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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) July 27, 1998
SOFTNET SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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NEW YORK 1-5270 11-1817252
(STATE OR OTHER (COMMISSION FILE NUMBER) (IRS EMPLOYER
JURISDICTION OF IDENTIFICATION NO.)
INCORPORATION)
520 LOGUE AVENUE, MOUNTAIN VIEW, CA 94043
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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Registrant's telephone number, including area code (650) 962-7470
(Former name or former address, if changed since last report.)
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ITEM 5: OTHER EVENTS.
SoftNet Systems, Inc. (the "Company") has announced the adoption of a Cable
Affiliates Incentive Program to provide incentives to the Company's cable
affiliates to launch the Company's ISP Channel Internet service. Under this
program, the Company will offer to pay incentive bonuses to cable affiliates
in cash or shares of its Common Stock based on the number of cable subscribers
covered by cable systems that enter into exclusive arrangements with the ISP
Channel. The amount of these incentive bonuses will depend on a variety of
factors, including the size of the covered systems and the length of
exclusivity of the contract. The Company has reserved up to 19.9% of its
outstanding shares of Common Stock, totaling approximately 1.6 millions
shares, for issuance under this program.
The Company has also determined to account for its Telecommunications
Division as a discontinued operation. The Company expects to dispose of this
division within the next 12 months, though no assurance can be made that it
will be able to do so. The Company's management does not anticipate a loss on
the sale and intends to use the sales proceeds to reduce outstanding
indebtedness and provide additional working capital for its other businesses.
Included with this Current Report on Form 8-K are revised versions of the
Company's Summary Consolidated Financial Data, Selected Consolidated
Historical Financial Data, Consolidated Financial Statements, and Management's
Discussion and Analysis of Financial Condition and Results of Operations,
reflecting the accounting impact of treating the Telecommunications Division
and as a discontinued operation.
In addition, as the Company has decided to focus its efforts on its other
businesses, particularly the expansion of its Internet Services Division, the
Company has restated its Risk Factors disclosure to reflect this revised
focus. A copy of this revised disclosure is attached to this report.
ITEM 7: EXHIBITS
23 Consent of PricewaterhouseCoopers L.L.P.
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RISK FACTORS
These risk factors include "forward-looking" statements within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act.
Although the Company believes that its plans, intentions, and expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such plans, intentions or expectations will be achieved. Actual
results will differ from such plans, intentions and expectations, and such
differences may be material. Important factors that could cause actual results
to differ materially from the Company's forward-looking statements are set
forth below. All forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by the
cautionary statements set forth herein. The Company disclaims any obligation
to update information contained in any forward-looking statement.
LIMITED OPERATING HISTORY OF THE INTERNET SERVICES DIVISION; UNPROVEN
BUSINESS; HISTORICAL LOSSES; NO ASSURANCE OF PROFITABILITY
The Company currently operates two continuing businesses: Micrographic
Technology Corporation ("MTC") and the Internet Services Division. The Company
is seeking a buyer for the Telecommunications Division, which is accounted for
as a discontinued operation. The Company's current strategy for growth is to
focus on substantially expanding the business of its Internet Services
Division, which was acquired in June 1996. The Company has very limited
operating history and experience in the Internet services business, and the
successful expansion of the Company's Internet Services Division will require
strategies and operations that are different from those historically employed
by the Company in connection with its two other businesses. There can be no
assurance that the Company will be able to develop or maintain strategies and
business operations that are necessary to increase the revenues of the
Company's Internet Services Division sufficiently to enable it to achieve
positive cash flow and profitability.
To be successful, the Company must, among other things, develop and market
products and services that are widely accepted by consumers and businesses at
prices that will yield cash flow sufficient to meet the Company's debt
service, capital expenditure and working capital requirements. The provision
of Internet services over cable infrastructure has only recently become
feasible on a broad scale. There are only a very limited number of companies
offering such services, none of which is currently profitable. The Company's
ISP Channel service has only recently been launched in seven cable franchise
areas (all of which have revenue-paying subscribers) in the United States, and
there can be no assurance that it will achieve broad consumer or commercial
acceptance. The success of the Company's ISP Channel service will depend upon
the willingness of subscribers to pay the monthly fees and installation costs
as well as to purchase or lease the equipment necessary to access the
Internet. Currently, the Company has only approximately 500 subscribers to its
ISP Channel service in these areas. Accordingly, it is difficult to predict
whether the Company's pricing model will prove to be viable, whether demand
for the Company's services will materialize at the prices it expects to charge
or whether current or future pricing levels will be sustainable. If such
pricing levels are not achieved or sustained or if the Company's services do
not achieve or sustain broad market acceptance, the Company's business,
financial condition, prospects and ability to repay its indebtedness will be
materially adversely affected.
The Company has sustained substantial losses over the last five fiscal
years. For the six months ended March 31, 1998 and the fiscal year ended
September 31, 1997, the Company had net losses of $3.7 million and $2.6
million, respectively, and as of March 31, 1998, the Company had an
accumulated stockholders' deficit of approximately $36 million. The Company
expects to incur substantial losses and experience substantial negative cash
flows as it expands its Internet Services Division. The costs of expansion
will include expenses in connection with: (i) the deployment of infrastructure
necessary to enable its cable affiliates to offer its services; (ii) research
and development of new product and service offerings; (iii) the continued
development of its direct and indirect selling and marketing efforts; and (iv)
any charges related to acquisitions, divestitures, business alliances or
changing technologies. The Company's prospects should also be considered in
light of the risks, expenses and difficulties encountered by companies
competing in new and rapidly evolving markets. There can be no assurance that
the Company will ever achieve favorable operating results or profitability.
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FLUCTUATIONS IN QUARTERLY RESULTS
The Company's results of operations have fluctuated and will likely continue
to fluctuate significantly from quarter to quarter, especially as the Company
implements a new strategic focus that will emphasize its Internet Services
Division. In addition, the Company is seeking a buyer for its
Telecommunications Division. As a result, the Company believes that period-to-
period comparisons of its revenues and results of operations are not
necessarily meaningful and should not be relied upon as indicators of future
performance. The Company's quarterly operating results may fluctuate
significantly in the future as a result of a variety of factors, many of which
are beyond the Company's control. Factors that may affect the Company's
quarterly operating results attributable to its Internet Services Division
include, among others, the rate at which the Company can enter into agreements
with cable operators, the exclusivity and term of such agreements, the rate of
subscription to the Company's Internet services, the prices subscribers pay
for such services, subscriber churn rates, changes in the revenue sharing
arrangements between the Company and its affiliated cable operators, the
ability of the Company and its cable affiliates to coordinate timely and
effective marketing, the success of the Company and its cable affiliates in
marketing the ISP Channel service to subscribers in such affiliates' local
cable areas, the quality of cable affiliates' cable infrastructure, the
quality of customer and technical support, and the rate at which the cable
affiliates can complete the installations required to initiate service for new
subscribers. Additional factors that may affect the Company's quarterly
operating results generally include the amount and timing of capital
expenditures and other costs relating to the expansion of the Company's
Internet Services Division, the introduction of new Internet services by the
Company or its competitors, customer acceptance of such services, price
competition or pricing changes in the Internet or cable industries, general
economic conditions and economic conditions specific to the Internet and cable
industries, and changes in law and regulation. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Factors that may affect the Company's quarterly operating results
attributable to MTC include, among other things, the size and timing of
customer orders and subsequent shipments, customer order deferrals in
anticipation of new products and services, timing of product introductions or
enhancements by the Company or its competitors, market acceptance of new
products and services, technological changes in the industry, competitive
pricing pressures, accuracy of customer forecasts of end-user demand, changes
in the Company's operating expenses, personnel changes, changes in the mix of
products sold, quality control of products sold, disruption in sources of
supply, capital spending, delays of payments by customers and general economic
conditions.
The Company expects to continue to engage in extensive research and
development activities and to evaluate new product and service opportunities.
This will require the Company to continue to invest in research and
development and sales and marketing, which could adversely affect short-term
results of operations. The Company believes that its future revenue growth and
profitability will depend in part on its success in developing new products
and services. Failure to increase revenues from new products and services,
whether due to lack of market acceptance, competition, technological change or
otherwise, would have a material adverse effect on the Company's business,
financial condition, prospects and ability to repay its indebtedness,
including the Notes.
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS
The Company is in the process of placing an offering (the "Debt Offering")
of approximately $150,000,000, or more, in Senior Notes ("Senior Notes"),
although there can be no assurance that the Company will be able to complete
such Debt Offering. In the event the Company is able to complete the Debt
Offering, the Company would be highly leveraged. In addition, the indenture
governing the Senior Notes would permit the Company and its subsidiaries to
incur substantial additional indebtedness subject to certain restrictions. The
degree to which the Company is leveraged could have important consequences to
the Company and its securityholders, including, but not limited to, the
following: (i) the Company's ability to obtain additional financing or
refinancing in the future for working capital, capital expenditures, service
development and enhancement, acquisitions, general corporate purposes or other
purposes may be materially limited or impaired; (ii) the Company's cash flow,
if any, may be unavailable for the Company's business as a substantial
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portion of the Company's cash flow must be dedicated to the payment of
principal and interest on its indebtedness; and (iii) the Company's high
degree of leverage may make it more vulnerable to economic downturns, may
limit its ability to withstand competitive pressures and may reduce its
flexibility in responding to changing business and economic conditions.
The Company expects that it will continue to generate substantial operating
losses and negative cash flow for the next several years. No assurance can be
given that the Company will be successful in developing and maintaining a
level of cash flow from operations sufficient to permit it to pay the
principal, premium, if any, and interest on its indebtedness. The ability of
the Company to make scheduled payments with respect to indebtedness will
depend upon, among other things: (i) the Company's ability to achieve
significant and sustained growth in cash flow; (ii) the rate of successful
commercial deployment of its Internet products and services; (iii) the market
acceptance, customer demand, rate of utilization and pricing for the Company's
products and services; (iv) future operating performance problems; (v) cable
affiliates' ability to complete development, upgrades and enhancements of
their cable infrastructure successfully; and (vi) economic, financial,
competitive, regulatory, and other factors, many of which are beyond the
Company's control. If the Company is unable to generate sufficient cash flow
to service its indebtedness it may have to reduce or delay entering into
affiliations with cable operators, deploying infrastructure and delivering its
services to existing cable affiliates. Additionally, in such circumstances,
the Company may have to restructure or refinance its indebtedness or seek
additional equity capital. There can be no assurance that any of these
strategies could be effected on satisfactory terms, if at all, in light of the
Company's high leverage, or that any such strategy would yield sufficient
proceeds to service and repay the Company's indebtedness. In the event of
default under such indebtedness, certain holders of such indebtedness would
have enforcement rights, including the right to accelerate such debt and the
right to commence an involuntary bankruptcy proceeding against the Company.
DEPENDENCE ON LOCAL CABLE OPERATORS AND THEIR CABLE INFRASTRUCTURE
Certain ISP Channel services are dependent on the quality of the cable
infrastructure. Cable system operators have announced and begun to implement
major infrastructure investments in order to increase the capacity of their
networks and deploy two-way capability. However, cable system operators have
limited experience with implementing such upgrades, and these investments have
placed a significant strain on the financial, managerial, operating and other
resources of cable system operators, most of which are already significantly
leveraged. Further, cable operators must periodically renew their franchises
with city, county, or state governments and, as a condition of obtaining such
renewal, may have to meet certain conditions imposed by the issuing
jurisdiction, which may have the effect of causing the cable operator to delay
such upgrades. The Company's contracts with its cable affiliates typically
have terms ranging from three to five years, and there can be no assurance
that the Company will be able to renew any such contracts. Moreover, even if
cable affiliates renew such contracts, there can be no assurance that such
renewal will be on terms satisfactory to the Company. In addition, cable
operators are primarily concerned with increasing television programming
capacity to compete with other modes of multichannel entertainment delivery
systems such as direct broadcast satellite ("DBS") and may consequently choose
to roll-out incompatible set-top boxes that do not support high-speed Internet
access services, rather than to upgrade their network infrastructures as
described above. Such upgrades thus have been, and the Company expects will
continue to be, subject to change, delay or cancellation. The failure of cable
operators to complete these upgrades in a timely and satisfactory manner, or
at all, would adversely affect the market for the Company's products in any
such operator's franchise area and, if repeated on a broad scale, could have a
material adverse effect on the Company's business, financial condition,
prospects and ability to repay its indebtedness.
The Company provides Internet services to cable systems irrespective of
their two-way capabilities. To the extent the Company provides Internet
services over cable systems to the home with a telephone line return path for
data from the home (under a "one-way" cable system), the Company's services
may not provide the high speed, quality of experience and availability of
certain applications, such as video conferencing, necessary to
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attract and retain subscribers to the ISP Channel service. Subscribers using a
telephone line return path will experience the upstream data transmission
speeds provided by their analog modems (typically 28.8 Kbps). It is not clear
what impact the lack of two-way capability will have on penetration levels for
the ISP Channel.
Because subscribers to the ISP Channel will subscribe through a cable
affiliate, the cable affiliate (and not the Company) will substantially control
the customer relationship with the subscriber. For example, under the Company's
existing contracts, cable affiliates are responsible for important functions,
such as billing for and collecting ISP Channel subscription fees and providing
the labor and costs associated with the distribution of local marketing
materials. Therefore, in addition to the Company's business being subject to
general economic and market conditions and factors relating to Internet service
providers and on-line services specifically, the success and future growth of
the Company's business will also be subject to economic and other factors
affecting its cable affiliates generally.
DEPENDENCE ON EXCLUSIVE ACCESS TO CABLE SUBSCRIBERS; NEED FOR AGGRESSIVE
IMPLEMENTATION AND DEPLOYMENT
The success of the Company's Internet Services Division is dependent, in
part, on its ability to gain exclusive access to cable consumers. This
exclusivity is a function of cable operators' dominance within their geographic
markets and the Company's exclusive relationship with such cable operators.
There can be no assurance that cable operators affiliated with the Company will
not face competition in the future or that the Company will be able to
establish and maintain exclusive relationships with cable operators. Currently,
a number of the Company's contracts with cable operators do not contain
exclusivity provisions. Even if the Company is able to establish and maintain
exclusive relationships with cable operators, there can be no assurance that
the Company will be able to do so on terms favorable to the Company or in
quantities to be profitable. In addition, the Company seeks to affiliate with a
large number of cable operators as quickly as possible because it will be
excluded from providing Internet over cable in those areas served by cable
operators with exclusive arrangements with other Internet service providers. If
the exclusive relationship between either the Company and its cable affiliates
or its cable affiliates and their cable subscribers is impaired, or if the
Company does not become affiliated with a sufficient number of cable operators,
the Company's business, financial condition, prospects and ability to repay its
indebtedness could be materially adversely affected.
SUBSTANTIAL FUTURE CAPITAL REQUIREMENTS
The development of the Company's business will require substantial capital
infusions as a result of (i) the Company's need to enhance and expand its
product and service offerings in order to maintain its competitive position and
increase its market share and (ii) the substantial investment in equipment and
corporate infrastructure required by the continued national deployment of the
ISP Channel. In addition, the Company anticipates that the majority of cable
affiliates with one-way cable systems will eventually upgrade their cable
infrastructure to two-way cable systems, at which time the Company will have to
upgrade its equipment on any affected cable system to handle two-way
transmissions. Even with the proceeds of the Debt Offering, if completed,
whether or when the Company ultimately can achieve cash flow levels sufficient
to support its operations, development of new products and services, and
expansion of its Internet Services Division, cannot be predicted accurately.
Unless such cash flow levels are achieved, the Company will require additional
borrowings, the sale of debt or equity securities, the sale of assets or
businesses, or some combination thereof, to provide funding for its operations.
In the event that the Company cannot generate sufficient cash flow from its
operations, or is unable to borrow or otherwise obtain additional funds to
finance its operations on desirable terms when needed, the Company's business,
financial condition, prospects and ability to repay its indebtedness would be
materially adversely affected.
MANAGEMENT OF GROWTH
To fully exploit the market for its products and services, the Company must
rapidly execute its sales strategy while managing anticipated growth by
implementing effective planning and operating processes. To manage its
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anticipated growth, the Company must, among other things, continue to
implement and improve its operational, financial and management information
systems, hire and train additional qualified personnel, continue to expand and
upgrade core technologies and effectively manage multiple relationships with
various customers, suppliers and other third parties. Consequently, such
expansion could place a significant strain on the Company's services and
support operations, sales and administrative personnel and other resources.
The Company may in the future also experience difficulties meeting the demand
for its products and services. Additionally, if the Company is unable to
provide training and support for its products, the implementation process will
be longer and customer satisfaction may be lower. There can be no assurance
that the Company's systems, procedures or controls will be adequate to support
the Company's operations or that the Company's management will be capable of
exploiting fully the market for the Company's products and services. Any
failure of the Company to manage its growth effectively could have a material
adverse effect on the Company's business, financial condition, prospects and
ability to repay its indebtedness.
NON-EXCLUSIVITY OF CABLE FRANCHISES; NON-RENEWAL OR TERMINATION OF FRANCHISES
Cable television companies operate under non-exclusive franchises granted by
local or state authorities that are subject to renewal and renegotiation from
time to time. A franchise is generally granted for a fixed term ranging from
five to 15 years but in many cases is terminable if the franchisee fails to
comply with the material provisions thereof. The Cable Television Consumer
Protection and Competition Act of 1992 prohibits franchising authorities from
granting exclusive cable television franchises and from unreasonably refusing
to award additional competitive franchises; it also permits municipal
authorities to operate cable television systems in their communities without
franchises. No assurance can be given that the cable television companies that
have contracts with the Company will be able to retain or renew their
franchises. The non-renewal or termination of any such franchises would result
in the termination of the Company's contract with the applicable cable
operator. Were an affiliated cable operator to lose its franchise, the Company
would seek to affiliate with the successor to the franchisee. No assurance can
be given that the Company would be able to achieve such replacement
affiliation or that to do so would not result in additional costs to the
Company. If the Company cannot affiliate with replacement cable operators in
sufficient numbers, the Company's business, financial condition, prospects and
ability to repay its indebtedness could be materially adversely affected.
RISK OF ACQUISITION OF CABLE AFFILIATE BY UNAFFILIATED CABLE OPERATOR
The Company believes that it is highly unlikely that a cable operator will
find it desirable, economically or otherwise, to devote the channel capacity
to offer Internet services to its subscribers over its infrastructure through
more than one provider. However, under many of the Company's initial
contracts, in the event a cable affiliate is acquired by an unaffiliated cable
operator that already has a relationship with one of the Company's competitors
or that does not enter into a contract with the Company, the Company may lose
its ability to offer its Internet services in the area served by such former
cable affiliate, which could have a material adverse effect on the Company's
business, financial condition, prospects and ability to repay its
indebtedness.
DEPENDENCE ON THIRD PARTY TECHNOLOGY AND SUPPLIERS
Many of the Company's products and service offerings incorporate technology
developed and owned by third parties. The markets for all of the products and
services used by the Company are characterized by intense competition, rapid
technological advances, evolving industry standards, changes in subscriber
requirements, frequent new product introductions and enhancements, and rapidly
evolving, alternative service offerings. Consequently, the Company must rely
upon third parties to develop and introduce technologies that enhance the
Company's current product and service offerings and enable the Company, in
turn, to develop its own products and services on a timely and cost-effective
basis to meet changing customer needs and technological trends in its
industries. Any impairment or termination of the Company's relationship with
any licensers of third party technology would force the Company to find other
developers on a timely basis or develop its own technology. There can be no
assurance that the Company will be able to obtain the third party technology
necessary to
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continue to develop and introduce new and enhanced products and services, that
the Company will obtain third party technology on commercially reasonable
terms or that the Company will be able to replace third party technology in
the event such technology becomes unavailable, obsolete or incompatible with
future versions of the Company's products or services. The absence of or any
significant delay in the replacement of third party technology would have a
material adverse effect on the Company's business, financial condition,
prospects and ability to service its indebtedness.
In addition, the Internet Services Division and MTC currently depend on a
limited number of suppliers for certain key products and services. In
particular, the Internet Services Division depends on Excite, Inc. ("Excite")
for national content aggregation, 3Com Corporation ("3Com") and Com21, Inc.
("Com21") for headend and cable modem equipment, Cisco Systems, Inc. ("Cisco")
for specific network routing and switching equipment, and, among others, MCI
Communications Corporation ("MCI") for national Internet backbone services.
Certain of the Company's cable modem and headend equipment suppliers are in
litigation over their patents. The Company could experience disruptions in the
delivery or increases in the prices of products and services purchased from
such vendors as a result of intellectual property litigation involving such
vendors. There can be no assurance that delays in key components or product
deliveries will not occur in the future due to shortages resulting from the
limited number of suppliers, the financial or other difficulties of such
suppliers or the possible limited availability in the suppliers' underlying
raw materials. In addition, the Company may not have adequate remedies against
such third parties as a result of breaches of their agreement with the
Company. The inability to obtain sufficient key components or to develop
alternative sources for such components, if and as required in the future,
could result in delays or reductions in product shipments, which in turn could
have a material adverse effect on the Company's customer relationships,
business, financial condition, prospects and ability to repay its
indebtedness.
Certain key products resold by the Company are currently contracted
exclusively for distribution in certain of the Company's markets. For
instance, the Company's Telecommunications Division currently maintains an
exclusive contract with Executone Information Systems, Inc. ("Executone") for
the resale of Executone's products in certain specified markets. For the
fiscal year ended September 30, 1997, such products accounted for
approximately 30% of the Telecommunications Division's revenues and 13% of the
Company's total revenues. Any change in the exclusivity provisions of these
types of contracts, or loss thereof, could have a materially adverse effect on
the Company's business, financial condition, prospects and ability to repay
its indebtedness.
COMPETITION
The markets for the Company's products and services are intensely
competitive, and the Company expects competition to increase in the future.
Many of the Company's competitors and potential competitors have substantially
greater financial, technical and marketing resources, larger subscriber bases,
longer operating histories, greater name recognition and more established
relationships with advertisers and content and application providers than the
Company. Such competitors may be able to undertake more extensive marketing
campaigns, adopt more aggressive pricing policies and devote substantially
more resources to developing Internet services or on-line content than the
Company. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive
pressures faced by the Company will not materially adversely affect the
Company's business, financial condition, prospects or ability to repay its
indebtedness. Any increase in competition could reduce the Company's gross
margins, require increased spending by the Company on research and development
and sales and marketing, and otherwise materially adversely affect the
Company's business, financial condition, prospects and ability to repay its
indebtedness.
Internet Services. The markets for the Company's Internet products and
services are extremely competitive, and the Company expects this competition
to intensify in the future. In the cable-based segment of the Internet access
industry, the Company also competes with other cable-based data services that
are seeking to contract with cable system operators to bring their services
into geographic areas that are not covered by an agreement
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between the Company and its cable affiliates. These competitors include
systems integrators such as Convergence.com, Online System Services, HSAnet
and Frontier Communications' Global Center business, as well as ISPs such as
Earthlink Network, Inc. ("Earthlink"), MindSpring Enterprises, Inc.
("MindSpring"), and IDT Corporation. Several cable system operators, including
CableVision Systems Corporation ("Cablevision"), Comcast Corporation
("Comcast"), Cox Enterprise, Inc. ("Cox"), MediaOne Group, Inc. ("MediaOne"),
Tele-Communications, Inc. ("TCI") and Time Warner Inc. ("Time Warner") have
deployed high-speed Internet access services over their existing local hybrid
fiber and coaxial cable networks. TCI, Cox and Comcast market through At Home
Corporation ("@Home") while Time Warner plans to market the RoadRunner service
through Time Warner's own cable systems as well as to other cable system
operators nationwide.
Some of the Company's most direct competitors in the access markets are
telephony-based access providers, including incumbent local exchange carriers
("ILECs"), national interexchange or long distance carriers ("IXCs"), fiber-
based competitive local exchange carriers ("CLECs"), Internet service
providers ("ISPs"), on-line service providers ("OSPs"), wireless and satellite
data service providers, and DSL-focused CLECs. Competitors in the Internet
services industry include AT&T Corp. ("AT&T"), BBN Corporation, Earthlink,
Netcom Online Communications Services, Inc., Concentric Network, PSInet Inc.,
and WorldCom, Inc., which provide basic Internet access to residential
consumers and businesses, generally using the existing telephone network
infrastructure. This method is widely available and inexpensive, and barriers
to entry are low, resulting in a highly competitive and fragmented market.
Some of the Company's competitors are offering diversified packages of
telecommunications services, including Internet access service, to residential
customers and could bundle such services, which could place the Company at a
competitive disadvantage. Many of these competitors are offering (or may soon
offer) technologies that will attempt to compete with some or all of the
Company's high-speed data service offerings. The bases of competition in these
markets include transmission speed, reliability of service, ease of access,
ratio of price to performance, ease of use, content quality, quality of
presentation, timeliness of content, customer support, brand recognition,
operating experience and revenue sharing.
In addition, the market for high-speed data transmission services is
characterized by several competing technologies that offer alternative
solutions. Competitive technologies include telecom-related wireline
technologies that utilize telephone copper twisted-pair wiring, such as ISDN
and DSL implementations, as well as wireless technologies such as local
multipoint distribution service ("LMDS"), multichannel multipoint distribution
service ("MMDS") and DBS. The Company's prospects may be further compromised
by Federal Communications Commission ("FCC") rules and regulations, which are
designed, at least in part, to increase competition in video and related
services, for example, new multi-channel video technologies and services known
as Open Video Systems ("OVS") and LMDS. While both are in nascent stages of
development, OVS and LMDS offer the potential for providing competition to
traditional cable television and other multi-channel video services. One form
of OVS involves delivery of signals over existing telephone lines. LMDS is a
broadband, wireless, digital service, and offers the potential for providing
Internet access along with a variety of other services, including traditional
multi-channel video entertainment. The FCC has also created a General Wireless
Communications Service ("GWCS") in which licensees are afforded broad latitude
in defining the nature and service area of the communications services they
offer. The full impact of the GWCS remains to be seen. Nevertheless, all of
these new technologies pose potential competition to the Company and its
business. Significant market acceptance of alternative solutions for high-
speed data transmission could decrease the demand for the Company's services
if such alternatives are viewed as providing faster access, greater
reliability, increased cost-effectiveness or other advantages over cable
solutions. Competition from telecom-related solutions is expected to be
intense.
There can be no assurance that technological developments will not have a
material adverse effect on the competitive position of the Company. The rapid
development of new competing technologies and standards increases the risk
that current or new competitors could develop products and services that would
reduce the competitiveness of the Company's products and services, which could
have a material adverse effect on the Company's business, financial condition,
prospects and ability to repay its indebtedness.
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Document Management. In the document management industry, the Company
competes on the basis of breadth of offering, cost, flexibility and customer
service. The Company has two direct competitors to its hardware products: Agfa
AG in Europe and Anacomp, Inc. worldwide. Indirect competitors include
International Business Machines Corp., Fuji Photo Film Co., Ltd., Mobius
Management Systems, Inc., Storage Technology and others. In most cases, the
Company's competitors have longer operating histories, greater name
recognition, and significantly greater financial, technical and marketing
resources. While the Company is not aware of any direct competitors to its
software product offerings, the industry is rapidly evolving and the Company
may face significant competition in the future.
UNPROVEN NETWORK SCALABILITY AND SPEED
Due to the limited deployment of the Company's ISP Channel service, the
ability of the Company to connect and manage a substantial number of on-line
subscribers at high transmission speeds is as yet unknown, and the Company
faces risks related to its ability to scale up to its expected subscriber
levels while maintaining superior performance. While peak downstream data
transmission speeds across cable infrastructure approaches 3 megabits per
second ("Mbps") in each 6 MHz channel, the actual downstream data transmission
speeds are likely to be significantly slower and will depend on a variety of
factors, including type and location of content, Internet traffic, the number
of active subscribers on a given cable network node, the number of 6 MHz
channels allocated by the cable affiliate (in its discretion) to carry the
Company's service, the capability of cable modems used and the service quality
of the cable affiliates' cable infrastructures. As subscriber penetration
increases, it may be necessary for the cable affiliates to add additional 6
MHz channels in order to maintain adequate downstream data transmission
speeds, which would render such additional channels unavailable to such cable
affiliates for video or other programming. There can be no assurance that
cable affiliates will provide additional capacity for this purpose. On two-way
cable systems, the upstream transmission data channel is located in a range
not used for broadcast by traditional cable infrastructures and is more
susceptible to interference than the downstream channel, resulting in a slower
peak upstream transmission speed. In addition to the factors affecting
downstream data transmission speeds, the level of interference in the cable
affiliates' upstream data broadcast range can materially affect actual
upstream data transmission speeds. The actual data delivery speeds that can be
realized by subscribers will be significantly lower than peak data
transmission speeds and will vary depending on the subscriber's hardware,
operating system and software configurations. There can be no assurance that
the Company will be able to achieve or maintain a speed of data transmission
sufficiently high to enable the Company to attract and retain its planned
numbers of subscribers, especially as the number of the subscribers to the
Company's services grows, and a perceived or actual failure by the Company to
achieve or maintain sufficiently high speed data transmission could
significantly reduce consumer demand for its services and have a material
adverse effect on its business, financial condition, prospects and ability to
repay its indebtedness.
DEPENDENCE ON NETWORK
The Company's success will depend upon the capacity, reliability and
security of the infrastructure used to carry data between its subscribers and
the Internet. A significant portion of such infrastructure is owned by third
parties, and accordingly the Company has no control over its quality and
maintenance. The Company relies on cable operators to maintain their cable
infrastructure. In addition, the Company relies on other third parties to
provide a connection from the cable infrastructure to the Internet. Currently,
the Company has transit agreements with MCI, MFS, Sprint Communications
Company ("Sprint"), and others to support the exchange of traffic between the
Company's network operations center ("NOC"), cable infrastructure and the
Internet. The failure of the Internet backbone, or the NOC, or any other link
in the delivery chain resulting in an interruption in the Company's operations
would have a material adverse effect on the Company's business, financial
condition, prospects and ability to repay its indebtedness.
RISK OF SYSTEM FAILURE
The Company's operations are dependent upon its ability to support its
highly complex infrastructure and avoid damages from fires, earthquakes,
floods, power losses, telecommunications failures, network software
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flaws, transmission cable cuts and similar events. The occurrence of one of
these events could cause interruptions in the services provided by the
Company. In addition, failure of an ILEC or other service provider to provide
communications capacity required by the Company, as a result of a natural
disaster, operational disruption or any other reason, could cause
interruptions in the services provided by the Company. Any damage or failure
that causes interruptions in the Company's operations could have a material
adverse effect on the Company's business, financial condition, prospects and
ability to repay its indebtedness.
SECURITY RISKS
Despite the implementation of security measures, the Company's or its cable
affiliates' networks may be vulnerable to unauthorized access, computer
viruses and other disruptive problems. ISPs and OSPs have in the past
experienced, and may in the future experience, interruptions in service as a
result of the accidental or intentional actions of Internet users.
Unauthorized access by current and former employees or others could also
potentially jeopardize the security of confidential information stored in the
computer systems of the Company and its subscribers. Such events may result in
liability of the Company to its subscribers and also may deter potential
subscribers. Although the Company intends to continue to implement industry-
standard security measures, such measures have been circumvented in the past,
and there can be no assurance that measures implemented by the Company will
not be circumvented in the future. Moreover, the Company has no control over
the security measures that the Company's cable affiliates adopt. Eliminating
computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service to the Company's subscribers,
which could have a material adverse effect on the Company's business,
financial condition, prospects and ability to repay its indebtedness. In
addition, the threat of these and other security risks may deter potential ISP
channel subscribers from purchasing the ISP Channel service, which could have
a material adverse effect on the Company's business, financial condition,
prospects and ability to repay its indebtedness.
DEPENDENCE ON HIGH-QUALITY CONTENT PROVISION AND ACCEPTANCE; DEVELOPING MARKET
FOR HIGH-QUALITY CONTENT
A key component of the Company's strategy is to provide a more compelling
interactive experience to Internet users than the experience currently
available to customers of dial-up ISPs and OSPs. The Company believes that, in
addition to providing high-speed, high-performance Internet access, it must
also develop and aggregate high-quality multimedia content. The Company's
success in providing and aggregating such content will depend in part on the
Company's ability to develop a customer base sufficiently large to justify
investments in the development of such content as well as (i) the ability of
content providers to create and support high-quality multimedia content; and
(ii) the Company's ability to aggregate content offerings in a manner that
subscribers find attractive. There can be no assurance that the Company will
be successful in these endeavors. In addition, the market for high-quality
multimedia Internet content has only recently begun to develop and is rapidly
evolving, and there is significant competition among ISPs and OSPs for
aggregating such content. If the market were to fail to develop, or were to
develop more slowly than expected, or if competition were to increase, or if
the Company's content offerings did not achieve or sustain market acceptance,
the Company's business, financial condition, prospects and ability to repay
its indebtedness would be materially adversely affected.
DEPENDENCE ON ADVERTISING REVENUES
The success of the Company's Internet Services Division depends in part on
the ability of the Company to entice advertisers to advertise through the ISP
Channel. The Company expects to derive significant revenues from
advertisements placed on co-branded and ISP Channel web pages and "click
through" revenues from products and services purchased through links from the
ISP Channel to vendors. While the Company believes that it can leverage the
ISP Channel to provide information to advertisers to help them better target
prospective customers, there can be no assurance that advertisers will find
such information useful or choose to advertise through the ISP Channel. There
can be no assurance that the Company will be able to attract advertising
revenues in quantities and at rates that are satisfactory to the Company. The
failure to do so could have a material adverse effect on the Company's
business, financial condition, prospects and ability to repay its
indebtedness.
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UNCERTAIN ACCEPTANCE AND MAINTENANCE OF THE ISP CHANNEL BRAND
The Company believes that establishing and maintaining the ISP Channel brand
are critical to attracting and expanding its subscriber base. Promotion of the
ISP Channel brand will depend, among other things, on the Company's success in
providing high-speed, high-quality consumer and business Internet products,
services and content, the marketing efforts of the cable affiliates, and the
reliability of the cable affiliates' networks and services, none of which can
be assured. The Company has little control over the cable affiliates'
marketing efforts or the reliability of their networks and services. If
consumers and businesses do not perceive the Company's existing products and
services to be of high quality or if the Company introduces new products or
services or enters into new business ventures that are not favorably received
by consumers and businesses, the Company will be unsuccessful in promoting and
maintaining its brand. To the extent the Company expands the focus of its
marketing efforts to geographic areas where the ISP Channel service is not
available, the Company risks frustrating potential subscribers who are not
able to access the Company's products and services. Furthermore, in order to
attract and retain subscribers, and to promote and maintain the ISP Channel
brand in response to competitive pressures, the Company may find it necessary
to increase substantially its financial commitment to creating and maintaining
a distinct brand loyalty among customers. If the Company were unable to
establish or maintain the ISP Channel brand successfully or if the Company
were to incur excessive expense in an attempt to improve its offerings or
promote and maintain its brand, the Company's business, financial condition,
prospects and ability to repay its indebtedness would be materially adversely
affected.
BILLING AND COLLECTIONS RISKS
The Company has recently commenced the process of designing and implementing
its billing and collections system for its Internet Services Division. It is
the Company's intention to bill for the services provided by this business
over the Internet and, in most cases, to collect these invoices through
payments received via the Internet. Such invoices and payments have security
risks. Given the complexities of such a system, there can be no assurance that
the Company will be successful in developing and implementing the system in a
timely manner or that it will be able to scale the system quickly and
efficiently if necessary to accommodate potential growth in the number of
subscribers requiring such a billing format. In some circumstances, the
Company's cable affiliates are responsible for billing and collection for the
Company's Internet access services. In any such instance, the Company has
little or no control over the accuracy and timeliness of its invoices or over
collection efforts. Given its relatively limited history with billing and
collection for Internet services, the Company cannot predict the extent to
which it may experience bad debts or the extent to which it will be able to
minimize such bad debts. If the Company encounters significant problems with
its billing and collections process, the Company's business, financial
condition, prospects and ability to repay its indebtedness could be materially
adversely affected.
DEPENDENCE ON THE GROWTH AND EVOLUTION OF THE INTERNET
Market acceptance of the Company's Internet services is substantially
dependent upon the growth and evolution of the Internet in ways that are best
suited for the Company's products and services. High-speed cable-based
Internet access is of greatest value to consumers of multimedia and other
bandwidth-intensive content. The nature of the content available over the
Internet, and the technologies available to access that content, are evolving
rapidly, and there can be no assurance that those applications that most favor
the Company's services and technology will be widely accepted by the
marketplace. In addition, to the extent that the Internet continues to
experience significant growth in the number of users and level of use, there
can be no assurance that the Internet infrastructure will continue to be able
to support the demands placed on it by such potential growth or that the
performance or reliability of the Internet will not be adversely affected. The
Internet could lose its commercial viability due to delays in the development
or adoption of new standards and protocols to handle increased levels of
Internet activity. There can be no assurance that the infrastructure or
complementary services necessary to make the Internet a viable commercial
marketplace will be developed. In particular, the Internet has only recently
become a medium for advertising and electronic commerce. If the necessary
infrastructure or
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complementary services or facilities are not developed, or if the Internet
does not become a viable commercial marketplace or platform for advertising
and electronic commerce, the Company's business, financial condition,
prospects and ability to repay its indebtedness could be materially adversely
affected.
POTENTIAL LIABILITY FOR DEFAMATORY OR INDECENT CONTENT
The law relating to liability of ISPs and OSPs for information carried on or
disseminated through their networks is currently unsettled. A number of
lawsuits have sought to impose such liability for defamatory speech and
indecent materials. A recent federal statute seeks to impose such liability,
in some circumstances, for transmission of obscene or indecent materials. In
one case, a court has held that an OSP could be found liable for defamatory
matter provided through its service, on the ground that the service provider
exercised active editorial control over postings to its service. The
imposition upon ISPs or OSPs of potential liability for materials carried on
or disseminated through their systems could require the Company to implement
measures to reduce its exposure to such liability, which may require the
expenditure of substantial resources or the discontinuation of certain
products or service offerings. In addition, the imposition of liability on the
Company for information carried on the Internet could have a material adverse
effect on the Company's business, financial condition, prospects and ability
to repay its indebtedness.
POTENTIAL LIABILITY FOR INFORMATION RETRIEVED AND REPLICATED
Because materials will be downloaded and redistributed by subscribers and
cached or replicated by the Company in connection with the Company's offering
of its services, there is a possibility that claims may be made against the
Company or its cable affiliates under both U.S. and foreign law for
defamation, negligence, copyright or trademark infringement, or other theories
based on the nature and content of such materials. Such types of claims have
been successfully brought against OSPs. In particular, copyright and trademark
laws are evolving both domestically and internationally, and there is
uncertainty concerning how broadly the rights afforded under these laws will
be applied to on-line environments. It is impossible for the Company to
determine who the potential rights holders may be with respect to all
materials available through the Company's services. In addition, a number of
third party owners of patents have claimed to hold patents that cover various
forms of on-line transactions or on-line technology. As with other OSPs,
patent claims could be asserted against the Company based upon its services or
technologies. The Company's liability insurance may not cover potential claims
of the foregoing types or may not be adequate to indemnify the Company for all
liability that may be imposed. Any imposition of liability that is not covered
by insurance or is in excess of insurance coverage could have a material
adverse effect on the Company's business, financial condition, prospects and
ability to repay its indebtedness.
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCTS AND SERVICES
There can be no assurance that the Company's future development efforts will
result in commercially successful products or that the Company's products and
services will not be rendered obsolete by changing technology, new industry
standards or new product announcements by competitors. The markets for all of
the Company's products and services are characterized by intense competition,
rapid technological advances, evolving industry standards, changes in
subscriber requirements, frequent new product introductions and enhancements,
and rapidly evolving, alternative service offerings. For example, the Company
expects digital set-top boxes capable of supporting high-speed Internet access
services to be commercially available in the next 18 months. Although the
widespread availability of set-top boxes could increase the demand for the
Company's Internet Service, there is no assurance that the demand for set-top
boxes will ever reach the level estimated by the Company and industry experts
or, if set-top boxes reach this level of popularity, that the Company will be
able to capitalize on such demand. If this scenario occurs or if other
technologies or standards applicable to the Company's products or service
offerings become obsolete or fail to gain widespread commercial acceptance,
then the Company's business, financial condition, prospects and ability to
repay its indebtedness will be materially adversely affected.
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The introduction of products or services embodying, or purporting to embody,
new technology or the emergence of new industry standards could also render
the Company's existing products and services, as well as products or services
under development, obsolete and unmarketable. Internet, telecommunications and
cable technologies are evolving rapidly. Many large corporations, including
large telecommunications providers, Regional Bell Operating Companies
("RBOCs") and telecommunications equipment providers, as well as large cable
system operators, regularly announce new and planned technologies and service
offerings that could impact the market for the Company's services. These
announcements can have the effect of delaying purchasing decisions by the
Company's customers and confusing the marketplace regarding available
alternatives. Such announcements could in the future adversely impact the
Company's business, financial condition, prospects and ability to repay its
indebtedness.
The Company's ability to adapt to changes in technology and industry
standards, and to develop and introduce new and enhanced products and service
offerings will be significant factors in maintaining or improving its
competitive position and its prospects for growth. Due to rapid technological
changes in the Internet and telecommunications industries, the lengthy product
approval and purchase processes of the Company's customers and the Company's
reliance on third party technology for the development of new products and
service offerings, there can be no assurance that the Company will
successfully introduce new products and services on a timely basis or achieve
sales of new products and services in the future, or, if sales are achieved,
that latent defects will not exist in the Company's products or equipment
purchased by the Company from third parties. In addition, there can be no
assurance that the Company will have the financial and manufacturing resources
necessary to continue to successfully develop new products or services based
on emerging technologies or to otherwise successfully respond to changing
technology and/or industry standards. Moreover, due to intense competition,
there may be a time-limited market opportunity for the Company's cable-based
consumer and business Internet services. There can be no assurance that the
Company will be successful in achieving widespread acceptance of its services
before competitors offer products and services with speed and performance
similar to the Company's current offerings. In addition, the widespread
adoption of new Internet or telecommuting technologies or standards, cable-
based or otherwise, could require substantial expenditures by the Company to
modify or adapt its equipment, products and services and could fundamentally
alter the character, viability and frequency of Internet-based advertising,
either of which could have a material adverse effect on the Company's
business, financial condition, prospects and ability to repay its
indebtedness.
The technology underlying capital equipment used by the Company such as
headends and cable modems is continuing to evolve and, accordingly, it is
possible that the equipment acquired by the Company could become out-of-date
or obsolete prior to the time the Company would otherwise intend to replace
such equipment. In any such circumstance, the Company may need to acquire
substantial amounts of new capital equipment, which could have a material
adverse effect on the Company's business, financial condition, prospects and
ability to repay its indebtedness.
ADVERSE EFFECT ON MTC OF GROWTH OF ALTERNATE TECHNOLOGIES
Revenues for MTC's products and services have been adversely affected in
recent years, and could in the future be substantially adversely affected by,
among other things, the increasing use of digital technology. MTC's revenues,
after giving effect to the discontinuation of the Telecommunications Division,
have represented substantially all of the Company's revenues for the past
several years.
The effect of digital and other technologies on the demand for MTC's
products and services depends, in part, on the extent of technological
advances and cost decreases in such technologies. The recent trend of
technological advances and attendant price declines in digital systems and
products is expected to continue. As a result, in certain instances, potential
MTC customers have deferred, and may continue to defer, investments in MTC
systems while evaluating the abilities of digital and other technologies.
The continuing development of local area computer networks and similar
systems based on digital technologies has resulted and will continue to result
in many MTC customers changing their use of MTC
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products from data storage and retrieval to primarily archival use. The
rapidly changing data storage and management industry also has resulted in
intense price competition in certain of MTC's markets.
Therefore, the Company has been and expects to continue to be impacted
adversely by the decline in the market for COM services, the high fixed costs
and declining market for COM systems and the attendant reduction in equipment
and supplies. The Company's revenues for maintenance of COM systems have
declined in part because of efficiencies associated with the Company's systems
and could decline further in the event of lesser use and fewer sales of COM
systems. The growth of alternate technologies has created consolidation in the
micrographics industry. To the extent consolidation in the micrographics
industry has the effect of causing major providers of micrographics services
and products to cease providing such services and products, the negative
trends in the industry, such as competition from alternate technologies
described above, may accelerate.
MTC PROPRIETARY TECHNOLOGY; RISK OF THIRD PARTY CLAIMS OF INFRINGEMENT
The industry in which MTC operates may be affected by an increasing number
of patents and frequent litigation based on allegations of patent and other
intellectual property infringement. To develop and maintain its competitive
position, MTC relies primarily upon the technical expertise and creative
skills of its personnel, confidentiality agreements and, to some degree,
patents and copyrights that it owns or, with respect to patents held by third
parties, has license rights to use. There can be no assurance that such
confidentiality or licensing agreements will not be breached, that others may
not infringe upon such patents or licenses, or that the Company would have
adequate remedies for any such breach for infringement. There can be no
assurance that patents issued to or licensed by the Company will not be
challenged or circumvented by competitors or be found to be sufficiently broad
to protect the Company's technology or to provide it with any competitive
advantage. Moreover, the Company may be materially adversely affected by
competitors who independently develop substantially equivalent technology.
Further, any litigation, either on behalf of or against the Company, relating
to such confidentiality or licensing agreements, patents or copyrights,
regardless of outcome, could result in substantial costs to the Company and
diversion of effort by management. Any infringement claim or other litigation
against or by the Company could have a material adverse effect on the
Company's business, financial condition, prospects and ability to repay its
indebtedness.
ACQUISITION-RELATED RISKS
The Company may from time to time acquire other businesses that the Company
believes will complement its existing business. The Company is unable to
predict whether or when any prospective acquisitions will occur or the
likelihood of a material transaction being completed on favorable terms and
conditions, if at all. The Company's ability to finance acquisitions may be
constrained by, among other things, its high degree of leverage following the
Debt Offering, if completed. The indenture that would govern the Senior Notes
may significantly limit the Company's ability to make desired acquisitions and
to incur indebtedness in connection with acquisitions. Such transactions, if
effected, are likely to involve certain risks, including, among other things:
the difficulty of assimilating the acquired operations and personnel; the
potential disruption of the Company's ongoing business and diversion of
resources and management time; the possible inability of management to
maintain uniform standards, controls, procedures and policies; the risks of
entering markets in which the Company has little or no direct prior
experience; and the potential impairment of relationships with employees or
customers as a result of changes in management. There can be no assurance that
any acquisition will be so made, that the Company will be able to obtain
additional financing needed to finance such acquisitions and, if any
acquisitions are so made, that the acquired business will be successfully
integrated into the Company's operations or that the acquired business will
perform as expected.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is dependent, in part, on its ability to attract
and retain qualified technical, marketing, sales and management personnel.
Competition for such personnel is intense and the Company's
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inability to attract and retain additional key employees or the loss of one or
more of its current key employees could materially adversely affect the
Company's business, financial condition, prospects and ability to repay its
indebtedness. The Company has recently assembled a new management team to
implement its strategy for launching its ISP Channel concept on a large-scale
basis, most of whom have been with the Company for less than six months. The
Company is currently seeking new employees in connection with the expansion of
its Internet Services Division. The loss of any member of the new team, or
failure to attract such personnel, could also have a material adverse effect
on the Company's business, financial condition, prospects and ability to repay
its indebtedness. There can be no assurance that the Company will be
successful in hiring or retaining key personnel.
GOVERNMENT REGULATION
Although the Company's services are not currently subject to direct
regulation by the FCC or any other federal or state communications regulatory
agency, changes in law or regulation relating to Internet connectivity and the
telecommunications markets, including changes that, directly or indirectly,
affect costs, limit usage of subscriber-related information or increase the
likelihood or scope of competition from the RBOCs or other telecommunications
companies, could affect the nature, scope and prices of the Company's
services. For example, proceedings are pending at the FCC to determine
whether, and to what extent, ISPs should be considered "telecommunications
carriers" and, if so, whether they should be required to contribute to the
Universal Service Fund. Although the FCC has decided for the moment that ISPs
are not telecommunications carriers, that decision is not yet final and is
being challenged by various parties, including the RBOCs. Some members of
Congress have also challenged the FCC's conclusion. Congressional
dissatisfaction with the FCC's conclusions could result in further changes to
the FCC's governing law. The Company cannot predict the impact, if any, that
future legal or regulatory changes might have on its business. In addition,
regulation of cable television may affect the speed at which the Company's
cable affiliates upgrade their cable infrastructures to two-way hybrid fiber
coaxial cable. Currently, the Company's cable affiliates have generally
elected to classify the distribution of the Company's services as "additional
cable services" under their respective franchise agreements, and to pay
franchise fees in accordance therewith. However, the election by cable
operators to classify Internet access as an additional cable service may be
challenged before the FCC, the courts or Congress, and any alteration in the
classification of service could potentially have an adverse impact on the
Company and its business.
Another risk lies in the possibility that local franchise authorities may
attempt to subject the cable affiliates to higher or other franchise fees or
taxes or otherwise require them to obtain additional franchises in connection
with their distribution of the Company's services. There are thousands of
franchise authorities in the United States alone, and thus it will be
difficult or impossible for the Company or its cable affiliates to operate
under a unified set of franchise requirements. In the event that the FCC or
another governmental agency were to classify the cable system operators as
"common carriers" or "telecommunications carriers" because of their provision
of Internet services, or if cable system operators were to seek such
classification as a means of limiting their liability, the Company's rights as
the exclusive ISP over the systems of certain of the cable affiliates could be
lost. In addition, if the Company or its cable affiliates were classified as
common carriers, they could be subject to government-regulated tariff
schedules for the amounts they charge for their services. To the extent the
Company increases the number of foreign jurisdictions in which it offers its
services, the Company will be subject to additional governmental regulation.
Any future implementation of any changes in law or regulation including those
discussed herein, could have a material adverse effect on the Company's
business, financial condition, prospects and ability to repay its
indebtedness.
In addition, the Company's business, financial condition, prospects and
ability to repay its indebtedness may also be adversely affected by the
imposition of certain tariffs, duties and other import restrictions on
components that the Company obtains from non-domestic suppliers. Changes in
law or regulation, in the United States or elsewhere, could materially
adversely affect the Company's business, financial condition, prospects and
ability to repay its indebtedness.
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PRODUCT LIABILITY
Some of the Company's products, such as those sold by MTC, are used to
provide information that relates to the customer's enterprise operations and
information that may be used in other critical applications. Any failure by
the Company's products to provide accurate and timely information could result
in claims against the Company. There can be no assurance that the Company's
insurance coverage would adequately cover any claim asserted against the
Company. A successful claim brought against the Company in excess of its
insurance coverage could have a material adverse effect on the Company's
business, financial condition, prospects and ability to repay its
indebtedness. Even unsuccessful claims could result in the Company's
expenditure of funds in litigation and management time and resources. There
can be no assurance that the Company will not be subject to product liability
claims, that such claims will not result in liability in excess of its
insurance coverage or that the Company's insurance will cover such claims or
that appropriate insurance will continue to be available to the Company in the
future at commercially reasonable rates.
RISKS RELATING TO MTC'S INTERNATIONAL OPERATIONS
After giving effect to discontinued operations, sales outside of the United
States accounted for approximately 22% and 27% of the Company's total revenues
for Fiscal 1997 and 1996, respectively, which are attributable solely to MTC.
Further development of foreign distribution channels for MTC's products and
services could require a significant investment, which could adversely affect
short-term results of operations. The Company believes that its future revenue
growth and profitability in the foreign markets will principally depend on its
success in developing these new distribution channels. Failure to increase
revenues from the introduction of new products and services to these markets
could have a material adverse effect on the Company's business, financial
condition, prospects and ability to repay its indebtedness. Because of its
export sales, MTC is subject to the risks of conducting business
internationally, including unexpected changes in regulatory requirements
(including the regulation of Internet access), uncertainty regarding liability
for information retrieved and replicated in foreign institutions, foreign
currency fluctuations which could result in reduced revenues or increased
operating expenses, tariffs and trade barriers, potentially longer payment
cycles, difficulty in accounts receivable collection, foreign taxes, and the
burdens of complying with a variety of foreign laws and trade standards. MTC
is also subject to general geopolitical risks, such as political and economic
instability and changes in diplomatic and trade relationships, in connection
with its international operations. In addition, the laws of certain foreign
countries may not protect MTC's proprietary technology to the same extent as
do the laws of the United States. There can be no assurance that the risks
associated with MTC's international operations will not materially adversely
affect the Company's business, financial condition, prospects and ability to
repay its indebtedness or require MTC to modify significantly its current
business practices.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of shares of the Common Stock by its existing shareholders
under Rule 144 of the Securities Act, or through the exercise of registration
rights or the issuance of shares of the Common Stock upon the exercise of
options or warrants, could materially adversely affect the market price of
shares of the Common Stock and could materially impair the Company's future
ability to raise capital through an offering of equity securities. No
predictions can be made as to the effect, if any, of market sales of such
shares or the availability of such shares for future sale will have on the
market price of shares of the Common Stock prevailing from time to time. At
June 30, 1998, the Company has reserved for issuance 2,886,493 shares of
Common Stock for issuance pursuant to outstanding Convertible Subordinated
Debentures, options and warrants. The Company also has reserved up to 19.9% of
its outstanding Common Stock as of May 29, 1998 for issuance under its cable
affiliate incentive program. The Company has issued Convertible Preferred
Stock that has a conversion price that fluctuates in relation to the price of
the Common Stock. At June 30, 1998, such Convertible Preferred Stock would be
convertible into 1,127,442 shares of Common Stock.
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HOLDING COMPANY STRUCTURE; RESTRICTIONS ON ACCESS TO SUBSIDIARY CASH FLOW
The Company is a holding company, conducting all of its operations through
its Subsidiaries. Because the Company conducts all of its operations through
subsidiaries, the Company's cash flow and its ability to service its
indebtedness will depend upon the cash flow of its subsidiaries and payments
of funds by those subsidiaries to the Company in the form of repayment of
loans, dividends or otherwise. In addition, these subsidiaries may incur
indebtedness or become parties to financing arrangements, which may contain
limitations on the ability of such subsidiaries to pay dividends or to make
loans or advances to the Company. Further, any holders of indebtedness
(including subordinated indebtedness and trade payables) of subsidiaries of
the Company would be entitled to repayment of such indebtedness from the
assets of the affected subsidiaries before such assets were made available for
distribution to the Company.
In the event that the Company is unable to generate sufficient cash flow or
is otherwise unable to obtain funds necessary to meet required payments of
principal, premium, if any, and interest on its indebtedness, the Company
would be in default under the terms of the agreements governing such
indebtedness. In the event of such default, the holders of such indebtedness
could elect to declare all of the funds borrowed thereunder to be due and
payable together with accrued and unpaid interest. If such an acceleration
were effected and the Company did not have sufficient funds to pay the
accelerated indebtedness, the holders could initiate foreclosure or other
enforcement action against the Company.
FAILURE TO SELL THE TELECOMMUNICATIONS DIVISION
The Company has decided to discontinue its Telecommunications Division, and
is currently seeking a buyer for this division. However, there can be no
assurance these efforts will be successful. If the Company is unable to
consummate a sale of the Telecommunications Division on terms it believes are
satisfactory, it will not obtain the proceeds anticipated from such sale,
which will correspondingly diminish the capital available to the Company to
implement its Internet Service Division's strategy. In the absence of such a
sale, management's attention could be substantially diverted to operate or
otherwise dispose of the Telecommunications Division. If a sale of the
Telecommunications Division is delayed, its value could be diminished.
Moreover, the Telecommunications Division could incur losses and operate on a
cash flow negative basis in the future. Any such event could have a material
adverse effect on the Company's business, financial condition, prospects and
ability to repay its indebtedness.
ABSENCE OF DIVIDENDS
The Company has not historically paid any cash dividends on its Common Stock
and does not expect to declare any such dividends in the foreseeable future.
Payment of any future dividends will depend upon earnings and capital
requirements of the Company, the Company's debt facilities and other factors
the Board of Directors deems relevant. The Company currently intends to retain
its earnings, if any, to finance the development and expansion of the Internet
Services Division, and therefore does not anticipate paying any cash dividends
in the foreseeable future. The Company's Certificate of Incorporation
prohibits the payment of cash dividends on the Common Stock, without the
consent of the holders of the Convertible Preferred Stock, while shares of the
Convertible Preferred Stock are outstanding and, upon liquidation of the
Company, requires payment of the liquidation value of the Convertible
Preferred Stock prior to any payments with respect to the Common Stock. The
Company's ability to pay dividends on its Common Stock is also restricted by
certain of the Company's financing agreements.
VOLATILITY OF STOCK PRICE
The market price for the Common Stock has been volatile and market
fluctuations may adversely affect the market price of the Common Stock without
regard to the operating performance of the Company. The Company believes that
factors such as announcements of developments related to the Company's
business, fluctuations in the Company's results of operations, sales of
substantial amounts of securities of the Company into the
18
<PAGE>
marketplace, general conditions in the Company's industries or the worldwide
economy, an outbreak of hostilities, a shortfall in revenues or earnings
compared to analysts' expectations, changes in analysts' recommendations or
projections, announcements of new products or services by the Company or its
competitors or developments in the Company's relationships with its suppliers
or customers could cause the price of the Common Stock to fluctuate in the
future, perhaps substantially. There can be no assurance that the market price
of the Common Stock will not experience significant fluctuations in the
future, including fluctuations that are unrelated to the Company's
performance. General market price declines or market volatility in the future
could adversely affect the market price of the Common Stock, and the current
market price of the Common Stock may not be indicative of future market
prices.
PROSPECTIVE ANTI-TAKEOVER PROVISIONS
The Company is a New York corporation. Following the Offering, it is the
Company's intention to solicit shareholder approval to reincorporate in
Delaware. Both the New York Business Corporation Law and the Delaware General
Corporation Law contain certain provisions that may have the effect of
discouraging, delaying or making more difficult a change in control of the
Company or preventing the removal of incumbent directors. In addition, the
Company is currently reviewing proposed changes to its Certificate of
Incorporation and Bylaws that would have the same effect. The existence of
these provisions may have a negative impact on the price of the Common Stock
and may discourage third party bidders from making a bid for the Company or
may reduce any premiums paid to shareholders for their Common Stock.
YEAR 2000 ISSUES
Many existing computer systems, related software applications and other
control devices use only two digits to identify a year in a date field,
without considering the impact of the upcoming change in the century. Such
systems, applications and/or devices could fail or create erroneous results
unless corrected so that they can process data related to the Year 2000. The
Company relies on such computer systems, applications and devices in operating
and monitoring all major aspects of its business, including, but not limited
to, its financial systems (such as general ledger, accounts payable and
payroll modules), customer services, internal networks and telecommunications
equipment, and end products. The Company also relies, directly and indirectly,
on the external systems of various independent business enterprises, such as
its customers, suppliers, creditors, financial organizations, and of
governments, both domestically and internationally, for the accurate exchange
of data and related information.
The Company is currently in the process of evaluating the potential impact
of the Year 2000 issue on its business and the related expenses that could
likely be incurred in attempting to remedy such impact (including testing and
implementation of remedial action). Management's current estimate is that the
costs associated with the Year 2000 issue should not have a material adverse
affect on the results of operations or financial position of the Company in
any given year. However, despite the Company's efforts to address the Year
2000 impact on its internal systems, the Company is not sure that it has fully
identified such impact or that it can resolve it without disruption of its
business and without incurring significant expenses. In addition, even if the
internal systems of the Company are not materially affected by the Year 2000
issue, the Company could be affected as a result of any disruption in the
operation of the various third party enterprises with which the Company
interacts such as cable affiliates, vendors and suppliers.
19
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and the
related Notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included herein. The consolidated
statement of operations data for the three years ended September 30, 1995,
1996 and 1997 and the consolidated balance sheet data at September 30, 1997
are derived from, and are qualified by reference to, the audited Consolidated
Financial Statements and the related Notes thereto included herein.
<TABLE>
<CAPTION>
(UNAUDITED)
SIX MONTHS
YEAR ENDED SEPTEMBER 30, ENDED MARCH 31,
------------------------------------------ ----------------
1993 1994 1995 1996 1997 1997 1998
------ ------- ------- ------- ------- ------- -------
($ IN THOUSANDS, EXCEPT PER SHARE)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
MTC:
COM equipment and
system software...... $ -- $ -- $ 265 $ 6,014 $ 6,347 $ 3,761 $ 1,020
All other............. 43 188 823 13,403 13,983 6,956 5,625
Internet Services:
Cable service......... 0 0 0 0 20 0 237
Dial-up service....... 0 0 0 150 587 305 339
Misc. one-time........ 0 0 0 17 401 313 8
------ ------- ------- ------- ------- ------- -------
Total revenues....... $ 43 $ 188 $ 1,088 $19,584 $21,338 $11,335 $ 7,229
====== ======= ======= ======= ======= ======= =======
Cost of revenues....... -- 172 783 11,375 11,935 6,371 5,252
Selling, engineering,
general and
administrative........ 837 1,180 7,548 10,921 11,191 4,400 5,257
Income (loss) from
continuing operations. (794) (1,164) (7,243) (2,712) (1,788) 564 (3,280)
Interest expense....... (37) (601) (456) (1,220) (1,145) (533) (596)
Other income .......... 3 2 5 5,708 49 81 170
Gain (loss) from
discontinued
operations............ 348 335 (1,962) (1,812) 739 426 115
Loss from extraordinary
items................. 0 0 0 (6,061) (486) 0 0
------ ------- ------- ------- ------- ------- -------
Net income (loss)...... $ (480) $(1,428) $(9,656) $(6,097) $(2,631) $ 538 $(3,591)
Preferred dividends.... 0 0 0 0 0 0 (63)
------ ------- ------- ------- ------- ------- -------
Net income (loss)
applicable to common
shares................ $ (480) $(1,428) $(9,656) $(6,097) $(2,631) $ 538 $(3,654)
====== ======= ======= ======= ======= ======= =======
Net income (loss) per
share:
Diluted................ $(0.14) $ (0.38) $ (2.22) $ (1.05) $ (0.40) $ 0.08 $ (0.52)
====== ======= ======= ======= ======= ======= =======
Shares used in per
share calculations:
Diluted................ 3,555 3,802 4,353 5,819 6,627 6,864 6,966
====== ======= ======= ======= ======= ======= =======
OTHER FINANCIAL DATA:
Depreciation and
amortization.......... 116 68 194 1,374 1,798 829 951
Capital Expenditures... 12 75 1,418 973 626 530 319
EBITDA (1)............. (678) (1,096) (2,049) 162 1,010 1,393 (2,329)
Ratio of earnings to
fixed charges (2)(3).. -- -- -- 2.2 -- 1.2 --
</TABLE>
<TABLE>
<CAPTION>
(UNAUDITED)
AS OF MARCH 31, 1998
--------------------
($ IN THOUSANDS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents............................. $ 17
Total assets.......................................... 21,934
Total debt............................................ 13,168
Total stockholders' equity............................ 3,387
</TABLE>
20
<PAGE>
- ---------------------
(1) EBITDA consists of net income (loss) from operations excluding net
interest, depreciation and amortization. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flow or results of operations in accordance with generally
accepted accounting principles for the periods indicated and may be
calculated differently than EBITDA for other companies. EBITDA presented
for Fiscal 1995 excludes a one-time write-off of $5.0 million for in
process, unproven technology associated with the Company's acquisition of
MTC on September 15, 1995. EBITDA presented for the fiscal year 1996
excludes a charge of $1.5 million for the write-down of certain software
inventory associated with the Company's decision to discontinue the
distribution of certain imaging products in favor of others. EBITDA
presented for the fiscal year 1997 excludes a charge of $1.0 million for
the write-off of prepaid license fees associated with certain imaging
products. See the Company's Consolidated Financial Statements and the
related Notes thereto.
(2) For purposes of these computations, earnings consist of income (loss) from
continuing operations before income taxes and extraordinary item plus
fixed charges. Fixed charges consist of interest expense (including
capitalized interest), amortization of deferred financing costs and one-
third of rental expense (the portion deemed representative of the interest
factor).
(3) Fixed charges did not exceed the Company's net losses for the fiscal years
ended 1993, 1994, 1995 and 1997 and for the six months ended March 31,
1998. Accordingly, the Company had a deficiency of earnings to fixed
charges of $(790), $(1,129), $(7,144), $(1,463) and $(2,972) for the
respective periods.
21
<PAGE>
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
The selected consolidated historical financial data set forth below for and
as of the three years ended September 30, 1995, 1996 and 1997 have been
derived from the audited Consolidated Financial Statements of the Company. The
following selected consolidated financial data should be read in conjunction
with the Consolidated Financial Statements and the related notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The following table sets forth for the periods selected consolidated
financial and operating data for the Company. The statement of operations and
balance sheet data have been derived from the Company's consolidated financial
statements audited by PricewaterhouseCoopers L.L.P. The selected consolidated
financial data should be read in conjunction with "Management's Discussions
and Analysis of Financial Conditions and Results of Operations" and the
consolidated financial statements and the notes thereto.
<TABLE>
<CAPTION>
(UNAUDITED)
SIX MONTHS
YEAR ENDED SEPTEMBER 30, ENDED MARCH 31,
------------------------------------------ ----------------
1993 1994 1995 1996 1997 1997 1998
------ ------- ------- ------- ------- ------- -------
($ IN THOUSANDS, EXCEPT PER SHARE)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
MTC:
COM equipment and
system software...... $ -- $ -- $ 265 $ 6,014 $ 6,347 $ 3,761 $ 1,020
All other............. 43 188 823 13,403 13,983 6,956 5,625
Internet Services:
Cable service......... 0 0 0 0 20 0 237
Dial-up service....... 0 0 0 150 587 305 339
Misc. one-time........ 0 0 0 17 401 313 8
------ ------- ------- ------- ------- ------- -------
Total revenues........ $ 43 $ 188 $ 1,088 $19,584 $21,338 $11,335 $ 7,229
====== ======= ======= ======= ======= ======= =======
Cost of revenues....... -- 172 783 11,375 11,935 6,371 5,252
Selling, engineering,
general and
administrative........ 837 1,180 7,548 10,921 11,191 4,400 5,257
Income (loss) from
continuing operations. (794) (1,164) (7,243) (2,712) (1,788) 564 (3,280)
Interest expense....... (37) (601) (456) (1,220) (1,145) (533) (596)
Other income .......... 3 2 5 5,708 49 81 170
Gain (loss) from
discontinued
operations............ 348 335 (1,962) (1,812) 739 426 115
Loss from extraordinary
items................. 0 0 0 (6,061) (486) 0 0
------ ------- ------- ------- ------- ------- -------
Net income (loss)...... $ (480) $(1,428) $(9,656) $(6,097) $(2,631) $ 538 $(3,591)
Preferred dividends.... 0 0 0 0 0 0 (63)
------ ------- ------- ------- ------- ------- -------
Net income (loss)
applicable to common
shares................ $ (480) $(1,428) $(9,656) $(6,097) $(2,631) $ 538 $(3,654)
====== ======= ======= ======= ======= ======= =======
Net income (loss) per
share:
Diluted................ $(0.14) $ (0.38) $ (2.22) $ (1.05) $ (0.40) $ 0.08 $ (0.52)
====== ======= ======= ======= ======= ======= =======
Shares used in per
share calculations:
Diluted................ 3,555 3,802 4,353 5,819 6,627 6,864 6,966
====== ======= ======= ======= ======= ======= =======
OTHER FINANCIAL DATA:
Depreciation and
amortization.......... 116 68 194 1,374 1,798 829 951
Capital Expenditures... 12 75 1,418 973 626 530 319
EBITDA (1)............. (678) (1,096) (2,049) 162 1,010 1,393 (2,329)
Ratio of earnings to
fixed charges (2)(3).. -- -- -- 2.2 -- 1.2 --
</TABLE>
<TABLE>
<CAPTION>
(UNAUDITED)
AS OF MARCH
31, 1998
--------------
($ IN THOUSANDS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 17
Total assets................................................ 21,934
Total debt.................................................. 13,168
Total stockholders' equity.................................. 3,387
</TABLE>
22
<PAGE>
- ---------------------
(1) EBITDA consists of net income (loss) from operations excluding net
interest, depreciation and amortization. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flow or results of operations in accordance with generally
accepted accounting principles for the periods indicated and may be
calculated differently than EBITDA for other companies. EBITDA presented
for Fiscal 1995 excludes a one-time write-off of $5.0 million for in
process, unproven technology associated with the Company's acquisition of
MTC on September 15, 1995. EBITDA presented for the Fiscal 1996 excludes a
charge of $1.5 million for the write-down of certain software inventory
associated with the Company's decision to discontinue the distribution of
certain imaging products in favor of others. EBITDA presented for the
Fiscal 1997 excludes a charge of $1.0 million for the write-off of prepaid
license fees associated with certain imaging products. See the Company's
Consolidated Financial Statements and the related Notes thereto.
(2) For purposes of these computations, earnings consist of income (loss) from
continuing operations before income taxes and extraordinary item plus
fixed charges. Fixed charges consist of interest expense (including
capitalized interest), amortization of deferred financing costs and one-
third of rental expense (the portion deemed representative of the interest
factor).
(3) Fixed charges did not exceed the Company's net losses for the fiscal years
ended 1993, 1994, 1995 and 1997 and for the six months ended March 31,
1998. Accordingly, the Company had a deficiency of earnings to fixed
charges of $(790), $(1,129), $(7,144), $(1,463) and $(2,972) for the
respective periods.
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with, and is qualified
in its entirety by reference to, the Consolidated Financial Statements of the
Company and the related Notes. The Company's fiscal year ends on September
30th of each year. "Fiscal 1998" refers to the twelve months ended September
30, 1998 with comparable references for other twelve month periods ending
September 30th. This discussion contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in the forward-looking statements as a
result of certain factors including, but not limited to, those discussed in
"Risk Factors." The Company disclaims any obligation to update information
contained in any forward-looking statement.
OVERVIEW
The Company currently operates through two continuing divisions: the
Internet Services Division and MTC. SoftNet is in the process of implementing
a new strategic focus that involves emphasizing the Internet Services
Division. As part of its new focus, the Company is currently seeking a buyer
for its Telecommunications Division and is now accounting for this division as
a discontinued operation.
MTC. Through MTC, the Company develops and manufactures sophisticated,
automated electronic document management and film-based imaging solutions for
customers with large-scale, complex, document-intensive requirements. MTC's
hardware and software products are based on an industry standard client-server
architecture, providing flexibility to connect to a wide variety of
information systems and produce output to various storage media, including
optical disk, magnetic disk and tape, CD-ROM, and microfilm and microfiche,
spanning the entire document lifecycle.
MTC's electronic and film-based imaging hardware systems typically range in
price between $200,000 and $1,000,000, and may represent a significant capital
commitment by MTC's customers, leading to a lengthy sales cycle of up to 24
months. Accordingly, MTC's operating results may fluctuate significantly from
period to period.
The Internet Services Division. The Company began providing Internet
services following its acquisition of the Internet Services Division in June
1996. The Company seeks to become the dominant provider of high-speed Internet
access via the existing cable television infrastructure to homes and
businesses in the franchise areas of small- and medium-sized cable television
systems. In addition, the Company seeks to maintain and build its traditional
dial-up Internet access business. The Company commenced marketing its cable
modem-based service, the ISP Channel, to selected cable operators and
potential subscribers in March 1998.
Potential Market. The growth of the Internet has been significant. By 2002,
Forrester estimates that 59% of U.S. households and 50% of U.S. businesses
will be on-line, and that annual spending by residential and business end-
users on U.S. Internet access and related services will increase from an
estimated approximately $6 billion in 1997 to nearly $50 billion. For many
users, the speed of such access will become an increasingly important factor
in choosing among service providers.
The Company's solution emphasizes the use of cable modems and, in the
future, television set-top boxes, due to the fact that the existing cable
infrastructure can be equipped to provide Internet access to over 90% of U.S.
households at speeds significantly in excess of those readily available using
the telecommunications infrastructure. Of the approximately 92.2 million U.S.
homes passed by cable, approximately 65% are under
24
<PAGE>
exclusive contract with competing cable-based Internet access services or, in
the Company's judgment, are located in cable systems to which one of these
competitors is likely to obtain exclusive rights for the provision of such
services. Such competitors include @Home and RoadRunner, both of which are
affiliated with large MSOs including, among others, Cablevision, Comcast, Cox,
MediaOne, TCI and Time Warner.
The Company believes that the above-mentioned competitive providers of
cable-based Internet access services presently intend to target large,
clustered systems in major DMAs, and that the remaining systems owned by the
MSO affiliates of such competitors, particularly systems with under 50,000
subscribers that have not been upgraded to carry two-way traffic, will in many
cases not be offered high-speed Internet capability by such competitors in the
next two to three years. In certain cases, the Company believes that such
systems may be divested by such competitors' MSO affiliates or permitted to
contract for high-speed Internet capability with non-affiliated providers such
as the Company. The remaining U.S. homes passed by cable are located in a
large number of small- and medium-sized cable systems as well as certain large
Independent MSOs. In evaluating the potential of these systems for investment,
the Company has targeted only those systems that are sufficiently large to
provide an adequate return on the required invested capital. Based on this
analysis, the Company believes that its addressable market is approximately 30
million homes, located in approximately 2,000 cable systems. Set forth below
is a summary of the total U.S. cable market, based on data compiled by
Claritas, an independent industry research consultant, and a summary of the
portion of this market that SoftNet intends to address, based on the
parameters described above.
ISP CHANNEL--POTENTIAL U.S. MARKET BASED ON SUBSCRIBERS(A)
<TABLE>
<CAPTION>
ISP CHANNEL ADDRESSABLE U.S.
TOTAL U.S. MARKET MARKET
------------------------------ ------------------------------
CABLE HOMES CABLE HOMES
SYSTEM SIZE SUBSCRIBERS PASSED SYSTEMS SUBSCRIBERS PASSED SYSTEMS
- ----------- ----------- ---------- ------- ----------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Cable Subs over 50,000.. 27,870,684 41,316,994 287 2,583,314 3,775,979 30
Cable Subs 5,000 to
49,999................. 28,317,985 39,565,810 1,793 16,774,574 22,772,280 1,183
Cable Subs 2,500 to
4,999.................. 3,100,040 4,156,319 891 2,558,862 3,396,048 741
Cable Subs 1,000 to
2,499.................. 2,300,091 3,542,782 1,473 -- -- --
Cable Subs less than
1,000.................. 2,039,717 3,623,699 6,957 -- -- --
---------- ---------- ------ ---------- ---------- -----
63,628,517 92,205,604 11,401 21,916,750 29,944,307 1,954
========== ========== ====== ========== ========== =====
</TABLE>
- ---------------------
(a) Source: Claritas (Total U.S. Market only) and the Company.
Market Penetration. As of July 14, 1998, the Company had contracts for its
ISP Channel service with 19 cable operators, including Galaxy, Palo Alto Cable
Co-op and Coral Springs Cable, representing over 100 cable systems and
approximately 575,000 homes passed. Nine of these systems, representing
approximately 175,000 homes passed, have been equipped and have begun offering
the Company's services, in most cases during the past two months. In addition,
the Company has non-binding letters of intent with three cable operators,
including Northland, representing approximately 525,000 homes passed.
Currently, the Company has approximately 500 residential and business
subscribers to its ISP Channel service. The Company also provides dial-up and
dedicated Internet access to approximately 1,100 residential and business
subscribers. The Company's contract with Galaxy for its ISP Channel service
represents 82% of its cable systems and 57% of its homes passed currently
under contract. In addition, the Company believes that its agreement with
Northland, if executed, will also constitute a significant percentage of its
cable systems and homes passed to date. See "Risk Factors--Dependence on Local
Cable Operators and their Cable Infrastructure" and "--Dependence on Exclusive
Access to Cable Subscribers Need for Aggressive Implementation and
Deployment."
In order to expand its cable-based Internet subscriber base significantly,
the Company expects to pursue aggressively affiliation agreements with cable
operators which will provide it with the exclusive right to market cable-based
Internet services to existing cable television subscribers in such cable
operators' systems. The Company's objective is to enter into exclusive
arrangements with cable operators representing approximately 7.5 million homes
passed in the next three years.
25
<PAGE>
It is the Company's objective to market its services aggressively and to
install its systems in as many cable systems as possible in the next few
years. The Company anticipates that this policy of rapid deployment will
result in substantial capital expenditures, operating losses and negative cash
flow in the near term. The Company believes it will need to raise substantial
additional capital to achieve its market penetration objectives. There can be
no assurance, however, that the Company will be able to raise sufficient
capital on acceptable terms, or at all, or that it will be able to implement
its strategy or achieve positive cash flow or profitability in a timely
fashion, or at all.
Revenue Sources. In providing its Internet services, the Company receives
revenue from the provision of (i) cable modem-based Internet access services
and (ii) traditional dial-up Internet access services. Currently, the Company
typically charges new cable modem-based Internet access subscribers a one-time
connection fee of $99, which fee includes modem installation and any required
modification of the existing cable television connection. Thereafter, each
subscriber pays an access fee, which is currently as low as $49 per month. The
Company anticipates that it will purchase a majority of cable modems used by
subscribers, who will be charged a nominal lease charge. The Company does not
charge new dial-up subscribers a connection fee, but does charge a monthly
access fee of approximately $20.
In addition to connection fees and monthly access fees, the Company intends
to pursue additional revenue opportunities from Internet advertising, e-
commerce and IP telephony. The Company also intends to pursue long distance
telephone services and telephony debit and credit cards.
In the future, as digital set-top boxes become available and are introduced
into the Company's affiliated cable systems, the Company expects to charge
those subscribers monthly access fees comparable to those now charged
traditional dial-up subscribers. The Company also expects to charge customers
a set-top connection fee to help defray installation expenses.
For cable-based Internet services, the Company typically shares 25% of total
revenues with cable affiliates for the first 200 subscribers in each system
and 50% thereafter. For other services, such as IP telephony, e-commerce and
advertising, the Company expects to share between 25% and 50% of total
revenues with the cable affiliates. The Company expects that no commissions
will be paid on cable modem lease income. The Company expects that these
commissions will be netted against revenues.
Cost of Services. Costs to the Company include installation costs, network
and cable operation costs and personnel and other costs. Operator commissions
vary by type of connectivity and size of contract.
Installation costs are expected to vary by type of connectivity and type of
customer. The Company charges new subscribers a one time fee to defray the
costs of installation, which includes labor and overhead. While currently the
installation fee does not cover the entire cost incurred, the Company expects
that over time installation costs will decline as cable modems become more
commercially available and are eventually bundled as standard equipment in new
PCs.
Other network costs include the cost of connection to the public switch
telephone network and the cost of leased fiber capacity.
Sales, Marketing and Operating Expenses. Sales, marketing and operating
expenses include the costs of the Company's cable affiliate program,
maintenance of its infrastructure, customer care, content and new business
development in addition to sales and marketing expenses.
EBITDA. Over the next three years, the Company will seek to become the
exclusive provider of Internet based high-speed data, video and telephony
services over cable systems representing approximately 7.5 million homes
passed, and to attract approximately 470,000 ISP Channel subscribers, or
approximately 6.3% of such homes passed. If it is able to accomplish this
objective, the Company expects the Internet Services Division to achieve
positive EBITDA within this timeframe. The Company's ability to generate
positive EBITDA will be
26
<PAGE>
affected by the Company's ability to contract with cable operators, attract
customers for its services, achieve anticipated pricing levels for its
services and maintain costs at anticipated levels. No assurance can be given
that the Company will be able to contract with sufficient cable operators,
attract an adequate amount of subscribers, or achieve and sustain the pricing
and cost levels that would be required for it to obtain such financial
results.
Capital Expenditures. In order to pursue its business plan, the Company
expects to incur significant capital expenditures to provision its turnkey
solution for cable operators, principally relating to the installation of
headend equipment and the purchase of customer premise equipment such as cable
modems. The cost of headend provisioning has averaged $45,000 for the nine
systems in which the Company currently provides service. The costs of cable
modems, currently approximately $179 to $349, is expected to decline. With
respect to the costs of cable modems, the Company believes that it will be
able to recoup a limited amount of such costs from its subscribers, either
through subscriber purchases or monthly lease charges. However, the Company
recognizes that, in line with experience in other subscription service
industries, it will need to subsidize both installation and customer premises
equipment (cable modems) costs. Such expenditures, however, are expected to be
offset in part by the savings resulting from decreased prices for such
equipment as production volumes increase.
HISTORICAL RESULTS OF OPERATION
The Company has changed significantly over the last several years as it has
entered certain businesses and exited or prepared to exit, others. For
example, on April 7, 1998, the Company announced its decision to divest its
Telecommunications Division and is currently considering purchase offers. The
discussion of the Company's results of operation below therefore treats the
Telecommunication Division as a discontinued operation. In addition, the
Company entered the Internet business in June 1996 with the purchase of the
Internet Services Division and began offering cable-based Internet services in
the first quarter of Fiscal 1998. Accordingly, year-to- year comparisons may
not be meaningful.
<TABLE>
<CAPTION>
(UNAUDITED)
FISCAL SIX MONTHS ENDED
------------------------- -------------------
MARCH 31, MARCH 31,
SEGMENT INFO 1995 1996 1997 1997 1998
- ------------ ------- ------- ------- --------- ---------
($ IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Sales
MTC.......................... $ 1,088 $19,417 $20,330 $10,717 $ 6,645
Internet Services............ -- 167 1,008 618 584
Cost of Sales
MTC.......................... 783 11,375 11,050 5,863 4,571
Internet Services............ -- -- 885 508 681
Gross Profit
MTC.......................... 305 8,042 9,280 4,854 2,074
Internet Services............ -- 167 123 110 (97)
Operating Expenses
MTC.......................... 6,329 8,162 8,714 3,282 3,296
Internet Services............ -- 478 1,273 566 1,047
Income (loss) from continuing
operations
MTC.......................... (6,024) (120) 566 1,572 (1,222)
Internet Services............ -- (311) (1,150) (456) (1,144)
Corporate Overhead........... (1,219) (2,281) (1,204) (552) (914)
------- ------- ------- ------- -------
Consolidated................. $(7,243) $(2,712) $(1,788) $ 564 $(3,280)
======= ======= ======= ======= =======
</TABLE>
SIX MONTHS ENDED MARCH 31, 1998 COMPARED TO SIX MONTHS ENDED MARCH 31, 1997
Consolidated net sales decreased $4.1 million, or 36.2%, for the six months
ended March 31, 1998, as compared to the six months ended March 31, 1997. The
decrease in consolidated net sales was primarily the result of a decrease in
net sales of MTC. Sales in this division decreased $4.1 million, or 38.0%, to
$6.6 million
27
<PAGE>
for the six months ended March 31, 1998, as compared to sales of $10.7 million
for the six months ended March 31, 1997. The decrease in MTC sales was
primarily the result of a decrease in the sale of COM equipment. COM equipment
sales were affected in the first quarter of Fiscal 1998 by the fact that MTC
entered the year with an order backlog of $1.4 million, as compared to an
order backlog of $3.4 million in the prior period. Internet Services Division
sales decreased $34,000, or 5.5%, to $584,000 for the six months ended March
31, 1998, as compared to sales of $618,000 for the six months ended March 31,
1997. Miscellaneous one-time sales decreased $305,000 to $8,000 for the six
months ended March 31, 1998, as compared to $313,000 for the same period in
1997. A miscellaneous one-time sales opportunity for the installation of an
Internet access system in the country of Milawi accounted for $187,000 of
these sales in the six months ended March 31, 1997. The decrease in
miscellaneous one-time sales was partially offset by an increase in sales of
$237,000 for the Division's cable services. The Internet Services Division had
not yet introduced this service to the market during the six months ended
March 31, 1997.
Consolidated gross profit decreased $3.0 million, or 60.2%, to $2.0 million
for the six months ended March 31, 1998, as compared to $5.0 million for the
six months ended March 31, 1997, with profit margins decreasing to 27.3% from
43.8% for the comparable period in 1997. The decrease in gross profit is
primarily the result of a decrease in gross profits of $2.8 million, or 57.3%,
of MTC. Gross profit margins in this division decreased to 31.2% from 45.3%
for the comparable period in 1997, primarily as the result of the decrease in
MTC's COM equipment sales, which contribute the highest product profit
margins. Gross profit decreased $207,000 in the Internet Services Division for
the six months ended March 31, 1998, primarily as a result of the
reclassification of certain web development expenses and certain other
expenses associated with the expansion of the division's technical support
staff to cost of goods sold. Similar expenses in prior year presentations have
not been reclassified, due to immateriality.
Operating expenses (including selling, engineering, general and
administrative expenses, less amortization) increased $874,000, or 23.3%, to
$4.6 million for the six months ended March 31, 1998, as compared to
$3.7 million for the six months ended March 31, 1997. The increase in
operating expenses is partially the result of the consolidation and relocation
of the Company's operations formerly based in Chicago to the Company's
facilities in Mountain View, California. These activities included a one time
write-off of leasehold improvements and moving expenses of $240,000. In
addition, operating expenses increased in the Internet Services Division by
$481,000, or 134.0%, to $840,000 for the six months ended March 31, 1998, as
compared with $359,000 for the same period in 1997. This increase in operating
expense is primarily the result of the increase in the Internet Services
Division's administrative, sales and marketing efforts supporting the
division's cable service offering.
Amortization expense decreased $17,000, or 2.6%, to $643,000 for the six
months ended March 31, 1998 from $660,000 for the six months ended March 31,
1997.
For the six months ended March 31, 1998, the Company had a net loss from
continuing operations of $3.3 million, as compared to net income from
continuing operations of $564,000 for the six months ended March 31, 1997.
Interest expense increased $63,000, or 11.8%, to $596,000 for the six months
ended March 31, 1998 from $533,000 for the six months ended March 31, 1997.
The Company made no provisions for income taxes for the six months ended
March 31, 1998 and the six months ended March 31, 1997 as a result of the
Company's net operating loss carry-forward.
The Company recognized a gain from operations with respect to its
discontinued Telecommunications Division of $115,000 for the six months ended
March 31, 1998, as compared to a gain from operations of $426,000 for the same
period in 1997.
For the six months ended March 31, 1998, the Company had a net loss
applicable to common shareholders of $3.7 million, as compared to net income
of $538,000 for the six months ended March 31, 1997.
28
<PAGE>
FISCAL 1997 COMPARED TO FISCAL 1996
Consolidated net sales increased $1.8 million, or 9.2%, to $21.3 million for
Fiscal 1997, as compared to $19.6 million for Fiscal 1996. MTC's sales
increased $913,000, or 4.7%, to $20.3 million for Fiscal 1997 as compared to
$19.4 million for Fiscal 1996. This increase in net sales is primarily the
result of increased monthly rental streams associated with the Division's
continued implementation of alternative customer leasing arrangements for its
core COM products. Sales in the Internet Services Division increased $841,000
to $1.0 million for Fiscal 1997 from $167,000 for Fiscal 1996. Sales in the
Internet Services Division for Fiscal 1996 consist only of fourth quarter
sales, as the Division was acquired in June 1996.
Consolidated gross profit increased $1.2 million, or 14.6%, to $9.4 million
for Fiscal 1997, as compared to $8.2 million for Fiscal 1996, with profit
margins increasing to 44.1% from 41.9% for the same period in 1996. Gross
profit increased $1.3 million, or 15.4%, in MTC to $9.3 million for Fiscal
1997 from $8.0 million for Fiscal 1996, with gross profit margins increasing
to 45.7% from 41.4% for the same period in 1996. The increase in gross profit
margin was primarily the result of increased productivity efficiencies in the
manufacturing operation, which in turn resulted from a strong backlog and
steady, customer order driven, manufacturing schedules. The Internet Services
Division recorded gross profits of $123,000 for Fiscal 1997, however year to
year comparisons are not meaningful, given the fact that the Division operated
for only one quarter in Fiscal 1996 and allocated no expense to cost of goods
sold during this one quarter period.
Operating expenses (including selling, engineering, general and
administrative, less amortization) decreased $24,000, or 0.2%, to $9.9 million
for Fiscal 1997 as compared to $9.9 million for Fiscal 1996. General and
administrative expenses associated with MTC and Corporate Overhead decreased a
combined $810,000, or 20.2%, to $3.2 million for Fiscal 1997, as compared to
$4.0 million in the same period in 1996. The decrease in these combined
general and administrative expenses is the result of certain overhead cost
cutting measures implemented to achieve back office efficiencies throughout
the Company. For MTC, engineering expenses increased $324,000, or 19.1%, to
$2.0 million for Fiscal 1997, as compared to $1.7 million for Fiscal 1996, as
a result of the Division's continued effort to expand and improve the products
offered to its customers. Included in the consolidated operating expenses are
two separate, one-time charges associated with changes in the Company's
product lines, in the amounts of $2.1 million for Fiscal 1997 and $2.2 million
for Fiscal 1996. Operating expenses in the Internet Services Division
increased $483,000 to $858,000 for Fiscal 1997, however year to year
comparisons are not meaningful given the fact that the Division operated for
only one quarter in Fiscal 1996.
Amortization expense increased $294,000, or 29.6%, to $1.3 million for
Fiscal 1997 from $993,000 for Fiscal 1996. This increase in amortization
expense is primarily the result of the additional amortization expense
associated with the acquisition of the Internet Services Division in June
1996.
The Company had a net loss from continuing operations of $1.8 million for
Fiscal 1997, as compared to a net loss from continuing operations of $2.7
million for Fiscal 1996.
Consolidated interest expense decreased $75,000, or 6.2%, to $1.1 million
for Fiscal 1997 as compared to $1.2 million for Fiscal 1996, primarily as a
result of the conversion of $4.5 million of convertible subordinated notes
since June 1996.
The Company recognized a gain on the sale of securities of $5.7 million in
Fiscal 1996. This gain was the result of the sale of all shares of IMNET
Systems, Inc. ("IMNET") held by the Company.
The Company made no provisions for income taxes for Fiscal 1997 and Fiscal
1996 as a result of the Company's net operating loss carry-forward.
The Company recognized a gain from operations with respect to its
discontinued Telecommunications Division of $739,000 for Fiscal 1997, as
compared to a loss from operations of $1.8 million for the same period in
1996. The loss incurred in Fiscal 1996 includes a loss from operations of $2.5
million associated with the disposal of the Company's wholly-owned subsidiary,
Communicate Direct, Inc.
29
<PAGE>
The Company recognized a loss from extraordinary item of $486,000 for Fiscal
1997, as compared to a loss from extraordinary item of $6.1 million for the
same period in 1996. The losses are associated with the disposal of the
Company's wholly-owned subsidiary, Communicate Direct, Inc.
For Fiscal 1997, the Company had a net loss applicable to common
shareholders of $2.6 million, as compared to a net loss of $6.1 million for
Fiscal 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Consolidated net sales increased by $18.5 million to $19.6 million for
Fiscal 1996 as compared to $1.1 million for Fiscal 1995. The increase in sales
was primarily the result of the acquisition of MTC in September 1995.
Consolidated gross profit increased $7.9 million to $8.2 million for Fiscal
1996 as compared to $305,000 for Fiscal 1995, with gross profit margin
increasing to 41.9% from 28.0% for the comparable period in 1995. The increase
in gross profit relates primarily to the inclusion of MTC's results for Fiscal
1996. During Fiscal 1996, in order to conform with industry practices, the
Company classified certain expenses as cost of sales which under prior
presentations would have been classified as general and administrative
expenses. Consistent with this presentation, the Company has reclassified
certain general and administrative expenses as cost of sales for Fiscal 1995.
Operating expenses (including selling, engineering, general and
administrative expenses, less amortization) increased $2.4 million to $9.9
million for Fiscal 1996, as compared to $7.5 million for Fiscal 1995. Selling,
engineering, general and administrative expenses increased a combined $6.1
million to $7.8 million for Fiscal 1996, as compared to $1.7 million for
Fiscal 1995, primarily from the inclusion of MTC's operations for the entire
fiscal year ended September 30, 1996. Included in the operating expenses for
Fiscal 1996 is a one-time charge of $2.2 million associated with changes in
the Company's product lines. Included in the operating expenses for Fiscal
1995 is a write-off of acquired in process, unproven technology of $5.0
million and acquisition expenses of $846,000, both of which are associated
with the acquisition of MTC in September 1995.
Amortization expense increased $964,000 to $993,000 for Fiscal 1996 as
compared to $29,000 for Fiscal 1995. This increase in amortization expense is
primarily the result of the additional amortization expense associated with
the acquisition of MTC in September 1995.
The Company had a net loss from continuing operations of $2.7 million for
Fiscal 1996, as compared to a net loss from continuing operations of $7.2
million for Fiscal 1995.
Consolidated interest expense increased $764,000 to $1.2 million for Fiscal
1996 as compared to $456,000 for Fiscal 1995. Interest expense increased as a
result of increased outstanding indebtedness during Fiscal 1996. The increase
in outstanding indebtedness was principally a result of acquisition debt and
borrowings to fund working capital.
The Company recognized a gain on the sale of securities of $5.7 million in
Fiscal 1996. This gain was the result of the sale of all shares of IMNET held
by the Company.
The Company recognized a loss from operations with respect to its
discontinued Telecommunications Division of $1.8 million for Fiscal 1996. The
Company recognized a loss from operations with respect to its discontinued
Telecommunications Division of $898,000 for Fiscal 1995, in addition to a loss
of $1.1 million associated with the discontinued operations and disposal of
Utilization Management Associates, Inc.
For Fiscal 1996, the Company had a net loss applicable to common
shareholders of $6.1 million, as compared to a net loss of $9.7 million for
Fiscal 1995.
30
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
For fiscal 1997, cash flows used in operating activities of continuing
operations were $1.4 million, as compared to $3.3 million for fiscal 1996. The
Company used $1.1 million in investing activities of continuing operations
during fiscal 1997, as compared to cash flows of $5.2 million provided by
investing activities of continuing operations in fiscal 1996. During fiscal
1996, the Company realized net proceeds of $7.7 million on the sale of
marketable securities. Cash flows provided by financing activities of
continuing operations increased $4.5 million to $2.4 million for fiscal 1997,
as compared to cash flows used in financing activities of continuing
operations of $2.1 million for fiscal 1996. This increase in cash flows was
primarily the result of the establishment of additional credit facilities
associated with certain lease arrangements the Company entered into with its
customers.
For the six months ended March 31, 1998, cash flows used in operating
activities of continuing operations were $2.5 million, as compared to $908,000
for the six months ended March 31, 1997. The Company used $243,000 in
investing activities of continuing operations during the six months ended
March 31, 1998, as compared to $924,000 for the same period in 1997. Cash
flows provided by financing activities of continuing operations increased
$962,000 million to $2.7 million for the six months ended March 31, 1998, as
compared to $1.8 million for the six months ended March 31, 1997. This
increase in cash flows was primarily the result of the realization of $4.6
million in net proceeds associated with the Company's private equity placement
on December 31, 1997 and the repayment of long-term debt of $2.0 million, as
compared to net borrowings of $1.9 million over the six months ended March 31,
1997.
On December 31, 1997, the Company sold 5,000 shares of Series A Preferred
Stock and warrants to purchase 150,000 shares of Common Stock for $5,000,000.
On January 2, 1998, $4.6 million in net proceeds from this sale were applied
to the Company's Revolving Credit Facility. On May 28, 1998, the Company sold
10,000 shares of Series B Preferred Stock and warrants to purchase 200,000
shares of Common Stock for $10,000,000. The Company has extended the maturity
of its Revolving Credit Facility, which has a maximum borrowing capacity of
$9.5 million, through July 15, 1999. During fiscal 1997, the Company obtained
an additional credit facility from the same lender, whereby MTC can borrow up
to $1.5 million against qualified lease arrangements it enters into with its
customers.
The Company believes that it will need to raise substantial additional
capital to fund the Company's aggregate capital expenditures and working
capital requirements, including operating losses, associated with achieving
its market penetration objectives. The Company's future cash requirements for
its business plan expansion will depend on a number of factors including (i)
the number of cable affiliate contracts, (ii) cable modem and associated costs
of equipment, (iii) the rate at which subscribers purchase the Company's
Internet service offering and (iv) the level of marketing required to acquire
and retain subscribers and to attain a competitive position in the
marketplace. In addition, the Company may wish to selectively pursue possible
acquisitions of businesses, technologies, content or products complementary to
those of the Company in the future in order to expand its Internet presence
and achieve operating efficiencies. The Company may seek to obtain additional
funding through the sale of public or private debt and/or equity securities or
through a bank credit facility. There can be no assurance as to the
availability or terms upon which such financing might be available.
YEAR 2000 ISSUE
Many existing computer systems and related software applications, and other
control devices, use only two digits to identify a year in a date field,
without considering the impact of the upcoming change in the century. Such
systems, applications and/or devices could fail or create erroneous results
unless corrected so that they can process data related to the Year 2000. The
Company relies on such computer systems, applications and devices in operating
and monitoring all major aspects of its business, including, but not limited
to, its financial systems (such as general ledger, accounts payable and
payroll modules), customer services, internal networks and telecommunications
equipment, and end products. The Company also relies, directly and indirectly,
on the
31
<PAGE>
external systems of various independent business enterprises, such as its
customers, suppliers, creditors, financial organizations, and of governments,
both domestically and internationally, for the accurate exchange of data and
related information.
The Company is currently in the process of evaluating the potential impact
of the Year 2000 issue on its business and the related expenses that could
likely be incurred in attempting to remedy such impact (including testing and
implementation of remedial action). Management's current estimate is that the
costs associated with the Year 2000 issue should not have a material adverse
affect on the results of operations or financial position of the Company in
any given year. However, despite the Company's efforts to address the Year
2000 impact on its internal systems, the Company is not sure that it has fully
identified such impact or that it can resolve it without disruption of its
business and without incurring significant expenses. In addition, even if the
internal systems of the Company are not materially affected by the Year 2000
issue, the Company could be affected as a result of any disruption in the
operation of the various third party enterprises with which the Company
interacts such as cable affiliates, vendors and suppliers.
32
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ 33
Consolidated Statements of Operations for years ended September 30, 1997,
1996 and 1995............................................................ 34
Consolidated Balance Sheets, September 30, 1997 and 1996.................. 35
Consolidated Statements of Shareholders' Equity for years ended September
30, 1997, 1996 and 1995.................................................. 36
Consolidated Statements of Cash Flows for years ended September 30, 1997,
1996 and 1995............................................................ 37
Notes to Consolidated Financial Statements................................ 38
Condensed Consolidated Statement of Operations for the Three Months and
Six Months Ended March 31, 1998 and March 31, 1997 (unaudited)........... 55
Condensed Consolidated Balance Sheets, March 31, 1998 and September 30,
1997 (unaudited)......................................................... 56
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
March 31, 1998 and March 31, 1997 (unaudited)............................ 57
Notes to Condensed Consolidated Financial Statements...................... 58
</TABLE>
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of SoftNet Systems, Inc.:
We have audited the consolidated financial statements of SoftNet Systems,
Inc. and Subsidiaries as listed in the preceding index to the consolidated
financial statements. 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 audits 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of SoftNet
Systems, Inc. and Subsidiaries as of September 30, 1997 and 1996 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended September 30, 1997 in conformity with
generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standard No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" in 1995.
The accompanying consolidated financial statements have been restated for
the effects of the discontinued operations of the telecommunications segment
as discussed in Note 17.
COOPERS & LYBRAND L.L.P.
/s/ PricewaterhouseCoopers L.L.P.
Chicago, Illinois
December 24, 1997 except for Note 17
as to which the date is July 27, 1998
33
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Net sales........................................... $21,338 $19,584 $ 1,088
Cost of sales....................................... 11,935 11,375 783
------- ------- -------
Gross profit.................................... 9,403 8,209 305
------- ------- -------
Operating expenses:
Selling........................................... 1,905 1,794 168
Engineering....................................... 2,234 1,770 59
General and administrative........................ 3,628 4,200 1,446
Amortization of goodwill and transaction costs.... 1,287 993 29
Costs associated with change in product line and
other............................................ 2,137 2,164 --
Write off of acquired in process unproven
technology....................................... -- -- 5,000
Acquisition costs and other....................... -- -- 846
------- ------- -------
Total operating expenses........................ 11,191 10,921 7,548
------- ------- -------
Loss from continuing operations..................... (1,788) (2,712) (7,243)
Interest expense.................................. (1,145) (1,220) (456)
Gain on sale of available-for-sale securities..... -- 5,689 --
Other income...................................... 49 19 5
------- ------- -------
Income (loss) from continuing operations before
income taxes and extraordinary item................ (2,884) 1,776 (7,694)
Provision for income taxes.......................... -- -- --
------- ------- -------
Income (loss) before discontinued operations and
extraordinary item................................. (2,884) 1,776 (7,694)
Discontinued operations:
Income (loss) from operations..................... 739 (1,812) (1,318)
Loss on disposal.................................. -- -- (644)
------- ------- -------
Loss before extraordinary item...................... (2,145) (36) (9,656)
Extraordinary item:
Loss on sale of business............................ (486) (6,061) --
------- ------- -------
Net loss............................................ $(2,631) $(6,097) $(9,656)
======= ======= =======
Loss per share:
Continuing operations............................. $ (0.44) $ 0.30 $ (1.77)
Discontinued operations........................... 0.11 (0.31) (0.30)
Loss on disposal.................................. -- -- (0.15)
Extraordinary item................................ (0.07) (1.04) --
------- ------- -------
Net loss.......................................... $ (0.40) $ (1.05) $ (2.22)
======= ======= =======
Weighted average shares outstanding............... 6,627 5,819 4,353
------- ------- -------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
34
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash..................................................... $ 37 $ 426
Accounts receivable, net................................. 5,135 3,837
Inventories.............................................. 1,326 2,793
Prepaid expenses and other............................... 319 254
-------- --------
Total current assets................................... 6,817 7,310
-------- --------
Property & equipment, net.................................. 1,108 1,336
Costs in excess of fair value of net assets acquired, net.. 5,141 6,255
Other assets............................................... 3,820 2,312
Net assets associated with discontinued operations......... 3,435 1,783
-------- --------
$ 20,321 $ 18,996
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................... $ 4,969 $ 4,039
Current portion of long-term debt........................ 1,384 603
Current portion of capital leases........................ 23 79
Deferred revenue......................................... 143 159
-------- --------
Total current liabilities.............................. 6,519 4,880
-------- --------
Long-term debt, net of current portion..................... 11,727 10,247
-------- --------
Capital leases, net of current portion..................... 47 76
-------- --------
Shareholders' equity
Preferred Stock, $.10 par value, 4 million shares
authorized, none outstanding............................ -- --
Common stock, $.01 par value, 25 million shares
authorized, 6,870,559 and 6,540,065 shares outstanding,
respectively............................................ 69 65
Capital in excess of par................................. 34,379 33,517
Accumulated deficit...................................... (32,420) (29,789)
-------- --------
Total shareholders' equity............................. 2,028 3,793
-------- --------
$ 20,321 $ 18,996
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
35
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK CAPITAL IN
------------- EXCESS OF ACCUMULATED
SHARES AMOUNT PAR VALUE DEFICIT
------ ------ ---------- -----------
<S> <C> <C> <C> <C>
Balance, October 1, 1994.................. 3,903 $39 $16,434 $(14,036)
Sale of common stock, net of issuance
costs.................................. 200 2 708 --
Value assigned to options and warrants
issued with the extension of senior
notes.................................. -- -- 66 --
Exercise of warrants.................... 100 1 187 --
Common stock issued in connection with
acquisitions, net of issuance costs.... 1,143 11 7,533 --
Conversion of convertible subordinated
notes.................................. 201 2 1,628 --
Settlement of related party receivable.. -- -- 1,028 --
Net loss................................ -- -- -- (9,656)
----- --- ------- --------
Balance, September 30, 1995............... 5,547 55 27,584 (23,692)
Exercise of warrants.................... 12 -- 21 --
Settlements of related party receivable. -- -- 815 --
Conversion of convertible subordinated
notes.................................. 781 8 4,077 --
Common stock issued in connection with
acquisitions, net of acquisition costs. 200 2 1,020 --
Net loss................................ -- -- -- (6,097)
----- --- ------- --------
Balance, September 30, 1996............... 6,540 65 33,517 (29,789)
Exercise of warrants.................... 251 3 432 --
Conversion of convertible subordinated
notes.................................. 70 1 386 --
Common stock issued to pay acquisition
costs.................................. 10 -- 44 --
Net loss................................ -- -- -- (2,631)
----- --- ------- --------
Balance, September 30, 1997............... 6,871 $69 $34,379 $(32,420)
===== === ======= ========
</TABLE>
In fiscal 1995, the Company recorded $7,738,000 of unrealized appreciation
of available-for-sale securities in a Shareholders' Equity account. In fiscal
1996, this amount was eliminated upon the sale of the securities.
The accompanying notes are an integral part of these consolidated financial
statements.
36
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................... $(2,631) $(6,097) $(9,656)
Adjustments to reconcile net loss to net cash used
in operating activities:
(Income) loss from discontinued operations......... (739) 1,812 1,318
Write-off of acquired in-process unproven
technology........................................ -- -- 5,000
Depreciation and amortization...................... 1,798 1,374 194
Write-off of prepaid software licenses............. 1,000 -- --
Write-off of capitalized product design costs...... 1,137 -- --
Acquisition costs.................................. -- -- 543
Loss on the disposal of property and equipment..... 40 -- 25
Gain on sale of available-for-sale securities...... -- (5,689) --
Debt discount and deferred financing amortization.. 19 95 87
Provision for bad debts............................ 174 101 --
Loss on sale of business........................... -- 6,061 --
Changes in operating assets and liabilities, net
of effect of purchase transactions and disposal
of discontinued operations:
Accounts receivable............................... (1,471) (521) (125)
Non-current lease receivable...................... (3,054) -- --
Inventories....................................... 1,466 (1,076) (464)
Prepaid expenses.................................. (65) (25) (27)
Accounts payable and accrued expenses............. 930 775 395
Deferred revenue.................................. 17 (81) (8)
------- ------- -------
Net cash used in operating activities of
continuing operations........................... (1,379) (3,271) (2,718)
------- ------- -------
Net cash used in operating activities of
discontinued operations......................... (1,089) (1,132) (1,951)
------- ------- -------
Cash flows from investing activities:
Net cash paid in connection with acquisitions...... -- (195) (2,450)
Purchase of prepaid software licenses.............. -- (1,000) --
Purchase of property and equipment................. (510) (732) (415)
Additions to capitalized product design............ (654) (462) --
Settlement of remaining obligations to owners of
discontinued operations........................... -- (117) --
Proceeds from sale of investment securities........ -- 7,678 1,027
Proceeds from sale of property and equipment....... 15 -- 31
Other.............................................. 15 -- (115)
------- ------- -------
Net cash provided by (used in) investing
activities of continuing operations............. (1,134) 5,172 (1,922)
------- ------- -------
Net cash used in investing activities of
discontinued operations......................... (46) (2,073) (1,134)
------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net of
deferred financing costs.......................... 3,665 -- 3,135
Repayment of long-term debt........................ (753) (48) (475)
Net borrowings (payments) under revolving credit
note.............................................. (831) (2,540) 1,659
Proceeds from settlement of related party
receivable........................................ -- 815 --
Repayment of prior revolving credit facility....... -- -- (383)
Proceeds from sale of available-for-sale
securities........................................ -- -- 720
Payment of put obligation.......................... -- (200) --
Proceeds from exercise of warrants................. 435 22 169
Capitalized lease obligations paid................. (85) (100) (118)
------- ------- -------
Net cash provided by (used in) financing
activities of continuing operations............. 2,431 (2,051) 4,707
------- ------- -------
Net cash provided by financing activities of
discontinued operations......................... 828 3,208 3,144
------- ------- -------
Net increase (decrease) in cash..................... (389) (147) 126
Cash, beginning of period........................... 426 573 447
------- ------- -------
Cash, end of period................................. $ 37 $ 426 $ 573
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
37
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. NATURE OF BUSINESS AND BASIS FOR PRESENTATION
SoftNet Systems, Inc. and Subsidiaries (the "Company") is engaged in the
business of developing, marketing, installing and servicing electronic
information and document management systems that allow customers to
electronically request and electronically receive information. The Company
operates through three segments: document management, telecommunications, and
Internet services. The document management segment designs, develops,
manufactures and integrates comprehensive, non-paper based systems and
components that enable the Company to deliver to its customers cost-effective
solutions for the storage, indexing and/or distribution of high-volume
computer generated or entered information. The telecommunications segment
sells and services telephone and computer hardware manufactured by others to
provide communications solutions through the design, implementation,
maintenance and integration of voice, data and video communications equipment
and services. Additionally, the telecommunications segment sells and installs
local and long distance network services. The Internet services segment
provides Internet access, World Wide Web and database development.
On September 15, 1995, a wholly-owned subsidiary of the Company merged with
Kansas Communications, Inc. ("KCI"), which was the surviving corporation in
the merger, pursuant to an Agreement and Plan of Reorganization dated March
24, 1995, by and between the Company and KCI (see Note 3). The transaction was
accounted for as a pooling of interests for financial reporting purposes and,
accordingly, the financial statements of the merged companies relating to all
periods presented had previously been restated and presented on a combined
basis. However, in July 1998, the Company's Board of Directors adopted a plan
to discontinue operations of the telecommunications segment (see Note 17),
which includes the operations of KCI. Accordingly, the operating results of
the telecommunications segment have been segregated from continuing operations
and reported as a separate line item on the statement of operations. The
assets and liabilities of such operations have been reflected as a net asset.
During 1995, the Company adopted a formal plan to dispose of Utilization
Management Association, Inc., a medical cost containment business.
Accordingly, the results of discontinued operations and the estimated loss on
disposal thereof have been reported separately from the continuing operations
of the Company for fiscal 1995 (see Note 5).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of SoftNet
Systems, Inc. ("SoftNet") and its subsidiaries ("Company"). All significant
intercompany accounts and transactions have been eliminated in preparation of
the consolidated financial statements.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of trade receivables. Credit risk is
minimized as a result of the large number and diverse nature of the Company's
customers. As of September 30, 1997, the Company had no significant
concentrations of credit risk.
Significant Customer
For the fiscal years ended September 30, 1997 and 1996, one customer
(different customer each year) accounted for 20% and 27%, respectively, of the
Company's consolidated revenue. No single customer of the Company accounted
for more than 20% of the Company's consolidated revenue in fiscal 1995.
38
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Cash and Cash Equivalents
The Company considers cash equivalents to include all highly liquid
financial instruments purchased with a maturity of three months or less to be
cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. The components of inventories as of
September 30, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Raw materials............................................... $ 126 $ 472
Work-in-process............................................. 217 424
Finished goods.............................................. 983 1,897
------ ------
$1,326 $2,793
====== ======
</TABLE>
Receivables
The Company has recorded an allowance for uncollectible accounts of $320,000
and $164,000 at September 30, 1997 and 1996, respectively.
Property and Equipment
Property and equipment are carried at cost less allowances for accumulated
depreciation. The cost of property and equipment held under capital leases is
equal to the lower of the net present value of the minimum lease payments or
the fair value of the leased property at the inception of the lease. Repairs
and maintenance are charged to expense as incurred.
Depreciation is computed by the straight-line method over the useful lives
of the related assets. The estimated useful lives range from three to five
years for equipment to seven years for property, principally office furniture.
Amortization of capital leases is included with depreciation expense.
Capitalized Software Costs
Certain costs of acquired software to be sold, leased, or otherwise marketed
are capitalized and amortized over the economic useful life of the related
software product, which is generally five years. Net unamortized capitalized
software costs, which resulted from the acquisition of MTC, are included in
other non-current assets and were $592,000, $792,000 and $991,000 at September
30, 1997, 1996 and 1995, respectively.
Investments in Equity Securities
In 1995, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 115 "Accounting for Certain Investments in Debt and Equity
Securities." The adoption of SFAS No. 115 resulted in an increase to
shareholders' equity in the fourth quarter of 1995 of $7.7 million upon the
completion by IMNET Systems, Inc. of its initial public offering of common
stock. Prior to this offering, there had been no public market for this common
stock. At September 30, 1995, the Company's investment in marketable equity
securities was classified as available-for-sale and, as a result, was stated
at fair value. During fiscal 1996 the Company sold its entire holdings of
IMNET Systems, Inc. and realized a gain of $5.7 million.
Fair Value of Financial Instruments
The fair value of the Company's debt, current and long-term, is estimated to
approximate the carrying value of these liabilities based upon borrowing rates
currently available to the Company for borrowings with similar terms.
39
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Costs in Excess of Fair Value of Net Assets Acquired
The excess of costs of acquired companies over the fair value of net assets
acquired (goodwill) are amortized on a straight-line basis over 10 to 20
years. Amortization expense for fiscal 1997, 1996 and 1995 was $1.1 million,
$813,000 and $29,000, respectively. During fiscal 1996 the Company wrote off
$3.6 million of net goodwill resulting from the sale of the non-application
oriented interconnect business in Chicago, IL (see Note 5). Accumulated
amortization at September 30, 1997, 1996 and 1995 was $1.9 million, $870,000
and $29,000, respectively.
The Company assesses the recoverability of unamortized goodwill by reviewing
the sufficiency of estimated future operating income and undiscounted cash
flows of the related entities to cover the amortization during the remaining
amortization period.
Revenue Recognition
Revenue from the document management segment is generated from four primary
sources, including product sales, installations, royalty and on-going
maintenance. Product sales and installation revenue are recognized upon
shipment, installation, or final customer acceptance, depending on specific
contract terms. Royalty revenue is recognized monthly based upon estimated
maintenance fees and is subject to verification against actual fees on a semi-
annual basis. Revenue from on-going maintenance is recognized as services are
completed.
Revenue from the Internet services segment is generated from initial and
recurring monthly Internet access and Web and database development. Set-up
fees for Internet access customers is recognized upon completion of the
service. Monthly access fees are recognized in the month of service. World
Wide Web and database development is recognized upon completion of the
service.
Leases to Customers
The Company's equipment lease transactions with its customers primarily
involve the leasing of Computer Output Microfiche ("COM") equipment. Lease
terms are typically for periods of 3 to 5 years. The Company typically leases
its COM equipment on a "price per fiche" basis, in which monthly rents are
driven by actual monthly microfiche production by the lessee. Leases contain
minimum monthly rents by establishing provisions for minimum production
volumes per month.
At September 30, 1997, the Company has entered into various sales-type
leases with its customers. These leases provide for minimum future rents of
$4.4 million and equipment residual values of $542,000. Unearned interest
relating to these leases total $673,000. The present value of these leases
($4.3 million) is recorded in trade receivables and other assets in the
accompanying consolidated balance sheet. Future minimum lease payments are as
follows (in thousands):
<TABLE>
<S> <C>
1998.............................. $1,491
1999.............................. 1,362
2000.............................. 892
2001.............................. 471
2002.............................. 168
------
Total......................... $4,384
======
</TABLE>
40
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Research and Development
Research and development is primarily incurred by the document management
segment. During fiscal 1997 and 1996, the Company expended $1.8 million and
$1.1 million, respectively, for research and development.
Income Taxes
The Company recognizes the amount of taxes payable or refundable for the
current year and recognizes deferred tax liabilities and assets for the
expected future tax consequences of events and transactions that have been
recognized in the Company's financial statements or tax returns. The Company
currently has substantial net operating loss carryforwards. The Company has
recorded a 100% valuation allowance against net deferred tax assets due to
uncertainty of their ultimate realization.
Loss Per Share
Loss per share is based on the weighted average number of common shares
outstanding during the periods. Common stock equivalents (outstanding options
warrants and convertible securities) are not included in the computations of
loss per share since their effect is anti-dilutive.
Recently Issued Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128. Earnings per Share (FAS
128), which specifies the computation, presentation and disclosure
requirements for earnings per share in order to simplify the computation of
earnings per share. FAS 128 is effective for financial statements ending after
December 15, 1997 and earlier application is not permitted. After the
effective date, all prior period earnings per share data shall be restated to
conform with the provisions of FAS 128. The adoption of FAS 128 is not
expected to have a material impact on the Company's earnings per share data.
In June 1997, the FASB issued FAS 130, Reporting Comprehensive Income. This
statement, effective for fiscal years beginning after December 15, 1997, would
require the Company to report components of comprehensive income in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income is defined by Concepts Statement
No. 6, Elements of Financial Statements, as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity during
a period except those resulting from investments by owners and distributions
to owners. The Company has not yet determined its comprehensive income.
Also in June 1997, the FASB issued FAS 131, Disclosures about Segments of an
Enterprise and Related Information. This statement, effective for financial
statements for periods beginning after December 15, 1997, requires that a
public business enterprise report financial and descriptive information about
its reportable operating segments. Generally, financial information is
required to be reported on the basis that it is used internally for evaluating
segment performance and deciding how to allocate resources to segments. The
adoption of FAS 131 is not expected to have a material impact on the Company's
financial statements.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of the revenues and expenses during the
reporting period. Actual results could differ from those estimates.
41
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Reclassifications
Certain reclassifications have been made in the 1995 financial statements to
conform with the 1997 and 1996 presentations.
3. MERGER
On September 15, 1995, a wholly-owned subsidiary of the Company merged
Kansas Communications, Inc. ("KCI") pursuant to an Agreement and Plan of
Reorganization dated March 24, 1995, by and between the Company and KCI. The
KCI shareholders received 1.3 million shares of the Company's common stock in
exchange for all of the outstanding shares of KCI. The business combination
was accounted for as a pooling of interests and, accordingly, the operations
of KCI had been included with the results of the Company for all periods
presented. However, in July 1998, the Company's Board of Directors adopted a
plan to discontinue operations of the telecommunications segment (see Note
17), which includes the operations of KCI. Accordingly, the operating results
of the telecommunications segment have been segregated from continuing
operations and reported as a separate line item on the statement of
operations. The assets and liabilities of such operations have been reflected
as a net asset.
KCI is a Kansas City-based company which sells and services telephone
systems, third-party computer hardware and application oriented peripheral
products such as voice mail, automated attendant systems, interactive voice
response (IVR) and video conferencing systems.
The following are the net revenues from continuing operations and net income
(loss) of the separate companies for the period preceding the acquisition (in
thousands):
<TABLE>
<CAPTION>
SOFTNET
SYSTEMS, INC. KCI COMBINED
------------- ------ --------
<S> <C> <C> <C>
Nine months ended June 30, 1995
(Unaudited):
Net sales.............................. $8,285 $7,564 $15,849
Net income (loss)...................... (1,777) 272 (1,505)
</TABLE>
In connection with the merger, the Company recorded transaction related
charges of $648,000 in fiscal 1995. The merger costs relate to expenses
incurred to consummate the transaction, including investment banking, legal
and accounting fees.
4. ACQUISITIONS
Milwaukee Operation of Executone Management Systems, Inc.
On December 29, 1995, the Company acquired the Milwaukee operations of
Executone Information Systems, Inc. ("Executone-Milwaukee"), in a business
combination accounted for as a purchase. Executone-Milwaukee sells and
services proprietary voice processing systems. The purchase price of
approximately $1.9 million consisted of $100,000 of cash and a note payable
for $1.8 million. The note was paid in February, 1996. The operations of
Executone-Milwaukee have been included in the results of the Company since
December 29, 1995. However, in July 1998, the Company's Board of Directors
adopted a plan to discontinue operations of the telecommunications segment
(see Note 17), which includes these operations. Accordingly, the operating
results of the telecommunications segment have been segregated from continuing
operations and reported as a separate line item on the statement of
operations. The assets and liabilities of such operations have been reflected
as a net asset.
42
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As a result of the acquisition, the Company recorded costs in excess of fair
value of net assets acquired of $1.8 million, an amount which is being
amortized on a straight-line basis over twenty years.
MediaCity World, Inc.
On June 21, 1996, the Company acquired MediaCity World, Inc. ("MCW"), in a
business combination accounted for as a purchase. MCW is an Internet Service
Provider with operations in the San Francisco Bay Area and Reno, Nevada. The
purchase price consisted of 200,000 shares of the Company's common stock
valued at $5.11 per share. The operations of MCW have been included in the
results of the Company since June 21, 1996. As a result of the acquisition of
MCW, the Company recorded costs in excess of fair value of net assets acquired
of $1.2 million, being amortized on a straight line basis over three years.
Communicate Direct, Inc.
On October 31, 1994, the Company acquired Communicate Direct, Inc. ("CDI")
in a business combination accounted for as a purchase. CDI, a Chicago-based
company, sold and serviced telephone systems, third-party computer hardware
and application oriented peripheral products such as voice mail, automated
attendant systems, interactive voice response ("IVR") and video conferencing
systems. The operations of CDI have been included with the results of the
Company from November 1, 1994 until they were subsequently sold. During fiscal
1996, the Company sold a significant portion of the CDI business and, during
fiscal 1997, all of the remaining operation was sold.
The Company acquired all of the outstanding stock of CDI for $1.9 million,
such consideration consisting of 290,858 shares of the Company's Series A
Convertible Preferred Stock ("Preferred Shares") valued at $6.00 per share and
cash. In April 1995, the Preferred Shares were converted into common shares on
a one-to-one basis following the approval of the Company's shareholders. The
acquisition price has been adjusted for settlement of an earn-out agreement
and resolution of certain post-closing purchase adjustments. The cost in
excess of fair value of net assets acquired incurred in connection with the
acquisition of CDI of $4.2 million was originally to be amortized on a
straight-line basis over ten years. As a result of the 1996 sale, the Company
wrote off the unamortized balance of the goodwill which arose from the
original acquisition (See Note 5).
Micrographic Technology Corporation
On September 15, 1995, the Company acquired Micrographic Technology
Corporation ("MTC") pursuant to an Agreement and Plan of Reorganization dated
March 24, 1995 in a business combination accounted for as a purchase
transaction. MTC is a designer, developer, manufacturer and integrator of
comprehensive, non-paper based systems and components that enable MTC to
deliver to its customers cost-effective solutions for storage, indexing and/or
distribution of high-volume output data streams. The MTC shareholders'
received 778,000 shares of the Company's common stock valued at $6.95 per
share, $1.1 million in cash and $2.8 million principal amount of the Company's
debentures. The operations of MTC have been included with the results of the
Company since September 16, 1995.
The cost in excess of fair value of net assets acquired incurred in
connection with the acquisition of MTC of $6.1 million is being amortized on a
straight-line basis over ten years. Additionally, in connection with the
acquisition of MTC, the Company incurred a one-time charge in fiscal 1995 of
$5.0 million for the write-off of acquired in-process unproven technology.
The following unaudited pro forma summary presents information as if the
acquisitions accounted for as purchases had occurred at the beginning of each
fiscal year. The pro forma information is provided for informational purposes
only. It is based on historical information and does not necessarily reflect
the actual
43
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
results that would have occurred nor is it necessarily indicative of future
results of operations of the combined enterprise (in thousands, except per
share data):
<TABLE>
<CAPTION>
YEARS ENDED
SEPTEMBER 30,
----------------
1996 1995
------- -------
(UNAUDITED)
<S> <C> <C>
Net sales from continuing operations................... $42,270 $40,020
Net loss from continuing operations.................... (328) (9,175)
Net loss per share..................................... $ (0.05) $ (2.02)
</TABLE>
5. DIVESTITURES
Utilization Management Associates, Inc.
During September 1995, the Company's Board of Directors approved a plan to
rescind its November 1993 acquisition of Utilization Management Associates,
Inc. ("UMA"). The plan provided for the exchange of the Company's interest in
UMA for all common shares of the Company held by the former shareholders of
UMA, including related put options, and the cancellation of SoftNet stock
options held by the former shareholders of UMA.
Effective November 20, 1995, the plan was executed such that the Company
paid the former shareholders of UMA $200,000 in satisfaction of it's common
stock put obligation and received in exchange 29,630 shares of SoftNet common
stock. In addition, the Company paid approximately $300,000 in cash and notes
for the termination of non-compete, employment, and earn-out agreements and an
irrevocable and unconditional release of the Company from any outstanding
obligations and liabilities to UMA or the shareholders of UMA.
In connection with the disposition, in fiscal 1995, the Company recorded a
loss on disposal of discontinued operations of $644,000, along with a loss
from discontinued operations of $420,000. Such amounts have not been adjusted
for any income tax effect given the Company's net operating loss carryforward.
For the year ended September 30, 1995, UMA contributed revenue of
approximately $860,000 to the consolidated revenues of the Company.
Communicate Direct, Inc.
In June 1996, CDI sold its non-application oriented interconnect business
located in the Chicago, IL metropolitan area to Next Call, Inc. ("Next Call")
for a $600,000 ten year note receivable. In connection with the sale, CDI
agreed to lend Next Call up to $1.0 million to fund operating losses, as
defined, for the first twelve months of operations. The loan agreement
required CDI to advance cash to Next Call on a monthly basis to cover
operating cash short fall. Next Call was required to repay such advances when
it became profitable on a cumulative basis. After the first twelve months, any
amount still outstanding from Next Call was to be forgiven. As of September
30, 1996, the Company had made $189,000 in advances pursuant to this
agreement. Subsequent to September 30, 1996, Next Call ceased operations.
As a result of the sale to Next Call and the uncertainty resulting from Next
Call's subsequent shut down, the Company incurred an extraordinary charge of
$6.0 million for the loss on the sale of this business, including the write-
off of unamortized goodwill which resulted from the initial purchase of CDI in
October 1994, deferred acquisition costs associated with the purchase of CDI,
severance payments, inventory, leasehold improvements, the notes receivable
from Next Call and all amounts loaned to the buyer. The loss resulting from
the disposition of certain assets and the assumption of certain liabilities of
CDI, within a two year period following a pooling of interests has been
classified as an extraordinary item as required by generally accepted
accounting principles.
44
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The disposition of CDI was not contemplated at the time of the pooling with
KCI. During fiscal 1997, CDI sold its operations that support its Fujitsu
maintenance base in the Chicago metropolitan area to a new company formed by
John I. Jellinek, the Company's former president, chief executive officer and
director and Philip Kenny, a former SoftNet director. The buyer acquired
certain assets in exchange for a $209,000 promissory note and the assumption
of current liabilities of approximately $750,000. In addition, at the closing
the buyer paid off $438,000 of existing Company bank debt and entered into a
sub-lease of CDI's facility in Buffalo Grove, Illinois. At the closing, the
buyer merged with Telcom Midwest, LLC., and the two former directors and the
other two shareholders of the merged company personally guaranteed obligations
arising out of the promissory note, the sub-lease arrangement and the
assumption of certain liabilities. The personal guarantees of the promissory
note are several. The personal guarantees of the sub-lease are limited to
$400,000 and are on a joint and several basis. The personal guarantees of
assumed liabilities are on a joint and several basis but are limited to the
two former directors. Concurrent with this transaction, Messrs. Jellinek and
Kenny resigned from the Company's board.
6. CHANGE IN PRODUCTS
During fiscal 1996, the Company acquired from IMNET an exclusive worldwide
manufacturing right to certain microfilm retrieval technology, partially in
exchange for the prepayment of fees for 250 software licenses. Accordingly,
the Company recorded a prepaid license fee of $1.0 million in other non-
current assets in the accompanying consolidated balance sheets. As of
September 30, 1997, the transfer to the Company of the technical and
manufacturing know-how for this technology has continued to be delayed.
Despite the ongoing negotiation and cooperation between the parties, the
Company determined there was a potential material risk in completing the
transfer and getting the product to market. As a result, the Company wrote-off
the prepaid license fee of $1.0 million in the fourth quarter of fiscal 1997
(see Note 14).
Also, in the fourth quarter of 1997, the Company reevaluated the development
and timely offering of its RAPID (Rapid Archiving Peripheral for Images and
Documents) product. Market driven product enhancements, and the resulting
technological setbacks, delayed the estimated product offering date at least
one year to the second quarter of fiscal 1998. As a result, the Company has
written-off $1.1 million of capitalized product design costs associated with
this product.
In June, 1996, the Company signed an agreement to distribute Lucent
Technologies, Inc. products in the Chicago, Illinois metropolitan area. In
connection with this distribution agreement and the repositioning of its
Chicago operations, the Company incurred one-time charges of $1.3 million for
severance payments, asset write-downs and other.
Included in the fourth quarter 1996 results is a charge of $1.5 million for
the write-down of certain software inventory resulting from the Company's
decision to discontinue the distribution of certain imaging products in favor
of others (see Note 14).
7. SIGNIFICANT FOURTH QUARTER EVENTS
Operating results in the fourth quarter of fiscal 1997 include the effects
of the following:
A. A charge of $1.0 million related to the write-off of prepaid license
fees (see Notes 6 and 14).
B. A charge of $1.1 million related to the write-off of capitalized product
design costs (see Notes 6 and 14).
45
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. PROPERTY AND EQUIPMENT
Balances of major classes of fixed assets and allowances for depreciation at
September 30, 1997 and 1996 are as follows: (in thousands)
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Leasehold improvements.................................... $ 155 $ 118
Furniture and fixtures.................................... 276 605
Equipment................................................. 1,566 1,214
------ ------
Total................................................. 1,997 1,937
Less allowance for depreciation and amortization.......... (889) (601)
------ ------
Property and equipment, net............................... $1,108 $1,336
====== ======
</TABLE>
9. DEBT
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Debt is summarized as follows: (in thousands)
Revolving Credit Note with maximum borrowings of $9.5
million bearing interest, payable monthly, at the bank's
prime rate plus 1% (the bank's prime rate 8.5% at
September 30, 1997). The note matures on January 15, 1999. $ 5,900 $ 6,099
Equipment Financing Agreement with a maximum borrowing
limit of $3.15 million, bearing interest at the bank's
prime rate plus 1% (the bank's prime rate being 8.5% at
September 30, 1997), principal and interest due in 60
monthly payments with the final payment due May 2002...... 2,398 --
Draw Note with maximum borrowings for $1.5 million bearing
interest, payable monthly, at the bank's prime rate plus
1% (the bank's prime rate being 8.5% at September 30,
1997)..................................................... 675 --
9% Convertible Debentures due September 2000, interest
payable quarterly, convertible into the Company's common
shares at $6.75 per share................................. 2,619 2,856
9% Convertible Subordinated Notes due December 1998,
interest payable quarterly, subordinated to all other
liabilities of the Company, convertible into the Company's
common shares at $5.00 per share.......................... 25 75
6% Convertible Subordinated Debentures, due February 2002
with semi-annual interest payments, convertible into the
Company's common stock at $8.10 per share (subject to
adjustment for anti-dilution)............................. 780 780
10% Convertible Subordinated Notes due October 1999,
bearing interest, payable quarterly, at 10% for the first
two years only and no interest thereafter, subordinated to
all other liabilities of the Company, convertible into the
Company's common shares at $4.10 per share................ 200 300
Promissory note due June 1998, interest payable at maturity
accruing at 5% (terms revised in 1997..................... 161 409
Promissory notes due November 1997, interest payable in
arrears on each principal due date accruing at 8.75%...... 75 200
Promissory note bearing interest at 12.25%, principal and
interest due in 24 monthly payments with final payment due
October 1999.............................................. 278 --
Bank loan dated August 25, 1995, bearing interest at prime
plus 1%, principal and interest due in 36 monthly
instalments with final payment due August 1998............ -- 74
Other...................................................... -- 57
------- -------
13,111 10,850
Less current portion debt.................................. (1,384) (603)
------- -------
Total long-term debt..................................... $11,727 $10,247
======= =======
</TABLE>
46
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The availability under the revolving credit note is subject to revisions on
a monthly basis based upon available assets (as defined). The revolving credit
note and the bank term loan (issued from the same bank) are collateralized by
substantially all of the assets of the Company.
The equipment financing agreement and the draw note were obtained from the
same bank as the revolving credit note and the assets collateralizing each
financing facility are excluded from the collateral associated with the
revolving credit note. The equipment financing agreement covers a specific
lease agreement and the draw note covers certain bank approved leases. The
leases are initiated by the Company acting as lessor through the ordinary
course of business.
In connection with the issuance of the 10% Convertible Subordinated Notes,
the Company issued warrants to purchase 298,000 shares of the Company's common
stock exercisable for five years expiring in 1999 at an exercise price of
$6.875 per share.
During fiscal 1997 and 1996, holders of the 6%, 9% and 10% convertible
subordinated notes converted $386,000 and $4.1 million face amount of notes
into 69,000 and 781,000 shares, respectively, of the Company's common stock.
An additional $200,000 of notes were converted into 49,000 shares of the
Company's common stock after year end.
In connection with the acquisition of MTC, the Company issued $2.9 million
of its 9% Convertible Subordinated Debentures (the "MTC 9% Debentures") due
September 2000. The MTC 9% Debentures are subordinated to senior indebtedness
of the Company and are convertible after September 15, 1996, into the
Company's common shares at $6.75 per share. The MTC 9% Debentures may be
prepaid by the Company in whole or in part at face value. During fiscal 1997,
of the total $386,000 of notes converted, $236,000 of these 9% debentures were
converted into 35,000 shares of the Company's common stock.
Also in connection with the acquisition of MTC, the Company assumed $1.8
million of 6% Convertible Subordinated Secured Debentures (the "Debentures")
due February 2002. The Debentures are convertible into the Company's common
stock at $8.10 per share. The Debentures are subject to redemption at the
option of the Company at face value, provided, however, that the Company
issues common share purchase warrants to purchase the same number of shares as
would have been issuable if the Debentures were converted. During fiscal 1996,
certain holders of the debentures converted $1.0 million face amount
Debentures into 126,000 shares of the Company's common stock.
During fiscal 1997, the Company sold certain assets of its
telecommunications segment for cash, a note receivable and the assumption of
certain liabilities. In addition, the buyer repaid certain bank loans of the
Company in the principal amount of $438,000 plus accrued interest (see Note
5).
Aggregate maturities of long-term debt for each of the next five fiscal
years are as follows (in thousands):
<TABLE>
<S> <C>
1998....................................... $1,384
1999....................................... 6,985
2000....................................... 3,521
2001....................................... 315
2002....................................... 906
</TABLE>
10. SALE OF COMMON STOCK
On October 26, 1994, the Company sold 200,000 shares of its common stock in
a Regulation S offering at $4.00 per share. In connection with the sale of
common stock, the Company incurred fees of $90,000 and issued warrants to
purchase 250,000 shares of its common stock exercisable for five years at an
exercise price of $6.875 per share (fair market value at the date of grant).
47
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. CAPITALIZED LEASE OBLIGATIONS AND OTHER LEASE COMMITMENTS
The Company leases computer equipment and certain other office equipment
under leases which are capital in nature. The Company has net assets of
$314,000 and $520,000 under these capital leases as of September 30, 1997 and
1996, respectively.
The Company has entered into operating leases for office space and
manufacturing facilities. These leases provide for minimum rents. These leases
generally include options to renew for additional periods. The Company's rent
expense for the years ended September 30, 1997, 1996 and 1995 was $828,000,
$755,000 and $282,000, respectively.
The aggregate amount of the lease payments under capital and operating
leases for the Company's continuing operations for each of the five fiscal
years ending September 30 is as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1998.................................................... $ 29 $ 644
1999.................................................... 22 264
2000.................................................... 23 248
2001.................................................... 9 230
2002.................................................... -- 75
---- ------
Total minimum lease payments............................ $ 83 $1,461
==== ======
Amount representing interest.......................... (13)
----
Present value of net minimum payments................... 70
Less current portion.................................. (23)
----
Capital lease obligation................................ $ 47
====
</TABLE>
12. INCOME TAXES
The Company's provision for income taxes in fiscal 1995 relates exclusively
to the operations of KCI, for tax liabilities incurred by KCI prior to the
merger with the Company. These amounts are included in "Loss from operations"
for discontinued operations in the accompanying statement of operations due to
the Company's decision to discontinue the telecommunications segment (see Note
17).
The components of the provision for income taxes are as follows for the
fiscal years ending September 30 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current
Federal................................................ $-- $-- $113
State.................................................. -- -- 23
--- --- ----
Total current........................................ -- -- 136
Deferred
Federal................................................ -- -- (10)
State.................................................. -- -- (2)
--- --- ----
Total deferred....................................... -- -- (12)
$-- $-- $124
=== === ====
</TABLE>
48
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The types of temporary differences between the tax basis of assets and
liabilities and their financial reporting amounts that give rise to deferred
taxes at September 30 and the approximate tax effects are as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
TEMPORARY TEMPORARY
DIFFERENCE TAX EFFECT DIFFERENCE TAX EFFECT
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Inventory and other operating
reserves.......................... $ 499 $ 170 $1,240 $ 422
Allowance for doubtful accounts.... 104 35 541 184
Reserve for note receivable........ -- -- 624 212
Unpaid accruals.................... 477 162 794 270
Reserve for lease termination...... -- -- 75 26
Deferred revenue................... 1,479 503 1,369 465
Other.............................. (17) (6) (9) (3)
Net operating loss carryforwards... 6,747 2,294 7,854 2,670
------ ------- ------ -------
Total deferred tax asset........... 3,158 4,246
Valuation allowance................ (3,158) (4,246)
------- -------
Net deferred tax asset............. $ -- $ --
======= =======
</TABLE>
A valuation allowance was recorded as a reduction to the deferred tax assets
due to the uncertainty of the ultimate realization of future benefits from
such deferred taxes.
Net operating loss carryforwards of approximately $6.7 million are available
as of September 30, 1997 to be applied against future taxable income. In
addition, net operating loss carryforwards of approximately $750,000 acquired
in connection with the acquisition of MTC are available to reduce recorded
goodwill when utilized. The net operating loss carryforwards expire between
1999 and 2010 and are subject to certain annual limitations as a result of the
changes in equity ownership.
49
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. STOCK OPTIONS AND WARRANTS
During fiscal 1995 the Company adopted the 1995 Long Term Incentive Plan
(the "1995 LTIP") whereby the Company, under the direction of the committee
appointed by the Board of Directors, can grant a variety of stock-based
compensation awards. The Company has reserved 1.5 million shares (including an
increase of 900,000 shares approved by the shareholders during fiscal 1997)
for issuance under the plan. Outstanding options and warrants to purchase
shares of common stock at September 30, 1997, 1996 and 1995 were as follows
(in thousands, except price per option data):
<TABLE>
<CAPTION>
SHARES PRICE PER OPTION
------ ----------------
<S> <C> <C>
Outstanding at October 1, 1994................... 730 1.75-6.125
Granted........................................ 924 1.75-8.50
Canceled....................................... (4) 4.0429
Expired........................................ -- --
Exercised...................................... (100) 1.75
-----
Outstanding at September 30, 1995................ 1,550 1.75-8.50
Granted........................................ 574 8.125-10.00
Canceled....................................... (542) 6.50-8.25
Expired........................................ -- --
Exercised...................................... (13) 1.75
-----
Outstanding at September 30, 1996................ 1,569 1.75-10.00
Granted........................................ 400 4.938-5.313
Canceled....................................... (283) 4.938-5.00
Expired........................................ -- --
Exercised...................................... (251) 1.75
Outstanding at September 30, 1997................ 1,435 1.75-10.00
-----
</TABLE>
Shares available under the Plan were 1,058,000, 303,000 and 600,000 at
September 30, 1997, 1996 and 1995, respectively. As of September 30, 1997,
1996 and 1995, there were 1.0 million, 1.2 million and 1.3 million exercisable
options and warrants, respectively.
During fiscal 1997, the Board of Directors elected to reduce the exercise
price on 297,000 options from $8.25 to $4.94 per share, the market price on
the day the board took such action. In addition, during fiscal 1996, the Board
of Directors elected to reduce the exercise price on 117,000 options from
$12.75 to $8.25 per share, the market price on the day the board took such
action.
During fiscal 1997, the Company was required to adopt Statement of Financial
Standards No. 123, Accounting for Stock-Based Compensation (FAS 123), which
encourages entities to adopt a fair value based method of accounting for stock
based compensation plans in place of the provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), for
all arrangements under which employees receive shares of stock or other equity
instruments of the employer.
As allowed by FAS 123, the Company will continue to apply the provisions of
APB 25 in accounting for its stock based employee compensation arrangements,
and will disclose the pro forma net loss and loss per share information in its
footnotes as if the fair value method suggested in FAS 123 had been applied.
Had compensation cost for the Company's LTIP been determined based on the
fair value at grant date for awards in fiscal 1997 and 1996 consistent with
the provisions of FAS 123, the Company's net loss and loss per share would
have been increased to the pro forma amounts indicated below:
50
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Net loss, as reported.................................. $(2,631) $(6,097)
Net loss, pro forma.................................... (3,207) (6,348)
Loss per common share, as reported..................... $ (.40) $ (1.05)
Loss per common share, pro forma....................... (.48) (1.09)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1997: dividend yield of 0.0%; expected
volatility of 58%; risk free interest rate spread of 5.8%-6.4%; and expected
life of 4 years. Options outstanding at September 30, 1997 had exercise prices
ranging from $4.94 to $5.31. The weighted average exercise price of these
outstanding options outstanding is $4.98 and the weighted average remaining
contractual life of those options is 8.8 years.
14. RELATED PARTY TRANSACTIONS
As of September 30, 1994, the Company was owed $4.2 million plus accrued
interest by Ozite Corporation (Ozite). A Director of the Company and the
former Chairman of the Board held substantial interests in Ozite. Due to
uncertainties about collecting these funds, the receivable from Ozite was
written off and charged against earnings in 1991, and, accordingly no amount
related to this receivable is recorded on the Company's consolidated financial
statements.
On July 26, 1995, Ozite shareholders approved a merger of Ozite with Pure
Tech with Pure Tech being the surviving corporation. As a condition of the
merger, Ozite was required to secure a general release from the Company and to
surrender certain securities in satisfaction of the amount owed to the
Company. As a result, the Company received 311,000 shares of Pure Tech common
stock, 267,000 shares of Artra Group Incorporated (ARTRA) Common Stock and 932
shares of Artra Preferred Stock. Subsequently, the Company sold all 311,025
shares of Pure Tech for net proceeds of $1.0 million, which was recorded as a
capital contribution during fiscal 1995. During fiscal 1996, the remaining
securities were sold for net proceeds of $815,000, which was recorded as a
capital contribution.
During fiscal 1997, CDI sold its operations that support its Fujitsu
maintenance base in the Chicago metropolitan area to a new company formed by
John I. Jellinek, the Company's former president, chief executive officer, and
director and Philip Kenny, a former SoftNet director. The buyer acquired
certain assets in exchange for a $209,000 promissory note and the assumption
of current liabilities of approximately $750,000. In addition, at the closing
the buyer paid off $438,000 of Company bank debt and entered into a sub-lease
of CDI's facility in Buffalo Grove, Illinois. At the closing, the buyer merged
with Telcom Midwest, LLC., and the two former directors and the other two
shareholders of the merged company personally guaranteed obligations arising
out of the promissory note, the sub-lease arrangement and the assumption of
certain liabilities. The personal guarantees of the promissory note are
several. The personal guarantees of the sub-lease are limited to $400,000 and
are on a joint and several basis. The personal guarantees of assumed
liabilities are on a joint and several basis but are limited to the two former
directors. Concurrent with this transaction, Messrs. Jellinek and Kenny
resigned from the Company's board.
In June 1996, the Company acquired the exclusive worldwide manufacturing
rights to IMNET's MegaSAR Microfilm Jukebox and completed and amended its
obligations under a previous agreement. The Company issued a $2.9 million note
for prepaid license fees, software inventory, the manufacturing rights, and
certain other
51
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
payables. Approximately $2.5 million was paid on this note during the fourth
quarter of fiscal 1996. Subsequently, in fiscal 1997, the outstanding $410,000
promissory note was further reduced by $249,000, and a new promissory not in
the face amount of $161,000 was executed.
In July 1997, due to a delay in the transfer to the Company of the technical
and manufacturing know-how for the MegaSAR product, the Company and IMNET
further amended the June 1996 Agreement. In an attempt to facilitate the
technology transfer, the Company accepted an order from IMNET for the first 14
MegaSAR units to be manufactured by the Company. A portion of the payment for
these initial units would be applied against the outstanding promissory note.
The transfer of the technology and the parts needed for production was to have
occurred no later than September 1, 1997.
As of September 30, 1997, the transfer to the Company of the technical and
manufacturing know-how for this product offering has continued to be delayed.
Despite the ongoing negotiation and cooperation between the two parties, the
Company determined there was a potential material risk in completing the
technology transfer and getting the product to market. As a result, in the
fourth quarter of fiscal 1997, the Company recorded a one-time charge of $1.0
million to write-off the associated prepaid licenses. The Company is currently
negotiating with IMNET to either complete the transfer or seek an alternative
solution.
During the fourth quarter of fiscal 1996, the Company decided to discontinue
its plans for distributing the IMNET microfilm retrieval software in favor of
another software developer's product. As a result, the Company recorded a one-
time charge of $1.5 million to write-off software inventory which is included
under the caption costs associated with change in product lines and other in
the accompanying consolidate statements of operations.
During fiscal 1996, the Company sold its entire holdings in IMNET for net
proceeds of $7.7 million. Accordingly, the Company recorded a gain on sale of
the securities of $5.7 million.
15. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid during the year for:
Interest................................................ $1,220 $1,730 $ 465
Income taxes............................................ -- -- 194
Non-cash investing and financing activities:
Common stock issued for acquisitions.................... -- 1,022 7,931
Securities received in settlement of $4,150,000 related
party receivable, at net realized value................ -- -- 1,027
Convertible subordinated debt issued for acquisitions... -- -- 2,856
Common stock issued for the conversion of subordinated
notes.................................................. 387 4,077 1,630
Conversion of Senior Notes and accrued interest to 9%
Convertible Notes...................................... -- -- 309
Note received in sale of a portion of CDI's operations.. 209 -- --
Equipment acquired by capital lease..................... 83 89 332
Common stock issued to pay acquisition costs............ 44 -- --
</TABLE>
52
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. SEGMENT INFORMATION
The Company operates principally in three industry segments: document
management, telecommunications and Internet services. The Company's
acquisition of MTC in September, 1995, significantly broadened its operations
in the document management industry. Prior to the acquisition, the Company's
document management operations were not material. Although the Company
acquired MCW, an Internet service provider, in June of 1996, its revenue and
results of operations in fiscal 1996 are immaterial. In July 1998, the Company
decided to discontinue its telecommunications operations and therefore, the
data relating to this segment is included as discontinued. Note 17 provides
segment data for telecommunications.
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED
SEPTEMBER 30,
----------------------------
1997 1996 1995
------ ------ ------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Net Sales
Document Management......................... 20,330 19,417 1,088
Internet Services........................... 1,008 -- --
Other....................................... -- 167 --
------ ------ ------
21,338 19,584 1,088
====== ====== ======
Income (loss) from continuing operations
Before income taxes
Document Management......................... 572 (a) (227)(b) (6,031)(c)
Internet Services........................... (1,152) -- --
Other....................................... (2,304) 2,003 (d) (1,663)
------ ------ ------
(2,884) 1,776 (7,694)
====== ====== ======
Identifiable Assets
Document Management......................... 15,049 14,426 11,262
Discontinued Business....................... 7,491 8,373 11,582
Internet Services........................... 1,364 -- --
Corporate................................... 473 1,467 12,552
Other....................................... -- 1,320 --
------ ------ ------
24,377 25,586 35,396
====== ====== ======
Depreciation and Amortization Expense
Document Management......................... 1,263 958 139
Internet Services........................... 458 -- --
Corporate................................... 76 306 55
Other....................................... 1 110 --
------ ------ ------
1,798 1,374 194
====== ====== ======
Capital Expenditures
Document Management......................... 137 614 2
Internet Services........................... 361 -- --
Corporate................................... 11 100 332
Other....................................... 1 18 81
------ ------ ------
510 732 415
====== ====== ======
</TABLE>
- ---------------------
(a) Includes $2.1 million charge for costs associated with change in product
line and other
(b) Includes $1.5 million charge for costs associated with change in product
(c) Includes $5.0 million charge for the write-off of acquired in-process
unproven technology
(d) Includes $5.7 million gain on sale of available-for-sale securities
53
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
17. SUBSEQUENT EVENT
On July 27, 1998, the Board of Directors of the Company approved a plan to
offer for sale its telecommunications segment. Accordingly, operating results
have been reclassified and reported in discontinued operations. The Company is
in the process of negotiating the sale of these operations and expects that
the sale will be completed within a twelve month period. Management does not
anticipate a loss on the sale and intends to use sale proceeds to reduce
outstanding indebtedness and provide additional working capital.
Operating results of discontinued telecommunications segment are as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Revenues....................................... $17,218 $21,803 $20,164
Income (loss) before income taxes.............. $ 739 $(1,812) $ (898)
Provision for income taxes..................... -- -- $ (124)
Net income (loss).............................. $ 739 $(1,812) $(1,022)
</TABLE>
Interest expense allocated to the discontinued telecommunications segment
totaled $49,000, $377,000 and $194,000 in 1997, 1996 and 1995 respectively.
Assets and liabilities of the discontinued telecommunications segment are as
follows at September 30:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Current assets:
Cash..................................................... $ -- $ --
Accounts receivable, net................................. 1,848 2,237
Inventories.............................................. 2,984 3,111
Prepaid expenses......................................... 154 86
------ ------
4,986 5,434
------ ------
Property, plant and equipment, net....................... 529 $ 978
Goodwill, net............................................ 1,759 1,846
Other noncurrent assets.................................. 217 115
------ ------
$7,491 $8,373
====== ======
Current liabilities:
Accounts payable......................................... $2,295 $4,633
Current portion, long term debt.......................... 328 141
Current portion, capital lease obligation................ 23 108
Deferred revenue......................................... 1,336 1,269
------ ------
3,982 6,151
------ ------
Long-term debt, net of current portion..................... 20 351
Capital lease obligation, net of current portion........... 54 88
------ ------
$4,056 $6,590
====== ======
Net assets associated with discontinued operations....... $3,435 $1,783
====== ======
</TABLE>
The financial statements have been restated for the effects of the
discontinued operations of the telecommunications segment.
54
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND SIX MONTHS ENDED MARCH 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS
MARCH 31, ENDED MARCH 31,
-------------------- ----------------
1998 1997 1998 1997
--------- --------- ------- -------
<S> <C> <C> <C> <C>
Net sales............................... $ 4,308 $ 5,680 $ 7,229 $11,335
Cost of sales........................... 2,957 3,214 5,252 6,371
--------- -------- ------- -------
Gross profit........................ 1,351 2,466 1,977 4,964
--------- -------- ------- -------
Operating expenses:
Selling............................... 547 476 1,104 1,058
Engineering........................... 643 564 1,225 1,114
General and administrative............ 1,106 888 2,285 1,568
Amortization of goodwill and
transaction costs.................... 322 321 643 660
--------- -------- ------- -------
Total operating expenses............ 2,618 2,249 5,257 4,400
--------- -------- ------- -------
Income (loss) from continuing
operations............................. (1,267) 217 (3,280) 564
Interest expense...................... (267) (294) (596) (533)
Other income.......................... 99 6 170 81
--------- -------- ------- -------
Income (loss) from continuing operations
before income taxes and extraordinary
item................................... (1,435) (71) (3,706) 112
Provision for income taxes.............. -- -- -- --
--------- -------- ------- -------
Income (loss) before discontinued
operations and extraordinary item...... (1,435) (71) (3,706) 112
Discontinued operations:
Income from operations................ 222 354 115 426
--------- -------- ------- -------
Net income (loss)....................... $ (1,213) $ 283 $(3,591) $ 538
========= ======== ======= =======
Preferred dividends..................... (63) -- (63) --
--------- -------- ------- -------
Net income (loss) applicable to common
shares................................. $ (1,276) $ 283 $(3,654) $ 538
========= ======== ======= =======
Earnings (loss) per common share:
Basic................................. $ (0.18) $ 0.04 $ (0.52) $ 0.08
========= ======== ======= =======
Diluted............................... $ (0.18) $ 0.04 $ (0.52) $ 0.08
========= ======== ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
55
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1998 AND SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, SEPT. 30,
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash..................................................... $ 17 $ 37
Accounts receivables, net................................ 5,449 5,135
Inventories.............................................. 2,303 1,326
Prepaid expenses and other............................... 436 319
-------- --------
Total current assets................................... 8,205 6,817
-------- --------
Property and equipment, net................................ 1,089 1,108
Costs in excess of fair value of net assets acquired, net.. 4,598 5,141
Other assets............................................... 3,856 3,820
Net assets associated with discontinued operations......... 4,186 3,435
-------- --------
$ 21,934 $ 20,321
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................... $ 5,022 $ 4,969
Current portion of long-term debt........................ 1,230 1,384
Current portion of capital leases........................ 10 23
Deferred revenue......................................... 357 143
-------- --------
Total current liabilities.............................. 6,619 6,519
-------- --------
Long-term debt, net of current portion..................... 11,887 11,727
-------- --------
Capital leases, net of current portion..................... 41 47
-------- --------
Shareholders' equity:
Preferred stock, $.10 par value, 4 million shares
authorized, Series A Convertible, 5,062.5 shares
outstanding at March 31, 1998........................... -- --
Common stock, $.01 par value, 25 million shares
authorized, 7,014,673 and 6,870,559 shares outstanding,
respectively............................................ 70 69
Capital in excess of par value........................... 39,391 34,379
Accumulated deficit...................................... (36,074) (32,420)
-------- --------
Total shareholders' equity............................. 3,387 2,028
-------- --------
$ 21,934 $ 20,321
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
56
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 1998 AND 1997
(IN THOUSANDS) (UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $(3,591) $ 538
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Income from discontinued operations...................... (115) (426)
Depreciation and amortization............................ 951 829
Provision for bad debts.................................. 157 2
Changes in operating assets and liabilities, net of
effect of purchase transactions And disposal of
discontinued operations:
Receivables............................................. 409 (4,525)
Inventories............................................. (658) 683
Prepaid expenses........................................ (52) 125
Accounts payable and accrued expenses................... 178 1,614
Deferred revenue........................................ 215 252
------- -------
Net cash used in operating activities of continuing
operations............................................ (2,506) (908)
------- -------
Net cash used in operating activities of discontinued
operations............................................ (382) (725)
------- -------
Cash flows from investing activities:
Purchase of property and equipment....................... (259) (422)
Additions to capitalized product design.................. -- (502)
Other.................................................... 16 --
------- -------
Net cash used in investing activities of continuing
operations............................................ (243) (924)
------- -------
Net cash used in investing activities of discontinued
operations............................................ (60) (103)
------- -------
Cash flows from financing activities:
Repayment of long-term debt............................... (748) (64)
Net borrowings (repayments) under revolving credit note... (1,235) 1,982
Proceeds from sale of preferred stock..................... 4,600 --
Proceeds from exercise of warrants........................ 141 --
Capitalized lease obligations paid........................ (21) (143)
------- -------
Net cash provided by financing activities of continuing op-
erations.................................................. 2,737 1,775
------- -------
Net cash provided by financing activities of discontinued
operations................................................ 434 522
------- -------
Decrease in cash........................................... (20) (363)
Cash, beginning of period.................................. 37 426
------- -------
Cash, end of period........................................ $ 17 $ 63
======= =======
Cash paid during the period for:
Interest................................................... $ 671 $ 504
Income taxes............................................... -- --
Supplemental non-cash transactions
Convertible debt issued for acquisition of equipment
leases................................................... $ 1,444 --
Common stock issued for the conversion of subordinated
notes.................................................... 210 --
Note received in sale of net assets....................... 110 --
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
57
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The financial information, except for the balance sheet as of September 30,
1997, included herein is unaudited; however, such information reflects all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the condensed
consolidated statements of financial position, results of operations and cash
flows as of and for the interim periods ended March 31, 1998 and 1997.
The Company's annual report on Form 10-K for the fiscal year ended September
30, 1997, as filed with the Securities and Exchange Commission, should be read
in conjunction with the accompanying condensed consolidated financial
statements. The condensed consolidated balance sheet as of September 30, 1997
was derived from the Company's audited Consolidated Financial Statements.
The results of operations for the three months and six months ended March
31, 1998 are based in part on estimates that may be subject to year-end
adjustments and are not necessarily indicative of the results to be expected
for the full year.
2. DEBT
Long-term debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, SEPTEMBER 30,
1998 1997
--------- -------------
<S> <C> <C>
Bank Debt (See Note 3)............................ $ 7,912 $ 8,973
Convertible Subordinated Notes.................... 4,858 3,624
Other............................................. 347 514
------- -------
13,117 13,111
Less current portion.............................. (1,230) (1,384)
------- -------
$11,887 $11,727
======= =======
</TABLE>
On January 2, 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to a single
investor in exchange for the assignment to the Company of certain equipment
leases and other consideration. The debentures are convertible into Common
Stock of the Company, at $8.25 per share, after December 31, 1998.
Subsequent to March 31, 1998, the Company issued 120,000 shares of common
stock pursuant to the conversion of $810,000 of convertible debt by a single
holder of the Company's 9% convertible subordinated notes due September 15,
2000. These 9% notes have a conversion price of $6.75 per share.
3. PREFERRED STOCK
On December 31, 1997, the Company sold 5,000 shares of Series A Convertible
Preferred Stock, $0.01 par value per share ("Convertible Preferred"), for an
aggregate purchase price of $5 million. The Convertible Preferred shares
accrue dividends at a rate of 5% per annum, payable quarterly, at the
Company's option, in cash or additional Convertible Preferred shares. In
addition, the Company issued warrants to purchase 170,000 shares of the
Company's common stock at prices at or above the market price (20,000 shares
at $6.625 expiring on December 31, 2000 and 150,000 shares at $7.95 expiring
on December 31, 2001). On January 2, 1998, the Company used the net proceeds
of $4.6 million, after issuance costs of $400,000, to reduce the balance of
the bank revolving credit note.
58
<PAGE>
Each share of Convertible Preferred is convertible, at the option of the
holder, into the number of shares of common stock as defined by the stated
value of the Convertible Preferred multiplied by 5% per annum, less any
dividends paid, divided by the conversion price. The stated value of the
Convertible Preferred is $1,000 per share and the conversion price is the
lower of $8.28 or a two day average market price within a 20 day trading
period prior to the conversion. Pursuant to the Company's Articles of
Incorporation, as amended, the holders of the Convertible Preferred stock may
only convert their outstanding Convertible Preferred stock into an aggregate
amount of common stock that does not exceed 19.99% of the outstanding common
stock of the Company. Any excess shares of common stock that are issuable upon
conversion of outstanding Convertible Preferred, that exceed this 19.99%
limitation, are subject to mandatory redemption at the option of the holder of
the Convertible Preferred stock, unless the Company either obtains stockholder
approval for the additional conversions over 20%, or the Company receives
permission to allow such an issuance from the American Stock Exchange. All
outstanding shares of Convertible Preferred, subject to the aforementioned
restrictions, automatically convert to common stock on December 31, 2000.
Holders of Convertible Preferred do not have voting rights, except for
certain protective provisions relating to changes in the rights of holders of
Convertible Preferred. The Convertible Preferred ranks senior to the Company's
common stock as to dividends, distributions and distribution of assets upon
liquidation, dissolution or winding up of the Company. The Convertible
Preferred is subject to mandatory redemption upon certain circumstances,
including the Company's (i) failure to convert the Convertible Preferred when
required (ii) bankruptcy, and (iii) suspension from trading on the American
Stock Exchange. The Company shall have the right to redeem the Convertible
Preferred on or after December 31, 1998 at a price equal to the greater of
130% of the stated value or the market price multiplied by the number of
shares of common stock into which the Convertible Preferred can be converted.
On March 31, 1998, the Company issued an additional 62.5 shares of
Convertible Preferred as payment for $62,500 of earned dividends on the
outstanding Convertible Preferred stock.
Subsequent to March 31, 1998, the Company issued a combined total of 299,946
shares of common stock, pursuant to the conversion of 2,000 shares of the
Company's outstanding Series A Convertible Preferred Stock. The Series A
Convertible Preferred Stock, including accrued dividends, was converted into
common shares at the conversion price of $6.69 per share.
4. STOCK OPTIONS AND WARRANTS
Outstanding options and warrants to purchase shares of common stock at March
31, 1998 were as follows (in thousands, except price per option data):
<TABLE>
<S> <C>
Outstanding at September 30, 1997................................. 1,435
Granted at exercise prices ranging from $6.625 to $7.95 per
share.......................................................... 862
Canceled........................................................ (18)
Exercised at exercise prices ranging from $1.75 to $5.313 per
share.......................................................... (103)
-----
Outstanding at March 31, 1998..................................... 2,176
=====
</TABLE>
5. EARNINGS (LOSS) PER SHARE
The Company adopted Statement of Financial Accounting Standard (SFAS) No.
128, "Earnings Per Share," in the quarter ended December 31, 1997. SFAS 128
requires the computation of basic and diluted earnings per share. Basic
earnings (loss) per common share is computed using the weighted average number
of common shares outstanding. Diluted earnings (loss) per common share is
computed using the weighted average number of common shares outstanding and
the dilutive common stock equivalents (using the treasury stock
59
<PAGE>
method for warrants and options). Summarized below is the reconciliation of
basic and diluted earnings (loss) per common share for the three months and
the six months ended March 31, 1998 and 1997 (in thousands except per common
share amounts):
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
--------------------------- ---------------------------
NET INCOME PER SHARE NET INCOME PER SHARE
(LOSS) SHARES AMOUNT (LOSS) SHARES AMOUNT
---------- ------ --------- ---------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
March 31, 1998:
Basic earnings (loss). $(1,276) 6,992 $(0.18) $(3,654) 6,966 $(0.52)
Effect of outstanding
securities (a)--
Warrants and
options............ -- -- -- --
Convertible debt.... -- -- -- --
Convertible
preferred stock.... -- -- -- --
------- ----- ------- -----
Diluted earnings
(loss)............... $(1,276) 6,992 $(0.18) $(3,654) 6,966 $(0.52)
------- ----- ------- -----
March 31, 1997:
Basic earnings........ $ 283 6,580 $ 0.04 $ 538 6,567 $ 0.08
Effect of outstanding
securities (b)--
Warrants and
options............ -- 351 -- 297
Convertible debt.... -- -- -- --
Convertible
preferred stock.... -- -- -- --
------- ----- ------- -----
Diluted earnings...... $ 283 6,931 $ 0.04 $ 538 6,864 $ 0.08
------- ----- ------- -----
</TABLE>
- ---------------------
(a) As the Company had a net loss, the outstanding securities were
antidilutive.
(b) The remaining outstanding securities were antidilutive.
6. SUBSEQUENT EVENT
On July 27, 1998, the Board of Directors of the Company approved a plan to
offer for sale its telecommunications segment. Accordingly, operating results
have been reclassified and reported in discontinued operations. The Company is
in the process of negotiating the sale of these operations and expects that
the sale will be completed within a twelve month period. Management does not
anticipate a loss on the sale and intends to use sale proceeds to reduce
outstanding indebtedness and provide additional working capital.
Operating results of discontinued telecommunications segment are as follows
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MARCH ENDED
31, MARCH 31,
------------- -------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues...................................... $4,443 $4,494 $8,392 $9,617
Net income.................................... $ 222 $ 354 $ 115 $ 426
</TABLE>
60
<PAGE>
Assets and liabilities of the discontinued telecommunications segment are as
follows:
<TABLE>
<CAPTION>
MARCH 31, SEPTEMBER 30,
1998 1997
--------- -------------
<S> <C> <C>
Current assets:
Cash........................................... $ -- $ --
Accounts receivable, net....................... 2,142 1,848
Inventories.................................... 2,904 2,984
Prepaid expenses............................... 204 154
------ ------
5,250 4,986
------ ------
Property, plant and equipment, net............. 430 529
Goodwill, net.................................. 1,711 1,759
Other noncurrent assets........................ 132 217
------ ------
$7,523 $7,491
====== ======
Current liabilities:
Accounts payable............................... $2,450 $2,295
Current portion, long term debt................ 38 328
Current portion, capital lease obligation...... 23 23
Deferred revenue............................... 783 1,336
------ ------
3,294 3,982
------ ------
Long-term debt, net of current portion......... -- 20
Capital lease obligation, net of current
portion....................................... 43 54
------ ------
$3,337 $4,056
====== ======
Net assets associated with discontinued
operations.................................... $4,186 $3,435
====== ======
</TABLE>
The financial statements have been restated for the effects of the
discontinued operations of the telecommunications segment.
61
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereto duly authorized.
Dated: July 27, 1998
/s/ Mark A. Phillips
By:__________________________________
MARK A. PHILLIPS,
Secretary
Chief Accounting Officer
62
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion by reference in the registration
statements on Form S-3 (Registration No. 333-57337), Form S-8 (Registration
No. 333-45589) and Form S-3 (Registration No. 333-45335) of our report dated
December 24, 1997, except for Note 17 as to which the date is July 27, 1998, on
our audits of the financial statements and financial statement schedules of
SoftNet Systems, Inc. and subsidiaries. We also consent to the reference to our
firm under the caption "Experts."
COOPERS & LYBRAND L.L.P.
/s/ PricewaterhouseCoopers L.L.P.
Chicago, Illinois
July 27, 1998
