<PAGE>
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 JUNE 30, 2000.
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.
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(Exact name of registrant as specified in its charter)
Delaware 77-0252931
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(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
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(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 June 30, 2000: 21,259,845
1
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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
June 30, 2000 and December 31, 1999 3
Unaudited Condensed Statements of Operations for the
Three and Six Months Ended June 30, 2000 and 1999 4
Unaudited Condensed Statements of Cash Flows for the
Six Months Ended June 30, 2000 and 1999 5
Notes to Unaudited Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 10
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 24
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 27
</TABLE>
As used in this report on Form 10-Q, unless the context otherwise requires,
the terms "we," "us," "the Company" or "Hybrid" refer to Hybrid Networks, Inc.,
a Delaware corporation.
2
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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>
June 30, December 31,
2000 1999 *
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,489 $ 13,394
Short term investments 1,166 -
Accounts receivable, net of allowance for doubtful accounts
of $200 in 2000 and 1999 2,465 1,138
Inventories 4,018 3,755
Prepaid expenses and other current assets 104 234
------------- -------------
Total current assets 13,242 18,521
Property and equipment, net 1,932 2,244
Intangibles and other assets 347 387
------------- -------------
Total assets $ 15,521 $ 21,152
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Convertible debenture $ 5,500 $ 5,500
Current portion of capital lease obligations 153 336
Accounts payable 2,215 2,035
Accrued liabilities and other 5,824 4,623
------------- -------------
Total current liabilities 13,692 12,494
Convertible debentures - long term 1 18,327
Capital lease obligations, less current portion - 29
Other long-term liabilities 126 122
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Total liabilities 13,819 30,972
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Contingencies
Stockholders' equity (deficit): Convertible preferred stock, $.001 par value:
Authorized: 5,000 shares;
Issued and outstanding: no shares in 2000 and no shares in 1999 - -
Common stock, $.001 par value:
Authorized: 100,000 shares;
Issued and outstanding: 21,260 shares in 2000
and 10,544 shares in 1999. 21 11
Additional paid-in capital 106,030 75,823
Unrealized gain on available-for-sale securities 41 107
Accumulated deficit (104,390) (85,761)
------------- --------------
Total stockholders' equity (deficit) 1,702 (9,820)
-------------- ----------------
Total liabilities and stockholders' equity (deficit) $ 15,521 $ 21,152
============= =============
*Condensed from audited financial statements
</TABLE>
The accompanying notes are an integral part of
these condensed financial statements
3
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HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ----------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Gross sales $ 4,773 $ 3,411 $ 6,574 $ 7,534
Sales discounts 2,026 407 2,150 407
---------- ---------- ---------- ----------
Net sales 2,747 3,004 4,424 7,127
Cost of sales 4,305 4,349 6,172 8,612
----------- ----------- ---------- ----------
Gross margin (loss) (1,558) (1,345) (1,748) (1,485)
----------- ----------- ---------- ----------
Operating expenses:
Research and development 1,788 932 3,180 2,311
Sales and marketing 2,115 404 5,121 1,022
General and administrative 3,533 1,601 6,657 2,513
----------- ----------- ---------- ----------
Total operating expenses 7,436 2,937 14,958 5,846
----------- ----------- ---------- ----------
Loss from operations (8,994) (4,282) (16,706) (7,331)
Interest income and other expense (1,208) - (999) 4
Interest expense (465) (207) (924) (415)
----------- ----------- ---------- ----------
NET LOSS (10,667) (4,489) (18,629) (7,742)
Other comprehensive loss:
Realized gain on available-for-sale securities
included in net loss (10) - (66) -
----------- ----------- ---------- ----------
Total comprehensive loss $ (10,677) $ (4,489) $ (18,695) $ (7,742)
=========== =========== ========== ==========
Basic and diluted net loss per share $ (0.73) $ (0.43) $ (1.30) $ (0.74)
=========== =========== ========== ==========
Shares used in basic and diluted per share calculation 14,602 10,507 14,297 10,492
=========== =========== ========== ==========
</TABLE>
The accompanying notes are an integral part of
these condensed financial statements.
4
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HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------------
2000 1999
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (18,629) $ (7,742)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 572 687
Sales discounts recognized on issuance of warrants 5,943 407
Compensation recognized on issuance of stock and stock options 2,281 539
Interest added to principal of convertible debentures 368 -
Provision for excess and obsolete inventory 235 529
Beneficial conversion of convertible debentures 149 -
Change in unrealized gain on securities (66) -
Common stock issued to induce conversion of debentures 1,170 -
Change in assets and liabilities:
Restricted cash - 515
Accounts receivable (1,326) 735
Inventories (498) 2,287
Prepaid expenses and other assets 116 254
Accounts payable 182 (379)
Other long term liabilities 4 40
Accrued liabilities and other 2,503 939
----------- -----------
Net cash used in operating activities (6,996) (1,189)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (206) -
Purchase of short term investments (1,166) -
----------- -----------
Net cash used in investing activities (1,372) -
----------- -----------
Cash flows from financing activities:
Repayment of capital lease obligations (213) (244)
Proceeds from exercise of stock options 676 47
----------- -----------
Net cash provided by (used in) financing activities 463 (197)
----------- -----------
Decrease in cash and cash equivalents (7,905) (1,386)
Cash and cash equivalents, beginning of period 13,394 3,451
---------- ----------
Cash and cash equivalents, end of period $ 5,489 $ 2,065
========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
Common stock issued to settle class action liability $ 1,303 $ -
Common stock issued upon conversion of convertible debentures 18,694
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid 514 415
Income taxes paid 1 1
</TABLE>
The accompanying notes are an integral part of
these condensed financial statements.
5
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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 June 30, 2000, the statements of operations for the three and six months
ended June 30, 2000 and June 30, 1999 and the statements of cash flows for the
six months periods ended June 30, 2000 and June 30, 1999 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, 1999 condensed
balance sheet data included herein was derived from audited financial statements
but does 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, 1999.
Results for any interim period are not necessarily indicative of
results for any other interim period or for the entire year.
The Company was organized in 1990 and has had operating losses since
then. The Company's accumulated deficit was $104,390,000 as of June 30, 2000 and
$85,761,000 as of December 31, 1999. Although the Company has raised large sums
of capital in the past, including over $35 million in net proceeds from its
initial public offering in November 1997 and over $18 million from the issuance
and sale of convertible debentures in September 1999, the Company is losing
money at a rate that will require it to raise additional capital in the near
future.
The Company expects to seek additional financing during 2000 through
debt, equity or equipment lease financing or through a combination of financing
vehicles. As of June 30, 2000, the Company had received a proposal for an
equipment lease line of credit on terms that we believe are favorable. The
Company is also working with their bank to arrange additional short term
financing. The Company's ability to continue as a going concern is dependent on
obtaining additional financing to fund its current operations and, ultimately,
generating sufficient revenues to obtain profitable operations. There is no
assurance that the Company will be successful in these efforts.
At June 30, 2000, the Company's liquidity consisted of cash and cash
equivalents of $5,489,000, $1,166,000 of short term investments and negative
working capital of $450,000. The Company's principal indebtedness consisted of
$5,500,000 in convertible debentures, the full amount of which was due beyond 12
months. Under the terms of the debenture, the Company may not make any plant or
fixed capital expenditures in excess of $1,500,000, $2,500,000, $5,500,000, and
$11,000,000 during the twelve months ending March 31, 1998, 1999, 2000, and
2001, respectively. The Company's capital expenditures exceeded the maximum
capital expenditures allowed for the twelve months ending March 31, 1999.
Consequently, the debt has been classified as a current liability in the
accompanying financial statements as the holder has the right to declare a
default under the convertible debenture at any time. The Company believes that
its cash balance, plus anticipated revenues from operations, and non-operating
cash receipts will be sufficient to meet the Company's working capital and
expenditure needs through 2000.
6
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REVENUE RECOGNITION
The Company normally ships its products based upon a bona fide purchase
order or volume purchase agreement. The Company generally recognizes revenue at
the time a transaction is shipped and collection of the resulting account
receivable is probable. Shipments on customer orders with either acceptance
criteria, installation criteria or rights of return are recognized as revenue
only when the criteria are satisfied according to the contract. Revenue related
to shipments to distributors is normally recognized upon receipt of payment for
such transactions.
Maintenance system support and service contracts are sold separately from
hardware and software. Maintenance revenue is recognized ratably over the term
of the maintenance system support and service contract, generally on a
straight-line basis. Other service revenue, primarily training and consulting,
is generally recognized at the time the service is performed. For the six months
ending June 30, 2000, the Company had recognized $2,091,000 as revenue from
sales to Sprint Corporation. As of June 30, 2000, the total amount of shipments
not recognized as revenue due to acceptance or testing criteria or because they
were sold to a distributor was $3,513,000, of which $3,096,000 was in connection
with shipments to Sprint and the balance of $417,000 was for shipments to other
customers.
In September 1999, Sprint committed to purchase $10 million of the
Company's products subject to certain conditions. In connection with Sprint's
commitment, the Company issued to Sprint warrants to purchase up to $8,397,873
in debentures that are convertible into 2,946,622 shares of our Common Stock at
$2.85 per share. Ten percent of the warrants will become exercisable on the
scheduled shipment dates when aggregate scheduled shipments of products and
services pursuant to purchase orders submitted by Sprint to the Company are at
least $1 million. With each additional $1 million of scheduled shipments, Sprint
will be entitled to exercise an additional 10% of the warrants until the
aggregate scheduled shipments is $10,000,000. In accordance with the Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," transactions in equity instruments with non-employees
for goods or services are accounted for using the fair value method prescribed
by SFAS 123. SFAS 123 requires that in each period in which the warrants are
earned, a non-cash charge will be recorded. The amount of such shipments
scheduled during the six months ended June 30, 2000 was $4,572,000 and, based on
the warrants' conversion ratio, this amount would give Sprint the right to
exercise 1,346,000 shares of the Company's Common Stock under the warrants. The
value of this purchase right, using the Black-Scholes valuation model, was
$5,943,000. Of this amount, $2,150,000 was recorded as a direct sales discount
to offset sales to Sprint and the balance of $3,793,000 was recorded as an
operating expense of the Sales and Marketing department.
The Company anticipates that Sprint will schedule additional shipments
in the third quarter of 2000 and that the Company will record substantial
non-cash charges, pursuant to SFAS 123, as additional portions of Sprint's
warrants become exercisable based on those shipments. As of June 30, 2000,
Sprint had scheduled additional future shipments through the quarter ending
September 30, 2000 of $4,913,000, which would bring the total amount of
scheduled shipments to $9.5 million. The amounts of the charges will depend
primarily on the amounts of the scheduled shipments and on the Company's stock
price at the times the shipments are scheduled. If the Company's stock price
increases the relative amount of the charges will increase; and if the Company's
stock price decreases, the relative amount of the charges will decrease.
The Company also anticipates that it will not recognize revenue on its
shipments of products to Sprint (or on most of those shipments) as and when
those shipments are made. That is because Sprint's orders are generally subject
to testing and acceptance procedures. Revenue will not be recognized unless and
until those procedures are completed and the products are accepted, which could
take a number of months. As of June 30, 2000, the Company had recognized revenue
in the amount of $207,000 relating to headend systems accepted by Sprint.
7
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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 are comprised of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------- --------
<S> <C> <C>
Raw materials $624 $2,251
Work in progress 1,050 190
Finished goods 2,344 1,314
---------- ----------
$4,018 $3,755
========== ==========
</TABLE>
The allowance for excess and obsolete inventory was $3,078,000 and $2,842,000 at
June 30, 2000 and December 31, 1999, respectively. The allowance for excess and
obsolete inventory includes a reserve reflecting the lower of cost or market
price for modem inventory to be shipped to Sprint pursuant to the Sprint
purchase contract. The amount of the reserve with respect to modem inventory was
$254,000 and $402,000 at June 30, 2000 and December 31, 1999, respectively.
CONTINGENCIES
SEC INVESTIGATION
By a subpoena to the Company dated in October 1998, the Securities and
Exchange Commission, Division of enforcement ("SEC"), requested that the Company
provide a wide variety of documents to the SEC. The Company produced numerous
documents in response to the subpoena. In addition, the SEC took the testimony
of numerous current and former employees of the Company.
On June 29, 2000, the SEC filed in the United States District Court for
the Northern District of California a complaint against the Company and three
former employees. On the same day, the Court approved the Company's settlement
with the SEC and entered judgment against the Company. The Court's order enjoins
the Company from violating the books and records and related provisions of the
federal securities laws but does not include any monetary penalties or an
injunction against the violation of the antifraud provisions of the securities
laws.
The Company does not believe, based on current information, that the
order will have a material adverse impact on the Company's business or financial
condition.
PACIFIC MONOLITHICS LAWSUIT
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 an action in Santa Clara County Superior Court,
California against the Company, two of its directors, four former directors (one
of whom was subsequently dismissed from the litigation), a former officer and
the Company's former auditors.
8
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The lawsuit concerned an agreement which the Company entered into in March 1998
to acquire Pacific Monolithics through a merger, which acquisition was never
consummated. The Complaint alleged that the Company induced Pacific Monolithics
to enter into the agreement by providing it with financial statements, and by
making other representations concerning the Company's financial condition and
results of operations, which were false and misleading, and further alleged that
the Company wrongfully failed to consummate the acquisition. The Complaint
stated causes of action against the Company for breach of contract and breach of
implied covenant of good faith and fair dealing, and against all defendants,
claim for fraud and negligent misrepresentation. The complaint sought
compensatory and punitive damages according to proof, plus attorneys' fees and
costs. In July 1999, the court granted the Company's motion to compel
arbitration and with respect to each defendant other than the Company's former
auditors, and stayed the lawsuit pending the outcome of the arbitration.
In October 1999, the plaintiff filed a Demand for Arbitration against
the Company and each individual defendant other than the Company's former
auditors with the San Francisco office of the American Arbitration Association.
In the Demand, Pacific Monolithics alleged claims for breach of contract, breach
of implied covenant of good faith and fair dealing, fraud and negligent
misrepresentation arising out of the proposed merger between the two companies.
The Demand sought unspecified compensatory and punitive damages, pre-judgement
interest and attorneys' fees and costs. In November 1999, the Company and each
individual defendant other than the Company's former auditors answered the
Demand by denying the claims and seeking an award of attorneys' fees and costs
pursuant to the agreement for the proposed merger. The arbitration hearing was
scheduled to commence on September 7, 2000.
On July 7, 2000, the Parties conducted a mediation of the dispute in
San Jose, California before the Honorable (Ret.) Peter Stone of JAMS, which
resulted in a stipulation of settlement of the litigation. Pursuant to the terms
of the stipulation of settlement, Pacific Monolithics has agreed to release all
of its claims, known and unknown, against the Company and its current or former
officers and directors, and dismiss with prejudice its lawsuit in exchange for
213,333 shares of the Company's Common Stock valued at approximately $2,000,000
and this amount has been accrued as of June 30, 2000. The parties anticipate
signing shortly a formal settlement agreement and mutual general release
memorializing the terms and the stipulation of settlement. The settlement
agreement and mutual release must be approved by the Bankruptcy Court. Counsel
for Pacific Monolithics has informed the Company that approval of the settlement
is expected.
9
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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, 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
Hybrid Networks, Inc., headquartered in San Jose, CA, is the worldwide
leader in MMDS fixed broadband wireless Internet-access systems. Hybrid designs,
develops, manufactures and markets fixed broadband wireless systems that enable
telecommunications companies, wireless systems operators and network providers
to offer high-speed Internet access to businesses and residences. Hybrid was
first to market with patented two-way wireless products that focus on the MMDS
spectrum and WCS spectrum in the United States and similar spectrum abroad. The
company's customers include Sprint, WorldCom, Look Communications and Andrew
Corp. With systems in place in more than 50 markets worldwide, Hybrid is part of
more fixed broadband wireless deployments than all of its competitors combined.
Since 1996, our principal product line has been the Hybrid Series 2000,
which consists of secure headend routers, wireless and cable routers and
management software for use with either wireless transmission or cable TV
facilities. To date, net sales include principally product sales and support and
networking services.
Our products have been sold primarily in the United States, although
international sales have been increasing. A small number of customers have
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 annual basis. The sales cycle for our products has been lengthy, and we
expect it to become longer as our customer base becomes increasingly
concentrated in a few large customers. Potential sales are subject to a number
of significant risks, including customers' budgetary constraints and internal
acceptance reviews. Any delay or loss of an order that is expected 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.
The wireless industry has not adopted the Data Over Cable System Interface
Specification (DOCSIS). Various vendors have formed consortia to promote
conflicting standards such as DOCSIS+, Orthogonal Frequency Division
Multiplexing (OFDM), and other variants for wireless markets. Our products use
DOCSIS chips with major proprietary enhancements that do not conform to
standards. We have committed to our customers that we will provide an open
interface for other vendors to build customer premises equipment. This will
enable them in the future to reduce the cost for customer provided equipment by
integrating the wireless broadband router and the transceiver. The DOCSIS
standard has inhibited our sales to cable customers and we sell only to maintain
or add on to existing systems. Our ability to develop and offer competitive
products on a
10
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timely basis could have a material effect on our business. 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. Further, we anticipate that in the future the sales mix of our products
will be increasingly weighted toward lower-margin products, thereby adversely
affecting our gross margins.
REVENUE RECOGNITION
We normally ship our products based upon a bona fide purchase order and
volume purchase agreement. We generally recognize revenue at the time a
transaction is shipped and collection of the resulting account receivable is
probable. Shipments on customer orders with either acceptance criteria,
installation criteria or rights of return are recognized as revenue only when
the criteria are satisfied according to the contract. Revenue related to
shipments to distributors is normally recognized upon receipt of payment for
such transactions. For the six months ending June 30, 2000, we had recognized
revenue from sales to Sprint Corporation in the amount of $2,091,000. An
additional $3,096,000 in shipments to Sprint and $417,000 in sales to other
customers were deferred because the shipments were subject to testing and
acceptance conditions or were sales to distributors with right of return.
Maintenance system support and service contracts are sold separately
from hardware and software. Maintenance revenue is recognized ratably over the
term of the maintenance system support and service contract, generally on a
straight-line basis. Other service revenue, primarily training and consulting,
is generally recognized at the time the service is performed.
In September 1999, Sprint committed to purchase $10 million of the
Company's products subject to certain conditions. In connection with Sprint's
commitment, the Company issued to Sprint warrants to purchase up to $8,397,873
in debentures that are convertible into 2,946,622 shares of our Common Stock at
$2.85 per share. Ten percent of the warrants will become exercisable on the
scheduled shipment dates when aggregate scheduled shipments of products and
services pursuant to purchase orders submitted by Sprint to the Company are at
least $1 million. With each additional $1 million of scheduled shipments, Sprint
will be entitled to exercise an additional 10% of the warrants until the
aggregate scheduled shipments is $10,000,000. In accordance with the Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," transactions in equity instruments with non-employees
for goods or services are accounted for using the fair value method prescribed
by SFAS 123. SFAS 123 requires that in each period in which the warrants are
earned, a non-cash charge is recorded. The amount of such shipments scheduled
during the six months ended June 30, 2000 was $4,572,000 and, based on the
warrants' conversion ratio, this amount would give Sprint the right to purchase
debentures exercisable into 1,346,000 shares of the Company's common Stock under
the warrants. The value of this purchase right, using the Black-Scholes
valuation model was $5,943,000. Of this amount, $ 2,150,000 was recorded as a
direct sales discount to offset sales to Sprint that were recognized as revenue
during the first half of 2000 and the balance of $ 3,793,000 was recorded as an
operating expense of the sales and marketing department.
Sprint has scheduled additional shipments in the third quarter of year
2000 and we expect to record substantial non-cash charges, pursuant to SFAS 123,
as additional portions of Sprint's warrants become exercisable based on those
shipments. The amounts of the charges will depend primarily on the amounts of
the scheduled shipments and on our stock prices at the times the shipments are
scheduled. If our stock price increases, the amount of the charges will
increase; and if our stock price decreases, the amount of the charges will
decrease. We also anticipate that we will not recognize revenue on our shipments
of products to Sprint (or on most of those shipments) as and when those
shipments are made. That is because Sprint orders are generally subject to
testing and acceptance procedures. Revenue will not be recognized unless and
until those procedures are completed and the products are accepted, which could
take a number of months.
11
<PAGE>
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 Six Months Ended
June 30, June 30,
------------------------ ----------------------
2000 1999 2000 1999
---------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Gross Sales 100.0% 100.0% 100.0% 100.0%
Sales Discounts 42.4% 11.9% 32.7% 5.4%
---------- ------------ ---------- ----------
Net Sales 57.6% 88.1% 67.3% 94.6%
Cost of sales 90.2% 127.5% 93.9% 114.3%
---------- ------------ ---------- ----------
Gross margin -32.6% -39.4% -26.6% -19.7%
---------- ------------ ---------- ----------
Operating expenses
Research and development 37.4% 27.3% 48.4% 30.7%
Sales and marketing 44.3% 11.8% 77.9% 13.6%
General and administrative 74.0% 46.9% 101.3% 33.3%
---------- ------------ ---------- ----------
Total operating expenses 155.7% 86.0% 227.6% 77.6%
---------- ------------ ---------- ----------
Loss from operations -188.3% -125.4% -254.2% -97.3%
Interest income and other expense, net -25.3% 0.0% -15.2% 0.1%
Interest expense -9.7% -6.1% -14.1% -5.5%
---------- ------------ ---------- ----------
Net loss -223.3% -131.5% -283.5% -102.7%
========== ============ ========== ==========
</TABLE>
NET SALES
Gross revenue was $4,773,000 for the quarter ended June 30, 2000
compared to $3,411,000 for the same quarter in 1999. Gross revenue was
$6,574,000 for the six months ended June 30, 2000 and $7,534,000 for the six
months ended June 30, 1999. Net revenue was $2,747,000 for the quarter ended
June 30, 2000 compared to net revenue of $3,004,000 for the same quarter of
1999. For the six months ended June 30, 2000 and June 30, 1999, net revenue was
$4,424,000 and $7,127,000, respectively. Non-cash sales discounts in connection
with shipments to Sprint during the quarter ending June 30, 2000 (described
under the heading "Revenue Recognition" above) were $2,026,000 . Non-cash sales
discounts in the quarter ending June 30, 1999 were $407,000. Non-cash sales
discounts for the six months ended June 30, 2000 were $2,150,000 compared with
$407,000 for the same period in 1999.
12
<PAGE>
The following table provides information regarding the respective
amounts of shipments and net sales by quarter for 1998, 1999, and the first two
quarters of 2000.
<TABLE>
<CAPTION>
(Amounts in $'000) 1998 1999 2000
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Shipments 4,406 1,187 2,252 2,796 3,965 3,501 2,980 1,808 2,152 7,100
Net sales 2,706 2,243 4,202 3,267 4,123 3,004 3,319 2,569 1,677 2,747
</TABLE>
We shipped $ 4,453,000 in products and services to Sprint during the
quarter ending June 30, 2000. Of this, $1,819,000 was recognized as immediate
revenue since it was not subject to testing and acceptance procedures. The
balance of $2,634,000 was subject to testing and acceptance procedures and was
carried as unrecognized revenue as of June 30, 2000. An additional $207,000 was
recognized as revenue in respect of shipments made in prior periods that
received final acceptance from Sprint. The recognized revenue for the quarter of
$ 2,026,000 has been offset in full by a sales discount related to the equipment
purchase agreement with Sprint (see "Revenue Recognition"). In addition to the
$2,634,000 of shipments to Sprint that have not yet been recognized as revenue,
an additional $213,000 in shipments to other customers during the quarter were
unrecognized as they were distributor sales. The total shipments to Sprint and
other customers not recognized as revenue due to acceptance, right of return
issues, and distributor sales at June 30, 2000 was $3,513,000.
We believe that the shipments made prior to June 30, 2000 as to which
our customer have acceptance criteria or return rights will, ultimately, be
recognized as revenue. However, it is possible that the customer will determine
that the criteria are not satisfied or that return rights will be exercised. In
such cases, the underlying amount of potential gross revenue will not be
recognized.
For the three months ended June 30, 2000, broadband wireless systems
operators and cable system operators accounted for 85% and 15% of gross sales,
respectively. During the same period in 1999, broadband wireless system
operators accounted for 32% of gross sales and cable system operators accounted
for 68% of gross sales. Three customers accounted for 42%, 30% and 13% of gross
sales during the second quarter of 2000 compared to three customers who
accounted for 41%, 28% and 25% of gross sales during the second quarter of 1999.
International sales (primarily to Canadian customers) accounted for 30% of gross
sales during the three months ended June 30, 2000 and 1.0% for the comparable
period in 1999.
GROSS MARGIN. Excluding the non-cash sales discount of $2,026,000,
gross margin for the quarter ended June 30, 2000 would have been $468,000 or
9.8% of gross recognized sales, a 134.8% increase over the comparable quarter in
1999. Gross margin on recognized revenue after deduction of non-cash sales
discounts was a negative 32.6% and a negative 39.4% of gross sales for the
quarters ended June 30, 2000 and 1999, respectively.
For the six months ended June 30, 2000 and excluding the non-cash sales
discount of $2,150,000, gross margin would have been $402,000 or 6.1% of gross
recognized sales, a 127.1% increase over the comparable period in 1999. For the
six months ended June 30, 2000 and June 30, 1999, gross margin on recognized
revenue after deduction of non-cash sales discounts was a negative 26.6% and a
negative 19.7%, respectively.
RESEARCH AND DEVELOPMENT. Research and development expenses include
ongoing headend, software and cable modem development expenses, as well as
design expenditures associated with new product development, production of the
new products, manufacturing cost reduction programs and improving
manufacturability of existing products. Research and development expenses
increased 91.8% to $1,788,000 for the quarter ended June 30, 2000 from $932,000
for the quarter ended June 30, 1999. Research and development expenses as a
percentage
13
<PAGE>
of gross sales were 37.4% and 27.3% for the second quarters of 2000
and 1999, respectively, and were 48.4% and 30.7% for the first half of 2000 and
1999. Personnel and outside consultant costs increased by $716,000 during the
quarter ending June 30, 2000 compared to the quarter ended June 30, 1999.
Outside consultants are used to accelerate the time to market of specific
projects in order to meet customer requirements. During the three months ended
June 30, 2000, compensation recognized on the vesting 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 of salaries
and related payroll costs for sales and marketing personnel, commissions,
advertising, promotions and travel. Sales and marketing expenses increased 423.5
% to $2,115,000 for the quarter ended June 30, 2000 from $404,000 for the
quarter ended June 30, 1999. For the six months ended June 30, 2000, sales and
marketing expenses increased 401.1% to $5,121,000 from $1,022,000 for the six
months ended June 30, 1999. Sales and marketing expenses as a percentage
of gross sales were 44.3% and 11.8% for the second quarters of 2000 and 1999,
respectively and 77.9% and 13.6% for the first half of 2000 and 1999,
respectively. The largest component of the sales and marketing expense for the
second quarter of 2000 was the non-cash charge of $1,608,000 resulting from
scheduled shipments to Sprint during the quarter and the effect of those
shipments on a portion of warrants we issued to Sprint in September 1999. This
charge and the related sales discount are described under the heading "Revenue
Recognition" above. Excluding the above described non-cash charges, the increase
in sales and marketing expenses for the three and six months periods ended June
30, 2000 compared to the same periods in 1999 was due to the continued expansion
of our sales and marketing activity compared to prior periods. During the three
months ended June 30, 2000, compensation recognized on the vesting 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 compensation, provision for doubtful accounts,
travel expenses, legal fees and costs of outside services. General and
administrative expenses increased 120.7% to$3,533,000 for the quarter ended June
30, 2000 from $1,601,000 for the quarter ended June 30, 1999. For the six months
ended June 30, 2000, general and administrative expenses increased 164.9% to
$6,657,000 from $2,513,000 for the six months ended June 30, 1999. General and
administrative expenses as a percentage of gross sales were 74.0% and 46.9% for
the second quarters of 2000 and 1999, respectively and 101.3% and 33.3% for the
first six months of 2000 and 1999, respectively. Legal fees for the quarter
ending June 30, 2000 were $2,170,000 and included a one-time special charge of
$2 million in connection with the settlement reached in the Pacific Monolithics
matter (see "Contingencies" above). During the three months ended June 30, 2000,
compensation recognized on the vesting of stock options with exercise prices at
below fair market value for employees engaged in administration amounted to
$69,000.
INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net
interest expense of $1,673,000 for the three months ended June 30, 2000 compared
to net interest expense and other expense of $207,000 for the three months ended
June 30, 1999. For the six months ended June 30, 2000, we incurred net interest
expense of $1,923,000 compared to net interest expense and other expense of
$411,000 for the six months ended June 30, 1999. The increase in net interest
expense and other expense for the three and six months periods was primarily due
to the $1,170,000 debt conversion expense incurred as a result of the conversion
of the $18.1 million convertible debentures on June 30, 2000 (see "Liquidity and
Capital Resources"). The convertible debenture agreement provides that the
debentures would be convertible at the Company's option after the end of year
2000. At the Company's request, however, the holders agreed to convert the
debentures during the quarter ending June 30, 2000. As an inducement to the
debenture holders for this early conversion, the Company agreed to a premium
that would be equivalent to the interest that would have been earned on the
debentures during the third and fourth quarters of 2000. The premium was paid in
the form of additional shares of Common Stock calculated at the conversion price
of $2.85 per share. In accordance with the Statement of Financial Accounting
Standards No. 84 (SFAS 84) (see "Liquidity and Capital Resources" below) this
resulted in a debt conversion expense of $1,170,000, which was booked as a
non-operating expense for the quarter ending June 30, 2000. In addition to the
debt conversion expense, net interest income (expense) and other expenses was
impacted by a reduction in the net interest income from short-term investments.
14
<PAGE>
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
over $35 million in net proceeds from our initial public offering. 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 (in the amount of $11.0 million) and certain venture
capital sources (in the amount of $7.1 million). The debentures were due in
September 2009 and bore interest at 4% per annum, compounded monthly (accrued
interest is automatically added to principal quarterly). The debentures were
convertible into Common Stock at the option of the respective holders at any
time and would have been convertible into Common Stock at our option at any time
after 2000. The conversion price was $2.85 per share. During the quarter ending
June 30, 2000, at the request of the Company, the holders agreed to convert the
entire principal amounting to a face value of $18,100,000 plus accrued interest
through June 30, 2000 of $594,000, into 6,559,310 shares of Common Stock. Upon
the conversion, we paid a premium as an inducement to the holders equivalent to
the interest that would have been added to the principal of the debentures for
the third and fourth quarters of 2000, amounting to $375,750. The premium was
paid in the form of additional shares of Common Stock calculated at the
conversion price of $2.85 per share and was equivalent to 131,842 shares of
Common Stock. In accordance with the Statement of Financial Accounting Standards
No.84 (SFAS 84), "Induced Conversion of Convertible Debt", when convertible debt
is converted to equity securities of the debtor pursuant to an inducement offer,
the debtor shall recognize an expense equal to the fair value of all securities
and other consideration transferred in the transaction in excess of the fair
value of securities issuable pursuant to the original conversion terms. Based on
the closing price of the Company's Common Stock on June 30, 2000, and in
accordance with SFAS 84, a debt conversion expense of $1,170,000 was incurred.
In September 1999, at the time of Sprint's purchase of our
debentures, we issued to Sprint warrants to purchase up to $8.4 million of
additional convertible debentures (subject to Sprint scheduling the shipment of
up to $10 million of products and services pursuant to purchase orders) which
debentures will be convertible into up to 2,946,622 shares of our Common Stock
on the same terms and conditions as the convertible debentures referred to
above. Assuming as of June 30, 2000 that Sprint would exercise all of its
purchase warrants, it would own 7,013,068 shares of our Common Stock,
representing approximately 32.9% of the 21,259,845 shares of our Common Stock
that would then be outstanding (assuming no other security holders exercised
their options, warrants or conversion privileges). On a fully diluted basis,
assuming that as of June 30, 2000 all other security holders exercised their
options, warrants and conversion privileges as well as Sprint, Sprint would own
approximately 22.3% of the 31,445,704 fully diluted shares of our Common Stock
that would then be outstanding. In addition, under the terms of our agreements
with Sprint, Sprint has substantial rights with respect to our corporate
governance. Two of our five directors are Sprint designees, and we cannot issue
any securities (with limited exceptions) or, in most cases, take any material
corporate action without Sprint's approval. Sprint has other rights and
privileges as well, including pre-emptive rights and a right of first refusal in
the case of any proposed change of control transaction, which right of first
refusal is assignable by Sprint to any third party.
Net cash used in operating activities was $6,996,000 and $1,189,000
during the first half of 2000 and 1999, respectively. The net cash used in
operating activities in the first half of 2000 was primarily the result of our
net loss of $18,629,000, and an increase in accounts receivable of $1,326,000,
offset by increases in other accrued liabilities (including an accrual for $2
million in connection with the Pacific Monolithics settlement), an increase of
$5.9 million in non cash charges in connection with the issuance of Sprint
purchase warrants (See "Revenue Recognition"), and $2.3 million in compensation
recognized on the issuance of stock and the vesting of stock options. Net cash
used in operating activities in the first half of 1999 was primarily due to our
net loss of $7,742,000, partially offset by a reduction in inventories of
$2,287,000 and an increase in non-cash charges.
Net cash used in investing during the first half of 2000 and was
$206,000 used for purchases of
15
<PAGE>
property and equipment (primarily computers, and engineering test equipment) and
$1,166,000 for the purchase of short term investments. There were substantially
no investing activities during the first half of 1999. 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.
The Company has received a proposal for equipment lease financing on terms which
we believe are favorable and we are working with our existing bankers on the
establishment of additional short term financing. At June 30, 2000, we did not
have any material commitments for capital expenditures.
Net cash provided by financing activities in the first half of 2000 was
$463,000 compared to net cash used in financing activities of $197,000 during
the first half of 1999. Net cash provided by financing activities during the
first half of 2000 was primarily due to the exercise of stock options by
employees and others offset by the repayment of capital lease obligations. Net
cash used in financing activities in the first half of 1999 was primarily the
result of repayment of capital lease obligations, partially offset by net
proceeds from issuance of common stock resulting from the exercise of stock
options.
At June 30, 2000, our liquidity consisted of cash and cash
equivalents of $5,489,000, short term investments of $1,166,000 and negative
working capital of $450,000, including short-term investments. We have
received an equipment lease financing proposal to cover up to $1 million in
future equipment purchases but as of June 30, 2000, this proposal had not
been finalized and no lease obligations had been incurred. We had no other
available line of credit or other source of borrowings or financing but we
are in discussion with our bankers regarding the arrangement of additional
short term borrowing. Our principal indebtedness consisted of the $5.5
million in convertible debentures which will be payable beyond the next 12
months, although such amount would be payable immediately if the holder were
to declare a default under the terms of such debentures. (See "Basis of
Presentation"). While we believe that, with respect to our current
operations, our cash balance, plus revenues from operations and non-operating
cash receipts will be sufficient to meet our working capital and expenditure
requirements through the end of year 2000, we may be required to cut back
substantially on our expenditures if we do not raise additional capital this
year. Even though we are seeking additional financing through equipment
leasing and debt and may seek additional financing during 2000 through debt,
equity, or through a combination of financing vehicles, there is no assurance
that additional financing will be available to us on acceptable terms, or at
all, when we require it.
SEASONALITY AND INFLATION
We do not believe that our business is seasonal or is impacted by
inflation.
16
<PAGE>
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 AND THE PRICE OF OUR COMMON STOCK COULD DECLINE.
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, but we are losing money at a rate that will
require us to raise additional capital to stay in business. While we believe we
have sufficient capital to continue operations through the year 2000, we likely
would be required to cut back substantially on our expenditures if we do not
raise additional capital later this year. We have agreed with Sprint Corporation
to manufacture and ship certain quantities of products this year, to assist
Sprint in testing and installation of the products, to perform maintenance and
other services and to develop certain new products and enhance existing
products. This requirement and other orders that we have recently received will
accelerate and increase our need for capital.
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)
uncertainty regarding our financial condition and results of operations, (vi)
our history of heavy losses and (vii) the other risk factors referred to below.
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 may not have sufficient capital or other resources
necessary to meet the requirements of Sprint and other large customers in the
future. Accordingly, we may be obliged to seek strategic alliances with other
companies to assist in the development of further products and services. We
might not be able to form such alliances at all or on terms that are beneficial
for us.
WE ARE LARGELY DEPENDENT ON SPRINT.
In September 1999, Sprint invested $11 million by 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. Sprint has
acquired our principal wireless customers, and we expect that our future
business will primarily come from wireless customers. Accordingly, our future
business will be substantially dependent upon orders from Sprint or from
companies selling to Sprint. Sprint is using our products in connection with the
first phase of its roll-out of wireless Internet access services. We have only a
small number of other customers.
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 if no one else did so),
Sprint would own as of June 30, 2000, approximately 32.9% of our common stock on
a beneficial ownership basis and 22.3% of our Common Stock on a fully diluted
basis. Under the terms of our agreements with Sprint, we cannot issue any
securities (with limited exceptions) or, in most cases, take material corporate
action without Sprint's approval. Sprint has other rights and privileges,
17
<PAGE>
including pre-emptive rights and a right of first refusal in the case of any
proposed change of control transaction, which right of first refusal is
assignable by Sprint to any third party. 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 price and other terms of any of those purchases and
in deciding whether or not to support any future investment in us or any future
strategic partnering or sale opportunity).
We have entered into an equipment purchase agreement with Sprint
whereby Sprint has agreed to purchase this year $10 million of our products and
services subject to certain conditions. The equipment purchase agreement does
not require Sprint to make any additional purchases, but it imposes substantial
requirements on us. We must meet Sprint's schedule for the manufacture and
shipment of products; we must develop certain new products and enhance existing
products according to Sprint's schedule and specifications; we must perform
substantial installation and maintenance services; and we have agreed to the
"open architecture" principle whereby we will license our technology to
qualified third parties. In addition, Sprint's obligation to purchase our
products is subject to extensive testing and acceptance procedures. If we fail
to meet the requirements of the agreement, we could be subject to heavy
penalties, including the obligation to license our intellectual property rights
to Sprint on a royalty-free basis.
WE HAVE NOT BEEN PROFITABLE TO DATE, AND WE MAY NEVER BE PROFITABLE. WE
EXPECT CONTINUING LOSSES FOR THE FORESEEABLE FUTURE.
We have not been profitable to date, and we cannot assure you that we
will ever achieve or sustain profitability. We were organized in 1990 and have
had operating losses each year since then. Our accumulated deficit was
$104,390,000 as of June 30, 2000 and $85,761,000 as of December 31, 1999. 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 experienced price
pressure on sales of our products in the past and these pressures continue. We
expect to incur losses for the foreseeable future.
WE MUST DEVELOP NEW PRODUCTS AND ENHANCEMENTS QUICKLY AND DEPLOY OUR
PRODUCTS ON A MUCH LARGER SCALE THAN WE HAVE IN THE PAST, AND WE MIGHT
NOT BE ABLE TO MEET THESE CHALLENGES.
In order to meet the existing and future demands of the market, we will
be required to develop new products and enhance our existing products. In
addition, Sprint and other potential large scale customers will require us to
demonstrate that our system can be successfully deployed on a much larger scale
than it has been in the past. We might not be able to meet these challenges.
WE ARE LARGELY DEPENDENT ON THE WIRELESS MARKET, AN EMERGING MARKET
SUBJECT TO UNCERTAINTIES.
While in the past over half our sales have been to cable customers, we
have been essentially shut out of the market for new installations by cable
customers. The wireless industry has not adopted the Data Over Cable System
Interface Specification (DOCSIS), a standard to which our products do not
conform. While the DOCSIS standard has inhibited our sales to cable customer, it
has not, to date, affected our ability to market to wireless system operators.
The market for broadband Internet access products has only recently
begun to develop. In the past, the broadband wireless industry has been
adversely affected by chronic under-capitalization. Recent investments by Sprint
and MCI in wireless operators are expected to have a significant effect upon the
industry. One effect has been to attract major competitors. Cisco is testing
high speed Internet access products for wireless applications using a new
technology that Cisco claims will replace existing technologies, including ours.
It is a variant of OFDM. We face other major competition in the wireless market
as well.
18
<PAGE>
The wireless industry itself competes with other technologies for
providing high speed Internet access, including cable and DSL. Cable companies
providing Internet access and telephone companies providing Internet access
through DSL are expanding into areas that were primarily considered commercially
reachable only by wireless service. 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. Physical interruptions such as
buildings, trees or uneven terrain can interfere with reception, thus limiting
broadband wireless system operators' customer bases. In addition, wireless
customers face a number of licensing and regulatory restrictions.
Conditions in the wireless 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. There can be no assurance that the wireless
industry market will grow or that our products will be accepted in the emerging
market.
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 cable operators or 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.
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.
PARTICIPANTS IN THE WIRELESS INDUSTRY HAVE FORMED CONSORTIA WHICH WE
HAVE NOT BEEN ALLOWED TO ENTER.
Many firms, some of which are much larger than we are and some of which
are small firms, are developing wireless products. These firms, including us,
are not all using the same technological base and approach. In order to promote
their products, the competing firms are seeking to develop consortia and other
alliances that will promote their technology as the industry standard. If other
technologies are adopted as the standard, our products could lose acceptance in
the marketplace and our growth would be seriously impaired.
On July 11, 2000, a group of six companies announced the creation of
the Wireless DSL (wDSL) Consortium. The participating companies are Nortel
Networks, Conexant Systems, Intel, ADC, Gigabit Wireless, and Vyyo. This
consortium aims to promote an open-air interface that will be interoperable
among multiple vendors. The consortium has decided to promote the Vyyo platform
and the DOCSIS+ technology as its initial offering to the marketplace. Other
companies may join the wDSL Consortium over time.
The members did not invite us to join this consortium, and its creation
is a market threat to our products. The consortium did not and does not intend
to adopt Hybrid's technology. Should the marketplace choose to utilize the wDSL
consortium products in the future, our business will be adversely affected.
Additional companies may join this consortium if it expands and the adverse
consequences would then be even more significant for our product development and
technology. The (possible) continued collaboration of these large and small
companies may result in development of new, additional products that may appear
more attractive to providers than ours.
19
<PAGE>
WE FACE SIGNIFICANT COMPETITION, INCLUDING COMPETITION FROM LARGE
COMPANIES.
Our market is intensely competitive, and we expect even more
competition in the future. 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. One of our principal competitors in the wireless market is Cisco,
which has recently announced that it has a competitive wireless technology that
will provide superior cost/benefit performance and will operate successfully in
environments in which it is difficult to obtain a clear line of sight as well as
environments with multipath interference (around buildings, flat roofs and
water, for example). Although we believe Cisco has not yet installed a
commercially operating system using this technology, we cannot assure you that
it will not do so or that Cisco's system will not provide benefits superior to
ours.
Other principal competitors include ADC, which is currently offering
the Vyyo (Phasecom) product and has credibility from its MMDS, WCS and UHF
transmitter division (formerly known as ITS Corp.); COM21, which is attempting
to adapt its proprietary cable system for wireless; Newbridge, which acquired
much of Stanford Telecom, a manufacturer of QPSK products, and which has itself
been acquired by Alcatel: and Nortel, which has developed products for the cable
market, and has recently announced that it is developing products for the
wireless market as well. Other competitors may be attracted by the recent
capital infusion in the industry by Sprint and MCI. Some of our partners are
major system integrators who could choose to develop their own designs in-house.
Lucent has shown an interest in entering the industry.
Telephone companies are learning to deploy forms of DSL to provide high
speed Internet access over existing telephone wires. They are also working with
computer vendors to have DSL cards installed when the computers are
manufactured, thereby reducing the telephone companies' distribution costs. DSL
and cable Internet access companies are continuing to expand the reach of their
services, thereby providing direct competition for wireless even in areas that
were previously considered too remote for economical access via DSL or cable.
We have agreed with Sprint that in the future we will allow third
parties to license our technology and offer products in competition with ours,
using our technology. This could generate significant new competitive challenges
for us. It might also not meet our objective of creating a defacto standard for
working systems
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.
WE FACE LITIGATION RISKS.
Although we have settled litigation with the SEC and with Pacific
Monolithics (see "Contingencies"), it is possible that we may be exposed to
further litigation in the future. 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
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(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 and third parties may bring litigation against us
challenging our patents.
MARKET PRESSURE TO REDUCE PRICES HAS HURT OUR BUSINESS AND THE PRESSURE
IS LIKELY TO INCREASE.
The market has historically demanded increasingly lower prices for our
products, and we expect downward pressure on the prices of our products to
continue and increase. Customers wishing to purchase client modems generally
must also purchase an Ethernet adapter for their computer. Our products are
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. Sprint and other large scale customers have increased the downward
pressure on our prices. 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. 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 the fourth quarter of 1999,
and which must substantially improve in order for us to operate profitably.
WE RELY ON A SINGLE MANUFACTURER FOR OUR END-USER PRODUCTS AND ON
SINGLE-SOURCE COMPONENTS, AND SOME OF THE COMPONENTS ARE BECOMING
OBSOLETE.
Our Series 2000 client routers are manufactured only by Sharp, and we
plan to have Sharp manufacture our new Wireless Broadband Router as well. 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 products, we will need to further reduce our prices,
and the underlying costs. As long as Sharp is the only manufacturing source of
our routers, our ability to reduce the manufacturing costs may be limited.
We have subcontractors for the standard components and subassemblies
for our headend products. Standard components include the Sun Microsystems Sparc
5 workstation and its Sun Operating System (OS); and Intel's Ethernet cards and
Pentium-based PCI processor cards. Our CyberMaster Downstream Router ("CMD") and
CyberMaster Upstream Router ("CMU") are built on Intel's Pentium-based
PCI/ISA-based computer cards installed in standard rack-mounted backplans from
Industrial Computer Source that are configured to our specifications. Our
proprietary software, Hybrid OS, is overlaid on a standard Berkeley Systems
operating system for the CMD and CMU.
We are dependent upon these and other key suppliers for a number of the
components for our 64-QAM products. There is only one vendor for the 64-QAM
demodulator semiconductors used in each of our new modem and WBR designs, and in
past periods these semiconductors have been in short supply. The CCM and N type
routers use BroadCom chip sets. The current WBR's use Libit chips. Hitachi is
the sole supplier of the processors used in certain of our routers. The former
Telecom Component Products Group of Standard Telecom (now part of Intel) 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 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 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.
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Our CyberManager 2000 Router is built on the Sparc 5/Sun workstation
computer, which Sun is no longer producing. As an interim measure, we have been
purchasing re-manufactured substitute units from a third party, but Sun is not
supporting them. Accordingly, we are in the process of modifying our software to
be able to use another workstation, and there is no assurance that we will be
able to do so successfully. In addition, certain of our products use chips
manufactured by National Semiconductor that have been discontinued. While
National Semiconductor has continued to supply these chips to us, there is no
assurance that they will do so indefinitely.
OUR LONG SALES CYCLE MAKES IT DIFFICULT FOR US TO FORECAST REVENUES,
REQUIRES US TO INCUR HIGH SALES COSTS AND AGGRAVATES FLUCTUATIONS IN
QUARTERLY OPERATING RESULTS. OUR SALES CYCLE MAY WELL GET LONGER.
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. There are often delays associated with our
customers' internal procedures to approve the large capital expenditures that
are typically involved in purchasing our products. This makes it difficult for
us to predict revenue. In addition, since we incur sales costs before we make a
sale or recognize related revenues, the length and uncertainty of our sales
cycle increases the volatility of our operating results because we may have high
costs without offsetting revenues.
Over the last year, the marketplace has consolidated so that our
principal customers and potential customers are large telcos. This consolidation
has greatly increased our selling expenses and lengthened our sales cycle.
INTERNATIONAL SALES COULD INVOLVE GREATER RISKS.
In the past, sales of our products outside of the United States have
not represented a significant portion of our net sales, but this may be
changing. In the second quarter of 2000, international sales accounted for
30% of our gross sales, compared to 1% in the second quarter of 1999. 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 and reduced intellectual
property protection. To increase our international coverage we rely on value
added resellers ( VAR's) or integrators. These VARS may not remain exclusive
Hybrid distributors and will attempt rather to meet the needs of their
customers. They also compete with each other in some areas so it may be
difficult for Hybrid to protect its international distribution channels.
WE DEPEND ON KEY PERSONNEL AND WE ARE IN A TIGHT JOB MARKET WHICH MAKES
HIRING THE PEOPLE WE NEED DIFFICULT.
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. We are in an
extremely tight labor market, and competition for such personnel is intense.
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 prevent us from meeting
our product development goals and could have an extremely adverse effect on our
business.
REDUCTIONS 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,
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we reduced our expenditures on research and development and on other aspects of
our business. We also reduced the number of our employees. While we believe
these reductions were necessary to conserve our 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 have hurt us competitively and may continue
to harm our business in the future. 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
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 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.
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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.
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.
Changes in previous decisions (filing window for 2-way licenses) by
the FCC to open up MMDS spectrum to permit flexible use for upstream and
downstream paths may adversely affect our future growth. If the FCC changes its
decision to open the MMDS spectrum for full utilization, the future growth of
the wireless industry could be limited.
VOLATILITY OF OUR STOCK PRICE.
The 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.
Our Common Stock was delisted from the Nasdaq National Market and did
not trade on Nasdaq between mid-June 1998 and July 6, 2000. The market price of
our Common Stock has fluctuated in the past and is likely to fluctuate in the
future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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PART II. OTHER INFORMATION
II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of Shareholders of the registrant held on May 2, 2000,
the Shareholders:
1. Elected two Class I directors, one Class II director and two Class III
directors for terms to expire at the Annual Meetings of Stockholders in
2001, 2002 and 2003, respectively.
<TABLE>
<CAPTION>
FOR WITHHELD
--- --------
<S> <C> <C>
Timothy S. Sutton - Class I 12,183,860 10,930
Theodore H. Schell- Class I 12,183,010 11,780
James R. Flach- Class II 12,185,010 9,780
Gary M. Lauder - Class III 12,183,060 11,730
Michael E. Greenbaum - Class III 12,173,567 21,223
</TABLE>
2. Approved the Company's 1999 Stock Option Plan.
FOR AGAINST ABSTAIN NON-VOTE
--- ------- ------- --------
6,568,788 187,509 21,273 5,417,220
3. Approved the Company's 1999 Officer Stock Option Plan.
FOR AGAINST ABSTAIN NON-VOTE
--- ------- ------- --------
6,511,786 240,910 24,874 5,417,220
4. Approved the appointment of Hein & Associates LLP as independent
auditors for the fiscal year ending December 31, 2000.
FOR AGAINST ABSTAIN
--- ------- -------
10,945,901 1,233,196 15,693
ITEM 5. OTHER INFORMATION
On July 25, 2000, Theodore H. Schell resigned from the board of directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
<S> <C>
10.01 Purchase of Equipment and Services Agreement between Sprint/United Management Company
and the Registrant dated May 1, 2000. (1)
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27.1 Financial Data Schedule
</TABLE>
(1) Incorporated by reference to the Exhibits with the same number in the
Company's current report on Form 8-K filed May 10, 2000.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K have been filed by the
Company since March 31, 2000.
1. On May 10, 2000, the Company reported under Item 5 "Other Events"
the entering into a Purchase of Equipment and Services Agreement
with Sprint/United Management Company.
2. On July 13, 2000, the Company reported under Item 5 "Other
Events":
That on June 29, 2000 a settlement had been reached with the
Securities and Exchange Commission (SEC) relating to the SEC's
investigation of registrant.
That on July 6, 2000 the registrant's common stock began trading
on the Nasdaq National Market System.
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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: August 14, 2000 HYBRID NETWORKS, INC.
/s/ Michael D. Greenbaum
--------------------------
Michael D. Greenbaum
Chief Executive Officer
/s/ Judson W. Goldsmith
--------------------------
Judson W. Goldsmith
Chief Financial Officer
(Principal Accounting Officer)
27
