SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
or
_ TRANSITION REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
[NO FEE REQUIRED] for the transition period from
________ to _________
Commission file No. ________
Com21, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-3201698
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
750 Tasman Drive
Milpitas, California 95035
(408) 953-9100
(Address, including zip code, and telephone number, including
area code, of the registrant's principal executive offices)
Securities registered under Section 12(b) of the Exchange Act
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value
Indicate by a checkmark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No _
Indicate by a check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _
At December 31, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $266,947,779, based on the
last trade price as reported by The Nasdaq National Market. For purposes of
this calculation, shares owned by officers, directors, and 10% stockholders
known to the registrant have been excluded. Such exclusion is not intended,
nor shall it be deemed, to be an admission that such persons are affiliates
of the registrant.
At December 31, 1998, there were 18,685,560 shares of the registrant's Common
Stock, $0.001 par value, issued and outstanding.
Information required by Part III of this Form 10-K is incorporated therein by
reference from the Company's definitive Proxy Statement with respect to its
1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A
within 120 days after December 31, 1998.
<TABLE>
COM21, INC.
INDEX
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PART I: Page
<S> <C> <C>
Item 1 Business 3
Item 2 Properties 30
Item 3 Legal Proceedings 30
Item 4 Submission of Matters to a Vote of Security Holders 31
PART II:
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 31
Item 6 Selected Financial Data 32
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 33
Item 7A Quantitative and Qualitative Disclosures About Market Risk 37
Item 8 Financial Statements and Supplementary Data 38
Item 9 Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 54
PART III:
Item 10 Directors and Executive Officers of the Registrant 54
Item 11 Executive Compensation 54
Item 12 Security Ownership of Certain Beneficial Owners and
Management 54
Item 13 Certain Relationships and Related Transactions 54
PART IV:
Item 14 Exhibits, Financial Statement Schedules, and Reports on
Form 8-K 54
Exhibit Index 55
Signatures 56
</TABLE>
2
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements including statements regarding our
strategy, financial performance and revenue sources that involve a number of
risks and uncertainties, including those discussed below at "Risk Factors."
While this outlook represents our current judgement on the future direction
of the business, such risks and uncertainties could cause actual results to
differ materially from any future performance suggested below. Readers are
cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Annual Report. Com21 undertakes no
obligation to publicly release any revision's to forward-looking statements
to reflect events or circumstances arising after the date of this document.
See "Risk Factors."
Part I
Item 1. Business
Com21, Inc. designs, develops, markets and sells value-added, high-speed
communications solutions for the broadband access market. Com21's ComUNITY
Access system enables cable operators to provide high-speed, cost-effective
Internet access to corporate telecommuter, small office/home office and
residential end-users in the U.S. and internationally. Com21's system also
enables cable operators to address the distinct price, performance, security
and other needs of these different end-user groups. Com21's products include
headend equipment, subscriber cable modems, network management software and
noise containment technologies. Cable operators can use Com21's ComUNITY
Access system to increase revenue opportunities by offering up to 16
different operator-defined transmission rates at varying price points to
address multiple markets. Com21's system is designed to be deployed on a
limited capital budget and can be upgraded and scaled as subscriber
penetration grows. Our system enables cable operators to lower their ongoing
cost of ownership through cost-effective noise management and remote cable
modem upgrades. The ComUNITY Access system is also designed to support future
applications, such as cable telephony and virtual private networks, which are
public data networks that transport private data and are generally referred
to as VPNs. Com21 is developing a DOCSIS-compliant cable modem for the North
American cable market, which is intended primarily to address the basic
requirements of the residential end-users, who typically tolerate lower
performance and security than business users. Com21 is working with Cisco
Systems, Inc. to enable interoperability of its DOCSIS-compliant cable modems
with Cisco's universal broadband router, which is a high speed router
intended to distribute different forms of data traffic over different network
architectures. Com21 expects its first DOCSIS-compliant cable modem to be
commercially available in the first half of 1999. In 1998, we shipped
approximately 320 ComCONTROLLER headends and more than 77,000 ComPORT modems
for use in 154 locations worldwide. In the North American market, we sell
directly to cable operators such as Charter Communications, Cox
Communications, Prime Cable and TCI, and to system integrators such as
HSAnet. Internationally, we sell to systems integrators, including Philips
and Siemens, which in turn sell to cable operators.
Industry Background
The volume of data traffic across communications networks has
increased significantly over the last several years due to the
proliferation of network-based communications and electronic commerce.
Businesses, ranging from large corporate enterprises to small
offices/home offices, are increasingly using the Internet, intranets
and extranets, not only for communication within and outside the enterprise,
but also to create cost-effective secure data connections known as virtual
private networks, between corporate sites or remote locations. VPNs extend
corporate network access to remote employees and external organizations,
including business partners, suppliers and customers. Consumers are
increasingly accessing data networks, primarily the Internet, to
communicate, collect and publish information and to purchase retail
goods. Because of its global reach, accessibility, use of open
standards and ability to enable real-time interaction, the Internet
has become a valuable communications medium for both businesses and
consumers.
The Internet and the devices used to provide access to it are
expected to continue their rapid growth. International Data
Corporation estimates that between 1995 and 1998 the number of
devices that had access to the Internet grew from approximately 14
million to 120 million and anticipates that the number of these
devices will grow to more than 515 million by 2002. Similarly, the
available content and number of users on the Internet is rapidly
increasing. IDC estimates that the number of World Wide Web pages
grew from approximately 18 million in 1995 to 829 million in 1998
and is expected to increase to 7.7 billion by 2002. The number of
Web users in the U.S. is expected to increase from approximately 39
million in 1997 to 136 million in 2002. A substantial percentage of
worldwide growth is expected to come from Western Europe and Asia,
which is projected to grow from approximately 21 million users in
1997 to 119 million users in 2002. In addition to the substantial
increase in the number of users in recent years, demand has
increased among business and consumer users for high-speed Internet
access to multimedia and other bandwidth-intensive information,
consisting of data, voice and video in the form of value-added
services and applications. This has resulted in a growing need for
improved transmission performance throughout the Internet. With the
increasing dependence on communications networks and the growing
demand for bandwidth-intensive information, existing transmission
speeds have become less tolerable and can negatively affect
business productivity.
3
Typically, the limiting factor in overall data transmission
performance is the "last mile" of the communications
infrastructure. This infrastructure consists primarily of copper
twisted-pair wire or coaxial cable and was originally designed for
analog transmission, such as analog voice or one-way analog video
signals, rather than high-speed two-way broadband digital
transmission. Today, there are multiple technologies that attempt
to address the need for high-speed last mile connections,
including:
- wireline telephone infrastructure technologies, such as:
- 56 kilobits per second, dial-up modem technologies;
- integrated services digital network, commonly known as
ISDN in the telecommunications industry;
- asymmetric digital subscriber line, commonly known
as ADSL in the telecommunications industry; and
- other digital subscriber line, commonly known as
XDSL in the telecommunications industry technologies;
- wireless infrastructure technologies, such as:
- direct broadcast satellite, commonly known as DBS
in the telecommunications industry;
- multichannel multipoint distribution service, commonly
known as MMDS in the telecommunications industry; and
- local multipoint distribution service, commonly
known as LMDS in the telecommunications industry;
- hybrid fiber-coaxial, cable infrastructure technologies, commonly
known as HFC in the telecommunications industry such as:
- cable modems.
While each of these technologies has certain advantages, the
cable infrastructure currently provides the highest available
transmission speed, with peak data transmission speeds of 30
megabits per second and "always-on" availability providing instant
access. In addition, cable infrastructure is widely deployed. Paul
Kagan Associates, Inc. estimates that at the end of 1997, cable
infrastructure passed approximately 95 million U.S. homes and more
than 185 million homes in Western Europe and Asia. Recognizing the
opportunity to capture additional revenues by offering data-over-
cable services, cable operators have begun to address the
burgeoning market for cable modem Internet access. Industry sources
estimate that there are currently in excess of 450 commercial
deployments of cable modem systems worldwide, including sites in
the U.S., Argentina, Australia, Brazil, Canada, France, Japan, The
Netherlands and Switzerland.
To fully realize the benefits of two-way data-over-cable
communications, cable operators must activate a data transmission
return path that travels from subscriber sites upstream to the
cable operator through the cable plant. Previously, cable operators
had not been required to activate an upstream return path because
television broadcast only requires downstream transmission. A
critical factor related to two-way cable modem service involves the
reduction, containment and management of "noise" in the upstream
return path. Noise accumulates from subscriber sites on the
upstream channel and interferes with transmission throughout the
entire cable plant. Excessive noise impairs the quality of upstream
transmissions and, in certain cases, results in significant
performance degradation. Cable plant noise consists of ambient
background noise in the cable plant itself and specific ingress
noise introduced through subscriber sites as a result of loose
fittings and connectors, cracks in coaxial cable shielding and
other physical plant imperfections. Common sources of ingress noise
at subscriber sites include electronic motors in appliances,
consumer electronics devices and office equipment. One approach to
dealing with excessive noise involves signal encoding or modulation
techniques that compensate for higher noise levels. These
techniques, however, typically result in decreased data
transmission rates. Other approaches for identifying and containing
ingress noise, such as the installation of high pass filters at
subscriber sites, are expensive and inefficient because they block
upstream transmission entirely and must be physically removed prior
to enabling two-way cable modem service. Once the high pass filter
is removed, ingress noise can re-enter the system from that site.
As a result, reducing noise to the low tolerance level required by
most two-way cable modem systems involves significant cost and time
for the cable operator, often delaying the commencement of service
and the consequent generation of revenue from subscribers.
4
Cable operators have been upgrading their plants to an HFC
cable infrastructure that enables them to offer more channels, to
add greater services and consequently to compete better with DBS
television providers' digital video offerings. HFC cable
infrastructure also facilitates reliable upstream data transmission
and contains noise by isolating portions of the network into
smaller distinct nodes. Each node typically serves 500 to 2,000
homes and has a separate return path to the headend. In order to
enable data service over HFC, cable operators must install return
path receivers at the headend based on the number of nodes to be
activated rather than on the number of potential cable modem
subscribers. To reduce the number of return path receivers that
cable operators would otherwise have to purchase, cable operators
can recombine separate return paths. However, the number of return
paths that can be combined is limited by the accumulated noise from
each path. As a result, early deployment costs can be significant
compared to the revenues generated by initial cable modem
subscribers.
In order to accelerate time-to-market and revenue generation,
and to reduce initial deployment costs, some cable modem Internet
access systems offer one-way "telephone return" service, with cable
transmission downstream and slower dial-up modem transmission
upstream. This approach enables earlier deployment of cable modem
systems by postponing the need to address upstream noise issues and
enables cost-effective determination of which markets are most
likely to be economically feasible for larger-scale, two-way
installations. However, with most currently available cable modems,
the eventual upgrade from one-way to two-way service requires the
purchase of a new two-way modem and generally requires a field
service visit to replace and install the dedicated one-way modem
with a two-way modem.
Cable operators are seeking to accelerate the acceptance of
cable modem service by their subscribers. Many major domestic cable
operators have established or invested in value-added data-over-
cable services such as @Home Network and Time Warner Cable's and US
West Media Group's joint Roadrunner service. In addition, several
domestic cable operators and other interested parties have
collaborated through the Multimedia Cable Network Systems, or MCNS,
industry group to develop the data-over-cable service interface
specification, DOCSIS, as a standard for multi-vendor interoperable
cable modems. Compliance with the DOCSIS standard should enable
interoperability between different manufacturers' cable modems and
headend equipment. The DOCSIS standard is expected to be widely
adopted for the North American cable market. A number of suppliers
are developing DOCSIS-compliant two-way cable modems, and some have
recently become commercially available in select markets.
Beyond the challenges of deploying cable modem Internet
services, most cable modem systems enable operators to offer one
level of service at a flat monthly rate and do not enable
customized features that meet the special requirements of distinct
market segments. Moreover, single service offerings curtail the
pricing flexibility of cable operators, thus preventing cable
operators from maximizing revenue opportunities. For example, a
residential subscriber with only limited access and speed
requirements such as sending and receiving e-mail, may elect not to
subscribe to a 256 kilobits per second service at $50 per month. In
contrast, a business subscriber would pay significantly more for
enhanced service. The lost revenue opportunity is particularly
acute in business markets, where telecommuting and small
office/home office users are generally willing to pay more for the
additional speed, security and VPN features they require.
In addition to data-over-cable service, telephony-over-cable
service has recently been made possible for cable operators due to
regulatory changes both in the U.S. and internationally. Such
deregulation has allowed cable operators to compete in the local
telephone market.
Com21 believes that there is a significant opportunity for a
provider of a cable modem system solution that would reduce the
total cost of deployment and ownership of a cable modem system and
enable different tiers of data transmission service and other
value-added features for distinct market segments. To reduce the
total cost of deployment and ownership, there is a need for a cable
modem system that provides reliable two-way data service on noisy
cable plants without significantly reducing data transmission
rates, and one that enables cable operators to remotely identify
sources of ingress noise and manages system noise in a manner that
permits equipment purchases to be more closely scaled with
subscriber penetration. In order to accelerate time-to-market, such
a system would also provide for cost-effective remote software-
based migration of cable modems from one-way to two-way service. By
enabling higher noise tolerance with a software-based migration
path from one-way to two-way service, cable operators could more
rapidly deploy data service and observe penetration patterns in
order to identify prime markets for the service. In addition, the
ability to offer different tiers of service and value-added
features such as VPNs and enhanced security for distinct business
and consumer market segments would enable cable operators to more
fully exploit the cable modem opportunity. Com21 believes that such
a system solution would be attractive to cable operators because it
would allow cable operators to increase revenues and profitability,
while lowering deployment cost and risk and accelerating time-to-
market.
5
The Com21 Solution
Com21 designs, develops, markets and sells value-added, high-
speed communications solutions for the broadband access market.
Com21's ComUNITY Access system enables cable operators to provide
high-speed, cost-effective Internet access to corporate
telecommuter, small office/home office and residential users in the
U.S. and internationally. Com21's system also enables cable
operators to address the distinct price, performance, security and
other needs of these different end-user groups. Com21's products
include headend equipment, subscriber cable modems, network
management software and noise containment technologies. Com21's
cable modem systems provide the following key benefits:
Increased Service Revenues. Com21's ComUNITY Access system
enables cable operators to increase revenues by offering up to 16
different cable operator-defined transmission rates at varying
price points to multiple markets. In a typical flat-rate cable
modem system, all subscribers are charged the same price,
regardless of individual bandwidth service and pricing
requirements. This results in lost revenue opportunities for cable
operators. In addition, the ComUNITY Access system enables cable
operators to provide value-added services, such as multiple VPNs
and enhanced security, targeted to business users. To accommodate
future value-added broadband applications, our underlying ATM-based
technology can also enable integrated services such as toll-quality
cable telephony and desktop video.
Reduced Deployment Costs. The ComUNITY Access system was
designed to lower deployment costs by providing a flexible solution
to address the needs of cable operators and their subscribers at
each step of cable modem system deployment. Com21 believes its
radio frequency technology tolerates higher levels of background
and ingress noise than do other commercially available radio
frequency technologies, thereby avoiding the costs otherwise
necessary to limit noise before deploying two-way cable modem
service. Com21's Return Path Multiplexer reduces the number of
return path receivers required in a cable operator's headend
equipment, which allows cable operators to purchase less headend
equipment initially and then cost-effectively scale the system over
time as subscriber penetration grows.
Accelerated Time-to-Market. The ComUNITY Access system
provides a comprehensive solution that enables cable operators to
bring broadband services to market quickly. In the initial stage of
deployment, the ComUNITY Access system can be implemented as a one-
way telephone return system. Upon implementation of a two-way
service, a cable operator can upgrade to a two-way system with a
simple software download to the end-user's existing ComPORT cable
modem. Com21 is also developing the capability to enable future
DOCSIS-compliant cable modems to communicate with PCs through a
universal serial bus interface, which will reduce the time and
resources needed to connect modems at subscribers' locations.
Reduced Deployment Risk. The ComUNITY Access system's
comprehensive solution mitigates deployment risk by enabling cable
operators to rapidly implement data-over-cable service using
telephone return service and observe service penetration patterns.
Cable operators can then deploy the capital necessary to upgrade
the plant and build a larger-scale two-way cable modem system only
in those markets where they observe sufficient penetration to
warrant such investment.
Reduced Long-Term Cost of Ownership. The ComUNITY Access
system reduces the long-term cost of ownership for cable operators.
Because a cable modem system's operational and maintenance expenses
typically exceed the costs of the capital equipment over the
expected life of the system, a system that requires less plant
maintenance will reduce the long-term cost of ownership for cable
operators. Com21's Network Management Provisioning System lowers
ongoing operating costs by enabling cable operators to remotely
detect, diagnose and manage network problems from a single
workstation. In addition, ComPORT cable modems can be remotely
upgraded with software downloads. The ComUNITY Access system can be
deployed with lower operational overhead because the cable operator
can use Com21's Ingress Noise Blocker as an intelligent filter to
prevent ingress noise from contaminating the upstream return path.
The INB opens only to allow data to be transmitted upstream, and is
closed otherwise, preventing aggregation of noise in the upstream
return path. The INB also enables a cable operator to more quickly
identify ingress noise sources. This reduces maintenance costs
because a cable operator need not devote substantial amounts of
personnel and resources to the identification of the source and
site of intermittent ingress noise.
Differentiated Services to End-Users. In addition to high-
speed, always-on and cost advantages, the ComUNITY Access system
enables cable operators to offer differentiated services with
significant benefits to their subscribers. In addition to value-
added services such as VPNs and enhanced security, each ComPORT
cable modem can support up to eight PCs. The ComUNITY Access system
supports multiple protocols, including IP, IPX, AppleTalk and
NETBEUI. ComPORT modems have an expansion slot to accommodate
application interface modules which can support future applications
such as cable telephony and VPNs.
6
The Com21 Strategy
As part of its business strategy, Com21's objectives are to:
Enhance Value to Cable Operators. Com21's principal strategy
is to provide products that enhance the value of cable operators'
cable modem deployments over the life of the investment. Cable
operators assess the viability, and ultimately the success, of an
investment in a cable modem system by considering the cost of
initial investment in cable modem equipment, service reliability,
overall operating and maintenance expenses and the service revenues
that can be generated. Com21's ComUNITY Access system is designed
to be deployed on a limited capital budget and can be upgraded and
scaled as subscriber penetration grows. Com21's system enables
cable operators to lower their ongoing cost of ownership through
cost-effective noise management and remote cable modem upgrades.
Cable operators can use Com21's system to increase revenues by
offering multiple tiers of service at varying prices to multiple
market segments. As a result of the value provided by its products,
the Company believes it will continue to be able to successfully
differentiate and sell its products based upon tangible benefits
delivered to the cable operator.
Leverage Technology Leadership. Com21's ATM-based architecture
is the foundation upon which Com21 has built an end-to-end Ethernet
broadband communications system with networking advantages.
Technological developments in multi-service scheduling
optimization, protocol simulation and application specific
integrated circuit (commonly referred to as an ASIC) integration
enable us to offer a scalable system to deliver tiered service
levels, VPNs and low-latency voice and video applications.
Moreover, the Com21's internal development of a network management
system, high performance, cost-effective radio frequency
transmitters/receivers and fast radio frequency switching systems
lowers the cost to cable operators of deploying and operating
Com21's equipment. Com21 focuses on the development of value-added
features for its products, such as its recently announced
enterprise cable telephony module for the ComPORT, which is
designed to enable cable operators to offer toll-quality voice
services to their business customers.
Capitalize on Emerging DOCSIS Standard. Com21 believes the
DOCSIS standard will accelerate the rate of adoption of cable modem
technology by providing multi-vendor interoperability. Com21
intends to continue to play an integral role in the development of
the DOCSIS standard. In this regard, we have participated in the
evolution of the DOCSIS standard as a core reviewer and content
reviewer to DOCSIS 1.0 and 1.1, and by contributing our protocol
expertise to the development of DOCSIS 1.2. We intend to leverage
our technology leadership, particularly in the areas of high
performance ASIC hardware, radio frequency modulation and noise
reduction to differentiate its DOCSIS-compliant cable modems from
the competition. We are currently developing a family of DOCSIS-
compliant products, the first of which we anticipate will be
commercially available in the first half of 1999. Com21 is in the
process of establishing a consumer-oriented sales channel, focusing
on both electronic commerce and traditional approaches to
distribute its DOCSIS-compliant cable modems.
Aggressively Penetrate Global Markets. Com21 believes the
market for cable modem systems is global and has developed
strategies to sell its products in regions where cable is widely
available, such as the U.S., Canada, Europe and Japan, and in
regions where cable is being aggressively deployed, such as China
and Latin America. In 1998, Com21 shipped approximately 320
ComCONTROLLER headends and more than 77,000 ComPORT modems, as
compared to approximately 170 ComCONTROLLER headends and more than
12,000 ComPORT modems in 1997. Com21 has shipped its systems for
use in 67 locations in North America and 87 locations
internationally. In North America, we sell directly to cable
operators such as Charter Communications, Cox Communications, Prime
Cable and TCI and to systems integrators such as HSAnet. To
facilitate market penetration, Com21's ComUNITY Access system has
been certified for use in @Home service areas. Internationally, we
sell primarily to systems integrators, including Philips and
Siemens, which in turn sell to cable operators.
Integrate Toll-Quality Voice. Com21 intends to integrate toll-
quality voice capability into its ComUNITY Access system and its
future DOCSIS product line. We are an active participant and have
been selected as a vendor author in CableLabs' PacketCable cable
telephony initiative. Com21's existing products have been designed
with quality of service capability to support toll-quality voice
transmission over a cable plant. Com21 believes that the
opportunity for cable telephony will be accelerated by AT&T's
acquisition of TCI and has recently demonstrated its enterprise
cable telephony module at the Western Cable Show in December 1998.
Increase Cost Efficiencies. While we intend to continue to
seek premium prices for our products, it anticipates that the cable
modem market will be characterized by declining prices. As a
result, we seek to reduce product costs, particularly with respect
to its end-user cable modems. In 1998, we improved our tuner design
to reduce manufacturing costs, integrated its cable modem design
into one printed circuit board and increased the proportion of
standard components used in the manufacture of our products. Com21
intends to realize future cost reductions from economies of scale
and relocation of manufacturing. We are working to achieve a higher
level of ASIC integration and to improve the design of its products
in order to increase manufacturing efficiencies. In addition, we
are developing plans to monitor continuous improvement of our
internal engineering and manufacturing management procedures. Com21
received ISO 9001 certification in December 1998.
7
Products
Com21's current product offering is the ComUNITY Access system.
The ComUNITY Access system.
The ComUNITY Access system consists of three primary parts:
- the ComCONTROLLER, a channel switch located at the cable
operator's headend;
- the ComPORT, a cable modem located at the subscriber's site;
and
- Network Management Provisioning System, an integrated
network management software package.
Com21's ComUNITY Access system has been certified for use in
@Home service areas. Additionally, Com21 offers the Return Path
Multiplexer and the Ingress Noise Blocker, devices used in the
containment of noise in the upstream channel. We have shipped
approximately 490 ComCONTROLLERs and more than 89,000 ComPORTs
since commercial shipments began in April 1997.
ComCONTROLLER Headend Switch. The ComCONTROLLER controls the
flow of data communications between the ComPORT modems located at a
subscriber's site and an external network, such as the Internet or
a corporate network. The ComCONTROLLER is designed with multiple
expansion slots that can accommodate multiple Ethernet or Fast
Ethernet interfaces. The ComCONTROLLER transmits data downstream at
30 megabits per second (using 64 quadrature amplitude modulation).
The expansion slots enable the addition of up to twelve 2.56
megabits per second (using quadrature phase shift keying) upstream
channel modules, scaling the upstream path to an aggregate
throughput of 30 megabits per second. The upstream channels can be
added on an incremental, hot-insertion basis, enabling a cable
operator to respond rapidly to system faults. A single
ComCONTROLLER is designed to support up to 2,000 ComPORT modems.
ComPORT Cable Modem. The ComPORT cable modem is deployed
within a subscriber's home or office. In addition to its cable
connection, the ComPORT is designed with a 10BaseT Ethernet port
for direct connection to the subscriber's PC Ethernet card or an
Ethernet hub for interconnecting up to eight PCs. Each ComPORT can
be used either on a one-way or two-way cable plant and can be
remotely configured for either plant by our Network Management
Provisioning System software. Com21 has developed a FastPacket
engine ASIC which filters and forwards data packets at Ethernet
wire speed. The ComPORT features an expansion port for the
insertion of future modules that will support applications such as
cable telephony and VPNs.
Network Management and Provisioning System. Network Management
Provisioning System is a network management software package that
facilitates subscriber provisioning, fault isolation, network
configuration, field inventory, auto-discovery and performance for
the ComUNITY Access system. Network Management Provisioning System
enables the cable operator to remotely monitor and manage the
ComUNITY Access system through a graphical user interface and to
remotely upgrade ComPORT cable modems. Network Management
Provisioning System is a simple network management protocol manager
running on a UNIX workstation connected to the ComCONTROLLER via a
separate out-of-band 10BaseT Ethernet channel. Com21 believes that
Network Management Provisioning Systems' ability to manage the
network elements of the ComUNITY Access system from a remote site
will further reduce cable operators' long-term cost of ownership by
reducing the number of visits cable operator technicians will need
to make to headend and subscriber sites. A standard PC Web browser
can be used to monitor and manage cable modems via an Internet
server application on the Network Management Provisioning System
station. A single Network Management Provisioning System station is
designed to manage up to 50 ComCONTROLLERs and 100,000 ComPORTs.
Return Path Multiplexer. Com21's Return Path Multiplexer is a
high-speed, multiport analog switching device which allows up to
eight upstream return paths to be connected to a single
ComCONTROLLER radio frequency receiver without electrically
combining the accumulated noise from the return paths. The Return
Path Multiplexer is designed to solve the problem of accumulated
noise inherent in HFC cable installations configured with large
numbers of return paths from distributed fiber nodes. The Return
Path Multiplexer utilizes a high-speed radio frequency switching
technology that enables it to pass one upstream return path at a
time to the ComCONTROLLER. This technology prevents the noise
accumulation that would otherwise occur if multiple upstream
returns were combined at the ComCONTROLLER. Since the Return Path
Multiplexer allows eight upstream connections, Com21 believes that
the installation of Return Path Multiplexers on a cable operator's
network will reduce the number of return path receivers required in
the cable operator's headend equipment and therefore reduce the
capital costs for a large-scale HFC cable modem deployment. Com21
has been shipping the Return Path Multiplexer since the third
quarter of 1998.
8
Mini ComCONTROLLER. Com21 has a smaller version of the
ComCONTROLLER which has three expansion slots for upstream receiver
and Ethernet modules. Com21 believes that this smaller headend
product addresses the requirements of smaller cable operators and
specialized applications (such as cable systems within a hotel)
that cannot justify the additional expense of the larger
ComCONTROLLER. Com21 has been shipping the Mini ComCONTROLLER since
the second quarter of 1998 and, in addition to being installed by
several cable operators, it has been deployed in certain locations
within the Marriott hotel chain.
The Ingress Noise Blocker. The Ingress Noise Blocker is an
external noise filter designed to meet the needs of cable operators
whose cable networks have excessive ingress noise and who want to
deploy two-way data service prior to solving costly overall system
noise issues. The Ingress Noise Blocker works with both two-way HFC
and coaxial-only cable plants and attaches to the cable tap outside
the subscriber's site. The Ingress Noise Blocker, which is remotely
controlled by the ComPORT, opens to allow upstream transmission of
traffic and closes at all other times, which limits the ability of
noise to enter the system. Because noise passes through the Ingress
Noise Blocker only when data is being transmitted from a
subscriber's site, the Ingress Noise Blocker allows Network
Management Provisioning Systems to rapidly detect and isolate
sources of noise. Although it is currently necessary for the
subscriber to have a ComPORT modem to control the Ingress Noise
Blocker, Com21 plans to license the Ingress Noise Blocker control
circuitry to other cable equipment vendors.
The ComUNITY Access system incorporates the following features:
- Multiple Service Levels. The ATM-based architecture provides
up to 16 levels of service that can be configured by the cable
operator, each with specified upstream and downstream data rates.
This feature enables the cable operator to tailor data-over-cable
service and pricing to different end-user demands, which increases
the ability to capture additional subscriber revenues by matching
supply with demand.
- Robust, High-Speed Architecture. The ComUNITY Access system
transmits downstream traffic at a rate of up to 30 megabits in one
6 megahertz channel. Each 1.8 megahertz channel of the upstream
spectrum can transmit traffic at a rate of 2.56 megabits per
second, and the system enables the cable operator to aggregate up
to twelve upstream channels, permitting total upstream throughput
of 30 megabits per second.
- One-Way and Two-Way Transmission Capability. The ComUNITY
Access system can be configured to support both one-way and two-way
cable plants. The ComPORT modem works with the subscriber's
personal computer and a dial-up Internet access service operated
either by the cable operator or an Internet service provider,
commonly known as an ISP, to enable a one-way system. The ComPORT
can be reconfigured remotely from one-way mode to two-way mode
through a software download without replacing a subscriber's modem.
- Superior Noise Containment Technology. Com21 has developed
noise containment technology which allows the system to tolerate
higher levels of noise, thereby enabling cable operators to install
the system on noisy cable plants that could not otherwise be used
for two-way data transmission.
- Multiple Protocols. The ComUNITY Access system supports
multiple protocols including IP, IPX, AppleTalk and NETBEUI.
- Privacy from Other Subscribers. The ComPORT can be
configured by the cable operator to block all non-IP protocols,
preventing subscribers on the same cable network from
accidentally gaining access to others' files.
- Data Security. Data encryption standard encryption and
public key management enable secure upstream and downstream data
communications between the ComCONTROLLER and the ComPORT.
- High-Value Business Networking. Com21's ComUNITY Access
system enables cable operators to establish private, secure sub-
networks within a ComCONTROLLER while providing dedicated
bandwidth. These sub-networks are known as virtual local area
networks. Using Network Management Provisioning System, the cable
operator can configure secure VPNs for the business connectivity
markets by partitioning the transmission channels into several
virtual local area network, then assigning cable modems to each
virtual local area network.
9
- Early Fault Detection. Network Management Provisioning
System offers high network visibility and control via a suite of
configurable alarms, diagnostic tools and performance monitoring
features.
Products Under Development
Secure IP Module. Com21 is developing a hardware-based secure
IP module to be inserted in the ComPORT's application interface
module expansion slot, which is designed to enable secure encrypted
data transmission over the Internet. Com21 believes that the secure
IP module will increase cable operators' service revenues by
providing them with an advanced security feature to sell to their
subscribers, such as VPN services. The secure IP module will be
commercially available in the first quarter of 1999.
Cable Telephony Module. Com21 is leveraging existing
ComCONTROLLER and ComPORT architecture to develop an application
interface module for the ComPORT to allow cable operators to
provide toll-quality voice through a standard RJ11 telephone
interface on the modem. The integration of this cable telephony
module will enable PBX-extensions via the ComPORT for the
telecommuter or small office/home office user. The cable telephony
module will be an integrated component of Com21's existing ComUNITY
Access system product line and is expected to be available for
commercial deployment in mid-1999. In addition, Com21 is developing
voice-over-IP technology which will be designed to allow access to
the public switched telephone network via the cable network.
DOCSIS Products Under Development
DOCSIS-Compliant Cable Modems. Com21 is leveraging its ComPORT
architecture, Packet Accelerator ASIC and radio frequency/tuner
design in conjunction with Broadcom's media access control silicon
to produce a family of high-performance DOCSIS-compliant cable
modems for the North American cable market. Initial products are
intended to comply with the DOCSIS 1.0 specifications and are
intended to be software-upgradeable. Com21's DOCSIS 1.0 cable modem
will be designed to support the secure IP module designed for the
ComPORT. Using the Broadcom chipsets, Com21's DOCSIS cable modem is
intended to support cable telephony and QoS as well as a USB
interface which will eliminate the need to install an Ethernet card
in a subscriber's PC USB port. We are working with Cisco to ensure
interoperability of our DOCSIS-compliant cable modems with Cisco's
universal broadband router. On March 4, 1999, CableLabs announced
the result of the certification process for the DOCSIS 1.0 cable
modem that began on January 18, 1999. Our DOCSIS 1.0 cable modem
was not certified at this time. We believe that this will not
affect our plan to commercially introduce our initial DOCSIS modem
in the first half of 1999.
Home Networking Module. Com21 is developing a plug-in module
for our DOCSIS-compliant cable modems that will connect the modem
to a home phone network.
The market for cable modem systems and products is
characterized by rapidly changing technologies and short product
life cycles. Our future success will depend in part upon our
ability to enhance our existing products and to develop and
introduce, on a timely basis, new products and features that meet
changing customer requirements and emerging industry standards.
Com21's product development efforts are subject to a number of
risks and we cannot assure you that these efforts will result in
the introduction of any new products that achieve market
acceptance. See "Risk Factors -- Our future success will depend in
part upon our ability to enhance our existing products and to
develop and introduce, on a timely basis, new products and features
that meet changing customer requirements and emerging industry
standards."
Technology
The Company invests in technology development to enable
scalable, reliable broadband data communications that can
accommodate a wide range of applications. Key technologies include:
- ATM architecture and ComUNITY media access control and
physical layer protocols, all of which provide the flexibility
and scalability to allow cable operators to build multi-tiered
services and VPNs;
- ASIC based cable modem design that allows Com21 to provide
high-speed, cost-effective, highly functional products;
- high performance radio frequency modulators and demodulators
which allow the cable operator to use Com21's products in a wider
range of cable systems; and
10
- noise mitigation technology, which addresses many of the
cable plant upstream noise problems and reduces the cable
operator's ongoing maintenance and operational costs.
ATM Architecture and ComUNITY Protocols. The ComUNITY Access
system has been designed using a high-performance cell-switching
broadband data transport architecture. This architecture optimizes
system performance for multiple simultaneous applications with a
variety of requirements for data rates and latency, including
Internet data, toll-quality voice and desktop video. In order to
transport and manage data flows for latency-sensitive applications
such as telephony, video conferencing or interactive games, the
ComUNITY Access system implements an ATM virtual circuit-based data
transport protocol upon shared broadband downstream and upstream
channels.
The ComUNITY protocols are specifically designed to
efficiently manage the ATM cell traffic on the broadband cable
television network, taking into account topological and physical
constraints of the two-way cable transmission systems. For example,
the protocol must do the following:
- provide secure point-to-point communications in physical
media that are inherently insecure broadcast channels;
- provide reliable data delivery in a noisy communications
channel;
- automatically calibrate for variations in phase delay and
signal attenuation arising from the condition of the physical
cable plant;
- minimize simultaneous transmission from multiple cable
modems to prevent return amplifier saturation and distortion;
- efficiently adapt to the traffic load among a large
subscriber base so that the system can grow and still provide high
service levels with low overhead costs; and
- provide stable performance under increasing traffic loads
and various traffic types with different quality of service
requirements.
The protocols also provide flexibility to handle a telephone
return capability for applications in a one-way system. As a result
of the work to develop robust low-level protocols, the ComUNITY
Access system can reliably perform in both coaxial systems as well
as modern HFC cable plants.
In addition, the ComUNITY Access system has been designed so
that each cable modem can enable multiple virtual circuits for
separate applications, allowing simultaneous, independent data
flows with different performance requirements. Specifically, a
single ComUNITY-based cable modem can simultaneously provide a
high-speed, latency-insensitive 10 megabits per second IP-based
Internet connection and a low-speed, short delay, latency-sensitive
64 kilobits per second link for a toll-quality voice connection,
with both data and voice applications operating independently.
FastPacket ASIC Technology. Com21 has internally developed a
custom ASIC to implement the major portions of the cable modem
functionality, including ComUNITY protocol control, data encryption
standard encryption, ATM segmentation and reassembly, packet
switching and filtering and multicast control. Because these
functions are integrated into the ASIC, the cable modem can operate
at high speeds without requiring an expensive external processor or
ATM components. FastPacket ASIC technology allows the ComUNITY
cable modem to filter and forward minimum size packets at Ethernet
wire speed. As a result, the incremental development costs of high-
speed packet-handling and additional ATM and networking
functionality have not been significant, and Com21 has been able to
decrease the size of the electronics design and reduce the
implementation to a single-sided printed circuit board.
High Performance RF Modulator and Demodulator Design. The
ComUNITY Access system's downstream and upstream channels occupy a
small portion of the cable plant and must coexist with existing
signals such as television channels in the 54-750 megahertz band as
well as other upstream services such as pay-per-view or cable
telephony in the 5-40 megahertz band. The transmitter must be
accurate enough to convert multi-bit symbols into a multi-level
phase/amplitude signal without creating interference into adjacent
channels and robust enough to perform in noisy upstream channels.
The receiver must be sensitive enough to detect and process a
complex quadrature amplitude modulation signal, in cable systems
that add signal distortions and are susceptible to noise.
Quadrature amplitude modulation encoding is a digital transmission
technique, used in a communications channel which trades off
greater signal to noise rates for higher data rates. Additionally,
these designs must be cost-effective and self-tuning without the
need for expensive, precision components or manual parametric
adjustments during the manufacturing process.
11
We have designed our own tuner that is less sensitive to
operating temperature fluctuations, works well with low signal
levels, has improved tolerance to adjacent TV signals, and cleanly
transmits signals with low noise. This technology has enabled us to
sell our internally developed radio frequency modulator as an
integrated component of our ComCONTROLLER product family, whereas
most other commercially available cable modem systems require cable
operators to purchase a frequency translator from third-party cable
equipment suppliers.
Noise Containment Technology. Reliable system performance in
the presence of a significant level of noise in the upstream
channel is a key issue for any cable modem system. There are two
basic ways to minimize the effect of noise on upstream data
transmission:
- reduce or eliminate noise from the upstream channel; or
- compensate for high noise levels using error correction
techniques. Com21 utilizes a combination of these techniques.
Com21 has developed technology specifically designed to reduce
upstream noise. The Ingress Noise Blocker is a cable modem-
activated filter attached to the cable tap outside the subscriber's
house. Using Com21's signal-powered dynamic radio frequency filter
technology, the Ingress Noise Blocker blocks upstream noise and
only allows return signals when the ComPORT is sending data
upstream. An industry source has stated that most of the upstream
ingress noise on cable plants originates from sources which add
noise into the cabling system from the cable tap to a subscriber's
television set. A cable plant with Ingress Noise Blocker filters
installed will have a lower level of ingress noise in the upstream
return path. This will result in reduced plant maintenance costs
related to identifying, minimizing and correcting ingress noise
problems.
Com21 has developed an Return Path Multiplexer, which is a
high-speed, multiport analog switching device which allows up to
eight upstream return paths to be connected to a single
ComCONTROLLER radio frequency receiver without combining the
accumulated noise from the return paths. Com21 has developed high-
speed radio frequency switching technology in the Return Path
Multiplexer which will allow a control signal from the
ComCONTROLLER to switch from one return path to another. This
enables a specific cable modem using a specific return path to
transmit to the ComCONTROLLER. Com21 has also developed control
mechanisms and management protocols to manage traffic switching
through the Return Path Multiplexer. To illustrate an Return Path
Multiplexer application, an HFC system serving 100,000 homes would
require 25 separate return paths (assuming 500 home fiber nodes and
eight return nodes combined). Without Com21's Return Path
Multiplexer, the cable operator would have to purchase several
headend units to enable data service for the entire HFC network.
Instead, the cable operator will be able to purchase a single
ComCONTROLLER and several Return Path Multiplexers at a
significantly lower cost. Com21's product development efforts are
subject to a number of risks, and there can be no assurance that
these efforts will result in the successful introduction of any
other new products, or that such products will achieve market
acceptance. See "Risk Factors -- Our current products are not
compatible with products offered by our competitors and are subject
to evolving industry standards. If our products do not comply with
any standards that achieve market acceptance, customers may refuse
to purchase our products."
The ComUNITY Access system incorporates an encoding technique
called forward error correction on upstream, and downstream
channels. Forward error correction is a technique that inserts
redundant information into the data stream so that a certain number
of data errors can be detected and corrected. This technique,
coupled with Com21's high performance radio frequency modem design,
allows Com21's cable modems to operate at high data rates with
nominal bit error rate of 10(-9) in a cable plant with a signal-to-
noise-ratio of 16 decibels. This bit error rate performance is
substantially better than the MCNS specification of 10(-9) bit
error rate at 25 decibel signal-to-noise ratio. As a result,
Com21's products can provide more reliable data service in noisier
cable plants than a modem built to that specification. More
specifically, the 9 decibel difference in performance lowers noise
sensitivity by a factor of eight.
Contribution to the DOCSIS Standard. Com21 intends to continue
to play an integral role in the continuing evolution of the DOCSIS
standard. In this regard, Com21 has participated in the development
of the DOCSIS standard, as a core reviewer and content reviewer to
DOCSIS 1.0 and 1.1, and by contributing its protocol expertise to
the development of DOCSIS 1.2.
Com21 is also a vendor-author to CableLabs' PacketCable
specification and is a core reviewer and content contributor to the
IEEE 802.14 standard.
12
Customers and Markets
Customers. Com21 began commercial shipments of its cable modem
products in April 1997. In 1998, Com21 shipped approximately 320
ComCONTROLLER headends and more than 77,000 ComPORT modems, as
compared to approximately 170 ComCONTROLLER headends and more than
12,000 ComPORT modems in 1997. Com21 has shipped its systems for
use in 67 locations in North America and 87 locations
internationally. In the U.S., we sell directly to cable operators
and systems integrators. Internationally, Com21 sells primarily to
systems integrators, including Philips and Siemens, who in turn
sell to cable operators.
The number of households currently passed in service areas
where Com21's cable modem systems have been commercially deployed
exceeds 9 million. Com21 considers a sale as a commercial
deployment if the cable operator to whom the sale was made has
begun offering data-over-cable services to paying subscribers. The
following table depicts an example of the geographic diversity of
commercial deployments of the ComUNITY Access system as of December
31, 1998.
<TABLE>
<CAPTION>
Com21 Commercial Deployments
_________________________________________________________________
Customer Location
___________________________ _________________________
<S> <C>
Prime Cable Chicago, Illinois
Cox Communications Las Vegas, Nevada
TCI Baton Rouge, Louisiana
Denver, Colorado
Pittsburgh, Pennsylvania
Charter Communications Pasadena, California
Newtown, Connecticut
Fibertel/TCI-International Buenos Aires, Argentina
France Telecom Bordeaux, France
Marseilles, France
Brutele/Igretec Charleroi, Belgium
Eneco NV Rotterdam, Netherlands
CTC Barcelona, Spain
Cablecom Zurich, Switzerland
Tokyo Cable Tokyo, Japan
Destiny Cable Manila, Philippines
Jaixing Cable Jaixing, China
Saturn Communications Wellington, New Zealand
</TABLE>
Com21 did not commence product shipments until April 1997. Our
success will depend on the timely adoption of our products by cable
operators and end users. The market for our products has only
recently begun to develop, is rapidly evolving and is characterized
by an increasing number of market entrants that compete or intend
to compete with the Company. See "Risk Factors -- We have a short
operating history, have incurred net losses since our inception and
expect future losses," "-- Our operating results in one or more
future periods are likely to fluctuate significantly and may fail
to meet or exceed the expectations of securities analysts or
investors," "-- Because our market is new and evolving, we cannot
accurately predict its future growth rate or its ultimate size, and
widespread acceptance of our products is uncertain" and "-- The
market in which we operate is highly competitive and has many more
established competitors."
In 1997, revenues attributable to Philips, 3Com and Siemens
accounted for 21%, 16% and 12% of total revenues, respectively. In
1998, revenues attributable to TCI, Philips and Siemens accounted
for 24%, 15% and 14% of total revenues, respectively. For the year
ended December 31, 1998, the top five customers accounted for an
aggregate of 66% of total revenues. See "Risk Factors - Our
customer base is concentrated and the and the loss of one or more
of our customers could cause our business to suffer" and
"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
In 1997 and 1998, revenues attributable to international
customers constituted 64% and 52% of total revenues, respectively.
Com21 believes that its ATM-based system has been adopted more
rapidly in Europe and other international markets because of the
greater acceptance of the benefits of ATM-based technology as well
as the more recently upgraded and installed cable plants. See "Risk
Factors -- We are subject to risks associated with operating in
international markets" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
13
The following customer examples illustrate how certain of
Com21's customers have deployed its products:
Fibertel/TCI-International is a cable operator with
approximately 800,000 households passed in Buenos Aires, Argentina.
Fibertel offers a single Internet service priced at $125 per month
for two-way service. Fibertel is marketing a private corporate
networking service that uses Com21's virtual local area network
capability and is selling dedicated line connections for business
applications using Com21's quality of service capability to
provision constant-bit-rate service per modem. Fibertel uses
various features of the ComUNITY Access system to provide different
service products for different subscribers' needs.
Charter, one of the largest cable television operators in the
U.S. with approximately 1.1 million subscribers, has deployed
service in several locations including the Pasadena, California
area, which passes approximately 300,000 households. Charter offers
Charter Pipeline, its general Internet service, at prices ranging
from $50 per month to $500 per month with five service tiers, with
the following service levels (upstream/downstream data rates):
- "diamond service" (2 megabits per second/1 megabits per second);
- "platinum service" (1 megabits per second/512 kilobits per second);
- "gold service" (768 kilobits per second/384 kilobits per second);
- "silver service" (512 kilobits per second/128 kilobits per second);
- "bronze service" (256 kilobits per second/56 kilobits per second).
In addition to its general Internet access service, Charter
has established a campus local area network extension on its cable
network using the ComUNITY Access system's virtual local area
network capability and provides off-campus connections to the
students and staff of the California Institute of Technology.
Charter also plans to use the ComUNITY Access system's telephone
return feature to provide access for subscribers who are not yet
two-way enabled.
Telia Stofa A/S is the second largest cable operator in
Denmark with more than 200,000 households passed. Telia Stofa is
using the ComUNITY Access system to deliver high-speed data-over-
cable service, along with other integrated services, to residential
and business customers, allocating varying levels of bandwidth to
address different subscriber requirements. Telia Stofa gives
residential and business users the option of choosing from three
different tiers of service: StofaNet Private, StofaNet Study and
StofaNet Business. This allows Telia Stofa to charge subscribers
according to the bandwidth used, versus a flat fee, and results in
increased revenues. Telia Stofa has indicated that one of the
primary reasons that Telia Stofa selected Com21 was that we offer
quality of service, virtual local area network and other future
integrated services.
Markets. Com21's products enable cable operators to serve three
primary end-user markets each of which has widely varying speed,
service and pricing requirements. The table below divides these
markets by user segment and outlines their typical access
requirements and attributes:
14
<TABLE>
<CAPTION>
Typical Access
Access Potential Solution
User Segment Requirement Applications Used Today
<S> <C> <C> <C>
_________________ __________________ _________________ ____________________
Corporate Tele- -Remote access to -Remote local -Analog Modem
commuter and Re- corporate local area network (28.8-56 Kbps)
mote Office area networks and access -ISDN (128 Kbps)
Users Intranets -VPN Provisioning -T-1 (1.54 Mbps)
-High speed Inte- -File Transfer
rnet access -"Always on" Int-
ernet access
-High Security
-Telephony enhance-
ments, e.g., PBX
extension
-Desktop video
Conferencing
_________________ __________________ _________________ ____________________
Small Office/Home -Remote access to -"Always on" -Analog modem
Office Users local area Internet Access (28.8-56 Kbps)
networks -Connectivity to -ISDN (128 Kbps)
-High speed several businesses -Fractional T-1
Internet access -Alternate tele- (384 Kbps)
phone Service
-Desktop video
conferencing
_________________ __________________ _________________ ____________________
Residential -Low to high speed -Internet access -Analog modem
Consumer Internet access -Web-based multi- (28.8-56 Kbps)
Internet Users media content,e.g. -ISDN (128 Kbps)
(Occasional and on-line services
Frequent) -E-mail, file
transfer
</TABLE>
Corporate Telecommuter and Remote Office Users. The needs of
corporate telecommuter and remote office business users include
high availability, high-speed access to corporate intranets and
corporate local area networks. These users also must interconnect
the local area networks among their various offices. Such offices
may be co-located, as in the case of a large campus, or remotely
located, as in the case of a sales office or a telecommuter's home.
A parallel application for this business market is the
interconnection of remote workers to a central telephone PBX,
distributing voice traffic to users throughout a campus or to a
remote office. Security and reliability are of utmost importance
for corporate users. Other applications which business users may
require include desktop video conferencing and rapid two-way
transfer of large data files. Corporate telecommuters and remote
office users are generally willing to pay a premium for highly
reliable, high-speed service with advanced features.
SOHO Users. Small office/home office businesses increasingly
find the Internet an efficient and cost-effective means to
communicate and transact with their customers and suppliers. Com21
believes these businesses require medium-to-high speed Internet
access that is reliable and always available. Small office/home
office users may have a local area network to connect to cable
modem services and may require routing in order to connect multiple
terminals. These businesses may also require desktop video
conferencing capability and connectivity with other businesses.
Because these requirements may be critical to running their
business, certain small office/home office users are willing to pay
more for higher-quality, secure, reliable service than are
residential consumer Internet users.
Residential Consumer Internet Users. Residential consumer
Internet users generally only require a connection to their ISP,
without the same level of security and reliability required by
business users. Frequent users desire medium-to-high speed access
to the Internet for Web browsing and downloading of multimedia
applications and files. Occasional users require low-to-medium
speed access to the Internet on a limited basis for Web browsing,
e-mail and on-line services. Occasional users generally prefer low-
cost service, whereas more frequent users are generally willing to
pay a slight premium for higher speed.
Manufacturing
Com21 tests and assembles its ComCONTROLLER headend equipment
in its facility in Milpitas, California. We outsource ComCONTROLLER
printed circuit board assemblies on a turnkey basis to Sanmina and
CMC, and perform final integration and burn-in on-site. Com21
configures the headend equipment and the network management and
provisioning software prior to customer shipment.
15
Com21 outsources turnkey manufacturing of the ComPORT cable
modem to Celestica, a contract manufacturer located in Toronto,
Canada. Together with Celestica, Com21 has developed and
implemented a series of product test methodologies, quality
standards and process control parameters. Com21 is working with
Celestica to set up production in a second Celestica facility
located in Monterrey, Mexico. We anticipate production at this
facility will begin in the first quarter of 1999. This move will
enable us to continue to reduce the cost of our modems and ensure
continuous supply without disruption if plant problems were to
occur. We believe that employing a turnkey manufacturer will enable
it to meet anticipated manufacturing needs and reduce the cost of
product procurement.
Com21's engineering team designs ASICs and performs simulation
testing. When the fundamental design is stable, Com21's contract
foundry fabricates the ASIC for prototype testing and upon
completion of these tests the ASIC is manufactured in volume by
Atmel. We believe our current manufacturing capabilities can
accommodate our requirements through the end of 2000. Warranty and
repair support is performed at our Milpitas facility. Com21
received ISO 9001 certification in December 1998.
Com21 maintains only a limited in-house manufacturing
capability for final assembly, testing and integration of headend
products. Our future success will depend, in significant part, on
our ability to manufacture, or have others manufacture, its
products cost-effectively and in volumes sufficient to meet
customer demand. There are a number of risks associated with our
dependence upon third party manufacturers, including but not
limited to the following:
- reduced control over delivery schedules;
- quality assurance;
- manufacturing yields and costs;
- the potential lack of adequate capacity during periods of
excess demand;
- limited warranties on products supplied to us;
- increases in prices; and
- the potential misappropriation of Com21's intellectual
property.
A manufacturing disruption could impact the production of
Com21's products for a substantial period of time, which could have
a material adverse effect on our business, operating results and
financial condition. Com21 has no long-term contracts or
arrangements with any of its manufacturers that guarantee the
availability of product, the continuation of particular payment
terms or the extension of credit limits. There can be no assurance
that Com21 will not experience supply problems in the future from
any of its manufacturers. Any such difficulties could have a
material adverse effect on our business, operating results and
financial condition.
In addition, Celestica is a foreign corporation, and we may
increase our use of foreign manufacturers in the future. Any
foreign or domestic regulations regarding foreign exports and
imports, trade barriers and tariffs currently in place or imposed
in the future could materially and adversely affect our ability to
obtain cable modems. Because lead times for materials needed to
produce cable modems and headend equipment can be between eight and
16 weeks, Com21 may not be able to meet the demand for its
products, which could adversely affect our ability to support cable
operators' expansion of cable modem service to cable operators'
customers. We have only limited experience manufacturing and
arranging for the manufacture of our products, and there can be no
assurance that we or any manufacturer of our products will be
successful in increasing its manufacturing volume. We may need to
procure additional manufacturing facilities and equipment, adopt
new inventory controls and procedures, substantially increase our
personnel and revise our quality assurance and testing practices.
We cannot assure you that any of these efforts will be successful.
See "Risk Factors -- We may not be able to produce sufficient
quantities of our products because we depend on third-party
manufacturers and have limited manufacturing experience" and "-- We
are subject to risks associated with operating in international
markets."
Marketing and Sales
Marketing. Domestically, we target our marketing efforts
primarily at cable operators. A limited number of cable operators
comprise the domestic cable industry and purchase decisions by each
cable operator are typically influenced by the cable operator's
technical experts. Direct marketing activities focus on reaching
these technical experts and creating product awareness and
credibility for Com21's systems within the cable operator
community. Internationally, we focus our marketing efforts on
supporting our systems integration partners' marketing programs.
16
A key factor to building global brand awareness for Com21
products is promoting the success of Com21's commercial cable modem
system deployments. Com21 also educates cable operators regarding
the benefits of providing tiered services to a diverse subscriber
base, ranging from residential consumers to business users. Com21
is also building its brand name through continued publicity and
referral efforts in both media and industry-centered activities.
Com21 markets its systems through several promotional programs,
including the following:
- direct mail campaigns to the larger cable operators;
- editorial presence in various trade magazines;
- public speaking opportunities;
- national cable trade show participation;
- Web site-based communication and promotion;
- media sponsorships; and
- participation in standards activities.
In anticipation of the introduction of our DOCSIS-compliant
cable modems, we are in the process of establishing alternative
distribution channels including Internet and retail channels. We
will also begin consumer marketing activities.
Sales. We have a sales force of 19 people in five North
American locations and four locations internationally. Currently,
Com21 sells its products in North America primarily through direct
sales channels to cable operators. Internationally, we sell our
products primarily to systems integrators, who in turn sell to
cable operators. Com21's two largest systems integrators are
Philips and Siemens, both of whom have a strong presence in
numerous markets. Com21's systems integrators have established
customer bases and relationships with cable operators. These
relationships allow Com21 to market and create brand awareness
within each region by selling locally into their respective
markets, and the local presence of the systems integrators bridges
cultural and communication gaps. As of December 31, 1998, Com21 had
agreements with 26 systems integrators in North America, Europe,
Asia, Latin America and the Pacific Rim.
Research and Development
Com21 focused its research and development efforts on
increasing the scalability and performance of its current products,
reducing the cable operator's cost of ownership, enhancing value-
added services for subscribers, reducing costs and supporting
emerging cable modem standards. In addition to enhancements of the
current ComUNITY Access system products, Com21 has also focused
research and development efforts on new products, including DOCSIS-
compliant cable modems, a secure IP module, an enterprise cable
telephony module and a home networking module. Other developments
underway include a 155 megabits per second OC-3 ATM interface to
provide an integrated connection to the cable operator's fiber
synchronous optical network distribution network, and next-
generation DOCSIS-compliant cable modems. See "Products -- Products
under development" and "-- DOCSIS products under development."
Our research and development expenditures were $12.4 million
in 1996, $13.5 million in 1997 and $19.9 million in 1998. Research
and development expenses primarily consist of salaries and related
costs of employees engaged in ongoing research, design and
development of our products and technology.
As of December 31, 1998, Com21 had a team of 89 engineers with
expertise in ASIC design and electronics, encryption, radio
frequency modulation and demodulation, digital electronics design,
networking, embedded software, and network management. The
engineering team includes three engineers with Ph.D.s and 42
engineers with advanced degrees. Com21 is seeking to hire
additional skilled engineers for research and development. If we
encounter delays in hiring additional engineers, our business,
operating results and financial condition could be adversely
affected. See "Risk Factors -- Competition for qualified personnel
in the cable networking equipment and telecommunications industries
is intense, and we may not be successful in attracting and
retaining these personnel."
17
Com21's future performance depends on a number of factors,
including its ability to identify emerging technological trends in
its target markets, develop and maintain competitive products,
enhance its products by adding innovative features that
differentiate its products from those of competitors, bring
products to market on a timely basis at competitive prices,
properly identify target markets and respond effectively to new
technological changes or new product announcements by others. We
cannot assure you that the design and introduction schedules for
any additions and enhancements to our existing and future products
will be met, that these products will achieve market acceptance, or
that these products will be able to be sold at average selling
prices that are favorable to us. In evaluating new product
decisions, we must anticipate well in advance the future demand for
product features and performance characteristics, as well as
available supporting technologies, manufacturing capacity, industry
standards and competitive product offerings. We must also continue
to make significant investments in research and development in
order to continually enhance the performance and functionality of
its products to keep pace with competitive products and customer
demands for improved performance, features and functionality. The
technical innovations required for Com21 to remain competitive are
inherently complex and require long development cycles. Such
innovations must be completed before developments in networking
technologies or standards render them obsolete and must be
sufficiently compelling to induce network equipment vendors to
favor them over alternative technologies. Moreover, Com21 must
generally incur substantial research and development costs before
the technical feasibility and commercial viability of a product
line can be ascertained. We cannot assure you that revenues from
future products or product enhancements will be sufficient to
recover the development costs associated with such products or
enhancements or that Com21 will be able to secure the financial
resources necessary to fund future development. The failure to
successfully develop new products on a timely basis could have a
material adverse effect on the Company's business, operating
results and financial condition. See "Risk Factors -- Our future
success will depend in part upon our ability to enhance our
existing products and to develop and introduce, on a timely basis,
new products and features that meet changing customer requirements
and emerging industry standards."
Customer Service and Technical Support
Com21 believes that successful long-term relations with its
customers require a service organization committed to customer
satisfaction. As of December 31, 1998, Com21 had 13 technical
support employees at its headquarters. Com21 makes available to all
new customers a five day training course prior to receiving and
installing a system. Customer personnel are trained in the
installation, maintenance and operation of the ComUNITY Access
system.
In North America, Com21 provides direct support by telephone
and at the customers' locations. Com21 supplies support 24 hours a
day, seven days a week. Internationally, systems integrators
provide first level support, and Com21 provides second level
support. Com21 maintains a customer call tracking system that
captures and monitors service activities. Com21 is able to identify
problems with a customer's ComUNITY Access system via a dialup
analog modem connection or a Web-based management interface to
assist with diagnostics.
Competition
The markets for Com21's products are intensely competitive,
rapidly evolving and subject to rapid technological change. The
principal competitive factors in this market include, or are likely
to include, product performance and features, reliability,
technical support and service, relationships with cable operators
and systems integrators, compliance with industry standards,
compatibility with the products of other suppliers, sales and
distribution capabilities, strength of brand name, price, long-term
cost of ownership to cable operators and general industry and
economic conditions. Many of Com21's current and potential
competitors have longer operating histories, greater name
recognition and significantly greater financial, technical,
marketing and distribution resources than we do. These competitors
may undertake more extensive marketing campaigns, adopt more
aggressive pricing policies and devote substantially more resources
to developing new products than we do. We cannot assure you that we
will be able to successfully compete against current or future
competitors or that the competitive pressures we face will not
materially adversely affect our business, operating results and
financial condition. In response to changes in the competitive
environment, we may make certain pricing, service, marketing or
other strategic decisions that could have a material adverse effect
on our business, operating results and financial condition. We
cannot assure you that our competitors will not develop
enhancements to, or future generations of, products that will offer
prices or performance superior to that of our products. Com21
believes that the broad adoption of the DOCSIS standard will cause
increased competition in the North American market, which is likely
to negatively affect our gross margin. We cannot assure you that
competitors will not develop DOCSIS-compliant cable modems more
quickly than Com21. Current customers that move to the DOCSIS
platform could choose alternative cable modem suppliers or choose
to purchase DOCSIS-compliant cable modems from competing suppliers.
This competition could materially adversely affect our business,
operating results and financial condition.
18
Com21's current and potential competitors include 3Com, Cisco
Systems, General Instrument Corporation, Hybrid, Motorola, Inc.,
Nortel Networks, Samsung Electronics Company, Ltd, Terayon
Communication Systems and Zenith Electronics Corporation. Some of
these competitors have existing relationships with many of our
prospective customers. We cannot assure you that we will be able to
establish relationships with cable operators who have existing
relationships with our competitors, and failure to establish these
relationships could have a material adverse effect on our business,
operating results and financial condition. In addition, Com21
anticipates that some large consumer electronics companies, such as
Matsushita (which markets products under the Panasonic brand name),
Sony Corp., Thomson and Toshiba America, Inc., will likely
introduce competitive cable modem products in the future. As the
DOCSIS standard is adopted in the North American market, the
distribution of cable modems may move into the retail channel. If
this occurs, the large consumer electronics companies could gain a
competitive advantage, due to their well-established retail
distribution capabilities. There can be no assurance that Com21
will be able to compete successfully against current or future
competitors or that competitive pressures faced by us will not have
a material adverse effect on Com21's business, operating results
and financial condition. See "Risk Factors-- The market in which we
operate is highly competitive and has many more established
competitors."
We also expect to face intense competition from wireless and
telco-related wireline technologies that provide high bandwidth
access in the local loop. Competing technologies include telco-
related xDSL implementations, such as ADSL and high bit rate
digital subscriber line, commonly known as HDSL in the
telecommunications industry, wireless offerings such as LMDS, MMDS
and DBS. We expect competition from telco-related wireline
solutions to be intense because of the ubiquity of the telephone
infrastructure. We cannot assure our cable modem technology will
compete effectively against wireline and wireless technologies.
Additionally, we believe that digital set-top boxes that integrate
cable modems to provide Internet access via the television may
compete with our cable modems in the lower end consumer Internet
access market. Equipment suppliers of such products include General
Instrument, NCI, Nokia, Panasonic, Philips, Scientific Atlanta and
WebTV (Microsoft).
Intellectual Property
Com21 relies on a combination of patent, copyright and
trademark laws, and on trade secrets, confidentiality provisions
and other contractual provisions to protect its proprietary rights.
These measures afford only limited protection. Com21 currently has
five issued U.S. patents and several pending patent applications.
See "Risk Factors -- Our failure to adequately protect our
proprietary rights may adversely affect us."
Employees
As of December 31, 1998, Com21 had a total of 176 full-time
employees and 11 full-time contractors. Of the total number of
employees, 89 were in research and development, 31 in marketing and
technical support, 23 in operations, 19 in sales and 14 in
administration. Com21's employees are not represented by any
collective bargaining agreement with respect to their employment by
Com21, and Com21 has never experienced an organized work stoppage.
Com21's future success is heavily dependent upon its ability
to hire and retain qualified technical, marketing and management
personnel. The competition for personnel is intense, particularly
for engineering personnel with related networking and integrated
circuit design expertise and for technical support personnel with
networking engineering expertise. See "Risk Factors -- Competition
for qualified personnel in the cable networking equipment and
telecommunications industries is intense, and we may not be
successful in attracting and retaining such personnel."
Risk Factors
You should carefully consider the risks described below before
making a decision to invest in Com21. You may lose all or part of
your investment. The risks and uncertainties described below are
not the only ones facing our company.
We have a short operating history, have incurred net losses
since our inception and expect future losses. We did not commence
product shipments until April 1997. As a result, we have only a
limited operating history upon which you may evaluate us and our
prospects. We have incurred net losses since inception and expect
to continue to operate at a loss through at least fiscal 1999. As
of December 31, 1998, we had an accumulated deficit of
approximately $48.7 million. To achieve profitable operations on a
continuing basis, we must successfully design, develop, test,
manufacture, introduce, market and distribute our products on a
broad commercial basis.
Our ability to generate future revenues will depend on a
number of factors, many of which are beyond our control. These
factors include the following:
19
- the rate at which cable operators upgrade their cable plants;
- our ability and the ability of cable operators to coordinate
timely and effective marketing campaigns with the availability of
upgrades;
- cable operators' success in marketing data-over-cable
services and our modems to subscribers;
- cable operators' success in setting prices for data
transmission installation service; and
- cable operators' success and timeliness in the installation
of subscriber site equipment.
Due to these factors, we cannot forecast with any degree of
accuracy what our revenues will be or how quickly cable operators
will adopt our systems. Therefore, we may not achieve, or be able
to sustain, profitability.
Our operating results in one or more future periods are likely
to fluctuate significantly and may fail to meet or exceed the
expectations of securities analysts or investors. Our operating
results are likely to fluctuate significantly in the future on a
quarterly and an annual basis due to a number of factors, many of
which are outside our control. Factors that could cause our
revenues to fluctuate include the following:
- variations in the timing of orders and shipments of our products;
- variations in the size of orders by our customers;
- new product introductions by us or by competitors;
- delays in introducing cable modems that comply with the new
data-over-cable service interface specification;
- the timing of upgrades of cable plants;
- variations in capital spending budgets of cable operators;
- delays in obtaining regulatory approval for commercial
deployment of cable modem systems; and
- general economic conditions and economic conditions specific
to the cable and electronic data transmission industries.
The amount and timing of our operating expenses generally will
vary from quarter to quarter depending on the level of actual and
anticipated business activities. Research and development expenses
will vary as we develop new products.
We have a limited backlog of orders, and total revenues for
any future quarter are difficult to predict. Supply, manufacturing
or testing constraints could result in delays in the delivery of
our products. Any delay in the product deployment schedule of one
or more of our cable operator customers would likely materially
adversely affect our operating results for a particular period.
A variety of factors affect our gross margin, including the following:
- the sales mix between our headend equipment and cable modems;
- the volume of products manufactured;
- the type of distribution channel through which we sell our products;
- the average selling prices of our products; and
- the effectiveness of our cost reduction efforts.
20
In the past we have experienced and we anticipate that we will
continue to experience decreases in the average selling price of
our cable modems and our other products. In addition, the sales mix
between our headend equipment and modems also affects our gross
margin. Sales of our cable modems yield lower gross margins than do
sales of our headend equipment. In the future, we anticipate that
our sales mix will be increasingly weighted toward cable modems. As
a result, we expect to experience continued downward pressures on
our gross margin. If price declines are not offset by a decline in
the costs of manufacturing our cable modems, our gross margin will
be adversely affected.
Because of these factors, our operating results in one or more
future periods are likely to fail to meet or exceed the
expectations of securities analysts or investors. In that event,
the trading price of our common stock would likely decline. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
We depend on cable operators for substantially all of our
sales. We depend on cable operators to purchase our headend
equipment and cable modems and to market data transmission service
to end-users. Cable operators may not have enough programming
channels over which they can offer these services. Even if a cable
operator chooses to provide data transmission services, it may not
choose our products to do so.
The future success of services providing data-over-cable
transmission depends upon the ability of cable systems to support
two-way communications. While many cable operators are in the
process of upgrading, or have announced their intention to upgrade,
their cable plants to hybrid fiber coaxial cable, commonly known as
HFC in the telecommunications industry, many cable operators have
delayed these upgrades for financial or regulatory reasons. Cable
operators have limited experience with cable plant upgrades, and
investments in upgrades place a significant strain on their
resources. Most cable operators are already highly leveraged and
may not have the capital required to upgrade their infrastructure
or to offer new services such as data-over-cable transmission.
Even after installation, we remain highly dependent on cable
operators to continue to maintain their cable plants so that our
products will operate at a consistently high performance level.
Accordingly, the success and future growth of our business will be
subject to economic and other factors affecting the cable
television industry, particularly the industry's ability to
continue to finance the substantial capital expenditures necessary
to use our products effectively.
The market in which we sell our products is characterized by
many competing technologies, and the technology on which our
product is based may not compete effectively against other
technologies. The market for high-speed data transmission services
has several competing technologies which offer alternative
solutions. Technologies which compete with our solution are:
- telephone company-related wireline technologies such as:
- dial-up (analog modems);
- integrated services digital network, commonly known as ISDN
in the telecommunications industry; and
- digital subscriber line, commonly known as DSL in the
telecommunications industry.
- wireless technologies such as:
- local multipoint distribution service, commonly known as
LMDS in the telecommunications industry;
- multi-channel multipoint distribution service, commonly
known as MMDS in the telecommunications industry; and
- direct broadcast satellite, commonly known as DBS in the
telecommunications industry.
In particular, because of the widespread reach of telephone
networks and the financial resources of telephone companies,
competition from telephone company-related solutions is expected to
be intense. Cable modem technology may not be able to compete
effectively against wireline or wireless technologies.
In addition, one of our competitors has developed a
commercially available alternative modulation technology.
Significant market acceptance of alternative solutions for high-
speed data transmission could decrease the demand for our products
if these alternatives are viewed as providing faster access,
greater reliability, increased cost-effectiveness or other
advantages.
21
Our current products are not compatible with products offered
by our competitors and are subject to evolving industry standards.
If our products do not comply with any standard that achieves
market acceptance, customers may refuse to purchase our products.
Our headend equipment and cable modem products do not interoperate
with the existing equipment of other cable modem suppliers.
Therefore, potential customers who wish to purchase broadband
Internet access products from multiple suppliers may be reluctant
to purchase our products.
The emergence or evolution of industry standards, either
through adoption by official standards committees or widespread use
by cable operators or telephone companies, could require us to
redesign our products. Our current products are not in full
compliance with the standards and developing specifications as
proposed by:
- data-over-cable service interface specification;
- Digital Audio Video Interactive Council and Digital and
Video Broadcast Organization;
- Institute of Electrical and Electronics Engineers;
- Internet Engineering Task Force; and
- other relevant standards bodies.
We expect the emerging data-over-cable service interface
specification, commonly referred to as the DOCSIS standard, to
achieve substantial market acceptance in North America, and we are
currently developing DOCSIS-compliant cable modems. The continuing
evolution of the DOCSIS standard may cause us to incur additional
costs associated with making our cable modems compliant with
various versions of the standard. We cannot assure you that our
DOCSIS-compliant cable modems will be introduced on schedule, or
that they will meet with market acceptance.
There is currently no generally accepted standard for data-
over-cable internationally. If any standards achieve market
acceptance and if our products do not comply with them, customers
may refuse to purchase our products. Additionally, different
implementations of the same specification could slow deployment of
our products if these differences cause our products not to be
interoperable with other companies' products. The widespread
adoption of the DOCSIS or other standards would likely cause
aggressive price competition in the cable modem market and result
in lower sales of our headend products and lower revenues from
licensing of our network management software. Any of these events
would adversely affect our gross margin and our operating results.
The development of new competing technologies and standards
increases the risk that current or new competitors could develop
products that would reduce the competitiveness of our products. If
any of these new technologies or standards achieve widespread
market acceptance, any failure by us to develop new products or
enhancements, or to address these new technologies or standards,
would harm our business.
Because our market is new and evolving, we cannot accurately
predict its future growth rate or its ultimate size, and widespread
acceptance of our product is uncertain. Our success depends on the
timely adoption of our products by cable operators and their
subscribers. The market for our products is rapidly evolving. An
increasing number of competitors have introduced or developed, or
are in the process of introducing or developing, cable modem
systems that compete with our own. Some of the critical issues
concerning the use of cable modems, including security,
reliability, cost, ease of deployment and administration, and
quality of service, remain largely unresolved and may harm our
business. Because our market is new and evolving, we cannot
accurately predict its future growth rate or its ultimate size.
Prior to purchasing our products, some cable operators may
require that their internal technical personnel or their Internet
service provider certify our products to determine if they work
with their systems. Certification of our products may not occur in
a timely manner, if at all. In some cases, in order for our
products to be certified we may have to make significant product
modifications. Failure to become certified could render us unable
to deploy our products in a timely manner with one or more cable
operators. Any of these possibilities could harm our business. The
market for cable modems may never fully develop, and even if it
does, we may not be able to compete successfully in that market. If
our products do not achieve widespread acceptance in their markets,
our business may be adversely affected.
22
If sales forecasted for a particular period are not realized
in that period due to the lengthy sales cycle of our products, our
operating results for that period will be harmed. The sales cycle
of our products is typically lengthy and involves:
- a significant technical evaluation;
- a commitment of capital and other resources by cable operators;
- delays associated with cable operators' internal procedures
to approve large capital expenditures;
- time required to engineer the deployment of new technologies
within the networks of cable operators; and
- testing and acceptance of new technologies that affect key
operations.
For these and other reasons, our sales cycle generally lasts
from six to 12 months. Furthermore, the announcement and projected
product introduction of DOCSIS-compliant cable modems have already
affected sales cycles, as most domestic cable operators have chosen
to delay large scale deployment of cable modems until DOCSIS-
compliant cable modems are available.
The market in which we operate is highly competitive and has
many more established competitors. The market for our products is
intensely competitive, rapidly evolving and subject to rapid
technological change.
Many of our current and potential competitors have been
operating longer, have better name recognition, better established
business relationships and significantly greater financial,
technical, marketing and distribution resources than we do. These
competitors may undertake more extensive marketing campaigns, adopt
more aggressive pricing policies and devote substantially more
resources to developing new or enhanced products than we do. If we
fail to develop DOCSIS-compliant cable modems in a timely manner,
our customers may choose another supplier for DOCSIS-compliant
cable modems, and our business, operating results and financial
condition could be materially adversely affected. See "Business --
Competition."
We must reduce the cost of our cable modems to remain
competitive. Certain of our competitors' cable modems are priced
lower than our cable modems. As headend equipment becomes more
widely deployed, the price of cable modems and related equipment
will continue to decline. In particular, we believe that the
adoption of industry standards, such as the DOCSIS standard, will
cause increased price competition for cable modems.
We may not be able to continually reduce the costs of
manufacturing our cable modems sufficiently to enable us to lower
our modem prices and compete effectively with other cable modem
suppliers. If we are unable to reduce the manufacturing costs of
our cable modems, our gross margin and operating results would be
harmed.
Our failure to adequately protect our proprietary rights may
adversely affect us. We rely on a combination of patent, copyright
and trademark laws, and on trade secrets and confidentiality
provisions and other contractual provisions to protect our
proprietary rights. These measures afford only limited protection.
We currently have five issued U.S. patents and several pending
patent applications. Our means of protecting our proprietary rights
in the U.S. or abroad may not be adequate and competitors may
independently develop similar technologies. Our future success will
depend in part on our ability to protect our proprietary rights and
the technologies used in our principal products. Despite our
efforts to protect our proprietary rights, unauthorized parties may
attempt to copy aspects of our products or to obtain and use trade
secrets or other information that we regard as proprietary. In
addition, the laws of some foreign countries do not protect our
proprietary rights as fully as do the laws of the U.S. Issued
patents may not preserve our proprietary position. Even if they do,
competitors or others may develop technologies similar to or
superior to our own. If we do not enforce and protect our
intellectual property, our business will be harmed.
From time to time, third parties, including our competitors,
have asserted patent, copyright and other intellectual property
rights to technologies that are important to us. We expect that we
will increasingly be subject to infringement claims as the number
of products and competitors in the cable modem market grows and the
functionality of products overlaps.
The results of any litigation matter are inherently uncertain.
In the event of an adverse result in any litigation with third
parties that could arise in the future, we could be required to pay
substantial damages, including treble damages if we are held to
have willfully infringed, to halt the manufacture, use and sale of
infringing products, to expend significant resources to develop
non- infringing technology, or to obtain licenses to the infringing
technology. Licenses may not be available from any third party that
asserts intellectual property claims against us, on commercially
reasonable terms, or at all. In addition, litigation frequently
involves substantial expenditures and can require significant
management attention, even if we ultimately prevail. For example,
in January 1998, Hybrid Networks filed an action against us,
accusing us of infringing certain of their patents. We settled this
matter in January 1999 through a patent cross-license agreement
that will not materially impact our business or results of
operations. However, there can be no assurance that we would be
able to successfully resolve similar incidents in the future.
23
Our failure to manage growth could adversely affect us. We have
rapidly and significantly expanded our operations and anticipate
that further significant expansion will be required to address
potential growth in our customer base and market opportunities. To
manage the anticipated growth of our operations, we will be
required to:
- improve existing and implement new operational, financial and
management information controls, reporting systems and procedures;
- hire, train and manage additional qualified personnel;
- expand and upgrade our core technologies; and
- effectively manage multiple relationships with our
customers, suppliers and other third parties.
We may not be able to install management information and
control systems in an efficient and timely manner, and our current
or planned personnel, systems, procedures and controls may not be
adequate to support our future operations.
In the future, we may experience difficulties meeting the
demand for our products and services. The installation and use of
our products requires training. If we are unable to provide
training and support for our products, the implementation process
will be longer and customer satisfaction may be lower. In addition,
our management team may not be able to achieve the rapid execution
necessary to fully exploit the market for our products and
services. We cannot assure you that our systems, procedures or
controls will be adequate to support the anticipated growth in our
operations. Any failure to manage growth effectively could
materially adversely affect our business, operating results and
financial condition.
Competition for qualified personnel in the cable networking
equipment and telecommunications industries is intense, and we may
not be successful in attracting and retaining these personnel. Our
future success will depend, to a significant extent, on the ability
of our management to operate effectively, both individually and as
a group. Given our early stage of development, we are dependent on
our ability to retain and motivate high caliber personnel, in
addition to attracting new personnel. Competition for qualified
personnel in the cable networking equipment and telecommunications
industries is intense, and we may not be successful in attracting
and retaining such personnel. During 1998, we hired 45 new
employees, an increase of approximately 34%, to our total work
force at December 31, 1997. We expect to add additional personnel
in the near future, including direct sales and marketing personnel.
There may be only a limited number of people with the requisite
skills to serve in those positions and it may become increasingly
difficult to hire these people. We are actively searching for
research and development engineers, who are in short supply. Our
business will suffer if we encounter delays in hiring these
additional engineers.
Competitors and others have in the past and may in the future
attempt to recruit our employees. We do not have employment
contracts with any of our key personnel. We do not maintain key
person life insurance on our key personnel. The loss of the
services of any of our key personnel, the inability to attract or
retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers, could negatively affect
our business.
We depend on strategic relationships. Our business strategy
relies to a significant extent on our strategic relationships with
other companies. These relationships include:
- software license arrangements for our network management system;
- marketing arrangements with Philips and Siemens; and
- DOCSIS-compliant cable modem development in conjunction with
Cisco to ensure the interoperability of our cable modem with
Cisco's universal broadband router.
24
These relationships may not be successful because we may not
be able to continue to maintain, develop or replace them in the
event any of these relationships are terminated. In addition, any
failure to renew or extend any licenses between us and any third
party may adversely affect our business.
We may not be able to produce sufficient quantities of our
products because we depend on third-party manufacturers and have
limited manufacturing experience. We contract for the manufacture
of cable modems and integrated circuit boards on a turnkey basis.
CMC Industries and Sanmina build printed circuit assemblies for our
headend products and Celestica manufactures our cable modems. Our
future success will depend, in significant part, on our ability to
have others manufacture our products cost-effectively and in
sufficient volumes. There are a number of risks associated with our
dependence on third-party manufacturers including the following:
- reduced control over delivery schedules;
- quality assurance;
- manufacturing yields and costs;
- the potential lack of adequate capacity during periods of
excess demand;
- limited warranties on products supplied to us; and
- increases in prices and the potential misappropriation of
our intellectual property.
Any manufacturing disruption could impair our ability to
fulfill orders. We have no long-term contracts or arrangements with
any of our vendors that guarantee product availability, the
continuation of particular payment terms or the extension of credit
limits. We may experience manufacturing or supply problems in the
future. We are dependent on our manufacturers to secure components
at favorable prices, but we may not be able to obtain additional
volume purchase or manufacturing arrangements on terms that we
consider acceptable, if at all. If we enter into a high-volume or
long-term supply arrangement and subsequently decide that we cannot
use the products or services provided for in the agreement, our
business will be harmed. Any such difficulties could harm our
relationships with customers. See "Business -- Manufacturing."
We may not be able to produce sufficient quantities of our
products because we obtain certain components from, and depend on,
certain key sole suppliers. Certain parts, components and equipment
used in our products are obtained from sole sources of supply. For
example, our headend equipment incorporates a radio frequency
modulation chip from one specific vendor, transmitter/receiver
components from another, and an Asynchronous Transfer Mode switch,
commonly known as an ATM in the telecommunications industry, from
yet another. Additional sole-sourced components may be incorporated
into our equipment in the future.
We do not have any long term supply contracts to ensure
sources of supply. If we fail to obtain components in sufficient
quantities when required, our business could be harmed. Our
suppliers may enter into exclusive arrangements with our
competitors, stop selling their products or components to us at
commercially reasonable prices or refuse to sell their products or
components to us at any price. Our inability to obtain sufficient
quantities of sole-sourced components, or to develop alternative
sources for components and/or products would materially adversely
affect our business. We rely on several companies including:
- Broadcom Corp. and Stanford Telecommunications, Inc.,
suppliers of modulation and demodulation components;
- Atmel Corporation, the fabricator of our semiconductor devices;
- Virata Limited, formerly Advanced Telecommunications Modules
Limited, a supplier of ATM switches;
- Hewlett-Packard Company, the supplier of HP Openview software;
- Wind River Systems, Inc., a supplier of embedded software; and
- Objectivity, Inc., a supplier of object-oriented database software.
25
If any of these manufacturers delay or halt production of any
of their components, our business, operating results and financial
condition could be materially adversely affected.
Our customer base is concentrated and the loss of one or more
of our customers could cause our business to suffer. A relatively
small number of customers have accounted for a large part of our
revenues to date, and we expect that this trend will continue.
During the year ended December 31, 1998, revenues attributable to
our top three customers, TCI, Philips and Siemens, accounted for
24%, 15% and 14% of total revenues, respectively. For the same
period, our top five customers accounted for an aggregate of 66% of
total revenues. We expect that our largest customers in the future
could be different from our largest customers today due to a
variety of factors, including customers' deployment schedules and
budget considerations. Because a limited number of cable operators
account for a majority of our prospective customers, our future
success will depend upon our ability to establish and maintain
relationships with these companies. We may not be able to retain
our current accounts or to obtain additional accounts. Both in the
U.S. and internationally, a substantial majority of households
passed are controlled by a relatively small number of cable
operators. The loss of one or more of our customers or our
inability to successfully develop relationships with other
significant cable operators could cause our business to suffer.
Our future success will depend in part upon our ability to
enhance our existing products and to develop and introduce, on a
timely basis, new products and features that meet changing customer
requirements and emerging industry standards. The market for cable
modem systems and products is characterized by rapidly changing
technologies and short product life cycles. Our future success will
depend in large part upon our ability to:
- identify and respond to emerging technological trends in the market;
- develop and maintain competitive products;
- enhance our products by adding innovative features that
differentiate our products from those of our competitors;
- bring products to market on a timely basis at competitive
prices; and
- respond effectively to new technological changes or new
product announcements by others.
If our product development and enhancements take longer than
planned, the availability of products would be delayed. Our future
success will depend in part upon our ability to enhance our
existing products and to develop and introduce, on a timely basis,
new products and features that meet changing customer requirements
and emerging industry standards, such as the DOCSIS standard.
On March 4, 1999, CableLabs announced the result of the
certification process for the DOCSIS 1.0 cable modem that began on
January 18, 1999. Our DOCSIS 1.0 cable modem was not certified at
this time. We believe that this will not affect our plan to
commercially introduce our initial DOCSIS modem in the first half
of 1999.
The technical innovations required for us to remain
competitive are inherently complex, require long development cycles
and are dependent in some cases on sole source suppliers. We will
be required to continue to invest in research and development in
order to attempt to maintain and enhance our existing technologies
and products, but we may not have the funds available to do so.
Even if we have sufficient funds, these investments may not serve
the needs of customers or be compatible with changing technological
requirements or standards. Most of the expenses must be incurred
before the technical feasibility or commercial viability can be
ascertained. Revenues from future products or product enhancements
may not be sufficient to recover the development costs associated
with the products or enhancements.
We rely on indirect distribution channels for our products and
need to develop additional distribution channels. Today, cable
operators and systems integrators purchase cable modems from
vendors through direct and indirect sales channels. In North
America, if the DOCSIS standard achieves widespread market
acceptance, we anticipate that the North American cable modem
market will shift to a consumer purchase model. If this occurs, we
will sell more of our cable modems directly through consumer sales
channels. Consequently, we have begun to establish new distribution
channels for our cable modems. We may not have the capital required
or the necessary personnel to develop these distribution channels,
which could materially adversely affect our business, operating
results and financial condition. To the extent that large consumer
electronics companies enter the cable modem market, their well-
established retail distribution capabilities would provide them
with a significant competitive advantage. See "Business --
Competition."
26
We are subject to risks associated with operating in
international markets. During the fiscal year ended December 31,
1998, revenues attributable to international customers accounted
for 52% of total revenues. We expect that a significant portion of
our sales will continue to be concentrated in international markets
for the foreseeable future. We intend to expand operations in our
existing international markets and to enter new international
markets, which will demand management attention and financial
commitment. In addition, a successful expansion of our
international operations and sales in certain markets will require
us to develop relationships with international systems integrators
and distributors. We may not be able to identify, attract or retain
suitable international systems integrators or distributors. We may
not be able to successfully expand our international operations.
Furthermore, to increase revenues in international markets, we
will need to continue to establish foreign operations, to hire
additional personnel to run these operations and to maintain good
relations with our foreign systems integrators and distributors. To
the extent that we are unable to successfully do so, our growth in
international sales will be limited and our operating results could
be adversely affected.
Our international sales to date have been denominated in U.S.
dollars. We do not currently engage in any foreign currency hedging
transactions. A decrease in the value of foreign currencies
relative to the U.S. dollar could make our products more expensive
in international markets.
In addition to currency fluctuation risks, international
operations involve a number of risks not typically present in
domestic operations, including:
- changes in regulatory requirements;
- costs and risks of deploying systems in foreign countries;
- licenses, tariffs and other trade barriers;
- political and economic instability;
- difficulties in staffing and managing foreign operations;
- potentially adverse tax consequences;
- difficulties in obtaining governmental approvals for products;
- the burden of complying with a wide variety of complex
foreign laws and treaties; and
- the possibility of difficult accounts receivable collections.
We are also subject to the risks associated with the
imposition of legislation and regulations relating to the import or
export of high technology products. We cannot predict whether
charges or restrictions upon the importation or exportation of our
products will be implemented by the U.S. or other countries. Future
international activity may result in sales dominated by foreign
currencies. Gains and losses on the conversion to U.S. dollars of
accounts receivable, accounts payable and other monetary assets and
liabilities arising from international operations may contribute to
fluctuations in our operating results. Any of these factors could
materially and adversely affect our business, operating results and
financial condition.
We may be subject to risks associated with acquisitions. We
continually evaluate strategic acquisitions of other businesses and
subscriber accounts. If we were to consummate an acquisition, we
would be subject to a number of risks, including:
- difficulty in assimilating the acquired operations and personnel;
- limits on our ability to retain the acquired subscribers;
- disruption of our ongoing business; and
- limits on our ability to successfully incorporate acquired
technology and rights into our service offerings and maintain
uniform standards, controls, procedures, and policies.
27
We may not be able to successfully overcome problems
encountered in connection with potential acquisitions. In addition,
an acquisition could materially adversely affect our operating
results by diluting our stockholders' equity, causing us to incur
additional debt, or requiring us to amortize acquisition expenses
and acquired assets.
We are subject to risks associated with the regulation of
information security products. Our products make use of encryption,
and are therefore subject to export restrictions administered by
the U.S. Department of Commerce, which permit the export of
encryption products only with the required level of export license.
We may therefore be at a disadvantage in competing for
international sales compared to companies located outside the U.S.
that are not subject to these restrictions. International customers
may be unwilling to purchase our products that are eligible for
export due to perceptions that these products are inferior to those
marketed within the U.S., may contain undocumented features which
undermine the products' security architecture, or are required to
incorporate security features which are unacceptable to the
customer. Although we have been granted all currently required U.S.
export licenses, we may not be able to continue to secure any
required licenses in a timely manner in the future. In certain
foreign countries, our distributors are required to secure licenses
or formal permission before products that incorporate encryption
features can be imported. Our distributors may not make the effort,
or be successful in the effort, to obtain the necessary licenses or
permission to import our products into certain countries. The
uncertainty involved in the interpretation and application of
import and export regulations may unduly delay or prevent the
export of our products, which may lead to a loss of revenues and
market position.
Recent legislative proposals have indicated the possibility
that our products sold for use within the U.S. may be required to
incorporate certain features to assist law enforcement agencies in
recovering suspect communications. If these proposals are enacted
into law, we may be obligated to incur significant expense in
complying with these regulations. In addition, the market
opportunities and customer acceptance of our products could be
materially adversely affected by our compliance with these laws,
leading to a loss of revenues and market share.
Our failure and the failure of our key suppliers and customers
to be year 2000 compliant would negatively impact our business. The
Year 2000 issue is the result of computer programs written using
two digits rather than four to define the applicable year. Computer
programs that have this date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a
temporary inability to process transactions, send invoices or
engage in similar normal business activities.
We are heavily dependent upon the proper functioning of our
own computer or data-dependent systems. This includes, but is not
limited to, our systems in information, business, finance,
operations, manufacturing and service. Any failure or
malfunctioning on the part of these or other systems could
adversely affect our business in ways that are not currently known,
quantifiable or otherwise anticipated by us.
We currently have only limited information on the Year 2000
compliance of key suppliers and customers. The operations of our
key suppliers and customers could be adversely affected in the
event they do not successfully and timely achieve Year 2000
compliance. Our business and results of operations could experience
material adverse effects if our key suppliers were to experience
Year 2000 issues that caused them to delay manufacturing or
shipment of key components to us. In addition, our results of
operations could be materially adversely affected if any of our key
customers encounter Year 2000 issues that cause them to delay or
cancel substantial purchase orders or delivery of our products.
While we have developed a plan to address Year 2000 issues, we
may be unable to complete all phases of the plan in a timely manner
or to upgrade any or all of our major systems in accordance with
our plan. Even if we make upgrades, they may not effectively
address the Year 2000 issue. If required upgrades are not completed
in a timely manner or are not successful, we may be unable to
conduct our business or manufacture our products. The systems of
other companies on which our systems rely may not be converted in a
timely manner. The failure to convert by another company, or the
occurrence of a conversion that is incompatible with our systems
would have a material adverse effect on our business. We intend to
establish, but have not yet established a contingency plan
detailing actions that will be taken in the event that the
assessment of the Year 2000 issue is not successfully completed on
a timely basis. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Year 2000
Readiness."
We may be subject to product returns and product liability
claims due to defects in our products. Our products are complex and
may contain undetected defects, errors or failures. These errors
have occurred in our products in the past and additional errors may
be expected to occur in our products in the future. The occurrence
of any defects, errors, or failures could result in delays in
installation, product returns and other losses to us or to our
cable operators or end-users. Any of these occurrences could also
result in the loss of or delay in market acceptance of our
products, which could have a material adverse effect on our
business, operating results and financial condition. We would have
limited experience with the problems that could arise with any new
products that we introduce.
28
Although we have not experienced any product liability claims
to date, the sale and support of our products entail the risk of
these claims. A successful product liability claim brought against
us could have a material adverse effect on our business, operating
results and financial condition.
Our products are subject to government regulations, and
changes in current or future laws or regulations that negatively
impact our products and technologies, in the U.S. or elsewhere,
could adversely affect our business. Our products are subject to
the regulations of the Federal Communications Commission and other
federal and state communications regulatory agencies. Changes in
the regulatory environment relating to the Internet connectivity
market, including regulatory changes that, directly or indirectly,
affect telecommunications costs, limit usage of subscriber-related
information or increase the likelihood or scope of competition from
telecommunications companies, could affect the prices at which
cable operators sell their services and thus indirectly impact our
business. In addition, we cannot predict the impact, if any, that
future regulation or regulatory changes might have on our business.
Regulation of cable television rates may affect the speed at which
the cable operators upgrade their cable infrastructures to two-way
HFC. Changes in current or future laws or regulations that
negatively impact our products and technologies, in the U.S. or
elsewhere, could adversely affect our business.
Our success is dependent on the successful deployment of IP-
based networks. Our products will depend in part upon the increased
use of the Internet and other networks based on the Internet
protocol by corporate telecommuters, small offices/home offices and
residential consumer users. Businesses are increasingly using the
Internet, intranets and extranets, not only for communication
within and outside the firm, but also to create cost-effective,
secure data connections known as virtual private networks, commonly
referred to as VPNs, between corporate sites or remote locations.
Critical issues concerning the commercial use of the Internet, such
as ease of access, security, reliability, and cost and quality of
service, remain unresolved and may affect the growth of Internet
use, especially in the business and consumer markets that we
target.
Despite growing interest in commercial applications for the
Internet and other IP-based networks, many businesses have been
deterred from adopting IP-based data communications systems for a
number of reasons, including:
- inconsistent quality of service;
- lack of availability of cost-effective, high-speed service;
- a limited number of local access points for corporate users;
- inability to integrate business applications on the Internet;
- the need to deal with multiple and frequently incompatible vendors;
- inadequate security; and
- lack of tools to simplify Internet access and use.
These issues and concerns may not be resolved or alleviated.
Failure of the Internet community to address and resolve these
issues, to develop or to develop as rapidly as expected could
materially adversely affect our business, operating results and
financial condition.
We may need additional capital in the future and may not be
able to secure adequate funds in terms acceptable to us. We
currently anticipate our existing cash balances and available line
of credit and cash flow expected to be generated from future
operations, will be sufficient to meet our liquidity needs for at
least the next twelve months. However, we may need to raise
additional funds if our estimates of revenues, working capital
and/or capital expenditure requirements change or prove inaccurate
or in order for us to respond to unforeseen technological or
marketing hurdles or to take advantage of unanticipated
opportunities.
29
In addition, we expect to review potential acquisitions that
would complement our existing product offerings or enhance our
technical capabilities. While we have no current agreements or
negotiations underway with respect to any potential acquisition,
any future transaction of this nature could require potentially
significant amounts of capital. Funds may not be available at the
time or times needed, or available on terms acceptable to us. If
adequate funds are not available, or are not available on
acceptable terms, we may not be able to take advantage of market
opportunities, to develop new products or to otherwise respond to
competitive pressures. This inability could materially adversely
affect our business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Our stock price is highly volatile and broad market
fluctuations may adversely affect the market price of our common
stock. The trading price of our common stock has fluctuated
significantly since our initial public offering in May 1998. In
addition, the trading price of our common stock could be subject to
wide fluctuations in response to quarterly variations in operating
results, announcements of technological innovations or new products
by us or our competitors, developments with respect to patents or
proprietary rights, changes in financial estimates by securities
analysts and other events or factors. In addition, the stock market
has experienced volatility that has particularly affected the
market prices of equity securities of many high technology
companies and that often has been unrelated or disproportionate to
the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of our common
stock.
The adoption of the Euro presents uncertainties for our
company. In January 1999, the new "Euro" currency was introduced in
certain European countries that are part of the European Monetary
Union ("EMU"). During 2002, all EMU countries are expected to be
operating with the Euro as their single currency. A significant
amount of uncertainty exists as to the effect the Euro will have on
the marketplace generally and, additionally, all of the rules and
regulations have not yet been defined and finalized by the European
Commission with regard to the Euro currency. We are currently
assessing the effect the introduction of the Euro will have on our
internal accounting systems and the sales of our products. We are
not aware of any material operational issues or costs associated
with preparing our internal systems for the Euro. However, we do
utilize third party vendor equipment and software products that may
or may not be EMU-compliant. Although we are currently taking steps
to address the impact, if any, of EMU compliance for these third
party products, the failure of any critical components to operate
properly post-Euro may have an adverse effect on our business or
results of operations or may require us to incur expenses to remedy
these problems.
This Form 10-K contains forward-looking statements. These
statements are not guarantees of future performance and are subject
to certain risks, uncertainties and other factors, some of which
are beyond our control, are difficult to predict and could cause
actual results to differ materially from those expressed or
forecasted in the forward-looking statements. This prospectus Form
10-K contains forward-looking statements that have been made under
the provisions of the Private Securities Litigation Reform Act of
1995. These forward-looking statements are not historical facts but
rather are based on current expectations, estimates and projections
about our industry, our beliefs, and assumptions. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates" and variations of these words and similar expressions
are intended to identify forward-looking statements. These
statements are not guarantees of future performance and are subject
to certain risks, uncertainties and other factors, some of which
are beyond our control, are difficult to predict and could cause
actual results to differ materially from those expressed or
forecasted in the forward-looking statements. These risks and
uncertainties include those described in "Risk Factors" and
elsewhere in this Form 10-K. Readers are cautioned not to place
undue reliance on these forward-looking statements, which reflect
our management's view only as of the date of this Form 10-K. We
undertake no obligation to update these statements or publicly
release the result of any revisions to the forward-looking
statements that we may make to reflect events or circumstances
after the date of this Form 10-K or to reflect the occurrence of
unanticipated events.
Item 2. Properties
Com21 leases approximately 44,600 square feet of
administrative, research and development, and manufacturing
facilities in Milpitas, California and intends to lease an
additional 26,000 square feet of space in Milpitas. Com21 believes
that after entering into the lease for the additional space, its
current facilities will be sufficient to handle our operations for
at least the next 12 months. We believe that future growth can be
accommodated by obtaining the necessary additional space. Com21
also leases three sales offices, in Denver, Colorado, Atlanta,
Georgia, and Toronto, Canada.
Item 3. Legal Proceedings
In January 1998, Hybrid Networks filed an action against us,
accusing us of infringing certain of their patents. We settled
this matter in January 1999 through a patent cross-license
agreement.
30
Item 4. Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
The Company's common stock is traded on the Nasdaq National
Market under the symbol "CMTO".
The following table sets forth the high and low bid quotations of
the Company's common stock for the periods indicated as reported by
The Nasdaq National Market or NASD electronic bulletin board.
Prices shown in the table represent inter-dealer quotations,
without adjustment for retail markup, markdown, or commission, and
do not necessarily represent actual transactions.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
Year ended December 31, 1998 $24.87 $ 8.37
Second quarter $23.75 $12.87
Third quarter $24.87 $ 8.37
Fourth quarter $22.75 $11.50
</TABLE>
The number of stockholders of record of common stock, $.001 par
value, of the Company was 223 at December 31, 1998.
Com21 has never declared, or paid, any cash dividends on its
Common Stock.
Use of Proceeds from Sales of Registered Securities. On February
23, 1999 the Company completed a public offering of its Common
Stock, $0.001 par value. The managing underwriters in the Offering
were Credit Suisse First Boston Corporation and Dain Rauscher
Wessels (the "Underwriters"). The shares of Common Stock sold in
the Offering were registered under the Securities Act of 1933, as
amended, on a Registration Statement on Form S-1 (the "Registration
Statement") (Reg. No. 333 79504) that was declared effective by the
SEC on February 23, 1999. The Offering commenced on March 1, 1999
after all 3,000,000 shares (of which 2,480,000 shares were offered
by the Company and 520,000 shares were offered by certain selling
shareholders) of Common Stock registered under the Registration
Statement were sold at a price of $23.50 per share. The aggregate
price of the Offering amount registered was $70,500,000. In
connection with the Offering, the Company paid an aggregate of
$3,690,000 in underwriting discounts and commissions to the
Underwriters. In addition, the following table sets forth an
estimate of all expenses incurred in connection with the Offering,
other than underwriting discounts and commissions. All amounts
shown are estimated except for the registration fees of the SEC and
the National Association of Securities Dealers, Inc. ("NASD").
<TABLE>
<S> <C>
SEC Registration fee $ 27,038
NASD filing fee 10,226
Nasdaq National Market listing fee 17,500
Printing and engraving expenses 165,000
Legal fees and expenses 100,000
Accounting fees and expenses 160,000
Blue Sky fees and expenses 5,000
Transfer Agent and Registrar fees 10,000
Miscellaneous 105,236
-----------------
Total 600,000
</TABLE>
After deducting the underwriting discounts and commissions and
the estimated offering expenses described above, the Company received
net proceeds from the offering of approximately $54,733,600 and the
selling stockholders received $11,476,400. As of March 3, 1999,
Com21 has used the net proceeds from its public offering of Common
Stock of the Company to invest in short-term and long-term,
interest bearing, investment grade securities and has used its
existing cash balances to fund the general operations of the
Company. The proceeds will be used for general corporate purposes,
including working capital and product development. A portion of
the net proceeds may also be used to acquire or invest in
complementary business or products or to obtain the right to use
complementary technologies. The Company has no agreements or
commitments with respect to any such acquisition or investments and
the Company is not currently engaged in any material negotiations
with respect to any such transaction. None of the Company's net
proceeds of the offering were paid directly or indirectly to any
director, officer, general partner of the Company or their
associates, persons owning 10% or more of any class of equity
securities of the Company, or an affiliate of the Company.
31
Item 6. Selected Financial Data
The following selected financial data should be read in
conjunction with our financial statements and related notes to
financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in this
Form 10-K. The statements of operations data for each of the years
in the three-year period ended December 31, 1998, and the balance
sheets data at December 31, 1997 and 1998, are derived from
financial statements which have been audited by Deloitte & Touche
LLP, independent auditors, and are included in this Form 10-K. The
historical results are not necessarily indicative of the operating
results to be expected in the future.
<TABLE>
<CAPTION>
Years Ended December 31,
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(In thousands, except per share data)
Statements of Operations Data:
<S> <C> <C> <C> <C> <C>
Total revenues $ - $ - $ 1,000 $ 15,649 $ 48,114
Cost of total revenues - - - 8,372 29,573
-------- -------- -------- -------- --------
Gross profit - - 1,000 7,277 18,541
Operating expenses:
Research and development 545 5,233 12,395 13,481 19,936
Sales and marketing - 770 1,970 5,277 10,273
General and administrative 349 919 1,548 1,782 3,871
-------- -------- -------- -------- --------
Total operating expenses 894 6,922 15,913 20,540 34,080
Loss from operations (894) (6,922) (14,913) (13,263) (15,539)
Total other income, net 58 257 447 229 2,190
-------- -------- -------- -------- --------
Loss before income taxes (836) (6,665) (14,466) (13,034) (13,349)
Income taxes 1 1 5 21 14
-------- -------- -------- -------- --------
Net loss $ (837) $ (6,666) $(14,471) $(13,055) $(13,363)
-------- -------- -------- -------- --------
Net loss per share,
basic and diluted(1) $ (0.54) $ (3.53) $ (7.64) $ (6.15) $ (1.10)
======== ======== ======== ======== ========
Shares used in computation,
basic and diluted(1) 1,562 1,887 1,894 2,124 12,150
======== ======== ======== ======== ========
Pro forma net loss per share,
basic and diluted(2) $ (0.31) $ (1.27) $ (1.84) $ (1.27) $ (.83)
======== ======== ======== ======== ========
Shares used in pro forma
computation, basic and
diluted(2) 2,685 5,265 7,851 10,279 16,062
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheets Data:
Cash, cash equivalents and
short-term investments $ 2,082 $ 3,273 $ 12,427 $ 17,950 $ 65,744
Working capital 2,023 2,328 9,097 19,523 68,084
Total assets 2,308 4,606 17,036 31,573 82,948
Long-term obligations - 275 1,292 1,508 936
Total stockholders' equity 2,222 3,288 12,056 23,283 73,366
</TABLE>
(1) The diluted net loss per share computation excludes potential
shares of common stock (convertible preferred stock, warrants to
purchase convertible preferred stock, options and warrants to
purchase common stock and common stock subject to our repurchase
rights), as their effect would be antidilutive. See Notes 1 and 7
of Notes to Financial Statements for a detailed explanation of the
determination of the shares used in computing basic and diluted net
loss per share.
(2) Includes the weighted average number of shares resulting from
the assumed conversion of all outstanding shares of convertible
preferred stock upon the effectiveness of the registration
statement related to the initial public offering in May 1998. See
Note 1 of Notes to Financial Statements for a detailed explanation
of the determination of the shares used in computing pro forma net
loss per share. The diluted pro forma net loss per share
computation excludes potential shares of common stock (warrants to
purchase convertible preferred stock, options and warrants to
purchase common stock and common stock subject to our repurchase
rights).
32
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
You should read the following discussion in conjunction with
Com21's financial statements and notes to financial statements. The
results described below are not necessarily indicative of the
results to be expected in any future period. Certain statements in
this discussion and analysis, including statements regarding our
strategy, financial performance and revenue sources, are forward-
looking statements based on current expectations and entail various
risks and uncertainties that could cause actual results to differ
materially from those expressed in the forward-looking statements,
including those described in "Risk Factors" and elsewhere in this
Form 10-K.
Overview
Com21, Inc. designs, develops, markets and sells value-added,
high-speed communications solutions for the broadband access
market. Com21's system enables cable operators to provide high-
speed, cost-effective Internet access to corporate telecommuter,
small office/home office and residential end-users in the U.S. and
internationally. Com21's system also enables cable operators to
address the distinct price, performance, security and other needs
of these different end-users. Our product family includes cable
modems, headend equipment, network management software and noise
containment technologies.
Com21 was incorporated in June 1992. From inception through
April 1997, our operating activities related primarily to
establishing a research and development organization, testing
prototype designs, building application-specific integrated circuit
design infrastructure, commonly known as an ASIC, commencing the
staffing of marketing, sales and field service and technical
support organizations and establishing manufacturing relationships.
We shipped our first product in April 1997. Since then, Com21 has
expanded its sales and marketing and customer support activities.
These activities include commencing trials with our cable operator
customers, expanding our customer base, developing customer
relationships, marketing the Com21 brand, hiring field service and
customer support personnel, building distribution channels,
developing new products and technologies and enhancing existing
products.
Com21's revenues consist primarily of sales of cable modems,
headend equipment and, to a lesser extent, the licensing of network
management software. We recognize revenue upon commercial shipment
of our products. As the cable operators that purchase our products
make data-over-cable services broadly available to their customers,
we expect our product mix to continue to shift more heavily toward
sales of cable modems. Pursuant to a Technology License and
Reseller Agreement with 3Com (the "3Com Agreement"), 3Com agreed to
pay royalties as 3Com shipped products that incorporated our
licensed technology and agreed to prepay royalties of $1,000,000 in
1997. 3Com provided us with royalty reports in 1997 showing the
shipment of royalty-bearing products and, accordingly, $7,000 was
recognized as license fee revenue in 1997. In addition, we received
an additional $500,000 in license fee revenue in 1997 from 3Com by
meeting certain conditions in the 3Com Agreement. Because the 3Com
Agreement expired as of December 31, 1998, the remaining $993,000
was recognized in 1998 as royalty revenue. Through December 31,
1998, a total of approximately $2.5 million of technology licensing
fees and royalties was included in our revenues.
To date, gross margin on sales of headend and related
equipment and software licenses has been higher than gross margin
on sales of cable modems. In 1999, we expect the average selling
prices of our cable modems to decrease due to greater competition,
particularly as cable modems which meet the DOCSIS standard become
widely available from multiple vendors. The DOCSIS standard should
enable interoperability between different manufacturers' cable
modems and headend equipment. Interoperability of cable networking
equipment will lead to greater competition as the market for
interoperable cable modems is opened to multiple vendors and
greater price competition.
Com21 tests and assembles headend equipment in our facility in
Milpitas, California. We outsource turnkey manufacturing of our
cable modems to Celestica, a contract manufacturer located in
Toronto, Canada. We have taken, and continue to take, steps to
reduce the manufacturing costs of our cable modem products by
consolidating functionality and component parts into ASICs, making
them easier to manufacture, using parts we believe will be sold in
high volume by a number of vendors. We are also working with
Celestica to facilitate more efficient manufacturing of cable
modems and to move certain of our manufacturing operations to a
lower cost Celestica facility, which will enable us to benefit from
Celestica's volume purchasing capability. We cannot assure you that
such cost-reduction efforts will be successful.
Research and development expenses consist principally of
salaries and related personnel expenses, consultant fees, prototype
expenses and development contracts related to the design,
development, testing and enhancement of headend equipment, cable
modems and network management software. As of December 31, 1998,
Com21 expensed all research and development costs as incurred. We
believe that continued investment in research and development is
critical to attaining our strategic product and cost reduction
objectives and, as a result, expect these expenses to increase in
absolute dollars.
33
Sales and marketing expenses consist of salaries and related
expenses for personnel engaged in direct and indirect selling,
marketing and field service support functions. These expenses also
include trade show and promotional expenditures. We intend to
pursue sales and marketing campaigns aggressively, and therefore
expect these expenses to increase in absolute dollars. In addition,
we intend to develop an electronic commerce web site and retail
sales channels, which is expected to increase sales and marketing
expenses.
General and administrative expenses consist primarily of
salaries and related expenses for executive, accounting and
administrative personnel, recruiting expenses, professional fees
and other general corporate expenses. We expect general and
administrative expenses to increase in absolute dollars as we add
personnel and incur additional costs related to the growth of our
business and operation as a public company. In addition, we compete
in a very competitive labor market. Therefore, it is necessary for
us to periodically make salary and other compensation adjustments
to hire and retain employees.
Results of Operations - Years Ended December 31, 1996, 1997 and
1998
Total Revenues. Total revenues increased from $1.0 million in
1996 to $15.6 million in 1997 and to $48.1 million in 1998. Total
revenues in 1996 consisted entirely of technology licensing fees
from the 3Com Agreement. Total revenues in 1997 consisted of a
technology licensing fee and a royalty fee, totaling $507,000
pursuant to the 3Com Agreement and $15.1 million from the sale of
products that commenced in April 1997. A majority of revenues
attributable to product sales during 1997 resulted from sales of
headend and related equipment, cable modems and network management
software fees. Revenues attributable to international customers
were 64% of total revenues in 1997. Total revenues in 1998
consisted of $47.1 million from product sales and $1.0 million from
the one-time recognition of deferred revenue resulting from the
expiration of the 3Com Agreement on December 31, 1998. Revenues
attributable to product sales during 1998 consisted of sales of
cable modems, headend and related equipment and network management
software fees. Revenues attributable to international customers
were 52% of total revenues in 1998. We expect to continue to derive
a significant portion of our revenues from international markets
for the foreseeable future. We intend to expand operations in the
international markets that we currently serve and to enter new
international markets, which will demand significant management
attention and financial commitment. To date, revenues attributable
to international customers have been denominated in U.S. dollars.
We do not currently engage in any foreign currency hedging
transactions. A decrease in the value of foreign currencies
relative to the U.S. dollar could make our products more expensive
in international markets. See "Risk Factors -- We are subject to
risks associated with operating in international markets."
Cost of Product Revenues. Cost of product revenues was $8.4
million in 1997. Cost of product revenues was $29.6 million in
1998. Com21 commenced product shipments in April 1997 and therefore
did not incur any costs associated with the sale of products in
1996. Cost of product revenues in 1997 consisted primarily of
materials cost and software technology license fees paid to third
parties. In 1997, our gross margin was 46.5%, and in 1998, our
gross margin was 38.5%. The decrease in gross margin in 1998 was
primarily attributable to an increase in sales of cable modems as a
percentage of total product sales, offset in part by the one-time
recognition of $1.0 million of deferred revenue resulting from the
expiration of the 3Com Agreement on December 31, 1998. We expect
that our gross margin will continue to decline through at least the
first half of 1999 primarily as a result of decreasing average
selling prices of cable modems due to competitive market factors
and, to a lesser extent, product mix because we expect revenues
from cable modem sales to continue to increase as a percentage of
total product revenues.
Research and Development. Research and development expenses
increased from $12.4 million in 1996 to $13.5 million in 1997 and
to $19.9 million in 1998. The increases in 1997 and 1998 were
primarily the result of increased personnel in our research and
development organization associated with product development.
Sales and Marketing. Sales and marketing expenses increased
from $2.0 million in 1996 to $5.3 million in 1997 and to $10.3
million in 1998. The increases in 1997 and 1998 were primarily due
to higher costs associated with increased personnel in sales and
marketing organizations. The increases in 1997 and 1998 also
reflected the significant costs associated with the increased
selling efforts resulting from the commencement of the commercial
shipment of our products in April 1997. These costs include travel
expenses, trade shows, print advertising, public relations and
other promotional costs. We expect sales and marketing expenses to
increase in both absolute dollars and as a percentage of sales in
1999 as we develop more consumer-oriented channels for our future
DOCSIS-compliant cable modems. In addition, we also compete in a
very competitive labor market and accordingly periodically make
salary and other compensation adjustments to hire and retain
employees.
34
General and Administrative. General and administrative
expenses increased from $1.5 million in 1996 to $1.8 million in
1997 and to $3.9 million in 1998. The increases in 1997 and 1998
were primarily attributable to increased personnel in Com21's
finance and administrative organization, as well as, in 1998,
increased legal fees associated with our patent litigation, which
was settled in January 1999, and increased professional fees
associated with operation as a public company.
Total Other Income. Total other income decreased from $447,000
in 1996 to $229,000 in 1997 and increased to $2.2 million in 1998.
The decrease in 1997 was primarily attributable to interest expense
associated with capital leases as well as a charge for the issuance
of warrants in connection with establishing a line of credit,
offset in part by higher earnings on increased average cash
balances. The increase in 1998 was primarily attributable to
interest earned on higher average balances of cash, cash
equivalents and short-term investments.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily
through private sales of preferred stock and common stock and an
initial public offering of common stock in May 1998 which, through
December 31, 1998, provided net cash proceeds to us of
approximately $121.9 million. Net cash used in operating activities
in 1996 was $11.6 million and was primarily attributable to a net
loss of $14.5 million, partially offset by $1.0 million in deferred
revenue from the 3Com Agreement, an increase in accounts payable,
accrued expenses, and depreciation and amortization expenses. Cash
used in investing activities in 1996 consisted of $2.3 million in
capital expenditures related primarily to the support of Com21's
engineering activities. Cash flows from financing activities were
$23.1 million in 1996 and consisted primarily of $23.2 million of
net proceeds from the issuance of Series F Preferred Stock
partially offset by the net repayment on borrowing arrangements.
Net cash used in operating activities in 1997 was $16.1
million and resulted primarily from a net loss of $13.1 million and
the increase of $5.0 million and $2.6 million in total accounts
receivable and inventories, respectively, offset in part by a total
increase of $2.4 million in accounts payable, accrued expenses and
other current liabilities and $2.2 million in depreciation and
amortization expenses. Cash used in investing activities in 1997
consisted of $2.1 million in capital expenditures primarily to
support product development and manufacturing activities. Cash
flows from financing activities in 1997 consisted primarily of net
proceeds of $23.7 million from the issuance of Series E Preferred
Stock and Series G Preferred Stock and $530,000 from the sale of
common stock upon exercise of stock options.
Net cash used in operating activities in 1998 was $11.1
million and resulted primarily from a net loss of $13.4 million and
the increase of $2.6 million in inventories, offset in part by a
total increase of $2.7 million in accounts payable, accrued
expenses and other current liabilities and $3.5 million in
depreciation and amortization expenses. Cash used in investing
activities in 1998 of $61.6 million consisted of $3.7 million in
capital expenditures primarily to support product development and
manufacturing activities and net purchases of investments of $57.9
million. Cash flows from financing activities in 1998 consisted
primarily of net proceeds of $62.8 million from the issuance of
common stock in our initial public offering and $624,000 from the
sale of common stock under our 1998 Employee Stock Purchase Plan
and upon exercise of stock options.
In future periods, Com21 anticipates significant increases in
working capital on a period-to-period basis primarily as a result
of planned increased product sales resulting in higher levels of
inventory. We contract for the manufacture of cable modems and
integrated circuit boards on a turnkey basis. We have a
manufacturing agreement with Celestica for the manufacture of
certain of our products. Unless terminated by the parties, the
agreement will extend for one year periods on December 31 of each
year. We have no long-term contracts or arrangements with any of
our manufacturers that guarantee the availability of product, the
continuation of particular payment terms or the extension of credit
limits. Our future success will depend, in significant part, on our
ability to manufacture, or have others manufacture, our products
successfully, cost- effectively and in volumes sufficient to meet
customer demand. Our dependence upon third party manufacturers
involves a number of risks. See "Risk Factors -- We may not be able
to produce sufficient quantities of our products because we depend
on third-party manufacturers and have limited manufacturing
experience" and Note 6 of Notes to Financial Statements.
At December 31, 1998, we had $65.7 million of cash, cash
equivalents and short-term investments. In addition, we had $5.0
million line of credit subject to borrowing base requirements. To
date, we have not drawn upon our line of credit. Other than capital
lease commitments, we have no material commitments for capital
expenditures. However, we anticipate that we will increase our
capital expenditures and lease commitments consistent with
anticipated growth in operations, infrastructure and personnel. We
may establish sales offices and lease additional space, which will
require us to commit to additional lease obligations, purchase
equipment and install leasehold improvements.
35
Com21 believes that our current cash, cash equivalents and
short-term investments, will be sufficient to meet its anticipated
cash requirements for at least twelve months, although we may seek
to raise additional capital during that time period. The sale of
additional equity or convertible debt securities could result in
additional dilution to our stockholders. There can be no assurance
that financing will be available in amounts or on terms acceptable
to us, if at all. See "Risk Factors -- We may need additional
capital in the future and may not be able to secure adequate funds
on terms acceptable to us."
Year 2000 Readiness
Many currently installed computer systems and software
products are coded to accept only two digit entries in the date
code field and cannot distinguish 21st century dates from 20th
century dates. These date code fields will need to distinguish 21st
century dates from 20th century dates to avoid system failures or
miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send
invoices or engage in similar normal business activities. As a
result, many companies' software and computer systems may need to
be upgraded or replaced in order to comply with such "Year 2000"
requirements.
Our Year 2000 plan which is currently in progress will
determine whether our products, internal systems, computers and
software, and the products and systems of our critical vendors and
suppliers are Year 2000 compliant. This plan is being implemented
in the following four consecutive phases:
I. Inventory and Data Gathering Phase: cataloguing of products
and systems and the products and systems of our critical vendors
and suppliers;
II. Testing Phase: determining whether cataloged products and
systems are Year 2000 compliant;
III. Replacement Phase: upgrading and replacement of non-
compliant products and systems; and
IV. Monitoring Phase: ongoing testing of our products and
systems for Year 2000 compliance.
Our Year 2000 plan has been implemented but not completed. To
date, results of our Year 2000 plan are the following:
- Products. We have developed internal tests to ascertain
whether our products are Year 2000 compliant. Based on these tests,
we believe our current products are Year 2000 compliant and, to the
extent necessary, all previously shipped products can be upgraded
to become Year 2000 compliant with currently available software
upgrades.
- Vendors. We are currently in the process of ascertaining
whether or not our vendors and suppliers are Year 2000 compliant.
- Manufacturing. Completion of our review of our assembly and
test equipment for Year 2000 compliance is expected to occur by
mid-1999.
- IT Systems. We conducted a preliminary survey of our
information technology hardware and software and anticipate that
any Year 2000 non-compliant hardware and software will be upgraded
or replaced prior to 2000.
- Non-IT Systems and Infrastructure. Machinery and equipment
used in our operations have been inventoried and are currently
being assessed for Year 2000 compliance.
Although we believe that our Year 2000 plan will identify all
of our material Year 2000 issues, we cannot assure you that we will
be able to identify, evaluate and resolve all these issues.
Costs. We do not currently expect that costs associated with
Year 2000 compliance will materially affect our operations or
financial position. However, if we discover Year 2000 problems in
the future, we may not be able to develop, implement, or test
remediation or contingency plans in a timely or cost-effective
manner.
36
Risks. We believe that the risks of noncompliance could
accelerate or delay purchases or replacement of our products and
services. Failure of third party products, such as a breakdown in
telephone, electric service or other utilities, e-mail, voicemail
or the World Wide Web could cause a disruption in cable operators'
service to customers. Disruptions in the services provided by
banks, telephone companies and the U.S. Postal Service could a
negatively impact our business. Although our products are
undergoing Year 2000 specific testing procedures, they may not
contain the date codes necessary to operate in the year 2000. Any
failure of these products to perform could result in the delay or
cancellation of product orders and the diversion of managerial and
technical resources from product development and other business
activities to attend to Year 2000 issues. These events could have a
material adverse effect on our business, operating results and
financial condition.
Contingency Plans. Until the completion of the Year 2000
compliance evaluation of our suppliers, and the completion of
internal IT and non-IT systems reviews, we do not believe that it
is practical to develop comprehensive contingency plans. Even if
these plans are completed and implemented in a timely manner they
may be insufficient to address any third party failures. We cannot
assure you that undetected internal and external Year 2000 issues
will not materially impact our business, financial condition,
results of operations and cash flows. See "Risk Factors -- Our
failure and the failure of our key suppliers and customers to be
year 2000 compliant could negatively impact our business."
Recently Issued Accounting Standard
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities." This statement
requires companies to record derivatives on the balance sheet as
assets or liabilities, measured at fair value. Gains or losses
resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. Statement of Financial Accounting
Standards No. 133 will be effective for Com21's fiscal year ending
December 31, 2000. Management believes that this statement will not
have a significant impact on our financial position, results of
operations or cash flows.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Sensitivity. Com21 maintains a short-term
investment portfolio consisting mainly of government and corporate
bonds purchased with an average maturity of less than one year.
These available-for-sale securities are subject to interest rate
risk and will fall in value if market interest rates increase. If
market interest rates were to increase immediately and uniformly by
10 percent from levels at December 31, 1998, the fair value of the
portfolio would decline by an immaterial amount. We generally have
the ability to hold our fixed income investments until maturity and
therefore we would not expect our operating results or cash flows
to be affected to any significant degree by the effect of a sudden
change in market interest rates on our securities portfolio.
Com21 has fixed rate long-term debt of approximately $1.0
million as of December 31, 1998, and a hypothetical 10 percent
decrease in interest rates would not have a material impact on the
fair market value of this debt. We do not hedge any interest rate
exposures.
37
Item 8. Financial Statements and Supplementary Data
<TABLE>
Index To Financial Statements
<CAPTION>
Page
<S> <C>
Independent Auditors' Report 39
Balance Sheets as of December 31, 1997 and 1998 40
Statements of Operations and Comprehensive Loss for
the Years Ended December 31, 1996, 1997 and 1998 41
Statements of Stockholders' Equity for the Years
Ended December 31, 1996, 1997 and 1998 42
Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998 43
Notes to Financial Statements 44
</TABLE>
38
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Com21, Inc.:
We have audited the accompanying balance sheets of Com21, Inc. as
of December 31, 1997 and 1998, and the related statements of
operations and comprehensive loss, stockholders' equity and cash
flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all
material respects, the financial position of Com21, Inc. as of
December 31, 1997 and 1998, and the results of its operations and
its cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
San Jose, California
January 18, 1999
39
<TABLE>
Com21, Inc.
BALANCE SHEETS
(In thousands, except share and par value amounts)
<CAPTION>
December 31,
-------------------------
1997 1998
ASSETS ------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 17,950 $ 7,135
Short-term investments - 58,609
Accounts receivable:
Trade (net of allowances of $121 and $908 in
1997 and 1998, respectively) 3,984 3,190
Related parties 1,052 1,644
Inventories 2,643 5,282
Prepaid expenses and other 430 586
------------ ------------
Total current assets 26,059 76,446
Property and Equipment - Net 5,311 6,247
Other Assets 203 255
------------ ------------
Total Assets $ 31,573 $ 82,948
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 2,832 $ 4,033
Accrued compensation and related benefits 1,009 1,739
Deferred revenue (principally related party in 1997) 1,004 238
Other current liabilities 481 1,232
Current portion of capital lease and debt obligations 1,210 1,120
------------ ------------
Total current liabilities 6,536 8,362
Deferred Rent 246 284
Capital Lease Obligations 1,320 936
Debt Obligations 188 -
------------ ------------
Total liabilities 8,290 9,582
Commitments and Contingencies (Notes 6 and 13)
Stockholders' Equity:
Convertible preferred stock, none authorized, issued and
outstanding in 1998:
Series A; $0.001 par value; 1,805,674 shares authorized, Issued
and outstanding; liquidation preference $2,853 2 -
Series B; $0.001 par value; 250,000 shares authorized, Issued
and outstanding; liquidation preference $500 - -
Series C; $0.001 par value; 166,667 shares authorized, Issued
and outstanding; liquidation preference $500 - -
Series D; $0.001 par value; 1,817,655 shares authorized; 1,812,500
shares Issued and outstanding; liquidation preference $7,250 2 -
Series E; $0.001 par value; 362,500 shares authorized; 361,908
shares Issued and outstanding; liquidation preference $1,629 - -
Series F; $0.001 par value; 3,125,000 shares authorized; 2,905,730
shares issued and outstanding; liquidation preference $23,246 3 -
Series G; $0.001 par value; 3,000,000 shares authorized; 2,655,125
shares issued and outstanding; liquidation preference $23,100 3 -
Preferred stock, $0.001 par value; none authorized, issued and
outstanding in 1997; 5,000,000 shares authorized and undesignated;
none issued and outstanding in 1998 - -
Common stock, $0.001 par value; shares authorized: 1997, 35,000,000;
1998, 40,000,000; shares issued and outstanding: 1997, 2,772,139;
1998, 18,685,560 3 19
Additional paid-in capital 58,722 122,131
Deferred stock compensation (116) (82)
Accumulated deficit (35,336) (48,699)
Accumulated other comprehensive loss - (3)
------------ ------------
Total stockholders' equity 23,283 73,366
------------ ------------
Total Liabilities and Stockholders' Equity $ 31,573 $ 82,948
============ ============
</TABLE>
See Notes to Financial Statements.
40
<TABLE>
Com21, Inc.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share amounts)
<CAPTION>
Years Ended December 31,
--------------------------------------
1996 1997 1998
Revenues: ------------ ------------ ------------
<S> <C> <C> <C>
Product ($4,014 and $6,637 in 1997 and 1998,
respectively, from related parties) $ - $ 15,142 $ 47,121
License fees - related party (Note 10) 1,000 507 993
------------ ------------ ------------
Total revenues 1,000 15,649 48,114
Cost of Product Revenues ($2,024 and $4,113 in 1997
and 1998, respectively, for related parties) - 8,372 29,573
------------ ------------ ------------
Gross Profit 1,000 7,277 18,541
------------ ------------ ------------
Operating Expenses:
Research and development 12,395 13,481 19,936
Sales and marketing 1,970 5,277 10,273
General and administrative 1,548 1,782 3,871
------------ ------------ ------------
Total operating expenses 15,913 20,540 34,080
------------ ------------ ------------
Loss From Operations (14,913) (13,263) (15,539)
------------ ------------ ------------
Other Income (Expense):
Interest and other income 629 679 2,535
Interest expense (185) (396) (318)
Other income (expense) - net 3 (54) (27)
------------ ------------ ------------
Total other income, net 447 229 2,190
------------ ------------ ------------
Loss Before Income Taxes (14,466) (13,034) (13,349)
Income Taxes 5 21 14
------------ ------------ ------------
Net Loss (14,471) (13,055) (13,363)
Other Comprehensive Loss, Net of Tax:
Unrealized loss on available-for-sale investments - - (3)
------------ ------------ ------------
Comprehensive Loss $ (14,471) $ (13,055) $ (13,366)
============ ============ ============
Net Loss Per Share, Basic and Diluted $ (7.64) $ (6.15) $ (1.10)
============ ============ ============
Shares Used in Computation, Basic and Diluted 1,894 2,124 12,150
============ ============ ============
Pro Forma Net Loss Per Share, Basic and Diluted (Note 1) $ (0.83)
============
Shares Used in Pro Forma Computation, Basic and Diluted (Note 1) 16,062
============
</TABLE>
See Notes to Financial Statements.
41
<TABLE>
Com21, Inc.
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
<CAPTION> Accumulated
Convertible Additional Deferred Other
Preferred Stock Common Stock Paid- Stock Compre- Total
------------------ ----------------- in Compen- Accumulated hensive Stockholders'
Shares Amount Shares Amount Capital sation Deficit Loss Equity
----------- ------ ---------- ------ ---------- -------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1996 4,034,841 $ 4 1,910,042 $ 2 $ 11,092 $ - $ (7,810) $ - $ 3,288
Exercise of stock options - - 102,639 - 46 - - - 46
Repurchase of shares - - (14,584) - (3) - - - (3)
Sale of Series F convertible preferred
stock (net of issuance costs of $50) 2,905,730 3 - - 23,193 - - - 23,196
Net loss - - - - - - (14,471) - (14,471)
----------- ------ ---------- ------ ---------- -------- ----------- --------- ------------
Balances, December 31, 1996 6,940,571 7 1,998,097 2 34,328 - (22,281) - 12,056
Exercise of stock options - - 774,042 1 529 - - - 530
Exercise of Series E preferred warrants 361,908 - - - 1,629 - - - 1,629
Issuance of Series F preferred warrants - - - - 72 - - - 72
Sale of Series G convertible preferred
stock (net of issuance costs of
$1,069) 2,655,125 3 - - 22,028 - - - 22,031
Deferred stock compensation - - - - 136 (136) - - -
Amortization of deferred stock
compensation - - - - - 20 - - 20
Net loss - - - - - - (13,055) - (13,055)
----------- ------ ---------- ------ ---------- -------- ----------- --------- ------------
Balances, December 31, 1997 9,957,604 10 2,772,139 3 58,722 (116) (35,336) - 23,283
Exercise of stock options - - 222,187 - 236 - - - 236
Issuance of common stock (net of
issuance costs of $6,209) - - 5,750,000 6 62,785 - - - 62,791
Sale of stock under employee stock
purchase plan - - 40,403 - 412 - - - 412
Conversion of preferred stock (9,957,604) (10) 9,957,604 10 - - - - -
Repurchase of shares - - (56,773) - (24) - - - (24)
Amortization of deferred stock
compensation - - - - - 34 - - 34
Unrealized loss on available-for-sale
investments - - - - - - - (3) (3)
Net loss - - - - - - (13,363) - (13,363)
----------- ------ ---------- ------ ---------- -------- ----------- --------- ------------
Balances, December 31, 1998 - $ - 18,685,560 $ 19 $122,131 $ (82) $(48,699) $ (3) $ 73,366
=========== ====== ========== ====== ========== ======== =========== ========= ============
</TABLE>
See Notes to Financial Statements.
42
<TABLE>
Com21, Inc.
STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Years Ended December 31,
--------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net loss $ (14,471) $ (13,055) $ (13,363)
Adjustments to reconcile net loss to net cash used
in operating activities:
Noncash interest expense (Note 7) - 72 -
Depreciation and amortization 1,042 2,163 3,517
Deferred rent 77 169 38
Gain on sales and maturities of investments - - (755)
Changes in operating assets and liabilities:
Accounts receivable - trade - (3,984) 794
Accounts receivable - related parties - (1,052) (592)
Inventories - (2,643) (2,639)
Prepaid expenses and other (183) (149) 59
Other assets (68) (98) (52)
Accounts payable 379 1,612 1,201
Accrued compensation and related benefits 518 428 730
Deferred revenue (principally related party) 1,000 4 (766)
Other current liabilities 68 388 751
------------ ------------ ------------
Net Cash Used in Operating Activities (11,638) (16,145) (11,077)
------------ ------------ ------------
Cash Flows From Investing Activities:
Purchases of property and equipment (2,345) (2,085) (3,744)
Purchases of investments - - (101,886)
Proceeds from sales and maturities of investments - - 44,029
------------ ------------ ------------
Net Cash Used in Investing Activities (2,345) (2,085) (61,601)
------------ ------------ ------------
Cash Flows From Financing Activities:
Proceeds from issuance of common stock 43 530 63,415
Proceeds from issuance of preferred stock 23,196 23,660 -
Proceeds from issuance of debt obligations 250 2,440 -
Repayments under capital lease obligations (232) (607) (1,033)
Repayments on debt obligations (120) (2,270) (519)
------------ ------------ ------------
Net Cash Provided by Financing Activities 23,137 23,753 61,863
------------ ------------ ------------
Net Change in Cash and Cash Equivalents 9,154 5,523 (10,815)
Cash and Cash Equivalents, Beginning of year 3,273 12,427 17,950
------------ ------------ ------------
Cash and Cash Equivalents, End of year $ 12,427 $ 17,950 $ 7,135
============ ============ ============
Noncash Investing and Financing Activities:
Property and equipment acquired under capital leases $ 1,722 $ 1,146 $ 675
============ ============ ============
Deferred stock compensation $ - $ 136 $ -
============ ============ ============
Issuance of preferred stock warrants in connection
with debt obligations $ - $ 72 $ -
============ ============ ============
Conversion of preferred stock into common stock $ - $ - $ 10
============ ============ ============
Unrealized loss on available-for-sale investments $ - $ - $ 3
============ ============ ============
Issuance of debt obligation for other current assets $ - $ - $ 215
============ ============ ============
Supplemental Cash Flow Information:
Cash paid for income taxes $ 5 $ 14 $ 14
============ ============ ============
Cash paid for interest $ 182 $ 324 $ 335
============ ============ ============
</TABLE>
See Notes to Financial Statements.
43
Com21, Inc.
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 1996, 1997 and 1998
1. Business and Significant Accounting Policies
Business - Com21, Inc. (the "Company") was incorporated in
Delaware in June 1992. The Company designs, develops, markets
and sells value-added, high-speed communications solutions for
the broadband access market. During 1997, the Company exited
the development stage for financial reporting purposes as it
completed its initial product development activities and
commenced shipping product.
Financial Statements Estimates - The preparation of financial
statements in conformity with generally accepted accounting
principles requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Such estimates include allowances for potentially
uncollectable accounts receivable, lower of cost or market
inventory valuation reserves, warranty costs, sales returns
and a valuation allowance for deferred tax assets. Actual
results could differ from those estimates.
Reclassifications - Certain prior year amounts in the
accompanying financial statements have been reclassified to
conform to current year presentation. These reclassifications
had no effect on the results of operations or financial
position for any year presented.
Fiscal Period - Although for presentation purposes the Company
has indicated that its year end is December 31, its fiscal
year actually ends on the last business day of the year. The
Company's fiscal years for 1996, 1997 and 1998 all ended on
December 31.
Cash Equivalents - The Company considers all highly liquid
debt instruments with maturities at the date of purchase of
three months or less to be cash equivalents.
Short-Term Investments - Short-term investments consist of
corporate and government bonds and are stated at fair value
based on quoted market prices. Short-term investments are
classified as available-for-sale based on the Company's
intended use. The difference between amortized cost and fair
value representing unrealized holding gains or losses are
recorded as a component of stockholders' equity as accumulated
other comprehensive loss. Gains and losses on sales of
investments are determined on a specific identification basis.
Inventories - Inventories consist of networking equipment,
modems and sub-assemblies stated at the lower of cost (first-
in, first-out method) or market.
Property and Equipment - Property and equipment are stated at
cost. Depreciation is computed using the straight-line method
over the estimated useful lives of the assets, generally three
to seven years. Amortization of leasehold improvements and
assets recorded under capital lease agreements are computed
using the straight-line method over the shorter of the lease
term or the estimated useful lives of the related assets.
Long-Lived Assets - The Company evaluates long-lived assets
for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable.
Income Taxes - The Company accounts for income taxes under an
asset and liability approach. Deferred income taxes reflect
the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax
purposes, and operating loss and tax credit carryforwards
measured by applying currently enacted tax laws. Valuation
allowances are provided when necessary to reduce net deferred
tax assets to an amount that is more likely than not to be
realized.
44
Certain Significant Risks and Uncertainties - Financial
instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and
cash equivalents, short-term investments and accounts
receivable. Cash and cash equivalents are held primarily with
one financial institution and consist primarily of commercial
paper and cash in bank accounts. The Company's investment
policy is to invest in instruments with minimum credit ratings
of A-1/P-1 (Short-Term) or AA (Long-Term). The Company sells
its products primarily to cable operators in North America and
primarily to systems integrators in Europe, Asia and
South/Central America, and generally does not require its
customers to provide collateral or other security to support
accounts receivable. To reduce credit risk, management
performs ongoing credit evaluations of its customers'
financial condition. The Company maintains allowances for
estimated potential bad debt losses. The recorded carrying
amount of cash and cash equivalents, short-term investments,
accounts receivable, accounts payable and debt obligations
approximate fair value.
The Company's customer base is highly concentrated. A
relatively small number of customers have accounted for a
significant portion of the Company's revenues, and the Company
expects that this trend will continue for the foreseeable
future. For the years ended December 31, 1996, 1997 and 1998,
the top five customers comprised 100%, 65% and 66%,
respectively, of the Company's total revenues.
The Company participates in a dynamic high technology industry
and believes that changes in any of the following areas could
have a material adverse effect on the Company's future
financial position, results of operations or cash flows:
advances and trends in new technologies and industry
standards; competitive pressures in the form of new products
or price reductions on current products; changes in product
mix; changes in the overall demand for products offered by the
Company; changes in third-party manufacturers; changes in key
suppliers; changes in certain strategic relationships or
customer relationships; litigation or claims against the
Company based on intellectual property (Note 13), patent,
product, regulatory or other factors; risk associated with
changes in domestic and international economic and/or
political conditions or regulations; availability of necessary
components; risks associated with Year 2000 compliance; and
the Company's ability to attract and retain employees
necessary to support its growth.
Revenue Recognition - The Company recognizes product revenue
upon shipment. Estimated sales returns and warranty costs,
based on historical experience by product, are recorded at the
time the product revenue is recognized. Installation and
training revenue are recognized as services are provided.
In 1998, the Company adopted Statement of Position ("SOP") 97-
2, "Software Revenue Recognition," which requires revenue
earned on software arrangements involving multiple elements to
be allocated to each element based on the relative fair values
of the elements. Revenue for software licenses is recognized
upon delivery provided that collection is probable. Software
support and maintenance revenue are deferred and amortized
over the maintenance period on a straight-line basis. Adoption
of this statement did not have a material impact on the
Company's financial position, results of operations and cash
flows.
Software Development Costs - Development costs incurred in the
research and development of new software products and
enhancements to existing software products are expensed as
incurred until technological feasibility has been established,
at which time certain development costs required to attain
general production release would be capitalized. To date, the
Company's software development has essentially been completed
concurrent with the establishment of technological
feasibility, and accordingly, no costs have been capitalized.
Stock-Based Compensation - The Company accounts for stock-
based awards to employees using the intrinsic value method in
accordance with Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees."
Comprehensive Loss - In 1998, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which requires an enterprise to report,
by major components and as a single total, the change in net
assets during the period from nonowner sources. Statements of
comprehensive loss for the years ended December 31, 1996, 1997
and 1998 have been included with the statements of operations.
Net Loss Per Share - In 1997, the Company adopted SFAS No.
128, "Earnings Per Share" which requires a dual presentation
of basic and diluted earnings per share ("EPS"). Basic EPS
excludes dilution and is computed by dividing net income
attributable to common stockholders by the weighted average of
common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other
contracts to issue common stock (convertible preferred stock,
warrants to purchase convertible preferred stock and common
stock options and warrants using the treasury stock method)
were exercised or converted into common stock. Potential
common shares in the diluted EPS computation are excluded in
net loss periods as their effect would be antidilutive. EPS
for all periods have been computed in accordance with SFAS No.
128.
45
Pro Forma Net Loss Per Share - Pro forma net loss per share,
basic and diluted, is computed by dividing net loss
attributable to common stockholders by the weighted average
number of common shares outstanding for the period and the
weighted average number of shares resulting from the assumed
conversion of outstanding shares of convertible preferred
stock.
Geographic Operating Information - In 1998, the Company
adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes annual
and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services,
geographic areas and major customers. The Company operates in
one reportable segment (Note 12).
Recently Issued Accounting Standard - In June 1998, the
Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging
Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes
in the values of those derivatives would be accounted for
depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS No. 133 will be effective
for the Company's fiscal year ending December 31, 2000.
Management believes that this statement will not have a
significant impact on the Company's financial position,
results of operations or cash flows.
2. Short-Term Investments
The fair value and the amortized cost of available-for-sale
securities at December 31, 1998 are presented in the table
below (in thousands):
<TABLE>
<CAPTION>
Unrealized
Amortized Holding Gains
Cost and (Losses) Fair Value
------------- ------------- -------------
<S> <C> <C> <C>
Corporate Bonds $ 30,803 $ 7 $ 30,810
Government Bonds 27,809 (10) 27,799
------------- ------------- -------------
Total $ 58,612 $ (3) $ 58,609
============= ============= =============
</TABLE>
Fair values are based on quoted market prices obtained from an
independent broker. Available-for-sale securities are
classified as current assets and all maturities are within one
year.
3. Inventories
Inventories consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1998
------------- -------------
(In thousands)
<S> <C> <C>
Raw materials and sub-assemblies $ 633 $ 142
Work-in-process 980 1,361
Finished goods 1,030 3,779
------------- -------------
Total $ 2,643 $ 5,282
============= =============
</TABLE>
4. Property and Equipment
Property and equipment consists of:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1998
------------- -------------
(In thousands)
<S> <C> <C>
Equipment under capital lease $ 3,367 $ 3,711
Computer equipment and software 2,904 4,604
Production equipment 1,931 3,905
Leasehold improvements 208 393
Furniture and fixtures 189 302
------------- -------------
8,599 12,915
Accumulated depreciation and amortization (3,288) (6,668)
------------- -------------
$ 5,311 $ 6,247
============= =============
</TABLE>
Accumulated amortization on capital leases as of December 31,
1997 and 1998 was approximately $1,167,000 and $2,265,000,
respectively.
46
5. Debt Obligations
Debt obligations consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1998
------------- -------------
(In thousands)
<S> <C> <C>
Unsecured borrowings due July 1, 1998 $ 84 $ -
Unsecured borrowings due October 1, 1998 119 -
Unsecured borrowings due August 1, 1999 257 168
Unsecured borrowings due November 1, 1999 81 45
Note payable due February 4, 1999 - 24
------------- -------------
541 237
Current portion (353) (237)
------------- -------------
Long-term portion $ 188 $ -
============= =============
</TABLE>
Notes Payable
The unsecured borrowings were obtained from notes payable
issued to a financing company for the purchase of computer
software and equipment. Borrowings bear interest at an
effective interest rate of 16.94% per annum and are payable in
monthly installments with the remaining unpaid principal and
interest due upon the maturity date. There are no debt
covenants associated with the notes payable.
In consideration for the unsecured borrowings due on October
1, 1998 and August 1, 1999 the Company issued the financing
company warrants to purchase 4,688 and 2,125 shares of Series
F convertible preferred stock, respectively, at a price of
$8.00 per share. The fair values of the warrants were
insignificant (Note 7).
In June 1998, the Company issued a note payable for $215,000
to a financing company for the payment of its directors' and
officers' insurance premiums for which the Company is the
beneficiary. Borrowings bear interest at an effective interest
rate of 7.30% per annum and are payable in equal monthly
installments (principal and interest) through February 4,
1999.
Revolving Line of Credit
In May 1997, the Company entered into a revolving line of
credit arrangement for working capital purposes. Under the
arrangement, the Company may borrow up to the lesser of
$5,000,000 or 80% of the Company's eligible domestic and
foreign accounts receivable. Borrowings bear interest at the
LIBOR rate (5.10% at December 31, 1998) plus 4.875% per annum.
The arrangement automatically renews for successive one-year
periods until terminated at the option of either party.
Dividends may not be declared by the Company without the
lender's prior consent. As of December 31, 1998, no amounts
were outstanding under the arrangement.
Concurrent with executing the revolving line of credit
arrangement, the Company borrowed an additional $2,000,000 on
a note which was repaid in full in 1997.
In consideration for these financing arrangements, the Company
issued warrants to purchase 25,000 shares of Series F
convertible preferred stock at a price of $8.00 per share
(Note 7). As described in Note 7, the fair value of such
warrants was $72,000 which was recorded as additional interest
expense in the accompanying statement of operations and
comprehensive loss for 1997.
47
6. Commitments
The Company leases its facilities and certain equipment under
noncancelable capital and operating leases. Future minimum
lease payments under the Company's capital and operating
leases and the present value of minimum lease payments under
capital leases as of December 31, 1998 are as follows:
<TABLE>
Year Ending Capital Operating
December 31, Leases Leases
-------------- ------------- -------------
(In thousands)
<S> <C> <C>
1999 $ 1,055 $ 1,464
2000 655 1,453
2001 349 853
2002 9 866
2003 - 892
Thereafter - 303
------------- -------------
Future minimum lease payments 2,068 $ 5,831
Amounts representing interest (12%) (249)
------------- -------------
Present value of future minimum lease
payments $ 1,819
=============
</TABLE>
In consideration for providing capital lease financing in
1996, the Company issued warrants to purchase 2,505 shares and
6,814 shares of Series F convertible preferred stock at a
price of $8.00 per share to two financing companies. The fair
values of the warrants were insignificant (Note 7).
Rent expense incurred under the operating leases was
approximately $501,000, $843,000 and $867,000 for the years
ended December 31, 1996, 1997 and 1998, respectively. Rent
expense under the facilities lease is recognized on a
straight-line basis over the term of the lease. The difference
between the amounts paid and the amounts expensed is
classified as deferred rent in the accompanying balance
sheets.
In 1998, the Company entered into product development and
license agreements whereby third parties will develop certain
technology deliverable in 1999 for an aggregate of $970,000.
As of December 31, 1998, the Company has aggregate purchase
obligations of approximately $15,200,000 in connection with
supply and manufacturing agreements.
7. Stockholders' Equity
Stock Split
On May 13, 1998, the Company effected a one-for-two reverse
split of the outstanding shares of common and convertible
preferred stock. All share and per share amounts in these
financial statements have been adjusted to give effect to the
reverse stock split.
Initial Public Offering
In May 1998, the Company completed its initial public offering
of 5,750,000 shares (which includes the full exercise of the
underwriters' overallotment of 750,000 shares) which generated
net proceeds to the Company of $62,791,000.
Authorized Shares
On March 10, 1998, the Board of Directors adopted a change in
the authorized number of shares of the common and undesignated
preferred stock to 40,000,000 and 5,000,000, respectively.
Convertible Preferred Stock
On April 22, 1998, holders of more than 50% of the Series D,
E, F and G convertible preferred stock, voting as a single
class, consented to the automatic conversion of all
outstanding shares of Series D, E, F and G convertible
preferred stock into common stock upon the completion of the
initial public offering regardless of the offering price per
share. Upon completion of the Company's initial public
offering in May 1998, all shares of Series A, B, and C
convertible preferred stock were converted to common stock in
accordance with their existing terms and all shares of Series
D, E, F and G convertible preferred stock were converted to
common stock in accordance with the stockholders' consent. All
shares were converted on a one-to-one basis.
48
Common Stock Warrants
Prior to the Company's initial public offering in May 1998,
the Company issued warrants to purchase shares of various
series of convertible preferred stock. Upon completion of the
Company's initial public offering, the outstanding warrants to
purchase 46,286 shares of convertible preferred stock were
automatically converted into warrants to purchase 46,286
shares of common stock at the same exercise prices. All such
warrants were outstanding at December 31, 1997 and 1998 and
were comprised of the following:
During 1995, in consideration of capital lease
financing provided by a financing company, the Company
issued warrants to purchase 5,154 shares of Series D
convertible preferred stock at a price of $5.82 per share.
The warrants expire in December 2005.
During 1996, in consideration of debt and capital
lease financing provided by two financing companies, the
Company issued warrants to purchase 14,007 shares of
Series F convertible preferred stock at a price of $8.00
per share. The warrants expire in 2006.
During 1997, in consideration of financing
arrangements provided, the Company issued warrants to
purchase 27,125 shares of Series F convertible preferred
stock at a price of $8.00 per share. The warrants expire
in May 2002 (25,000 warrants) and February 2007 (2,125
warrants).
The fair value of the warrants issued in 1995 and 1996, in
connection with debt financing, were insignificant. The fair
value of the warrants issued in 1997, in connection with debt
financing, was approximately $72,000. Accordingly, the fair
value was recognized as additional interest expense in the
accompanying statement of operations and comprehensive loss
for 1997.
Common Stock
At December 31, 1997 and 1998, the Company had the right to
repurchase 320,311 and 139,640 shares of common stock
outstanding, respectively. The number of shares subject to
repurchase is reduced over a two- to four-year vesting period.
The Company has the right to repurchase these shares at the
original issuance price.
Net Loss Per Share
The following is a reconciliation of the numerators and
denominators of the basic and diluted net loss per share
computations (in thousands, except per share amounts):
<TABLE>
Years Ended December 31,
---------------------------------------------
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Net Loss (Numerator):
Net loss, basic and diluted $ (14,471) $ (13,055) $ (13,363)
------------- ------------- -------------
Shares (Denominator):
Weighted average common shares outstanding 1,910 2,244 12,377
Weighted average common shares outstanding
subject to repurchase (16) (120) (227)
------------- ------------- -------------
Shares used in computation, basic and
diluted 1,894 2,124 12,150
------------- ------------- -------------
Net Loss Per Share, Basic and Diluted $ (7.64) $ (6.15) $ (1.10)
============= ============= =============
</TABLE>
During 1996, 1997 and 1998, the Company had securities
outstanding which could potentially dilute basic EPS in the
future, but were excluded in the computation of diluted EPS in
such periods, as their effect would have been antidilutive due
to the net loss reported in such periods. Such outstanding
securities consist of the following at December 31, 1998:
warrants to purchase 46,286 shares of common stock; 139,640
outstanding shares of common stock subject to repurchase; and
options to purchase 2,369,341 shares of common stock.
Equity Plans
Under the Company's 1995 Stock Option Plan (the "1995 Plan"),
as restated and amended in January 1998, the Company may grant
options to purchase up to 3,000,000 shares of common stock to
employees, directors and consultants at prices not less than
the fair market value at the date of grant for incentive stock
options and not less than 85% of fair market value at the date
of grant for nonstatutory stock options. These options
generally expire ten years from the date of grant and are
immediately exercisable. The Company has a right of repurchase
(at the option exercise price) of common stock issued from
option exercises for unvested shares. The right of repurchase
generally expires 25% after the first 12 months from the date
of grant and then ratably over a 36-month period.
49
In 1998, the Company adopted the 1998 Stock Incentive Plan
(the "1998 Stock Plan") and the 1998 Employee Stock Purchase
Plan (the "1998 Purchase Plan").
The 1998 Stock Plan serves as the successor equity incentive
program to the Company's 1995 Plan. Options outstanding under
the 1995 Plan on April 1, 1998 (2,023,510 shares) were
incorporated into the 1998 Stock Plan. Such incorporated
options continue to be governed by their existing terms. In
addition, the share reserve was increased by 500,000 shares
and could be increased up to an additional 271,570 shares for
repurchases of unvested common shares issued under the 1995
Plan. As of December 31, 1998, 16,732 shares of such unvested
common shares were repurchased and added to the share reserve.
Under the 1998 Stock Plan, the Company is authorized to issue
shares of common stock to employees, directors and consultants
under five separate programs: Discretionary Option, Stock
Issuance, Salary Investment Option Grant, Automatic Option
Grant and Director Fee Option Grant. The number of shares
reserved for issuance under the 1998 Stock Plan automatically
increases at the beginning of each calendar year, beginning in
1999, by an amount equal to 5% of the total number of shares
of common stock outstanding at the end of the preceding year
(934,278 shares on January 4, 1999). The Discretionary Option
Program of the 1998 Stock Plan provides for the grant of
options under terms comparable to those provided on options
granted under the 1995 Plan except that all options are to be
granted at a price not less than fair market value on the date
of grant.
<TABLE>
Stock option activity under the Plans was as follows:
<CAPTION>
Outstanding Options
Shares -----------------------------
Available Number Weighted Average
for Grant of Shares Exercise Price
------------- ------------- ---------------
<S> <C> <C> <C>
Balances, January 1, 1996 (3,130 vested at a weighted
average price of $0.40 per share) 158,750 566,250 $ 0.39
Reserved 1,000,000 - -
Granted (weighted average fair value of $0.16 per share) (1,171,315) 1,171,315 0.58
Canceled 44,698 (44,697) 0.62
Exercised - (102,639) 0.45
------------- -------------
Balances, December 31, 1996 (205,706 vested at a
weighted average price of $0.44 per share) 32,133 1,590,229 0.52
Reserved 500,000 - -
Granted (weighted average fair value of $1.29 per share) (587,990) 587,990 3.66
Canceled 75,266 (75,266) 0.64
Exercised - (774,042) 0.68
------------- -------------
Balances, December 31, 1997 (286,130 vested at a
weighted average price of $0.57 per share) 19,409 1,328,911 1.80
Reserved 1,266,732 - -
Granted (weighted average fair value of $5.45 per share) (1,368,615) 1,368,615 11.59
Canceled 105,998 (105,998) 4.05
Exercised - (222,187) 1.06
------------- -------------
Balances, December 31, 1998 23,524 2,369,341 7.42
============= =============
</TABLE>
Additional information regarding options outstanding at
December 31, 1998 is as follows:
<TABLE>
Options Outstanding Vested Options
-------------------------------------- -------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Outstanding Life (years) Price Vested Price
----------- ------------ --------- --------- --------
<S> <C> <C> <C> <C> <C>
$0.20 - $ 0.40 464,855 7.0 $ 0.40 275,821 $ 0.40
$0.80 - $ 0.88 310,999 7.9 0.81 118,333 0.81
$3.30 - $ 7.10 457,869 8.9 6.46 66,637 6.33
$9.00 - $24.25 1,135,618 9.5 12.49 3,716 9.00
----------- ---------
$0.20 - $24.25 2,369,341 8.7 7.42 464,507 1.42
=========== =========
</TABLE>
Under the 1998 Purchase Plan, eligible employees are allowed
to have salary withholdings of up to 10% of their base
compensation to purchase shares of common stock at a price
equal to 85% of the lower of the market value of the stock at
the beginning or end of defined purchase periods. The initial
purchase period commenced upon the initial public offering of
the Company's common stock in May 1998. In 1998, 40,403 shares
were purchased by and distributed to employees at a price of
$10.20 per share. At December 31, 1998, $211,000 had been
contributed by employees that will be used to purchase shares
in 1999 at a price determined under the terms of the 1998
Purchase Plan. At December 31, 1998, the Company had 209,597
shares of its common stock reserved for future issuance under
this plan.
50
Deferred Stock Compensation
As discussed in Note 1, the Company accounts for its stock-
based awards to employees using the intrinsic value method in
accordance with APB No. 25. Accordingly, the Company recorded
deferred compensation expense equal to the difference between
the grant price and deemed fair value of the Company's common
stock for options granted prior to December 31, 1997. Such
deferred compensation expense aggregated $136,000 and is being
amortized to expense over the four-year vesting period of the
options.
Additional Stock Plan Information
Since the Company continues to account for its stock-based
awards to employees using the intrinsic value method in
accordance with APB No. 25, SFAS No. 123, "Accounting for
Stock-Based Compensation," requires the disclosure of pro
forma net income (loss) and earnings (loss) per share had the
Company adopted the fair value method as of the beginning of
1995. Under SFAS 123, the fair value of stock-based awards to
employees is calculated through the use of option pricing
models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options
without vesting restrictions, which significantly differ from
the Company's stock option awards. These models also require
subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect
the calculated values. The Company's fair value calculations
on stock-based awards under the 1995 and 1998 Stock Plans were
made using the Black-Scholes option pricing model with the
following weighted average assumptions: expected life, 5 years
from the date of grant in 1996 and 1997 and 4.5 years from the
date of grant in 1998; stock volatility, 0% in 1996 and 1997
and 50% in 1998; risk-free interest rate, 6.75% in 1996 and
1997 and 5.0% in 1998; and no dividends during the expected
term. The Company's calculations are based on a single option
award valuation approach, and forfeitures are recognized as
they occur. The Company's fair value calculations on stock-
based awards under the 1998 Purchase Plan were also made using
the Black-Scholes option pricing model with the following
weighted average assumptions: expected life, six months; stock
volatility, 50%; risk free interest rate, 5.0%; and no
dividends during the expected term. If the computed fair
values of the 1996, 1997 and 1998 awards had been amortized to
expense over the vesting period of the awards, pro forma net
loss would have been approximately $(14,522,000) ($(7.67) per
share, basic and diluted) in 1996, $(13,153,000) ($(6.19) per
share, basic and diluted) in 1997 and $(14,454,000) ($(1.19)
per share, basic and diluted) in 1998.
8. Income Taxes
Income tax expense for the years ended December 31, 1996, 1997
and 1998 consisted solely of state franchise taxes.
<TABLE>
The components of deferred income tax assets are as follows:
<CAPTION>
December 31,
-----------------------------
1997 1998
------------- -------------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Accruals and reserves not currently deductible $ 827 $ 1,868
Capitalized start-up costs 765 472
Capitalized research and development costs 890 1,864
Net operating loss carryforwards 11,272 14,325
Tax credit carryforwards 2,998 4,437
Depreciation 500 1,206
------------- -------------
Total gross deferred tax assets 17,252 24,172
Valuation allowance (17,252) (24,172)
------------- -------------
Total deferred tax assets $ - $ -
============= =============
</TABLE>
The net change in the total valuation allowance for the year
ended December 31, 1998 was a net increase of $6,920,000. The
increase in the valuation allowance was primarily a result of
increased net operating loss and tax credit carryforwards
increased accruals and reserves not currently deductible and
capitalized research and development costs generated in 1998
which the Company provided a full valuation allowance against
based on the Company's evaluation of the likelihood of
realization of future tax benefits resulting from the deferred
tax assets.
51
As of December 31, 1998, the Company had available for
carryforward net operating losses for federal and state income
tax purposes of approximately $37,825,000 and $19,305,000,
respectively. Net operating losses of $564,000 for federal and
state tax purposes attributable to the tax benefit relating to
the exercise of nonqualified stock options and disqualifying
dispositions of incentive stock options are excluded from the
components of deferred income tax assets. The tax benefit
associated with this net operating loss will be recorded as an
adjustment to stockholders' equity when the Company generates
taxable income. Federal net operating loss carryforwards will
expire if not utilized beginning in the years 2009 through
2018. State net operating loss carryforwards will expire if
not utilized beginning in the years 1999 through 2003.
As of December 31, 1998, the Company had available for
carryforward research and experimental tax credits for federal
and state income tax purposes of approximately $2,621,000 and
$1,509,000, respectively. Federal research and experimentation
tax credit carryforwards expire from 2009 through 2018. The
Company also had approximately $307,000 in California
manufacturers investment credits.
Current Federal and California tax laws include substantial
restrictions on the utilization of net operating losses and
tax credits in the event of an "ownership change" of a
corporation. Accordingly, the Company's ability to utilize net
operating loss and tax credit carryforwards may be limited as
a result of such "ownership change" as defined. Such a
limitation could result in the expiration of carryforwards
before they are utilized.
9. Major Customers
Revenues for 1996 resulted from license fee revenue from one
preferred stockholder.
As of December 31, 1997, one unaffiliated customer and one
preferred stockholder represented 24% and 14%, respectively,
of total accounts receivable. Sales to these customers in 1997
represented 21% and 12% of total 1997 revenues, respectively.
In addition, 1997 sales to another preferred stockholder
represented 16% of total 1997 revenues.
As of December 31, 1998, three unaffiliated customers
represented 15%, 10%, and 10% of total accounts receivable,
and one stockholder represented 34% of total accounts
receivable. Sales to this stockholder represented 14% of total
1998 revenues. In addition, sales to two other unaffiliated
customers represented 24% and 15% of total 1998 revenues.
10. Related Party Transactions
In March 1996, a preferred stockholder entered into a five-
year licensing agreement with the Company to license certain
technology on a nonexclusive basis. Under the terms of this
agreement: (i) the Company received a nonrefundable license
fee of $1,000,000 in 1996 (which accounted for all of 1996
revenues), and (ii) if the Company met certain conditions in
1997, it would be entitled to an additional $500,000 of
nonrefundable license fees. In March 1997, the Company met
such conditions and received additional nonrefundable license
fees of $500,000 from this preferred stockholder. Such license
fees were recognized as revenue in 1997. In addition, the
Company also received prepaid royalties pursuant to the
licensing agreement of $1,000,000 in 1997. Upon shipment of
product incorporating the Company's technology, $7,000 was
recognized as license fee revenue in 1997; and the remaining
$993,000 was recognized in 1998 as license fee revenue at the
expiration of the royalty period on December 31, 1998. In
April 1998, this preferred stockholder sold its entire
interest in the Company to three other existing preferred
stockholders.
In 1996, the Company paid a director $22,000 in consulting
fees.
For the year ended December 31, 1997, total revenues included
sales to three preferred stockholders of approximately
$2,509,000, $1,889,000 and $123,000 (with related cost of
revenues of approximately $999,000, $951,000 and $74,000,
respectively). As of December 31, 1997, accounts receivable
included amounts due from the same three preferred
stockholders of approximately $364,000, $688,000, and $0,
respectively.
For the year ended December 31, 1998, total revenues included
sales to two stockholders of approximately $6,600,000 and
$1,030,000 (with related cost of revenues of approximately
$4,098,000 and $15,000 respectively). As of December 31, 1998,
accounts receivable included amounts due from one stockholder
of approximately $1,644,000.
52
11. Employee Benefit Plan
In 1995, the Company adopted a defined contribution retirement
plan (the "Retirement Plan"), which has been determined by the
Internal Revenue Service to be qualified under Section 401(k)
of the Internal Revenue Code of 1986. The Retirement Plan
covers essentially all full-time employees. Eligible employees
may make voluntary contributions to the Retirement Plan up to
15% of their annual compensation. The Company has not made any
employer contributions to the Retirement Plan.
12. Geographic Operating Information
The Company operates in one reportable segment: the design,
development, marketing, and sales of value-added, high-speed
communications solutions for the broadband access market, and
follows the requirements of SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information." For the
year ended December 31, 1998, the Company recorded revenue
from customers throughout the United States and Canada;
Switzerland, Germany, the U.K., The Netherlands, France,
Spain, Denmark, Norway, Sweden, Finland, Belgium, Czech
Republic, Turkey (collectively referred to as "Europe");
Japan, China, Thailand, Taiwan, Indonesia (collectively
referred to as "Other Asia"), Hong Kong; Argentina, Chile,
Panama, Venezuela, Colombia (collectively referred to as
"Other South/Central America"), Brazil; and Australia/New
Zealand. The following presents total revenues for the years
ended December 31, 1996, 1997 and 1998 and long-lived assets
as of December 31, 1997 and 1998 by geographic territory (in
thousands):
<TABLE>
1997 1998
-------------------- --------------------
1996 Long- Long-
Total Total Lived Total Lived
Revenues* Revenues* Assets Revenues* Assets
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
United States $ 1,000 $ 5,589 $ 5,157 $ 23,032 $ 6,188
Canada - 161 357 1,332 314
Europe - 4,672 - 12,521 -
Hong Kong - 130 - 255 -
Other Asia - 1,597 - 1,624 -
Brazil - 106 - 490 -
Other South/Central America - 565 - 1,537 -
Australia/New Zealand - 2,829 - 7,323 -
--------- --------- --------- --------- ---------
Total $ 1,000 $ 15,649 $ 5,514 $ 48,114 $ 6,502
========= ========= ========= ========= =========
</TABLE>
* Net revenues are attributed to countries based on
invoicing location of customer.
13. Litigation
In January 1998, Hybrid Networks, Inc. filed an action against
the Company, accusing the Company of infringing certain of
their patents. The Company settled this matter in January 1999
through a patent cross-license agreement that has no material
adverse effect on the Company's financial position, results of
operations or cash flows.
53
Item 9. Changes In and Disagreements With Accountants On
Accounting and Financial Disclosure
Not applicable.
Part III
Pursuant to General Instruction G. to Form 10-K, the
information required by Items 10, 11, 12, and 13 of Part III
is incorporated by reference from the Company's definitive
Proxy Statement with respect to its 1999 annual meeting of
stockholders, to be filed pursuant to Regulation 14A within
120 days after December 31, 1998.
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K
(a) Financial Statements and Financial Statement Schedule
1. Financial Statements. The financial statements of the
Company listed in Item 14(a) and the report of Deloitte &
Touche LLP, Independent Auditors, are filed or incorporated by
reference as part of this annual report. See Index to
Financial Statements on page 38.
2. Financial Statement Schedule. The financial statement
schedule of the Company listed in Item 14(a) is incorporated
by reference as part of this annual report. The financial
statement schedule was previously filed as an exhibit to the
Registrant's Registration Statement on Form S-1 (File No. 333-
70945) declared effective on February 23, 1999.
All other schedules have been omitted because they are not
applicable, not required, or the required information is
included in the Financial Statements or notes thereto.
3. Exhibits.
The Exhibits listed on the accompanying Index to Exhibits on
page 55 are filed or incorporated by reference as part of this
annual report.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of
the fiscal year ended December 31, 1998.
(c) Exhibits
The following exhibit list states, in the case of certain
exhibits, a prior SEC filing which contains the exhibit and
from which it is incorporated by reference.
54
Index to Exhibits
<TABLE>
Number Exhibit Title
- ------------- ---------------------------------------------------------------
<S> <C>
3.1(1) Registrant's Amended and Restated Certificate of Incorporation.
3.2(1) Registrant's Amended and Restated Bylaws.
4.1(1) Form of Registrant's Specimen Common Stock Certificate.
4.2(1) Amended and Restated Information and Registration Rights
Agreement, among the Registrant and the investors and founders
named therein, dated July 22, 1997.
10.1(1) Lease Agreement between the Company, John Arrillaga and
Richard T. Peery, dated May 10, 1996.
10.2+(1) Technology License and Reseller Agreement between the Company
and 3Com Corporation, dated March 22, 1996.
10.3+(1) Reseller Agreement between the Company and 3Com Corporation,
dated July 30, 1997.
10.4+(1) Hardware and Software Technology License Agreement between the
Company, Advanced Telecommunications Modules, Limited and Advanced
Telecommunications Modules, Inc., dated February 1, 1996.
10.5(1) Registrant's 1995 Stock Option Plan.
10.6(1) Registrant's 1998 Stock Incentive Plan.
10.7(1) Registrant's 1998 Employee Stock Purchase Plan.
10.8(1) Form of Indemnity Agreement entered into by Registrant with each
of its executive officers and directors.
10.9(1) Loan and Security Agreement between Registrant and Greyrock
Business Credit, dated May 30, 1997.
10.10+(1) International OEM Agreement between the Company, Advanced
Telecommunications Modules, Inc. and Advanced Telecommunications
Modules, Limited, dated March 7, 1996.
10.11+(1) Agreement for Manufacturing Services between the Company and
Celestica, Inc., dated October 25, 1996.
10.12+(1) Wind River Systems, Inc. VxWorks License Agreement.
10.13+(1) Purchase and License Agreement by and between the Company and
Siemens AG, dated December 2, 1997.
10.14+(1) Distribution Agreement by and between the Company and Philips
Public Telecommunication Systems, dated November 26, 1997.
16.1(1) Letter from KPMG Peat Marwick LLP regarding Change in Certifying
Accountant.
23.1 Independent Auditors' Consent.
27.1(2) Financial Data Schedule.
- -------------
+ Confidential treatment has been granted as to a portion of this
Agreement.
(1) Previously filed as an Exhibit to the Registrant's Registration
Statement on Form S-1 (File No. 333-48107) declared effective on
May 18, 1998.
(2) Previously filed as an exhibit to the Registrant's Registration
Statement on Form S-1 (File No. 333-70945) declared effective on
February 23, 1999.
(d) Financial Statement Schedules
See Item 14(a) and Item 14(b) above.
55
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized
In accordance with Section 13 or 15(d) of the Exchange Act,
the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: March 10 , 1999
_____________
COM21, INC.
By: /s/ Peter D. Fenner
_________________________
Peter D. Fenner
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appear below hereby constitutes and appoints,
jointly and severally, Peter Fenner and David L. Robertson,
and each of them acting individual, as his attorney-in-fact,
each with full power of substitution and resubstitution, for
him or her in any and all capacities, to sign any and all
amendments to this Annual Report on Form 10-K (including post-
effective amendments), and to file the same, with exhibits
thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said
attorneys-in-fact full power and authority to do and perform
each and every act and thing requisite and necessary to be
done in connection therewith as fully to all intents and
purposes as he might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact, or their
substitute or substitutes, may lawfully do or cause to be done
by virtue hereof.
In pursuant to the requirements of the Securities Exchange Act
of 1934, this Report has been signed below by the following
persons on behalf of the Registrant and in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
/s/ Peter D. Fenner March 10
_________________________ President and Chief Executive ____________, 1999
Peter D. Fenner Officer
Principal Executive Officer
/s/ David L. Robertson Vice President, Finance Chief March 10
_________________________ Financial Officer, (Principal ____________, 1999
David L. Robertson Financial and Accounting
Officer) and Secretary
/s/ Paul Baran March 10
_________________________ ____________, 1999
Paul Baran Director
/s/ Robert A. Hoff March 10
_________________________ ____________, 1999
Robert A. Hoff Director
/s/ C. Richard Kramlich March 10
_________________________ ____________, 1999
C. Richard Kramlich Director
/s/ Scott J. Loftesness March 10
_________________________ ____________, 1999
Scott J. Loftesness Director
56
/s/ William R. Hearst, III March 10
_________________________ ____________, 1999
William R. Hearst, III Director
/s/ Robert C. Hawk March 10
_________________________ ____________, 1999
Robert C. Hawk Director
/s/ Robert W. Wilmot March 10
_________________________ ____________, 1999
Robert W. Wilmot Director
57
Exhibit 23.1 - Consent of Independent Accountants
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration
Statement No. 333-57441 of Com21, Inc. on Form S-8 of our
report dated January 18, 1999 appearing in the Annual Report
on Form 10-K of Com21, Inc. for the year ended December 31,
1998.
DELOITTE & TOUCHE LLP
San Jose, California
March 5, 1999
58
</TABLE>
