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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
COMMISSION FILE NUMBER: 0-23289
HYBRID NETWORKS, INC.
---------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0252931
- ----------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6409 Guadalupe Mines Road, San Jose, California 95120
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(Address of principal executive offices)
(408) 323-6500
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(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares outstanding at September 30, 1999: 10,677,242
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HYBRID NETWORKS, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
- -------------------------------------------------- -------------
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
Unaudited Condensed Balance Sheets as of
September 30, 1999 and December 31, 1998 3
Unaudited Condensed Statements of Operations
for the Three and Nine Months Ended
September 30, 1999 and 1998 4
Unaudited Condensed Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 5
Notes to Unaudited Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 14
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 29
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 30
ITEM 2. CHANGES IN SECURITIES 32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 37
SIGNATURES 38
</TABLE>
As used in this report on Form 10-Q, unless the context otherwise requires,
the terms "we," "us," or, "the Company" and "Hybrid" refer to Hybrid Networks,
Inc., a Delaware corporation.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HYBRID NETWORKS, INC.
UNAUDITED CONDENSED BALANCE SHEETS
(in thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 8,113 $ 3,451
Restricted cash - 515
Short term investments 9,012 -
Accounts receivable, net of allowance for doubtful accounts
of $200 in 1999 and 1998 343 1,433
Inventories 2,225 5,224
Prepaid expenses and other current assets 538 864
-------- --------
Total current assets 20,231 11,487
Property and equipment, net 2,508 3,438
Intangibles and other assets 414 495
-------- --------
Total assets $ 23,153 $ 15,420
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Convertible debenture $ 5,500 $ 5,500
Current portion of capital lease obligations 384 465
Accounts payable 1,287 2,063
Accrued liabilities and other 4,074 4,271
-------- --------
Total current liabilities 11,245 12,299
Convertible debentures - long term 12,623 -
Capital lease obligations, less current portion 91 365
Other long-term liabilities 114 54
-------- --------
Total liabilities 24,073 12,718
-------- --------
Commitments and contingencies
Stockholders' equity (deficit): Convertible preferred stock, $.001 par value:
Authorized: 5,000 shares;
Issued and outstanding: no shares in 1999 and - -
no shares in 1998
Common stock, $.001 par value:
Authorized: 100,000 shares;
Issued and outstanding: 10,677 shares in 1999 and
10,440 shares in 1998 11 10
Additional paid-in capital 75,022 66,261
Accumulated deficit (75,974) (63,569)
Unrealized gain on investments 21 -
-------- --------
Total stockholders' equity (deficit) (920) 2,702
-------- --------
Total liabilities and stockholders' equity (deficit) $ 23,153 $ 15,420
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements
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HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
---------------------------- ----------------------------
1999 1998 1999 1998
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales $ 3,319 $ 4,202 $ 10,447 $ 9,151
Cost of sales 3,060 4,479 11,674 10,547
-------- -------- -------- --------
Gross margin (loss) 259 (277) (1,227) (1,396)
-------- -------- -------- --------
Operating expenses:
Research and development 820 1,674 3,131 7,507
Sales and marketing 356 966 1,377 2,856
General and administrative 1,746 4,044 4,272 6,868
-------- -------- -------- --------
Total operating expenses 2,922 6,684 8,780 17,231
-------- -------- -------- --------
Loss from operations (2,663) (6,961) (10,007) (18,627)
Interest income and other expenses, net 33 86 50 744
Interest expense (2,033) (208) (2,448) (667)
-------- -------- -------- --------
NET LOSS (4,663) (7,083) (12,405) (18,550)
Other comprehensive loss:
Unrealized gain on investments 21 - 21 -
Reclassification for gain included in net loss - - - (92)
-------- -------- -------- --------
Total comprehensive loss $ (4,642) $ (7,083) $(12,384) $(18,642)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.44) $ (0.68) $ (1.18) $ (1.78)
======== ======== ======== ========
Shares used in basic and diluted per share calculation 10,637 10,430 10,539 10,394
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
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HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(12,405) $(18,550)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,014 1,485
Amortization of discount related to beneficial conversion feature 1,826 -
Sales discounts recognized on issuance of warrants 407 -
Compensation recognized on issuance of stock and stock options 745 -
Provision for doubtful accounts - 150
Provision for obsolete inventory 529 -
Write off technology license - 1,283
Change in assets and liabilities:
Restricted cash 515 (511)
Accounts receivable 1,090 (375)
Inventories 2,470 423
Prepaid expenses and other assets 326 9
Accounts payable (777) (834)
Other long term liabilities 61 -
Accrued liabilities and other (197) 1,383
-------- --------
Net cash used in operating activities (4,396) (15,537)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (3) (3,818)
Disposal of property and equipment - 65
Purchase of short-term investments (8,991) (11,772)
Proceeds from disposal of short-term investments - 12,665
-------- --------
Net cash used in investing activities (8,994) (2,860)
-------- --------
Cash flows from financing activities:
Repayment of capital lease obligations (355) (393)
Net proceeds from issuance of convertible debenture 18,101 -
Net proceeds from issuance of common stock 306 82
-------- --------
Net cash provided by (used in) financing activities 18,052 (311)
-------- --------
Increase (decrease) in cash and cash equivalents 4,662 (18,708)
Cash and cash equivalents, beginning of period 3,451 26,158
-------- --------
Cash and cash equivalents, end of period $ 8,113 $ 7,450
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
Property and equipment acquired under capital leases $ - $ 280
Discount for beneficial conversion feature of convertible debenture 7,304 -
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid 622 $ 615
Income taxes paid 1 1
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
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HYBRID NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The accompanying condensed financial statements of Hybrid Networks, Inc.
(the "Company" or "Hybrid") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet
as of September 30, 1999, the statements of operations for the three and nine
months ended September 30, 1999 and 1998 and the statements of cash flows for
the nine month periods ended September 30, 1999 and 1998 are unaudited but
include all adjustments (consisting only of normal recurring adjustments) which
the Company considers necessary for a fair presentation of the financial
position at such dates and the operating results and cash flows for those
periods. Although the Company believes that the disclosures in the accompanying
financial statements are adequate to make the information presented not
misleading, certain information normally included in financial statements and
related footnotes prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. The December 31, 1998 condensed
balance sheet data included herein were derived from audited financial
statements but do not include all disclosures required by generally accepted
accounting principles. The accompanying financial statements should be read in
conjunction with the financial statements as contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. During the nine
months of 1999 and the years ended December 31, 1998, 1997, and 1996, the
Company incurred net losses of $12,405,000, $24,625,000, $21,602,000, and
$8,515,000, respectively. The Company had an accumulated deficit of
$75,974,000 as of September 30, 1999 and is highly dependent on its ability
to obtain sufficient additional financing in order to fund the current and
planned operating levels. Additionally, the Company is subject to certain
lawsuits and is subject to an official investigation by the Securities and
Exchange Commission regarding its financial reporting practices. These
factors among others raise substantial doubt about the ability of the Company
to continue as a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company
be unable to continue as a going concern. The Company's continuation as a
going concern is dependent upon its ability to obtain additional financing to
continue its product development and marketing plans and to fund other
general operating expenses, achievement of a financially satisfactory
resolution to outstanding litigation and the SEC investigation, and
ultimately is dependent upon its ability to obtain sufficient customer demand
for its products to attain profitable operations. No assurance can be given
that the Company will be successful in these efforts.
In September 1999, the Company obtained additional financing in the amount
of $18.1 million that will fund operations beyond the end of this year.
Additional financing may be needed during 2000 to continue operations as
currently contemplated. (See--"Liquidity and Capital Resources").
Results for any interim period are not necessarily indicative of results
for any other interim period or for the entire year.
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COMPUTATION OF BASIC AND DILUTED LOSS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of shares
of common stock outstanding for the period. Diluted earnings per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity. All
such securities or other contracts were anti-dilutive for all periods presented
and, therefore, excluded from the computation of earnings per share.
INVENTORIES
Inventories comprise the following:
<TABLE>
<CAPTION>
Sept. 30, Dec. 31,
1999 1998
--------- --------
<S> <C> <C>
Raw materials $ 713 $ 1,371
Work in progress 513 386
Finished goods 999 3,467
------- -------
$ 2,225 $ 5,224
======= =======
</TABLE>
ISSUANCE OF SECURITIES TO SPRINT CORPORATION.
Pursuant to a Securities Purchase Agreement dated August 30, 1999 between
us and Sprint Corporation (the "Sprint Purchase Agreement"), we issued and sold
to Sprint on September 9, 1999 (i) an $11 million face amount 4% Convertible
Class A Debenture due 2009 (the "Class A Debenture") which will be convertible,
as described below, into 3,859,649 shares of our Common Stock (subject to
adjustment), at a conversion price of $2.85 per share (subject to adjustment),
(ii) a $1,000 face amount 4% Convertible Class B Debenture due 2009 (the "Class
B Debenture") which is convertible at any time at the election of Sprint into up
to 1,000 shares of a newly created series of our Preferred Stock designated
Class J Preferred Stock, par value $1.00 per Share (the "Preferred Stock"), at
the rate of one share of Preferred Stock for each $1.00 principal amount of
Class B Debenture, and (iii) warrants (the "Warrants") to purchase at $1.00 per
Warrant up to 8,397,873 (subject to adjustment) debentures that will have
substantially the same terms as the Class A Debenture (the "Warrant Debentures")
and will be convertible at a conversion price of $2.85 per share (subject to
adjustment) into 2,689,455 shares of Common Stock (subject to adjustment). In
consideration for such securities, Sprint paid a purchase price of $11,001,000
and agreed to purchase $10 million of our products on terms that are to be
negotiated, as described below. We granted to Sprint in the Sprint Purchase
Agreement certain rights regarding corporate governance, the right to appoint
two directors to our Board of Directors, certain rights of first refusal,
preemptive rights and other rights, as described below. Pursuant to the Sprint
Purchase Agreement, we also entered into a 1999 Amended and Restated Investor
Rights Agreement (the "Rights Agreement") and a Warrant Agreement, both dated as
of September 9, 1999, and we and Sprint agreed to enter into an Equipment
Purchase Agreement, as described below.
CLASS A DEBENTURE. The Class A Debenture is in the principal amount of $11
million and bears interest at the rate of 4% per annum, on a 360 day basis,
actual days elapsed. Interest is payable quarterly in arrears commencing on
October 1, 1999 and thereafter on the first business day of each calendar
quarter. Instead of paying interest in cash, we will pay interest on the Class A
Debenture by adding each month the amount of interest to the outstanding
principal amount due
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after the Class A Debenture. Sprint will have the right to convert the
principal of the Class A Debenture (or any portion of the principal thereof
which is $1.00 or an integral multiple of $1.00) into shares of Common Stock
at the rate of one share of Common Stock for each $2.85 principal amount of
the Class A Debenture (subject to adjustment as provided in the Class A
Debenture, the "Conversion Price"). The Class A Debenture is convertible at
any time, at the option of Sprint, following the first of the following to
occur: (i) December 31, 1999 (unless we agree in writing to an earlier date),
(ii) a Change of Control (as defined below) or (iii) receipt by Sprint of a
Change of Control Notice (as defined below) from us. For purposes of the
Class A Debenture, "Change of Control" means the occurrence of any of the
following: (a) any person shall have acquired beneficial ownership of more
than 25% of our outstanding voting stock (within the meaning of Section 13(d)
or 14(d) of the Exchange Act); or (b) individuals who immediately following
the closing were directors of ours (which includes the directors designated
by Sprint, together with any replacement or additional directors who were
nominated or appointed by a majority of directors in office immediately
following the closing or by a majority of such directors and their nominees
or appointees) cease to constitute a majority of our Board of Directors. In
the event that a proposed Change of Control will occur pursuant to an
agreement to which we are a party, we will give notice of such proposed
Change of Control (a "Change of Control Notice") to Sprint at least 10
business days prior to the consummation of the transactions contemplated by
such agreement.
At any time on or after December 31, 2000, we will have the right to
convert the principal of the Class A Debenture (or any portion of the
principal hereof which is $1.00 or an integral multiple of $1.00) into shares
of Common Stock at the Conversion Price.
The Class A Debenture is subject to adjustment for certain additional
issuance of capital stock or rights to acquire capital stock ("Additional
Stock") and for any stock split, reverse stock split, stock dividend,
recapitalization, merger, consolidation or sale of substantially all our
assets. If any Additional Stock is issued during the period commencing
September 9, 1999 and ending March 9, 2000 for per share consideration less
than the then Conversion Price, the then Conversion Price will be reduced to
the per share price at which such Additional Stock is issued (ratchet
antidilution). If any Additional Stock is issued after March 9, 2000 for per
share consideration less than the then Conversion Price, the then Conversion
Price will be adjusted based on a weighted average calculation (weighted
average antidilution). In the Sprint Securities Purchase Agreement, we
represented that on September 9, 1999 the number of shares of Common Stock
outstanding on a fully diluted basis (assuming the exercise of all stock
options and warrants and the conversion of all debentures and any other
convertible instruments) after the transactions described herein was
30,396,481 and that 3,859,649 (the number of shares into which the Series A
Debenture was convertible at $2.85 per share) constituted 12.6977% of such
fully diluted number. If the actual number of shares then outstanding was
greater than 30,396,481, the initial Conversion Price of $2.85 would be
reduced so that the number of shares of Common Stock into which the Series A
Debenture would be convertible upon issuance would represent 12.6977% of the
outstanding shares of Common Stock on a fully diluted basis.
CLASS B DEBENTURE. The Class B Debenture is in the principal amount of
$1,000 and bears interest at the rate of 4% per annum, on a 360 days basis,
actual days elapsed, which is payable in full at maturity or upon conversion.
The Class B Debenture is convertible at any time at the option of the
Purchaser into 1,000 shares of Preferred Stock. As long as the total number
of shares of our Common Stock that Sprint and its affiliates owns or would
own assuming the conversion of all debentures and the exercise of all
Warrants as a percentage of all outstanding shares of our Common Stock on a
fully diluted basis ("Sprint's Interest") is 10% or more, (a) the holders of
Preferred Stock, voting as a separate class, will have the right to elect two
directors to serve on our Board of Directors and (b) the affirmative vote of
the holders of a majority of the shares of Preferred Stock will be necessary
for us to:
(i) adopt an Annual Business Plan (as defined) or take any
actions that materially deviate from such plan;
(ii) make any capital expenditures in excess of $2 million in
the aggregate in any fiscal year, except to the extent contemplated in the
Annual Business Plan;
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(iii) make any acquisition or disposition of any interests in
any other person or business enterprise or any assets, in a single transaction
or a series of related transactions, in which the fair market value of the
consideration paid or received by us exceeds $1 million;
(iv) organize, form or participate in any joint venture or
similar entity involving the sharing of profits in which the assets or services
to be contributed or provided by us to such joint venture or other entity have a
fair market value in excess of $1 million;
(v) form a subsidiary;
(vi) issue any Common Stock, preferred stock or other capital
stock or any stock or securities (including options and warrants) convertible
into or exercisable or exchangeable for Common Stock, preferred stock or other
capital stock or amend the terms of any such stock or securities or any
agreements relating thereto (other than employee stock options approved by our
Board of Directors and Common Stock issued upon exercise thereof) or effect any
stock split or reverse stock split or combination;
(vii) enter into any transaction between us, on the one hand,
and any Affiliate or Associate of ours (as defined), on the other, other than
the payment of compensation and other benefits to employees and directors in the
ordinary course of business;
(viii) declare or pay any dividend or other distribution with
respect to our capital stock;
(ix) incur any indebtedness for borrowed money or capital
lease obligations that are not expressly contemplated in the then-current Annual
Business Plan in excess of $250,000 in the aggregate during any fiscal year;
(x) amend our Certificate of Incorporation or Bylaws or create
or amend a stockholders' rights plan;
(xi) declare bankruptcy; or
(xii) liquidate or dissolve.
The Certificate of Designations for the Preferred Stock states that the
voting rights specified in the certificate shall terminate at such time as
any share of the Preferred Stock ceases to be owned by Sprint and its
Affiliates (as defined).
WARRANTS. Pursuant to a Warrant Agreement dated September 9, 1999,
Sprint purchased 8,397,873 Warrants to purchase Warrant Debentures at $1.00
per Warrant Debenture. The Warrant Debentures will have substantially the
same terms as the Class A Debenture (including the conversion rights referred
to above). The Warrants will be exercisable on the earliest date that Sprint
has submitted to us at least $1 million of purchase orders under the
Equipment Purchase Agreement to be negotiated between us and Sprint. On that
date, 10% of the Warrants (rounded to the nearest whole Warrant) will become
exercisable. Thereafter, an additional 10% of the Warrants (rounded to the
nearest whole Warrant) will become exercisable for each additional $1 million
of purchase orders as are submitted by Sprint to us under the Equipment
Purchase Agreement, such that the entire amount of Warrants will be
exercisable when $10 million of purchase orders have been submitted.
The Warrant Agreement provides that, if at any time before March 9, 2000
we amend the terms of its outstanding $5.5 Million Debenture we issued in
1997, or enter into any other arrangement with the holder of the $5.5 Million
Debenture, that increases the number of shares of our Common Stock that would
be outstanding on a fully diluted basis, then we must issue to Sprint such
number of additional Warrants as would be necessary to cause Sprint's
Interest to remain the same. Also, if prior to March 9, 2000, the holder of
the $5.5 Million Debenture gives notice to us demanding payment of any
portion of the principal amount of $5.5 Million Debenture (and we
subsequently
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repay a portion of such principal prior to maturity), or if we voluntarily
repay a portion of the principal amount of the $5.5 Million Debenture before
March 9, 2000, then we must issue to Sprint a number of additional Warrants
equal to 2.85 times (a) the amount by which the repaid amount divided by the
Conversion Price of the Debentures (as defined below) exceeds the number of
shares of Common Stock into which the repaid amount of the $5.5 Million
Debenture would have been convertible (if it had not been repaid), (b)
divided by 3.
OTHER RIGHTS GRANTED TO SPRINT. The Sprint Purchase Agreement also
provides a right of first refusal if we enter into a "Change of Control
Agreement," which is defined to include (i) any merger or consolidation of
ours which results in a Change of Control (as defined above), (ii) any
disposition of a substantial portion of our assets, (iii) any sale or
issuance of stock (including a tender offer) that results in a Change of
Control or (iv) any other transaction that results in a Change of Control. If
we enter into a Change of Control Agreement with a third party at any time at
which Sprint's Interest is 10% or greater, we must provide a complete copy of
the Change of Control Agreement (including all schedules and exhibits) and
any related agreements to Sprint within one business day following the
execution of the Change of Control Agreement. The delivery of the Change of
Control Agreement to the Sprint will constitute a binding offer by us to
consummate with Sprint the transactions contemplated by the Change of Control
Agreement on the terms as set forth in the Change of Control Agreement. Such
offer will be irrevocable for a period ending at 11:59 p.m., Kansas City
time, on the 60th day following the day of delivery of the Change of Control
Agreement to Sprint, which period may be extended as provided in the Sprint
Purchase Agreement. The Sprint Purchase Agreement provides that Sprint may
assign all or any part of its right of first refusal to any other Person (as
defined), whether or not an affiliate of Sprint.
The Sprint Purchase Agreement further provides that, for so long as
Sprint's Interest is equal to or greater than 10%, if we determine to issue
for cash consideration additional securities of ours, including options,
warrants, convertible instruments or other direct or indirect rights to
acquire equity securities of ours ("Equity Securities") to third parties,
other than Equity Securities issued or proposed to be issued to or for the
benefit of any Person (as defined in the Purchase Agreement) who serves as an
employee or director of ours in the ordinary course of business, we will
offer Sprint the right to purchase that certain portion of the additional
Equity Securities as will permit Sprint to maintain the same percentage
ownership interest in us (on a fully diluted basis) as it had immediately
before the issuance of the Equity Securities.
For so long as Sprint's Interest is equal to or greater than 10%, if we
determine to issue additional Equity Securities to officers or employees or
for other than cash consideration, and the issuance of such additional Equity
Securities would cause Sprint's Interest to fall below 10%, Sprint shall
have, under the Sprint Purchase Agreement, the right to purchase from us such
number of shares of Common Stock as will cause Sprint's Interest to remain at
or above 10%.
Under the Sprint Purchase Agreement, as long as Sprint's Interest is 10%
or greater, we are not permitted to take the actions referred to above (in
(i) through (xii) under the heading "Series B Debenture") without Sprint's
prior written approval.
RIGHTS AGREEMENT. Pursuant to the Sprint Purchase Agreement, we, Sprint
and holders of a majority of the "Registrable Securities" under our prior
registration rights agreement, together with the investors referred to below,
entered into the Rights Agreement dated September 9, 1999. Under the Rights
Agreement, Sprint has the right on two occasions to require us to register
under the Securities Act of 1933, at our expense, Sprint's sale of shares of
our Common Stock that Sprint acquires pursuant to the Sprint Purchase
Agreement. In addition, Sprint and the other holders of Registrable
Securities (as defined in the Rights Agreement) have (a) piggyback
registration rights to participate, at our expense, in any registration by us
for our own account or for the account of any stockholder (other than
registrations on Form S-8 or Form S-4, but including any registration
pursuant to Sprint's demand registration rights) and (b) the right to require
us to register, at our expense, the sale of the Registrable Securities on
Form S-3, subject to certain conditions.
EQUIPMENT PURCHASE AGREEMENT. Under the Sprint Purchase Agreement,
Sprint agreed to purchase $10 million of certain types of our products
pursuant to an Equipment Purchase
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Agreement that is to be negotiated between us and Sprint. Certain terms of
the agreement have been specified by the parties, and they have agreed to
negotiate in good faith to resolve all open terms in order to execute
Equipment Purchase Agreement by December 31, 1999. If we are unable to agree
upon all terms by that date, any unresolved terms will be submitted to
arbitration.
ISSUANCE OF DEBENTURES TO OTHER INVESTORS.
Concurrent with the closing of the Sprint Purchase Agreement, we issued
and sold to certain other investors (the "Investors") for $7.1 million 4%
Convertible Debentures due 2009 in the aggregate face amount of $7.1 million
(the "Debentures"). The Debentures will be convertible into an aggregate of
2,491,228 shares of our Common Stock (subject to adjustment) at a conversion
price of $2.85 per share shares (subject to adjustment). The terms of the
Debentures are substantially the same as the terms of the Class A Debentures.
CONTINGENCIES
CLASS ACTION LITIGATION
In June 1998, five class action lawsuits were filed in Santa Clara
County Superior Court, California against us, our five directors then in
office (one of whom was an officer at that time), two former officers and one
former director. The lawsuits were brought on behalf of purchasers of our
Common Stock during the class period commencing November 12, 1997 (the date
of our initial public offering) and ending June 1, 1998. In July 1998, a
sixth class action lawsuit was filed in the same court against the same
defendants, although the class period was extended to June 18, 1998. All six
lawsuits also named as defendants the underwriters in our initial public
offering, but the underwriters have since been dismissed from the cases.
The complaints in these lawsuits claim that we and the other defendants
violated the anti-fraud provisions of the California securities laws,
alleging that the financial statements we used in connection with our initial
public offering and the financial statements we issued subsequently during
the class period, as well as related statements made on our behalf during the
initial public offering and subsequently regarding our past and prospective
financial condition and results of operations, were false and misleading. The
complaints also allege that we and the other defendants made these
misrepresentations in order to inflate the price of our stock for the initial
public offering and during the class period. We and the other defendants
denied the charges of wrongdoing.
The parties have agreed to settle these lawsuits as discussed below.
In July and August 1998, two class action lawsuits were filed in the
U.S. District Court for the Northern District of California. Both of these
federal class action lawsuits were brought against the same defendants as the
six state court class actions referred to above, except that the second
federal class action lawsuit also named as a defendant Pricewaterhouse
Coopers (PwC), our former independent auditors. (The underwriters in our
initial public offering were named as defendants in the first federal class
action lawsuit but were subsequently dismissed.) The class period for the
first federal class action lawsuit is from November 12, 1997 to June 1, 1998,
and the class period in the second class action lawsuit extends to June 17,
1998. The complaints in both federal class action lawsuits claim that we and
the other defendants violated various provisions of the federal securities
laws, on the basis of allegations that are similar to those made by the
plaintiffs in the state class action lawsuits. We and the other defendants
denied these charges of wrongdoing.
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We believe that the state and federal class action lawsuits hurt our business
during the latter part of 1998, made it more difficult for us to attract and
retain employees, disrupted our management, sales and marketing, engineering
and research and development staffs, contributed to our inability during the
year to complete the restatement of our financial statements and adversely
affected the sales of our products and services.
In March 1999, we and the other parties to the state class action
lawsuits and the federal class action lawsuits (other than PwC) reached an
agreement in principle to settle the lawsuits. In June 1999, the parties
signed a formal stipulation of settlement and the court preliminarily
approved the settlement. Under the agreement, (i) our insurers would pay $8.8
million on our behalf (and on behalf of the other officer and director
defendants), (ii) we would issue 3.0 million shares of our Common Stock to
the plaintiffs (the number of shares would be increased proportionately to
the extent that there are more than 10.5 million shares of our Common Stock
outstanding on the date of distribution so that, as of such date, the
plaintiffs would hold approximately 22.6% of all of the shares of our Common
Stock that are then outstanding), (iii) if we are acquired prior to December
3, 1999, then, in addition to the consideration referred to in (i) and (ii),
we would pay to the plaintiffs an amount equal to 10% of the consideration
received by our stockholders in the acquisition. As a result of the agreement
and a related agreement between us and our insurers, we have paid, and will
not be reimbursed by our insurers for, $1.2 million in attorney's fees and
other litigation expenses that would otherwise be covered by its insurance,
and we will not have insurance coverage for the attorney's fees and expenses
relating to the settlement that we incur in the future.
In August 1999, the United States District Court for the Northern
District of California, San Jose Division, entered a Final Judgment and Order
of Dismissal in the class action litigation in which, among other things, the
court approved the settlement of that litigation as provided in the
Stipulation of Settlement, dismissed with prejudice all of the Released
Claims (as defined therein), except for certain minor claims referred to in
Exhibit 1 to the order, and declared that such Released Claims are released
as of the Effective Date (as defined in the Stipulation of Settlement). The
period in which to appeal the order will expire in November 1999.
SEC INVESTIGATION
In October 1998, the Securities and Exchange Commission began a formal
investigation of us and unidentified individuals with respect to our
financial statements and public disclosures. We have been producing documents
in response to the Securities and Exchange Commission's subpoena and are
cooperating with the investigation. A number of current and former officers,
other employees and directors have testified or may testify before the
Securities and Exchange Commission's staff.
LAWSUIT BY PACIFIC MONOLITHICS
In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as
debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court,
California against us, our five directors then in office (one of whom was an
officer at that time), a former director (as to whom the action was
subsequently dismissed), a former officer and PwC. The lawsuit concerns an
agreement which we entered into in March 1998 to acquire Pacific Monolithics
through a merger, which acquisition was never consummated. The complaint
alleges that we induced Pacific Monolithics to enter into the agreement by
providing it with financial statements, and by making other representations
concerning financial condition and results of operations, which were false
and misleading, and further alleges that we wrongfully failed to consummate
the acquisition. The complaint claims the defendants committed breach of
contract and breach of implied covenant of good faith and fair dealing, as
well as fraud and negligent misrepresentation. The complaint seeks
compensatory and punitive damages according to proof, plus attorneys' fees
and costs. The plaintiff has attempted to initiate discovery, which
defendants have opposed on the basis that the plaintiff and we had agreed
that any disputes would be submitted to arbitration. The defendants have
filed a motion to compel arbitration and to stay the court action.
In July 1999, the court granted our motion to compel arbitration and to
stay the lawsuit pending the outcome of the arbitration. In October 1999,
Pacific Monolithics submitted a Demand for
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Arbitration to the American Arbitration Association. Our response is not yet
due. No date for the arbitration hearing has yet been set.
We do not believe, based on current information (which is only
preliminary, since discovery has not commenced in the litigation), that the
outcome of the arbitration will have a material adverse impact on our
financial statements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE DISCUSSION IN THIS ITEM SHOULD BE READ IN CONJUNCTION WITH THE
CONDENSED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED IN ITEM 1 OF THIS
REPORT ON FORM 10-Q. THE DISCUSSION IN THIS ITEM CONTAINS FORWARD-LOOKING
STATEMENTS RELATING TO FUTURE EVENTS OR FINANCIAL RESULTS, SUCH AS STATEMENTS
INDICATING THAT "WE BELIEVE," "WE EXPECT," "WE ANTICIPATE" OR "WE INTEND" THAT
CERTAIN EVENTS MAY OCCUR OR CERTAIN TRENDS MAY CONTINUE. OTHER FORWARD-LOOKING
STATEMENTS INCLUDE STATEMENTS ABOUT THE FUTURE DEVELOPMENT OF PRODUCTS OR
TECHNOLOGIES, MATTERS RELATING TO OUR PROPRIETARY RIGHTS, YEAR 2000 COMPLIANCE,
FACILITIES NEEDS, OUR LIQUIDITY AND CAPITAL NEEDS AND OTHER STATEMENTS ABOUT
FUTURE MATTERS. ALL THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES. YOU SHOULD NOT RELY TOO HEAVILY ON THESE STATEMENTS; ALTHOUGH
THEY REFLECT THE GOOD FAITH JUDGMENT OF OUR MANAGEMENT, THEY INVOLVE FUTURE
EVENTS THAT MIGHT NOT OCCUR. WE CAN ONLY BASE SUCH STATEMENTS ON FACTS AND
FACTORS THAT WE CURRENTLY KNOW. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS,
INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS REPORT ON
FORM 10-Q.
OVERVIEW
GENERAL
We are a broadband access equipment company that designs, develops,
manufactures and markets wireless and cable systems that provide high speed
access to the Internet and corporate intranets for both businesses and
consumers. Our products remove the bottleneck over the local connection to the
end-user which causes slow response time for those accessing bandwidth-intensive
information. Our Series 2000 product line consists of secure headend routers,
wireless and cable modems and management software for use with either wireless
transmission or cable TV facilities.
We sell our products primarily in the United States. Our customers include
broadband wireless system operators, cable system operators and ISPs.
Historically, a small number of customers has accounted for a substantial
portion of our net sales, and we expect the trend to continue. As a result, we
have experienced, and expect to continue to experience, significant fluctuations
in our results of operations on a quarterly and an annual basis. The sales cycle
for our products has been lengthy, generally lasting three to nine months, and
is subject to a number of significant risks, including customers' budgetary
constraints and internal acceptance reviews. Because our sales cycle may be long
and uncertain, and because we depend on relatively few customers who place
relatively large orders, any delay or loss of an order that is expected to be
received in a quarter can have a major effect on our sales and operating results
for that quarter. The same is true of any failure of a customer to pay for
products on a timely basis.
The market for high-speed network connectivity products and services is
intensely competitive and is characterized by rapid technological change, new
product development and product obsolescence, and evolving industry standards.
Our ability to develop and offer competitive products on a timely basis that
satisfy industry demands, such as for two-way QPSK, or industry standards could
have a material effect on our business. In addition, the market for our products
has historically experienced significant price erosion over the life of a
product, and we have experienced and expect to continue to experience pressure
on our unit average selling prices. While we have initiated cost reduction
programs to offset pricing pressures on our products, there can be no assurance
that we will keep pace with competitive price pressures or improve our gross
margins. If we are unable to continue to reduce costs quickly enough, our
profitability will be adversely affected. Our profitability is also affected by
the sales mix of headends and modems. Our single-user modems generally have
lower margins than our multi-user modems, both of which have lower margins than
our headend routers. Due to current customer demand, we anticipate that the
sales mix of modems will be weighted toward lower-margin modems in the
foreseeable future. As a result, our gross margins, and our business, could be
adversely affected.
Historically, our products have been sold for use with cable TV facilities
and wireless transmission in approximately equal proportions (varying from
quarter to quarter). Due to
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consolidation among cable companies, the adoption of the DOCSIS cable
standard by large cable operations, the existence of established
relationships between our competitors and cable system operators and other
factors, we anticipate that sales to cable operators will involve a
substantially smaller portion of our business in the future. Our principal
cable customer, RCN Corporation, has indicated that it will substantially
reduce its purchases of our products in the future.
We believe our products are particularly well suited for use in broadband
wireless applications. Until this year, however, the wireless industry has
suffered from undercapitalization and poor financial performance. During 1999,
the wireless industry has received a substantial infusion of capital,
principally from investment by telephone companies. Sprint Corporation announced
that it will acquire PCTV-Speedchoice and other wireless operators (which
constitute our principal wireless customers). In September 1999, Sprint invested
$11.0 million in our securities (and we received an additional $7.1 million in
investment from venture capital sources), and Sprint committed to purchase at
least $10 million of our products for wireless applications. As part of the
investment, Sprint acquired veto rights with respect to most material corporate
actions we might take as well as other substantial rights and privileges. We
anticipate that the success of our future operations will depend to a
substantial extent upon our relationship with Sprint and whether Sprint selects
our products for use in connection with Sprint's wireless high speed Internet
access services in the future.
Due to our diminished capital resources during the first three quarters of
1999 (see "--Liquidity and Capital Resources"), we reduced our expenditures for
research and development and sales and marketing during this period. In February
1999, we implemented a reduction in force. As of September 30, 1999, the number
of our full-time employees was 36 compared to 87 full-time employees at December
31, 1998. Following the infusion of funds we received in September 1999, as
indicated above, we are seeking to hire new employees and plan to increase our
expenditures for research and development, sales and marketing.
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RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales represented by
the items in our statements of operations for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
------------------ ----------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Sales 92.2% 106.6% 111.7% 115.2%
------ ------ ------ ------
Gross margin 7.8% -6.6% -11.7% -15.2%
------ ------ ------ ------
Operating expenses
Research and development 24.7% 39.8% 30.0% 82.0%
Sales and marketing 10.7% 23.0% 13.2% 31.2%
General and administrative 52.6% 96.2% 40.9% 75.1%
------ ------ ------ ------
Total operating expenses 88.0% 159.0% 84.1% 188.3%
------ ------ ------ ------
Loss from operations -80.2% -165.6% -95.8% -203.5%
Interest income and other expense, net 1.0% 2.0% 0.5% 8.1%
Interest expense -61.3% -4.9% -23.4% -7.3%
------ ------ ------ ------
Net loss -140.5% -168.5% -118.7% -202.7%
====== ====== ====== ======
</TABLE>
NET SALES. Our net sales decreased by 21.0% to $3,319,000 for the
quarter ended September 30, 1999 from $4,202,000 the quarter ended September
30, 1998 and increased by 14.1% to $10,447,000 for the nine months ended
September 30, 1999 from $9,151,000 for the nine months ended September 30,
1998. Decreased sales for the quarter ending September 30, 1999 were
primarily due to a decrease in sales of headend routers. Increased sales for
the first nine months of the year were due to increases in modem sales which
more than offset decreases in headend router sales.
For the three months ended September 30, 1999, broadband wireless
systems operators, cable system operators and ISPs accounted for 43%, 45% and
12% of net sales, respectively. For the three months ended September 30, 1998
wireless system operators, cable system operators and ISPs accounted for 34%,
60% and 6% of net sales, respectively. Three customers accounted for 33%,
24%, and 12% of net sales during the third quarter of 1999. Three customers
accounted for 17%, 16% and 13% of net sales during the comparable period in
1998. International sales accounted for 9% of net sales during the three
months ended September 30, 1999 and 0% for the comparable period in 1998.
GROSS MARGIN. Gross margin was a positive 7.8% of net sales for the
quarter ended September 30, 1999 and negative 6.6% of net sales for the
quarter ended September 30, 1998. For the nine months ended September 30,
1999 and September 30, 1998, gross margin was a negative 11.7% and a negative
15.2%, respectively. The increase in gross margin in the quarter ending
September 30, 1999 compared to the similar quarter in 1998 is primarily
attributed to a favorable change in the product mix (increased sales of
multi-user modems as compared to single-user modems), improved margins for
headend routers and reduced costs attributable to manufacturing overhead.
Gross margin for the nine months ending
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September 30, 1999 continued to be negative but at a lower figure than
for the comparable period in 1998 due primarily to improved margins for
headend routers.
RESEARCH AND DEVELOPMENT. Research and development expenses include
ongoing headend, software and cable modem development expenses, as well as
design expenditures associated with product cost reduction programs and
programs for improving manufacturability of our existing products. Research
and development expenses decreased 51.0% to $820,000 for the quarter ended
September 30, 1999 from $1,674,000 for the quarter ended September 30, 1998.
For the nine months ended September 30, 1999, research and development
expenses decreased 58.3% to $3,131,000 from $7,507,000 for the nine months
ended September 30, 1998. Research and development expenses as a percentage
of net sales were 24.7% and 39.8% for the third quarters of 1999 and 1998,
respectively, and were 30.0% and 82.0% for the first nine months of 1999 and
1998, respectively. Research and development expenses decreased primarily due
to reduced employee headcount and related expenses due to diminished capital
resources during the period. During the three months ended September 30,
1999, compensation recognized on the grant of stock options with exercise
prices at below fair market value for employees engaged in research and
development amounted to $131,000.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and related payroll costs of sales and marketing personnel,
commissions, advertising, promotions and travel. Sales and marketing expenses
decreased 63.1% to $356,000 for the quarter ended September 30, 1999 from
$966,000 for the quarter ended September 30, 1998. For the nine months ended
September 30, 1999, sales and marketing expenses decreased 51.8% to $1,377,000
from $2,856,000 for the nine months ended September 30, 1998. Sales and
marketing expenses as a percentage of net sales were 10.7% and 23.0% for the
third quarters of 1999 and 1998, respectively, and 13.2% and 31.2% for the first
nine months of 1999 and 1998, respectively. Sales and marketing expenses
decreased primarily due to reduced employee headcount and related expenses
(resulting from our diminished capital resources) and the refocusing of the
business to a small number of existing wireless customers. During the three
months ended September 30, 1999, compensation recognized on the grant of stock
options with exercise prices at below fair market value for employees engaged in
sales and marketing amounted to $15,000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of executive personnel salaries, provision for doubtful accounts,
travel expenses, legal fees and costs of outside services. General and
administrative expenses decreased 56.8% to $1,746,000 for the quarter ended
September 30, 1999 from $4,044,000 for the quarter ended September 30, 1998. For
the nine months ended September 30, 1999, general and administrative expenses
decreased 37.8% to $4,272,000 from $6,868,000 for the nine months ended
September 30, 1998. General and administrative expenses as a percentage of net
sales were 52.6% and 96.2% for the third quarters of 1999 and 1998,
respectively, and 40.9% and 75.1% for the first nine months of 1999 and 1998,
respectively. During the quarter ended September 30, 1999, expenses remained
high in absolute dollars due to work in finalizing the class action litigation
settlement and legal expenses associated with the SEC investigation. Expenses
remained relatively high in absolute dollars for the nine months ended September
30, 1999 due to continued work on getting our financial statements audited and
work in connection with the class action settlement and the SEC investigation.
During the three months ended September 30, 1999, compensation recognized on the
grant of stock options with exercise prices at below fair market value for
employees engaged in administration amounted to $60,000.
INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net
interest expense of $2,000,000 for the three months ended September 30, 1999
compared to net interest expense of $122,000 for the three months ended
September 30, 1998. For the nine months ended September 30, 1999, we incurred
net interest expense of $2,398,000 compared to net interest income of $77,000
during the nine months ended September 30, 1998. The increase in net interest
expense for the quarter and for the nine month period was primarily due to
amortization of a deemed discount of approximately $7.3 million which results
from the difference between the conversion price ($2.85) of the $18.1 million of
convertible debentures which we agreed to issue on August 30, 1999 and the then
market price of our Common Stock ($4.00). This deemed discount will be
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amortized over the four months ending December 31, 1999 (the date on which
the debentures become convertible). The amortization charge related to the
deemed discount was approximately $1.8 million for September 1999 and will be
approximately $5.5 million for the fourth quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations primarily through a
combination of debt, equity and equipment lease financing. In 1997, we raised
$42.5 million in net proceeds through our initial public offering (in
November 1997) and other debt and equity financings. By September 1999, our
cash and cash equivalents had been virtually exhausted. In September 1999, we
raised $18.1 million through the issuance and sale of convertible debentures
to Sprint Corporation (in the amount of $11.0 million) and certain venture
capital sources (in the amount of $7.1 million). The debentures are due in
September 2009 and bear interest at 4% per annum, compounded monthly (accrued
interest is automatically added to principal monthly). The debentures will be
convertible into Common Stock at the option of the respective holders at any
time after December 31, 1999 or upon a change of control, whichever occurs
first, and will be convertible into Common Stock at our option at any time
after 2000. The conversion price is $2.85 per share, subjected to
antidilution adjustment (ratchet antidilution adjustment for the first six
months, and weighted average antidilution thereafter). The debentures would
be convertible into 6,350,877 shares of Common Stock at the current
conversion price of $2.85.
In connection with the purchase of convertible debentures, Sprint
Corporation also acquired warrants to purchase up to $8.4 million of additional
convertible debentures, which debentures will be convertible into 2,689,455
shares of Common Stock, on the same terms as the convertible debentures referred
to above. The warrants were issued in consideration for Sprint's obligation to
purchase at least $10 million of our products on terms that are to be
negotiated, and the exercisability of the warrants is tied to Sprint's
submission of purchase orders for our products (10% of the warrants become
exercisable for each $1 million of purchase orders submitted).
Assuming that as of September 9, 1999 Sprint converted all its convertible
debentures and exercised all its warrants, it would own 6,806,271 shares of our
Common Stock, representing approximately 39% of the 17,473,967 shares of our
Common Stock that would then be outstanding (as adjusted for the issuance of
Common Stock pursuant to such debentures and warrants and assuming no other
outstanding options, warrants or debentures are exercised).
Under the terms of Sprint's investment, it will have substantial corporate
governance rights (including veto rights over most material actions we might
take) and substantial additional rights and privileges, as described in greater
detail in Item 2 of Part II below.
Net cash used in operating activities was $4,396,000 and $15,537,000
during the first nine months of 1999 and 1998, respectively. The net cash
used in operating activities in the first nine months of 1999 was primarily
the result of our net loss of $12,405,000, partially offset by a reduction in
inventories of $2,999,000, a reduction in accounts receivable of $1,090,000
and an increase in non-cash charges attributable principally to the
amortization of the deemed discount on the debentures referred to above and
to compensation charges recognized on the grant of stock options to employees
at exercise prices which were lower than fair market on the date of grant.
Net cash used in operations in the first nine months of 1998 was primarily
the result of our net loss of $18,550,000.
Net cash used in investing activities was $8,994,000 and $2,860,000 during
the first nine months of 1999 and 1998, respectively. Net cash used in investing
activities for the first nine months of 1999 was primarily due to the purchase
of short term investments in the amount of $8,991,000. Net cash used in
investing activities for the first nine months of 1998, was primarily a result
of the purchase of property and equipment of $3,818,000, partially offset by net
proceeds from short term investments of $893,000. In the past, we have funded a
substantial portion of our property and equipment expenditures from direct
vendor leasing programs and third party commercial lease arrangements. At
September 30, 1999, we did not have any material commitments for capital
expenditures.
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Net cash from financing activities was $18,052,000 for the first nine
months of 1999 compared to a net use of cash of $311,000 for the first nine
months of 1998. The increase was the result of the issuance in September 1999 of
the convertible debentures in the principal amount of $18,101,000 referred to
above.
At September 30, 1999, our liquidity consisted of cash and cash equivalents
and short term investments of $17,125,000. We had no available line of credit or
other source of borrowings or financing. Our principal indebtedness consists of
the $18.1 million convertible debentures issued in September 1999 and a
convertible debenture issued in April 1997 in the principal amount of $5.5
million (the "$5.5 Million Debenture").
RISKS RELATED TO THE YEAR 2000 ISSUE.
BACKGROUND. The "Year 2000 Issue" refers generally to the problems that
some software, including firmware embedded in our products, may have in
determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results.
OUR READINESS PLAN. We have developed a Year 2000 readiness plan for the
current versions of our products. The plan includes development of corporate
awareness, assessment, implementation (including remediation, upgrading and
replacement of certain product versions), validation testing and contingency
planning. We continue to respond to customer concerns about prior versions of
our products on a case-by-case basis and we believe most products that could be
affected have been withdrawn from service.
We have completed our plan, except for contingency planning, with respect
to the current versions of all of our products to assure that they are Year 2000
compliant. As a result of our readiness plan all of the current versions of each
of our products currently offered for sale are Year 2000 compliant (with the
exception of final quality assurance and customer network testing), when
configured and used in accordance with the related documentation, and provided
that the underlying operating system of the host machine and any other software
used with or in the host machine or our products are also Year 2000 compliant.
In some cases, our products require an upgrade which is either sold as a
complete substitute or as a kit for in-service systems to be Year 2000
Compliant. We consider our products to be Year 2000 compliant if they have the
ability to: (i) correctly handle date information needed for the December 31,
1999 to January 1, 2000 date change; (ii) function according to the product
documentation provided for this date change without changes in operation
resulting from the advent of a new century, assuming correct configuration;
(iii) where appropriate, respond to two-digit date input in a way that resolves
the ambiguity as to century in a disclosed, defined, and predetermined manner;
and (iv) recognize year 2000 as a leap year.
RISKS. Despite our testing and testing by our current customers, and any
assurances from developers of products incorporated into our products, our
products may contain undetected errors or defects associated with Year 2000 date
functions. Also, certain prior versions of our products are not fully Year 2000
compliant and may remain in service. Known or unknown errors or defects in our
products could result in delay or loss of revenue, diversion of development
resources, damage to our reputation, or increased service and warranty costs,
any of which could materially adversely affect our business.
We do not currently have any information concerning the Year 2000
compliance status of our customers. If our customers suspend or defer
investments in system enhancements or new products to address Year 2000
compliance problems, our business could be materially adversely affected.
Some commentators have predicted significant litigation regarding Year 2000
compliance issues. Because this type of litigation lacks precedent, it is
uncertain whether or to what extent we may be affected by it.
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We have an ongoing program in an effort to prevent any adverse effects
caused by the Year 2000 issue with regard to our mission critical internal
information systems (including the third-party software for our management
information systems, networks and desktop applications, and our hardware
telecommunications technology). With respect to Mission Critical internal
systems, we are currently 100% Year 2000 compliant.
COSTS. We have funded our Year 2000 efforts from operating cash. While we
do not expect such costs to be material, additional costs will be incurred
related to Year 2000 programs for administrative personnel to manage our
readiness plans, technical support for our product engineering and customer
satisfaction. Although we are currently not aware of any material operational
issues or costs associated with preparing our internal information systems for
the Year 2000, we may experience material unanticipated problems and costs
caused by undetected errors or defects in the technology used in our information
systems. We can give no assurance that other material problems and costs will
not arise in connection with Year 2000 compliance or that these problems and
costs will not adversely affect our business.
CONTINGENCY PLANNING. We have not developed a comprehensive contingency
plan to address situations that may result if we are unable to achieve Year 2000
readiness of our critical operations. The cost of developing and implementing
such a plan may itself be material. We are also subject to external forces that
might generally affect industry and commerce, such as utility or transportation
company Year 2000 compliance failures and related service interruptions. Were we
to experience an unanticipated Year 2000 interruption, business operations could
be seriously impaired for an indefinite period of time until remedial efforts
could be achieved.
SEASONALITY AND INFLATION.
We do not believe that our business is seasonal or that it is impacted by
inflation.
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RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU
SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN
THIS REPORT ON FORM 10-Q BEFORE INVESTING IN OUR COMMON STOCK. THE RISKS
DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE
AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY BECOME IMPORTANT
FACTORS THAT AFFECT OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS OCCUR, OR IF
OTHERS OCCUR, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION COULD BE
SERIOUSLY HARMED.
WE WILL NEED ADDITIONAL CAPITAL.
Although we raised over $35 million in net proceeds from our initial
public offering in November 1997, our capital resources were virtually
exhausted by September 1999. In September, we raised $18.1 million from the
issuance and sale of convertible debentures. We anticipate that we will need
to raise additional capital during 2000. Our ability to raise additional
capital may be limited by a number of factors, including (i) Sprint's veto
rights, right of first refusal and other substantial rights and privileges,
(ii) our dependence upon Sprint's business (which is not assured) and, to a
lesser extent, the business of a few other customers, (iii) possible
continuing uncertainties and concerns as a result of our past financial
reporting difficulties, class action litigation and related issues, (iv) our
need to increase our work force quickly and effectively and to reduce the
cost of our existing products and develop new products, (v) our Common Stock
being delisted from the Nasdaq National Market and not traded on any other
public market (except for sales on the Pink Sheets which have occurred
without our consent), (vi) uncertainty regarding our financial condition and
results of operations, (vii) our history of heavy losses and (viii) the other
risk factors referred to herein. We can give no assurance that we will be
able to raise the additional capital we will need in the future or that any
financing we may be able to obtain will not be on terms that are detrimental
to our business and our ability to raise additional capital.
WE ARE LARGELY DEPENDENT ON SPRINT
In September 1999, Sprint invested $11 million in purchasing convertible
debentures from us and acquired warrants to purchase additional convertible
debentures. The warrants are in consideration for a commitment by Sprint to
purchase $10 million of our products by the end of 2000, but the terms of such
purchases are subject to negotiation. Sprint is acquiring our principal wireless
customers, and we expect that our future business will come primarily from
wireless customers. Accordingly, our future business will probably be
substantially dependent upon orders from Sprint or from companies selling to
Sprint. Sprint is considering using our products in connection with its roll-out
of wireless Internet access services, but it has made no commitment to do so and
there can be no assurance that it will do so.
In connection with Sprint's investment in us, Sprint obtained substantial
corporate governance rights. Two of our five directors are Sprint designees, and
if Sprint exercised all its warrants and conversion privileges (and if no one
else did so), Sprint would own approximately 39% of our Common Stock. Under the
terms of our agreements with Sprint, we cannot issue any securities or, in most
cases, take material corporate action without Sprint's approval. Sprint has
other rights and privileges, including pre-emptive rights and a right of first
refusal in the case of any proposed change of control transaction. (See Item 2
of Part II below.) As a result, Sprint will have a great deal of influence on us
in the future. We have no assurance that Sprint will exercise this influence in
our best interests, as Sprint's interests are in many respects different than
ours (e.g., in deciding whether to purchase our products, in negotiating the
terms of any such purchases and in deciding whether or not to support any future
investment in us or any future strategic partnering or sale opportunity).
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OUR LIMITED OPERATING HISTORY AND HEAVY LOSSES MAKE OUR BUSINESS DIFFICULT
TO EVALUATE.
We were organized in 1990 and have had operating losses each year since
then. Our accumulated deficit was $75,974,000 as of September 30, 1999 and
$63,569,000 as of December 31, 1998. The revenue and profit potential of our
business is unproven. The market for our products has only recently begun to
develop, is rapidly changing, has an increasing number of competing technologies
and competitors, and many of the competitors are significantly larger than we
are. We have had negative gross margins in prior periods and the price pressures
on sales of our products continues. We expect to incur losses for some time.
WE FACE LITIGATION RISKS.
Although the class action lawsuits have been settled, we continue to
face litigation with Pacific Monolithics (referred to in Part II, Item 1
"Legal Proceedings"), and we are subject to an investigation by the SEC. It
is difficult for us to evaluate what the outcome of the Pacific Monolithics
litigation or the SEC investigation will be. Responding to the investigation
has been, and probably will continue to be, expensive and time-consuming for
us, and responding to the Pacific Monolithics litigation may be expensive as
well. We do not know whether the results of the litigation or the
investigation will be damaging for us.
It is possible that we may be exposed to further litigation in the
future, particularly in light of the restatement of our financial statements,
and the adverse developments that have occurred partly as a result of the
restatement. In addition, litigation may be necessary in the future to
enforce our intellectual property rights or to determine the validity and
scope of our patents or of the proprietary rights of others. Such litigation
might result in substantial costs and diversion of resources and management
attention. Furthermore, our business activities may infringe upon the
proprietary rights of others, and in the past third parties have claimed, and
may in the future claim, infringement by our software or products. Any such
claims, with or without merit, could result in significant litigation costs
and diversion of management attention, and could require us to enter into
royalty and license agreements that may be disadvantageous to us or suffer
other harm to our business. If litigation is successful against us, it could
result in invalidation of our proprietary rights and liability for damages,
which could have a harmful effect on our business. We initiated one patent
infringement litigation to enforce our patent rights, and it resulted in a
settlement in which we granted licenses to the defendants containing terms
that are in some respects favorable to them, including a right of first
refusal to purchase our patents that we granted to one defendant (Com21,
Inc.) in the event that we propose in the future to sell our patents (whether
separately or together with our other assets) to any third party.
Nonetheless, we may find it necessary to institute further infringement
litigation in the future in an effort to assert our patent rights, and third
parties may bring litigation against us challenging our patents. Any such
litigation could be time consuming and costly for us and could result in our
patents being held invalid or unenforceable. Furthermore, even if the patents
are upheld or are not challenged, third parties might be able to develop
other technologies or products without infringing any such patents.
REDUCTION IN OUR EXPENDITURES AND IN THE NUMBER OF OUR EMPLOYEES HAVE HURT
OUR BUSINESS. WE PLAN TO INCREASE EXPENDITURES IN THE FUTURE, BUT WE MIGHT
NOT BE ABLE TO DO SO EFFECTIVELY.
Commencing in the latter part of 1998 and continuing through the first
three quarters of 1999, we reduced our expenditures on research and development
and on other aspects of our business. We also reduced the number of our
employees. During the first quarter of 1999, we implemented a reduction in force
that reduced the number of full-time employees to 32 as of March 31, 1999
compared to 87 full-time employees at December 31, 1998. At September 30, 1999,
the number of full time employees had increased to 36. We used consultants
heavily to supplement our workforce, and as of September 30, 1999 we had 15
consultants in various areas. While we believe these reductions were necessary
to conserve our remaining capital resources, they have limited and delayed the
enhancement of our products and our development of new products, and our sales
and marketing efforts have been adversely affected. These limitations on our
activities (together with the other factors referred to above and elsewhere
herein) have hurt us competitively and may continue to harm our business in the
future.
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In September 1999, we raised $18.1 million and we are now attempting to
hire additional personnel on an expedited basis in order to achieve our product
development goals. We operate in an extremely competitive environment for
technical and other qualified personnel, and there can be no assurance that we
will be able to achieve our hiring and product development goals.
MARKET PRESSURE TO REDUCE PRICES MAY HURT OUR BUSINESS.
The market has historically demanded increasingly lower prices for our
products, and we expect downward pressure on the prices of our products to
continue. The list prices for our Series 2000 client modems currently range from
approximately $320 to $480, depending upon features and volume. Customers
wishing to purchase client modems generally must also purchase an Ethernet
adapter for their computer. These prices make our products relatively expensive
for the consumer electronics and the small office or home office markets. Market
acceptance of our products, and our future success, will depend in significant
part on reductions in the unit cost of our client modems. In a number of
instances, the prices of our competitors' products are lower than ours. Our
ability to reduce our prices has been limited by a number of factors, including
our reliance on a single manufacturer of our modems and on single-sources for
certain of the components of our products.
One of the principal objectives of our research and development efforts has
been to reduce the cost of our products through design and engineering changes,
although, as indicated above, we have recently had to reduce the scope of our
research and development efforts due to lack of capital resources. We have no
assurance that we will be able to redesign our products to achieve substantial
cost reductions or that we will otherwise be able to reduce our manufacturing
and other costs, or that any reductions in cost will be sufficient to improve
our gross margins, which have been negative until this quarter and which must
substantially improve in order for us to operate profitably.
We expect that the market price pressure to reduce the prices on our
products will continue to exert downward pressure on our gross margins. Our
gross margins are also affected by the sales mix of our headends and modems. Our
single-user modems generally have lower margins than our multi-user modems, both
of which have lower margins than our headends. We anticipate that, due to
customer demand, the sales mix of our products may continue to be weighted
toward lower-margin modems.
WE RELY ON A SINGLE MANUFACTURER FOR OUR MODEMS AND ON SINGLE-SOURCE
COMPONENTS.
Our Series 2000 client modems are manufactured by Sharp Corporation through
an agreement we have had since early 1997 with Sharp and its distributor, Itochu
Corporation. We have not developed an alternative manufacturing source. Our
inability to develop alternative manufacturing sources has adversely affected
our ability to reduce the manufacturing costs of our modems despite competitive
pressures that have caused us to reduce our selling prices. We expect downward
pressure on the prices of our products to continue. In order for us to compete
effectively in the sale of modems, we will need to reduce our prices, and the
underlying costs, of our modems. As long as Sharp is the only manufacturing
source of our modems, our ability to reduce the manufacturing costs of our
modems may be limited.
We are dependent upon certain key suppliers for a number of the components
for our 64QAM products. For example, we have only one vendor, BroadCom
Corporation, for the 64QAM demodulator semiconductors that are used in our
client modem products, and in past periods these semiconductors have been in
short supply. In 1997, BroadCom announced a program whereby certain of its
technological and product enhancements may be made available to certain of our
competitors before making them available to us, thereby giving us a competitive
disadvantage. Hitachi is the sole supplier of the processors used in certain of
our modems. Stanford Telecom (now Intel), which is a competitor for at least one
of our broadband wireless products, is currently the sole supplier for certain
components used in our products. There can be no assurance that these and other
single-source components will continue to be available to us, or that deliveries
of them to us will not be interrupted or delayed (due to shortages or other
factors). Having single-source components also makes it more difficult for us to
reduce our cost for these components and makes us
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vulnerable to price increases by the component manufacturer. Any significant
interruption or delay in the supply of components for our products or any
increase in our costs for components, or our inability to reduce component
costs, could hurt our business.
WE ARE IN AN INTENSELY COMPETITIVE MARKET, AND WE COMPETE WITH MUCH LARGER
COMPANIES.
Our market is intensely competitive, and we expect even more competition in
the future. The principal competitive factors in this market include:
- product performance and features including both downstream and
upstream transmission capabilities,
- reliability and stability of operation,
- system and network installation capability,
- evolution to new services and RF architectures,
- sales and distribution capability,
- technical support and service,
- general industry and economic conditions.
While we believe our products and services are competitive with or superior
to those of our wireless competitors, we have been hampered by a lack of
resources, by disruptions resulting from management and personnel changes, and
by uncertainties caused by our past financial reporting difficulties referred to
at the beginning of this report. Although our products have been particularly
well received in the broadband wireless market, financial difficulties among our
wireless customers have limited our sales to and collections from these
customers until recently. In addition, conditions in our market could change
rapidly and significantly as a result of technological changes, and the
development and market acceptance of alternative technologies could decrease the
demand for our products or render them obsolete. Similarly, emergence or
evolution of industry standards or specifications in wireless may put us at a
disadvantage in relation to competitors. There can be no assurance that we will
be able to compete successfully in the future.
In general, our competitors are producers of asymmetric cable modems and
other types of cable modems and other broadband access products. Most of our
competitors are substantially larger and have greater financial, technical,
marketing, distribution, customer support and other resources, as well as
greater name recognition and access to customers, than we have. Many of our
competitors are in a better position to withstand any significant reduction in
capital spending by cable or broadband wireless system operators.
WIRELESS CABLE COMPETITORS. Our principal competitors in the wireless
broadband wireless market include Cisco Systems (which has proprietary
products under development due to its acquisition of Clarity Wireless, Inc.),
COM21 (which is attempting to adapt its proprietary cable systems for
wireless), ADC/Phasecom, Adaptive Broadband, Harris, 3Com, Motorola,
Newbridge Networks and other vendors that are attracted by recent investments
by MCI WorldCom and Sprint in wireless operations. Stanford Telecom is the
sole supplier for certain components used in our products and has indicated
that they might stop shipping these components to us. (Intel is in the
process of acquiring the T.C.P (components) division of Stanford Telecom and
has indicated that upon completion of the acquisition this restriction would
be withdrawn. There is, however, no guarantee that this acquisition will be
completed.) Our products have been more widely accepted in the broadband
wireless market than in the cable market partly because the adoption of the
DOCSIS standard has not had a significant effect on wireless customers. We
believe that products meeting the present DOCSIS standard will not perform
well over wireless. This belief is based on the performance of the adaptive
equalizer in the modem in the presence of multiple signals, the power
required from the transceiver in the return path and the probable disruption
of the TDMA return path in the presence of noise or multi-path propagation.
However, there can be no assurance that improvements in integrated circuit
technology, transceiver output power levels or changes in the
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DOCSIS TDMA protocol will not allow systems developed for cable to perform
effectively over wireless. One of the DOCSIS compliant vendors might also
modify the DOCSIS equipment to a proprietary non-standard form to work over
wireless.
CABLE MODEM COMPETITORS. The adoption of the DOCSIS cable standard by large
cable operators has adversely affected our ability to sell to cable customers,
particularly new customers. Further, our products are not compatible with
headend equipment and modems of other suppliers of broadband Internet access
products, including DOCSIS products, and, as a result, potential customers who
wish to purchase broadband Internet access products from multiple suppliers are
reluctant to purchase our products. This limits cable sales to existing
customers and small operators with special requirements.
OTHER COMPETITION. Broadband wireless and cable system operators face
competition from providers of alternative high speed connectivity systems. In
the wireless high speed access market, broadband wireless system operators
are in competition with satellite TV providers. In telephony networks, xDSL
technology enables digitally compressed video and Internet access signals to
be transmitted through existing telephone lines to the home. Market
acceptance of xDSL, or other wired technologies such as ISDN, or satellite
technologies, such as DBS, could decrease the demand for our products.
Recently, several companies, including Compaq, Intel, Microsoft, 3Com,
Alcatel, Lucent, several RBOCs, MCI WorldCom and others announced the
formation of a group focused on accelerating the pace of ADSL service. Key
customers use DSL and wireless technology to offer Internet access choosing
the most cost effective technology to provide the service to particular
subscribers.
To be successful, we must respond promptly and effectively to the
challenges of new competitive products and tactics, alternate technologies,
technological changes and evolving industry standards. We must continue to
develop products with improved performance over two-way wireless transmission
facilities. There can be no assurance that we will meet these challenges.
EVOLVING INDUSTRY STANDARDS, COMPETING TECHNOLOGIES AND TECHNOLOGICAL
CHANGES MAY HURT OUR BUSINESS.
Our products are not in compliance with the DOCSIS standard that has been
adopted by a number of large cable operators, and this has adversely affected
our ability to sell to cable customers, particularly new customers. Further, our
products are not compatible with headend equipment and modems of other suppliers
of broadband Internet access products, including DOCSIS products, and, as a
result, potential customers who wish to purchase broadband Internet access
products from multiple suppliers may be reluctant to purchase our products. Our
products are not in compliance with the DAVIC specifications that are supported
in Europe. The emergence of these standards has hurt our business, and the
adoption of other industry standards in the future could have a further adverse
effect.
There are a number of competing technologies for providing high speed
Internet access. Alternative high speed connectivity technologies include wired
technologies such as xDSL and ISDN. As indicated in "Competition" above, several
large companies have announced the formation of a group to accelerate the pace
of ADSL service. To the extent that customers view these or other alternative
technologies as providing faster access or greater reliability or
most-effectiveness, sales of our products would be adversely affected.
The market for high speed Internet access products is characterized by
rapidly changing technologies and short product life cycles. The rapid
development of new competing technologies increases the risk that the
competitiveness of our products could be adversely affected. Future advances in
technology may not be beneficial to, or compatible with, our business and
products, and we might not be able to respond to the advances, or our response
might not be timely or cost-effective. Market acceptance of new technologies and
our failure to develop and introduce new products and enhancements to keep pace
with technological developments could hurt our business.
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OUR MARKET IS NEW AND DEVELOPING, AND WE MUST DEPEND UPON WIRELESS
OPERATORS.
The market for broadband Internet access products has only recently begun
to develop and is characterized by an increasing number of market entrants and
competing technologies. Our success will depend primarily on our ability to sell
our products to wireless broadband system operators and on their sales of our
client modems to end-users.
We have become increasingly dependent on sales to broadband wireless
system operators and distributors. Our net sales to customers in the
broadband wireless industry increased from $2.4 million in 1997 to $4.7
million in 1998 and to $4.2 million for the nine months ended September 30,
1999. The adoption of the DOCSIS standard, which has adversely affected our
sales to cable system operators, has not had a significant effect on wireless
customers. We believe that products meeting the present DOCSIS standard will
not perform well over wireless, but this could change in the future as a
result of modifications in the DOCSIS TDMA protocol, improvements in
technology or other developments. The principal disadvantage of wireless
cable is that it requires a direct line of sight between the wireless cable
system operator's antenna and the customer's location and the installation of
an antenna at the customer premises. Therefore, despite a typical range of up
to 35 miles, a number of factors, such as buildings, trees or uneven terrain,
can interfere with reception, thus limiting broadband wireless system
operators' customer bases. We estimate that there were only approximately 1.0
million wireless video cable customers in the United States as of March 1998.
In addition, current technical and legislative restrictions have limited the
number of analog channels that wireless cable companies can offer in the most
commonly used frequency bands to 33. In order to better compete with cable
system operators, satellite TV and telcos, broadband wireless system
operators have begun to examine the implementation of digital TV and/or
Internet access to create new revenue streams. To the extent that such
operators choose to invest in digital TV, such decisions will limit the
amount of capital available for investment in deploying other services, such
as Internet access. To the extent wireless operators choose to provide
Internet access, there is no assurance that they will not select technologies
other than our high speed modem system to do so (such as Internet plus
telephony, or new equipment standards such as DOCSIS with which our products
are not compatible). While many broadband wireless system operators are
currently utilizing telephone return for upstream data transmission, we
believe that wireless operators will demand two-way wireless transmission as
more of these entities obtain licenses for additional frequencies under the
FCC two-way authorization for MMDS frequencies released in September 1998. We
have refined and are continuing to develop our products so as to satisfy the
two-way transmission needs of broadband wireless system operators, and our
customers have fourteen two way wireless headend installations in place to do
this. But, there can be no assurance that we or our customers will be
successful in our efforts to make this a commercially viable alternative to
two-way cable. The failure of our products to gain market acceptance would
hurt our business.
In the past, our ability to sell our products to broadband wireless
customers has been adversely affected by chronic undercapitalization in the
broadband wireless industry. The weak financial condition of many existing
and potential customers has made them reluctant to undertake the substantial
capital commitments necessary to introduce and market Internet access
products and services. A number of wireless customers have been unable to pay
for the products we shipped to them. Recent investments by Sprint and MCI
WorldCom in wireless operators are expected to have a significant effect upon
the industry. There can be no assurance, however, that Sprint or MCI WorldCom
will elect to purchase our products in the future.
Our sales to cable system operators have in the past constituted
approximately half our business. We expect these sales to decline substantially
in the future. RCN, our largest cable customer, has indicated that it will not
purchase our products for installations in new markets. In selling to cable
system operators, we face a number of difficulties. Our products are not in
compliance with the DOCSIS standard that has been adopted by a number of large
cable operators and which is preferred by Excite@Home, which has adversely
affected our sales. Also, our products are not compatible with the headend
equipment or modems of other suppliers. Many cable system operators and their
customers may be reluctant to adopt and commit to a technology such as ours
which has not gained wide acceptance among their industry peers. Certain of our
competitors have already established relationships in the cable market and with
Excite@Home, further limiting our ability to sell products to penetrate the
market. The cable industry has undergone evolution and reorganization, which has
adversely affected certain of our customer relationships. Moreover, the extent
to which (and the
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manner in which) cable system operators will commit to providing broadband
Internet access remains uncertain. Cable system operators have a limited
number of programming channels over which they can offer services, and there
can be no assurance that they will choose to provide Internet access. Cable
service operators have little experience in providing Internet networks or
launching, marketing and supporting Internet services, and providing such
services will involve substantial capital expenditures. To the extent that
cable service operators elect to provide Internet access, there is no
assurance that they will choose to do so through our cable modem systems.
WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.
A small number of customers has accounted for a large portion of our net
sales, and we expect this trend to continue. Our headend equipment and modems do
not operate with other companies' headend equipment or modems, and, as a result,
we are typically the sole source provider to our customers. In the third quarter
of 1999, RCN Corporation and PCTV-Speedchoice (which is being acquired by
Sprint) accounted for, in the aggregate, 57% of our net sales (33%, and 24% of
our net sales, respectively). In 1998, RCN accounted for 25% of our net sales.
The fact that our customer base is highly concentrated increases our risk of
loss as a result of the loss of any of our principal customers. RCN has
announced that it will no longer purchase our product for installations in new
markets. There is no assurance that PCTV will continue as our customer after it
is acquired by Sprint.
THE SALES CYCLE FOR OUR PRODUCTS IS LENGTHY AND UNCERTAIN AND OUR OPERATING
RESULTS FLUCTUATE WIDELY.
The sale of our products typically involves a great deal of time and
expense. Customers usually want to engage in significant technical evaluation
before making a purchase commitment. During 1999, our sales have been primarily
limited to a few customers. There are often delays associated with our
customers' internal procedures to approve the large capital expenditures that
are typically involved in purchasing our products. Because our sales cycle may
be long and uncertain, and because we depend on a relatively few customers who
place relatively large orders, any delay or loss of an order that is expected to
be received in a quarter can have a major effect on our sales and operating
results for that quarter. The same is true of any failure of a customer to pay
for products on a timely basis.
These factors, together with the other factors referred to in this "Risk
Factors" section, tend to cause our operating results to vary substantially from
quarter to quarter. These fluctuations have adversely affected the prices of our
Common Stock in the past and may adversely affect such prices in the future.
WE DEPEND ON KEY PERSONNEL.
Our success depends in significant part upon the continued services of our
key technical, sales and management personnel. Any officer or employee can
terminate his or her relationship with us at any time. Our future success will
also depend on our ability to attract, train, retain and motivate highly
qualified technical, marketing, sales and management personnel. Competition for
such personnel is intense, and there can be no assurance that we will be able to
attract and retain key personnel. The loss of the services of one or more of our
key personnel or our failure to attract additional qualified personnel could
have a material adverse effect on our business, operating results and financial
condition.
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WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY.
We rely on a combination of patent, trade secret, copyrights and trademark
laws and contractual restrictions to establish and protect our intellectual
property rights. We cannot assure you that our patents will cover all the
aspects of our technology that require patent protection or that our patents
will not be challenged or invalidated, or that the claims allowed in our patents
will be of sufficient scope or strength to provide meaningful protection or
commercial advantage to us. We have initiated one patent infringement lawsuit to
enforce our patent rights, and it resulted in a settlement in which we granted
licenses to the defendants containing certain terms that are in some respects
favorable for them, including a right of first refusal to purchase our patents
that we granted to one defendant (Com21, Inc.) in the event that in the future
we propose to sell our patents (separately or together with our other assets) to
any third party. We do not know whether we will bring litigation in the future
in an effort to assert our patent rights, or whether other companies will bring
litigation challenging our patents. Any such litigation could be time consuming
and costly for us and could result in our patents being held invalid or
unenforceable. Furthermore, even if the patents are upheld or are not
challenged, third parties might be able to develop other technologies or
products without infringing any such patents.
We have entered into confidentiality and invention assignment agreements
with our employees, and we enter into non-disclosure agreements with certain of
our suppliers, distributors and customers, in order to limit access to and
disclosure of our proprietary information. There can be no assurance that these
contractual arrangements or the other steps we take to protect our intellectual
property will prove sufficient to prevent misappropriation of our technology or
deter independent third-party development of similar technologies. The laws of
certain foreign countries may not protect our products or intellectual property
rights to the same extent as do the laws of the United States.
We have in the past, received, and may in the future receive, notices from
third parties claiming that our products, software or asserted proprietary
rights infringe the proprietary rights of third parties. We expect that
developers of wireless and cable modems will be increasingly subject to
infringement claims as the number of products and competitors in our market
grows. While we are not currently subject to any such claim, any future claim,
with or without merit, could be time consuming, result in costly litigation,
cause product shipment delays or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements might not be available on terms
acceptable to us or at all.
In the future, we may also file lawsuits to enforce our intellectual
property rights, to protect our trade secrets or to determine the validity and
scope of the proprietary rights of others. Such litigation, whether successful
or not, could result in substantial costs and diversion of resources. As
indicated above we were engaged during 1998 in an infringement lawsuit that we
brought against two third parties. In 1999, in order to stop the diversion of
resources caused by the litigation, we entered into a settlement pursuant to
which the defendants obtained licenses to our products on terms that in certain
respects were favorable to the defendants. Nonetheless, we may find it necessary
to institute further infringement litigation in the future.
DEFECTS IN OUR PRODUCTS COULD CAUSE PRODUCT RETURNS AND PRODUCT LIABILITY.
Products as complex as those offered by us frequently contain undetected
errors, defects or failures, especially when first introduced or when new
versions are released. In the past, such errors have occurred in our products
and there can be no assurance that errors will not be found in our current and
future products. The occurrence of such errors, defects or failures could result
in product returns and other losses. They could also result in the loss of or
delay in market acceptance of our products.
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GOVERNMENT REGULATION MAY ADVERSELY AFFECT OUR BUSINESS.
We are subject to varying degrees of governmental, federal, state and local
regulation. For instance, the jurisdiction of the FCC extends to high speed
Internet access products such as ours. The FCC has promulgated regulations that,
among other things, set installation and equipment standards for communications
systems. Further, regulation of our customers may adversely affect our business.
VOLATILITY OF OUR STOCK PRICE.
Our Common Stock has been delisted from the Nasdaq National Market and has
not traded on Nasdaq since mid-June 1998. Until June 1999, there had not been
current information regarding our business and financial condition for over one
year, and our previous financial statements have been restated. The market price
of our Common Stock has fluctuated in the past and is likely to fluctuate in the
future.
INTERNATIONAL SALES COULD INVOLVE GREATER RISKS.
To date, sales of our products outside of the United States have
represented an insignificant portion of our net sales. To the extent that we
sell our products internationally, such sales will be subject to a number of
risks, including longer payment cycles, export and import restrictions, foreign
regulatory requirements, greater difficulty in accounts receivable collection,
potentially adverse tax consequences, currency fluctuations and political and
economic instability.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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PART II. OTHER INFORMATION
II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
CLASS ACTION LITIGATION
In June 1998, five class action lawsuits were filed in Santa Clara
County Superior Court, California against us, our five directors then in
office (one of whom was an officer at that time), two former officers and one
former director. The lawsuits were brought on behalf of purchasers of our
Common Stock during the class period commencing November 12, 1997 (the date
of our initial public offering) and ending June 1, 1998. In July 1998, a
sixth class action lawsuit was filed in the same court against the same
defendants, although the class period was extended to June 18, 1998. All six
lawsuits also named as defendants the underwriters in our initial public
offering, but the underwriters have since been dismissed from the cases.
The complaints in these lawsuits claim that we and the other defendants
violated the anti-fraud provisions of the California securities laws,
alleging that the financial statements we used in connection with our initial
public offering and the financial statements we issued subsequently during
the class period, as well as related statements made on our behalf during the
initial public offering and subsequently regarding our past and prospective
financial condition and results of operations, were false and misleading. The
complaints also allege that we and the other defendants made these
misrepresentations in order to inflate the price of our stock for the initial
public offering and during the class period. We and the other defendants
denied the charges of wrongdoing.
The parties have agreed to settle these lawsuits as discussed below.
In July and August 1998, two class action lawsuits were filed in the
U.S. District Court for the Northern District of California. Both of these
federal class action lawsuits were brought against the same defendants as the
six state court class actions referred to above, except that the second
federal class action lawsuit also named as a defendant Pricewaterhouse
Coopers (PwC), our former independent auditors. (The underwriters in our
initial public offering were named as defendants in the first federal class
action lawsuit but were subsequently dismissed.) The class period for the
first federal class action lawsuit is from November 12, 1997 to June 1, 1998,
and the class period in the second class action lawsuit extends to June 17,
1998. The complaints in both federal class action lawsuits claim that we and
the other defendants violated various provisions of the federal securities
laws, on the basis of allegations that are similar to those made by the
plaintiffs in the state class action lawsuits. We and the other defendants
denied these charges of wrongdoing.
We believe that the state and federal class action lawsuits hurt our
business during the latter part of 1998, made it more difficult for us to
attract and retain employees, disrupted our management, sales and marketing,
engineering and research and development staffs, contributed to our inability
during the year to complete the restatement of our financial statements and
adversely affected the sales of our products and services.
In March 1999, we and the other parties to the state class action lawsuits
and the federal class action lawsuits (other than PwC) reached an agreement in
principle to settle the lawsuits. In June 1999, the parties signed a formal
stipulation of settlement and the court preliminarily approved the settlement.
Under the agreement, (i) our insurers would pay $8.8 million on our behalf (and
on behalf of the other officer and director defendants), (ii) we would issue 3.0
million shares of our Common Stock to the plaintiffs (the number of shares would
be increased proportionately to the extent that there are more than 10.5 million
shares of our Common Stock outstanding on the date of
30
<PAGE>
distribution so that, as of such date, the plaintiffs would hold approximately
22.6% of all of the shares of our Common Stock that are then outstanding), (iii)
if we are acquired prior to December 3, 1999, then, in addition to the
consideration referred to in (i) and (ii), we would pay to the plaintiffs an
amount equal to 10% of the consideration received by our stockholders in the
acquisition. As a result of the agreement and a related agreement between us and
our insurers, we have paid, and will not be reimbursed by our insurers for, $1.2
million in attorney's fees and other litigation expenses that would otherwise be
covered by its insurance, and we will not have insurance coverage for the
attorney's fees and expenses relating to the settlement that we incur in the
future.
On August 13, 1999, the United States District Court for the Northern
District of California, San Jose Division, entered a Final Judgment and Order of
Dismissal in the class action litigation in which, among other things, the court
approved the settlement of that litigation as provided in the Stipulation of
Settlement, dismissed with prejudice all of the Released Claims (as defined
therein), except for certain minor claims referred to in Exhibit 1 to the order,
and declared that such Released Claims are released as of the Effective Date (as
defined in the Stipulation of Settlement). The period in which to appeal the
order will expire in November 1999.
SEC INVESTIGATION
In October 1998, the Securities and Exchange Commission began a formal
investigation of us and unidentified individuals with respect to our financial
statements and public disclosures. We have been producing documents in response
to the Securities and Exchange Commission's subpoena and are cooperating with
the investigation. A number of current and former officers, other employees and
directors have testified or may testify before the Securities and Exchange
Commission's staff.
LAWSUIT FILED BY PACIFIC MONOLITHICS
In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as
debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court,
California against us, our five directors then in office (one of whom was an
officer at that time), a former director (as to whom the action was
subsequently dismissed), a former officer and PwC. The lawsuit concerns an
agreement which we entered into in March 1998 to acquire Pacific Monolithics
through a merger, which acquisition was never consummated. The complaint
alleges that we induced Pacific Monolithics to enter into the agreement by
providing it with financial statements, and by making other representations
concerning our financial condition and results of operations, which were
false and misleading, and further alleges that we wrongfully failed to
consummate the acquisition. The complaint claims the defendants committed
breach of contract and breach of implied covenant of good faith and fair
dealing, as well as fraud and negligent misrepresentation. The complaint
seeks compensatory and punitive damages according to proof, plus attorneys'
fees and costs. The plaintiff has attempted to initiate discovery, which
defendants have opposed on the basis that the plaintiff and we had agreed
that any disputes would be submitted to arbitration. The defendants have
filed a motion to compel arbitration and to stay the court action.
In July 1999, the court granted our motion to compel arbitration and to
stay the lawsuit pending the outcome of the arbitration. In October 1999,
Pacific Monolithics submitted a Demand for Arbitration to the American
Arbitration Association. Our response is not yet due. No date for the
arbitration hearing has yet been set.
We do not believe, based on current information (which is only preliminary,
since discovery has not commenced in the litigation), that the outcome of the
arbitration will have a material adverse impact on our financial statements.
31
<PAGE>
ITEM 2. CHANGES IN SECURITIES
ISSUANCE OF SECURITIES TO SPRINT CORPORATION.
Pursuant to a Securities Purchase Agreement dated August 30, 1999 between
us and Sprint Corporation (the "Sprint Purchase Agreement"), we issued and sold
to Sprint on September 9, 1999 (i) an $11 million face amount 4% Convertible
Class A Debenture due 2009 (the "Class A Debenture") which will be convertible,
as described below, into 3,859,649 shares of our Common Stock (subject to
adjustment), at a conversion price of $2.85 per share (subject to adjustment),
(ii) a $1,000 face amount 4% Convertible Class B Debenture due 2009 (the "Class
B Debenture") which is convertible at any time at the election of Sprint into up
to 1,000 shares of a newly created series of our Preferred Stock designated
Class J Preferred Stock, par value $1.00 per Share (the "Preferred Stock"), at
the rate of one share of Preferred Stock for each $1.00 principal amount of
Class B Debenture, and (iii) warrants (the "Warrants") to purchase at $1.00 per
Warrant up to 8,397,873 (subject to adjustment) debentures that will have
substantially the same terms as the Class A Debenture (the "Warrant Debentures")
and will be convertible at a conversion price of $2.85 per share (subject to
adjustment) into 2,689,455 shares of Common Stock (subject to adjustment). In
consideration for such securities, Sprint paid a purchase price of $11,001,000
and agreed to purchase $10 million of our products on terms that are to be
negotiated, as described below. We granted to Sprint in the Sprint Purchase
Agreement certain rights regarding corporate governance, the right to appoint
two directors to our Board of Directors, certain rights of first refusal,
preemptive rights and other rights, as described below. Pursuant to the Sprint
Purchase Agreement, we also entered into a 1999 Amended and Restated Investor
Rights Agreement (the "Rights Agreement") and a Warrant Agreement, both dated as
of September 9, 1999, and we and Sprint agreed to enter into an Equipment
Purchase Agreement, as described below.
Assuming that as of September 9, 1999 Sprint converted the Class A
Debenture and the Class B Debenture, exercised the Warrants and converted the
Warrant Debentures acquired upon such exercise (and assuming that Sprint paid
$8,397,873 upon such exercise), Sprint would own 6,806,271 shares of our Common
Stock, representing approximately 39% of the 17,473,967 shares of our Common
Stock that were outstanding at August 30, 1999 (as adjusted for the issuance of
Common Stock pursuant to the Series A Debenture and the Warrants and assuming no
outstanding warrant, convertible debenture or option held by any other person is
exercised or converted) and 100% of the 1,000 shares of Preferred Stock
outstanding. The number of shares of Common Stock into which the Class A
Debentures or Warrant Debentures will be convertible may be increased due to
certain adjustments as described below.
CLASS A DEBENTURE. The Class A Debenture is in the principal amount of $11
million and bears interest at the rate of 4% per annum, on a 360 day basis,
actual days elapsed. Interest is payable quarterly in arrears commencing on
October 1, 1999 and thereafter on the first business day of each calendar
quarter. Instead of paying interest in cash, we will pay interest on the Class A
Debenture by adding each month the amount of interest to the outstanding
principal amount due after the Class A Debenture. Sprint will have the right to
convert the principal of the Class A Debenture (or any portion of the principal
thereof which is $1.00 or an integral multiple of $1.00) into shares of Common
Stock at the rate of one share of Common Stock for each $2.85 principal amount
of the Class A Debenture (subject to adjustment as provided in the Class A
Debenture, the "Conversion Price"). The Class A Debenture is convertible at any
time, at the option of Sprint, following the first of the following to occur:
(i) December 31, 1999 (unless we agree in writing to an earlier date), (ii) a
Change of Control (as defined below) or (iii) receipt by Sprint of a Change of
Control Notice (as defined below) from us. For purposes of the Class A
Debenture, "Change of Control" means the occurrence of any of the following: (a)
any person shall have acquired beneficial ownership of more than 25% of our
outstanding voting stock (within the meaning of Section 13(d) or 14(d) of the
Exchange Act); or (b) individuals who immediately following the closing were
directors of ours (which includes the directors designated by Sprint, together
with any replacement or additional directors who were nominated or appointed by
a majority of directors in office immediately following the closing or by a
majority of such directors and their nominees or appointees) cease to constitute
a majority of our Board of Directors. In the event that a proposed Change of
Control will occur pursuant to an agreement to which we are a party, we will
give notice of such proposed Change of
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<PAGE>
Control (a "Change of Control Notice") to Sprint at least 10 business days
prior to the consummation of the transactions contemplated by such agreement.
At any time on or after December 31, 2000, we will have the right to
convert the principal of the Class A Debenture (or any portion of the principal
hereof which is $1.00 or an integral multiple of $1.00) into shares of Common
Stock at the Conversion Price.
The Class A Debenture is subject to adjustment for certain additional
issuance of capital stock or rights to acquire capital stock ("Additional
Stock") and for any stock split, reverse stock split, stock dividend,
recapitalization, merger, consolidation or sale of substantially all our assets.
If any Additional Stock is issued during the period commencing September 9, 1999
and ending March 9, 2000 for per share consideration less than the then
Conversion Price, the then Conversion Price will be reduced to the per share
price at which such Additional Stock is issued (ratchet antidilution). If any
Additional Stock is issued after March 9, 2000 for per share consideration less
than the then Conversion Price, the then Conversion Price will be adjusted based
on a weighted average calculation (weighted average antidilution). In the Sprint
Securities Purchase Agreement, we represented that on September 9, 1999 the
number of shares of Common Stock outstanding on a fully diluted basis (assuming
the exercise of all stock options and warrants and the conversion of all
debentures and any other convertible instruments) after the transactions
described herein was 30,396,481 and that 3,859,649 (the number of shares into
which the Series A Debenture was convertible at $2.85 per share) constituted
12.6977% of such fully diluted number. If the actual number of shares then
outstanding was greater than 30,396,481, the initial Conversion Price of $2.85
would be reduced so that the number of shares of Common Stock into which the
Series A Debenture would be convertible upon issuance would represent 12.6977%
of the outstanding shares of Common Stock on a fully diluted basis.
CLASS B DEBENTURE. The Class B Debenture is in the principal amount of
$1,000 and bears interest at the rate of 4% per annum, on a 360 days basis,
actual days elapsed, which is payable in full at maturity or upon conversion.
The Class B Debenture is convertible at any time at the option of the Purchaser
into 1,000 shares of Preferred Stock. As long as the total number of shares of
our Common Stock that Sprint and its affiliates owns or would own assuming the
conversion of all debentures and the exercise of all Warrants as a percentage of
all outstanding shares of our Common Stock on a fully diluted basis ("Sprint's
Interest") is 10% or more, (a) the holders of Preferred Stock, voting as a
separate class, will have the right to elect two directors to serve on our Board
of Directors and (b) the affirmative vote of the holders of a majority of the
shares of Preferred Stock will be necessary for us to:
(i) adopt an Annual Business Plan (as defined) or take any
actions that materially deviate from such plan;
(ii) make any capital expenditures in excess of $2 million in
the aggregate in any fiscal year, except to the extent contemplated in the
Annual Business Plan;
(iii) make any acquisition or disposition of any interests in
any other person or business enterprise or any assets, in a single transaction
or a series of related transactions, in which the fair market value of the
consideration paid or received by us exceeds $1 million;
(iv) organize, form or participate in any joint venture or
similar entity involving the sharing of profits in which the assets or services
to be contributed or provided by us to such joint venture or other entity have a
fair market value in excess of $1 million;
(v) form a subsidiary;
(vi) issue any Common Stock, preferred stock or other capital
stock or any stock or securities (including options and warrants) convertible
into or exercisable or exchangeable for Common Stock, preferred stock or other
capital stock or amend the terms of any such stock or securities or any
agreements relating thereto (other than employee stock options approved by our
33
<PAGE>
Board of Directors and Common Stock issued upon exercise thereof) or effect any
stock split or reverse stock split or combination;
(vii) enter into any transaction between us, on the one hand,
and any Affiliate or Associate of ours (as defined), on the other, other than
the payment of compensation and other benefits to employees and directors in the
ordinary course of business;
(viii) declare or pay any dividend or other distribution with
respect to our capital stock;
(ix) incur any indebtedness for borrowed money or capital
lease obligations that are not expressly contemplated in the then-current Annual
Business Plan in excess of $250,000 in the aggregate during any fiscal year;
(x) amend our Certificate of Incorporation or Bylaws or create
or amend a stockholders' rights plan;
(xi) declare bankruptcy; or
(xii) liquidate or dissolve.
The Certificate of Designations for the Preferred Stock states that the voting
rights specified in the certificate shall terminate at such time as any share of
the Preferred Stock ceases to be owned by Sprint and its Affiliates (as
defined).
WARRANTS. Pursuant to a Warrant Agreement dated September 9, 1999, Sprint
purchased 8,397,873 Warrants to purchase Warrant Debentures at $1.00 per Warrant
Debenture. The Warrant Debentures will have substantially the same terms as the
Class A Debenture (including the conversion rights referred to above). The
Warrants will be exercisable on the earliest date that Sprint has submitted to
us at least $1 million of purchase orders under the Equipment Purchase Agreement
to be negotiated between us and Sprint. On that date, 10% of the Warrants
(rounded to the nearest whole Warrant) will become exercisable. Thereafter, an
additional 10% of the Warrants (rounded to the nearest whole Warrant) will
become exercisable for each additional $1 million of purchase orders as are
submitted by Sprint to us under the Equipment Purchase Agreement, such that the
entire amount of Warrants will be exercisable when $10 million of purchase
orders have been submitted.
The Warrant Agreement provides that, if at any time before March 9, 2000 we
amend the terms of its outstanding $5.5 Million Debenture we issued in 1997, or
enter into any other arrangement with the holder of the $5.5 Million Debenture,
that increases the number of shares of our Common Stock that would be
outstanding on a fully diluted basis, then we must issue to Sprint such number
of additional Warrants as would be necessary to cause Sprint's Interest to
remain the same. Also, if prior to March 9, 2000, the holder of the $5.5 Million
Debenture gives notice to us demanding payment of any portion of the principal
amount of $5.5 Million Debenture (and we subsequently repay a portion of such
principal prior to maturity), or if we voluntarily repay a portion of the
principal amount of the $5.5 Million Debenture before March 9, 2000, then we
must issue to Sprint a number of additional Warrants equal to 2.85 times (a) the
amount by which the repaid amount divided by the Conversion Price of the
Debentures (as defined below) exceeds the number of shares of Common Stock into
which the repaid amount of the $5.5 Million Debenture would have been
convertible (if it had not been repaid), (b) divided by 3.
CHANGES IN OUR BOARD OF DIRECTORS. In order to fulfill a condition of the
Sprint Purchase Agreement, two of our current directors (Stephen E. Halprin and
Douglas M. Leone) resigned upon the closing and two persons designated by Sprint
were appointed to fill the vacancies created by the resignations: Theodore H.
Schell, Sprint's Senior Vice President, Corporate Strategy and Development, and
Timothy S. Sutton, President of Sprint's Broadband Wireless Group. The Sprint
Purchase Agreement also provides for certain nomination rights with respect to
our Board of Directors.
34
<PAGE>
OTHER RIGHTS GRANTED TO SPRINT. The Sprint Purchase Agreement also provides
a right of first refusal if we enter into a "Change of Control Agreement," which
is defined to include (i) any merger or consolidation of ours which results in a
Change of Control (as defined above), (ii) any disposition of a substantial
portion of our assets, (iii) any sale or issuance of stock (including a tender
offer) that results in a Change of Control or (iv) any other transaction that
results in a Change of Control. If we enter into a Change of Control Agreement
with a third party at any time at which Sprint's Interest is 10% or greater, we
must provide a complete copy of the Change of Control Agreement (including all
schedules and exhibits) and any related agreements to Sprint within one business
day following the execution of the Change of Control Agreement. The delivery of
the Change of Control Agreement to the Sprint will constitute a binding offer by
us to consummate with Sprint the transactions contemplated by the Change of
Control Agreement on the terms as set forth in the Change of Control Agreement.
Such offer will be irrevocable for a period ending at 11:59 p.m., Kansas City
time, on the 60th day following the day of delivery of the Change of Control
Agreement to Sprint, which period may be extended as provided in the Sprint
Purchase Agreement. The Sprint Purchase Agreement provides that Sprint may
assign all or any part of its right of first refusal to any other Person (as
defined), whether or not an affiliate of Sprint.
The Sprint Purchase Agreement further provides that, for so long as
Sprint's Interest is equal to or greater than 10%, if we determine to issue for
cash consideration additional securities of ours, including options, warrants,
convertible instruments or other direct or indirect rights to acquire equity
securities of ours ("Equity Securities") to third parties, other than Equity
Securities issued or proposed to be issued to or for the benefit of any Person
(as defined in the Purchase Agreement) who serves as an employee or director of
ours in the ordinary course of business, we will offer Sprint the right to
purchase that certain portion of the additional Equity Securities as will permit
Sprint to maintain the same percentage ownership interest in us (on a fully
diluted basis) as it had immediately before the issuance of the Equity
Securities.
For so long as Sprint's Interest is equal to or greater than 10%, if we
determine to issue additional Equity Securities to officers or employees or for
other than cash consideration, and the issuance of such additional Equity
Securities would cause Sprint's Interest to fall below 10%, Sprint shall have,
under the Sprint Purchase Agreement, the right to purchase from us such number
of shares of Common Stock as will cause Sprint's Interest to remain at or above
10%.
Under the Sprint Purchase Agreement, as long as Sprint's Interest is 10% or
greater, we are not permitted to take the actions referred to above (in (i)
through (xii) under the heading "Series B Debenture") without Sprint's prior
written approval.
RIGHTS AGREEMENT. Pursuant to the Sprint Purchase Agreement, we, Sprint and
holders of a majority of the "Registrable Securities" under our prior
registration rights agreement, together with the investors referred to below,
entered into the Rights Agreement dated September 9, 1999. Under the Rights
Agreement, Sprint has the right on two occasions to require us to register under
the Securities Act of 1933, at our expense, Sprint's sale of shares of our
Common Stock that Sprint acquires pursuant to the Sprint Purchase Agreement. In
addition, Sprint and the other holders of Registrable Securities (as defined in
the Rights Agreement) have (a) piggyback registration rights to participate, at
our expense, in any registration by us for our own account or for the account of
any stockholder (other than registrations on Form S-8 or Form S-4, but including
any registration pursuant to Sprint's demand registration rights) and (b) the
right to require us to register, at our expense, the sale of the Registrable
Securities on Form S-3, subject to certain conditions.
EQUIPMENT PURCHASE AGREEMENT. Under the Sprint Purchase Agreement, Sprint
agreed to purchase $10 million of certain types of our products pursuant to an
Equipment Purchase Agreement that is to be negotiated between us and Sprint.
Certain terms of the agreement have been specified by the parties, and they have
agreed to negotiate in good faith to resolve all open terms in order to execute
Equipment Purchase Agreement by December 31, 1999. If we are unable to agree
upon all terms by that date, any unresolved terms will be submitted to
arbitration.
ISSUANCE OF DEBENTURES TO OTHER INVESTORS.
35
<PAGE>
Concurrent with the closing of the Sprint Purchase Agreement, we issued and
sold to certain other investors (the "Investors") for $7.1 million 4%
Convertible Debentures due 2009 in the aggregate face amount of $7.1 million
(the "Debentures"). The Debentures will be convertible into an aggregate of
2,491,228 shares of our Common Stock (subject to adjustment) at a conversion
price of $2.85 per share shares (subject to adjustment). The terms of the
Debentures are substantially the same as the terms of the Class A Debentures.
The Investors include partnerships associated with Accel Partners, which
purchased in the aggregate $5.6 million of the Debentures (convertible into
an aggregate of 1,964,912 shares of Common Stock, subject to adjustment);
OSCCO III, L.P., which purchased $750,000 of the Debentures (convertible into
263,158 shares of Common Stock, subject to adjustment); and Gary M. Lauder,
who purchased $750,000 of the Debentures (convertible into 263,158 shares of
Common Stock, subject to adjustment). James R. Flach, a director the Company
who recently became its Chief Executive Officer, is an executive partner of
Accel Partners but has informed us that he holds no voting or dispositive
power with respect to the securities held by the Accel partnerships. Stephen
E. Halprin, a general partner of OSCCO Management Partners III, which is the
general partner of OSCCO III, L.P., was a director until his resignation upon
the closing of the Sprint Purchase Agreement and the issuance and sale of the
Debentures. Mr. Halprin disclaims beneficial ownership of OSCCO III, L.P.
securities except to the extent of his pecuniary interest therein. Mr. Lauder
is a director.
Assuming that as of September 9, 1999, the following Investors converted
all their Debentures and exercised all warrants held by them to purchase shares
of our Common Stock, and including all shares of Common Stock otherwise owned by
such Investors, such Investors would own the respective numbers of shares of
Common Stock set forth below, representing approximately the respective
percentages set forth below of the shares of Common Stock outstanding as of
August 30, 1999 (adjusted for the respective Investors to include the Common
Stock issuable upon conversion of the Debentures and warrants held by those
Investors, but assuming that no other debentures, warrants, options or other
convertible securities were converted or executed):
<TABLE>
<CAPTION>
No. of Shares of Common % of Shares of Common
Investors Stock Stock
<S> <C> <C>
All partnerships associated with
Accel Partners 2,833,768 17.3%
OSCCO III, L.P. 759,563 6.9%
Gary M. Lauder 539,207 4.9%
</TABLE>
36
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3.1 Certificate of Designations of Series J
Non-Convertible Preferred Stock of the Registrant (1)
10.1 Securities Purchase Agreement between Sprint
Corporation and the Registrant dated as of August 30,
1999 (1)
10.2 Warrant Agreement between Sprint Corporation and the
Registrant dated as of September 9, 1999 (1)
10.3 1999 Amended and Restated Investor Rights Agreement
dated as of September 9, 1999 (1)
10.4 Form of 4% Convertible Class A Debenture due 2009 (1)
10.5 Form of 4% Convertible Class B Debenture due 2009 (1)
10.1 Securities Purchase Agreement among the Registrant and
certain investors dated as of August 30, 1999 (1)
10.7 Form of 4% Convertible Debenture due 2009 (1)
27.1 Financial Data Schedule
-----------------
(1) Incorporated by reference to the Exhibits with the same number in the
Company's current report on Form 8-K filed September 24, 1999.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K have been filed by the Company
since June 30, 1999
1. On September 24, 1999, the Company reported under Item 5. "Other
Events" and Item 7. "Exhibits" that on September 9, 1999 the Company issued
and sold certain securities pursuant to agreements entered into on August 30,
1999.
2. On October 12, 1999, the Company reported under Item 5. "Other
Events" the appointment of Thara M. Edson as Vice President, Finance and
Chief Financial Officer.
3. On October 28, 1999, the Company reported under Item 5. "Other
Events" the resignation of Carl S. Ledbetter, its Chief Executive Officer,
and the appointment of James R. Flach as acting Chief Executive Officer.
37
<PAGE>
HYBRID NETWORKS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 1999 HYBRID NETWORKS, INC.
/s/ James R. Flach
-----------------------
James R. Flach
Chief Executive Officer
/s/ Thara Edson
-----------------------
Thara Edson
Chief Financial Officer
(Principal Accounting Officer)
38
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUAMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 9/30/99
BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE THREE MONTHS THEN ENDED
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 8,113
<SECURITIES> 9,012
<RECEIVABLES> 543
<ALLOWANCES> 200
<INVENTORY> 2,225
<CURRENT-ASSETS> 20,231
<PP&E> 5,697
<DEPRECIATION> 3,189
<TOTAL-ASSETS> 23,153
<CURRENT-LIABILITIES> 11,244
<BONDS> 18,123
0
0
<COMMON> 11
<OTHER-SE> (931)
<TOTAL-LIABILITY-AND-EQUITY> 23,153
<SALES> 10,447
<TOTAL-REVENUES> 10,447
<CGS> 11,674
<TOTAL-COSTS> 11,674
<OTHER-EXPENSES> 8,780
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,448
<INCOME-PRETAX> (12,405)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,405)
<EPS-BASIC> (1.18)
<EPS-DILUTED> (1.18)
</TABLE>
