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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 2
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___ .
COMMISSION FILE NUMBER: 0-26820
TERA COMPUTER COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 93-0962605
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
411 FIRST AVENUE SOUTH, SUITE 600, SEATTLE, WASHINGTON 98104-2860
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 701-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK , $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 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 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.
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of March 26, 1999 was approximately $89,982,000, based upon the
last sale price of $6.6875 reported for such date on the Nasdaq National Market
System.
As of March 26, 1999, there were 15,894,301 shares of Common Stock issued
and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be delivered to shareholders in connection
with the Registrant's Annual Meeting of Shareholders to be held on May 5, 1999
are incorporated by reference into Part III.
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TERA COMPUTER COMPANY
FORM 10-K/A
FOR FISCAL YEAR ENDED DECEMBER 31, 1998
INDEX
<TABLE>
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Page
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PART I
<S> <C> <C>
Item 1. Business 3
Item 2. Properties 25
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item E.O. Executive Officers of the Company 27
PART II
Item 5. Market for the Company's Common Equity and Related
Stockholder Matters 29
Item 6. Selected Financial Data 31
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 40
PART III
Item 10. Directors and Executive Officers of the Company 41
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management 41
Item 13. Certain Relationships and Related Transactions 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 42
</TABLE>
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In Amendment No. 1 to its Annual Report on Form 10-K for 1998, the Company
amended its financial statements to reclassify, beginning with the third
quarter of 1998, certain manufacturing expenses and costs relating to
inventory adjustments as Manufacturing Costs and Inventory Adjustments.
These expenses include personnel and allocated overhead for its
manufacturing group, production expenses not directly related to the cost of
sales for delivered systems, and inventory adjustments, including revaluations
and cost variations arising from changes in production yields, inventory
obsolescence, inventory consumed in the manufacturing process and capitalized
manufacturing labor and overhead costs. These expenses previously had been
classified as Research and Development expenses. Corresponding changes have been
made to Management's Discussion and Analysis of Financial Condition and results
of Operations in Item 7, beginning on page 32. In addition certain financial
notes have been amended to clarify the disclosures.
In Amendment No. 2 to its Annual Report on Form 10-K for 1998, the Company
revised certain information in the Quarterly Financial Data table in Item 8 to
correspond with the changes made in Amendment No. 1.
PART I
ITEM 1. BUSINESS
INTRODUCTION
The Company designs, develops and markets high performance general purpose
parallel computer systems. Tera's Multithreaded Architecture System ("MTA")
system addresses not only a wide range of scientific and engineering
applications such as simulation and visualization of complex mechanical and
biochemical systems, but also emerging commercial applications such as
computer-aided design and visualization, information-on-demand and database
mining. The Company believes that its MTA system architecture represents a
significant breakthrough in high performance computing that will enable the
Company to offer systems with several times the price/performance of currently
available commercial high performance computer systems. Typical MTA system
configurations are expected to sell for between $5 million and $40 million. The
Company installed a two-processor MTA system at the San Diego Supercomputer
Center in April 1998 and recognized its first revenue from product sales. In
December 1998, this system was upgraded to a four-processor system which was
accepted by the San Diego Supercomputer Center in January 1999. Following
receipt of purchase orders, the Company plans to upgrade this system in stages
to larger configurations as it receives production printed circuit boards,
integrated circuits and other components from its vendors which are then
integrated into a commercially acceptable system. See "--Risk Factors - Our
Reliance on Third Party Suppliers Poses Significant Risks."
The Company was incorporated under the laws of the State of Washington in
December 1987. Its principal offices are located at 411 First Avenue South,
Suite 600, Seattle, Washington, 98104-2860, and its telephone number is (206)
701-2000.
HIGH PERFORMANCE COMPUTER INDUSTRY
Historically the need for greater computing power for scientific, engineering
and commercial applications has increased significantly. This need typically has
been met by high performance computer systems for scientific and engineering
applications and by mainframes for commercial applications, with millions of
dollars invested per system.
For scientific applications, the increased need for computing power has been
driven by an increased focus on highly challenging basic and applied scientific
problems that can be met only through numerically intensive computation. For
engineering applications, high performance computers provide a method of
decreasing the time to market through the use of computational modeling to
develop and verify engineering solutions across a broad range of industries. The
U.S. Government has recognized that the continued development and use of high
performance computer systems for these technical applications is of critical
importance to the economic competitiveness of the United States.
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For commercial applications, pressures resulting from global competition,
reduced cost of communication and the proliferation of data from the enormous
number of workstations and personal computers also have increased the need for
high performance computing. For competitive reasons, many large commercial users
have concluded that enterprise-wide computing applications require immediate
interactive processing of available data. In order to process data in such a
manner, users must move away from batch processing but cannot do so because of
the limited computational capacities of their existing systems.
Computer architects have taken a variety of approaches in their efforts to
achieve higher levels of performance. Traditionally, high performance computer
systems use a few of the fastest available single processors. Improvements in
performance have been achieved through faster switching times and greater
densities and, in the case of numerically intensive applications, by employing
vector processing. This approach, employed most notably by Cray Research
Corporation (prior to its acquisition by Silicon Graphics, Inc) and NEC
Corporation, repeatedly applies the same operation to each of a sequence of data
elements. Vector multiprocessing is highly effective for many scientific and
engineering applications, but not for most commercial applications. Moreover,
these systems are limited in size and have a high cost of computation.
A number of computer companies, including IBM, Silicon Graphics, Inc.,
Hitachi, Ltd., Fujitsu, Ltd., Sun Microsystems, Inc. and Hewlett-Packard
Corporation, have turned to massively parallel processing as a way to achieve
greater computational power and improved price/performance. Massively parallel
processing enables large numbers of processors to act either concurrently on
multiple tasks, or in concert on a single computationally-intensive task. In
these systems, each processor is directly connected to its own private memory
and the programmer must manage the movement of data among memory units. As a
result, computer systems relying on this architecture are difficult to program
and have limited applicability.
While some users have developed scientific and engineering software for
certain applications on massively parallel systems, it has not been practical
for them to migrate a large number of third-party software applications to these
systems. The Company believes that the absence of an easy-to-use software
development environment has inhibited third-party application programs, which in
turn has severely restricted market acceptance of massively parallel processing
systems.
Users of high performance computer systems therefore have limited choices.
Mainframes and vector multiprocessing systems permit a conventional programming
environment, but are subject to inherent size limitations and are limited in the
number of processors used, while massively parallel processing systems are
difficult or impractical to program and perform poorly for most applications.
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THE TERA SOLUTION
The Company believes that its MTA system architecture represents a
significant breakthrough in high performance computing. The key to this
breakthrough is its scalable shared memory, which the Company believes will
enable the MTA system to overcome limitations of currently available commercial
high performance computer systems. The MTA system is designed to have all of the
following key attributes to serve the evolving needs of the high performance
computer market effectively: (i) sustainable high speed, (ii) broad
applicability, (iii) ease of software programmability and portability, (iv)
scalability, (v) balanced input/output capability and (vi) a future product
migration path. See "--Technology " and "--Products."
Scalable shared memory provides every processor with equal access to every
memory location. This greatly simplifies programming because it eliminates
concerns about the layout of data in memory. It also provides a very flexible
and efficient approach to parallelism since any available processor can operate
on any data no matter where the data are located. Applications with irregular or
unpredictable internal data flow patterns are facilitated by this capability.
The historical drawback of shared memory has been its slowness due to some
processors being physically distant from some areas of memory and the likelihood
of conflicts when two or more processors attempt to access the same memory
location. Both factors increase the latency, or delay, experienced when a
processor attempts to access a memory location. The MTA system's architecture is
designed to be latency tolerant: a processor never wastes time waiting to access
memory. Tera`s design accomplishes this by using a combination of multithreaded
architecture and a high bandwidth interconnection network.
The MTA system software supports and leverages the scalable shared memory
that the architecture provides. Programs are analyzed and parallelism is
extracted automatically, greatly simplifying the implementation of new
applications. In addition, most programs written for Cray Research's vector
multiprocessing systems are automatically translated by Tera's system software
to run at high speed on the MTA system with minimal changes. The Company intends
to further extend its compatibility with competitors' systems to increase the
attractiveness of the MTA system to both potential customers and independent
software vendors ("ISV's").
STRATEGY
Tera's objective is to be the leading provider of high performance computer
systems to the scientific, engineering and emerging commercial markets. Key
elements of the Company's strategy include:
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- Establish and Leverage a Dominant Position in the Very High Performance
Scientific Computer Market.
Initially the Company intends to target the very high performance scientific
computer market. Sales targets in this market include government agencies,
supercomputer centers and research laboratories in the United States and
Western Europe. These users generally are easily identifiable and well
established, possess significant resources, develop their own application
software, and are reliant upon, and are early customers for, innovative high
performance computer systems. The Company's delivery of its MTA system to the
San Diego Supercomputer Center is in an example of its progress in
implementing this strategy.
The Company believes that establishing a dominant position in the very high
performance scientific market should provide it with the necessary foundation
and credibility, financial and otherwise, to attract ISV's to port their
application software to the MTA system. The Company believes that the
availability of such third-party software should enable it to address
effectively the worldwide high performance engineering computer market for
applications such as computational fluid dynamics and molecular modeling. For
example, the Company is porting LS-DYNA, a car-crash simulation code owned by
Livermore Software Technology Corporation; Gaussian, a leading molecular
modeling code owned by Gaussian, Inc., and, MSC/NASTRAN, a leading structural
analysis code used in a wide variety of engineering applications, which is
owned by MacNeal-Schwendler Corporation.
In addition, the Company intends to develop and support, both internally and
in cooperation with ISV's, application software to enable the Company to
address certain segments of the emerging commercial computer market. See
"--Risk Factors--Significant Sales Depends Upon the Porting of Third Party
Application Software."
- Establish and Leverage Strategic Relationships.
The Company is establishing strategic relationships with leading participants
in various segments of the high performance computer market. The Company
believes these relationships should enable it to take advantage of the
superior resources, technological capabilities and proprietary positions of
these entities in advancing Tera's position in the high performance computer
market.
Over its history, the Company has received approximately $19.3 million from
the Department of Defense Advanced Research Projects Agency ("DARPA") to
assist in funding the development of the MTA system. Pursuant to its
agreements with DARPA, the Company has exclusive commercial rights to the
technical data and computer software developed with this funding. The
Company's obligation under this funding has been to use its best efforts to
develop the technology, and it is not subject to any penalty
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or repayment provision if it were unsuccessful. The Company currently has one
contract with DARPA to develop certain components of its next generation MTA
system, and is also engaged as a subcontractor to the University of
California, San Diego, which is the prime contractor under a contract with
DARPA to evaluate certain defense-related software programs on multi-threaded
architecture. See "--Risk Factors--Continued Government Funding is
Uncertain."
The Company intends to emphasize the development of relationships with large
scale high performance computer users, such as Fortune 200 companies and
major financial institutions, in tandem with the ISV's supplying software to
these organizations to port that software to the MTA system.
TECHNOLOGY
The MTA system is designed to incorporate the following technological
characteristics:
Sustained High Speed. The MTA system's high speed is due to a combination of a
high clock rate and multithreaded scalar pipelines. Presently, each processor
has an execution rate of about 800 million operations per second with peak
64-bit floating point performance also about 800 million floating point
operations per second. Each input/output processor has a peak transfer rate of
up to four hundred million bytes per second. Sustained performance is expected
to be up to 50% of these figures.
Scalability. The MTA system is designed to use a large number of processors in a
single system effectively. The current design supports systems of up to 256
processors, although at this time the Company does not plan on building a system
in the current gallium arsenide or CMOS implementations larger than 64
processors. The next generation MTA system is expected to accommodate several
thousand processors.
Multithreaded Architecture. The MTA system architecture supports up to 128
separate threads of execution per processor (over 8,000 threads in a
64-processor system). When a processor dispatches an instruction for the current
thread, it instantly switches to the next thread which is ready to continue. The
hardware handles this switching automatically, with no intervening machine
cycles, resulting in zero switching overhead.
Threads may come from totally separate programs or from a single program. Tera's
compilers automatically extract parallelism from software programs and create
multiple threads to maximize performance. The MTA operating system is designed
to execute multiple user programs simultaneously, even within a single
processor. The input/output processors are latency tolerant and address data
anywhere in the system.
High Bandwidth Interconnection Network. All hardware resources in the MTA
system, namely computational processors, input/output processors and memory
units, are
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interconnected via a three-dimensional pipelined network. This network is a key
factor in the ability of MTA systems to scale up to thousands of processors
without compromising system performance or programmability.
Compilers and Runtime System. The MTA system software exploits the speed
potential of the hardware without burdening the programmer with the details of
how this is accomplished. The MTA system's parallelizing compilers analyze
programs written in conventional languages, such as FORTRAN, C or C++, and
determine the parts of a program's computations that can be executed
simultaneously. The compiler then generates the machine instructions to create
separate execution threads for these parallel parts. Tera's runtime system, in
conjunction with its compilers, automatically distributes and balances the
threads in a parallel program to the available processors, and adapts to
changing parallelism as the application runs by acquiring and releasing
processors. The Tera debugger allows programmers to find mistakes in their
applications by displaying and monitoring the instructions and variables in an
application program. The debugger is tightly integrated with the compiler and
runtime system to allow users to debug parallel programs.
Software Portability. Tera's compilers are designed to compile most programs
written for Cray Research's vector multiprocessing systems into parallel
programs automatically. Typical scientific applications contain between 10,000
and 1,000,000 lines of source code. It can take years to rewrite a program to
run on new hardware, and additional years of testing and use before the code is
considered trustworthy enough for actual production work. This portability
problem is a major deterrent to the acceptance of any new computer system. To
overcome this problem, Tera has designed its language compilers and libraries to
be compatible with those from Cray Research, with the goal that most Cray
Research applications can be ready for production use in a few weeks to a few
months.
Operating System. The dominant operating system in high performance computing is
UNIX. Tera's operating system, MTX, a fully distributed and symmetric
implementation of UNIX, provides high performance network connections and a
highly concurrent file system. Both batch processing and interactive processing
are supported. Tera has delivered MTX to SDSC, and is integrating more standard
UNIX utilities and high performance I/O peripherals and increasing system
stability. The Company anticipates that MTX will become commercially stable with
sufficient features for the commercial market prior to the end of 1999.
PRODUCTS
The Company has designed a number of configurations of the MTA system. Each
system will be constructed from resource modules with the model number
indicating the number of these resource modules, e.g., the MTA-16 model has 16
resource modules. Each resource module contains the following resources:
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- a computational processor ("CP")
- an input/output processor ("IOP"); and
- two memory units.
Each resource is individually connected to a separate routing node in the MTA
system's interconnection network. Each resource connection is designed to be
capable of supporting data transfers to and from memory at full processor rate
in both directions, as are all of the connections between the network routing
nodes themselves.
The Company built a prototype from production components in late 1996, which
was used to verify and debug mechanical components and assembly procedures. In
1997, the Company began construction of its initial production MTA system. In
December 1997, the Company installed a single processor MTA system at SDSC. In
April 1998, the Company installed a two-processor system at SDSC, which it
upgraded to a four-processor system in December 1998 and which was accepted by
SDSC in January 1999. The Company plans to upgrade this system in stages to
larger configurations as it receives production printed circuit boards.
integrated circuits and other components from its vendors which are then
integrated into a commercially acceptable system, assuming receipt of additional
purchase orders.
The Company is working on successive product implementations and generations.
The Company is currently engaged in a project to move from gallium arsenide
integrated circuits to CMOS (complementary metal-oxide silicon) integrated
circuits, which will enable the Company to improve system performance and
price/performance and lower the cost of entry level systems. The Company is also
working on network configurations for very large system sizes. These future
products will be designed to enhance the Company's technological position while
potentially broadening its market acceptance. The Company believes that denser
integrated circuit technology should enable the scaling up of systems to
thousands of processors while preserving its uniform shared memory programming
model. Finally, the Company may take advantage of the ability of the MTA system
to scale down to compete with workstation and other microprocessor-based
products either directly or through a relationship with a current participant in
that market. See "--Risk Factors -- "Completing the Development of the MTA
System Poses Ongoing Technical Challenges" and "--CMOS Implementation Will
Require Significant Resources and May Not Be Successful."
MARKETS AND APPLICATIONS
The MTA system has been designed for prospective customers with demanding
science, engineering and commercial applications. Because of its general purpose
characteristics, the Company believes that the MTA system may be employed across
a broad range of mainstream and emerging high performance computer applications,
and should find early acceptance in industries with key "time-to-market" issues.
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While funding for certain defense programs has decreased in recent years,
total U.S. government expenditures for high performance computer systems have
been augmented by funding under various high performance computing programs. In
addition, important areas of civilian research, such as energy and environmental
studies, climate modeling and toxic mitigation, are receiving federal funding,
and the formerly defense-oriented national research laboratories are in many
cases reorganizing for non-military projects. See "--Risk Factors--Continued
Government Funding is Uncertain."
Government agencies, supercomputer centers and research laboratories are
particularly attractive prospective customers for Tera because they generally
have a higher tolerance for risks inherent in a complex, innovative product.
This market has a limited number of customers that are well known to each other
and to their existing and potential suppliers, including Tera. The Company
maintains relationships with many of the management and staff of these potential
customers. Addressing this market initially will help the Company avoid the
costs of assembling a large sales organization and developing a broad range of
application software. With a sales cycle for its intended products of two years
or longer, the Company will add sales, service, training and support personnel
as needs arise.
As third-party application software becomes available on the MTA system, the
Company has begun to increase its marketing efforts to the high performance
engineering and commercial computer market, where it believes major growth
opportunities may exist. This market is more risk-averse than its initial market
and the Company does not expect significant sales in this market until the MTA
system is well established.
Scientific and Engineering Applications. The Company expects that its
prospective customers running scientific and engineering applications will
purchase MTA systems largely for numerically intensive computations and will
increasingly make use of the MTA system's input/output capabilities to handle
the large amounts of data associated with such computations. The Company's
prospective customers include government agencies, supercomputer centers and
research laboratories that are expected to use the MTA system for a variety of
applications, including basic research in the fields of biology, chemistry,
environmental science, materials science and physics.
Prospective customers within the United States government include such
organizations as the National Science Foundation, the Department of Defense, the
National Security Agency, the Department of Energy, the National Aeronautics and
Space Administration and the National Institutes of Health. These prospective
customers have a number of computationally-intensive applications, including the
following:
- National security - Human genome sequencing
- Severe storm modeling - Military battlefield simulation
- Earth observation - Groundwater pollutant transport
- Climate modeling - Computational biology
- Computational fluid dynamics - Computational chemistry
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The Company intends to market its MTA systems to a wide range of prospective
industrial customers with major computationally-intensive, technical computing
requirements, including the following:
- Automobile crash simulation - Petroleum reservoir modeling
- Structural analysis - Electromagnetic simulation
- Nuclear reactor design - Multidisciplinary optimization
- Drug and chemical design - Animations, computer graphics
Emerging Commercial Applications. The Company expects that prospective
commercial customers may purchase MTA systems either to implement strategic new
applications or to improve their processing capabilities for traditional
commercial applications. These applications include:
- - Interactive Simulation and Visualization -- allowing users the ability to
design and develop products such as automobiles, aircraft and buildings.
- - Information-on-Demand -- the management, storage and distribution of
multimedia data for instantaneous access by thousands of interactive,
simultaneous users.
- - Database Mining -- access and examination of databases to identify
significant data patterns relevant to consumer preferences, insurance claims
and fraud.
RESEARCH AND DEVELOPMENT
The Company's primary research and development activities have included the
design of the hardware components and software required for its MTA system. The
Company's research and development expenses were approximately $10.5 million in
1996, $13.5 million in 1997, and $16.4 million in 1998. The Company believes
that its future performance will depend in large part on its ability to design,
develop, contract for the manufacture of, and market for, its MTA system.
Additionally, the Company must develop ongoing enhancements to its MTA system
and its MTX operating system and develop new product generations. Consequently,
the Company will be required to continue to devote a substantial portion of its
resources to research and development activities.
MANUFACTURING
While the Company has designed all of the MTA system hardware components, it
subcontracts the manufacture of these components, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a sole or limited
source basis to third-party suppliers. The Company's strategy is to avoid the
large capital commitment and overhead associated with establishing manufacturing
facilities and to maintain the flexibility
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to adopt new technologies if and when they become available without the risk of
equipment obsolescence. The Company performs final system integration and
testing, and designs and maintains its MTA system software internally.
Hardware. The Company's general strategy is to capitalize on state-of-the-art
commercial technology available from third-party suppliers. The Company
contracts with Vitesse Semiconductor Corporation and TriQuint Semiconductor,
Inc., for the supply of gallium arsenide wafers and with a limited number of
vendors for various printed circuit boards, flex circuits, power supplies, and
test and packaging services and purchases other components and services on an
as-needed basis. The Company has contracted with Taiwan Semiconductor
Manufacturing Company Ltd. as its CMOS foundry. In general, the Company has
designed hardware components using such suppliers' tools and procedures. The
Company has designed at-speed testers to be used for diagnosis and repair both
in assembly and in the field. Component failures are analyzed in cooperation
with the supplier of the component to determine the cause and to take corrective
action. See "--Risk Factors--Our Suppliers May Not Deliver Acceptable Hardware
Components" and "--Our Reliance on Third Party Suppliers Poses Significant
Risks."
Quality Assurance. The MTA system uses the test and simulation programs
developed during product design for both manufacturing testing and field
maintenance. A large amount of built-in test support has been incorporated in
the design of the MTA system to minimize both the time and effort required to
integrate a complete system and the time needed to diagnose and repair it
on-site. Quality assurance is performed at the component, board, modular
subsystem and complete system level. The Company has designed the MTA system to
incorporate a high degree of manufacturability and serviceability, including
completely scannable logic and lithographic interconnection techniques.
Software. Most of the MTA system software has been designed, and all of it
will be maintained, by the Company. Although the Company's MTX operating system
is based on UNIX, the kernel and the file system were implemented by the Company
to allow much greater parallelism. UNIX utilities are being ported to the MTA
system. The Company has licensed certain mathematical library routines from IBM.
COMPETITION
The high performance computer market is intensely competitive. The barriers
to entry and the cost of remaining competitive are high. The Company's
competitors can be divided into two general categories: established companies
that are well-known in the high performance computer market and new entrants
capitalizing on developments in massively parallel processing and increased
computer performance through clusters or networks of workstations.
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The high performance computer market has been dominated by Cray Research (now
owned by Silicon Graphics, Inc.). Other participants in the market include IBM
and Japanese companies such as Fujitsu, Ltd., Hitachi, Ltd., and NEC
Corporation. To date, the Japanese suppliers, as a group, have been largely
unsuccessful in the U.S. high performance computer market but have been enjoying
increasing success in foreign markets. Tera competes with these companies by
offering MTA systems with superior performance, together with software
compatibility with the installed Cray computer base. See "--Technology--Software
Portability." To the extent that all of these companies continue to use vector
multiprocessing systems, they remain subject to inherent limitations of vector
multiprocessing system performance and on system scalability. See "--High
Performance Computer Industry." Each of these competitors, however, has broader
product lines and substantially greater engineering, manufacturing, marketing
and financial resources than the Company.
A number of companies, including IBM, Silicon Graphics, Inc., Hitachi, Ltd.,
Fujitsu, Ltd., Sun Microsystems, Inc., Hewlett-Packard Corporation and Compaq
Computer Corporation, have developed or plan to develop massively parallel
systems for the high performance market. Massively parallel systems have been
limited in applicability and difficult to program, although a breakthrough in
architecture or software technology could change this situation. See "--High
Performance Computer Industry" and "--Risk Factors--Competition in the High
Performance Computer Market is Intense."
INTELLECTUAL PROPERTY. The Company attempts to protect its trade secrets and
other proprietary rights through formal agreements with its employees,
customers, suppliers and consultants, and through patent protection. Although
the Company intends to protect its rights vigorously, there can be no assurance
that its contractual and other security arrangements will be successful. There
can be no assurance that such arrangements will not be terminated or that the
Company will be able to enter into similar arrangements on favorable terms if
required in the future. Although the Company has not been a party to any
material intellectual property litigation, third parties may assert proprietary
rights claims covering certain of the Company's products and technologies. See
"--Risk Factors--We May Not Be Able To Protect Our Proprietary Information and
Rights Adequately."
Due to the abundance of prior art in the computer sciences, Tera does not
expect to acquire broad-based patent protection of its MTA system architecture,
although the Company will attempt to obtain patent protection for significant
aspects of its MTA system architecture. The Company has one software patent
covering certain aspects of compiler optimization, and in 1998 the Company filed
another 15 patent applications covering a variety of hardware and software
inventions.
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EMPLOYEES
As of December 31, 1998, the Company employed 109 employees (up from 84 at
the end of 1997) on a full-time basis, of whom 70 were in engineering, 19 were
in manufacturing, nine were in sales and marketing, and 11 were in
administration. The Company also employed nine individuals on a part-time or
temporary basis or as interns. The Company has no collective bargaining
agreement with its employees. The Company has never experienced a work stoppage
and believes that its employee relations are excellent.
RISK FACTORS
The following factors should be considered in evaluating our business,
operations and prospects:
FAILURE TO COMPLETE DEVELOPMENT OF A COMMERCIALLY ACCEPTABLE MTA SYSTEM WOULD
JEOPARDIZE OUR VIABILITY. Our inability to overcome the technical challenges
involved in integrating and completing MTA systems that satisfy internal
performance specifications and that are commercially acceptable would jeopardize
our viability as an ongoing business. The development of a new very high
performance computer system is a lengthy and technically challenging process and
requires a significant investment of capital and other resources. Several
companies in this market experienced extreme financial difficulty in the 1990s,
including Thinking Machines Corporation, Cray Computer Corporation, Kendall
Square Research Corporation and Supercomputer Systems, Inc. We first integrated
multiple MTA resource modules into commercially configured computer systems in
1998, and have not yet built the MTA system to meet stringent commercial
reliability standards. To date, we have sold one MTA system to the National
Science Foundation, which is installed at the San Diego Supercomputer Center,
and have no purchase orders for additional systems. We have not yet achieved
the level of stability required to meet stringent commercial reliability
standards and cannot be certain when, if ever, we will do so.
OUR INABILITY TO OVERCOME THE TECHNICAL CHALLENGES OF COMPLETING THE DEVELOPMENT
OF THE MTA SYSTEM COULD CAUSE OUR BUSINESS TO FAIL. Continued delays in
completing the hardware components or software of our MTA system, or in
integrating the full system, could materially and adversely affect our business
and results of operations. From time to time during the development process of
the MTA system, we have been required to redesign certain components of the MTA
system because of previously unforeseen design flaws. For example, various
processor and network chip technologies we thought were functional across
multiple configurations have subsequently been discovered to require additional
design features to function as intended and to achieve a fully operational
system scalable to multiple processors. We also continue to find certain flaws
or "bugs" in our MTX system software, which require correction. This redesign
work, particularly on integrated circuits and printed circuit boards, has been
costly and caused delays in the development of our prototype systems, in the
delivery of our initial MTA system and in upgrades to that system. We expect
that additional modifications to the hardware components, system software and
the integrated system will be necessary as we build larger MTA systems for the
commercial market.
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<PAGE> 15
OUR INABILITY TO OBTAIN ACCEPTABLE HARDWARE COMPONENTS WILL DELAY OUR
DEVELOPMENT EFFORTS AND STRAIN OUR FINANCIAL RESOURCES. The manufacture of
components for the MTA system is a difficult and complex process, and few
companies can meet our design requirements. Manufacturing difficulties or
limitations of the suppliers could result in:
- - a limitation on the number of MTA systems that can be assembled using such
components;
- - unacceptably high prices for those components, with a resulting loss of
profitability and loss of competitiveness for our products; and
- - increased demands on our financial resources, requiring additional equity
and/or debt financings to continue business operations.
Our suppliers have previously experienced problems in manufacturing MTA system
components to our design and quality specifications. In prior years we have been
forced to redesign certain components for manufacture by alternative suppliers
because our original suppliers were unable to consistently manufacture
components of satisfactory quality. In 1997 and 1998, we experienced varying
(and sometimes "zero") yields of gallium arsenide integrated circuits, limited
and delayed deliveries of such integrated circuits, poor yields on packaged
integrated circuits and deliveries of a very limited number of reliable printed
circuit boards. Together, these supply constraints caused substantial delays in
our ability to deliver the initial MTA system to the San Diego Supercomputer
Center and upgrading that system to larger configurations. Although we are
working with our suppliers to solve these problems, there can be no assurance
that they will be able to manufacture the components to our design and quality
specifications.
WE WILL NEED ADDITIONAL CAPITAL TO CONTINUE BUSINESS OPERATIONS. Our present
cash resources and revenue from anticipated sales of MTA systems and existing
service contracts will not be sufficient to finance our planned operations
throughout 1999. We believe we will need to raise at least $12 million in 1999
to meet our contractual commitments and to continue our current levels of
business operations even if we receive revenues from product sales when
anticipated; we have raised approximately $7 million from financings in the
first quarter of 1999. If we do not receive revenues from system sales when
anticipated, then we will need additional capital. The Company is seeking a
lease line of credit for capital goods for up to $1.5 million. Even if we raise
all $12 million, receive revenue from product sales, and obtain the lease line
of credit, we may raise additional equity capital in 1999 to enhance our
financial position for future operations. Financings may not be available to
us when needed or, if available, may not be available on satisfactory terms or
may be dilutive to our shareholders. If no financing is available to us or is
available only on a limited basis, then we would have
15
<PAGE> 16
to significantly reduce our current operations, including inventory purchases,
research and design expenditures and numbers of employees.
OUR UNCERTAIN PROSPECTS FOR REVENUES AND EARNINGS COULD ADVERSELY AFFECT AN
INVESTMENT IN US. We cannot be certain that we will be successful in delivering
and receiving payments for any additional MTA systems, or whether we will be
able to generate additional sales or achieve a profitable level of operations in
the future. We have experienced net losses in each year of our operations, and
had an accumulated net loss of approximately $62.6 million as of December 31,
1998. We incurred net losses of $12.1 million in 1996, $15.8 million in 1997,
and $19.8 million in 1998. We expect to incur substantial further losses until
we make sales on a regular basis. We do not expect to have a profitable fiscal
quarter prior to 2000, if then.
Whether we will achieve additional revenue, or any earnings, will depend
upon a number of factors, including:
- - our ability to assemble production quality MTA systems in commercial
quantities;
- - our ability to achieve broad market acceptance of the MTA system;
- - the level of revenue in any given period;
- - the terms and conditions of sale or lease for an MTA system;
- - the MTA system model or models sold; and
- - our expense levels and manufacturing costs.
OUR RELIANCE ON THIRD PARTY SUPPLIERS JEOPARDIZES OUR ABILITY TO MEET PRODUCTION
SCHEDULES AND TO SATISFY FUTURE CUSTOMER ORDERS. We subcontract the manufacture
of substantially all of our hardware components, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a sole or limited
source basis to third party suppliers. We obtain our gallium arsenide integrated
circuits primarily from Vitesse Semiconductor Corporation; printed circuit
boards from Multilayer Technology, Inc. and Johnson Matthey Electronics; flex
circuits from Compunetics, Inc.; power supplies from ABB Power Supplies, Inc.;
uninterruptible power supplies from Piller, Inc.; cooling distribution units
from C.H. Bull Company; and will receive our CMOS integrated circuits from
Taiwan Semiconductor Manufacturing Company. We rely on Cadence Design Systems,
Inc., for significant design assistance on the CMOS implementation. We are
exposed to substantial risks because of our reliance on these and other limited
or sole source suppliers. For example:
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<PAGE> 17
- - if a reduction or interruption of supply of our components occurred, it could
take us a considerable period of time to identify and qualify alternative
suppliers to redesign our products as necessary and recommence manufacture;
- - if we were ever unable to locate a supplier for a component, we would be
unable to assemble and deliver our products;
- - one or more suppliers may make strategic changes in their product lines,
which may result in the delay or suspension of manufacture of our components
or systems; and
- - some of our key suppliers are small companies with limited financial and
other resources, and consequently may be more likely to experience financial
difficulties than larger, well established companies.
OUR INABILITY TO COMPLETE THE REPLACEMENT OF OUR CURRENT INTEGRATED CIRCUITS
WITH CMOS INTEGRATED CIRCUITS COULD DELAY COMMERCIAL SALES AND RESULTING
REVENUES. Over the next several years we plan to replace in stages most of our
gallium arsenide integrated circuits with integrated circuits made of CMOS. We
believe that CMOS integrated circuits will enable us to offer larger, more cost
effective systems. For example, the 24 gallium arsenide integrated circuits
currently on each processor board will be replaced by one CMOS microprocessor.
This process requires the redesign of most of our integrated circuits,
integrated circuit packages and printed circuit boards, which in turn involves
significant effort by our engineers and requires us to devote significant
capital for non-recurring engineering expenses, including payments to potential
suppliers for design assistance. If we encounter significant problems with this
redesign, we may be delayed substantially in delivering larger systems, which
would materially and adversely affect our working capital, business and results
of operations. If we are successful in producing CMOS components as planned, we
may not be able, or desire, to use most of the then remaining inventory of
gallium arsenide components, and we may incur a substantial expense in writing
off such inventory.
A SUBSTANTIAL NUMBER OF OUR SHARES ARE ELIGIBLE FOR FUTURE SALE WHICH MAY
DEPRESS MARKET PRICES. Sale of a substantial number of our shares of common
stock in the public market or the prospect of such sales could materially and
adversely affect the market price of the common stock. As of December 31, 1998,
we had outstanding:
- - 14,235,085 shares of common stock, of which 800,000 shares have certain
"adjustment rights" that may require us to issue additional shares;
- - 6,000 shares of Series B Convertible Preferred Stock convertible into an
indeterminate number of shares of common stock; and
- - privately placed warrants to purchase another 1,072,936 shares of common
stock.
17
<PAGE> 18
Almost all of our outstanding shares of common stock may be sold without
substantial restrictions. In addition, as of December 31,1998, we had
outstanding options under our option plans to purchase an aggregate of 2,583,036
shares of common stock. All of the shares purchased under the option plans are
available for sale in the public market, subject in some cases to volume and
other limitations.
Sales in the public market of substantial amounts of our common stock,
including sales of common stock issuable upon conversion of the Series B
Convertible Preferred Stock or the exercise of the privately placed warrants or
under the adjustment rights, could depress prevailing market prices for the
common stock. Even the perception that such sales could occur may impact market
prices.
ADDITIONAL SHARES ISSUABLE BY US WOULD DILUTE EXISTING SHAREHOLDINGS AND COULD
HINDER OUR ABILITY TO OBTAIN ADDITIONAL FINANCING. We may be required to issue
substantial additional shares of common stock to holders of our Series B
Convertible Preferred Stock and to holders of common stock that have certain
"adjustment" rights. The Series B Convertible Preferred Stock has a variable
conversion rate, equal to the lowest market "sale" price in the five trading
days prior to each conversion. The number of shares that would be issuable upon
conversion of the $6,000,000 of Series B Convertible Preferred Stock outstanding
as of December 31, 1998 (excluding any issuance of common stock in payment of 5%
per annum accrued dividends on the Series B Convertible Preferred Stock) is
illustrated below:
<TABLE>
<CAPTION>
Conversion Number of Shares of
Price Common Stock Issuable
- ---------- ---------------------
<S> <C>
$ 10.00 600,000
$ 8.00 750,000
$ 6.00 1,000,000
$ 4.00 1,500,000
</TABLE>
The Series B convertible preferred stock may be converted at any time, but
tends to be converted when there are substantial increases in market prices in a
short period. Such sales may lessen such increases. As of March 8, 1999,
$285,000 of the Series B Convertible Preferred Stock had been converted into an
aggregate of 50,716 shares of common stock.
In September and December 1998, we sold a total of 800,000 shares of common
stock with certain "adjustment" rights pursuant to which we are required to
issue warrants to purchase additional shares of common stock with an exercise
price of $0.01 per share to the holders (or to their permitted assigns) if the
market price of our common stock is less than a specified target value on
certain "measurement dates," based on the average closing bid prices for the 15
trading days ending prior to the measurement dates. We agreed with the
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<PAGE> 19
holders that the first measurement date would be on February 22, 1999, as of
which date we issued warrants to acquire 536,585 additional shares of common
stock (the "February Adjustment Warrants").
The next measurement date will be on May 22, 1999. Assuming that the holders
continue to hold all of the 800,000 shares issued to them in September and
December 1998 and all of the February Adjustment Warrants, the number of
warrants to purchase additional shares that would be issued to the investors on
that date is illustrated below:
<TABLE>
<CAPTION>
Market Price
of Number of Additional Shares
Common Stock of Common Stock Issuable
- ------------ --------------------------
<S> <C>
$12.00+ - 0 -
$10.00 80,000
$ 8.00 200,000
$ 6.00 478,048
$ 4.00 1,385,365
</TABLE>
For subsequent measurement dates, the adjustment provision operates
similarly. If the market price is less than the applicable target value for
measurement dates after May 22, 1999, then the number of shares to be issued
will be increased by 1.25%, which reflects a negotiated issuance premium.
Assuming that the market price of the common stock on May 22, 1999 were $8.00
per share and the holders continue to hold the original 800,000 shares, the
February Adjustment Warrants, and the warrants to purchase an additional 200,000
shares assumed to be issued on May 22, 1999, our obligation to issue warrants to
acquire additional shares on August 22, 1999 (the third measurement date) may be
illustrated as follows:
<TABLE>
<CAPTION>
Market Price Number of Additional
of Shares of Common Stock
Common Stock Issuable
- ---------------- ---------------------
<S> <C>
$12.00+ - 0 -
$10.00 - 0 -
$ 8.00 - 0 -
$ 6.00 300,731
$ 4.00 1,219,390
</TABLE>
The existence of the Series B Convertible Preferred Stock and the
possibility of the issuance of warrants to acquire additional shares upon
adjustment, as described above, as well as the existence of outstanding warrants
and options, may prove to be a hindrance to our future equity financings.
Further, the holders of such warrants and options may
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<PAGE> 20
exercise them at a time when we would otherwise be able to obtain additional
equity capital on terms more favorable to us. Such factors could materially and
adversely affect our ability to meet our capital needs.
OUR INABILITY TO SELL MTA SYSTEMS AT EXPECTED PRICES WOULD ADVERSELY AFFECT OUR
GROWTH PROSPECTS AND FINANCIAL VIABILITY. Most of our potential customers
already own or lease very high performance computer systems. Some of our
competitors may offer trade-in allowances or substantial discounts to potential
customers, and we may not be able to match these sales incentives. We may be
required to provide discounts to make sales or to finance the leasing of our
products, which would result in a deferral of our receipt of cash for such
systems. These developments could materially and adversely affect our business
and results of operations.
LACK OF GOVERNMENT FUNDING FOR SUPERCOMPUTER SYSTEMS WOULD ADVERSELY AFFECT OUR
BUSINESS AND INCREASE OUR CAPITAL REQUIREMENTS. The inability of U.S. and
foreign government agencies to procure additional very high performance
computer systems, due to lack of funding or for any other reason, would
materially and adversely affect our business, results of operations and need
for capital. We have targeted U.S. and foreign government agencies and
research laboratories for our early sales. Our first sale was to the U.S.
National Science Foundation for installation at the San Diego Supercomputer
Center. The U.S. Government historically has facilitated the development of,
and has constituted a market for, new and enhanced very high performance
computer systems. If the U.S. government or foreign governments were
to reduce or delay funding of certain high technology programs employing high
performance computing, then one of our target markets would be seriously
adversely affected.
THE ABSENCE OF THIRD-PARTY APPLICATION SOFTWARE TRANSLATED TO RUN ON THE MTA
SYSTEM COULD ADVERSELY AFFECT OUR ABILITY TO MAKE COMMERCIAL SALES. In order to
make sales in markets beyond the very high performance scientific market, such
as government agencies and research laboratories, to engineering and other
commercial markets, we must be able to attract independent software vendors to
port their software application programs so that they will run on the MTA
system. We also plan to modify and port third-party software applications to the
MTA system ourselves to facilitate the expansion of our potential markets. There
can be no assurance that we will be able to induce independent software vendors
to port their applications, or that we will successfully port third-party
applications to the MTA system, and the failure to do so could materially
reduce our revenues and delay profitability.
RAPID GROWTH COULD STRAIN OUR MANAGEMENT AND FINANCIAL RESOURCES. If we are
successful in manufacturing and marketing the MTA system, we believe that we
would undergo a period of rapid growth that could place a significant strain on
our management, financial and other resources. Our ability to manage our growth
will require us:
- - to continue to improve our operational and financial systems;
- - to motivate and effectively manage our employees;
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<PAGE> 21
- - to complete the implementation of a new financial, budgeting and management
information system; and
- - to enhance internal control systems.
Our success will depend on our management's ability to make these changes and to
manage our operations effectively over the long term.
WE MAY BE UNABLE TO ATTRACT, RETAIN AND MOTIVATE KEY PERSONNEL, AND AS A RESULT
WE MAY NOT BE ABLE TO GROW AS WE EXPECT OR EFFECTIVELY IMPLEMENT OUR BUSINESS
PLAN. Our success also will depend in large part upon our ability:
- - to attract and retain highly skilled technical and marketing and sales
personnel;
- - to provide technological depth and support;
- - to complete and enhance the MTA system hardware and software; and
- - to develop implementations of the MTA system.
Competition for highly skilled management, technical, marketing and sales
personnel is intense. We may not succeed in attracting and retaining such
personnel.
We are dependent on Burton J. Smith, our Chairman of the Board and Chief
Scientist, and James E. Rottsolk, our Chief Executive Officer. The loss of
either officer's services could have a material impact on our ability to achieve
our business objectives. We are the beneficiary of key man life insurance
policies on the lives of Messrs. Smith and Rottsolk in the amount of $2 million
and $1 million, respectively. We have no employment contracts with either Mr.
Smith or Mr. Rottsolk, or with any other employee.
OUR QUARTERLY PERFORMANCE MAY VARY SIGNIFICANTLY AND COULD CAUSE OUR STOCK PRICE
TO BE VOLATILE. If we are able to attain market acceptance of the MTA system,
one or a few system sales may account for a substantial percentage of our
quarterly and annual revenue. This is due to the anticipated high average sales
price of the MTA system models and the timing of purchase orders and product
acceptances. Because a number of our prospective customers receive funding from
the U.S. or foreign governments, the timing of orders from such customers may be
subject to the appropriation and funding schedules of the relevant government
agencies. The timing of orders and shipments also could be affected by other
events outside our control, such as:
- - changes in levels of customer capital spending;
- - the introduction or announcement of competitive products;
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<PAGE> 22
- - the availability of components; or
- - currency fluctuations and international conflicts or economic crises.
Because of these factors, revenue, net income or loss and cash flow are likely
to fluctuate significantly from quarter to quarter.
U.S. EXPORT CONTROLS COULD HINDER OUR SALES TO FOREIGN CUSTOMERS AND OUR FUTURE
PROSPECTS. The U.S. Government regulates the export of high performance computer
systems such as the MTA system. Delay or denial in the granting of any required
licenses could materially and adversely affect our business and results of
operations.
WE MAY NOT BE ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE. Our market is
characterized by rapidly changing technology, accelerated product obsolescence,
and continuously evolving industry standards. Our success will depend upon our
ability to complete development of the MTA system and to introduce new products
and features in a timely manner to meet evolving customer requirements. We may
not succeed in these efforts. Our business and results of operations will be
materially and adversely affected if we incur delays in developing our products
or if such products do not gain broad market acceptance. In addition, products
or technologies developed by others may render our products or technologies
noncompetitive or obsolete.
WE MAY BE UNABLE TO COMPETE SUCCESSFULLY IN THE HIGH PERFORMANCE COMPUTER
MARKET. Our competitors include established companies that are well known in the
high performance computer market and new entrants capitalizing on developments
in parallel processing and increased computer performance through networking.
The high performance computer market is highly competitive and has been
dominated by Cray Research, a division of Silicon Graphics, Inc. Other
participants in the market include IBM Corporation and Japanese companies such
as NEC Corporation, Fujitsu, Ltd., and Hitachi, Ltd. Each of these competitors
has broader product lines and substantially greater research, engineering,
manufacturing, marketing and financial resources than we do.
A number of companies have developed or plan to develop parallel systems for
the high performance computer market. To date, these products have been limited
in applicability and scalability and are often difficult to program. A
breakthrough in architecture or software technology could change this situation.
Such a breakthrough would materially and adversely affect our business and
results of operations.
The performance of the MTA system may not be competitive with the computer
systems offered by our competitors, and we may not compete successfully over
time against new entrants or innovative competitors at the lower end of the
market.
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<PAGE> 23
Furthermore, periodic announcements by our competitors of new high
performance computer systems and price adjustments may materially and adversely
affect our business and results of operations.
WE MAY NOT BE ABLE TO PROTECT OUR PROPRIETARY INFORMATION AND RIGHTS ADEQUATELY.
We rely on a combination of copyright and trade secret protection,
non-disclosure agreements and licensing arrangements to establish, protect and
enforce our proprietary information and rights. In addition, we have 15 patent
applications pending and plan to file additional patent applications. There can
be no assurance, however, that patents will be issued from the pending
applications or that any issued patents will protect adequately those aspects of
our technology to which such patents will relate. Despite our efforts to
safeguard and maintain our proprietary rights, there can be no assurance that we
will succeed in doing so or that our competitors will not independently develop
or patent technologies that are substantially equivalent or superior to our
technologies.
Although we are not a party to any present litigation regarding proprietary
rights, third parties may assert intellectual property claims against us in the
future. Such claims, if proved, could materially and adversely affect our
business and results of operations. In addition, even meritless claims require
management attention and cause us to incur significant expense.
The laws of certain countries do not protect intellectual property rights to
the same extent or in the same manner as do the laws of the United States.
Although we continue to implement protective measures and intend to defend our
proprietary rights vigorously, there can be no assurance that these efforts will
succeed.
OUR STOCK PRICE MAY BE VOLATILE. The trading price of our common stock could be
subject to significant fluctuations in response to, among other factors:
- - variations in quarterly operating results;
- - changes in analysts' estimates;
- - announcements of technological innovations by us or our competitors; and
- - general conditions in the high performance computer industry.
In addition, the stock market is subject to price and volume fluctuations that
particularly affect the market prices for small capitalization, high technology
companies. These fluctuations are often unrelated to the operating performance
of these companies. Continued stock price volatility could result in the
issuance of additional shares of common stock. See "--Risk Factors--Additional
Shares Issuable By Us Would Dilute Existing Shareholdings and Could Hinder Our
Ability to Obtain Additional Financing."
23
<PAGE> 24
IT MAY BECOME MORE DIFFICULT TO SELL OUR STOCK IN THE PUBLIC MARKET. Our common
stock is quoted on the Nasdaq National Market. In order to remain listed on this
market, the Company must meet Nasdaq's listing maintenance standards. If the bid
price of our common stock falls below $5.00 for an extended period, or we are
unable to continue to meet Nasdaq's standards for any other reason, our common
stock could be delisted from the Nasdaq National Market.
If the common stock were delisted, we likely would seek to list the common
stock on the Nasdaq SmallCap Market or for quotation on the American Stock
Exchange or a regional stock exchange. However, listing or quotation on these
markets or exchanges could reduce the liquidity for our common stock.
If the common stock were not listed or quoted on another market or exchange,
trading of the common stock would be conducted in the over-the-counter market on
an electronic bulletin board established for unlisted securities or in what are
commonly referred to as the "pink sheets." As a result, an investor would find
it more difficult to dispose of, or to obtain accurate quotations for the price
of, the common stock. In addition, a delisting from the Nasdaq National Market
and failure to obtain listing or quotation on such other market or exchange
would subject our securities to so-called "penny stock" rules that impose
additional sales practice and market-making requirements on broker-dealers who
sell and/or make a market in such securities. Consequently, removal from the
Nasdaq National Market and failure to obtain listing or quotation on another
market or exchange could affect the ability or willingness of broker-dealers to
sell and/or make a market in the common stock and the ability of purchasers of
the common stock to sell their securities in the secondary market. In addition,
if the market price of the common stock falls to below $5.00 per share, we may
become subject to certain penny stock rules even if our common stock is still
quoted on the Nasdaq National Market. While such penny stock rules should not
affect the quotation of our common stock on the Nasdaq National Market, such
rules may further limit the market liquidity of the common stock and the ability
of investors to sell the common stock in the secondary market.
WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS. We have not previously paid any
dividends on our common stock and for the foreseeable future we intend to
continue our policy of retaining any earnings to finance the development and
expansion of our business.
CERTAIN PROVISIONS OF OUR ARTICLES AND BYLAWS COULD MAKE A PROPOSED ACQUISITION
WHICH IS NOT APPROVED BY OUR MANAGEMENT MORE DIFFICULT. Certain provisions of
our Restated Articles of Incorporation and Restated Bylaws could make it more
difficult for a third party to acquire us. These provisions could limit the
price that certain investors might be willing to pay in the future for our
common stock. For example, our Articles and Bylaws provide for:
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<PAGE> 25
- - a staggered Board of Directors, so that only two of six new directors are
elected each year;
- - removal of a director only for cause and only upon the affirmative vote of
not less than two-thirds of the shares entitled to vote to elect directors;
- - the issuance of preferred stock, without shareholder approval, with rights
senior to those of the common stock;
- - no cumulative voting of shares;
- - calling a special meeting of the shareholders only upon demand by the holders
of not less than 30% of the shares entitled to vote at such a meeting;
- - amendments to the Articles of Incorporation require the affirmative vote of
not less than two-thirds of the outstanding shares entitled to vote on the
amendment, unless the amendment was approved by a majority of "continuing
directors" (as that term is defined in our Articles);
- - special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors;
- - special procedures to bring matters before our shareholders at our annual
shareholders' meeting; and
- - special procedures for nominating members for election to the Board of
Directors.
ITEM 2. PROPERTIES
In December 1998, we moved to Merrill Place in downtown Seattle, Washington,
which we occupy pursuant to a ten-year lease. We are now leasing approximately
85,000 square feet and in three years we are committed to lease approximately
132,000 square feet. The initial base rental, fully serviced but excluding
parking, is approximately $145,000 per month. We will have an option to extend
the lease for another five years after the initial ten-year term. We expect this
space to be adequate for our needs for the foreseeable future.
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<PAGE> 26
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the fourth
quarter of 1998.
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<PAGE> 27
ITEM E.O. EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company as of March 20, 1999 were as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Burton J. Smith 58 Chairman of the Board and
Chief Scientist
James E. Rottsolk 54 Chief Executive Officer and
President
Kenneth W. Johnson 56 Vice President - Finance, Chief
Financial Officer, and
Secretary
Brian D. Koblenz 38 Vice President - Software
Gerald E. Loe 49 Vice President - Hardware
Engineering
Katherine L. Rowe 42 Vice President - Manufacturing
Richard M. Russell 54 Vice President - Marketing
</TABLE>
Burton J. Smith has been the Chairman of the Board and Chief Scientist since
the Company's inception in 1987. He is a recognized authority on high
performance computer architecture and programming languages for parallel
computers, and is the principal architect of the MTA system. Prior to
co-founding Tera, Mr. Smith was a Fellow of the Supercomputing Research Center
(now Center for Computing Sciences), a division of the Institute for Defense
Analyses, from 1985 to 1988. He was honored in 1990 with the Eckert-Mauchly
Award given jointly by the Institute for Electrical and Electronic Engineers and
the Association for Computing Machinery, and was elected a Fellow of both
organizations in 1994. Mr. Smith received his S.M., E.E. and Sc.D. degrees from
the Massachusetts Institute of Technology.
James E. Rottsolk is a co-founder of the Company and has served as its Chief
Executive Officer and President since its inception. Prior to co-founding Tera
in 1987, Mr. Rottsolk served as an executive officer with several high
technology start-up companies. Mr. Rottsolk received his A.M. and J.D. degrees
from the University of Chicago.
Kenneth W. Johnson joined the Company in September 1997 as Vice President -
Finance, Chief Financial Officer and Secretary. Prior to joining the Company,
Mr. Johnson practiced law in Seattle for twenty years with Stoel Rives LLP and
predecessor firms, where his practice emphasized corporate finance. Mr. Johnson
received his A.B. degree from Stanford University and his J.D. degree from
Columbia University Law School.
Brian D. Koblenz served as Tera's Group Leader, Languages and Compilers, from
1990 until May 1994, when he assumed his present position as Vice President -
Software. Prior
27
<PAGE> 28
to joining the Company, Mr. Koblenz was Principal Software Engineer at Digital
Equipment Corporation ("Digital"), from 1986 to 1989. He was lead designer of
Digital's high performance vector FORTRAN compiler and participated in the Alpha
architecture and VAX vectorization efforts. He received his B.S. from the
University of Vermont and his M.S. from the University of Washington.
Gerald E. Loe joined the Company in 1992 as Vice President - Hardware
Engineering and Manufacturing. He was named Vice President - Hardware
Engineering in 1996. Prior to joining the Company, he was Vice President of
Operations at Siemens Quantum Inc., a high-end radiology ultrasound company,
from 1989 to 1992. Mr. Loe received his B.S.M.E. from the Massachusetts
Institute of Technology and his M.B.A. from Harvard Business School.
Katherine L. Rowe joined the Company as Director of Manufacturing in 1994 and
was named Vice President - Manufacturing in 1996. From April 1998 to September
1998, she was on leave and was reelected to her position upon her return. Prior
to joining the Company, Ms. Rowe was an Engineering Manager at ELDEC
Corporation, an aerospace electronics company, and was Manufacturing Manager and
Project Manager in new product development at Physio-Control Corporation, a
medical electronics company. She received her S.M. from Massachusetts Institute
of Technology and her B.S.M.E. from Purdue University.
Richard M. Russell joined the Company as Director of New Business Development
in 1995 and was named Vice President- - Marketing in March 1998. Prior to
joining the Company, he worked in a variety of sales and marketing positions at
several high technology companies, including Cray Research, Inc. from 1976
through 1990 and Kendall Square Research Corporation from 1991 through 1994. Mr.
Russell was educated in England.
28
<PAGE> 29
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY and RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market under the
symbol TERA; prior to January 20, 1998, the Company's stock was traded on the
Nasdaq SmallCap Market. On March 8, 1999, the Company had 14,328,701 shares of
common stock outstanding which were held by 407 holders of record. The Company
has not paid cash dividends on its common stock. The Company currently
anticipates that it will retain all available funds for use in its business and
does not anticipate paying any cash dividends on its common stock in the
foreseeable future.
The quarterly high, low and closing sales prices of the common stock for the
periods indicated are as follows:
<TABLE>
<CAPTION>
1997 1998
----------------------------------- -------------------------------
High Low Close High Low Close
--------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
First Quarter 6 1/4 3 5/16 5 5/8 15 10/32 10 1/4 12 3/4
Second Quarter 6 3/8 3 7/8 5 1/2 14 1/2 9 5/8 12
Third Quarter 18 3/16 4 7/16 12 7/8 12 1/4 6 1/4 7 3/4
Fourth Quarter 17 3/4 9 3/4 15 1/4 8 15/16 5 1/2 6 1/4
</TABLE>
On March 26, 1999, the closing sale price for the common stock was $6 11/16.
These quotations reflect inter-dealer prices, without retail mark-up, mark-down
or commission, and may not represent actual transactions.
SALES OF UNREGISTERED SECURITIES
On February 18, 1998, the Company issued 2,500 shares to a consultant for
services rendered. The issuance was exempt from the registration provisions of
the Securities Act of
29
<PAGE> 30
1933 under Section 4(2) thereof, based on the nature of the offering and status
of the recipient.
On June 30, 1998, the Company raised $5,674,406, net of issuance costs of
$325,596, in cash through the negotiated private sale of 6,000 shares of its
Series B Convertible Preferred Stock (the "Series B Stock") and 100,000 common
stock purchase warrants to two accredited investors, Advantage Fund II Ltd. and
Genesee Fund Limited - Portfolio B. The Series B Stock is convertible from
time to time into shares of common stock at a conversion price equal to the
lower of $14.52 per share or the lowest sale (regular way) price during the
five consecutive trading days ending one day prior to the date on which a
notice of conversion is delivered to the Company, with the conversion price
subject to adjustment in certain conditions. The warrants are exercisable at a
price of $6.00 per share, subject to adjustment pursuant to common antidilution
provisions. Further information regarding these securities is contained in
Note 9 of the Notes to Financial Statements. See "Business--Risk Factors--
Additional Shares Issuable By Us Would Dilute Existing Shareholders and Could
Hinder Our Ability to Obtain Additional Financing." There were no sales agents
or underwriters involved in this placement. The sale was exempt from the
registration provisions of the Securities Act of 1933 under Section 4(2)
thereof, based on the nature of the offering and status of the investors.
On September 30, 1998, the Company raised $6,000,000 in cash through the
negotiated private sale of 600,000 shares of common stock and 121,008 common
stock purchase warrants to two accredited investors, Advantage Fund II Ltd. and
Koch Industries, Inc. On December 16, 1998, the Company raised another
$2,000,000 in cash through the negotiated private sale of 200,000 shares of
common stock and 40,336 common stock purchase warrants to two accredited
investors, Genesee Fund Limited - Portfolio B and Koch Industries, Inc. The
Company has agreed to issue additional shares of common stock to these investors
if the market price of the common stock does not meet certain target levels at
specified times during the next two years. The warrants are exercisable at a
price of $6.00 per share, subject to adjustment pursuant to common antidilution
provisions. See "Business--Risk Factors--Additional Shares Issuable By Us Would
Dilute Existing Shareholders and Could Hinder Our Ability to Obtain Additional
Financing.". Further information regarding these securities is contained in Note
9 of the Notes to Financial Statements. There were no sales agents or
underwriters involved in this placement. The sale was exempt from the
registration provisions of the Securities Act of 1933 under Section 4(2)
thereof, based on the nature of the offering and status of the investors.
On December 21, 1998, the Company issued 175,975 shares of common stock to
the owners of Merrill Place, where our new Seattle offices are located, in
payment of certain tenant improvements. On the same date the Company also
issued 12,982 shares of common stock as a prepaid lease deposit. These sales
were exempt from the registration provisions of the Securities Act of 1933
under Section 4(2) thereof, based on the nature of the offering and the status
of the recipients.
30
<PAGE> 31
ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share amounts and Statistical Data)
<TABLE>
<CAPTION>
Years Ended December 31, 1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Operating Data:
Revenue $ -- $ -- $ -- $ 74 $ 1,988
Manufacturing costs and
inventory adjustments 2,528
Research and Development 5,575 6,679 10,504 13,547 13,918
Research Funding 4,410 2,196 185 349 253
Net Loss 2,123 5,646 12,077 15,755 19,804
Loss for Common Stock 2,123 5,646 18,806 18,672 20,737
Loss per Common Share $ 1.00(1) $ 2.13(1) $ 3.53 $ 2.13 $ 1.70
Weighted Average
Shares Outstanding 2,119(1) 2,646(1) 5,321 8,785 12,212
Balance Sheet Data:
Cash and cash equivalents $ 21 $ 4,285 $ 929 $ 13,329 $ 3,162
Working capital (3,850) 2,642 (22) 14,342 7,269
Capital leases, long-term
portion 168 419 114 532 573
Total Assets 1,168 7,269 4,617 20,859 20,288
Redeemable Securities -- -- -- 9,478 --
Shareholders' Equity (3,219) 4,092 1,128 6,368 11,889
Statistical Data:
Number of Full-Time Employees 56 66 61 84 109
</TABLE>
- ----------
(1) These numbers have been adjusted to give effect to the approximately
one-for-3.5231 reverse split of the Common Stock effected in September 1995.
31
<PAGE> 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The information set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below includes "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, and is subject to the safe harbor created by that Section. Factors that
realistically could cause results to differ materially from those projected in
the forward looking statements are set forth in this section and under "Business
- --Risk Factors." The following discussion should also be read in conjunction
with the Financial Statements and accompanying Notes thereto.
OVERVIEW
We had an accumulated net loss of approximately $62.6 million as of December
31, 1998. Our funding through the end of 1998 has been primarily from the sale
of approximately $73.1 million of securities, research funding from the Defense
Advanced Research Projects Agency ("DARPA") of approximately $19.3 million, and
revenue of approximately $2.0 million.
We have experienced net losses in each year of operations and expect to incur
substantial further losses until we make additional sales, and possibly
thereafter. In April 1998, we recognized our first revenue from product sales
with our delivery of a two-processor MTA system to the San Diego Supercomputer
Center ("SDSC"). We upgraded the MTA system at SDSC in December 1998 to four
processors. This larger system was accepted by SDSC in January 1999 and we will
recognize the revenue from that delivery in the first quarter of 1999. Assuming
receipt of purchase orders, we plan to upgrade the MTA system in SDSC in stages
to larger configurations as we receive production printed circuit boards,
integrated circuits and other components that we integrate into a commercially
acceptable system. See "Business--Risk Factors--Development Status of the MTA
System" and "Business--Strategy."
We generally recognize revenue from sales of MTA systems upon acceptance of
the system by the customer, although depending on sales contract terms, revenue
may be recognized upon shipment or deferred until clarification of funding; we
recognize revenue from the maintenance of the MTA system ratably over the term
of each maintenance agreement and service revenue as services are performed.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998.
REVENUE. We had revenue in 1998 of approximately $2.0 million, up from
$73,500 in 1997. 1998 revenues included $1.3 million from the sale of the
two-processor MTA
32
<PAGE> 33
system to SDSC, our first revenue from product sales. We had $714,000 of service
revenue in 1998, up from $73,500 in 1997. Service revenue in both years was
pursuant to a subcontract with SDSC to evaluate multithreaded architecture for
certain defense applications. We expect to complete this subcontract for another
$283,000 in 1999, of which our portion, after payments to our subcontractors,
will be approximately $54,000; this contract expires on June 30, 1999. We also
anticipate receiving revenue in 1999 from sales of larger configurations to SDSC
and from other sales to potential customers in 1999, although we currently have
no contracts or purchase orders for such sales. See "Business--Risk Factors."
OPERATING EXPENSES. Cost of revenue from product sales was high in 1997 and
1998 as a percentage of the revenue due to favorable pricing terms provided to
SDSC and the inclusion of costs of system infrastructure to support a full 16
processor MTA system. The cost of service revenue in 1998 was 82% of
service revenue, an increase from 71% in 1997, due to increased billings from
our subcontractors.
In the third quarter of 1998, we began incurring manufacturing expenses
reflecting our progress to commercial production. These expenses include
personnel cots and allocated overhead for our manufacturing group, production
expenses not directly related to cost of sales for delivered systems, and
inventory adjustments, such as revaluations and cost variations arising from
changes in production yields, inventory obsolescence, inventory consumed as part
of the manufacturing process and capitalized manufacturing labor and overhead
costs. These expenses totaled $2.5 million for the third and fourth quarters
ended December 31, 1998, including personnel costs and allocated overhead of
$1.4 million, production expenses of $410,000 and net inventory adjustments of
$697,000, with $1.8 million of inventory obsolescence and consumed inventory
partially offset by favorable cost variations and capitalized costs.
Research and development expenses constitute the largest portion of our
operating expenses, and include costs associated with the development of the MTA
system, including personnel expense, depreciation and lease expense on
facilities and equipment and nonrecurring engineering, software and hardware
costs. Research and development expenses increased from $10.5 million in 1996 to
$13.5 million in 1997, a 29% increase and increased only slightly to $13.9
million in 1998; the increase in 1998 would have been greater except for the
incurring of manufacturing costs and inventory adjustments beginning in
mid-1998, as discussed above.
Research and development expenses for 1997 included a $832,000 charge as
compensation expense related to certain performance-based stock options; without
that charge, 1997 research and development expenditures would have been
approximately $12.8 million.
Salaries, benefits and allocated overhead for research and development
increased from $5 million in 1996, to $7.3 million in 1997 (excluding the
compensation expense for performance-based stock options), largely reflecting
additional personnel and higher wages in 1997. These salaries, benefits and
allocated overhead decreased to $6.7 million in 1998 largely due to the separate
recognition of the manufacturing group described above.
Engineering expenses, consisting of payments to third parties for services
and products, were $ 4.8 million in 1996, $3.2 million in 1997 and $3.1 million
in 1998. The decline of approximately $1.6 million in engineering expenses from
1996 to 1997 was largely due to lower expenditures on the MTA prototype, which
decreased from $1.3 million in 1996 to $402,000 in 1997 and essentially ceased
after the third quarter of 1997. In 1997, we spent nearly $2.0 million on
further engineering expenses on the current MTA implementation, compared to $1.6
million in 1998. We also spent approximately $1.2 million in 1997 and $1.7
million in 1998 on the conversion from gallium arsenide integrated circuits to
CMOS integrated circuits, primarily for design services from Cadence Design
Services, Inc.
33
<PAGE> 34
While we expect that research and development expenditures will continue to
be a major expense, they are expected to decrease as a percentage of total
operating expenses and will generally include expenditures related to continuing
engineering of the MTA system, research and development related to the next
generation MTA system and related software development, including personnel
expense, depreciation and lease expense on facilities and equipment.
Marketing and sales expense has increased from $665,000 in 1996 to $1.1
million in 1997 and to over $1.8 million in 1998, as we have continued to
increase sales and customer support staff and expenditures in connection with
sales and marketing, benchmarks and development of third party applications
software. In 1997, marketing and sales expenses increased to 6.9% of total
operating expenses, up from 5.4% in 1996, with a significant increase in the
fourth quarter as we then opened a two-person, branch sales office in Japan and
added a third U.S. salesperson. With the impact of these expenses for all of
1998 plus additional sales support personnel during the year, marketing and
sales expenses increased by over $720,000, constituting 8.2% of total 1998
operating expense. We expect that we will continue to increase our marketing and
sales activities as we build larger MTA systems for sale to industrial and
commercial customers.
Our general and administrative expenses have increased each year consistent
with expansion of our infrastructure. These expenses were nearly $1.1 million in
1996, nearly $1.6 million in 1997 and over $2.1 million in 1998, an increase of
48% in 1997 over 1996 and a further 36% increase in 1998 over 1997. The increase
in expenditures in 1997 over 1996 was primarily due to additional staff and
further increases in legal, investor relations, stock transfer and other costs
associated with being a publicly owned company. The increase in these expenses
for 1998 over 1997 was due largely to higher wages and operating costs
associated with being a publicly owned company. General and administrative
expenses are expected to increase commensurate with any growth in our
operations.
34
<PAGE> 35
RESEARCH FUNDING. We have been billing DARPA under a $1 million research
contract awarded in September 1995. Billings increased in 1997 to $349,000 over
$185,000 in 1996, and then declined to $253,000 in 1998. There remains
approximately $205,000 to be billed under this contract, which expires in
September 1999.
OTHER INCOME (EXPENSE). Other income increased by $138,000 in 1997 to
$101,000 as interest income increased from $106,000 to $140,000 while interest
expense declined from $118,000 to $100,000, reflecting the Company's increased
cash position due to the sales of equity securities throughout the year. We
increased other income by another $76,000 in 1998 primarily due to increasing
interest income to $365,000, due to our increased cash position after completion
of a $10 million financing in December 1997 and other financings in 1998, which
was offset in part by interest expense of $188,000, largely due to a fully
utilized lease line of credit.
TAXES. We made no provision for federal income taxes in 1996, 1997 or 1998 as
we have continued to incur net operating losses. As of December 31, 1998, the
Company had net operating loss carry-forwards of approximately $60.7 million
which expire in years 2003 through 2018, if not utilized. Our net operating loss
carry-forwards and certain other tax attributes (including its research credit
of approximately $2.5 million at December 31, 1998) would be limited to an
annual utilization for losses and credits for periods prior to 1996 of
approximately $700,000. This limitation may result in the expiration of net
operating losses and credits before utilization.
PREFERRED STOCK. We amortized a total of $2.0 million related to the
conversions of our Series B and Series C Convertible Preferred Stock during 1997
into common stock at a discount from the fair market value of the common stock,
and recorded dividends of $90,000 on these securities, almost all of which were
paid in shares of our common stock, based on the market price at the time of
payment. In December 1997, we issued $10,000,000 of its Series A Convertible
Preferred Stock, and recorded a preferred stock discount of approximately
$800,000 from the allocation of proceeds to warrants issued with the Series A
Convertible Preferred Stock.
In 1998, we paid all of the $468,000 of dividends on our outstanding shares
of Series A Convertible Preferred Stock and Series B Convertible Preferred
Stock, issued in June 1998, in shares of common stock, based on the market price
at the time of payment. In addition we amortized in the third quarter the
preferred stock discount resulting from the allocation of proceeds to warrants
issued in connection with the Series B Convertible Preferred Stock, which
resulted in another $465,000 non-cash charge to the Loss for Common Stock.
YEAR 2000. Issues relating to the Year 2000 result from many computer
programs being written using two digits rather than four to define the
applicable year, so that the year "00" may be interpreted as the year 1900
rather than 2000. A related issue is the ability to
35
<PAGE> 36
recognize the Year 2000 as a leap year. Software programs and embedded
microcircuitry that have date-sensitive features may have Year 2000 issues.
These programs may include software tools that we use in the development of the
hardware and operating systems of our MTA system, the software programs and
embedded chips used in our internal systems and software programs and equipment
used in the normal operation of our business. In addition, key suppliers may
have issues relating to the Year 2000 that could affect their ability to
provide needed products and services.
We are conducting a formal review of our products, our internal network
system, the hardware and software tools we are using and our key suppliers
regarding the potential impact on us regarding Year 2000 issues. The review is
being conducted by representatives from our finance, manufacturing, engineering,
purchasing and systems administration departments. We believe there is no
significant exposure relating to our MTA system and its Unix-based operating
system. We expect that our formal review will be largely completed as to other
matters by the end of the second quarter of 1999.
Based upon the responses to date and informal inquiries, we believe no
significant modifications to our internal network or computer systems are
necessary to address Year 2000 issues. We installed a materials requirement
planning II system in 1998 that is Year 2000 compliant. We have received
assurances that the services provided at our new offices in Seattle are Year
2000 compliant, except for one system that our landlord has agreed to remedy.
Our review is ongoing with respect to our other internal systems and the various
software development tools we use. We are making inquiries of our suppliers and
service providers to obtain assurances concerning their Year 2000 compliance and
their ability to continue to provide products and services to us which are Year
2000 compliant. We have assumed that basic public utilities will continue to be
available to us after January 1, 2000, and are not aware of any information to
the contrary. To date we have not identified any material deficiencies or
remediation requirements and have not budgeted for any remediation costs or
costs associated with responding to other parties' Year 2000 noncompliance. The
Company does not separately track the internal costs for its Year 2000 review,
and current and future anticipated costs are expected to include only payroll
and related costs for the employees engaged in the review. We are reevaluating
these positions periodically as we continue our review.
At this point we cannot predict the effect of the Year 2000 issues on our
suppliers or the resulting effect on us. We have not yet developed a contingency
plan of operating in the event that critical systems of vendors, suppliers or
other third parties are not Year 2000 compliant, or that the software
development tools, software programs and equipment we use internally are not
Year 2000 compliant. We plan on completing a contingency plan once our inquiries
are completed and to have a contingency plan in place by the end of the third
quarter of 1999. If any of our critical systems are not Year 2000 compliant or
if critical suppliers from whom we obtain products and services are not Year
2000 compliant, then Year 2000 issues could have a material adverse effect on
our business, financial condition and results of operations.
36
<PAGE> 37
LIQUIDITY AND CAPITAL RESOURCES
Since our inception in 1987 through December 31, 1998, our principal sources
of liquidity have been net proceeds from the sale of equity totaling $73.1
million, DARPA research funding and subcontracts totaling $19.3 million and
sales receipts of approximately $2.0 million. At December 31, 1998, we had $3.2
million in cash and had no bank line of credit.
During 1998, we spent almost $22.9 million of cash on operating activities,
up from $17.7 million in 1997. During 1999, our operating activity expenses will
depend primarily upon personnel costs, the cost of inventory and third party
engineering expenses related to future implementations of the MTA system,
primarily the conversion to CMOS technology. Our overall wages and benefits
increased from $6.2 million in 1997 to $9.2 million in 1998, while total
expenses related to inventory, including inventory additions and scrap,
increased in 1998 to approximately $12.7 million, a $7 million increase over
1997. We expect that personnel costs will continue to increase in 1999, although
not as rapidly as in 1997 and 1998 as we have slowed the growth of personnel
pending the receipt of additional sales orders. Similarly, we expect inventory
costs to decrease in 1999, since we plan only modest inventory additions pending
receipt of purchase orders. In 1998, we incurred third party engineering
expenses related to the CMOS implementation of the MTA system of $1.7 million
and we expect those expenditures to increase in 1999.
In 1998, our investing activity consisted of additional property, plant and
equipment of over $2 million, of which $1.2 million was spent on computer and
electronic test equipment, $400,000 on leasehold improvements and $373,000 on
computer software.
In 1998, we raised approximately $14.8 million through the sale of
securities, primarily through sales of $14.0 million preferred stock and common
stock in private placements and stock option and warrant exercises for the
balance. We believe that in addition to our current funds and revenue from
anticipated sales of MTA systems, we will need to raise at least $12 million in
equity and debt financings in 1999 to meet our contractual commitments, which
principally consist of operating leases and licenses for software tools and
third-party engineering services pertaining to the CMOS implementation of our
MTA system, and to continue our present level of business activities in 1999 and
beyond. See "Business--Risk Factors--Additional Shares Issuable By Us Would
Dilute Existing Shareholdings and Could Hinder Our Ability To Obtain Additional
Financing." The Company is seeking a lease line of credit for capital goods for
up to $1.5 million. If we were unable to raise the necessary funds, then we
would delay inventory purchases, reduce third-party engineering services and
reduce personnel. We believe that we will be cash-flow positive once we have
sales receipts of approximately $10 million per quarter; we do not anticipate
such level of sales prior to 2000, if then.
In certain circumstances, the holders of our Series B Convertible Perferred
Stock and common stock with adjustment rights could demand that we repurchase
such shares. These circumstances generally relate to the inability of such
holders to sell their shares in market transactions, material defaults by us
in performing under the relevant transaction documents, a merger or
consolidation resulting in a change of control and an inability by us, as a
result of applicable Nasdaq rules, to issue all the shares of common stock that
the holders would be entitled. If the event giving rise to this repurchase
obligation was not within our sole control, such as a decline in the market
price of our common stock, then we could elect not to repurchase these shares.
To the extent that the events giving rise to any such repurchase obligation are
within our control, we plan to conduct our operations so as not cause any event
that would give rise to a repurchase obligation. If the event giving rise to
any such repurchase obligation is within our control, we likely would be unable
to repurchase any shares delivered to us for repurchase absent receipt of
additional capital. We would be subject to certain penalties for failure to
repurchase any such shares in these circumstances. See Note 9 of the Notes to
Financial Statements for further information regarding these obligations.
In the first quarter of 1999, we raised over $7 million in equity and debt
financings, and an investor has an option to invest another $5 million later
this year. We will require further
37
<PAGE> 38
additional working capital if anticipated sales of the MTA system are
substantially delayed. We plan to raise additional equity capital in 1999, even
if revenues are received from sales of MTA systems when anticipated, in order to
enhance our financial position for future operations. There can be no assurance
that any additional financing will be available on acceptable terms when needed
or, if available, will be available on satisfactory terms or that such
financings will not be dilutive to our shareholders. See "Business--Risk
Factors--Additional Shares Issuable By Us Would Dilute Existing Shareholdings
and Could Hinder Our Ability To Obtain Additional Financing."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
Substantially all of our cash equivalents and marketable securities are held
in money market funds or commercial paper of less than 90 days that is held to
maturity. Accordingly we believe that the market risk arising from our holdings
of these financial instruments is minimal. All of our current contract payments
are payable in U.S. dollars, and consequently we do not have any foreign
currency exchange risks. We do not hold any derivative instruments and have not
engaged in hedging transactions.
38
<PAGE> 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Balance Sheets at December 31, 1997 and December 31, 1998............................F1
Statements of Operations for each of the three years in the period ended
December 31, 1998................................................................F2
Statements of Shareholders' Equity for each of the three years in the period ended
December 31, 1998................................................................F3
Statements of Cash Flows for each of the three years in the period ended
December 31, 1998................................................................F4
Notes to Financial Statements........................................................F5
Independent Auditors' Report........................................................F19
</TABLE>
QUARTERLY FINANCIAL DATA
(In thousands, except per share data)
The following table presents unaudited quarterly financial information for
the two years ended December 31, 1998. In the opinion of management, this
information contains all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation thereof. The operating results
are not necessarily indicative of results for any future periods.
<TABLE>
<CAPTION>
1997 1998
------------------------------------------- -------------------------------------------
For the Quarter Ended: 3/31 6/30 9/30 12/31 3/31 6/30 9/30 12/31
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue $ $ $ $ 74 $ 21 $ 1,527 $ 232 $ 208
Cost of Sales 52 16 1,429 209 161
Manufacturing Costs and
Inventory Adjustments 920 1,608
Research and Development 2,044 3,068 3,871 4,564 4,313 3,561 2,425 3,619
Marketing and Sales 165 208 262 484 410 374 484 562
General and Administrative 306 393 367 495 475 505 516 635
Net Loss (2,415) (3,565) (4,275) (5,500) (5,061) (4,299) (4,154) (6,290)
Amortization of Preferred
Stock Discount (26) (337) (484) (1,980) (465)
Loss for Common Stock (2,441) (3,940) (4,775) (7,516) (5,191) (4,393) (4,760) (6,392)
Loss Per Common Share,
Basic and diluted $ (0.37) $ (0.55) $ (0.46) $ (0.69) $ (0.46) $ (0.37) $ (0.39) $ (0.47)
</TABLE>
The Company's future operating results may be subject to quarterly
fluctuations as a result of a number of factors, including the timing of
deliveries of the Company's products.
39
<PAGE> 40
See "Business--Risk Factors." Quarter-to-quarter comparisons should not be
relied upon as indicators of future performance.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
40
<PAGE> 41
TERA COMPUTER COMPANY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BALANCE SHEETS
DECEMBER 31, DECEMBER 31,
1997 1998
----------- -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 13,329,115 $ 3,161,867
Accounts receivable 99,696 378,933
Related party receivable 368,008 306,819
Inventory 4,290,873 10,246,029
Advances to suppliers 325,385 415,834
Prepaid expenses and other assets 410,754 585,008
----------- -----------
Total current assets 18,823,831 15,094,490
Property and equipment, net 1,914,925 4,501,613
Lease deposits 120,629 537,101
Other long-term assets 155,033
----------- -----------
Total assets $ 20,859,385 $ 20,288,237
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 2,138,343 $ 5,470,617
Accrued payroll and related expenses 1,713,553 1,544,056
Deferred revenue 19,178
Contract adjustment reserve 250,000 250,000
Current portion of obligations under capital leases 379,597 542,045
----------- -----------
Total current liabilities 4,481,493 7,825,896
Obligations under capital leases
less current portion 532,321 573,054
Commitments and contingencies
Redeemable Securities:
Preferred Stock, par $.01 - Authorized 5,000,000 shares;
issued and outstanding, 10,000 and 0 shares of Series A Convertible 9,477,709
Shareholders' equity:
Preferred Stock, par $.01 - Authorized, 5,000,000 shares;
issued and outstanding, 0 and 6,000 shares of Series B Convertible 5,674,406
Common Stock, par $.01 - Authorized, 25,000,000 shares;
issued and outstanding, 11,248,096 and 14,204,430 shares 49,168,180 68,744,437
Preferred stock dividend distributable 75,000
Accumulated deficit (42,800,318) (62,604,556)
----------- -----------
Total shareholders' equity 6,367,862 11,889,287
----------- -----------
Total liabilities and shareholders' equity $ 20,859,385 $20,288,237
=========== ===========
</TABLE>
See accompanying notes
F-1
<PAGE> 42
TERA COMPUTER COMPANY
- --------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Product and other revenue $ $ $ 1,274,323
Service revenue 73,531 713,670
----------- ----------- -----------
73,531 1,987,993
----------- ----------- -----------
Operating expenses:
Cost of product and other revenue 1,231,494
Cost of service revenue 51,891 584,045
Manufacturing costs and inventory
adjustments 2,528,124
Research and development 10,503,747 13,546,785 13,917,696
Marketing and sales 664,911 1,119,431 1,830,457
General and administrative 1,057,168 1,561,145 2,131,261
----------- ----------- -----------
12,225,826 16,279,252 22,223,077
----------- ----------- -----------
Research funding 185,236 349,407 253,469
----------- ----------- -----------
Loss from operations (12,040,590) (15,856,314) (19,981,615)
Other income/(expense) (36,748) 101,085 177,377
----------- ----------- -----------
Net loss (12,077,338) (15,755,229) (19,804,238)
Preferred stock dividend (89,964) (467,657)
Amortization of preferred stock discount (6,728,603) (2,827,242) (464,733)
----------- ----------- -----------
Loss for common stock $ (18,805,941) $ (18,672,435) $ (20,736,628)
=========== =========== ===========
Loss per common share, basic and diluted $ (3.53) $ (2.13) $ (1.70)
=========== =========== ===========
Weighted average shares outstanding, basic
and diluted 5,320,785 8,784,943 12,211,875
=========== =========== ===========
</TABLE>
See accompanying notes
F-2
<PAGE> 43
TERA COMPUTER COMPANY
- --------------------------------------------------------------------------------
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series B Convertible
Preferred Stock Common Stock
------------------------ ---------------------------------
Number of Number of
Shares Amount Shares Amount
-------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
BALANCE, January 1, 1996 3,889,455 $ 19,059,818
Exercise of stock options 33,414 75,143
Exercise of warrants 213,946 2,149,995
Conversion of Series A preferred shares 2,360,000 6,888,194
Net loss
-------- ----------- ------------ ------------
BALANCE, December 31, 1996 6,496,815 28,173,150
Exercise of stock options 151,026 1,244,136
Exercise of warrants 198,729 118,125
Private placement, net of
issuance costs of $62,135 299,333 1,060,405
Issuance of shares under Employee
Stock Purchase Plan 40,736 192,661
Exercise of redeemable stock purchase
warrants net of issuance costs of $66,989 2,838,665 10,585,646
Conversion of Series B preferred shares 740,266 2,814,386
Issuance of common stock for services 4,000 17,500
Conversion of Series C preferred shares 478,526 4,962,171
Net loss
-------- ----------- ------------ ------------
BALANCE, December 31, 1997 11,248,096 49,168,180
Exercise of stock options 153,234 219,629
Exercise of warrants 433,376 124,946
Issuance of shares under Employee
Stock Purchase Plan 29,820 271,085
Issuance of common stock for
leasehold improvements 175,975 1,313,653
Issuance of common stock for services 2,500 27,265
Common stock issued in
private placement 800,000 8,000,000
Issuance of common stock for
prepaid rent 12,982 96,911
Conversion of Series A preferred shares 1,342,123 9,477,709
Issuance of Series B preferred stock,
net of issuance costs of $325,594 6,000 5,674,406
Issuance of common stock for
accrued dividends 6,324 45,059
Preferred stock dividend
Net loss
-------- ----------- ------------ ------------
BALANCE, December 31, 1998 6,000 $ 5,674,406 14,204,430 $ 68,744,437
======== =========== ============ ============
</TABLE>
<TABLE>
<CAPTION>
Preferred
Stock Accumulated
Dividend Deficit Total
-------- -------------- ------------
<S> <C> <C> <C>
BALANCE, January 1, 1996 $(14,967,751) $ 4,092,067
Exercise of stock options 75,143
Exercise of warrants 2,149,995
Conversion of Series A preferred shares 6,888,194
Net loss (12,077,338) (12,077,338)
------- -------------- ------------
BALANCE, December 31, 1996 (27,045,089) 1,128,061
Exercise of stock options 1,244,136
Exercise of warrants 118,125
Private placement, net of
issuance costs of $62,135 1,060,405
Issuance of shares under Employee
Stock Purchase Plan 192,661
Exercise of redeemable stock purchase
warrants net of issuance costs of $66,989 10,585,646
Conversion of Series B preferred shares 2,814,386
Issuance of common stock for services 17,500
Conversion of Series C preferred shares 4,962,171
Net loss (15,755,229) (15,755,229)
------- -------------- ------------
BALANCE, December 31, 1997 (42,800,318) 6,367,862
Exercise of stock options 219,629
Exercise of warrants 124,946
Issuance of shares under Employee
Stock Purchase Plan 271,085
Issuance of common stock for
leasehold improvements 1,313,653
Issuance of common stock for services 27,265
Common stock issued in
private placement 8,000,000
Issuance of common stock for
prepaid rent 96,911
Conversion of Series A preferred shares 9,477,709
Issuance of Series B preferred stock,
net of issuance costs of $325,594 5,674,406
Issuance of common stock for
accrued dividends 45,059
Preferred stock dividend 75,000 75,000
Net loss (19,804,238) (19,804,238)
------- -------------- ------------
BALANCE, December 31, 1998 $75,000 $(62,604,556) $ 11,889,287
======= ============== ============
</TABLE>
See accompanying notes.
F-3
<PAGE> 44
TERA COMPUTER COMPANY
- --------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Operating activities
Net loss $(12,077,338) $(15,755,229) $(19,804,238)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization 836,964 801,753 802,663
Loss on disposal of assets 20,616 8,087
Cash provided (used) by changes in operating assets and liabilities:
Accounts receivable 2,020 (59,651) (279,237)
Inventory (851,960) (3,438,913) (5,955,156)
Other assets 89,772 (303,131) (745,759)
Accounts payable and other accrued liabilities 384,127 1,068,100 3,332,274
Accrued payroll and related expenses 420,345 583 (169,497)
Deferred revenue 19,178
Advances to suppliers 672,895 (15,308) (90,449)
------------ ------------ ------------
Net cash used by operating activities (10,502,559) (17,693,709) (22,890,221)
Investing activities
Purchases of property and equipment (423,151) (1,542,344) (2,075,698)
Proceeds from disposal of assets 24,500
------------ ------------ ------------
Net cash used by investing activities (398,651) (1,542,344) (2,075,698)
Financing activities
Related party (receivable)/payments (368,008) 61,189
Shareholder (receivable)/payments (1,074,997) 1,074,997
Sale of common stock 2,226,407 21,927,031 8,859,895
Sale of preferred stock 6,886,925 8,545,709 5,674,406
Capital leases, net (493,085) 456,679 203,181
------------ ------------ ------------
Net cash provided by financing activities 7,545,250 31,636,408 14,798,671
------------ ------------ ------------
Net increase/(decrease) in cash and cash equivalents (3,355,960) 12,400,355 (10,167,248)
Cash and cash equivalents
Beginning of year 4,284,720 928,760 13,329,115
------------ ------------ ------------
End of year $ 928,760 $ 13,329,115 $ 3,161,867
============ ============ ============
Supplemental disclosure of cash flow information
Cash paid for interest $ 117,732 $ 97,598 $ 201,803
============ ============ ============
</TABLE>
Non-cash investing and financing activities
The Company issued 175,975 shares of common stock for leasehold improvements of
$1,313,653 on December 21, 1998.
Preferred stock in the amount of $9,477,709 was converted into 1,342,123 shares
of common stock in 1998.
Preferred stock in the amount of $7,776,557 was converted into 1,218,792 shares
of common stock in 1997.
Preferred stock in the amount of $6,888,000 was converted into 2,360,000 shares
of common stock in 1996.
See accompanying notes.
F-4
<PAGE> 45
TERA COMPUTER COMPANY
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1 DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
BUSINESS Tera Computer Company ("Tera" or the "Company") designs,
builds and sells high performance general-purpose parallel
computer systems based on its unique multiheaded architecture,
the "MTA system." The MTA system addresses a wide range of
scientific and engineering applications and is suited for
emerging commercial applications.
GOING CONCERN The Company has experienced significant operating
losses since inception in 1987. The accompanying financial
statements have been prepared assuming the Company will continue
as a going concern. These losses have been primarily funded by
sales of stock. In 1998 the Company emerged from being a
development stage enterprise with its first product sale.
However, revenue levels have not yet been achieved to sustain
operations and generate positive cash flows. Management plans to
sustain operations through product sales, additional equity and
debt financings, and/or other financing arrangements with
investors and financial institutions. The Company raised more
than $37 million in equity and debt financings in the first six
months of 1999 (See Note 12 Subsequent Events). The Company is
seeking a lease line of credit for capital goods for up to $1.5
million. If the Company does not have product sales when
anticipated, it would need to raise additional funds. If the
Company were not able to raise the necessary funds when needed,
it would delay inventory purchases, reduce or delay third-party
engineering services and reduce personnel.
REVENUE RECOGNITION Tera generally recognizes revenue from
product sales upon customer acceptance; however, depending on
sales contract terms, revenue may be recognized upon shipment, or
delayed until clarification of funding. Maintenance revenues are
recognized ratably over the term of the maintenance contract.
Service revenues are recognized as services are performed.
In April 1998 Tera recognized its first revenue from product
sales with its delivery of a two-processor MTA system to the San
Diego Supercomputer Center ("SDSC"). In December 1998 the Company
installed a four-processor MTA system at SDSC. After testing and
evaluation, the system was accepted by SDSC in January 1999. Upon
receipt of purchase orders, the Company plans to upgrade the SDSC
system in stages to larger configurations as it receives
production
F-5
<PAGE> 46
printed circuit boards, integrated circuits and other components
that are integrated into a commercially acceptable system.
Tera's service revenues in 1997 and 1998 were for services
performed under an evaluation subcontract with the SDSC, which is
the prime contractor with the Defense Advanced Research Projects
Agency. This subcontract has been extended to June 30, 1999.
RESEARCH FUNDING In September 1995, the Company entered into a $1
million, three-year, cost-sharing contract with the Defense
Advanced Research Projects Agency. As of December 31, 1998, the
Company had billed $795,000 under this contract. This contract
has been extended to September 30, 1999. Under the terms of this
contract, the Company recognizes research funding as allowable
costs attributable to the performance of the contract are
incurred.
RESEARCH AND DEVELOPMENT Research and development costs include
costs incurred in the development and production of the Company's
initial prototype system, hardware and software development
expenses, costs incurred to enhance and support existing software
features and expenses related to future implementations of the
MTA system. Research and development costs are expensed as
incurred. Statement of Financial Accounting Standards SFAS No.
86, Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed, does not materially impact the
Company.
CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of
highly liquid financial instruments that are readily convertible
to cash and have original maturities of three months or less at
the time of acquisition.
INVENTORIES Inventories are stated at the lower of cost (first
in, first out) or market. The Company regularly reevaluates the
technological usefulness of various inventory components as it
builds larger MTA system configurations. When it is discovered
that previously inventoried components do not function as
intended in a fully operational system scalable to multiple
processors, the costs associated with these components are
expensed. The Company included these costs as a part of its
research and development expenses for the first six months of
1998 and classified these costs as part of manufacturing costs
and inventory adjustments for the second six months of 1998.
PROPERTY AND EQUIPMENT Property and equipment are recorded at
cost less accumulated depreciation and amortization. Depreciation
is calculated on a straight-line basis over the estimated useful
lives of the related assets, ranging from three to seven years.
Equipment under capital leases is depreciated over the lease
term. Leasehold improvements are amortized over the lesser of
their estimated useful lives or the term of the lease.
LONG-LIVED ASSETS Management periodically evaluates long-lived
assets, consisting primarily of property and equipment, to
determine whether there has been any impairment of the value of
these assets and the appropriateness of their remaining useful
lives. No impairment loss has been recognized through December
31, 1998.
F-6
<PAGE> 47
FAIR VALUES OF FINANCIAL INSTRUMENTS At December 31, 1998 the
Company had the following financial instruments: cash and cash
equivalents, accounts receivable, accounts payable, accrued
liabilities and capital lease obligations. The carrying value of
cash and cash equivalents, accounts receivable, accounts payable
and accrued liabilities approximates their fair value based on
the liquidity of these financial instruments or based on their
short-term nature. The carrying value of capital lease
obligations approximates fair value based on the market rates
available to the Company for debt of similar risk and maturities.
INCOME TAXES The Company accounts for taxes under SFAS No. 109,
Accounting for Income Taxes.
LOSS PER SHARE Basic and diluted net loss per share is computed
based on the weighted average number of shares of common stock
outstanding.
In 1997, SFAS No. 128, Earnings per Share replaced the
calculation of primary and fully diluted earnings per share with
basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of
options, warrants and convertible securities. Diluted earnings
per share is very similar to the previously designated fully
diluted earnings per share. Because Tera's stock options and
warrants are not dilutive (due to net losses), there is no
difference between basic and diluted net loss per share.
USE OF ESTIMATES Preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
NOTE 2 SIGNIFICANT RISKS AND UNCERTAINTIES
MANUFACTURING RISKS AND RELIANCE ON THIRD-PARTY SOLE SOURCE
SUPPLIERS Tera subcontracts the manufacture of substantially all
of its hardware components, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a
sole or limited source basis to third party suppliers. The
manufacture of these components is a difficult and complex
process. The Company's suppliers have previously experienced, and
may in the future again experience, problems in manufacturing the
components to the Company's design and quantity specifications.
Future manufacturing difficulties or limitations of the suppliers
could result in:
- substantial delays in the delivery of necessary hardware
components to the Company;
- a material and adverse affect on the Company's ability
to complete and deliver production models of the MTA
system;
- a limitation on the number of MTA systems that can be
produced using such components to fill future orders;
unacceptably high prices
F-7
<PAGE> 48
- for those components, with a resulting loss of
profitability or loss of competitiveness for the
Company's products; and
- increased demands upon the Company's financial
resources.
Absent improved yields, increased production capacity or a
reallocation of such suppliers' output to meet the Company's
needs, the Company may be unable to obtain a sufficient quantity
of suitable components to meet future production and delivery
schedules. The Company is exposed to these additional risks based
on its reliance on third party suppliers:
- some of the Company's key suppliers are small companies
with limited financial and other resources, and
consequently may be more likely to experience financial
difficulties than larger, well established companies;
- any or all of the Company's suppliers may make strategic
changes in their product lines, which may result in the
delay or suspension of manufacture of the Company's
components or systems;
- if a reduction or interruption of supply of the
Company's components occurred, it could take the Company
a considerable period of time to identify and qualify
alternative suppliers to redesign its products as
necessary and recommence manufacture; and
- if the Company were ever unable to locate a supplier for
its components, it would be unable to produce and
deliver its products, which would materially and
adversely affect the Company's business and results of
operations.
MARKETING RISKS The Company's initial market for early sales are
U.S. and foreign government agencies and research laboratories.
If the U.S. or foreign governments were to reduce or delay
funding programs employing high performance computing, then the
Company's initial target markets would be seriously adversely
affected.
In order to expand its market beyond the very high performance
scientific market, and particularly beyond government agencies
and research laboratories, to engineering and other commercial
markets, the Company must be able to attract independent software
vendors to port their software application programs so that they
will run on the MTA system. The Company also plans to modify and
port third-party software applications to the MTA system to
facilitate the expansion of its potential markets. There can be
no assurance that the Company will be able to induce independent
software vendors to port their applications, or that the Company
will successfully port third-party applications to the MTA
system, and the failure to do so could materially and adversely
affect the Company's business and results of operations.
RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS Rapidly changing
technology, accelerated product obsolescence and rapidly changing
industry standards characterize the Company's market. The
Company's success will depend upon its ability to complete
development of the MTA system and to introduce new
F-8
<PAGE> 49
features in a timely manner to meet evolving customer
requirements. The Company may not succeed in these efforts. The
Company's business and results of operations will be materially
and adversely affected if the Company incurs delays in developing
its products or if such products do not gain broad market
acceptance. In addition, products or technologies developed by
others may render the Company's products or technologies
noncompetitive or obsolete.
NOTE 3 BALANCE SHEET INFORMATION
Detailed balance sheet data is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 1998
------------ ------------
<S> <C> <C>
Inventory
Components and subassemblies $ 3,801,381 $ 9,346,646
Work in process 885,753 252,000
Finished goods 922,501
Inventory allowance (396,261) (275,118)
------------ ------------
$ 4,290,873 $ 10,246,029
============ ============
Finished goods primarily consist of components necessary to upgrade
a two processor MTA system to four processors. These components were
shipped to a customer in December, 1998 and the four processor MTA
system was accepted by the customer in January, 1999
Prepaid expenses and other assets
Current deposits $ 272,982 $ 439,509
Prepaid insurance 137,772 145,499
------------ ------------
$ 410,754 $ 585,008
============ ============
Current deposits consist of the current portion of the initial
deposit paid for capitalized leased equipment and prepayments made on
service contracts
Property and equipment
Computer and electronic test equipment $ 3,337,827 $ 4,564,855
Computer software 886,030 1,260,943
Furniture and fixtures 347,117 385,489
Leasehold improvements 1,749,039
------------ ------------
Total property and equipment 4,570,974 7,960,326
Accumulated depreciation and amortization (2,656,049) (3,458,713)
------------ ------------
$ 1,914,925 $ 4,501,613
============ ============
</TABLE>
At December 31, 1997 and 1998, Tera held equipment under
capitalized leases with an original cost of $1,695,312 and $1,620,987
and a net book value of $890,786 and $1,160,194, respectively.
NOTE 4 RELATED PARTY RECEIVABLE
During 1998, Tera accepted promissory notes in the aggregate
principal amount of $395,515 as collateral for payment by the
Company of the option exercise prices aggregating $53,954 and
federal income taxes due from the exercise of employee stock
options aggregating $341,561. These notes replaced promissory
notes in the aggregate principal amount of $317,716
F-9
<PAGE> 50
originally issued during 1997. The notes are due and payable in
twelve months and bear interest at a rate of 4.33% per year.
These notes and the unpaid accrued interest are secured by a
pledge of shares of Tera's common stock. The Company's rights to
payment are not limited to such security. For financial statement
presentation, the amount of $53,954 related to subscribed stock
has been excluded from both the outstanding receivable and
contributed capital balances.
NOTE 5 LEASE AGREEMENTS
Tera leases certain property and equipment under capital leases
pursuant to master equipment lease agreements. Under such
agreements, the Company has acquired computer and other equipment
in the amount of $890,785 and $684,476, net of accumulated
amortization of $804,526 and $460,793 in 1997 and 1998. See Note
3 above. The capital lease line of credit for $800,000, of which
$500,000 had been expended as of December 31, 1997, expired on
that date. An interim lease line of credit for $425,000 was
granted on January 9, 1998 and expired on April 30, 1998.
In December 1998 the Company occupied new facilities for its
Seattle operations pursuant to a ten-year operating lease, which
may be extended at the option of the Company for an additional
five years. Under this lease, Tera initially occupies 85,000
square feet; in June 2000 it will occupy 95,000 square feet and
in December 2001 it will occupy approximately 131,000 square
feet. Sales offices in the United States, France and Japan are
rented pursuant to month-to-month or similar arrangements.
Minimum lease commitments are:
<TABLE>
<CAPTION>
Capital Operating
leases leases
------------ -------------
<S> <C> <C>
1999 $ 684,368 $ 1,997,789
2000 566,554 1,864,165
2001 208,934 2,000,689
2002 2,479,785
2003 2,491,059
Thereafter 13,263,287
------------ -------------
1,459,856 $ 24,096,774
=============
Less amounts representing interest 344,757
------------
$ 1,115,099
============
</TABLE>
Lease expenses for 1996, 1997, and 1998 were $585,017, $601,215
and $664,606, respectively.
NOTE 6 COMMITMENTS
The Company is contractually committed to acquire components, and
manufacturing and engineering services totaling $1,945,000 of
which $416,000 had been advanced to suppliers as of December 31,
1998. Commitments are for goods and services to be provided to
Tera by either specific dates or by achieving milestones
identified in the contracts.
F-10
<PAGE> 51
NOTE 7 FEDERAL INCOME TAXES
Due to continued losses from operations, there has been no
provision for federal income taxes for any period.
As of December 31, 1996, 1997 and 1998, the Company had federal
net operating loss carryforwards of approximately $24,063,000,
$39,153,000 and $60,732,000, respectively. The Company also had
federal research and experimentation tax credit carryforwards of
approximately $1,283,000, $1,825,000 and $2,454,000,
respectively. The net operating loss credit carryforwards will
expire at various dates beginning in 2003 through 2018 if not
utilized.
Due to the issuance and sale of shares of convertible preferred
stock and the Company's initial public offering, Tera incurred
an "ownership change" pursuant to applicable regulations in
effect under the Internal Revenue Code of 1986, as amended.
Therefore, Tera's use of losses incurred through the date of
the ownership change will be limited during the carryforward
period. The Company estimates that net operating loss
carryforwards incurred prior to the public offering are limited
to an annual utilization of approximately $700,000. The
research and experimentation credit is similarly limited. The
annual limitation may result in the expiration of net operating
losses and credits before utilization.
Deferred income taxes reflect the net tax effects of temporary
differences between the tax basis of assets and liabilities and
the corresponding financial statement amounts. Significant
components of the Company's deferred income tax assets are as
follows:
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Contract adjustment reserve $ 85,000 $ 85,000
Inventory reserve 94,000
Accrued compensation 236,000 211,000
Other 6,000 (40,000)
Research and experimentation 1,825,000 2,454,000
Net operating loss carryforwards 13,312,000 20,649,000
State tax loss carryforwards 613,000
------------ ------------
Net deferred tax assets 15,464,000 24,066,000
Valuation allowance for deferred tax assets (15,464,000) (24,066,000)
------------ ------------
Deferred tax balance $ -- $ --
============ ============
</TABLE>
The Company has fully reserved its deferred tax assets.
Management believes sufficient uncertainty exists regarding the
realizability of the deferred tax assets such that a full
valuation allowance is required. The net change in the valuation
allowance during the years ended December 31, 1997 and 1998 was
$5,464,000 and $8,602,000, respectively.
<TABLE>
The following table reconciles the federal statutory income tax
rate to the Company's effective tax rate.
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Federal income tax rate 34% 34% 34%
Effect of net operating loss
carryforward and valuation
allowance (34%) (34%) (34%)
----- ----- -----
Effective income tax rate - - -
===== ===== =====
</TABLE>
F-11
<PAGE> 52
NOTE 8 REDEEMABLE SECURITIES
In December 1997, the Company issued 10,000 shares of Series A
Convertible Preferred Stock with a stated value of $1,000 per
share, for proceeds of $9,477,709, net of issuance costs of
$522,291, along with five-year common stock purchase warrants to
purchase a total of 125,000 shares with an exercise price of
$19.19 per share. All shares of the Series A Preferred Stock were
converted into shares of Common Stock by December 31, 1998.
NOTE 9 SHAREHOLDERS' EQUITY
PREFERRED STOCK In 1997, the Company issued 3,000 shares of
Series B convertible preferred stock for $2,814,386, net of
issuance costs of $170,898, and 5,000 shares of Series C
convertible preferred stock for $4,962,171, net of issuance costs
of $37,829, in two private placements. All shares of the Series B
and Series C convertible preferred stock were converted into
shares of common stock during 1997.
In 1998, the Company issued 6,000 shares of Series B convertible
preferred stock at a stated value of $1,000 per share, for
proceeds of $5,674,406, net of issuance costs of $325,594, along
with five year common stock purchase warrants to purchase a total
of 100,000 shares with an exercise price of $15.00 per share.
Each share of the Series B convertible preferred stock is
convertible at the option of the holder at a conversion price
equal to the lesser of $14.52 or 100% of the lowest sales price
during the five consecutive trading days ending one day prior to
the date on which a notice of conversion is delivered to the
Company, with the conversion price subject to adjustments in
certain conditions. For example, if 100 shares of Series B
convertible preferred stock were converted on a certain date, and
if the lowest sales price during the five trading days preceding
the conversion date were $6.00, then the Company would issue
16,666 shares of common stock, determined by multiplying the
number of shares times the stated value of $1,000 (100 X $1,000 =
$100,000) and dividing the result by $6.00, the lowest sales
price. Similarly, if the lowest sales price were $10.00, then the
Company would issue 10,000 shares of common stock.
The holders of the Series B convertible preferred stock are
entitled to receive quarterly dividends at the rate of 5% of the
stated value per annum (or $50.00 per share). Dividends accrue
from the date of issuance through and including the date that the
shares are converted or redeemed. Dividends may be paid in cash
or common stock, at the Company's option, based on the lowest
sale price during the five trading days preceding the date of
payment.
The Company may redeem any or all of the Series B convertible
preferred shares at any time upon a minimum of 20 days notice at
a redemption price equal to the greater of (i) the sum of the
stated value of the shares being redeemed and the accrued and
unpaid dividends thereon times 115% plus any dividends in
arrears, or (ii) the product of the number of shares of common
stock issuable upon conversion of the shares being redeemed,
including any accrued and unpaid dividends thereon and any
dividends in arrears, and the arithmetic average of the closing
prices of the common stock during the five trading days
immediately prior to the redemption date.
F-12
<PAGE> 53
The Company may be required to redeem the Series B convertible
preferred stock upon the occurrence of certain specified events,
provided that such event was within the Company's sole control.
These events include: (a) the absence of a closing bid price for
the common stock for five consecutive trading days; (b) the
common stock ceases to be listed for trading on the Nasdaq
National Market System or SmallCap Market or other specified
exchanges; (c) a holder is unable to sell his or her shares of
common stock for a period of 30 days pursuant to a registration
statement covering those shares; (d) the Company defaults in
performing a material obligation pursuant to the subscription
agreement and any other agreements between the Company and the
holder; (e) the Company is involved in a merger or consolidation
pursuant to which the Company's shareholders prior to the
transaction do not hold at least 51% of the voting securities of
the surviving corporation or the common stock of the surviving
corporation is not listed for trading on the Nasdaq National
Market System or SmallCap market or specified exchanges; or (f)
to the extent that the Company would be required to issue more
than 2,437,500 shares of common stock. If such an event were to
occur and an investor delivered a notice of redemption, the
Company would be required to redeem the shares of Series B
convertible preferred stock at the redemption price described
above.
If, however, the event was caused by circumstances that were not
within the sole control of the Company, the Company may elect not
to redeem the shares. In such event the conversion percentage,
currently 100%, shall be reduced by six percentage points and the
ceiling price, currently $14.52, shall be reduced by six percent,
for each for each 30 days that the underlying event continues to
exist.
COMMON STOCK WITH ADJUSTMENT RIGHTS In September and December
1998, the Company issued an aggregate of 800,000 shares of common
stock for an aggregate of $8,000,000, before issuance costs of
approximately $85,000, along with five year common stock purchase
warrants to purchase a total of 161,344 shares with an exercise
price of $10.04 per share. The shares of common stock have
certain "adjustment rights" pursuant to which the Company may be
required to issue additional shares of common stock or common
stock purchase warrants if the market price of the common stock
is less than a specified target value (initially $12.00) on
certain "measurement dates," determined by the average of the
closing bid prices for the common stock for the fifteen trading
days preceding the applicable measurement date. Thus if the
target value were $12.00 and the market price as of the
measurement date were $8.00, and an investor held 400,000 shares
of the common stock with adjustment rights, then the ratio of
$12.00/$8.00 times the 400,000 shares held results in a total of
600,000 shares; subtracting the original 400,000 shares, the
Company would issue an additional 200,000 shares. From then on,
the new target value would be $8.00 per share.
The original agreements were amended by the Company and the
holders of these shares in March 1999. Pursuant to the amended
agreements, the original 800,000 shares were divided into two
pools: with respect to the first 400,000 (the "Pool A shares")
the Company issued adjustment warrants, exercisable at $0.01
per share for ten years, to purchase an aggregate of 536,585
shares of common stock. The initial target value with respect
to the Pool A Shares and shares issuable upon exercise of the
adjustment warrants is $6.50, and the initial target value with
respect to the
F-13
<PAGE> 54
remaining 400,000 (the "Pool B Shares") remains at $12.00. Under
the agreements as amended, the Company may issue shares of common
stock or warrants upon subsequent adjustments.
The next measurement date is May 22, 1999. Subsequent measurement
dates are every three months thereafter through September 30,
2001. The adjustment provisions described above will operate
similarly for measurement dates after May 22, 1999, although if
the market price is less than the applicable target value on such
measurement dates, then the number of shares or adjustment
warrants to be issued will be increased by 1.25%, which reflects
a negotiated issuance premium.
The Company may repurchase any or all of the common shares with
adjustment rights and all adjustment warrants at any time upon a
minimum of 20 days notice at a repurchase price equal to the
greater of (i) the most recent adjustment price applicable to
such shares and warrants, or (ii) the product of the number of
shares and warrants being redeemed and the arithmetic average of
the closing market prices of the common stock during the five
trading days immediately prior to the redemption date.
The Company may be required to repurchase the shares of common
stock with repurchase rights, together with any adjustment
warrants issued, upon the occurrence of certain specified events,
provided that such event was within the Company's sole control.
These events include: (a) the absence of a closing bid price for
the common stock for five consecutive trading days; (b) the
common stock ceases to be listed for trading on the Nasdaq
National Market System or SmallCap Market or other specified
exchanges; (c) a holder is unable to sell his or her shares of
common stock for a period of 30 days pursuant to a registration
statement covering those shares; (d) the Company defaults in
performing a material obligation pursuant to the subscription
agreement and any other agreements between the Company and the
holder; (e) the Company is involved in a merger or consolidation
pursuant to which the Company's shareholders prior to the
transaction do not hold at least 51% of the voting securities of
the surviving corporation or the common stock of the surviving
corporation is not listed for trading on the Nasdaq National
Market System or SmallCap market or specified exchanges; or (f)
to the extent that the Company would be required to issue more
shares of common stock than permitted under Nasdaq Rule 4460(i).
If such an event were to occur and an investor delivered a notice
of repurchase, the Company would be required to repurchase the
common stock and adjustment warrants at the repurchase price
described above.
If, however, the event was caused by circumstances that were not
within the sole control of the Company, the Company may elect not
to repurchase the shares and warrants. In such event the Company
may be required to issue additional shares to the holders equal
to 6% of the shares of common stock with adjustment rights and
adjustment warrants for each for each 30 days that the underlying
event, continues to exist.
F-14
<PAGE> 55
SECURITYHOLDER WARRANTS At December 31, 1998, the Company had
outstanding warrants to purchase an aggregate of 1,072,936 shares
of common stock, as follows:
<TABLE>
<CAPTION>
Shares of Exercise Price Expiration
Common Stock per share Date of Warrants
- ---------------- --------------- -------------------
<S> <C> <C>
97,208 $ 6.00 February 28, 2000
20,321 14.09 September 24, 2000
90,488 6.00 December 31, 2001
317,250 3.94 April 21, 2002
155,000 4.50 June 25, 2002
125,000 19.19 December 23, 2002
100,000 15.00 June 30, 2003
161,344 10.04 September 28, 2003
5,801 6.00 November 7, 2005
524 6.00 May 21, 2006
- ----------------
1,072,936
================
</TABLE>
STOCK OPTION PLANS Tera has four stock option plans that provide
for option grants to employees, directors and others. Two of
these plans, the 1988 Employee Stock Option Plan and the 1993
Employee Stock Option Plan, were terminated by the Board of
Directors in 1995. Options granted under the Company's option
plans generally vest over four years or as otherwise determined
by the plan administrator. Options to purchase shares expire no
later than ten years after the date of grant.
A summary of Tera's stock option activity and related
information follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
--------- -------- ------- -------
<S> <C> <C> <C> <C>
Balance, January 1, 1996 995,852 $ 2.70 567,342 $ 1.42
Granted 890,650 5.21
Exercised (33,414) 1.36
Canceled (42,020) 4.45
---------
Balance, December 31, 1996 1,811,068 3.92 660,758 2.18
Granted 412,357 5.52
Exercised (151,026) 2.33
Canceled (36,494) 4.52
---------
Balance, December 31, 1997 2,035,905 4.37 931,309 3.25
Granted 742,090 8.44
Exercised (153,234) 1.43
Canceled (41,725) 6.61
---------
Balance, December 31, 1998 2,583,036 $ 5.68 1,158,125 $ 4.15
=========
Available for grant at
December 31, 1998 74,500
=========
</TABLE>
In 1997, the Company issued certain performance-based stock options to employees
for an aggregate of 59,324 shares of common stock; Messrs. Smith and Rottsolk
granted options on an equal number of shares of common stock that they held. All
these options were exercised in 1997 when the performance criteria were met, and
the Company recognized compensation expense of $832,000.
F-15
<PAGE> 56
Outstanding and exercisable options by price range as of December
31, 1998 are as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------- ----------------------------
Range of Weighted Weighted Weighted
Exercise Average Average Average
Price Number Remaining Exercise Number Exercise
Per share Outstanding Life (Years) Price Exercisable Price
- ------------------------------- ---------------- --------------- ----------- --------------- -----------
<S> <C> <C> <C> <C> <C> <C>
$ 0.35 - $ 3.00 296,314 2.1 $ 1.06 290,314 $ 1.09
3.01 - 6.00 1,515,070 7.3 5.21 850,237 5.15
6.01 - 9.00 762,652 9.5 8.33 17,574 6.72
12.01 - 15.00 9,000 9.3 13.69 - -
- ------------------------------- ---------------- --------------- ----------- --------------- -----------
$ 0.35 - $15.00 2,583,036 7.4 $ 5.68 1,158,125 $ 4.15
=============================== ================ =============== =========== =============== ===========
</TABLE>
In 1996, the Company established an Employee Stock Purchase Plan
(1996 ESPP). The maximum number of shares of the Company's common
stock that employees may acquire under the 1996 ESPP is 1,000,000
shares. Eligible employees are permitted to acquire shares of the
Company's common stock through payroll deductions not exceeding
15% of base wages. The purchase price per share under the 1996
ESPP is the lower of (a) 85% of the fair market value of the
Company's Common Stock at the beginning of each six month
offering period or (b) the fair market value of the Common Stock
at the end of each six month offering period.
FAIR VALUE INFORMATION The Company applies Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees
and related Interpretations in accounting for its stock option
and purchase plans. Had compensation cost for the Company's stock
option plans and its stock purchase plan been determined based on
the fair value at the grant dates for awards under those plans
consistent with the method of SFAS No. 123, Accounting for
Stock-Based Compensation, the Company's loss for common stock and
loss per common share for the years ended December 31, 1996,
1997, and 1998 would have been increased to the pro forma amounts
indicated below:
Loss for common stock -
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
As reported $(18,805,941) $(18,672,435) $(20,736,628)
Pro forma $(19,395,460) $(19,802,773) $(22,932,967)
Loss per common share -
</TABLE>
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
As reported $(3.53) $(2.13) $(1.70)
Pro forma $(3.65) $(2.25) $(1.88)
</TABLE>
F-16
<PAGE> 57
The estimated fair values of options granted during 1996, 1997
and 1998 were $4.76, $5.85 and $8.21 per share, respectively;
these fair values were estimated as of the dates of grant using
the Black-Scholes option-pricing model with the following
weighted-average assumptions: no dividend yield, expected
volatility of 94%, risk-free interest rate of 6.50%, 5.74% and
5.4% for 1996, 1997 and 1998, respectively, and an expected term
of 9.64 years. Pro forma compensation cost of options granted
under the 1996 ESPP is measured based on the discount from market
value.
NOTE 10 401(K) PLAN
The Company has a retirement plan covering substantially all
employees that provides for voluntary salary deferral
contributions on a pre-tax basis in accordance with Section
401(k) on the Internal Revenue Code of 1986, as amended. The
Company may make voluntary matching contributions in amounts
determined annually by the Board of Directors. As of December 31,
1998 the Company had contributed approximately $321,000 to the
Plan, and had accrued $139,000.
NOTE 11 RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, Reporting
Comprehensive Income, which establishes the standards for
reporting comprehensive income and its components in financial
statements. Comprehensive income as defined includes all changes
in equity during a period from non-owner sources. Examples of
items to be included in comprehensive income, which are excluded
from net income, include foreign currency translation adjustments
and unrealized gains/losses on available-for-sale securities. The
Company had no comprehensive income items to report for the years
ended December 31, 1997 and 1998.
In June 1997, the FASB issued SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information, which
establishes standards for reporting information about operating
segments in annual financial statements. It also establishes
standards for related disclosures about products and services,
geographic areas and major customers. The adoption of this new
standard had no effect on the earnings or financial position of
the Company as it currently has only one segment.
In June 1998, the FASB issued SFAS No. 133, Accounting for
Derivatives and Hedging Activities, which establishes accounting
and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging
activities. This statement is effective for all quarters and
fiscal years beginning after June 15, 1999. Because the Company
has never used nor currently intends to use derivatives,
management does not anticipate that the adoption of this new
standard will have a significant effect on earnings or the
financial position of the Company.
F-17
<PAGE> 58
NOTE 12 SUBSEQUENT EVENTS
On March 10, 1999, the Company raised $4,890,485, net of issuance
costs of $109,515, through the negotiated private sale of
1,111,111 shares of its common stock, and 1,111,111 common stock
purchase warrants exercisable at a price of $5.16 per share with
a five year term. If the market price of the Company's common
stock is below $6.00 for certain measurement dates during the
next two years, the Company would be required to issue
additional shares of common stock to the investors. The first
measurement date is when a registration statement covering the
resale of the common stock issued in March 1999 is declared
effective. Investors can purchase an additional 968,992
shares of common stock at $5.16 per share and 1,076,658 common
stock purchase warrants exercisable at $5.16 per share. Investors
may exercise this option at any time after the initial closing
and expires 90 days after the first registration statement
becomes effective.
During February and March of 1999, the Company issued over
$2,200,000 in 8% Convertible Promissory Notes, due March 31,
2001, in a private placement. The notes are convertible at the
option of the holder into common stock at $5.00 per share.
Additionally, each investor received warrants to purchase 3,000
shares of common stock at $5.00 per share for each $100,000
principal amount of notes.
On March 22, 1999, the Company and the holders of common stock
issued in September and December 1998 amended certain terms
regarding the adjustment provisions pursuant to which the
Company may be required to issue additional shares of common
stock to the holders and related matters. See Note 9 for a
discussion of the governing provisions, as amended.
On June 21, 1999, the Company raised $30,292,120, prior to fees
and other issuance costs of approximately $1,190,000 and
including subscribed stock of $1,070,000, in a private sale of
6,417,820 shares of common stock and 42,373 shares of common
stock issued in payment of other fees, along with warrants to
purchase 6,417,820 shares of common stock with an exercise price
of $4.72 per share. The subscribed stock will not be recognized
as contributed capital until such shares have been paid for.
F-18
<PAGE> 59
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Tera Computer Company
Seattle, Washington
We have audited the accompanying balance sheets of Tera Computer Company (the
Company) as of December 31, 1997 and 1998, and the related statements of
operations, shareholders' 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 Tera Computer Company 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.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has recently emerged from being a development stage
enterprise and has not yet achieved revenue levels to sustain operations and
therefore the Company's losses from operations raise substantial doubts about
its ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
\s\ DELOITTE & TOUCHE LLP
Seattle, Washington
March 22, 1999
(June 21, 1999 as to Note 12)
F-19
<PAGE> 60
PART III
Certain information required by Part III is omitted from this Report as the
Company will file a definitive proxy statement for the Annual Meeting of
Shareholders to be held on May 5, 1999, pursuant to Regulation 14A (the "Proxy
Statement") not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included in the Proxy Statement is
incorporated herein by reference. Only those sections of the Proxy Statement
which specifically address the items set forth herein are incorporated by
reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information with respect to Directors may be found under the captions "The
Board of Directors" and "Proposal 1: Election of Two Directors" in the Company's
Proxy Statement. Such information is incorporated herein by reference.
Information with respect to Executive Officers may be found on pages 27 and 28
hereof, under the caption "Executive Officers of the Company." Information with
respect to compliance with Section 16(a) of the Exchange Act by the persons
subject thereto may be found under the caption "Information About Tera Common
Stock Ownership" in the Proxy Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information in the Proxy Statement set forth under the captions "How We
Compensate Directors," "How We Compensate Executive Officers," "The Board of
Directors" and "The Committees of the Board" is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the Proxy Statement set forth under the caption
"Information About Tera Common Stock Ownership" is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Transactions" in the
Proxy Statement is incorporated herein by reference.
41
<PAGE> 61
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) EXHIBIT LISTING
<TABLE>
<S> <C>
3.1 Restated Articles of Incorporation(1)
3.2 Restated Bylaws(1)
4.1 Statement of Rights and Preferences of the Series A Convertible
Preferred Stock of the Company, as filed with the Secretary of
State of the State of Washington on December 23, 1997(7)
4.2 Statement of Rights and Preferences of the Series B Convertible
Preferred Stock of the Company, as filed with the Secretary of
State of the State of Washington on June 30, 1998(8)
4.3 Subscription Agreement, as of September 30, 1998, by and between the Company
and each of Advantage Fund II Ltd. and Koch Industries, Inc.(9)
4.4 Form of Warrant Issued by the Company to Advantage Fund II Ltd. and to Koch
Industries, Inc.(10)
4.5 Amendment to Subscription Agreement, dated as of September 30, 1998, by and
between the Company and each of Advantage Fund II Ltd. and Koch Industries, Inc.(9)
4.6 Waiver Agreement, dated as of December 23, 1997, between the Company and
Advantage Fund II Ltd.(9)
4.7 Waiver Agreement, dated as of December 23, 1997, between the
Company and Genesee Fund Limited - Portfolio B(9)
4.8 Waiver Agreement, dated as of June 30, 1998, between the Company and
Advantage Fund II Ltd.(9)
4.9 Waiver Agreement, dated as of June 30, 1998, between the
Company and Genesee Fund Limited - Portfolio B(9)
4.10 Subscription Agreement, dated as of December 16, 1998, by and
between the Company and each of Genesee Fund Limited -
Portfolio B and Koch Industries, Inc.(11)
4.11 Amendment Agreement, dated as of March 22, 1999, by and among Registrant,
Advantage Fund II Ltd. and Koch Industries, Inc. (11)
4.12 Amendment Agreement, dated as of March 22, 1999, by and among Registrant,
Genesee Fund Limited - Portfolio B and Koch Industries, Inc. (11)
4.13 Form of Warrant issuable to Advantage Fund II Ltd., Genesee Fund Limited -
Portfolio B, and Koch Industries, Inc. (11)
4.14 Market Sales Agreement, dated as of March 22, 1999, by and between Registrant
and each of Advantage Fund II Ltd. and Genesee Fund Limited - Portfolio B (11)
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 Agreement between the Defense Advanced Research Projects Agency and the
Company, Contract No. MDA972-95-C-0003, dated February 23, 1995(3)
10.67 Cooperative Research and Development Agreement No. TC-695-93 between Regents
of the University of California and the Company, dated July 15, 1994(2)
10.7 Agreement between Cadence Design Systems, Inc. and the Company entitled
"Statement of Work for Gate Array and Standard Cell Place and Route," dated
May 30, 1995(3)
</TABLE>
42
<PAGE> 62
<TABLE>
<S> <C>
10.8 Agreement between the Advanced Research Projects Agency and the Company,
Contract No. DABT63-95-C-0096, dated September 27, 1995(5)
10.9 Cooperative Agreement between The Regents of the University of
California, University of California, San Diego and the
Company, dated November 11, 1996(6)
10.10 Subcontract Agreement between The Regents of the University of
California and the Company, effective July 1, 1997(12)
10.12 Lease Agreement between Merrill Place, LLC and the Company,
dated November 21, 1997(12)
10.13 Agreement, dated as of October 1, 1998, by and between the
Company and Unisys Corporation(9)
23.1 Independent Auditors' Consent
27.1 Financial Data Schedule
</TABLE>
- ------------------
(1) Incorporated by reference to Amendment No. 3 to Form SB-2 Registration
Statement, Registration No. 33-95460-LA, as filed with the Commission on
September 22, 1995.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995, and to the
Order granting the Company's application respecting Confidential Treatment.
(4) Incorporated by reference to Post-Effective Amendment No. 3 on Form S-3 to
Form SB-2 Registration Statement, Registration Statement No. 33-95460-LA, as
filed with the Commission on December 6, 1996, and to the Order granting the
Company's application respecting Confidential Treatment.
(5) Incorporated by reference to Form 10K-SB as filed with the Commission for
fiscal year ended December 31, 1995, and to the Order granting the Company's
application respecting Confidential Treatment.
(6) Incorporated by reference to Form 10-QSB as filed with the Commission for
the quarterly period ended September 30, 1996, and to the Order granting the
Company's application respecting Confidential Treatment.
(7) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-44137, as filed with the Commission on January 12, 1998.
43
<PAGE> 63
(8) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-60167, as filed with the Commission on July 30, 1998.
(9) Incorporated by reference to the Company's Form 10-Q, as filed with the
Commission for the quarterly period ended September 30, 1998.
(10) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-67885, as filed with the Commission on November 24, 1998.
(11) Incorporated by reference to the Amendment No. 1 to Form S-3 Registration
Statement, Registration No. 333-67885, as filed with the Commission on March 29,
1999.
(12) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
(b) REPORTS ON FORM 8-K
We filed three reports on Form 8-K during 1998 as follows:
On October 8, 1998, reporting a private placement that had closed on
September 30, 1998, under "Item 5--Other Events;"
On November 19, 1998, setting forth the capitalization of the Company as
of September 30, 1998, under "Item 5--Other Events;" and
On December 23, 1998, reporting a private placement that had closed on
December 16, 1998, under "Item 5--Other Events."
44
<PAGE> 64
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Company
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Seattle, State of Washington, on August 25, 1999.
TERA COMPUTER COMPANY
By JAMES E. ROTTSOLK
--------------------------------
James E. Rottsolk
Chief Executive Officer
and President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of Company and in the capacities indicated on
August 25, 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
By JAMES E. ROTTSOLK Chief Executive Officer,
-------------------------- President and Director
James E. Rottsolk
By BURTON J. SMITH Chief Scientist and Director
--------------------------
Burton J. Smith
By TERREN S. PEIZER Chairman of the Board of
-------------------------- Directors
Terren S. Peizer
By KENNETH W. JOHNSON Chief Financial Officer
--------------------------
Kenneth W. Johnson
By PHILISSA SARGIN Chief Accounting Officer
--------------------------
Philissa Sargin
By Director
--------------------------
David N. Cutler
By DANIEL J. EVANS Director
--------------------------
Daniel J. Evans
By KENNETH W. KENNEDY Director
--------------------------
Kenneth W. Kennedy
By JOHN W. TITCOMB, JR. Director
--------------------------
John W. Titcomb, Jr.
</TABLE>
45
<PAGE> 65
EXHIBIT INDEX
<TABLE>
<S> <C>
3.1 Restated Articles of Incorporation(1)
3.2 Restated Bylaws(1)
4.1 Statement of Rights and Preferences of the Series A Convertible
Preferred Stock of the Company, as filed with the Secretary of State
of the State of Washington on December 23, 1997(7)
4.2 Statement of Rights and Preferences of the Series B Convertible
Preferred Stock of the Company, as filed with the Secretary of State
of the State of Washington on June 30, 1998(8)
4.3 Subscription Agreement, as of September 30, 1998, by and between the
Company and each of Advantage Fund II Ltd. and Koch Industries,
Inc.(9)
4.4 Form of Warrant Issued by the Company to Advantage Fund II Ltd. and
to Koch Industries, Inc.(10)
4.5 Amendment to Subscription Agreement, dated as of September 30, 1998,
by and between the Company and each of Advantage Fund II Ltd. and Koch
Industries, Inc.(9)
4.6 Waiver Agreement, dated as of December 23, 1997, between the Company
and Advantage Fund II Ltd.(9)
4.7 Waiver Agreement, dated as of December 23, 1997, between the Company
and Genesee Fund Limited - Portfolio B(9)
4.8 Waiver Agreement, dated as of 12 June 30, 1998, between the Company
and Advantage Fund II Ltd.(9)
4.9 Waiver Agreement, dated as of June 30, 1998, between the Company and
Genesee Fund Limited - Portfolio B(9)
4.10 Subscription Agreement, dated as of December 16, 1998, by and
between the Company and each of Genesee Fund Limited - Portfolio B
and Koch Industries, Inc.(11)
4.11 Amendment Agreement, dated as of March 22, 1999, by and among Registrant,
Advantage Fund II Ltd. and Koch Industries, Inc. (11)
4.12 Amendment Agreement, dated as of March 22, 1999, by and among Registrant,
Genesee Fund Limited - Portfolio B and Koch Industries, Inc. (11)
4.13 Form of Warrant issuable to Advantage Fund II Ltd., Genesee Fund Limited -
Portfolio B, and Koch Industries, Inc. (11)
4.14 Market Sales Agreement, dated as of March 22, 1999, by and between Registrant
and each of Advantage Fund II Ltd. and Genesee Fund Limited - Portfolio B (11)
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 Agreement between the Defense Advanced Research Projects Agency and
the Company, Contract No. MDA972-95-C-0003, dated February 23,
1995(3)
10.6 Cooperative Research and Development Agreement No. TC-695-93 between
Regents of the University of California and the Company, dated July
15, 1994(2)
10.7 Agreement between Cadence Design Systems, Inc. and the Company
entitled "Statement of Work for Gate Array and Standard Cell Place
and Route," dated May 30, 1995(3)
</TABLE>
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<TABLE>
<S> <C>
10.8 Agreement between the Advanced Research Projects Agency and the Company,
Contract No. DABT63-95-C-0096, dated
September 27, 1995(5)
10.9 Cooperative Agreement between The Regents of the University of
California, University of California, San Diego and the
Company, dated November 11, 1996(6)
10.10 Subcontract Agreement between The Regents of the University of
California and the Company, effective July 1, 1997(12)
10.11 Lease Agreement between Merrill Place, LLC and the Company,
dated November 21, 1997(12)
10.12 Agreement, dated as of October 1, 1998, by and between the
Company and Unisys Corporation(9)
23.1 Independent Auditors' Consent
27.1 Financial Data Schedule
</TABLE>
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(1) Incorporated by reference to Amendment No. 3 to Form SB-2 Registration
Statement, Registration No. 33-95460-LA, as filed with the Commission on
September 22, 1995.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995, and to the
Order granting the Company's application respecting Confidential Treatment.
(4) Incorporated by reference to Post-Effective Amendment No. 3 on Form S-3 to
Form SB-2 Registration Statement, Registration Statement No. 33-95460-LA, as
filed with the Commission on December 6, 1996, and to the Order granting the
Company's application respecting Confidential Treatment.
(5) Incorporated by reference to Form 10K-SB as filed with the Commission for
fiscal year ended December 31, 1995, and to the Order granting the Company's
application respecting Confidential Treatment.
(6) Incorporated by reference to Form 10-QSB as filed with the Commission for
the quarterly period ended September 30, 1996, and to the Order granting the
Company's application respecting Confidential Treatment.
(7) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-44137, as filed with the Commission on January 12, 1998.
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(8) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-60167, as filed with the Commission on July 30, 1998.
(9) Incorporated by reference to the Company's Form 10-Q, as filed with the
Commission for the quarterly period ended September 30, 1998.
(10) Incorporated by reference to Form S-3 Registration Statement, Registration
No. 333-67885, as filed with the Commission on November 24, 1998.
(11) Incorporated by reference to the Amendment No. 1 to Form S-3 Registration
Statement, Registration No. 333-67885, as filed with the Commission on March 29,
1999.
(12) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
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<PAGE> 1
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference into Registration Statement Nos.
333-36563, 333-60167 and 333-44137 on Form S-3 and Nos. 333-12747 and 333-08990
on Form S-8 of Tera Computer Company of our report dated March 22, 1999 (June
21, 1999 as to Note 12), which includes an explanatory paragraph concerning the
Company's ability to continue as a going-concern, included in this amended
Annual Report on Form 10-K/A of Tera Computer Company for the year ended
December 31, 1998.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
Seattle, Washington
August 25, 1999
