<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 SEPTEMBER 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.
---------------------------------------------------------------------
(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
----------------------------------------------------------
(Address of principal executive offices)
(408) 323-6500
---------------------------------------------------------------
(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, 2000: 21,672,537
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 September 30, 2000 and December 31, 1999 3
Unaudited Condensed Statements of Operations for the
Three and Nine Months Ended September 30, 2000 and 1999 4
Unaudited Condensed Statements of Cash Flows for the
Nine Months Ended September 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 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 26
</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>
September 30, December 31,
2000 1999*
ASSETS ----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,836 $ 13,394
Accounts receivable, net of allowance for doubtful accounts
of $200 in 2000 and 1999 2,646 1,138
Inventories 8,916 3,755
Prepaid expenses and other current assets 640 234
------------- -------------
Total current assets 15,038 18,521
Property and equipment, net 1,836 2,244
Intangibles and other assets 331 387
------------- -------------
Total assets $ 17,205 $ 21,152
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Convertible debenture $ 5,500 $ 5,500
Current portion of capital lease obligations 99 336
Accounts payable 4,410 2,035
Accrued liabilities and other 5,619 4,623
------------- -------------
Total current liabilities 15,628 12,494
Convertible debentures - long term 1 18,327
Capital lease obligations, less current portion - 29
Other long-term liabilities 129 122
------------- -------------
Total liabilities 15,758 30,972
------------- -------------
Contingencies
Stockholders' equity (deficit):
Convertible preferred stock, $.001 par value:
Authorized: 5,000 shares;
Issued and outstanding: no shares in 2000 and 1999 - -
Common stock, $.001 par value:
Authorized: 100,000 shares;
Issued and outstanding: 21,672 shares in 2000
and 11,481 shares in 1999. 22 11
Additional paid-in capital 118,743 75,823
Unrealized gain on available-for-sale securities 11 107
Accumulated deficit (117,329) (85,761)
------------- --------------
Total stockholders' equity (deficit) 1,447 (9,820)
------------- --------------
Total liabilities and stockholders' equity (deficit) $ 17,205 $ 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 Nine Months Ended
September 30, September 30,
------------------------ ----------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Gross sales $ 5,788 $ 3,319 $ 12,362 $ 10,854
Sales discounts 313 - 2,463 407
---------- ---------- ---------- ----------
Net sales 5,475 3,319 9,899 10,447
Cost of sales 4,483 3,060 10,655 11,674
----------- ----------- ---------- ----------
Gross margin (loss) 992 259 (756) (1,227)
----------- ----------- ---------- ----------
Operating expenses:
Research and development 1,702 820 4,882 3,131
Sales and marketing 10,573 356 15,694 1,377
General and administrative 1,540 1,746 8,197 4,272
----------- ----------- ---------- ----------
Total operating expenses 13,815 2,922 28,773 8,780
----------- ----------- ---------- ----------
Loss from operations (12,823) (2,663) (29,529) (10,007)
Interest income and other expense 80 33 (919) 50
Interest expense (196) (2,033) (1,120) (2,448)
----------- ----------- ---------- ----------
NET LOSS (12,939) (4,663) (31,568) (12,405)
Other comprehensive loss:
Unrealized gain on investments - 21 - 21
Realized gain on available-for-sale securities
included in net loss (30) - (96) -
----------- ----------- ---------- ----------
Total comprehensive loss $ (12,969) $ (4,642) $ (31,664) $ (12,384)
======= ======= ====== ======
Basic and diluted net loss per share $ (0.61) $ (0.44) $ (1.90) $ (1.18)
======= ======= ====== ======
Shares used in basic and diluted per share calculation 21,352 10,637 16,624 10,539
======= ======= ====== ======
</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>
Nine Months Ended
September 30,
------------------------
2000 1999
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (31,568) $ (12,405)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 841 1,014
Sales discounts recognized on issuance of warrants 16,133 407
Issuance of stock for settlement of litigation 2,000 -
Compensation recognized on issuance of stock and stock options 2,483 745
Interest added to principal of convertible debentures 368 -
Provision for excess and obsolete inventory (862) 529
Beneficial conversion of convertible debentures 149 1,826
Change in unrealized gain on securities (96) -
Common stock issued to induce conversion of debentures 1,170 -
Change in assets and liabilities:
Restricted cash - 515
Accounts receivable (1,509) 1,090
Inventories (4,298) 2,470
Prepaid expenses and other assets (430) 326
Accounts payable 2,375 (777)
Other long term liabilities 6 61
Accrued liabilities and other 2,301 (197)
----------- -----------
Net cash used in operating activities (10,937) (4,396)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (353) (3)
Purchase of short term investments - (8,991)
----------- -----------
Net cash used in investing activities (353) (8,994)
----------- -----------
Cash flows from financing activities:
Repayment of capital lease obligations (265) (355)
Proceeds from issuance of convertible debenture - 18,101
Proceeds from exercise of stock options 997 306
----------- -----------
Net cash provided by financing activities 732 18,052
----------- -----------
Increase (decrease) in cash and cash equivalents (10,558) 4,662
Cash and cash equivalents, beginning of period 13,394 3,451
---------- ----------
Cash and cash equivalents, end of period $ 2,836 $ 8,113
========= =========
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 -
Discount for beneficial conversion feature of convertible debenture - 7,304
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid 678 622
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 September 30, 2000, the statements of operations for the three and nine
months ended September 30, 2000, and September 30, 1999, and the statements of
cash flows for the nine months periods ended September 30, 2000, and September
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 $117,329,000 as of September 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 September 30, 2000, the Company had arranged a short term
financing line of credit from their commercial bank on terms that we believe are
favorable. 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.
As of September 30, 2000, the Company's liquidity consisted of cash and
cash equivalents of $2,836,000 and negative working capital of $590,000. 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 debentures, 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 ended March 31, 1998, 1999, 2000 and 2001,
respectively. The Company's capital expenditures exceeded the maximum capital
expenditures allowed for the twelve months ended 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. While the Company believes that, with respect
to its current operations, its cash balance, plus revenues from operations,
non-operating cash receipts and short term bank financing will be sufficient to
meet its working capital and expenditure requirements through the end of year
2000, it may be required to cut back substantially on its expenditures if it
does not raise additional capital this year.
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 nine
months ended September 30, 2000, the Company had recognized $4,078,000 as
revenue from sales to Sprint Corporation. As of September 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 $10,232,000, of which
$9,224,000 was in connection with shipments to Sprint and $1,008,000 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 became exercisable on the scheduled
shipment dates when aggregate scheduled shipments of products and services
pursuant to purchase orders submitted by Sprint to the Company were at least $1
million. With each additional $1 million of scheduled shipments, Sprint is
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 nine months ended September 30, 2000, reached the $10,000,000 maximum and,
based on the warrants' conversion ratio, this amount would give Sprint the right
to exercise 2,946,622 shares of the Company's Common Stock under the warrants.
The final value of this purchase right, using the Black-Scholes valuation model,
was $16,133,000. Of this amount, $2,463,000 was recorded as a direct sales
discount to offset recognized sales to Sprint. The balance of $13,670,000 was
recorded as an operating expense of the Sales and Marketing department.
The Company anticipates that it will not recognize revenue on its
shipments of headend systems to Sprint 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 September 30, 2000, the Company had recognized revenue in the amount of
$207,000 relating to headend systems accepted by Sprint.
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.
7
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INVENTORIES
Inventories are comprised of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------- --------
<S> <C> <C>
Raw materials $1,533 $2,251
Work in progress 951 190
Finished goods 6,432 1,314
---------- ----------
$8,916 $3,755
========== ==========
</TABLE>
The allowance for excess and obsolete inventory was $1,980,000 and
$2,842,000 on September 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 $93,000 and $402,000 on September 30, 2000,
and December 31, 1999, respectively.
CONTINGENCIES
SEC INVESTIGATION
By a subpoena to the Company 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 filed
suit 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. The lawsuit concerned an
agreement that the Company entered into in March 1998, to acquire Pacific
Monolithics through a merger. The merger was never consummated. The Complaint
alleged that the Company induced Pacific Monolithics to enter into the
agreement by providing it with false and misleading financial statements, by
making other representations concerning the Company's financial condition and
results of operations, which were also 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 the implied covenant of good faith and fair dealing, and
against all defendants, claims 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 in respect to each defendant except for the
Company's former auditors, and stayed the lawsuit pending the outcome of the
8
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arbitration.
In October 1999, the plaintiff filed a Demand for Arbitration against
the Company and each individual defendant except for 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 the 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-judgment
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 participated in a mediation of the
dispute in San Jose, California before the Honorable (Ret.) Peter Stone of JAMS.
The mediation resulted in a Stipulation for Settlement of the litigation. The
Parties formalized the terms of settlement by entering a Settlement Agreement &
Mutual General Release and Covenant Not to Sue (the "Agreement") dated August
21, 2000. The Company's former auditors also joined in the Agreement.
Pursuant to the terms of the Agreement, in full settlement and
compromise of all of Pacific Monolithics' claims against the Company and its
current and former officers and directors, and in exchange for Pacific
Monolithics full release thereof, the Company agreed to deliver to Pacific
Monolithics the total sum of 213,333 shares of the Company's common stock,
valued at $2,000,000.00 as of July 7, 2000.
The Company delivered 213,333 shares of its common stock to Pacific
Monolithics on September 14, 2000. On September 19, 2000, the Company filed, and
the Santa Clara Superior Court entered, a Request for Dismissal with Prejudice
of the lawsuit.
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 64 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 this 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 made the commitment 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 timely basis could have a material effect on our
business. The market for our
10
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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 nine months ended September 30, 2000, we had
recognized revenue from sales to Sprint Corporation in the amount of $4,078,000.
As of September 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 $10,232,000, of which $9,224,000 was in connection with
shipments to Sprint and $1,008,000 was for shipments to other customers.
We anticipate that we will not recognize revenue on our shipments of
headend products to Sprint 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.
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 became exercisable on the scheduled
shipment dates when aggregate scheduled shipments of products and services
pursuant to purchase orders submitted by Sprint to the Company were 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 nine months ended September 30, 2000, reached the $10,000,000 maximum and,
based on the warrants' conversion ratio, this amount would give Sprint the right
to exercise 2,946,622 shares of the Company's Common Stock under the warrants.
The final value of this purchase right, using the Black-Scholes valuation model,
was $16,133,000. Of this amount, $2,463,000 was recorded as a direct sales
discount to offset recognized sales to Sprint. The balance of $13,670,000 was
recorded as an operating expense of the Sales and Marketing department. No
additional amounts will be recorded as an offset to revenue, or as an expense,
insofar as the warrants have fully vested.
11
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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
September 30, September 30,
-------------------------- -----------------------
2000 1999 2000 1999
------------------------ ---------- ----------
<S> <C> <C> <C> <C>
Gross Sales 100.0% 100.0% 100.0% 100.0%
Sales Discounts 5.4% 0.0% 19.9% 3.7%
---------- ---------- ---------- ----------
Net Sales 94.6% 100.0% 80.1% 96.3%
Cost of sales 77.4% 92.2% 86.2% 107.6%
---------- ---------- ---------- ----------
Gross margin 17.2% 7.8% -6.1% -11.3%
---------- ---------- ---------- ----------
Operating expenses
Research and development 29.4% 24.7% 39.5% 28.8%
Sales and marketing 182.7% 10.7% 127.0% 12.7%
General and administrative 26.6% 52.6% 66.3% 39.4%
---------- ---------- ---------- ----------
Total operating expenses 238.7% 88.0% 232.8% 80.9%
---------- ---------- ---------- ----------
Loss from operations -221.5% -80.2% -238.9% -92.2%
Interest income and other expense, net 1.3% 1.0% -7.4% 0.5%
Interest expense -3.4% -61.3% -9.0% -22.6%
---------- ---------- ---------- ----------
Net loss -223.6% -140.5% -255.3% -114.3%
========== ========== ========= =========
</TABLE>
NET SALES
Gross revenue was $5,788,000 for the quarter ended September 30, 2000,
compared to $3,319,000 for the same quarter in 1999. Gross revenue was
$12,362,000 for the nine months ended September 30, 2000, and $10,854,000 for
the nine months ended September 30, 1999. Net revenue was $5,475,000 for the
quarter ended September 30, 2000, compared to net revenue of $3,319,000 for the
same quarter of 1999. For the nine months ended September 30, 2000, and
September 30, 1999, net revenue was $9,899,000 and $10,447,000, respectively.
Non-cash sales discounts in connection with shipments to Sprint during the
quarter ended September 30, 2000, (described under the heading "Revenue
Recognition" above) were $313,000. Non-cash sales discounts in the quarter ended
September 30, 1999, were zero. Non-cash sales discounts for the nine months
ended September 30, 2000, were $2,463,000 compared with $407,000 for the same
period in 1999. Growth in revenues for the three and nine month periods of 2000
compared to the same periods in 1999 is primarily due to the increased sales of
fixed broadband wireless equipment.
The following table provides information regarding the respective
amounts of shipments of
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<PAGE>
products and services and net sales by quarter for 1999 and the first three
quarters of 2000.
<TABLE>
<CAPTION>
1999 2000
Q1 Q2 Q3 Q4 Q1 Q2 Q3
------ ------ ------- ----- ------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Shipments 3,965 3,501 2,980 1,808 2,464 7,394 12,254
Net sales 4,123 3,005 3,319 2,569 1,677 2,747 5,475
</TABLE>
We shipped $8,115,000 in products and services to Sprint during the
quarter ended September 30, 2000. Of this amount, $1,987,000 was recognized as
immediate revenue since it was not subject to testing and acceptance procedures.
The balance of $6,128,000 was subject to testing and acceptance procedures and
has not yet been recognized as revenue as of September 30, 2000. $313,000 of the
recognized Sprint revenue for the quarter has been offset by a sales discount
related to the equipment purchase agreement with Sprint (see "Revenue
Recognition"). In addition to the shipments to Sprint, we shipped $4.1 million
in products and services to customers other than Sprint during the quarter ended
September 30, 2000. Revenue recognized during the quarter ended September 30,
2000 for customers other than Sprint included amounts based on shipments made
during the current quarter and, primarily, on shipments made in prior quarters.
The total shipments to Sprint and other customers not recognized as
revenue due to acceptance, right of return issues and distributor sales at
September 30, 2000, was $10,232,000. We believe that the shipments made prior
to September 30, 2000, as to which our customers 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 September 30, 2000, broadband wireless
systems operators and cable system operators accounted for 92% and 8% of
gross sales, respectively. During the same period in 1999, broadband wireless
system operators accounted for 43% of gross sales and cable system operators
and ISPs accounted for 57% of gross sales. Three customers accounted for 34%,
24% and 23% of gross sales during the third quarter of 2000, compared to
three customers who accounted for 33%, 24% and 12% of gross sales during the
third quarter of 1999. International sales (primarily to a Canadian customer
in 2000) accounted for 24% of gross sales during the three months ended
September 30, 2000 and 9% for the comparable period in 1999.
GROSS MARGIN. For the three months ended September 30, 2000, and
excluding the non-cash sales discount of $313,000, gross margin would have been
$1,305,000 or 22.5% of gross recognized sales, a 403.8% increase over the
comparable quarter in 1999. Gross margin on recognized revenue after deduction
of non-cash sales discounts was 17.2% and 7.8% of gross sales for the quarters
ended September 30, 2000, and 1999, respectively.
For the nine months ended September 30, 2000 and excluding the non-cash
sales discount of $2,463,000, gross margin would have been $1,707,000 or 13.8%
of gross recognized sales, a 308.2% increase over the comparable period in 1999.
Gross margin on recognized revenue after deduction of non-cash sales discounts
was a negative 6.1% and a negative 11.3% of gross sales for the nine months
ended September 30, 2000, and 1999, respectively.
RESEARCH AND DEVELOPMENT. Research and development expenses include
ongoing headend and software development expenses as well as design expenditures
associated with new
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product development, new product production, manufacturing cost reduction
programs and improvements in the manufacturability of existing products.
Research and development expenses increased 107.6% to $1,702,000 for the quarter
ended September 30, 2000, from $820,000 for the quarter ended September 30,
1999. Research and development expenses as a percentage of gross sales were
29.4% and 24.7% for the third quarters of 2000, and 1999, respectively, and were
39.5% and 28.8% for the first nine months of 2000, and 1999, respectively.
Personnel and outside consultant costs increased by $682,000 during the quarter
ended September 30, 2000 compared to the quarter ended September 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
September 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 $87,000.
SALES AND MARKETING. Sales and marketing expenses consist of
salaries and related payroll costs for sales and marketing personnel,
commissions, advertising, promotions and travel. The largest component of the
sales and marketing expense for the third quarter of 2000, was the non-cash
charge of $9,877,000 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 non-cash
charges related to the Sprint purchase warrants (See Revenue Recognition
above), sales and marketing expenses increased 95.5% to $696,000 for the
quarter ended September 30, 2000, from $356,000 for the quarter ended
September 30, 1999. For the nine months ended September 30, 2000, such sales
and marketing expenses increased 47.0% to $2,024,000 from $1,377,000 for the
nine months ended September 30, 1999. Sales and marketing expenses, excluding
the non-cash charges related to the Sprint purchase warrants, as a percentage
of gross sales were 12.0% and 10.7% for the third quarters of 2000, and 1999,
respectively and 16.4% and 12.7% for the first nine months of 2000, and 1999,
respectively. Excluding the non-cash charges from the Sprint warrants, the
increase in sales and marketing expenses for the three and nine month periods
ended September 30, 2000, compared to the same periods in 1999 was because of
the continued expansion of our sales and marketing activity compared to prior
periods. During the three months ended September 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 $10,000.
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 decreased 11.8% to $1,540,000 for the quarter ended
September 30, 2000, from $1,746,000 for the quarter ended September 30, 1999.
For the nine months ended September 30, 2000, general and administrative
expenses increased 91.9% to $8,197,000 from $4,272,000 for the nine months ended
September 30, 1999. General and administrative expenses as a percentage of gross
sales were 26.6% and 52.6% for the third quarters of 2000, and 1999,
respectively and 66.3% and 39.4% for the first nine months of 2000, and 1999,
respectively. The large increase in general and administrative expenses for the
nine months ended September 30, 2000, compared to the similar period in 1999,
was due in large part to the $2 million settlement and the related legal fees in
connection with the settlement reached in the Pacific Monolithics matter during
the second quarter of 2000. (see "Contingencies" above) and a charge of $1.3
million in the first quarter of 2000 in connection with a separation agreement
entered into with a former director. During the three months ended September 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 $66,000.
INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net
interest expense of $116,000 for the three months ended September 30, 2000,
compared to net interest expense of $2,000,000 for the three months ended
September 30, 1999. For the nine months ended September 30, 2000, we incurred
net interest expense of $2,039,000 compared to net interest expense of
$2,398,000 for the nine months ended September 30, 1999. The decrease in net
interest expense for the three months ended September 30, 2000, compared to
the similar period in 1999, was due primarily to the $1.8 million interest
charge taken during the 1999 period in connection with the
14
<PAGE>
amortization of a deemed discount related to the $18.1 million convertible
debentures which were issued in August 1999. The debentures were converted to
common stock in June 2000. Net interest income (expense) and other expenses were
affected by a reduction in the net interest income from short-term investments.
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 ended
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 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 September 30, 2000, that Sprint would exercise all of its purchase
warrants, it would own 7,013,068 shares of our Common Stock, representing
approximately 28.5% of the 24,619,159 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 September 30, 2000, all other security holders exercised their options,
warrants and conversion privileges as well as Sprint, Sprint would own
approximately 21.8% of the 32,117,489 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 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 $10,937,000 and $4,396,000
during the first nine months of 2000 and 1999, respectively. The net cash used
in operating activities in the first nine months of 2000, was primarily the
result of our net loss of $31,568,000, which was offset in part by an increase
in the sales discounts recognized on the issuance of warrants. Inventories
increased during the period by $4,298,000. Net cash used in operating activities
in the first nine months of 1999 was primarily due to our net loss of
$12,405,000, partially offset by a reduction in inventories of $2,470,000, a
reduction in accounts receivable of $1,090,000 and an increase in non-cash
charges and compensation charges recognized on the grant of stock options to
employees.
Net cash used in investing activities during the first nine months of
2000 was $353,000 which was due to the purchases of property and equipment
(primarily computers, and engineering test equipment). Net cash used in
investing activities in the first nine months of 1999, was $8,994,000 for the
purchase of short-term investments. In the past, we have funded a portion of our
property and equipment expenditures from direct vendor leasing programs and
third party commercial lease arrangements. The Company expects to continue to
explore these and other financing alternatives in the future. At September 30,
2000, we did not have any material commitments for capital expenditures.
15
<PAGE>
Net cash provided by financing activities in the first nine months of
2000, was $732,000 compared to net cash provided by financing activities of
$18,052,000 during the first nine months of 1999. Net cash provided by financing
activities during the first nine months 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 provided by financing activities in the
first nine months of 1999, was primarily the result of the issuance in September
1999, of convertible debentures in the principal amount of $18,101,000 referred
to above.
As of September 30, 2000, our liquidity consisted of cash and cash
equivalents of $2,836,000 and negative working capital of $590,000. The Company
has arranged a short-term financing line of credit with its commercial bank on
terms that we feel are favorable. Our principal indebtedness consisted of the
$5.5 million in convertible debentures that will be payable beyond the next 12
months. Under the terms of the debenture, we 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. Our capital expenditures exceeded the maximum capital expenditures
allowed for the twelve months ended 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. While we believe that, with respect to our current operations, our
cash balance, plus revenues from operations, non-operating cash receipts and
short term bank financing 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 have secured additional financing through a short term
bank line of credit 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 NOT
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 1999, we raised $18.1 million through 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, ship, test, install and perform maintenance on
certain quantities of our products this year. In addition, we have agreed to
provide other services including enhancing our existing products and developing
certain new products. This agreement with Sprint and other orders that we have
recently received will 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 the Sprint agreement and other large
customers in the future. Accordingly, we may need to seek strategic alliances
with other companies to assist in the development of new 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 purchased from us some convertible debentures
with an aggregate value of $11 million and pursuant to that agreement we also
issued to Sprint some warrants to purchase additional convertible debentures.
The warrants were issued in consideration for a commitment by Sprint to purchase
$10 million of our products by the end of the calendar year 2000. We expect that
our future business will primarily come from wireless customers and Sprint has
acquired or controls our principal wireless customers. Accordingly, our future
business will be substantially dependent upon orders from Sprint or from
companies selling to Sprint. Sprint is currently using our products in
connection with its initial offering of wireless Internet access services. We
have only a small number of other customers.
Sprint also possesses substantial corporate governance rights. By
virtue of the various agreements in connection with the purchase of $11 million
in convertible debentures, Sprint may designate two directors of the Board.
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, 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. Furthermore, if Sprint exercises all its warrants
(and assuming
17
<PAGE>
that no other warrant holders exercise), Sprint would own as of September 30,
2000, approximately 28.5% of our common stock on a beneficial ownership basis
and 21.8% of our common stock on a fully diluted basis. 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 an aggregate value of $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 every year to date. Our accumulated deficit was
$117,329,000 as of September 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 BE ABLE TO QUICKLY AND EFFECTIVELY DEVELOP NEW PRODUCTS,
DEVELOP ENHANCEMENTS FOR OUR EXISTING PRODUCTS 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 broadband
wireless and cable markets, we must 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 BROADBAND WIRELESS MARKET, AN EMERGING
MARKET SUBJECT TO UNCERTAINTIES.
Historically over half our sales have been to cable customers. We
have been, as expected, essentially shut out of the market of new
installations for cable customers by the general adoption of the Data Over
Cable System Interface Specification ("DOCSIS"). This is a standard to which
our products do not conform. The wireless industry has not adopted DOCSIS.
Accordingly, the DOCSIS standard has inhibited our sales to cable customers,
but 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 had 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 also competes with other technologies such as
cable and DSL, to provide high-speed Internet access. Cable companies providing
Internet access and telephone companies providing Internet access through DSL
service are expanding into areas that were previously 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 standard that is supported in
Europe. The emergence of these standards has hurt our cable business, and the
adoption of wireless industry standards in the future could also have a similar
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 our products
could be rendered uncompetitive. 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 changes in technology, 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.
Some firms that are developing broadband wireless systems and products
are much larger than we are. These firms and other smaller firms are not all
using the same technological base and approach. In order to promote their
products, these competing firms are seeking to develop consortia and other
alliances to 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.
We were not invited to join this consortium, and its existence is a
market threat to our products. The consortium does not intend to adopt
Hybrid's technology. Should the marketplace choose to adopt the wDSL
consortium products as the industry standard, 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, Cisco, 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. Gigabit Wireless also
has a product under development which we believe has some meaningful
similarities to Cisco's product.
Other principal competitors include ADC and Nortel. ADC has offered the
Vyyo (FORMERLY Phasecom) product and has market and technology credibility from
its MMDS, WCS and UHF transmitter division. ADC recently announced the
acquisition of Broadband Access Systems, a leading head-end vendor for cable.
Nortel has products for cable and has a strong sales position and credibility
because of their networking, network management and fiber optic transmission
products.
Other competitors include COM21, which is attempting to adapt its
proprietary cable system for wireless; Alcatel, which has acquired Newbridge and
much of Stanford Telecom, a manufacturer of QPSK products. There are several
other small companies attracted by the recent capital infusion in the industry
by Sprint and MCI. In addition, Lucent has shown an interest in entering the
industry and Motorola has shown an interest as well.
Telephone companies are learning to provide forms of DSL service 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.
Our business depends upon the technical success and working
relationships of our allies producing other parts of the system. As an example,
one transceiver must be installed for each Hybrid Wireless Broadband Router.
California Amplifier has the major share of the transceiver market in Sprint and
many other accounts. Other vendors such as Andrew or TSI might not be able to
instantly meet the demand if California Amplifier had problems. Transmitters are
produced by three vendors and the vendor is often chosen because their product
already matches the transmitters in place when the spectrum is acquired. Two
transmitter producers, Thomcast and EMCEE, resell Hybrid products. Many of the
Sprint deployments use transmitters produced by ADC, a competitor to Hybrid. The
head end downconverters and antennas are produced by this same group of
companies. Andrew Corporation supplies transmitter antennas. We have been
successful in asking customers to buy direct from our allied vendors so that we
can be impartial but there is no guarantee that this virtual integrator approach
can continue.
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.
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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, to determine the validity and scope of
our patents and to determine the validity and scope of the proprietary rights of
others. Such litigation might result in substantial costs as well as a diversion
of managerial resources and attention. Furthermore, our business activities may
infringe upon the proprietary rights of others, and they may claim that our
products infringe upon their proprietary rights. Any such claims, with or
without merit, could result in significant litigation costs and diversion of
management attention, as well as harm to our business, including having to enter
into royalty and license agreements that may have terms that are disadvantageous
to us. If litigation is successful against us, it could result in the
invalidation of our proprietary rights and our incurring 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 and third
parties may institute litigation against us challenging the validity of our
patents. We may also face litigation over other aspects of our business,
including employment or other commercial matters that, if concluded in a manner
adverse to us, could adversely affect our operating results and financial
condition.
MARKET PRESSURE TO REDUCE PRICES HAS HURT OUR BUSINESS AND THE PRESSURE
IS LIKELY TO INCREASE.
Historically, the market has demanded increasingly lower prices for our
products, and we expect downward pressure on the prices of our products to
continue and increase. Our products are relatively expensive for the consumer
electronics and the small office or home office markets. For example, customers
who purchase one of our modems must usually also purchase an Ethernet adaptor.
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 historically been negative 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 and Wireless Broadband Routers are
manufactured only by Sharp, and we plan to have Sharp manufacture our new
Wireless Broadband Router as well. Our decision not 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
workstation and its Sun Operating System ("OS"); and Intel's Ethernet cards and
processors. Our CyberMaster Downstream Router ("CMD") and CyberMaster Upstream
Router ("CMU") use Intel's 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
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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 Wireless
Broadband Router ("WBR") designs, and in past periods these semiconductors
have been in short supply. The current WBRs use Texas Instruments chips.
Hitachi is the sole supplier of the processors used in our WBRs. Intel is
currently the sole supplier for demodulator assemblies used in our CMU
products. 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. 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.
Our CyberManager 2000 Router is built on the Sparc /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 testing modified software
to be able to use another workstation, and there is no assurance that we will be
able to launch this product successfully.
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 service providers
including telecom companies. 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 third quarter of 2000, international sales accounted for 24% of
our gross sales, compared to 9% in the third 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, political and
economic instability and reduced intellectual property protection. To increase
our international coverage we rely on value added resellers ("VARs") 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. In addition, the frequency spectrum and
amount of spectrum available internationally varies from country to country. We
will be dependent on our VARs to develop compliant transceivers and
transmitters, which may slow deployment in some international markets.
WE DEPEND ON KEY PERSONNEL AND HIRING AND RETAINING QUALIFIED EMPLOYEES
IS DIFFICULT.
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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.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY.
We rely on a combination of patent, trade secret, copyright and
trademark laws in addition to 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 certain persons claiming that our products, software or asserted
proprietary rights infringe the proprietary rights of such persons. 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 if 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 management resources.
As indicated above, we were engaged during 1998 in an infringement lawsuit that
we brought against two alleged infringers. 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 ours 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.
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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, prescribe the installation and equipment standards for
communications systems. Furthermore, regulation of our customers may adversely
affect our business.
The capacity of downstream spectrum in the MMDS band is not a problem
for current deployments but the upstream does severely limit capacity. Our
customers generally only have MDS 1 and 2 for the return. This gives 12 MHz
bandwidth enhanced to 50 MHz if using ten sector return antennas. Any increase
in this capacity or the deployment of more cells usually requires additional
spectrum. Each of our customers has filed for two-way operation in the MMDS band
for the end of year 2000 but the FCC has to approve their filings. Operators in
nearby cities must co-operate and show their plans do not cause interference..
Delays in approvals 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 1. LEGAL PROCEEDINGS. See "Contingencies" in Part I
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Pursuant to a Settlement Agreement & Mutual General Release and
Covenant Not to Sue, the Company issued 213,333 shares of the Company's
common stock to Pacific Monolithics, Inc.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The following Current Reports on Form8-K have been filed by the Company
since June 30, 2000.
1. On August 14, 2000, the Company reported under Item 5 "Other
Events" the appointment of Jud Goldsmith as Vice President of
Finance and Chief Financial Officer.
2. On September 15, 2000, the Company announced that in a press
release and conference call on September 13, 2000, it
discussed its shipment projections for the next three fiscal
years.
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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: November 2, 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)
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