingly, the
fair value of the assets and liabilities were recorded based upon their fair
value at the time of the transaction. Harmonic determined that technological
feasibility of the acquired in-process technology had not yet been established.
Harmonic also believed that NMC's existing technology would generate no further
revenue on account of its
16
<PAGE> 18
obsolescence. Accordingly, no value was assigned to the existing technology. In
accordance with generally accepted accounting principles, Harmonic wrote off
acquired in-process research and development expenses of $14.0 million as a
one-time charge to operations in the first quarter of 1998.
Historically, NMC had developed receiver cards for data transmission over
cable, wireless and satellite networks. These analog products operated at
transmission speeds of 5.5Mbps and had been sold only to a limited number of
customers. NMC concluded during 1997 that these analog products were rapidly
becoming obsolete and discontinued research and development efforts. Based on
customer feedback and expected market trends, NMC commenced technology
development of the CyberStream System, a digital system designed to provide
substantially increased transmission speeds of 48Mbps to 52Mbps and to
incorporate differentiated service capabilities and sophisticated network
management.
At the time of the NMC acquisition, the CyberStream System was NMC's only
research and development project in process. The CyberStream System was
comprised of a data gateway at the satellite uplink or cable headend, network
management and control features at the headend, and a receiver card for
installation in a personal computer or a local area network router device. Just
prior to the acquisition, NMC had initiated production of a limited number of
prototype receiver cards in order to participate in pilot trials with two
prospective customers. Shipment of the prototype cards commenced at the end of
1997.
Harmonic determined that since these products were intended for deployment
in networks with large numbers of subscribers, NMC would have to engage in
ongoing trials over an extended period to determine the products' technological
feasibility. As part of these trials, NMC also shipped initial versions of
operating software, but was several months away from completion of critical
elements of the CyberStream System, such as quality of service, simple network
management protocol and porting of the software to the Windows 98 and NT
platforms. Subsequent to the acquisition, Harmonic expended $1.9 million in 1998
in research and development costs to accelerate development and to incorporate
changes resulting from field trial evaluations.
To estimate the value of NMC's existing and in-process technology, the
total income forecasted was allocated to existing, in-process and future
technology based on the products' scheduled release dates and expected lives. No
value was ascribed to existing technology due to its obsolescence nor to future
technology that was not in development at the date of acquisition. The forecasts
assumed timely release of the products as anticipated by Harmonic and that NMC
would utilize Harmonic distribution channels. Estimated revenues for the
purchased in-process products were assumed to commence by the middle of fiscal
year 1998 and increase through fiscal year 2002, at which time they were assumed
to decrease through fiscal year 2007, as newer products would be released.
Rapid change and improvements in technology characterize the high-speed
data delivery market. Harmonic's future success will depend on its ability to
achieve scientific and technological advances and to translate such advances
into commercially competitive products on a timely basis that keep pace with
competing technological developments and address the increasingly sophisticated
needs of our customers.
Interest and Other Income, Net
Interest and other income, net, consisting principally of interest income,
was $0.5 million in 1998, $0.7 million in 1997 and $1.0 million in 1996. The
decreases in 1998 and 1997 were due primarily to lower interest income on lower
average cash and cash equivalents balances.
Income Taxes
No provision for income taxes was recorded for 1998 due to the net loss
incurred. The provision for income taxes for 1997 and 1996 was based on an
estimated annual tax rate of 5% resulting from federal and state alternative
minimum taxes and utilization of net operating loss carryforwards. Harmonic had
available federal net operating loss carryforwards of approximately $2.0 million
at December 31, 1998. Under current tax law, Harmonic's utilization of its net
operating loss carryforwards and tax credits may be limited in certain
circumstances resulting from a change in ownership. In 1999, Harmonic expects to
have an effective annual tax rate substantially lower than statutory rates,
approximating 20% to 25%, due to the utilization of net
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operating loss carryforwards and tax credit carryforwards. Beyond 1999, Harmonic
expects to have an effective annual tax rate that approximates statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
Harmonic completed its initial public offering in May 1995, raising
approximately $24.2 million, net of offering costs. Prior to that, Harmonic
satisfied its liquidity needs primarily from the net proceeds of private sales
of preferred stock, and to a lesser extent, from capital equipment leases and
bank borrowings.
Cash used in operations was $2.0 million in 1998 compared to cash provided
by operations of $2.0 million in 1997 and $0.3 million in 1996. The increase in
cash used in operations in 1998 compared to 1997 was primarily due to the net
loss and higher inventory levels, partially offset by improved customer
collections and higher accounts payable and accrued liabilities. The increase in
cash provided by operations in 1997 compared to 1996 was principally
attributable to slower growth in receivables, inventory and prepaid expenses and
other assets, partially offset by lower net income, accounts payable and accrued
liabilities.
Net working capital was $32.3 million at December 31, 1998, including $9.2
million of cash and cash equivalents. During 1998, Harmonic had a bank line of
credit and equipment term loan facilities which provided up to $12.0 million and
$3.0 million in borrowings, respectively. There were no outstanding borrowings
under the bank line at December 31, 1998, although Harmonic had guaranteed
certain borrowing facilities of its subsidiaries totaling $0.9 million with
letters of credit and had total letters of credit issued under the line of $2.7
million, which expire at various dates throughout fiscal year 1999. As of
December 31, 1998, borrowings of $577,000 were outstanding under the term loan.
These facilities were available until December 1998. During the fourth quarter
of 1998, Harmonic agreed to the principal terms of an amended and restated bank
line of credit facility, which was finalized in March 1999. The new facility
provides for borrowings of up to $10.0 million with a $3.0 million equipment
term loan sub-limit. This new line, which expires in March 2000, bears interest
at the bank's prime rate plus 0.5% (prime rate plus 1.0% under the term loan
sub-limit). The line is secured by substantially all of the assets of Harmonic.
Additions to property, plant and equipment were approximately $4.4 million
during 1998 compared to $4.8 million in 1997 and $6.7 million in 1996
respectively. While Harmonic currently has no material commitments, it expects
to spend approximately $5.0 million on capital expenditures in 1999, primarily
for manufacturing and test equipment.
Harmonic believes that its existing liquidity sources, including its new
bank line of credit facility, and anticipated funds from operations will satisfy
its cash requirements for at least the next twelve months.
YEAR 2000 READINESS DISCLOSURE
Many currently installed computer systems and software 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 twenty-first century dates
from twentieth century dates. As a result, many companies' software and computer
systems may need to be upgraded or replaced in order to comply with such "Year
2000" or "Y2K" requirements.
Harmonic has established a corporate-wide program to address the Y2K issue.
This program encompasses product, internal systems and supplier and business
partner compliance. The project is comprised of identification of risks,
assessment of risks, development of remediation or contingency plans and
implementation and testing.
Based upon the assessments to date, all hardware products currently under
development or released, and all software products currently under development
are Y2K compliant. Certain software products currently installed at customer
sites are not Y2K compliant and Harmonic is working with its customers to
provide migration paths for each product. Harmonic's significant internal
systems have been purchased from outside vendors and are Y2K compliant. Harmonic
is in the process of upgrading internal systems that are not currently Y2K
compliant, and expects to have this process completed by mid-1999. To date, Y2K
costs have not been material to Harmonic and Harmonic does not expect that its
Y2K costs will exceed $100,000 in the future. Harmonic currently does not have a
contingency plan to address Y2K issues related to its products and
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internal systems, but will develop a contingency plan by mid-1999 if its
products and internal systems are not yet Y2K compliant. In addition, Harmonic
is working with its suppliers and business partners to identify at what stage
they are in the process of identifying and addressing the Y2K issue and to
assess the resulting risks and develop appropriate contingency plans. Harmonic
will continue to perform compliance reviews and tests to ensure compliance on an
ongoing basis. Harmonic currently does not anticipate that the cost of its Y2K
program will be material to its financial condition and results of operations.
Although Harmonic has established and commenced its program to address Y2K
issues, the failure of Harmonic products to operate properly with regard to the
Y2K requirements could (a) cause Harmonic to incur unanticipated expenses to
remedy any problems, (b) cause a reduction in sales and (c) expose Harmonic to
related litigation by its customers, each of which could harm our business,
operating results and financial condition. In addition, Harmonic and third
parties with whom it conducts business may utilize equipment or software that
may not be Y2K compliant. Failure of Harmonic's or any such third party's
equipment or software to operate properly with regard to the Y2K requirements
could cause, among other things, Harmonic or any such third party to incur
unanticipated expenses or efforts to remedy any problems, which could have a
material adverse effect on its or their respective business, operating results
and financial condition. Furthermore, the purchasing patterns of customers or
potential customers may be affected by Y2K issues as companies expend
significant resources to evaluate and to correct their equipment or software for
Y2K compliance and as they simultaneously evaluate the preparedness of the third
parties with whom they deal. These expenditures may result in reduced funds
available to purchase products and services such as those offered by Harmonic,
which could have a material adverse effect on Harmonic business, operating
results and financial condition.
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FACTORS THAT MAY EFFECT FUTURE RESULTS OF OPERATIONS
Our Operating Results Are Likely To Fluctuate Significantly And May Fail To
Meet Or Exceed The Expectations Of Securities Analysts Or Investors, Causing Our
Stock Price To Decline.
Our operating results have fluctuated in the past and are likely to
continue to fluctuate in the future, on an annual and a quarterly basis, as a
result of several factors, many of which are outside of our control. Some of the
factors that may cause these fluctuations include:
- the level of capital spending of our customers, both in the U.S. and in
foreign markets;
- changes in market demand;
- the timing and amount of customer orders;
- competitive market conditions;
- our unpredictable sales cycles;
- new product introductions by our competitors or by us;
- changes in domestic and international regulatory environments;
- market acceptance of new or existing products;
- the cost and availability of components, subassemblies and modules;
- the mix of our customer base and sales channels;
- the mix of our products sold;
- our development of custom products;
- the level of international sales; and
- economic conditions specific to the cable television industry and general
economic conditions.
In addition, we often recognize a substantial portion of our revenues in
the last month of the quarter. We establish our expenditure levels for product
development and other operating expenses based on projected sales levels, and
expenses are relatively fixed in the short term. Accordingly, variations in
timing of sales can cause significant fluctuations in operating results. In
addition, because a significant portion of our business is derived from orders
placed by a limited number of large customers, the timing of such orders can
also cause significant fluctuations in our operating results. Our expenses for
any given quarter are typically based on expected sales and if sales are below
expectations in any given quarter, the adverse impact of the shortfall on our
operating results may be magnified by our inability to adjust spending to
compensate for the shortfall. As a result of all these factors, our operating
results in one or more future periods may fail to meet or exceed the
expectations of securities analysts or investors. In that event, the trading
price of our common stock would likely decline.
We Depend on Cable Industry Capital Spending for Substantially All of Our
Revenue.
Almost all of our sales have been derived, directly or indirectly, from
sales to cable television operators and we expect these sales to constitute a
substantial majority for the foreseeable future. Demand for our products depends
to a significant extent upon the magnitude and timing of capital spending by
cable television operators for constructing, rebuilding or upgrading their
systems. The capital spending patterns of cable television operators are
dependent on a variety of factors, including:
- access to financing;
- cable television operators' annual budget cycles;
- the status of federal, local and foreign government regulation of
telecommunications and television broadcasting;
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- overall demand for cable television services and the acceptance of new
broadband services;
- competitive pressures (including the availability of alternative video
delivery technologies such as satellite broadcasting); and
- discretionary customer spending patterns and general economic conditions.
Our net sales in the second half of 1997 and the first quarter of 1998 were
negatively affected by a slow-down in spending by cable television operators in
the U.S. and in foreign markets. The factors contributing to this slow-down in
capital spending included:
- consolidation and system exchanges by our domestic cable customers, which
generally have had the initial effect of delaying certain system
upgrades;
- uncertainty related to development of digital video and cable modem
industry standards;
- delays associated with the evaluation of new services and system
architectures by many cable television operators;
- emphasis on marketing and customer service strategies by some
international cable television operators instead of construction of
networks; and
- general economic conditions in international markets.
While our net sales increased in the last three quarters of 1998 from the
level achieved in the first quarter of 1998 due to increased spending in the
U.S. cable television industry, spending by international cable television
operators generally remained weak. We cannot predict when international cable
television spending will increase and whether U.S. cable television spending
will continue to grow. In addition, cable television capital spending can be
subject to the effects of seasonality, with fewer construction and upgrade
projects typically occurring in winter months and otherwise being affected by
inclement weather.
Our Customer Base is Concentrated and the Loss of One or More of Our Key
Customers Would Harm Our Business.
Historically, a significant majority of our sales have been to relatively
few customers. Sales to our ten largest customers in 1996, 1997 and 1998
accounted for approximately 72%, 56% and 66%, respectively, of net sales. Due in
part to the consolidation of ownership of domestic cable television systems, we
expect that sales to relatively few customers will continue to account for a
significant percentage of our net sales for the foreseeable future. For example,
in 1998, sales to Tele-Communications, Inc., or TCI, which was recently acquired
by AT&T, represented approximately 17% of our net sales and sales to a Chinese
distributor represented approximately 11%. Almost all of our sales are made on a
purchase order basis, and none of our customers has entered into a long-term
agreement requiring it to purchase our products. The loss of, or any reduction
in orders from, a significant customer would harm our business.
We Depend On Our International Sales and are Subject to the Risks Associated
With International Operations.
Sales to customers outside of the United States in 1996, 1997 and 1998
represented 57%, 59% and 43% of net sales, respectively, and we expect that
international sales will continue to represent a substantial portion of our net
sales for the foreseeable future. Our international operations are subject to a
number of risks, including:
- changes in foreign government regulations and telecommunications
standards;
- import and export license requirements, tariffs, taxes and other trade
barriers;
- fluctuations in currency exchange rates;
- difficulty in collecting accounts receivable;
- the burden of complying with a wide variety of foreign laws, treaties and
technical standards;
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- difficulty in staffing and managing foreign operations; and
- political and economic instability.
While our international sales are typically denominated in U.S. dollars,
fluctuations in currency exchange rates could cause our products to become
relatively more expensive to customers in a particular country, leading to a
reduction in sales or profitability in that country. We do not currently engage
in any foreign currency hedging transactions. Gains and losses on the conversion
to U.S. dollars of accounts receivable, accounts payable and other monetary
assets and liabilities arising from international operations may contribute to
fluctuations in operating results. Furthermore, payment cycles for international
customers are typically longer than those for customers in the United States.
Unpredictable sales cycles could cause us to fail to meet or exceed the
expectations of security analysts and investors for any given period. Further,
we cannot assure you that foreign markets will continue to develop.
In recent periods, certain Asian and Latin American currencies have
devalued significantly in relation to the U.S. dollar. We believe that financial
developments in Asia and Latin America were a major factor contributing to lower
international net sales in fiscal 1998 as compared to fiscal 1997. In addition,
the uncertain financial situation in Asia has placed financial pressure on some
of our distributors. In response, we increased accounts receivable reserves in
the first quarter of 1998. We are continuing to evaluate the effect on our
business of recent financial developments in Asia and Latin America. Given the
current political and economic uncertainties in China and throughout Asia, we
cannot assure you that shipment of orders to Asia, including China, will be made
as scheduled, or at all. We cannot assure you that our sales and collection
cycles in Asia and Latin America will not continue to be harmed by the uncertain
financial climate. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
We Must be Able to Manage Expenses and Inventory Risks Associated With Meeting
the Demand of Our Customers.
From time to time, we receive indications from our customers as to their
future plans and requirements to ensure that we will be prepared to meet their
demand for our products. In the past, however, we have received such indications
but, on occasion, we did not ultimately receive purchase orders for our
products. We must be able to effectively manage expenses and inventory risks
associated with meeting potential demand for our products. In addition, if we
fail to meet customers' supply expectations, we may lose business from such
customers. If we expend resources and purchase materials to manufacture products
and such products are not purchased, our business and operating results could
suffer.
The Market in Which We Operate is Intensely Competitive and Many of Our
Competitors are Larger and More Established.
The market for cable television transmission equipment is extremely
competitive and has been characterized by rapid technological change. Harmonic's
current competitors include significantly larger corporations such as ADC
Telecommunications, ANTEC (a company owned in part by TCI), General Instrument,
Philips and Scientific-Atlanta. Additional competition could come from new
entrants in the broadband communications equipment market, such as Lucent
Technologies. Most of these companies are substantially larger and have greater
financial, technical, marketing and other resources than we do. Many of these
large organizations are in a better position to withstand any significant
reduction in capital spending by cable television operators. In addition, many
of our competitors have more long standing and established relationships with
domestic and foreign cable television operators than we do. We cannot assure you
that we will be able to compete successfully in the future or that competition
will not harm our business.
If any of our competitors' products or technologies were to become the
industry standard or if any of our smaller competitors were to enter into or
expand relationships with larger companies through mergers, acquisitions or
otherwise, our business could be seriously harmed. Further, our competitors may
bundle their products or incorporate functionality into existing products in a
manner that discourages users from purchasing our products. See
"Business -- Competition."
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Broadband Communications Markets are Relatively Immature and Characterized by
Rapid Technological Change.
Broadband communications markets are relatively immature, making it
difficult to accurately predict the markets' future growth rate, size and
technological direction. In view of the evolving nature of these markets, it is
possible that cable television operators, telephone companies or other suppliers
of broadband wireless and satellite services will decide to adopt alternative
architectures or technologies that are incompatible with our current or future
products. If we are unable to design, develop, manufacture and sell products
that incorporate or are compatible with these new architectures or technologies,
our business will suffer.
We Need to Develop and Introduce New and Enhanced Products In a Timely Manner
to Remain Competitive.
Broadband communications markets are characterized by continuing
technological advancement, changes in customer requirements and evolving
industry standards. To compete successfully, we must design, develop,
manufacture and sell new or enhanced products that provide increasingly higher
levels of performance and reliability. However, we may not be able to
successfully develop or introduce these products. Moreover, these products may
not achieve broad commercial acceptance and may have lower gross margins than
our other products.
In addition, to successfully develop and market our planned products for
digital applications, we may be required to enter into technology development or
licensing agreements with third parties. We cannot assure you that we will be
able to enter into any necessary technology development or licensing agreement
on terms acceptable to us, or at all. The failure to enter into technology
development or licensing agreements when necessary could limit our ability to
develop and market new products and, accordingly, could materially and adversely
affect our business and operating results.
We Need to Effectively Manage Our Growth.
The growth in Harmonic's business has placed, and is expected to continue
to place, a significant strain on Harmonic's personnel, management and other
resources. Harmonic's ability to manage any future growth effectively will
require us to attract, train, motivate and manage new employees successfully, to
integrate new employees into our overall operations, to retain key employees and
to continue to improve our operational, financial and management systems. If we
fail to manage our future growth effectively, our business could suffer.
Competition for Qualified Personnel is Intense, and We May Not Be Successful
in Attracting and Retaining Personnel.
Our future success will depend, to a significant extent, on the ability of
our management to operate effectively, both individually and as a group. We are
dependent on our ability to retain and motivate high caliber personnel, in
addition to attracting new personnel. Competition for qualified technical and
other personnel is intense, particularly in the San Francisco Bay Area and
Israel, and we may not be successful in attracting and retaining such personnel.
Competitors and others have in the past and may in the future attempt to
recruit our employees. While our employees are required to sign standard
agreements concerning confidentiality and ownership of inventions, we generally
do not have employment contracts or noncompetition agreements with any of our
personnel. The loss of the services of any of our key personnel, the inability
to attract or retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers and other technical personnel, could
negatively affect our business.
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Our Acquisition of NMC Has Created Numerous Risks and Challenges for Us.
The acquisition of New Media Communication Ltd., or NMC, has placed, and is
expected to continue to place, a significant strain on our personnel, management
and other resources. The acquisition of NMC in January 1998 has allowed us to
develop and expand our product offerings to include broadband high-speed data
delivery hardware and software and increased the scope of our international
operations in Israel. The acquisition of NMC continues to impose challenges,
including:
- the dependence on the evolution and growth of the market for wireless and
satellite broadband services;
- difficulties in the assimilation of operations, research and development
efforts, products, personnel and cultures of Harmonic and NMC;
- our ability to successfully develop, manufacture and gain market
acceptance of the products of NMC; and
- the amortization of goodwill resulting from the acquisition of NMC.
We cannot assure you that we will be able to successfully address these
challenges, and our failure to do so could materially and adversely affect our
business, financial condition and operating results.
We May be Subject to Risks Associated with Acquisitions.
We have made and may make investments in complementary companies, products
or technologies. If we make acquisitions, we could have difficulty assimilating
or retaining the acquired companies' personnel and operations or integrating the
acquired technology or products into ours. These difficulties could disrupt our
ongoing business, distract our management and employees and increase our
expenses. Moreover, our profitability may suffer because of acquisition-related
costs or amortization costs for acquired goodwill and other intangible assets.
Furthermore, we may have to incur debt or issue equity securities to pay for any
future acquisitions, the issuance of which could be dilutive to our existing
shareholders. If we are unable to successfully address any of these risks, our
business, financial condition and operating results could be harmed.
If Sales Forecasted For A Particular Period Are Not Realized In That Period
Due To The Unpredictable Sales Cycles Of Our Products, Our Operating Results For
That Period Will Be Harmed.
The sales cycles of many of our products, particularly our newer products
and products sold internationally, are typically unpredictable and usually
involve:
- a significant technical evaluation;
- a commitment of capital and other resources by cable and other network
operators;
- delays associated with cable and other network operators' internal
procedures to approve large capital expenditures;
- time required to engineer the deployment of new technologies or services
within broadband networks; and
- testing and acceptance of new technologies that affect key operations.
For these and other reasons, our sales cycles generally last three to six
months, but can last up to 12 months. If orders forecasted for a specific
customer for a particular quarter do not occur in that quarter, our operating
results for that quarter could be substantially lower than anticipated.
Our Failure to Adequately Protect Our Proprietary Rights May Adversely Affect
Us.
We currently hold 12 issued United States patents and 9 issued foreign
patents, and have a number of patent applications pending. Although we attempt
to protect our intellectual property rights through patents, trademarks,
copyrights, maintaining certain technology as trade secrets and other measures,
we cannot assure you that any patent, trademark, copyright or other intellectual
property right owned by us will not be
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invalidated, circumvented or challenged, that such intellectual property right
will provide competitive advantages to us or that any of our pending or future
patent applications will be issued with the scope of the claims sought by us, if
at all. We cannot assure you that others will not develop technologies that are
similar or superior to our technology, duplicate our technology or design around
the patents that we own. In addition, effective patent, copyright and trade
secret protection may be unavailable or limited in certain foreign countries in
which we do business or may do business in the future.
We believe that the future success of our business will depend on our
ability to translate the technological expertise and innovation of our personnel
into new and enhanced products. We generally enter into confidentiality or
license agreements with our employees, consultants, vendors and customers as
needed, and generally limit access to and distribution of our proprietary
information. Nevertheless, we cannot assure you that the steps taken by us will
prevent misappropriation of our technology. In addition, we have taken in the
past, and may take in the future, legal action to enforce our patents and other
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could harm our business and
operating results.
In order to successfully develop and market our planned products for
digital applications, we may be required to enter into technology development or
licensing agreements with third parties. Although many companies are often
willing to enter into such technology development or licensing agreements, we
cannot assure you that such agreements will be negotiated on terms acceptable to
us, or at all. The failure to enter into technology development or licensing
agreements, when necessary, could limit our ability to develop and market new
products and could cause our business to suffer.
As is common in our industry, we have from time to time received
notification from other companies of intellectual property rights held by those
companies upon which our products may infringe. Any claim or litigation, with or
without merit, could be costly, time consuming and could result in a diversion
of management's attention, which could harm our business. If we were found to be
infringing on the intellectual property rights of any third party, we could be
subject to liabilities for such infringement, which could be material, and could
be required to seek licenses from other companies or to refrain from using,
manufacturing or selling certain products or using certain processes. Although
holders of patents and other intellectual property rights often offer licenses
to their patent or other intellectual property rights, we cannot assure you that
licenses would be offered, that the terms of any offered license would be
acceptable to us or that failure to obtain a license would not cause our
operating results to suffer.
We May Need Additional Capital in the Future and May Not be Able to Secure
Adequate Funds in Terms Acceptable to Us.
We currently anticipate that our existing cash balances and available line
of credit and cash flow expected to be generated from future operations will be
sufficient to meet our liquidity needs for at least the next twelve months.
However, we may need to raise additional funds if our estimates change or prove
inaccurate or in order for us to respond to unforeseen technological or
marketing hurdles or to take advantage of unanticipated opportunities.
In addition, we expect to review potential acquisitions that would
complement our existing product offerings or enhance our technical capabilities.
While we have no current agreements or negotiations underway with respect to any
potential acquisition, any future transaction of this nature could require
potentially significant amounts of capital. Funds may not be available at the
time or times needed, or available on terms acceptable to us. If adequate funds
are not available, or are not available on acceptable terms, we may not be able
to take advantage of market opportunities, to develop new products or to
otherwise respond to competitive pressures.
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We Purchase Several Key Components, Subassemblies and Modules Used in the
Manufacture or Integration of Our Products from Sole or Limited Sources, and We
are Increasingly Dependent on Contract Manufacturers.
Many components, subassemblies and modules necessary for the manufacture or
integration of our products are obtained from a sole supplier or a limited group
of suppliers. Our reliance on sole or limited suppliers, particularly foreign
suppliers, and our increasing reliance on subcontractors involves several risks,
including a potential inability to obtain an adequate supply of required
components, subassemblies or modules and reduced control over pricing, quality
and timely delivery of components, subassemblies or modules. Certain key
elements of our digital headend products are provided by a sole foreign
supplier. We do not generally maintain long-term agreements with any of our
suppliers or subcontractors. An inability to obtain adequate deliveries or any
other circumstance that would require us to seek alternative sources of supply
could affect our ability to ship our products on a timely basis, which could
damage relationships with current and prospective customers and harm our
business. We attempt to limit this risk by maintaining safety stocks of these
components, subassemblies and modules. As a result of this investment in
inventories, we may be subject to an increasing risk of inventory obsolescence
in the future, which could harm our business. See "Business -- Manufacturing and
Suppliers."
We Face Risks Associated with Having Important Facilities and Resources
Located in Israel.
Harmonic maintains two facilities in the State of Israel with a total of
approximately 60 employees. The personnel at these facilities represent a
significant portion of our research and development operations. Accordingly, we
are directly influenced by the political, economic and military conditions
affecting Israel, and any major hostilities involving Israel or the interruption
or curtailment of trade between Israel and its present trading partners could
significantly harm our business.
In addition, most of our employees in Israel are currently obligated to
perform annual reserve duty in the Israel Defense Forces and are subject to
being called for active military duty at any time. We cannot predict the effect
of these obligations on Harmonic in the future.
Our Business Could be Adversely Impacted by Year 2000 Compliance Issues.
During the next year, many software programs may not recognize calendar
dates beginning in the year 2000. This problem could force computers or machines
which utilize date dependent software to either shut down or provide incorrect
information. To address this problem, we have examined our computer and
information systems, contacted our software and hardware providers, and, where
necessary, made upgrades to our systems.
Based upon the assessments to date, all hardware products currently under
development or released, and all software products currently under development
are Y2K compliant. Certain software products currently installed at customer
sites are not Y2K compliant and Harmonic is working with its customers to
provide migration paths for each product. Undetected errors or defects may
remain. Disruptions to our business or unexpected costs may arise because of
undetected errors or defects in the technology used in our products,
manufacturing processes or internal information systems, which are comprised
predominantly of third party software and hardware. If we, or any of our key
suppliers or customers, fail to mitigate internal and external Year 2000 risks,
we may temporarily be unable to process transactions, manufacture products, send
invoices or engage in similar normal business activities or we may experience a
decline in sales, which could materially and adversely affect our business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000 Readiness
Disclosure."
Our Stock Price May Be Volatile.
The market price of our common stock has fluctuated in the past and is
likely to fluctuate in the future. In addition, the securities markets have
experienced significant price and volume fluctuations and the market prices of
the securities of technology companies have been especially volatile. Investors
may be unable to resell their shares of our common stock at or above the
offering price. In the past, companies that have experienced
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volatility in the market price of their stock have been the object of securities
class action litigation. If we were the object of securities class action
litigation, it could result in substantial costs and a diversion of management's
attention and resources. See "Market for the Registrant's Common Stock and
Related Security Holder Matters."
Our Certificate of Incorporation and Bylaws and Delaware Law Contain
Provisions that Could Discourage a Takeover.
Provisions of our Amended and Restated Certificate of Incorporation,
Bylaws, and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows of Harmonic due to adverse changes
in market prices and rates. Harmonic is exposed to market risk because of
changes in foreign currency exchange rates as measured against the U.S. Dollar
and currencies of Harmonic's subsidiaries in Israel and in the United Kingdom.
Harmonic has not engaged in hedging activities as of December 31, 1998 and does
not expect to do so in the foreseeable future.
Harmonic has subsidiaries in Israel and the United Kingdom whose sales are
generally denominated in U.S. dollars. While Harmonic does not anticipate that
near-term changes in exchange rates will have a material impact on future
operating results, fair values or cash flows, Harmonic cannot assure you that a
sudden and significant change in the value of the Israeli Shekel or British
Pound would not harm Harmonic's financial condition and results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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(a) Index to Consolidated Financial Statements
Report of Independent Accountants........................... 29
Consolidated Balance Sheets as of
December 31, 1998, and 1997............................... 30
Consolidated Statement of Operations
for the years ended, December 31, 1998, 1997 and 1996..... 31
Consolidated Statement of Stockholders' Equity
for the years ended December 31, 1998, 1997, and 1996..... 32
Consolidated Statement of Cash Flows
for the years ended December 31, 1998, 1997, and 1996..... 33
Notes to Consolidated Financial Statements.................. 34
</TABLE>
(b) Financial Statement Schedules: All financial statement schedules have
been omitted because the information is not required to be set forth herein, is
not applicable or is included in the financial statements or notes thereto.
27
<PAGE> 29
(c) Selected Quarterly Financial Data: The following table sets forth for
the period indicated selected quarterly financial data for the Company.
FISCAL YEARS BY QUARTER (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
------------------------------------- -------------------------------------
QUARTERLY DATA: 4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
--------------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales......................... $27,097 $22,382 $18,174 $16,204 $17,350 $17,545 $20,514 $19,033
Gross profit...................... 10,369 8,434 6,662 5,090 7,979 7,899 9,736 8,991
Income (loss) from
operations(1)................... 583 (1,044) (2,929) (18,553) (97) 360 2,016 2,227
Net income (loss)(1).............. 628 (831) (2,885) (18,365) 580 413 1,838 2,098
Basic net income (loss) per
share(2)........................ 0.03 (0.04) (0.12) (0.80) 0.03 0.02 0.09 0.10
Diluted net income (loss) per
share(2)........................ 0.02 (0.04) (0.12) (0.80) 0.03 0.02 0.08 0.09
</TABLE>
- ---------------
(1) The loss from operations and net loss for the first quarter of 1998 includes
a one-time charge of $14.0 million for acquired in-process technology. See
Note 2 of Notes to Consolidated Financial Statements.
(2) See Note 5 of Notes to Consolidated Financial Statements for a discussion of
the shares used to compute net income (loss) per share. All per share
amounts have been retroactively adjusted to reflect the two-for-one stock
split made effective on October 14, 1999.
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Not applicable.
28
<PAGE> 30
REPORT OF INDEPENDENT ACCOUNTANTS
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Harmonic Inc. and its subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
--------------------------------------
PRICEWATERHOUSECOOPERS LLP
San Jose, CA
January 20, 1999, except as to
Note 14, which is as of March 15, 1999
and Note 5, which is as
of October 14, 1999
29
<PAGE> 31
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1997
--------- --------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 9,178 $13,670
Accounts receivable, net.................................. 17,646 16,458
Inventories............................................... 22,385 15,474
Prepaid expenses and other assets......................... 1,175 1,774
-------- -------
Total current assets.............................. 50,384 47,376
Notes receivable............................................ -- 1,300
Property and equipment, net................................. 10,726 10,077
Intangibles and other assets................................ 1,314 134
-------- -------
$ 62,424 $58,887
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 7,534 $ 3,708
Accrued liabilities....................................... 10,355 4,896
Current portion of long-term debt......................... 177 --
-------- -------
Total current liabilities......................... 18,066 8,604
Long-term debt, less current portion........................ 400 --
Other non-current liabilities............................... 484 352
Commitments and Contingencies (Notes 11 and 13)
Stockholders' equity:
Preferred Stock, $.001 par value, 5,000,000 shares
authorized; no shares issued or outstanding............ -- --
Common Stock, $.001 par value, 50,000,000 shares
authorized; 23,451,688 and 20,828,594 shares issued and
outstanding............................................ 23 21
Capital in excess of par value............................ 70,913 55,906
Accumulated deficit....................................... (27,472) (6,019)
Accumulated other comprehensive income.................... 10 23
-------- -------
Total stockholders' equity........................ 43,474 49,931
-------- -------
$ 62,424 $58,887
======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE> 32
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net sales................................................... $ 83,857 $74,442 $60,894
Cost of sales............................................... 53,302 39,837 33,163
-------- ------- -------
Gross profit................................................ 30,555 34,605 27,731
-------- ------- -------
Operating expenses:
Research and development.................................. 13,524 11,676 9,237
Sales and marketing....................................... 18,162 13,599 9,827
General and administrative................................ 6,812 4,824 3,463
Acquired in-process technology............................ 14,000 -- --
-------- ------- -------
Total operating expenses............................... 52,498 30,099 22,527
-------- ------- -------
Income (loss) from operations............................... (21,943) 4,506 5,204
Interest and other income, net.............................. 490 682 1,025
-------- ------- -------
Income (loss) before income taxes........................... (21,453) 5,188 6,229
Provision for income taxes.................................. -- 259 311
-------- ------- -------
Net income (loss)........................................... $(21,453) $ 4,929 $ 5,918
======== ======= =======
Net income (loss) per share:
Basic.................................................. $ (0.92) $ 0.24 $ 0.29
======== ======= =======
Diluted................................................ $ (0.92) $ 0.21 $ 0.26
======== ======= =======
Weighted average shares:
Basic.................................................. 23,244 20,690 20,211
======== ======= =======
Diluted................................................ 23,244 23,046 22,948
======== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
31
<PAGE> 33
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK CAPITAL IN OTHER
--------------- EXCESS OF ACCUMULATED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE
SHARES AMOUNT PAR VALUE DEFICIT INCOME EQUITY INCOME(LOSS)
------ ------ ---------- ----------- ------------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995..................... 19,808 $20 $53,855 $(16,866) $ -- $ 37,009
Net income................. -- -- -- 5,918 -- 5,918 $ 5,918
--------
Other comprehensive
income................... $ 5,918
========
Exercise of stock
options.................. 416 -- 240 -- -- 240
Issuance of Common Stock
under Stock Purchase
Plan..................... 98 -- 474 -- -- 474
------ --- ------- -------- ---- --------
Balance at December 31,
1996..................... 20,322 20 54,569 (10,948) -- 43,641
Net income................. -- -- -- 4,929 -- 4,929 $ 4,929
Currency translation....... -- -- -- -- 23 23 23
--------
Other comprehensive
income................... $ 4,952
========
Exercise of stock
options.................. 370 1 611 -- -- 612
Issuance of Common Stock
under Stock Purchase
Plan..................... 136 -- 726 -- -- 726
------ --- ------- -------- ---- --------
Balance at December 31,
1997..................... 20,828 21 55,906 (6,019) 23 49,931
Net loss................... -- -- -- (21,453) -- (21,453) $(21,453)
Currency translation....... -- -- -- -- (13) (13) (13)
--------
Other comprehensive loss... $(21,466)
========
Exercise of stock
options.................. 374 -- 784 -- -- 784
Issuance of Common Stock
under Stock Purchase
Plan..................... 174 -- 830 -- -- 830
Acquisition of New Media
Communication Ltd........ 2,076 2 13,393 -- -- 13,395
------ --- ------- -------- ---- --------
Balance at December 31,
1998..................... 23,452 $23 $70,913 $(27,472) $ 10 $ 43,474
====== === ======= ======== ==== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE> 34
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $(21,453) $ 4,929 $ 5,918
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization............................. 4,283 3,441 2,506
Acquired in-process technology............................ 14,000 -- --
Changes in assets and liabilities, net of effects of
acquisition:
Accounts receivable.................................... (1,040) (3,815) (6,841)
Inventories............................................ (6,393) (692) (5,606)
Prepaid expenses and other assets...................... 1,697 139 (1,848)
Accounts payable....................................... 3,187 (1,896) 3,403
Accrued and other liabilities.......................... 3,694 (140) 2,781
-------- ------- -------
Net cash (used in) provided by operating
activities........................................ (2,025) 1,966 313
Cash flows used in investing activities:
Acquisition of property and equipment..................... (4,384) (4,767) (6,743)
Acquisition of New Media Communication Ltd., net of cash
received............................................... (280) -- --
Long-term advances........................................ -- (1,300) --
-------- ------- -------
Net cash used in investing activities................ (4,664) (6,067) (6,743)
Cash flows from financing activities:
Proceeds from issuance of Common Stock.................... 1,614 1,338 714
Borrowings under bank line and term loan.................. 1,377 -- --
Repayments under bank line and term loan.................. (800) -- --
-------- ------- -------
Net cash provided by financing activities............ 2,191 1,338 714
Effect of exchange rate changes on cash and cash
equivalents............................................... 6 23 --
-------- ------- -------
Net decrease in cash and cash equivalents................... (4,492) (2,740) (5,716)
Cash and cash equivalents at beginning of period............ 13,670 16,410 22,126
-------- ------- -------
Cash and cash equivalents at end of period.................. $ 9,178 $13,670 $16,410
======== ======= =======
Supplemental disclosure of cash flow information:
Interest paid during the period........................... $ 80 $ -- $ 21
Income taxes paid during the period....................... $ 146 $ 323 $ 285
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
33
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Harmonic Inc. ("Harmonic" or the "Company") designs, manufactures and
markets digital and fiber optic systems for delivering video, voice and data
services over cable, satellite and wireless networks. Our advanced solutions
enable cable television and other network operators to provide a range of
broadcast and interactive broadband services that include high-speed Internet
access, telephony and video on demand. We offer a broad range of fiber optic
transmission and digital headend products for hybrid fiber coax, satellite and
wireless networks, and our acquisition of New Media Communication Ltd. in
January 1998 has allowed us to develop and expand our product offerings to
include high-speed data delivery software and hardware.
Reincorporation and Reverse Stock Split. The Company originally
incorporated in California in June 1988. In May 1995, the Company reincorporated
in Delaware. In conjunction with the reincorporation, all outstanding shares of
the predecessor California company were exchanged into common stock of the
Delaware company in a one-for-three reverse stock split.
Basis of Presentation. The consolidated financial statements of the Company
include the financial statements of the Company and its wholly-owned
subsidiaries. All intercompany accounts and balances have been eliminated. The
Company's fiscal quarters end on the Friday nearest the calendar quarter end.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from those estimates.
Cash Equivalents. The Company considers all highly liquid investments
purchased with an original maturity date of three months or less at the date of
purchase to be cash equivalents and are stated at amounts that approximate fair
value, based on quoted market prices. The Company's investments are classified
as held-to-maturity.
Fair Value of Financial Instruments. The carrying value of the Company's
financial instruments, including cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities approximate fair value due to their
short maturities.
Revenue Recognition. Revenue is recognized upon shipment of product except
when probability of collection is not assured or contract provisions require
customer acceptance. In these situations, revenue is recognized when collection
is assured or customer acceptance has occurred. The Company does not provide
rights of return to end users or distributors. A provision for the estimated
cost of warranty is recorded at the time revenue is recognized.
Inventories. Inventories are stated at the lower of cost, using the
weighted average method, or market.
Property and Equipment. Property and equipment are recorded at cost.
Depreciation and amortization are computed using the straight-line method based
upon the shorter of the estimated useful lives of the assets, which range from
two to ten years, or the lease term of the respective assets, if applicable.
Depreciation and amortization expense related to equipment and improvements for
the years ended December 31, 1998 and 1997 was $3,979,000 and $3,441,000,
respectively.
Intangibles and Other Assets. Goodwill acquired in connection with the
acquisition of businesses is included in "Intangibles and other assets."
Amortization is provided on a straight-line basis over the estimated useful life
of five years. See Notes 2 and 4.
Long-Lived Assets. The Company records impairment losses on long-lived
assets used in operations, such as equipment and improvements, and intangible
assets when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the carrying amounts of
the assets.
34
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concentrations of Credit Risk. Financial instruments which subject the
Company to concentrations of credit risk consist primarily of cash and cash
equivalents and accounts receivable. Cash and cash equivalents are maintained
with high quality financial institutions and are invested in short-term, highly
liquid investment grade obligations of government and commercial issuers, in
accordance with the Company's investment policy. The investment policy limits
the amount of credit exposure to any one financial institution or commercial
issuer. The Company's accounts receivable are derived from sales to cable
television and other network operators and distributors as discussed in Note 12.
The Company performs ongoing credit evaluations of its customers and generally
does not require collateral. The Company provides for expected losses but to
date has not experienced any material losses. At December 31, 1998, receivables
from three customers represented 24%, 15%, and 14%, respectively. At December
31, 1997, receivables from one customer represented 25% of accounts receivable.
Currency Translation. The Company's Israeli operations' functional currency
is the U.S. Dollar. All other foreign subsidiaries use the respective local
currency as the functional currency. When the local currency is the functional
currency, gains and losses from translation are included in stockholders'
equity. Realized gains and losses resulting from foreign currency transactions
have not been material to the consolidated statements of operations for the
years ended December 31, 1998, 1997, and 1996.
Income Taxes. Deferred tax assets and liabilities are recognized for the
expected tax consequences of temporary differences between the tax bases of
assets and liabilities and their financial statement reported amounts under the
provisions of Statement of Financial Accounting Standards No. 109 ("SFAS 109"),
which has been applied for all periods presented.
Accounting for Stock-Based Compensation. The Company's stock-based
compensation plans are accounted for in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees." In January
1996, the Company adopted the disclosure requirements of Statement of Financial
Accounting Standards 123 ("SFAS 123").
Comprehensive Income. Effective January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). SFAS No. 130 requires that all items recognized under
accounting standards as components of comprehensive income be reported in an
annual financial statement that is displayed with the same prominence as other
annual financial statements. The Company's comprehensive income has been
included in the Consolidated Statement of Stockholders' Equity for all periods
presented.
Accounting for Derivatives and Hedging Activities. In June 1998, the
Financial Accounting Standards Board issued Statement No. 133 "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires
companies to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives will be reported in the statement of operations or as a
deferred item, depending on the use of the derivatives and whether they qualify
for hedge accounting. The Company does not expect SFAS 133 to have an impact
upon the Company's consolidated financial statements, as the Company does not
engage in hedging activities.
Reclassification. Certain amounts in prior years' financial statements and
related notes have been reclassified to conform to the 1998 presentation. These
reclassifications are not material.
NOTE 2: ACQUISITION OF NEW MEDIA COMMUNICATION LTD.
On January 5, 1998, the Company acquired New Media Communication Ltd.
("NMC"), a privately held supplier of broadband, high-speed data delivery
software and hardware, in exchange for the issuance of 2,075,822 shares of
Harmonic Common Stock and the assumption of all outstanding NMC stock options.
NMC has been a development stage company since its founding in 1996 and its
revenues through 1998 were not material in relation to those of the Company. The
acquisition was accounted for using the purchase method of accounting.
Accordingly, the results of operations of NMC have been included in the
consolidated
35
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
financial statements of the Company from the date of acquisition. The purchase
price of approximately $17.6 million was allocated to the acquired assets,
in-process research and development ("IPRD") and goodwill. In connection with
the acquisition, $14.0 million was expensed in the first quarter of 1998 as IPRD
and approximately $1.5 million was allocated to goodwill. The goodwill is being
amortized on a straight-line basis over the estimated useful life of five years.
The portion of the purchase price allocated to IPRD was identified and
valued through extensive interviews, analysis of data provided by NMC concerning
development projects, their stage of development, the time and resources needed
to complete them and their expected income generating ability and associated
risks. The income approach, which includes an analysis of the cash flows, and
risks associated with achieving such cash flows, was used in valuing the IPRD.
Management is primarily responsible for estimating the fair value of the IPRD.
At the time of the acquisition, NMC had commenced development of the
CyberStream System, a digital system for high-speed data transmission over
cable, wireless and satellite networks. The CyberStream System was NMC's only
research and development project in process at the acquisition date.
Technological feasibility of the acquired technology had not been established at
the time of the acquisition and the acquired technology had no future
alternative uses. No value was attributed to NMC's existing analog products as
management believed that no further revenue would be generated due to
obsolescence.
The value of IPRD was determined by estimating the expected cash flows from
the acquired technology and discounting the net cash flows back to their present
values based on the following assumptions:
Net cash flows. The net cash flows are based on estimates of revenue, cost
of sales, operating expenses and income taxes for the project. At the date of
the acquisition, management expected commercial release of the CyberStream
system to commence by the middle of fiscal year 1998 and for revenues to
increase through fiscal year 2002, at which time they were assumed to decrease
through fiscal year 2007, as newer products would be released. The valuation
assumed that projected margins would increase based on higher sales volumes and
expenses would increase based on the growth of the business.
Discount rate. Discounting the net cash flows back to their present value
was based on the Company's weighted average cost of capital of 16%. The
risk-adjusted discount rate applied to the cash flows from IPRD was 19%. The
risk premium of 3% for IPRD was due to inherent uncertainties surrounding the
acquired technology. The most significant risks associated with the acquired
technology include consumer acceptance, technology and resource risks.
The following table sets forth the pro-forma net sales, net income and net
income per share of the Company for the year ended December 31, 1997, giving
effect to the acquisition of NMC as if it had occurred as of the beginning of
the period presented:
<TABLE>
<CAPTION>
PRO FORMA
(UNAUDITED)
----------------------
1997
----------------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C>
Net sales................................................. $75,086
Net income................................................ $ 1,903
Net income per share:
Basic................................................... $ 0.08
Diluted................................................. $ 0.08
Weighted average shares:
Basic................................................... 22,766
Diluted................................................. 25,122
</TABLE>
36
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3: CASH AND CASH EQUIVALENTS
At December 31, 1998 and 1997, the Company had the following amounts in
cash and cash equivalents, with original maturity dates of three months or less
at the date of purchase. Realized gains and losses for the years ended December
31, 1998 and 1997 and the difference between gross amortized cost and estimated
fair value at December 31, 1998 and 1997 were immaterial.
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
------ -------
(IN THOUSANDS)
<S> <C> <C>
Commercial paper.......................................... $2,154 $ 7,956
Cash and money market accounts............................ 7,024 5,714
------ -------
Total cash and cash equivalents................. $9,178 $13,670
====== =======
</TABLE>
NOTE 4: BALANCE SHEET DETAILS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Accounts receivable:
Gross accounts receivable.............................. $18,646 $17,208
Less: allowance for doubtful accounts.................. (1,000) (750)
------- -------
$17,646 $16,458
======= =======
Inventories:
Raw materials.......................................... $ 3,747 $ 4,356
Work-in-process........................................ 4,557 3,127
Finished goods......................................... 14,081 7,991
------- -------
$22,385 $15,474
======= =======
Property and equipment:
Furniture and fixtures................................. $ 2,051 $ 1,585
Machinery and equipment................................ 19,854 15,692
Leasehold improvements................................. 2,779 2,779
------- -------
24,684 20,056
Less: accumulated depreciation and amortization........ (13,958) (9,979)
------- -------
$10,726 $10,077
======= =======
Intangibles and other assets:
Other assets........................................... $ 98 $ 134
Goodwill............................................... 1,520 --
------- -------
1,618 134
Less: accumulated amortization......................... (304) --
------- -------
$ 1,314 $ 134
======= =======
Accrued liabilities:
Accrued compensation................................... $ 3,655 $ 1,837
Customer deposits...................................... 2,234 101
Deferred revenue....................................... 1,466 402
Accrued warranties..................................... 575 626
Other.................................................. 2,425 1,930
------- -------
$10,355 $ 4,896
======= =======
</TABLE>
37
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5: NET INCOME (LOSS) PER SHARE
During the quarter ended December 31, 1997, the Company adopted Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128").
SFAS 128 requires presentation of both Basic EPS and Diluted EPS on the face of
the statement of operations. Basic EPS, which replaces primary EPS, is computed
by dividing net income available to common stockholders (numerator) by the
weighted average number of common shares outstanding (denominator) during the
period. Unlike the computation of primary EPS, Basic EPS excludes the dilutive
effect of stock options and warrants. Diluted EPS replaces fully diluted EPS and
gives effect to all dilutive potential common shares outstanding during a
period. In computing Diluted EPS, the average price for the period is used in
determining the number of shares assumed to be purchased from exercise of stock
options and warrants rather than the higher of the average or ending price as
used in the computation of fully diluted EPS.
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Net income (loss) (numerator)........................ $(21,453) $ 4,929 $ 5,918
======== ======= =======
Shares calculation (denominator):
Average shares outstanding -- basic.................. 23,244 20,690 20,212
Effect of Dilutive Securities:
Potential Common Stock relating to stock options
and warrants....................................... -- 2,356 2,736
-------- ------- -------
Average shares outstanding -- diluted................ 23,244 23,046 22,948
======== ======= =======
Net income (loss) per share -- basic................. $ (0.92) $ 0.24 $ 0.29
======== ======= =======
Net income (loss) per share -- diluted............... $ (0.92) $ 0.21 $ 0.26
======== ======= =======
</TABLE>
Options and warrants to purchase 5,888,236, 1,028,300 and 159,500 shares of
common stock were outstanding during 1998, 1997 and 1996, respectively, but were
not included in the computation of diluted EPS because either the option's
exercise price was greater than the average market price of the common shares or
inclusion of such options would have been antidilutive. The price ranges of
these options and warrants were from $0.15 to $11.37 per share for 1998, $8.25
to $11.37 per share for 1997 and $8.44 to $11.37 per share for 1996.
All per share amounts have been retroactively adjusted to reflect the
two-for-one stock split made effective on October 14, 1999.
NOTE 6: LINE OF CREDIT
During 1998, the Company had a bank line of credit facility (the "line"),
providing for borrowings of up to $12,000,000. The line was available until
December 1998. As discussed in Note 14, the Company renegotiated its bank line
of credit facility in the fourth quarter of 1998 and finalized the amended and
restated facility in March 1999. The line contained certain financial covenants
and interest on borrowings was at the bank's prime rate or LIBOR plus 2%. The
Company has guaranteed certain borrowings of its subsidiaries totaling $0.9
million with letters of credit and has total letters of credit issued under the
line of $2.7 million which expire at various dates throughout fiscal year 1999.
There were no outstanding borrowings at December 31, 1998 and 1997.
38
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7: LONG-TERM DEBT
During 1998, the Company had an equipment term loan (the "term loan")
facility, providing for borrowings of up to $3,000,000 on a secured basis. The
outstanding principal balance of the term loan on December 31, 1998 is payable
in 36 monthly installments beginning January 1999. As of December 31, 1998,
borrowings of $577,000 were outstanding under the term loan. Interest on
borrowings is at the bank's prime rate plus 0.5%, payable monthly. Aggregate
principal payments required under the term loan are $177,000, $191,000, and
$209,000 for the years ending December 31, 1999, 2000, and 2001, respectively.
The term loan was available until December 1998. As discussed in Note 14, the
Company renegotiated its term loan facility in the fourth quarter of 1998 and
finalized the amended and restated facility in March 1999.
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1998 1997
------ -----
(IN THOUSANDS)
<S> <C> <C>
Equipment term loan......................................... $ 577 $ --
Less: current portion....................................... (177) --
----- ----
$ 400 $ --
===== ====
</TABLE>
NOTE 8: CAPITAL STOCK
Initial Public Offering. In May 1995, the Company completed its initial
public offering ("IPO") of 5,200,000 shares of Common Stock, 1,200,000 of which
were sold by existing stockholders, at a price of $6.75 per share. Net proceeds
to the Company were approximately $24.2 million, after underwriter commissions
and associated costs. Upon the closing of the IPO, all outstanding shares of
Mandatorily Redeemable Convertible Preferred Stock automatically converted into
14,189,496 shares of Common Stock. Also effective with the closing of the IPO,
the Company was authorized to issue 5,000,000 shares of undesignated Preferred
Stock, of which none were issued or outstanding at December 31, 1998 and 1997.
Common Stock Warrants. In June 1994, the Company entered into a
distribution agreement, in connection with which it issued a warrant to purchase
up to 1,597,496 shares of Common Stock at $2.78 per share. The warrant had a
fair value of $200,000, which was charged to results of operations in the second
quarter of 1994. The warrant will become exercisable in June 1999 and expire at
the earlier of six years from the date of issuance or the closing of a
significant acquisition transaction, as defined in the warrant. The Company has
reserved 1,597,496 shares of Common Stock for issuance upon exercise of this
warrant.
In 1993, the Company issued a warrant to purchase up to 44,444 shares of
the Company's Common Stock at an exercise price of $2.25 per share in
conjunction with an equipment lease line facility. The fair value of the warrant
was nominal, and the warrant expires at the earlier of seven years from the date
of issuance or the merger or sale of the Company meeting certain criteria. The
Company has reserved 44,444 shares of Common Stock for issuance upon exercise of
this warrant.
NOTE 9: BENEFIT AND COMPENSATION PLANS
Stock Option Plans. In 1988, the Company adopted an incentive and
non-statutory stock option plan (the "1988 Plan") for which 2,251,834 shares
have been reserved for issuance. Following adoption of the 1995 Stock Plan (the
"1995 Plan") at the effectiveness of the Company's IPO, no further grants have
been, or will be, made under the 1988 Plan. Options granted under the 1988 Plan
and the 1995 Plan are for periods not to exceed ten years. Exercise prices of
incentive stock option grants under both plans must be at least 100% of the fair
market value of the stock at the date of grant and for nonstatutory stock
options must be at least 85% of the fair market value of the stock at the date
of grant. Under both plans, the options generally vest 25% at one year from date
of grant, and an additional 1/48 per month thereafter. The Company has reserved
3,240,000 shares of Common Stock for issuance under the 1995 Plan. Upon the
closing of the acquisition of New Media
39
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Communication Ltd. ("NMC") in January 1998, the 1997 Non-Statutory Option Plan
(the "1997 Plan") became effective. The Company assumed all outstanding NMC
options and issued new options at the closing totaling 800,000 shares. No
further grants have been, or will be, made under the 1997 Plan. Options granted
under the 1997 Plan were at fair market value and for periods not to exceed ten
years with vesting generally under the same terms as the 1988 and 1995 plans.
Director Option Plan. Effective upon the IPO, the Company adopted the 1995
Director Option Plan (the "Director Plan") and reserved 100,000 shares of Common
Stock for issuance thereunder. The Director Plan provides for the grant of
nonstatutory stock options to certain nonemployee directors of the Company
pursuant to an automatic, nondiscretionary grant mechanism.
The following table summarizes activities under the Plans:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVAILABLE STOCK OPTIONS AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
---------------- ------------- --------------
(IN THOUSANDS, EXCEPT EXERCISE PRICE)
<S> <C> <C> <C>
Balance at December 31, 1995........................... 884 2,306 $ 1.83
Options granted........................................ (688) 688 6.36
Options exercised...................................... -- (416) 0.49
Options canceled....................................... 14 (96) 2.87
------ ------ ------
Balance at December 31, 1996........................... 210 2,482 3.28
Shares authorized...................................... 960 -- --
Options granted........................................ (1,008) 1,008 9.04
Options exercised...................................... -- (370) 1.65
Options canceled....................................... 308 (354) 7.13
------ ------ ------
Balance at December 31, 1997........................... 470 2,766 5.11
Shares authorized...................................... 1,950 -- --
Options granted........................................ (2,128) 2,128 6.24
Options exercised...................................... -- (374) 2.10
Options canceled....................................... 240 (274) 7.28
------ ------ ------
Balance at December 31, 1998........................... 532 4,246 $ 5.80
====== ====== ======
</TABLE>
The following table summarizes information regarding stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
STOCK OPTIONS OUTSTANDING
---------------------------------------------------- STOCK OPTIONS EXERCISABLE
WEIGHTED-AVERAGE ---------------------------------
NUMBER REMAINING NUMBER
RANGE OF OUTSTANDING AT CONTRACTUAL LIFE WEIGHTED-AVERAGE EXERCISABLE AT WEIGHTED-AVERAGE
EXERCISE PRICES DEC. 31, 1998 (YEARS) EXERCISE PRICE DEC. 31, 1998 EXERCISE PRICE
--------------- -------------- ---------------- ---------------- -------------- ----------------
(IN THOUSANDS, EXCEPT EXERCISE PRICE AND LIFE)
<S> <C> <C> <C> <C> <C>
$ 0.15 - 0.90 690 3.8 $0.36 690 $0.36
1.12 - 2.32 250 8.1 1.68 236 1.67
3.60 - 6.87 1,576 8.2 5.70 568 5.58
7.06 - 11.37 1,730 8.9 8.65 362 9.27
----- --- ----- ----- -----
4,246 7.7 $5.80 1,856 $3.86
===== === ===== ===== =====
</TABLE>
The weighted-average fair value of options granted in 1998 was $6.79. The
weighted-average fair value of options granted in 1997 and 1996 was $9.14 and
$6.47, respectively.
Employee Stock Purchase Plan. Effective upon the IPO, the Company adopted
the 1995 Employee Stock Purchase Plan (the "Purchase Plan") for which 800,000
shares have been reserved for issuance. The Purchase Plan enables employees to
purchase shares at 85% of the fair market value of the Common Stock at the
beginning or end of each six month purchase period. The Purchase Plan is
intended to qualify as an
40
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
"employee stock purchase plan" under Section 423 of the Internal Revenue Code.
174,476, 136,542 and 97,954 shares were issued under the Purchase Plan during
1998, 1997 and 1996, respectively.
Fair Value Disclosures. The Company accounts for its stock-based
compensation plans in accordance with the provisions of Accounting Principles
Board Opinion No. 25. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value method at the
grant dates, as prescribed in SFAS 123, the Company's net income (loss) and net
income (loss) per share would have been as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ ------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Net income (loss):
As reported............................................... $(21,453) $4,929 $5,918
Pro forma................................................. (26,457) 3,209 4,474
Basic net income (loss) per share:
As reported............................................... $ (0.92) $ 0.24 $ 0.29
Pro forma................................................. (1.14) 0.15 0.22
Diluted net income (loss) per share:
As reported............................................... $ (0.92) $ 0.21 $ 0.26
Pro forma................................................. (1.14) 0.14 0.19
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
EMPLOYEE STOCK OPTIONS EMPLOYEE STOCK PURCHASE PLAN
--------------------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
----------- ----------- ----------- ----------- ----------- ----
<S> <C> <C> <C> <C> <C> <C>
Dividend yield........ 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Volatility............ 65% 55% 47.5% 65% 55% 47.5%
Risk-free interest
rate................ 4.4% - 5.6% 5.6% - 6.7% 5.2% - 6.5% 4.6% - 5.5% 5.1% - 6.3% 5.7%
Expected life
(years)............. 4 4 4 2 2 2
</TABLE>
Retirement/Savings Plan. The Company has a retirement/savings plan which
qualifies as a thrift plan under Section 401(k) of the Internal Revenue Code.
This plan allows participants to contribute up to 20% of total compensation,
subject to applicable Internal Revenue Service limitations. Effective April 1,
1997, the Company began to make discretionary contributions to the plan of $0.25
per dollar contributed by eligible participants up to a maximum contribution per
participant of $750 per year.
NOTE 10: INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................................... $ -- $168 $246
Foreign................................................... -- 90 41
State..................................................... -- 1 24
---- ---- ----
$ -- $259 $311
==== ==== ====
</TABLE>
41
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The income tax provision reconciles to the provision at the federal
statutory rate as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997 1996
------- ------- ------
(IN THOUSANDS)
<S> <C> <C> <C>
Provision at statutory rate................................. $(7,294) $ 1,764 $2,118
Differential in rates on foreign earnings................... 774 (111) --
State taxes, net of federal benefit......................... -- 1 16
Foreign sales corporation benefit........................... -- (176) --
Acquired in-process technology and non-deductible
goodwill.................................................. 4,863 -- --
Utilization of net operating loss carryovers................ -- (1,661) (2,490)
Future benefits not currently recognized.................... 2,116 364 429
Alternative minimum tax..................................... -- 51 162
Other....................................................... (459) 27 76
------- ------- ------
$ -- $ 259 $ 311
======= ======= ======
</TABLE>
Deferred tax assets comprise the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Net operating loss carryovers............................... $ 845 $ 303 $ 1,964
Research and development credit carryovers.................. 3,285 2,452
2,112
Capitalized research and development costs.................. 71 234
254
Reserves not currently deductible........................... 2,814 1,657 1,187
Other....................................................... 419 96 12
------- ------- -------
Total deferred tax assets......................... 7,434 4,742 5,529
Valuation allowance......................................... (7,434) (4,742) (5,529)
------- ------- -------
Net deferred assets......................................... $ -- $ -- $ --
======= ======= =======
</TABLE>
The deferred tax assets valuation allowance at December 31, 1998, 1997 and
1996 is attributed to federal and state deferred tax assets. Management believes
that sufficient uncertainty exists regarding the realizability of these items
such that a full valuation allowance has been recorded.
At December 31, 1998, the Company had approximately $1,968,000 of net
operating loss carryovers for federal tax reporting purposes available to offset
future taxable income; such carryovers will expire in the years ending 2009
through 2019. The federal net operating loss carryovers do not include
approximately $4,887,000 resulting from disqualifying dispositions or exercises
of non-incentive stock options, the tax benefit of which, when realized, will be
accounted for as an addition to capital in excess of par value, rather than as a
reduction of the provision for income taxes. At December 31, 1998, the Company
also had approximately $2,175,000, and $1,110,000, of research and development
credit carryovers for federal and state tax reporting purposes, respectively.
The federal research and development credit carryovers will expire in the years
ending 2004 through 2019. The state research and development carryovers will be
carried forward indefinitely, until utilized.
The amounts of and the benefit from net operating losses and tax credits
that can be carried forward may be limited in the event of a cumulative stock
ownership change of greater than 50% over a three year period.
42
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11: RESEARCH AND DEVELOPMENT GRANTS
BIRD. In accordance with separate agreements signed with the Israel-U.S.
Binational Industrial Research and Development Foundation ("BIRD") in December
1994 and December 1997, the Company obtained grants for research and development
projects amounting to 50% of the actual expenditures incurred on each of the two
projects subject to a maximum of $560,000 and $845,000, respectively. The
Company earned the maximum of $560,000 under the first grant, which was offset
against research and development expenses from 1995 through 1997. Under the
second grant, the Company earned approximately $81,000 in 1998, which was also
offset against research and development expenses for the same period. The
Company is not obligated to repay the grants regardless of the outcome of its
development efforts; however, it is obligated to pay the BIRD royalties at the
rate of 2.5% - 5% of sales of any products or development resulting from such
research, but not in excess of 150% of each grant. During 1998, approximately
$175,000 of royalty expense was incurred.
Chief Scientist. An agreement was signed in May 1998 with the Israeli Chief
Scientist Office ("Chief Scientist") in which the Company obtained a grant for a
research and development project amounting to 50% of the actual expenditures
incurred, subject to a maximum of 1,113,000 Israeli Shekels which translated at
the December 31, 1998 exchange rate approximates $265,000. The Company earned
$265,000 during 1998, which was offset against research and development expense
for the same period. The Company is not obligated to repay the grants regardless
of the outcome of its development efforts; however, it is obligated to pay the
Chief Scientist royalties at the rate of 3% - 5% of sales of any products or
development resulting from such research, but not in excess of 100% of the
grant. During 1998, royalty expenses incurred were not significant.
NOTE 12: GEOGRAPHIC INFORMATION AND SIGNIFICANT CUSTOMERS
The Company operates in one industry segment and markets its products
worldwide through its own direct sales force and through systems integrators and
distributors. The Company has a manufacturing facility located in the U.S.,
international sales and support centers in Europe and Asia, and its New Media
Communication Ltd. subsidiary and a research and development facility in Israel.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Geographic information consists of the following:
Net Sales:
United States....................................... $47,422 $30,651 $26,122
Canada.............................................. 7,208 12,806 9,119
China............................................... 11,647 8,254 1,139
United Kingdom...................................... 3,511 5,530 9,323
Other foreign countries............................. 14,069 17,201 15,191
------- ------- -------
Total............................................ $83,857 $74,442 $60,894
======= ======= =======
Long-lived assets:
United States....................................... $10,384 $ 8,617 $ 8,076
Israel.............................................. 1,501 1,373 675
Other foreign countries............................. 57 87 --
------- ------- -------
Total............................................ $11,942 $10,077 $ 8,751
======= ======= =======
</TABLE>
The Company sells to a significant number of its end users through
distributors. In 1998 sales to one domestic customer and one foreign distributor
represented 17% and 11% of total net sales, respectively. In 1997, sales to one
distributor represented 17% of total net sales. In 1996, sales to three
distributors represented 15%, 15% and 13% of total net sales, respectively.
43
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 1998, 1997 and 1996, sales of optical transmitters accounted for
approximately 54%, 63%, and 71%, respectively, of net sales and sales of optical
node receivers, return path and network management products accounted for
approximately 35%, 37%, and 29%, respectively, of net sales. In 1998, TRANsend
and CyberStream digital products accounted for 11% of net sales. There were no
significant sales of digital products in 1997 or 1996.
NOTE 13: COMMITMENTS AND CONTINGENCIES
Commitments. The Company leases its facilities under noncancelable
operating leases which expire at various dates through 2006. Total rent expense
related to these operating leases were $1,602,000 $1,413,000, and $828,000, for
1998, 1997 and 1996, respectively. Future minimum lease payments under
noncancelable operating leases at December 31, 1998, were as follows: (in
thousands)
<TABLE>
<S> <C>
1999....................................................... $ 1,479
2000....................................................... 1,511
2001....................................................... 1,415
2002....................................................... 1,324
2003....................................................... 1,352
Thereafter................................................. 3,848
-------
$10,929
=======
</TABLE>
The Company has subleased a portion of its headquarters through December
1999. Under the terms of the sublease, the sublessee is required to make
payments aggregating $399,000 for 1999.
Contingencies. The Company is a party to certain litigation matters and
claims which are normal in the course of its operations and, while the results
of litigation and claims cannot be predicted with certainty, management believes
that the final outcome of such matters will not have a materially adverse effect
on the Company's consolidated financial position or results of operations.
NOTE 14: SUBSEQUENT EVENTS
Amendment of Line of Credit. On March 5, 1999, the Company's amended and
restated bank line of credit facility (the "line") was finalized, providing for
borrowings of up to $10,000,000 with a $3,000,000 equipment term loan sub-limit
(the "term loan"). The line contains certain financial covenants and is
available until March 2000. Borrowings pursuant to the line bear interest at the
bank's prime rate plus 0.5% (prime rate plus 1.0% under the term loan) and are
payable monthly. The line is secured by substantially all of the assets of the
Company. The outstanding principal balance of the term loan on March 5, 2000
will be payable in 36 monthly installments beginning April 2000.
Exercise of Common Stock Warrant. In March 1999, the Common Stock warrant
issued in connection with the 1994 distribution agreement was amended whereby
the warrant shall become exercisable immediately prior to the effectiveness of a
registration statement of the Company's Common Stock, subject to certain
conditions. In consideration of the acceleration of exercisability of the
warrant, the warrant holder agreed to reduce the number of shares issuable under
the warrant from 1,597,496 shares to 1,440,000 shares.
44
<PAGE> 46
PART III
Certain information required by Part III is omitted from this Report on
Form 10-K/3A in that the Registrant will file its definitive Proxy Statement for
its Annual Meeting of Stockholders to be held on May 12, 1999, pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended (the "1999
Proxy Statement"), not later than 120 days after the end of the fiscal year
covered by this Report, and certain information included in the Proxy Statement
is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers -- See the section entitled "Executive Officers" in
Part I, Item 1 hereof.
(b) Directors -- The information required by this Item is incorporated by
reference to the section entitled "Election of Directors" in the 1999
Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is included in the 1999 Proxy
Statement under the caption "Executive Compensation" and is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information related to security ownership of certain beneficial owners and
security ownership of management is set forth in the 1999 Proxy Statement under
the caption "Security Ownership of Certain Beneficial Owners and Management" and
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. See Index to Financial Statements at Item 8 on page
27 of this Report:
(a)(2) Exhibits. The documents listed on the Exhibit Index of this Report are
filed herewith. The 1999 Proxy Statement shall be deemed to have been
"filed" with the Securities and Exchange Commission only to the extent
portions thereof are expressly incorporated herein by reference. Copies
of the exhibits listed in the Exhibit Index will be furnished, upon
request, to holders or beneficial owners of the Company's Common Stock.
(b) Reports on Form 8-K. None.
45
<PAGE> 47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Harmonic Inc., a Delaware corporation, has
duly caused this Report on Form 10-K/3A to be signed on its behalf by the
undersigned, hereunto duly authorized, in the City of Sunnyvale, State of
California, on March 10, 2000.
HARMONIC INC.
By: /s/ ANTHONY J. LEY
------------------------------------
Anthony J. Ley
Chairman of the Board,
President and Chief
Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this registration statement has been signed by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ ANTHONY J. LEY Chairman of the Board, President and March 10, 2000
- ------------------------------------------ Chief Executive Officer
(Anthony J. Ley) (Principal Executive Officer)
/s/ ROBIN N. DICKSON Chief Financial Officer (Principal March 10, 2000
- ------------------------------------------ Financial and Accounting Officer)
(Robin N. Dickson)
/s/ BARRY LEMIEUX* Director March 10, 2000
- ------------------------------------------
(Barry Lemieux)
/s/ E. FLOYD KVAMME* Director March 10, 2000
- ------------------------------------------
(E. Floyd Kvamme)
/s/ DAVID A. LANE* Director March 10, 2000
- ------------------------------------------
(David A. Lane)
/s/ MOSHE NAZARATHY* Director March 10, 2000
- ------------------------------------------
(Moshe Nazarathy)
/s/ MICHEL L. VAILLAUD* Director March 10, 2000
- ------------------------------------------
(Michel L. Vaillaud)
*By: /s/ ROBIN N. DICKSON
------------------------------------
(Robin N. Dickson)
Attorney-In-Fact
</TABLE>
46
<PAGE> 48
EXHIBIT INDEX
The following Exhibits to this report are filed herewith, or if marked with
a (i), (ii), (iii), (iv), (v), (vi), or (vii) are incorporated herein by
reference.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
3.1(i) Certificate of Incorporation of Registrant.
3.2(i) Form of Restated Certificate of Incorporation of Registrant.
3.3(i) Bylaws of Registrant.
4.1(i) Form of Common Stock Certificate.
10.1(i)+ Form of Indemnification Agreement.
10.2(i)+ 1988 Stock Option Plan and form of Stock Option Agreement.
10.3(i)+ 1995 Stock Plan and form of Stock Option Agreement.
10.4(i)+ 1995 Employee Stock Purchase Plan and form of Subscription
Agreement.
10.5(i)+ 1995 Director Option Plan and form of Director Option
Agreement.
10.6(i) Registration and Participation Rights and Modification
Agreement dated as of July 22, 1994 among Registrant and
certain holders of Registrant's Common Stock.
10.7(i) Distributor Agreement dated June 15, 1994 by and between
Registrant and Scientific-Atlanta, Inc.
10.8(i) Warrant to purchase Common Stock of Registrant issued to
Scientific-Atlanta, Inc. on June 15, 1994.
10.10(i) Warrant to purchase Series D Preferred Stock of Registrant
issued to Comdisco, Inc. on February 10, 1993.
10.14(ii) Business Loan Agreement, Commercial Security Agreement and
Promissory Note dated August 26, 1993, as amended on
September 14, 1995, between Registrant and Silicon Valley
Bank.
10.15(ii) Facility lease dated as of January 12, 1996 by and between
Eastrich No. 137 Corporation and Company.
10.16(iv) Amended and Restated Loan and Security Agreement dated
December 24, 1997 between Registrant and Silicon Valley
Bank.
10.17(iii)+ Change of Control Severance Agreement dated March 27, 1997
between Registrant and Anthony J. Ley.
10.18(iii)+ Form of Change of Control Severance Agreement between
Registrant and certain executive officers of Registrant.
10.19(iv) Stock Purchase Agreement, dated September 16, 1997 among
Registrant, N.M. New Media Communication Ltd., ("NMC") and
Sellers of NMC.
10.20(v) First Amendment to Stock Purchase Agreement, dated November
25, 1997 among Registrant, N.M. New Media Communication
Ltd., ("NMC") and Sellers of NMC.
10.21(vi) Registration Rights Agreement dated as of January 5, 1998 by
and among the Registrant and the persons and entities listed
on Schedule A thereto (the "NMC Shareholders").
10.22* Second Amended and Restated Loan and Security Agreement
dated March 5, 1999 between Registrant and Silicon Valley
Bank.
10.23(vii) 1997 Nonstatutory Stock Option Plan.
</TABLE>
<PAGE> 49
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
21.1* Subsidiaries of Registrant.
23.1 Consent of Independent Accountants.
24.1* Power of Attorney.
27.1* Financial Data Schedule.
</TABLE>
- ---------------
* Previously Filed
(i) Previously filed as an Exhibit to the Company's Registration Statement on
Form S-1 No. 33-90752.
(ii) Previously filed as an Exhibit to the Company's 10-K for the year ended
December 31, 1995.
(iii) Previously filed as an Exhibit to the Company's 10-K for the year ended
December 31, 1996.
(iv) Previously filed as an Exhibit to the Company's Current Report on 8-K
dated September 29, 1997.
(v) Previously filed as an Exhibit to the Company's Current Report on 8-K dated
January 6, 1998.
(vi) Previously filed as an Exhibit to the Company's Registration Statement on
Form S-3 dated January 8, 1998.
(vii) Previously filed as an Exhibit to the Company's Registration Statement on
Form S-8 dated January 14, 1998.
+ Management Contract or Compensatory Plan or Arrangement required to be
filed as an exhibit to this report on Form 10-K.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 33-94138, 333-38025, 333-44265, 333-65051 and
333-86649) of Harmonic Inc. of our report dated January 20, 1999, except as to
Note 14, which is as of March 15, 1999, and Note 5, which is as of October 14,
1999, which appears on page 29 of this Annual Report on Form 10-K/3A.
PricewaterhouseCoopers LLP
San Jose, California
March 10, 2000
