U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K/A
Amendment No. 1
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended September 30, 1998.
OR
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934.
Commission File No.: 1-5270
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
New York 11-1817252
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
520 Logue Avenue, Mountain View, California 94043
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 962-7470
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
------------------- on which registered
common stock, par -----------------------
value $.01 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant at December 31, 1998 was approximately $130.3 million.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at December 31, 1998
- ------------------------------- --------------------------------
common stock, $.01 par value 8,631,087
Documents Incorporated by Reference:
Proxy Statement for the Annual Meeting of Shareholders
to be held on March 16, 1999 (Part III)
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PART I
Item 1. Business
Except for historical information contained herein, the matters discussed
in this Annual Report on Form 10-K contain forward-looking statements that
involve risks and uncertainties that could cause actual results to differ
materially from those anticipated by such forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those risks
discussed under the caption "Risk Factors."
Having been in a variety of businesses since its inception in 1956, the
Company changed its name on June 29, 1993 to SoftNet Systems, Inc. in
association with its decision at that time to focus on the document management
and health care cost containment industries. Later that year, the Company
entered into a purchase agreement to purchase Utilization Management Associates,
Inc., a company which was also engaged in the health care cost containment
business. In October 1994, the Company decided to further diversify its
operations into the telecommunications industry by purchasing Communicate
Direct, Inc., a company which sold, installed and serviced telephone systems. In
September 1995, the Company both merged with Kansas Communications, Inc.
("KCI"), a provider of telecommunications solutions, and purchased Micrographic
Technology Corporation ("MTC"), a world-wide provider of document management
solutions. Also at this time, the Company rescinded its purchase of Utilization
Management Associates, Inc. In December 1995, KCI purchased the Milwaukee
operation of Executone Management Systems, Inc., which sold and serviced
proprietary voice processing systems, further expanding its Midwest market. In
June 1996, the Company purchased Media City World, Inc. (subsequently renamed
ISP Channel, Inc.("ISP Channel")), an Internet services business, and decided to
divest itself of the operations of Communicate Direct, Inc.
The Company is now in the process of implementing a new strategy
emphasizing its Internet services business through ISP Channel. The Company
currently owns three businesses: its telecommunications business (KCI), its
document management business (MTC) and its Internet service business (ISP
Channel). Each business operates through a wholly owned subsidiary of the
Company. As part of its new focus, the Company has signed separate letters of
intent to sell KCI and MTC. The Company is now accounting for KCI as a
discontinued operation. Because the sale of MTC remains subject to shareholder
approval, the Company is accounting for MTC as a continuing business rather than
a discontinued operation. The sale of MTC and KCI is intended to enable the
Company to aggressively expand its ISP Channel. See "Business --Micrographic
Technology Corporation."
On November 22, 1998, the Company announced its intention to purchase
Intelligent Communications Incorporated ("Intellicom"), the former Xerox Skyway
Network. This acquisition is expected to be completed by June 30, 1999.
Intellicom has a proprietary two-way satellite technology that can be used to
provide Internet access while bypassing the often expensive telephony costs
involved in connecting to the Internet. The Company believes that integrating
this new technology into its existing business plan will allow the Company to
cost effectively provide its ISP Channel service to smaller cable systems in
more remote areas as well as to certain other markets including multiple
dwelling units ("MDU's"), hotels, hospitals, and schools, thereby decreasing the
Company's cost basis and increasing the Company's potential market size. See
"Business -- Intelligent Communications, Inc."
In connection with its increased emphasis on cable-based Internet services,
the Company has built a highly experienced management team to grow its Internet
business, including President and Chief Executive Officer, Dr. Lawrence B.
Brilliant (co-founder of The Well, one of the first on-line communities); Chief
Operating Officer, Garrett J. Girvan (former Chief Operating Officer and Chief
Financial Officer of Viacom Cable); Chief Financial Officer, Douglas S. Sinclair
(formerly Chief Financial Officer of Silicon Valley Networks, Inc.); Director
and President of ISP Channel, Ian B. Aaron (former Director of Marketing, Sales
and Product Development of GTE Business Communications); Vice President and
General Counsel, Steven M. Harris (formerly Vice President, Broadband Services,
Pacific Telesis Group); Chief Marketing Officer, Kevin Gavin (formerly Regional
Vice President of Teligent, Inc.); Director, Edward A. Bennett (former President
of Prodigy Services, President and Chief Executive Officer of VH-1 Networks and
Chief Operating Officer of Viacom Cable); and Director, Sean P. Doherty (former
Chief Operating Officer of At Home Corporation ("@Home")). In addition, the
Company has recruited a number of key employees and consultants with significant
industry experience, including Atam Lalchandani (former Chief Financial Officer
of @Home) and Howard Rheingold (author of Virtual Communities).
The Company's current principal executive office is located at 520 Logue
Avenue, Mountain View, California 94043. To reduce its future rent costs per
square foot, the Company has signed a lease at 650 Townsend Street, San
Francisco, California 94103, and it intends to move its principal executive
offices and ISP Channel to this location in the first calendar quarter of 1999.
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ISP Channel
The Company seeks to become the dominant cable-based provider of high-speed
Internet access and other Internet-related services to homes and businesses in
the franchise areas of those cable systems unaffiliated with the six largest
U.S. cable operators and certain other smaller systems. The Company estimates
that its target market comprises over 2,600 systems passing approximately 22
million U.S. homes. As of December 31, 1998, the Company has contracts with
cable operators representing approximately 1.4 million homes passed. In
addition, the Company plans to target certain other markets including MDUs,
hotels, hospitals and schools, which will significantly increase the size of the
Company's market. The Company's Internet service, which is marketed using the
brand name "ISP Channel," provides residential and business subscribers access
to the Internet over the existing cable television infrastructure at speeds up
to 1.5 megabits per second ("Mbps"). This increased speed means that the
required download time for a 10 megabyte file is less than one minute, and
allows subscribers to benefit from sophisticated multimedia applications and
programming. The ISP Channel also offers an intuitive user interface provided
through a co-branding agreement with Excite, Inc. ("Excite"), and local
information, news and entertainment customized for each community served.
Services
High-Speed Internet Access.
The Company's ISP Channel offering utilizes the cable television
infrastructure and the Company's network and content technologies to provide a
rapidly deployable, relatively inexpensive method of access to the Internet for
residential and business subscribers at speeds up to 1.5 Mbps. The ISP Channel
service enables subscribers to experience graphically rich, interactive, and
multimedia applications thereby improving the Internet experience. As of
December 31, 1998, the Company had contracts for its ISP Channel service with 28
cable operators, including Galaxy Telecom L.P. ("Galaxy"), Cable Communications
Co-op of Palo Alto ("Palo Alto Cable Co-op") and Advanced Cable Communications,
Inc. (dba Coral Springs Cable TV, "Coral Springs Cable"), representing 119 cable
systems and approximately 1.4 million homes passed. Nineteen of these systems,
representing over 216,000 homes passed, have been equipped and have begun
offering the Company's services, in most cases during the past three months. In
addition, the Company has non-binding letters of intent with 10 cable operators,
including 39 systems, representing approximately 359,000 homes passed. As of
December 31, 1998, the Company had approximately 1,250 residential and business
subscribers to its ISP Channel service, plus approximately 500 customer orders
in backlog. The Company also provides non-cable based dial-up and dedicated
Internet access to approximately 1,100 residential and business subscribers. For
areas where two-way cable is not yet available, the Company deploys a telephone
return solution, which uses the cable infrastructure for high-speed downstream
transmission and telephone dial-up access for upstream transmission. To use the
ISP Channel via cable modem, residential and business subscribers need a
personal computer with at least a 66 MHz, 486 or equivalent microprocessor and
16 megabytes of main memory. When compatible set-top boxes become widely
available, the Company plans to deliver its high-speed Internet access through
televisions.
Residential. All ISP Channel subscribers are provided an e-mail address,
roaming services, access to unique newsgroups and chat services and personal Web
space as part of their monthly fee. Additionally, the Company provides a
co-branded "cable affiliate/ISP Channel/Excite" default home page that allows
each subscriber to personalize his or her portal to the Internet. Monthly
service charges are currently as low as $39 for flat rate residential service,
with installation charges of approximately $99. The retail price of cable modems
currently ranges from $179 to $349.
Business. The Company's business solutions include Internet and intranet
services over existing cable infrastructure and traditional telephone data lines
when necessary. The Company provides its cable affiliates the ability to offer
local telecommuters, SOHO subscribers and business customers a comprehensive
selection of Internet and corporate local area network ("LAN") access for
employees in the office, and virtual private network ("VPN") and remote local
area network ("RLAN") applications, which extend corporate network access to
remote employees and external organizations, including business partners,
suppliers and customers. The Company's future business services are expected to
include on-line software distribution, secure high-speed data storage
facilities, international roaming services and office-to-office IP telephony.
Prices vary significantly depending on functionality and speed.
On-line Services.
The Company's content and programming services enhance the subscriber's
on-line experience by aggregating local and national content through a national
co-branding agreement with Excite. The Company's network architecture and local
cable headend caching and collaborative server functionality facilitate the
distribution of multimedia applications,
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including multi-player games, video conferencing and multicast video
applications, as well as local and national advertising.
National Content Aggregation. The Company has entered into a joint venture
with Excite to provide co-branded ISP Channel/Excite content aggregation,
directory and search services. The co-branded content incorporates a custom
on-line presence for the cable affiliate, including on-line cable schedules,
pay-per-view and, in the future, bill payment options. Personalization also
allows a subscriber to use the co-branded ISP Channel/Excite "push" technology
to create a customized default page incorporating the subscriber's interests,
including local and national news, weather, sports, stock portfolio, horoscope,
local city information and hundreds of other selections. In addition, the
co-branded "cable affiliate/ISP Channel/Excite" user interface provides a
simplified, intuitive navigation tool for the subscriber.
Local On-line Communities. The Company plans to develop and deploy local
on-line communities that target the interests of local residents, including
civic, commercial and education issues. The on-line communities provide a
graphical directory of local services, including shops, restaurants and events
currently not focused on by national, regional or city-wide content aggregation
services. As part of the local content strategy, the Company is developing local
on-line community conferencing forums under the name "LOCALE" to expand local
interests. Local on-line community conferencing forums include an on-line PTA to
foster better communications between parents and teachers and an online town
hall to provide residents a more timely method to communicate with city
officials. The Company also provides subscribers the ability for subscribers to
create their own online conferencing forums.
Video Conferencing and Collaborative Computing. Each of the Company's local
cable affiliate collaborative servers facilitates high-speed desktop video
conferencing (15-30 frames per second) and collaborative computing not feasible
using traditional Internet dial-up access methods. The local collaborative
server allows users to work on documents over the network while engaged in voice
and videoconferences. The Company provides an intuitive user interface that is
integrated into the browser to facilitate "single-click" conferencing to
individuals or groups.
Web Hosting Services. The Company provides a full complement of Web hosting
and server collocation. The Company's Virtual Merchant hosting service allows
businesses to create an online storefront using available software and receive
orders over the Internet in a matter of hours. Cost-effective Web hosting
packages target small business and are deployed in 24 to 48 hours. Commercial
extranet applications allow a business to let their customers or vendors access
their LANs using cable modems or dial-up facilities. Monthly charges for Web
hosting and collocation range from $25 to $1,500 per month depending on
bandwidth usage, number of inquiries (or "hits") per month and scripting and
database requirements.
Local and National Advertising. Through its cable affiliates, the Company
plans to offer the ability to bundle local Internet banner and multimedia
advertising with the existing cable video advertising sales efforts. Through the
Company's network architecture, local and national advertising content will be
stored in the Network Operating Center ("NOC") and replicated at the local cable
affiliate headend to enhance performance. The Company's network architecture
utilizes multicast routing to enable the efficient distribution of
Internet-based advertising, and video and audio content services from content
providers and the NOC to many ISP Channel subscribers simultaneously.
Development of New Services. As the Internet continues to evolve and
encompass additional applications, the Company plans to develop new products and
services targeted to this marketplace for the future. Such products and services
may include set-top box applications, Internet based telephony services
(sometimes called IP telephony), enhancements to the ISP Channel/Excite portal
and improved on-line communities.
Network Architecture
The Company's scalable, distributed network architecture links the
high-bandwidth capacity of the local cable infrastructure with leased nationwide
Internet backbone facilities from major telecommunications carriers, including
MCI, MFS and Sprint. The Company has designed its network to move content closer
to the subscriber (thereby increasing speed of access) and provide end-to-end
network management. The Company's backbone vendors provide it with scalable
Internet backbone capacity, and thereby enable the Company to respond quickly to
increases in demand, avoiding the need to build and maintain a parallel Internet
network.
Network Operations Center. The Company's NOC, which includes a network of
highly redundant servers, network management systems and broadband Internet
access facilities, manages core subscriber services, such as e-mail, newsgroups,
conferencing and chat facilities, and local content replication. The NOC
provides nationwide provisioning
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for all subscriber services, whether the customer registers at the local cable
affiliate's business office, via a cable affiliate personalized toll-free
telephone number, or through an automated online provisioning system. The
Company is in the process of building a new state-of-the-art facility to support
the activities of a growing number of cable affiliates and provide the maximum
service availability that consumers and commercial subscribers demand. To date,
the Company has deployed one NOC in Mountain View, California and plans to
deploy regional data centers ("RDCs") as justified by the geographic
concentration of cable affiliates in order to reduce operating and capital
expenditures and to provide a level of network redundancy.
Local Content Replication. The Company's network architecture utilizes
content replication technologies to enhance the speed at which content is
delivered to subscribers and makes more efficient use of the cable affiliates'
local headend Internet connectivity by moving the requested information closer
to subscribers. By replicating frequently accessed content in storage servers
located in each cable affiliate's headend, the Company delivers large multimedia
files, including graphically rich Web pages and multimedia content, to numerous
local cable modem subscribers without frequent re-transmission over the
Internet.
Total Network Management. The Company utilizes a network of dedicated
servers to monitor connectivity and performance from the NOC to each online
cable affiliate headend and its respective cable modem subscribers. In addition,
the Company's NOC currently monitors over 250 independent routers and servers on
the Internet, including major backbone providers, major Internet service
providers ("ISPs"), frequently accessed Web sites, and major nationwide peering
and routing facilities across the country. The NOC allows the Company to
automatically reroute Internet traffic to maintain subscriber cable modem
performance despite regional Internet congestion and backbone outages.
Redundant Leased Backbone Facilities. The Company connects cable affiliate
headends to the Internet via facilities leased from MCI, MFS, Sprint and others.
By utilizing multiple providers, the Company can assure maximum network
availability while enhancing the routing efficiency of cable modem subscribers'
Internet requests. National network agreements allow the Company to provide
scalable local connections to its cable affiliates. The Company's network
architecture facilitates high performance, rapid cost-effective deployment
independent of location and software scalability for responsive additions to
network capacities.
Cable Affiliate Headends. Affiliated cable system headends are connected to
the Internet and in turn the NOC through the Company's leased backbone
facilities. Each Internet connection utilizes a high performance router
supporting speeds up to 45 Mbps, which can be upgraded to 155 Mbps as required.
Currently, the Company is deploying headend equipment from 3Com and Com21. In
addition, the Company purchases telephone access lines to support local dial-up
Internet access services or dial-up return for one-way cable systems. The
Company actively monitors its dial-up facilities and purchases additional lines
as necessary to meet subscriber demand. The Company installs servers into the
cable affiliate headend to support local caching, collaborative and IP telephony
functions. Local collaborative servers facilitate desktop video conferencing and
collaborative document sharing. The Company has been evaluating technology from
several IP telephony vendors and plans to deploy IP telephony servers to
facilitate IP telephony services through the Company's network.
Cable Modems and Television Set-Top Boxes. Residential subscribers can
connect to the Internet over the local cable infrastructure using a cable modem
and, in the future will be able to connect via an integrated television set-top
box. In the case of cable modems, the coaxial cable is connected to the cable
modem and the cable modem is connected to an Ethernet card installed in a
subscriber's PC. Internal cable modem PC cards do not require the Ethernet card
installation. In the case of television based high-speed Internet access, the
coaxial cable is attached directly to the set-top box. The Company currently
provides a custom installation CD that allows a cable modem subscriber to choose
either Microsoft Internet Explorer or Netscape Navigator, along with a selection
of popular utility programs. The Company currently uses cable modems
manufactured by 3Com and Com21.
Sales and Marketing
To Cable Operators.
The Company markets its services through the establishment of exclusive
relationships with cable operators whose systems are primarily located in
secondary and tertiary markets and bedroom communities of major DMAs. The
Company uses its seven person sales force with offices in Atlanta, Georgia,
Bethesda, Maryland, Chicago, Illinois, Denver, Colorado and Los Angeles and
Mountain View, California to market the ISP Channel. This sales force targets
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the corporate offices of national and regional multiple system operators
("MSOs"). The sales force employs a team-selling approach targeting key
management, marketing and engineering personnel within each cable system. The
Company participates in three national industry trade shows, the Atlantic, NCTA
and Western, in addition to 17 state-sponsored local cable industry trade shows.
The Company began offering telephone-based Internet services in June 1996
and cable-based Internet services in the fourth quarter of fiscal 1997. As of
December 31, 1998, the Company had contracts for its ISP Channel service with 28
cable operators, including Galaxy, Palo Alto Cable Co-op and Coral Springs
Cable, representing 119 cable systems and approximately 1.4 million homes
passed. Nineteen of these systems, representing approximately 216,000 homes
passed, have been equipped and have begun offering the Company's services, in
most cases during the past three months. In addition, the Company has
non-binding letters of intent with ten cable operators, including 39 systems,
representing approximately 359,000 homes passed. As of December 31, 1998, the
Company had approximately 1,250 residential and business subscribers to its ISP
Channel service, plus approximately 500 customer orders in backlog. The Company
also provides non-cable based dial-up and dedicated Internet access to
approximately 1,100 residential and business subscribers.
The Company has a revenue sharing arrangement with its cable affiliates
pursuant to which a cable affiliate generally receives 25% of Internet services
revenue for the first 200 ISP Channel subscribers on a cable system and
approximately 50% of such revenues thereafter. In addition, the Company has
adopted an affiliate incentive program whereby certain cable operators have been
offered either cash or shares of common stock as an incentive to sign an
exclusive contract with the Company for the provision of Internet services to
their cable systems. It is the Company's intention, however, that the affiliate
incentive program will only offer common stock beginning January 1, 1999. The
Company has reserved up to 19.9% of its outstanding common stock as of May 29,
1998 for issuance to cable affiliates under this program. The number of shares
of common stock that may be paid to any individual cable affiliate will depend
on a variety of factors, including the number and size of the cable systems
covered by a contract with an MSO, the number of homes passed and the number of
cable subscribers in a system, the services provided by the Company and the
length of exclusivity of the contract. These incentive payments are expected to
range between $2.00 and $5.00 worth of stock per home passed, based on the fair
market value of the common stock at the time a letter of intent or definitive
agreement is entered into with a cable affiliate, depending upon the various
factors described above. The Company may issue stock or pay cash incentives at
the time a contract is entered into, or it may place the stock or cash incentive
amounts in escrow to be disbursed as cable systems are deployed.
To Internet Subscribers.
Through Cable Affiliates. The Company's agreements with its cable
affiliates provide the Company a conduit to reach potential subscribers. Cable
affiliates provide the Company with television advertising time and the ability
to include material describing the Company's services in bills mailed to cable
subscribers. The Company creates all of the content to be included in such
marketing efforts. The Company has produced an infomercial and is planning to
produce 30 and 60 second commercials to be aired by cable operators.
Direct to the Public. The Company markets directly to homes and businesses
in its cable affiliates' franchise areas through telemarketing, direct mail,
door hangers, and local event marketing. In addition, the Company telemarkets to
existing cable subscribers using the cable affiliate's current subscriber list.
Agreement with Excite
The Company's agreement with Excite creates a strategic relationship
between the companies that will promote the development and national presence of
the Company. Under the agreement, Excite designs, creates and promotes Web pages
for its "Excite Search" and "My Excite Channel" services that display the names
of both the Company and Excite to ISP Channel subscribers. Excite has sole
responsibility for providing and maintaining, at its expense, the resulting Web
portal. The Company is responsible for incorporating the co-branded My Excite
Channel service as a default home page for, or display a link to the co-branded
My Excite Channel service on, the ISP Channel or any personalized service
application.
Excite will sell advertising on the co-branded pages, and will create at
least one promotional space within its service that may be sold by the Company
or its cable affiliates. Excite and the Company will share a portion of the
advertising revenues received from banner advertising that appears on co-branded
pages. Under the terms of the agreement between the Company and its cable
affiliates, the Company may, in turn, share a portion of such revenue with its
cable affiliates.
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Customer Care and Billing
As part of the Company's strategy to leverage local cable affiliates' brand
identities, the Company is developing a comprehensive provisioning, billing and
customer care system that allows for its services to be individualized and
co-branded for each cable affiliate system. The Company has entered into
contracts with PeopleSoft, Inc. ("PeopleSoft") (a billing system vendor),
Clarify Inc. ("Clarify") (a customer care system vendor) and Aspect
Telecommunications ("Aspect") (a call center system vendor) to design and
implement an integrated, flexible and scalable solution. The Company's Customer
Care Center ("CCC") is being designed to provide customer service from a central
care center located in Mountain View, California. The CCC will provide
individualized toll-free support for each affiliated cable system for pre-sales
information and through which subscribers can coordinate all services including
provisioning, billing and technical support. Additionally, the Company will
provide cable affiliates with the ability to access individualized Web-based
reporting and call monitoring for all customer care service including
telemarketing, sales and technical support.
Provisioning. The Company today provisions service by means of an
individualized toll-free number with personalized answering for each cable
affiliate system. The Company is in the process of implementing an on-line
provisioning system using the PeopleSoft billing platform that will enable a
subscriber to purchase a cable modem in a retail location or at the cable
affiliate's business office and register and provision the service on-line 24
hours per day. The on-line services will include provisioning, Web-based or
e-mail bill presentation and Web-based service modification.
Billing. The Company currently provides the ability for cable affiliates or
the Company to be responsible for billing and collection. If any cable affiliate
elects to bill ISP Channel subscribers within its franchise area, the Company
maintains a duplicate subscriber record in its system for provisioning and
reconciliation. If the Company provides the billing and collection services, the
Company provides the bill delivery via e-mail and settles accounts
electronically via major credit cards, debit cards or electronic check cashing
services.
Technical Support. The CCC currently utilizes a state of the art digital
private telephone exchange ("PBX") and Automatic Call Distribution ("ACD")
system to provide full-time individualized technical support for each cable
affiliate system. The Company is currently implementing a new Aspect ACD system
accompanied by Clarify's customer care software allowing a subscriber's
information and history to be presented to a technical support representative in
conjunction with each call. The Company's "knowledge base system" facilitates
expedient trouble shooting and historical reporting on an individualized cable
system basis delivered to cable affiliates in real-time through a Web-based
interface or monthly via e-mail.
Vendor Relationships
In addition to the relationships that the Company has with Excite, MCI, MFS
and Sprint, the Company currently depends on a limited number of other suppliers
for certain key technologies used to provide Internet related services. In
particular, the Company depends on 3Com Corporation and Com21, Inc.for headend
and cable modem technology and Cisco Systems, Inc. for network routing and
switching hardware.
Competition
The Company faces competition in two broad areas: (i) competition for
partnerships with cable operators from other cable modem-based providers of
Internet access services, and (ii) competition from other types of providers of
Internet services.
Even if a consumer believes that cable-based Internet access is the best
method of accessing the Internet, the consumer may not be able to obtain this
service from the Company unless the consumer lives in an area serviced by a
cable operator that has partnered with the Company. Thus, an additional and
important class of competition could come from companies which seek to partner
with cable operators and offer to equip these cable systems with Internet access
capability or to manage the cable operator's Internet services or from cable
operators who decide not to choose a partner but rather to build their own
Internet service themselves.
National Cable Modem Service Providers. Competitive cable modem service
providers such as @Home and RoadRunner (and their respective cable partners) are
deploying high-speed Internet access services over HFC cable
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networks. Where deployed, these networks provide similar services to those
offered by the Company. These providers and their MSO affiliates have
substantially greater financial and operational resources than the Company and
may accordingly be able to deploy their service more rapidly and aggregate
content more effectively than the Company. In addition, such competitive
providers enjoy an inherent advantage in marketing their services to their MSO
affiliates by virtue of such affiliations.
System Integrators. Companies like Convergence.com, HSAnet, OSS and the
GlobalCenter service of Frontier Communications offer their services to cable
operators to assist these cable operators in upgrading their systems to carry
Internet and Web-based applications. These companies initially charged cable
operators for their technical services, but recently some have adopted a
partnership model similar to the Company's in which the systems integrator will
absorb the cost of the technical upgrading of the system and the integrator and
the cable operator will share revenues.
There are many competing technologies for delivering Internet access to
homes and businesses which compete with the Company's ISP Channel. The number of
such competing technologies is growing and the Company expects that competition
will intensify in the future. The Company's competitors comprise several
categories of providers of Internet services: incumbent local exchange carriers
("ILECs") , interexchange carriers ("IXCs"), competitive local exchange carriers
("CLECs"), ISPs, online service providers (" OSPs"), wireless and satellite data
service providers and digital subscriber line ("DSL") focused CLECs.
Many of these competitors are offering (or may soon offer) technologies and
services that will directly compete with the ISP Channel. Such technologies
include integrated services digital network ("ISDN"), DSL and wireless data.
Certain bases of competition in the Company's markets include transmission
speed, reliability of service, breadth of service availability,
price/performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital availability
and exclusive contracts. The Company believes that it compares unfavorably with
its competitors with regard to, among other things, brand recognition, operating
experience, exclusive contracts, and capital availability. Many of the Company's
competitors and potential competitors have substantially greater resources than
the Company and there can be no assurance that the Company will be able to
compete effectively in its target markets.
Each of these classes of competitors is detailed below:
ILECs. All of the largest ILECs that are present in the Company's target
markets are conducting technical and/or market trials of DSL-based data
services. In addition, at least three regional Bell operating companies
("RBOCs") have sought Federal Communications Commission ("FCC") approval to
provide DSL-based data services across local access and transport area ("LATA")
boundaries prior to the date on which the RBOC is permitted to provide
long-distance voice service across such boundaries. The RBOCs' requests are
being challenged at the FCC by competitors. As they move forward in implementing
DSL-based data services (and secure any additional needed regulatory approvals),
the RBOCs and other ILECs will represent strong competition in all of the
Company's target service areas. The ILECs have an established brand name and
reputation for high quality in their service areas, possess sufficient capital
to deploy DSL equipment rapidly, have their own copper lines and can bundle
digital data services with their existing analog voice services to achieve
economies of scale in serving customers.
National Long Distance Carriers. IXCs, such as AT&T, Sprint and WorldCom
have deployed large-scale Internet access networks, sell connectivity to
businesses and residential customers and have high brand recognition. They also
have interconnection agreements with many of the ILECs, and those agreements may
include collocation spaces from which they could begin to offer DSL services
competitive with the ISP Channel. On June 24, 1998, AT&T and TCI announced their
intention to merge. Such a merger, if consummated, would allow AT&T to provide
Internet services using TCI's cable infrastructure and would give AT&T a
significant economic and voting interest in @Home.
Fiber-Based CLECs ("FCLECs"). FCLECs such as Intermedia Communications
Group, Inc. ("Intermedia") and ICG Communications, Inc. ("ICG") have extensive
fiber networks in many metropolitan areas primarily providing high-speed digital
and voice circuits to large customers. Some FCLECs have announced plans to offer
DSL services competitive with the ISP Channel in many markets targeted by the
Company. These companies could modify their current business focuses to include
residential and small business customers using cable-based access or DSL in
combination with their current fiber networks.
Internet Service Providers. ISPs such as BBN (acquired by GTE Corporation),
UUNET Technologies, Inc. (acquired by WorldCom), Earthlink, Concentric Network
Corporation, MindSpring, Netcom (acquired by ICG) and
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PSINet, Inc. provide Internet access to residential and business customers,
generally using the existing public switched telephone network at ISDN speeds or
below. Some ISPs such as HarvardNet Inc. in Massachusetts, InterAccess in
Illinois and Vitts Corporation in New Hampshire have begun offering DSL-based
services. Additional ISPs could become DSL service providers competitive with
the Company.
Online Service Providers. OSPs include companies such as America Online
("AOL"), Compuserve (acquired by AOL), MSN (a subsidiary of Microsoft Corp.),
Prodigy, Inc., WorldGate Inc. ("WorldGate") and WebTV (acquired by Microsoft
Corp.) that provide, over the Internet and on proprietary online services,
content and applications ranging from news and sports to consumer video
conferencing. These services are designed for broad consumer access over
telecommunications-based transmission media, which enable the provision of
digital services to the significant number of consumers who have personal
computers with modems. In addition, they provide Internet connectivity, ease of
use and consistency of environment. Many of these OSPs have developed their own
access networks for modem connections. If these OSPs were to extend their access
networks to cable-based access or DSL, they would be competitors of the Company.
Wireless and Satellite Data Service Providers ("WSDSPs"). WSDSPs are
developing wireless and satellite-based Internet connectivity. The Company may
face competition from terrestrial wireless services, including, two Gigahertz
("GHz") and 28 GHz wireless cable systems, multichannel multipoint distribution
service ("MMDS") and local multipoint distribution service ("LMDS"), and 18 GHz
and 39 GHz point-to-point microwave systems. For example, the FCC is currently
considering new rules to permit MMDS licensees to use their systems to offer
two-way services, including high-speed data, rather than solely to provide
one-way video services. The FCC also recently awarded LMDS licenses, which can
be used for high-speed data services as well. In addition, companies such as
Teligent, Inc., Advanced Radio Telecom Corp. and WinStar Communications, Inc.
hold point-to-point microwave licenses to provide fixed wireless services such
as voice, data and videoconferencing.
The Company also may face competition from satellite-based systems.
Motorola Satellite Systems, Inc., Hughes Space and Communications Group (a
subsidiary of General Motors Corporation), Teledesic and others have filed
applications with the FCC for global satellite networks which can be used to
provide broadband voice and data services.
In January 1997, the FCC allocated 300 MHz of spectrum in the 5 GHz band
for unlicensed devices to provide short-range, high-speed wireless digital
communications. These frequencies must be shared with incumbent users without
causing interference. Although the allocation is designed to facilitate the
creation of new wireless LANs, it is too early to predict whether users of these
frequencies could become competitors of the ISP Channel.
DSL-focused CLECs. Certain companies, such as Covad Communications Group
("Covad") and Rhythms NetConnections, Inc. have obtained CLEC certification and
are offering high-speed data services using a strategy of collocating in ILEC
central offices. The 1996 Act specifically grants any and all CLECs the right to
negotiate interconnection agreements with the ILEC providing for such
collocation.
Federal Regulation
Internet Regulation
The Company's Internet services are not currently subject to direct
regulation by the FCC or any other governmental agency. However, it is possible
that new laws and regulations may be adopted that would subject the provision of
the Company's Internet services to government regulation. Certain other
legislative initiatives, including those involving taxation of Internet services
and payment of access charges by ISPs, are also possible. Any new laws regarding
the Internet, particularly those that impose regulatory or financial burdens,
could impact adversely the Company's ability to provide various services and
could have a material adverse effect on the Company's results of operations and
financial condition. The Company cannot predict the impact, if any, that any
future laws or regulatory changes may have on its business.
The introduction of, or changes to, regulations that directly or indirectly
affect the regulatory status of Internet services, affect telecommunications
costs (including the application of reciprocal compensation requirements, access
charges or universal service contribution obligations to Internet services), or
increase the competition from regional telecommunications companies or others,
could have a material adverse effect on the Company's results of operations and
financial condition. For instance, if the FCC determines, through any one of its
ongoing or future proceedings, that the Internet is subject to regulation, the
Company could be required to comply with a number of FCC entry/exit
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regulations, reporting, fee, and record-keeping requirements, marketing
restrictions, access charge obligations, and universal service contribution
obligations, which could adversely impact the Company's ability to provide
various planned services and have a material adverse effect on the Company's
results of operations and financial condition. The Company cannot predict the
impact, if any, that regulations or regulatory changes may have on its business.
A final determination by the FCC that providing Internet transport or telephony
services to customers over an IP-based network is subject to regulation also
could impact adversely the Company's ability to provide various planned services
and could have a material adverse effect on the Company's results of operations
and financial condition.
Since Internet services are a relatively recent phenomenon, the legal and
regulatory framework is still in its nascent state of development. The evolving
state of law and regulation is reflected in the FCC's April 10, 1998 Report to
Congress (the "April Report"). In the April Report, the FCC discussed whether
ISPs should be classified as telecommunications carriers, and, on that basis, be
required to contribute to the USF. The April Report concluded that Internet
access service-which the FCC defined as an offering combining computer
processing, information storage, protocol conversion, and routing
transmissions-is an "information service" under the Telecommunications Act of
1996 and thus not subject to regulation. In contrast, the FCC found that the
provision of transmission capabilities to ISPs and other information services
providers do constitute "telecommunications services" under the
Telecommunications Act of 1996. Consequently, parties providing those
telecommunications services are subject to current FCC regulation (and the
corresponding USF obligations).
Another major and unresolved regulatory issue concerns the obligation of
ISPs to pay access charges to ILECs. A proceeding has been pending before the
FCC since December 1996 that raises the issue whether ILECs can assess
interstate access charges on information service providers, including ISPs.
Unlike "basic services," "enhanced services," which are generally analogous to
"information services" and include Internet access services, are exempt from
interstate access charges. The FCC concluded that that exemption for information
services (including Internet access) should remain in place pending the outcome
of the proceeding. On a more general level, the FCC has questioned the
efficiency of the access charge regime and whether access charges- originally
designed in the context of wireline voice services-should be extended to ISPs,
even if it is ultimately concluded that they are telecommunications carriers.
Another major and unresolved regulatory proceeding that could affect the
benefit and cost of the Company's service offerings (to the extent the Company
becomes involved in the exchange of traffic), involves "reciprocal
compensation." Reciprocal compensation relates to the fees paid by one carrier
to terminate traffic on another carrier's network. In July 1997, the FCC was
petitioned to clarify its rules on whether CLECs that serve ISPs are entitled to
reciprocal compensation under the Telecommunications Act of 1996 for calls
originated by customers of an ILEC to an ISP served by a CLEC within the same
local calling area. The ISPs and CLECs believe that such calls are subject to
reciprocal compensation when they originate and terminate within the same local
calling area. In contrast, the ILECs believe that all such calls are interstate
in nature and are not subject to reciprocal compensation. Although the FCC has
not yet resolved the issue, every state that has addressed the issue from an
intrastate perspective (at least fifteen in number) has determined that calls to
ISPs are to be treated as local for purposes of reciprocal compensation.
Resolution of reciprocal compensation issues could increase ISP costs by
increasing telephone charges if the FCC takes a position contrary to the states'
position, and thereby requires states to reverse course.
Another major regulatory issue concerns Internet-based telephony. In the
April Report, the FCC observed that Internet-based telephone service (which the
FCC called "IP telephony") appears to be a telecommunications service rather
than an unregulated information service. The FCC explained that it would
determine on a case-by-case basis whether to regulate the service and thereby
require providers of IP telephony to contribute to the USF. The FCC did not
address the regulatory status of cable system facilities used to provide
Internet access or the USF obligations of cable systems providing such access.
The ultimate resolution of issues concerning cable system provision of Internet
access, as well as IP telephony issues, could affect the regulatory status,
cost, and other aspects of the Company's service offerings. The Company could
also be affected in a material adverse way by federal and state laws and
regulations relating to the liability of on-line services companies and Internet
access providers for information carried on or disseminated through their
networks. Several private lawsuits seeking to impose such liability upon on-line
services companies and Internet access providers are currently pending. In
addition, legislation has been enacted and new legislation has been proposed
that imposes liability for the transmission of or prohibits the transmission of
certain types of information on the Internet, including sexually explicit and
gambling information. The imposition of potential liability on the Company and
other Internet access providers for information 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 Company to expend
substantial resources or to discontinue certain service or product offerings.
The increased attention to liability issues as a result of these lawsuits and
legislative actions and proposals could impact the growth of Internet use. While
the Company carries
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professional liability insurance, it may not be adequate to compensate claimants
or may not cover the Company in the event the Company becomes liable for
information carried on or disseminated through its networks. Any costs not
covered by insurance incurred as a result of such liability or asserted
liability could have a material adverse effect on the Company's results of
operations and financial condition, its ability to meet its obligations under
the Notes and the value of the Warrants and the Warrant Shares.
State Regulation
As use of the Internet has proliferated in the past several years, state
legislators and regulators have increasingly shown interest in regulating
various aspects of the Internet. Much of the legislation that has been proposed
to date may, if enacted, handicap further growth in the use of the Internet. It
is possible that the state legislatures and regulators will attempt to regulate
the Internet in the future, either by regulating transactions or by restricting
the content of the available information and services. Enactment of such
legislation or adoption of such regulations could have a material adverse impact
on the Company.
One area of potential state regulation concerns taxes. A significant number
of bills have been introduced in state legislatures that would tax commercial
transactions on the Internet. For its part, the United States Congress is
currently considering federal legislation to impose a moratorium on state
Internet taxes for a fixed number of years until a coherent policy could be
developed for state Internet taxation, or, in the alternative, to establish
model rules that could govern tax regulation by all states. Future laws or
regulatory changes that lead to state taxation of Internet transactions could
have a material adverse impact on the Company.
Although customer-level use of the Internet to conduct commercial
transactions is still in its infancy, a growing number of corporate entities are
engaging in Internet transactions. This Internet commerce has given rise to a
number of legal and regulatory issues, such as (i) whether and how certain
provisions of the Uniform Commercial Code (adopted by 49 states) apply to
transactions carried out on the Internet and (ii) how to decide which
jurisdiction's laws are to be applied to a particular transaction. It is not
possible to predict how state law will evolve to address new transactional
circumstances created by Internet commerce, or whether the evolution of such
laws will have a material adverse impact on the Company.
State legislators and regulators have also sought to restrict the
transmission or limit access to certain materials on the Internet. For example,
in the past several years, various state legislators have sought to limit or
prohibit: (i) certain communications between adults and minors, (ii) anonymous
and pseudonymous use of the Internet, (iii) on-line gambling, and (iv) the
offering of securities on the Internet. Enforcement of such limitations or
prohibitions in some states could affect transmission in other states. State
laws and regulations that restrict access to certain materials on the Web could
inadvertently block access to other permissible sites. The Company cannot
predict the impact, if any, that any future laws or regulatory changes in this
area may have on its business.
Some states have also sought to impose tort liability or criminal penalties
on various conduct involving the Internet, such as the use of "hate" speech,
invasion of privacy, and fraud. The adoption of such laws could adversely impact
the transmission of non-offensive material on the Internet and, to that extent,
possibly have a material adverse impact on the Company's business.
The Company anticipates that it may in the future seek to offer
telecommunications service as a CLEC. All states in which the Company operates
require a certification or other authorization from the state regulatory
commission to offer intrastate telecommunications services. Many of the states
in which the Company operates are in the process of addressing issues relating
to the regulation of CLECs. Some states may require authorization to provide
enhanced services.
The Telecommunications Act contains provisions that prohibit states and
localities from adopting or imposing any legal requirement that may prohibit, or
have the effect of prohibiting, the ability of any entity to provide any
interstate or intrastate telecommunications service. The FCC is required to
preempt any such state or local requirements to the extent necessary to enforce
the Telecommunications Act's open market entry requirements. States and
localities may, however, continue to regulate the provision of intrastate
telecommunications services and require carriers to obtain certificates or
licenses before providing service.
In states where the Company operates, rulemaking proceedings, arbitration
proceedings and other state regulatory proceedings that may affect the Company's
ability to compete with ILECs are now underway or may be instituted in the
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future. These proceedings involve a variety of telecommunications issues,
including but not limited to: pricing and pricing methodologies of local
exchange and intrastate interexchange services; development and approval of
resale agreements between ILECs and CLECs and among CLECs; terms and conditions
governing the provision of telecommunications services; customer service and
unauthorized changes in customer-selected telephone service providers;
complaints regarding anticompetitive practices and transactions between
affiliated telecommunications companies; denial of entry into telecommunications
markets; discount levels for resale of local exchange and toll services;
treatment of and compensation for calls to Internet service providers; charges
for access to ILEC networks; cost sharing and implementation of interim and
permanent number portability; dialing parity; access to and responsibility for
universal service funding; and review and recommendation to the FCC concerning
RBOC authorization to offer in-region long distance service. To the extent the
Company decides in the future to install its own transmission facilities,
rulemaking proceedings, arbitration proceedings and other state regulatory
proceedings may also affect the Company's ability to compete with ILECs. These
proceedings may involve issues including but not limited to: collocation of ILEC
and CLEC facilities; interconnection agreements between ILECs and CLECs; and
access to unbundled and combined network elements of ILECs. In addition, states
in which the Company operates may consider legislation that involves issues
including but not limited to: any of the aforementioned issues in rulemaking
proceedings, arbitration proceedings and other state regulatory proceedings;
alternative forms of regulation; and limitations on the provision of competitive
telecommunications services.
Local Regulation
Although local jurisdictions generally have not sought to regulate the
Internet, it is possible that such jurisdictions will seek to impose regulations
in the future. In particular, local jurisdictions may attempt to tax various
aspects of Internet access or services, such as transactions handled through the
Internet or subscriber access, as a way of generating municipal revenue. The
imposition of local taxes and other regulatory burdens by local jurisdictions
could have a material adverse impact on the Company.
The Company's networks may also be subject to numerous local regulations
such as building codes and licensing. Such regulations vary on a city by city
and county by county basis. To the extent the Company decides in the future to
install its own transmission facilities, it will need to obtain rights-of-way
over private and publicly owned land. There can be no assurance that such
rights-of-way will be available to the Company on economically reasonable or
advantageous terms.
The foregoing discussion of regulatory factors does not describe all laws,
regulations, or restrictions that may apply to the Company. Nor does it review
all laws or regulations under consideration by federal and state governmental
bodies that may affect the Company's operations. It is possible that present and
future laws and regulations not discussed here could have a material adverse
effect on the Company's results of operations and financial condition, its
ability to meet its obligations under the Notes and the value of the Warrants
and the Warrant Shares.
Backlog
As of December 31, 1998, the ISP Channel had 28 signed contracts
representing 119 cable systems and approximately 1.4 million homes passed.
Nineteen of these systems, representing over 216,000 homes passed, have been
equipped and have begun offering the Company's services. One hundred of these
systems, representing approximately 1.2 million homes passed, are in backlog. As
of December 31, 1998, the Company had approximately 1,250 residential and
business subscribers to its ISP Channel service, plus approximately 500 customer
orders in backlog.
Employees
As of December 31, 1998 the Company had eight full-time employees at its
corporate headquarters. The ISP Channel had 86 employees.
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Micrographic Technology Corporation
As part of its new focus, the Company has signed a letter of intent to sell
MTC which, because of its size in relation to the Company's overall assets and
because of the concurrent sale of the Company's telecommunications business,
KCI, is subject to approval of the Company's shareholders. The Board of
Directors of the Company intends to submit a proposal to sell MTC together with
its recommendation in favor of such proposal to the Company's shareholders at
its 1999 annual meeting of shareholders and has no reason to believe that such
proposal will not be approved. Because such sale is subject to approval of the
Company's shareholders and the execution of definitive agreements, however, the
sale of MTC is not reflected herein as a discontinued business.
MTC designs, 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 manufactures a family of Computer Output to Microfilm ("COM")
production systems, from which it has historically derived the majority of its
revenues. MTC's proprietary software captures information from a variety of
sources, then intelligently indexes and directs the data for storage,
distribution and retrieval. MTC expects that its business will increasingly be
focused on the distribution and retrieval of electronically captured information
over a variety of communications media, such as the Internet, LANs and wide area
networks ("WANs"). To this end, MTC is pursuing a strategy of partnering with
providers of features or elements that enhance MTC's electronic data
distribution solutions.
Products and Services
MTC's products consist of a variety of electronic and film-based solutions.
Electronic Solutions
Information Distribution System. The integrated IDS software solution
allows users to automatically collect, organize and transport information to the
print or storage media of choice, enhancing the productivity and cost efficiency
of computer output and storage operations. The following product options
comprise MTC's IDS solution:
Information Distribution System Executive ("IDS EXEC"). The IDS EXEC
software product integrates input, management, execution and reporting
activities under a single point of control, improving efficiency. The IDS
EXEC console manages all data input, job resources, job prioritization and
production, tracks job status and reports audit and job statistics. The IDS
EXEC also intelligently indexes source information for convenient and
timely retrieval irrespective of the storage medium. Additionally, IDS EXEC
makes it possible to reorder images submitted in one sequence to any other
logical ordering sequence specified by the user. Finally, the IDS EXEC
platform contains a variety of Internet-specific applications that offer
its users Internet-based data input and document viewing.
Document Organizer. Document Organizer is a client/server-based
bundling system that analyzes documents and organizes them for production.
Document Organizer arranges large-scale print applications, such as bank
statements or insurance policies, according to the customer's distribution
and retrieval requirements. This allows customers to deliver their
important information according to priority, production process, and
delivery schedule.
Page Handler. Page Handler is a high-speed electronic page-print
interpreter that accepts mainframe print application input which it then
transforms into a variety of output formats, including Internet-compatible
formats, providing the customer with added flexibility as application needs
change.
Computer Output to Laser Disk ("COLD") Integration. MTC is a
value-added reseller of integrated COLD solutions for document management.
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Film-Based Solutions
MTC's film-based imaging systems, an alternative to paper and long-term
electronic storage, convert scanned or digital information directly from a
computer or magnetic tape to an analog format for archiving on microfilm or
microfiche. MTC's film-based solutions include:
COM Systems. MTC is a leading manufacturer of automated "cut fiche"
recording and duplicating systems and related software. MTC's COM systems
provide an architectural platform that has universal capability to transfer any
data format to fiche. A key differentiating factor of MTC's COM system is its PC
based client-server architecture. MTC's RAPID 16 millimeter microfilm product
will be released for beta testing in the fourth quarter of fiscal 1998.
Other. MTC offers a complete line of original and duplicate microfilm and
chemicals for use in its COM printer and duplicator systems. MTC acquires a
significant portion of its microfilm and media supplies from Eastman Kodak and
sells them on a drop-ship basis. MTC also supplies spare parts for the worldwide
maintenance of its installed COM user base. Maintenance is subcontracted to
third party organizations, for which MTC receives a monthly royalty.
Customers
MTC markets its products and services principally to high-volume
document-intensive organizations, such as banks, brokerages and other financial
services companies and document-based service providers. Other customers include
businesses primarily in the healthcare industry and government agencies who
desire to use imaging technology to archive large quantities of documents.
Current customers include over 50 service bureaus and organizations such as
Equifax Inc., the Federal Aviation Administration, the Deutsche Bundesbank,
Deutsche Bank AG, Royal Bank of Scotland Group plc, the United States Marine
Corps, and Xerox Corporation.
Competition
The document management industry is highly competitive and rapidly
changing. MTC competes on the basis of breadth of offering, cost, flexibility
and customer service. MTC's strategy of designing its software solutions around
an open architecture has allowed its existing solutions to be more readily
adaptable to changes in the computer industry and more readily acceptable by new
technologies. MTC believes that these intelligent software platforms give its
overall document management solutions a competitive advantage.
MTC has two direct competitors to its hardware products: Agfa, AG in Europe
and Anacomp worldwide. Indirect competitors include IBM, Fuji, Mobius Management
Systems, Inc., Storage Technology and others. In most cases, MTC's competitors
have longer operating histories, greater name recognition, and significantly
greater financial, technical and marketing resources than MTC. While MTC is not
aware of any direct competitors to its software product offerings, the industry
is rapidly evolving and MTC may face significant competition in the future.
Sales and Marketing
MTC markets its document management solutions and services worldwide. In
the United States, MTC employs a six person direct sales force. Internationally,
MTC uses a network of exclusive distributors .
In order to increase its competitive advantage in certain markets, MTC has
developed a comprehensive leasing alternative for its customers. This leasing
alternative, commonly referred to as a price per fiche program ("PPF"), is a
bundled COM service solution that involves a monthly lease payment based upon
the customer's actual monthly microfiche production, a minimum monthly
production provision and lease terms of typically three to five years. In order
to meet the changing needs of its customers' financing requirements, MTC intends
to increase its emphasis on PPF programs. MTC is currently negotiating with its
international distributors, along with several institutions that have a global
financing presence, to develop similar PPF programs for international markets.
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.
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Suppliers
MTC purchases the raw materials needed for both its manufacturing and spare
part supply operations from various third party vendors. MTC believes that it
can source these purchased parts from a variety of competing vendors and that no
single vendor possesses a critical component that cannot be purchased elsewhere.
MTC currently subcontracts its maintenance services to third party
organizations.
MTC purchases a significant amount of its microfilm and media supplies from
Eastman Kodak. MTC believes it has a strong partnership with Eastman Kodak and
the two parties are currently operating under a signed vendor agreement
extending through December 31, 2000. Alternative suppliers are available to MTC,
however, in the event of an interruption in the vendor relationship.
Research and Development
MTC believes that its future revenue growth and profitability will
principally depend on its success in developing new products, services and
distribution channels. MTC expects to continue to evaluate new product and
service opportunities and engage in extensive research and development
activities. For the year ended September 30, 1997, MTC spent approximately $1.8
million on research and development efforts.
Employees
As of December 31, 1998, MTC had 66 full-time employees.
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Intelligent Communications, Inc.
Intelligent Communications, Inc. ("Intellicom") provides two-way satellite
Internet access options utilizing very small aperture terminal ("VSAT")
technology. Intellicom focuses its sales penetration efforts on rural markets,
particularly ISPs, educational institutions and small businesses. In addition to
providing Internet access options, Intellicom provides Internet-based
applications, consulting services and full Internet services to the marketplaces
it serves. Intellicom's access options include both VSAT dedicated and dial-up
Internet access (including ISDN and direct network connectivity). Intellicom's
other products and services include Web server hosting and integration services,
client software development and maintenance services, training and network
integration and consulting services. Intellicom's VSAT network infrastructure
currently allows network connectivity throughout North America. Intellicom's
VSAT-based point of presence ("POP") locations can be placed throughout the 48
lower states as well as in southern Canada and south Alaska. Intellicom may
provide its Internet services in the C-band satellite arena in addition to its
Ku-band offering. Many international satellites utilize the C-band architecture
and Intellicom expects to retrofit its equipment for C-band coverage areas with
little difficulty.
Intellicom's objective is to become the leading provider of complete
communications solutions using Internet and VSAT-related technologies to rural,
suburban and urban educational institutions, ISPs and private corporate
Intranets. As a national ISP, Intellicom provides a cost-effective alternative
for Internet services and solutions to rapidly growing Internet customer
networks. Intellicom has worked toward achieving this position by focusing on
building a high performance network infrastructure, integrating and expanding
its suite of value-added products and services, investing in its network
operations and technical support infrastructure, expanding and tailoring its
sales and marketing efforts to reach its targeted customers more effectively,
and building and leveraging relationships with strategic partners.
Products and Services
Intellicom provides its customers with a comprehensive range of Internet
access options, applications and consulting services. Intellicom believes that,
over time, its strategic focus on business applications for the Internet and its
niche network connectivity options will play a larger role in differentiating
Intellicom from its competitors. Intellicom's options and services include a
stable, low-cost VSAT system based on two-way satellite technology, providing
high-speed access to the Internet. Early in 1998, Intellicom introduced the T1
Plus product line as a solution to the marketplace. In addition, Intellicom
developed the Edge Connector server to enhance the VSAT network connectivity
system. This comprehensive package of Internet applications is customized to
work within the VSAT network, specifically for the ISP industry. Cache Plus,
similar to the Edge Connector, was created as Intellicom's answer to Internet
backbone congestion. The objective of Cache Plus is to move a substantial amount
of the Web, FTP and NNTP traffic from the Internet backbone to the "network
edge" via a local proxy server. This proxy server is a "child" to a large
"parent" proxy server at Intellicom's data center in Fremont, California.
Connectivity between the child and parent is accomplished by utilizing
Intellicom's satellite based TCP/IP network and a VSAT antenna at the remote
location. This VSAT connection is accomplished with either a two-way VSAT
solution or a receive-only VSAT antenna. The child proxy server is benefited by
the proxy activity from other users on the satellite carrier. The major benefit
of such technology lies in its ability to cache a majority of the web's most
popular sites.
The proxy server connection is available through three different VSAT
service options and pricing packages. Each solution requires a local proxy
server utilizing the ICP protocol standard. Intellicom makes its Edge Connector
server solution available and delivers it pre-configured to operate as a DNS,
Web, Telnet, FTP, E-Mail and Proxy server. This system is based on the Unix
operating system and is available in numerous configurations. Network address
translation is also a configuration option for this server.
Additionally, Intellicom offers connectivity services based on a range
of VSAT, ISDN and dedicated leased circuit options for customers ranging from
115Kbps to 2Mbps data transfer speeds. The majority of customers use Intellicom
as their primary gateway to the Internet and rely on Intellicom to connect,
secure and maintain their network integrity. Intellicom designs and out-source
manufactures VSAT equipment specifically for its applications.
Intellicom makes a variety of other products and services available,
including Web server hosting and content development services, client software
products and training. All of these products and services are integrated to
provide customers with a total solution to their Internet application needs.
Intellicom enables Internet users to purchase access, applications, products and
services, including network integration services, through a single source.
Intellicom's Network Operations Center continually monitors traffic across
Intellicom's network. In addition to network monitoring,
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Intellicom also provides technical support to its customers via a toll-free
telephone number 24 hours a day, 7 days a week.
Sales and Marketing
Intellicom coordinates national advertising campaigns using intensified
direct mailings focusing on ISPs, educational institutions and corporate
intranets. The corporate sales and marketing staff will be broken into the
following three divisions: (i) network sales, (ii) reseller network sales and
(iii) content and hosting sales. Intellicom has begun negotiating international
alliances and/or partnering arrangements with other larger telecommunications
companies for international marketing and satellite capacity.
Intellicom is also focusing on building and leveraging relationships with
its strategic partners. This involves expanding market coverage by partnering
into new POP locations and building new relationships with other Internet
products and service providers. This focus will extend the reach of the
Intellicom network to virtually all major cities and locations throughout the
United States. By expanding Intellicom's network coverage, Intellicom is
positioning itself to create marketing relationships with corporations and
membership based organizations (e.g. rural electric associations, credit unions,
etc.). Expanded network coverage will also allow Intellicom to provide private
labeled network connectivity to its partners.
Competition
The market for Internet access services is extremely competitive.
Intellicom believes that its ability to compete successfully depends upon a
number of factors, including: market presence; the capacity, reliability, and
security of its network infrastructure; the pricing policies of its competitors
and suppliers; the timing and release of new products and services by Intellicom
and its competitors; and industry and general economic trends.
The competitors of Intellicom are broken into three groups: (i) other
Internet Access Providers including Netcom On-Line Communications, Inc.,
Performance Systems International, Bolt, Beranek and Newman, Inc. (BBN)
(acquired by GTE), Prodigy and America On-Line, (ii) telecommunications
companies, including MCI, AT&T and Sprint, and (iii) other VSAT based network
connectivity companies, including NSN, CyberSat and Hughes Satellite Service.
Many of these competitors have greater market presence, engineering and
marketing capabilities and financial, technological and personnel resources than
those of Intellicom.
While Intellicom believes that the price and performance characteristics of
its products and services are currently competitive, increased competition may
result in price reductions, reduced gross margin and loss of market share, any
of which could materially affect Intellicom's business, operating results and
financial condition. Many of Intellicom's current and potential competitors have
significantly greater financial, technical, marketing, and other resources than
Intellicom. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale, and support of their products
than Intellicom. The introduction of products embodying new technologies and the
emergence of new industry standards could render Intellicom's existing products
obsolete and unmarketable. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties. Accordingly, it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share. There
can be no assurance that Intellicom will be able to compete successfully against
current or future competitors or that the pressures faced by Intellicom will not
materially adversely affect its business, operating results and financial
condition.
Although most of the established on line services and telecommunications
companies currently offer only limited Internet access, many have announced
plans to offer expanded Internet access capabilities. Intellicom expects that
all of the major on line services and telecommunications companies will compete
fully in the Internet access market and expand the availability of terrestrial
based dedicated circuits, such as ISDN and fiber optics. Intellicom believes
that new competitors, including large networking, software, media, and other
technology and telecommunications companies will enter the wireless based
Internet access markets, resulting in even greater competition for Intellicom.
Certain companies have obtain or expanded their Internet access products and
services as a result of acquisitions which may permit Intellicom's competitors
to devote greater resources to the development and marketing of new competitive
products and services and the marketing of existing products and services. Also,
the ability of some of Intellicom's competitors to bundle other services and
products with Internet access services could place Intellicom at a competitive
disadvantage. Intellicom's competitors are primarily using equipment made by
other third party firms, whereas, Intellicom develops its
17
<PAGE>
equipment specifically for its target markets. The majority of Intellicom
competitors are also focused offshore at the international markets.
Due to increased competition, Intellicom expects to encounter pricing
pressures which could result in significant reductions in the average selling
price of Intellicom's many services. This may include the cost of Internet
access services. There can be no assurance that Intellicom will be able to
offset the effects of price reductions with an increase in its customer base,
its revenues, cost reductions, or otherwise. Also, Intellicom believes that the
industry will see mergers and consolidation in the near future, which could
result in greater price and other competition in the industry. Increase price or
other competition could also result from erosion of Intellicom's market share
and could have a material adverse effect on Intellicom's business, financial
condition, and results of operations. There can be no assurance that Intellicom
will have the financial resources, technical expertise, or marketing and support
capacity to continue to compete successfully.
Employees and Facilities
As of December 31, 1998, Intellicom had 20 employees plus four contract
workers. None of Intellicom's employees is currently subject to any collective
bargaining agreement.
Intellicom operates from thee principal facilities. Corporate headquarters
are located in a 9,000 square foot office space rented in Fremont, California.
Intellicom leases a 6,300 square foot warehouse in Hayward, California and a
1,400 square foot Customer Service Center in Chippewa Falls, Wisconsin.
Intellicom's handles client-side technical support issues and order fulfillment
through its Customer Service Center in Chippewa Falls, Wisconsin.
Legal Proceedings
Intellicom has no material pending litigation.
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<PAGE>
Factors Affecting the Company's Operating Results
The risks and uncertainties described below are not the only ones facing
SoftNet. Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also impair our business operations. If any of the
following risks actually occur, our business, financial condition or results of
operations could be materially adversely affected. In such case, the trading
price of our common stock could decline.
This Annual Report on Form 10-K also contains "forward-looking" statements
that involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including the risks faced by us described below and elsewhere
in this Annual Report on Form 10-K.
We Cannot Predict Our Success Because We Have Operated Our Internet Services
Business Only for a Short Period of Time
We are in the process of selling our non-Internet related subsidiaries to
focus on substantial expansion of our Internet subsidiary, ISP Channel, Inc. We
acquired ISP Channel, Inc. in June 1996. As such, we have very limited operating
history and experience in the Internet services business. The successful
expansion of the ISP Channel service will require strategies and business
operations that differ from those historically employed in connection with our
two other businesses. To be successful, we must develop and market products and
services that are widely accepted by consumers and businesses at prices that
provide cash flow sufficient to meet our debt service, capital expenditures and
working capital requirements. Consequently, we cannot assure you that our
ability to develop or maintain strategies and business operations for the ISP
Channel services will achieve positive cash flow and profitability.
There is No Proven Commercial Acceptance of ISP Channel, Inc.'s Services
It has become feasible to offer Internet services over existing cable lines
and equipment on a broad scale only recently. There is no proven commercial
acceptance of cable-based Internet services. There are only a few companies
offering such services, and none of these companies are currently profitable.
Because this industry is in its early stages, it is currently very difficult to
predict whether providing cable-modem Internet services will become a viable
business model.
We have launched the ISP Channel service in 19 cable systems in the United
States, but we cannot assure you that it will achieve broad consumer or
commercial acceptance. We currently only have approximately 1,600 subscribers to
the ISP Channel service. The success of the ISP Channel service will depend upon
the willingness of subscribers to pay the monthly fees and installation costs
associated with the service and to purchase or lease the equipment necessary to
access the Internet. Accordingly, we cannot predict whether our pricing model
will prove to be viable, whether demand for our services will materialize at the
prices we expect to charge, or whether current or future pricing levels will be
sustainable. If we do not achieve or sustain such pricing levels or if our
services do not achieve or sustain broad market acceptance, then our business,
financial condition, prospects and ability to repay our debts will be materially
adversely affected.
We Anticipate Having Negative Cash Flow, Net Losses and Accumulated
Stockholders' Deficits for the Foreseeable Future
We have sustained substantial losses over the last five fiscal years. For
the fiscal year ended September 30, 1998, we had a net loss of $17.3 million and
for the fiscal year ended September 30, 1997, we had a net loss of $2.6 million.
As of September 30, 1998, we had an accumulated stockholders' deficit of
approximately $6.2 million. We expect to incur substantial additional losses and
experience substantial negative cash flows as we expand the ISP Channel service.
The costs of expansion will include expenses incurred in connection with:
o installing the equipment necessary to enable our cable affiliates to
offer our services;
o research and development of new product and service offerings;
o the continued development of our direct and indirect selling and
marketing efforts; and
o possible charges related to acquisitions, divestitures, business
alliances or changing technologies, including the possible acquisition
of Intelligent Communications, Inc.
Our continued negative cash flow and net losses may result in depressed
market prices for our common stock. We cannot assure you that we will ever
achieve favorable operating results or profitability.
19
<PAGE>
We Will Require Substantial Future Capital to Implement Our Business Plan
The development of our business will require substantial capital infusions
as a result of:
o our need to enhance and expand product and service offerings to
maintain our competitive position and increase market share; and
o the substantial investment in equipment and corporate resources
required by the continued national launching of the ISP Channel
service.
In addition, we anticipate 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 we will have to upgrade our equipment on
any affected cable system to handle two-way transmissions. We cannot accurately
predict whether or when we will ultimately achieve cash flow levels sufficient
to support our operations, development of new products and services, and
expansion of the ISP Channel service. Unless we reach such cash flow levels, we
will require additional financing to provide funding for operations. In the
event we complete a long-term debt financing, we will be highly leveraged and
such debt securities will have rights or privileges senior to those of our
current shareholders. In the event that equity securities are issued to raise
additional capital, the percentage ownership of our shareholders will be
reduced, shareholders may experience additional dilution and such securities may
have rights, preferences and privileges senior to those of our common stock. In
the event that we cannot generate sufficient cash flow from operations, or are
unable to borrow or otherwise obtain additional funds on favorable terms to
finance operations when needed, our business, financial condition, prospects and
ability to repay our debts would be materially adversely affected.
The Unpredictability of Our Quarterly Results May Adversely Affect the Trading
Price of Our Common Stock
We cannot predict with any significant degree of certainty our quarterly
revenue and operating results, which have fluctuated in the past and will likely
fluctuate in the future. As a result, we believe that period-to-period
comparisons of our revenues and results of operations are not necessarily
meaningful and you should not rely upon them as indicators of future
performance. It is likely that in one or more future quarters our results may
fall below the expectations of analysts and investors. In such event, the
trading price of our common stock would likely decrease. Many of the factors
that could cause our quarterly operating results to fluctuate significantly in
the future are beyond our control.
Factors that could affect ISP Channel, Inc. include, among others:
o the number of subscribers who retain our Internet services;
o changes in the revenue sharing arrangements between us and our
affiliated cable operators;
o our ability and that of our cable affiliates to coordinate timely and
effective marketing strategies, in particular, our strategy for
marketing the ISP Channel service to subscribers in such affiliates'
local cable areas;
o the rate at which our cable affiliates can complete the installations
required to initiate service for new subscribers;
o the amount and timing of capital expenditures and other costs relating
to the expansion of the ISP Channel service;
o competition in the Internet or cable industries; and
o changes in law and regulation.
In addition, we are selling MTC and KCI, our non-Internet subsidiaries. MTC
has not been accounted for as a discontinued operation because its sale is
dependent on shareholder approval. MTC and KCI have historically accounted for
the majority of our revenues. Accordingly, the sale of KCI and MTC would make
historical comparisons of operating results less meaningful.
Issuance of Common Stock Pursuant to Existing Obligations Will Result in
Dilution to the Common Stockholders
The total number of shares of our common stock underlying all of our
convertible securities, assuming the maximum amounts that we could be obligated
to issue without our consent, is 7,477,814 which would have been 86.6% of our
outstanding common stock as of December 31, 1998. The issuance of common stock
as a result of these obligations could result in significant dilution to the
holders of our common stock.
20
<PAGE>
We are obligated to issue up to 1,760,227 shares of our common stock on the
exercise of warrants and vested options and the conversion of certain of our
convertible debt. Our preferred stock and 9% senior subordinated convertible
notes due 2001 could convert into an additional 5,717,587 shares of common stock
without our consent. However, we do not know the exact number of shares of our
common stock that we will issue upon conversion of these securities because they
potentially have floating conversion prices based on the average market prices
of the common stock for a number of trading days immediately prior to
conversion.
The floating conversion price feature of the Series B Preferred Stock,
Series C Preferred Stock, and 9% senior subordinated convertible notes due 2001
begin February 28, 1999, May 29, 1999 and July 1, 1999, respectively. Generally,
decreases in the market price of the common stock below their initial conversion
prices would result in more shares of common stock being issued upon their
conversion. The 5,717,587 shares underlying our preferred stock and 9% senior
subordinated convertible notes due 2001 assumes that the stockholders approve
the issuance of in excess of 19.99% of our outstanding common stock in
connection with conversion of our preferred stock. We are seeking such approval
at our 1999 Annual Meeting.
The following table sets forth the number of shares of common stock
issuable upon conversion of the outstanding preferred stock and our 9% senior
subordinated convertible notes due 2001 and percentage ownership that each
represents assuming:
o the market price of the common stock is 25%, 50%, 75% and 100% of the
market price of the common stock on December 31, 1998, which was
$17.38 per share;
o the floating conversion price feature of the preferred stock and 9%
senior subordinated convertible notes due 2001 was in effect;
o the maximum conversion prices of the preferred stock was not adjusted
as provided in our certificate of incorporation; and
o the conversion price was equal to the market price at the time of
conversion in the event the market price was less than the maximum
conversion price.
<TABLE>
On December 31, 1998, there were 8,631,087 shares of common stock,
10,251.56 shares of Series B Preferred Stock, 7,625.39 shares of Series C
Preferred Stock and $12,000,000 principal amount under the 9% senior
subordinated convertible notes due 2001 outstanding. The Series B Preferred
Stock cannot convert into more than 2,000,000 shares of our common stock. In the
event that more than 2,000,000 shares of common stock would be required to fully
convert the Series C Preferred Stock, we must either honor conversion requests
over the 2,000,000 share limit or redeem the remaining Series C Preferred Stock
for cash, at its stated value of $1,000 per share plus accrued but unpaid
dividends.
<CAPTION>
9% Senior
Series B Series C Subordinated
Preferred Stock Preferred Stock Convertible Notes Total
--------------- --------------- ----------------- -----
Percent of Shares Shares Shares Shares
Market Price Underlying % Underlying % Underlying % Underlying %
------------ ---------- - ---------- - ---------- - ---------- -
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
25% ($4.35) 2,000,000 18.8 1,752,963 16.9 1,717,587 16.6 5,470,550 38.8
50% ($8.69) 1,179,696 12.0 877,490 9.2 1,380,897 13.8 3,438,083 28.5
75% ($13.04) 786,162 8.4 847,265 8.9 920,245 9.6 2,553,672 22.8
100% ($17.38) 776,633 8.3 847,265 8.9 705,882 7.6 2,329,780 21.3
</TABLE>
Dilution may result in a decrease in the market price of our common stock
To the extent any of these shares of common stock are issued, the market
price of our common stock may decrease because of the additional shares on the
market. If the actual price of the common stock decreases, the holders of such
preferred stock could convert into greater amounts of common stock, the sales of
which could further depress the stock price. In addition, any significant
downward pressure on the market price of the common stock that may be caused by
the holders of the preferred stock converting and selling material amounts of
common stock could encourage short sales by such holders or others. Such short
sales could place further downward pressure on the price of our common stock.
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<PAGE>
The ownership limitations in our certificate of incorporation may not
protect against dilution
Our certificate of incorporation does not allow us to issue shares of our
common stock to holders of our preferred stock if such issuance would result in
such holders beneficially owning more than 4.99% or our outstanding common
stock. The 4.99% ownership limitation does not prevent the holders from
converting into common stock and then selling such common stock to stay below
the limitation, except that such holders cannot convert into more than 19.99% of
our common stock unless we have received shareholder approval. SoftNet is
seeking shareholder approval for conversions of its preferred stock in excess of
19.99% at its 1999 Annual Meeting.
We May Be Required to Make Cash Payments to Holders of Preferred Stock
We are required by our certificate of incorporation and the rules of the
American Stock Exchange to obtain shareholder approval prior to issuing more
than 19.99% of our common stock upon conversion of the Series A Preferred Stock,
Series B Preferred Stock and Series C Preferred Stock. If we do not obtain such
shareholder approval, we will be required to make cash payments to holders of
the Series B Preferred Stock or Series C Preferred Stock who attempt to convert
over the 19.99% limit, unless SoftNet obtains a waiver from the American Stock
Exchange rule or otherwise ceases to be subject to such rule. The cash payments
would be equal to the number of shares of common stock that we would have issued
absent the 19.99% limit multiplied by the market price at the time of the
attempted conversion.
In addition, in the event the 2,000,000 share limit is reached with respect
to the Series C Preferred Stock, SoftNet must either honor conversion requests
or redeem in cash the remaining Series C Preferred Stock. The market price of
our common stock would have to fall to $3.75 or below for five days within a
thirty day trading period to reach the 2,000,000 share limit.
The following table sets forth the amount of such cash payment assuming:
o the market price of the common stock is 25%, 50%, 75%, 100%, 125%,
150% and 175% of the market price of the common stock on December 31,
1998, which was $17.38 per share;
o the floating conversion price feature of the Series B Preferred Stock
and Series C Preferred Stock was in effect;
o the maximum conversion price of the Series B Preferred Stock and
Series C Preferred Stock was not increased; and
o the conversion price was equal to the market price at the time of
conversion in the event the market price was less than the maximum
conversion price.
<TABLE>
The actual cash payments may be significantly greater than those listed if
the market price of our common stock increases above $30.42. In addition, the
floating conversion price feature is based on the average market prices of the
common stock for a number of trading days immediately prior to conversion.
Therefore, cash payments may also be significantly greater than those listed if
the market price of our common stock at the time of attempted conversion was not
equal to the conversion price.
<CAPTION>
Cash Payment for Attempted Conversions
--------------------------------------
Percentage of
Market Price Series B Preferred Stock Series C Preferred Stock Total Cash Payments
------------ ------------------------ ------------------------ -------------------
<S> <C> <C> <C> <C>
25% ($4.35) $ 5,736,206 $ 7,625,390 $ 13,361,596
50% ($8.69) 4,330,786 7,625,390 11,956,176
75% ($13.04) 10,251,560 2,163,775 12,415,335
100% ($17.38) 13,497,887 2,883,927 16,381,814
125% ($21.73) 16,876,242 3,605,738 20,481,980
150% ($26.07) 20,246,831 4,325,890 24,572,721
175% ($30.42) 23,625,186 5,047,702 28,672,888
</TABLE>
Such cash payments will adversely affect our financial condition and
ability to implement the business plan for ISP Channel, Inc. In addition, we
will be required to raise funds elsewhere, which could be difficult in the event
shareholder
22
<PAGE>
approval is not obtained. If we do not receive shareholder approval, there can
be no assurance that we would be able to obtain adequate sources of additional
capital.
We May Be Required to Repay Our 9% Senior Subordinated Convertible Notes Due
2001 in Cash
The terms of the 9% Senior Subordinated Convertible Notes due 2001 prohibit
their holders from converting such notes into more than 1,717,587 shares of our
common stock. In the event that we cannot honor conversions of the 9% Senior
Subordinated Convertible Notes due 2001 because they would result in greater
than an aggregate of 1,717,587 shares of common stock being issued upon such
conversions, then we must convert such outstanding principal amount up to the
1,717,587 limit and prepay the remaining outstanding principal amount. The
prepayment amount would be equal to the greater of:
o 130% of the then outstanding principal amount of such unconverted
notes, plus any accrued but unpaid interest; and
o the product of the number of shares of additional common stock that
would have been issued absent the 1,717,587 share limitation and
either the conversion price or market price (whichever is greater at
the time of such attempted conversion)
We would not reach the 1,717,587 share limit unless the floating conversion
price feature were in effect and the market price of the common stock fell below
$6.99. If the market price of the common stock was $4.35, which is 25% of the
market price of the common stock as of December 31, 1998, we would be required
to make cash payments of $5,887,046. This amount does not take into account any
interest that accrues on the outstanding principal amount of the 9% Senior
Subordinated Convertible Notes due 2001. This amount also assumes that the
market price at the time of conversion and the conversion price were equal. The
market price at the time of conversion and the conversion price potentially
could not be equal because the conversion price is calculated using market
prices during the thirty days prior to conversion.
In addition, if the holders of the 9% Senior Subordinated Convertible Notes
due 2001 cannot convert or resell the common stock issued upon conversion other
than because the 1,717,587 share limit is reached, the terms of the 9% Senior
Subordinated Convertible Notes due 2001 permit the holders to require us to make
cash payments equal to the greater of:
o 108% of the then outstanding principal amount of such unconverted
notes if the event occurs prior to July 1, 1999 and 112% of the then
outstanding principal amount of such unconverted notes thereafter,
plus any accrued but unpaid interest; and
o the product of the number of shares of additional common stock that
would have been issued absent the inability to convert or resell and
either the conversion price or market price (whichever is greater at
the time of such attempted conversion)
The maximum amount of such cash payments, assuming the market price and the
conversion price were equal, is $13,440,000, without taking into account any
interest that would accrue. If the market price and the conversion price are not
equal, then the maximum amount of such cash payments could be significantly
higher.
Such cash payments will adversely affect our financial condition and
ability to implement the business plan for ISP Channel, Inc.
We Rely Substantially on Our Cable Affiliates to Provide Our Internet Services
to Subscribers
The success of our business depends upon our relationship with our cable
affiliates. Therefore, in addition to economic conditions, market conditions and
factors relating to Internet service providers and on-line services
specifically, our success and future business growth will also be subject to
economic and other factors affecting our cable affiliates.
We do not have direct contact with our subscribers
Because subscribers to the ISP Channel service must subscribe through a
cable affiliate, the cable affiliate (and not SoftNet) will substantially
control the customer relationship with the subscriber. For example, under our
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 distribution of local marketing materials.
23
<PAGE>
Failure or delay by cable operators to upgrade their systems may adversely
affect subscription levels
Certain ISP Channel services are dependent on the quality of the cable
networks of our cable affiliates. Currently, most cable systems are capable of
providing only information from the Internet to the subscribers, and require a
telephone line to carry information from the subscriber to the Internet. These
systems are called "one-way" cable systems. Cable operators have announced and
begun making major upgrades to their systems to increase the capacity of their
networks and to enable traffic both to and from the Internet over their
networks, so-called "two-way capability." However, cable system operators have
limited experience with implementing such upgrades. These investments have
placed a significant strain on the financial, managerial, operational and other
resources of cable system operators, most of which already maintain a
significant amount of debt.
Further, cable operators must periodically renew their franchises with
city, county or state governments. These governmental bodies may impose
technical and managerial conditions before granting a renewal, and these
conditions may cause the cable operator to delay such upgrades.
In addition, cable operators are primarily concerned with increasing
television programming capacity to compete with other forms of entertainment
delivery systems, such as direct broadcast satellite. Consequently, cable
operators may choose not to upgrade their networks for two-way Internet
capability. Such upgrades have been, and we expect will continue to be, subject
to change, delay or cancellation. Cable operators' failure to complete these
upgrades in a timely and satisfactory manner, or at all, would adversely affect
the market for our products and services in any such operators' franchise area.
In addition, cable operators may roll-out Internet access systems that are
incompatible with our high-speed Internet access services. If repeated on a
broad scale, such failures could have a material adverse effect on our business,
financial condition, prospects and ability to repay our debts.
The Unavailability of Two-Way Capability in Certain Markets May Affect
Subscription Levels
We provide Internet services to cable systems irrespective of their two-way
capabilities. For one-way cable systems, we provide Internet services over cable
systems to homes with a telephone line return path for data from the home. In
those circumstances, our services may not provide the high speed access, quality
of experience and availability of certain applications, such as video
conferencing, necessary to attract and retain subscribers to the ISP Channel
service. Subscribers using a telephone line return path will experience data
transmission speeds to the Internet that are provided by their analog modems
which is typically 28.8 kilobits per second. It is not clear what impact the
lack of two-way capability will have on subscription levels for the ISP Channel
service.
Our Growth Depends on Exclusive Access to Cable Subscribers
The success of the ISP Channel service is dependent, in part, on our
ability to gain exclusive access to cable consumers. Our ability to gain
exclusive access to cable customers depends upon our ability to develop
exclusive relationships with cable operators that are dominant within their
geographic markets. We cannot assure you that affiliated cable operators will
not face competition in the future or that we will be able to establish and
maintain exclusive relationships with cable operators. Currently, a number of
our contracts with cable operators do not contain exclusivity provisions. Even
if we are able to establish and maintain exclusive relationships with cable
operators, we cannot assure the ability to do so on favorable terms or in
sufficient quantities to be profitable. In addition, we are seeking affiliations
with a large number of cable operators as quickly as possible because we will be
excluded from providing Internet over cable in those areas served by cable
operators with exclusive arrangements with other Internet service providers. Our
contracts with cable affiliates typically range from three to seven years, and
we cannot assure you that such contracts will be renewed on satisfactory terms.
If the exclusive relationship between either us and our cable affiliates or our
cable affiliates and their cable subscribers is impaired, if we do not become
affiliated with a sufficient number of cable operators, or if we are not able to
continue our relationship with a cable affiliate once the initial term of its
contract has expired, our business, financial condition, prospects and ability
to repay our debts could be materially adversely affected.
Future Revenue Growth and Profitability Will Depend in Part on the Success of
Our Research and Development Activities
We expect to continue extensive research and development activities and to
evaluate new product and service opportunities. These activities will require
our continued investment in research and development and sales and marketing,
which could adversely affect our short-term results of operations. We believe
that future revenue growth
24
<PAGE>
and profitability will depend in part on our ability to develop and successfully
market 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 our
business financial condition, prospects and ability to repay our debts.
We Will Need to Manage Our Expanding Business Effectively
To exploit fully the market for our products and services, we must rapidly
execute our sales strategy while managing anticipated growth through the use of
effective planning and operating procedures. To manage our anticipated growth,
we must, among other things:
o continue to develop and improve our operational, financial and
management information systems;
o hire and train additional qualified personnel;
o continue to expand and upgrade core technologies; and
o effectively manage multiple relationships with various customers,
suppliers and other third parties.
Consequently, such expansion could place a significant strain on our
services and support operations, sales and administrative personnel and other
resources. We may, in the future, also experience difficulties meeting demand
for our products and services. Additionally, if we are unable to provide
training and support for our products, it will take longer to install our
products and customer satisfaction may be lower. We cannot assure that our
systems, procedures or controls will be adequate to support our operations or
that management will be able to exploit fully the market for our products and
services. Our failure to manage growth effectively could have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
Cable Affiliates May Be Unable to Renew Their 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 the franchise may be terminated if the
franchisee fails to comply with the material provisions of the franchise. 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. This Act
also permits municipal authorities to operate cable television systems in their
communities without franchises. We cannot assure that cable television companies
having contracts with us will retain or renew their franchises. Non-renewal or
termination of any such franchises would result in the termination of our
contract with the applicable cable operator. If an affiliated cable operator
were to lose its franchise, we would seek to affiliate with the successor to the
franchisee. We cannot, however, assure an affiliation with such successor. In
addition, affiliation with a successor could result in additional costs to us.
If we cannot affiliate with replacement cable operators, our business, financial
condition, prospects and ability to repay our debts could be materially
adversely affected.
We May Lose Cable Affiliates through Acquisition by Unaffiliated Cable Operators
Under many of our initial contracts, if a cable affiliate is acquired by an
unaffiliated cable operator that already has a relationship with one of our
competitors or chooses not to enter into a contract with us, we may lose our
ability to offer Internet services in the area served by such former cable
affiliate entirely or on an exclusive basis. Such a loss could have a material
adverse effect on our business, financial condition, prospects and ability to
repay our debts.
We Depend on Third-Party Technology to Develop and Introduce New Technology We
Use
The markets for the products and services we use are characterized by the
following:
o intense competition;
o rapid technological advances;
o evolving industry standards;
o changes in subscriber requirements;
o frequent new product introductions and enhancements; and
o alternative service offerings.
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Because of these factors, we have chosen to rely upon third parties to
develop and introduce technologies that enhance our current product and service
offerings. If our relationship with such third parties is impaired or
terminated, then we would have to find other developers on a timely basis or
develop our own technology. We cannot predict whether we will be able to obtain
the third-party technology necessary for continued development and introduction
of new and enhanced products and services. In addition, we cannot predict
whether we will obtain third-party technology on commercially reasonable terms
or replace third-party technology in the event such technology becomes
unavailable, obsolete or incompatible with future versions of our products or
services. The absence of or any significant delay in the replacement of
third-party technology would have a material adverse effect on our business,
financial condition, prospects and ability to repay our debts.
We Depend on Third-Party Suppliers for Certain Key Products and Services
We currently depend on a limited number of suppliers for certain key
products and services. In particular, we depend on Excite, Inc. for national
content aggregation, 3Com Corporation and Com21, Inc. for headend and cable
modem equipment, Cisco Systems, Inc. for specific network routing and switching
equipment, and, among others, MCIWorldCom, Inc. for national Internet backbone
services. Excite recently announced that it is being acquired by one of our
primary competitors, At Home. If, due to this acquisition, Excite were to
terminate its contract with us in November 1999, we would need to find a new
provider of national content aggregation. Additionally, certain of our cable
modem and headend equipment suppliers are in litigation over their patents. We
could experience disruptions in the delivery or increases in the prices of
products and services purchased from vendors as a result of this intellectual
property litigation. We cannot predict when delays in the delivery of key
components and other products may occur 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, we may not have adequate remedies against such third
parties as a result of breaches of their agreements with us. The inability to
obtain sufficient key components or to develop alternative sources for such
components could result in delays or reductions in our product shipments. If
that were to happen, it could have a material adverse effect on our customer
relationships, business, financial condition, prospects and ability to repay our
debts.
We Depend on Third-Party Carriers to Maintain Their Cable Systems Which Carry
Our Data
Our success will depend upon the capacity, reliability and security of the
network used to carry data between our subscribers and the Internet. A
significant portion of such network is owned by third parties, and accordingly
we have no control over its quality and maintenance. We rely on cable operators
to maintain their cable systems. In addition, we rely on other third parties to
provide a connection from the cable system to the Internet. Currently, we have
transit agreements with MCIWorldCom, Sprint Communications Company, and others
to support the exchange of traffic between our network operations center, cable
system and the Internet. The failure of any other link in the delivery chain
resulting in an interruption of our operations would have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
We Experience Intense Competition in Our Markets
The markets for our products and services are intensely competitive, and we
expect competition to increase in the future. Many of our 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 we do. 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 we can. We cannot predict whether we will be able to
compete successfully against current or future competitors or that competitive
pressures faced by us will not materially adversely affect our business,
financial condition, prospects or ability to repay our debts. Any increase in
competition could reduce our gross margins, require increased spending by us on
research and development and sales and marketing, and otherwise materially
adversely affect our business, financial condition, prospects and ability to
repay our debts.
We face competition from many sources, which include:
o Other cable-based access providers;
o Telephony-based access providers; and
o Alternative technologies, such as telecom-related solutions
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Cable-based access providers
In the cable-based segment of the Internet access industry, we compete with
other cable-based data services that are seeking to contract with cable system
operators. These competitors include:
o systems integrators such as Convergence.com, Online System Services,
HSAnet and Frontier Communications' Global Center business; and
o Internet service providers such as Earthlink Network, Inc., MindSpring
Enterprises, Inc., and IDT Corporation.
Several cable system operators have begun to provide high-speed Internet
access services over their existing networks. The largest of these cable system
operators are CableVision Systems Corporation, Comcast Corporation, Cox
Enterprise, Inc., MediaOne Group, Inc., Tele-Communications, Inc. and Time
Warner Inc. Tele-Communications, Cox and Comcast market through At Home
Corporation, 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. In particular, At Home has announced its intention to compete
directly in the small-to medium-sized cable system market.
Telephone-based access providers
Some of our most direct competitors in the access markets are
telephone-based access providers, including incumbent local exchange carriers,
national interexchange or long distance carriers, fiber-based competitive local
exchange carriers, ISPs, online service providers, wireless and satellite data
service providers, and competitive local exchange carriers that use digital
subscriber line technologies. Some of these competitors are among the largest
companies in the country, including AT&T Corp, MCIWorldCom., Sprint and Quest
Communications International, Inc. Other competitors include BBN Corporation,
Earthlink, Netcom Online Communications Services, Inc., Concentric Network, and
PSInet Inc. Internet access via the existing telephone infrastructure is widely
available and inexpensive, and barriers to entry are low. The result is a highly
competitive and fragmented market.
Some of our potential competitors are offering diversified packages of
telecommunications services to residential customers. If these companies bundle
Internet access service with other telecommunications services, then we would be
at a competitive disadvantage. Many of these companies are offering (or may soon
offer) technologies that will attempt to compete with some or all of our
Internet data service offerings. The bases of competition in these markets
include:
o transmission speed;
o reliability of service;
o ease of access;
o ratio of price to performance;
o ease of use;
o content quality;
o quality of presentation;
o timeliness of content;
o customer support;
o brand recognition; and
o operating experience and revenue sharing.
Alternative technologies
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, such as integrated services digital network and digital subscriber
line technologies, and wireless technologies such as local multipoint
distribution service, multichannel multipoint distribution service and direct
broadcast satellite. Our prospects may be impaired by Federal Communications
Commission rules and regulations, which are designed, at least in part, to
increase competition in video and related services. The FCC has also created a
General Wireless Communications Service 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 General Wireless Communications Service
remains to be seen. Nevertheless, all of these new technologies pose potential
competition to our business. Significant market acceptance of alternative
solutions for high-speed data transmission could decrease the demand for our
services if such alternatives are viewed as
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providing faster access, greater reliability, increased cost-effectiveness or
other advantages over cable solutions. Competition from telecom-related
solutions is expected to be intense.
We cannot predict whether and to what extent technological developments
will have a material adverse effect on our competitive position. 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 our products and services. If that were to happen, it
could have a material adverse effect on our business, financial condition,
prospects and ability to repay our debts.
Increased Usage May Reduce Our Transmission Speed
Because the ISP Channel service has been operational for a relatively short
period of time, our ability to connect and manage a substantial number of
on-line subscribers at high transmission speeds is unknown. In addition, we face
risks related to our ability to scale up to expected subscriber levels while
maintaining superior performance. While peak downstream data transmission speeds
across the cable network approaches 30 megabits per second in each 6 MHz
channel, the actual downstream data transmission speeds for each cable
subscriber will be significantly slower and will depend on a variety of factors,
including:
o actual speed provisioned for the subscriber's cable modem;
o quality of the server used to deliver content;
o overall Internet traffic congestion;
o the number of active subscribers on a given 6 MHz channel at the same
time;
o the capability of cable modems used; and
o the service quality of the cable affiliates' cable networks.
As the number of subscribers increases, it may be necessary for our cable
affiliates to add additional 6 MHz channels in order to maintain adequate data
transmission speeds from the Internet. These additions would render such
channels unavailable to such cable affiliates for video or other programming. We
cannot assure you that our cable affiliates will provide additional capacity for
this purpose. On two-way cable systems, the transmission data channel to the
Internet is located in a range not used for broadcast by traditional cable
networks and is more susceptible to interference than the transmission data
channel from the Internet, resulting in a slower peak transmission speed to the
Internet. In addition to the factors affecting data transmission speeds from the
Internet, the interference level in the cable affiliates' data broadcast range
to the Internet can materially affect actual data transmission speeds to the
Internet. The actual data delivery speeds 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. We
cannot assure you that we will be able achieve or maintain data transmission
speeds high enough to attract and retain our planned numbers of subscribers,
especially as the number of subscribers to our services grows. Consequently, a
perceived or actual failure by us to achieve or maintain high speed data
transmission could significantly reduce consumer demand for our services and
have a material adverse effect on our business, financial condition, prospects
and ability to repay our debts.
System Failure May Cause Interruption of Internet Services
Our operations are dependent upon our ability to support a highly complex
network and avoid damages from fires, earthquakes, floods, power losses,
telecommunications failures, network software flaws, transmission cable cuts and
similar events. The occurrence of any one of these events could cause
interruptions in the services we provide. In addition, the failure of an
incumbent local exchange carrier or other service provider to provide the
communications capacity we require, as a result of a natural disaster,
operational disruption or any other reason, could cause interruptions in the
services we provide. Any damage or failure that causes interruptions in our
operations could have a material adverse effect on our business, financial
condition, prospects and ability to repay our debts.
We May Be Vulnerable to Unauthorized Access, Computer Viruses and Other
Disruptive Problems
While we have taken substantial security measures, our networks or those of
our cable affiliates may be vulnerable to unauthorized access, computer viruses
and other disruptive problems. Internet service providers and online service
providers have experienced in the past, and may experience in the future,
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 our computer systems and those of our
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subscribers. Such events may result in our liability to our subscribers and may
deter others from becoming subscribers, which could have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts. Although we intend to continue using industry-standard security measures,
such measures have been circumvented in the past, and we cannot assure you that
these measures will not be circumvented in the future. Moreover, we have no
control over the security measures that our cable affiliates adopt. Eliminating
computer viruses and alleviating other security problems may cause our
subscribers delays due to interruptions or cessation of service. Such delays
could have a material adverse effect on our business, financial condition,
prospects and ability to repay our debts.
We Must Provide High-Quality Content and the Market for High-Quality Content has
Only Recently Begun to Develop
A key part of our strategy is to provide Internet users a more compelling
interactive experience than the one currently available to customers of dial-up
Internet service providers and online service providers. We believe that, in
addition to providing high-speed, high-performance Internet access, to be
successful we must also develop and aggregate high-quality multimedia content.
Our success in providing and aggregating such content will depend in part on:
o our ability to develop a customer base large enough to justify
investments in the development of such content;
o the ability of content providers to create and support high-quality
multimedia content; and
o our ability to aggregate content offerings in a manner subscribers
find attractive.
We cannot assure you that we 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 Internet service providers and online service providers for
obtaining such content. If the market fails to develop, or develops more slowly
than expected, or if competition increases, or if our content offerings do not
achieve or sustain market acceptance, our business, financial condition,
prospects and ability to repay our debts will be materially adversely affected.
Our Success Will Depend, in Part, on Obtaining Advertising Revenues, Which May
Not Come to Fruition
The success of the ISP Channel service depends in part on our ability to
draw advertisers to the ISP Channel. We expect 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. We believe that we can leverage the ISP Channel to
provide demographic information to advertisers to help them better target
prospective customers. Nonetheless, we have not generated any significant
advertising revenue yet and we cannot assure you that advertisers will find such
information useful or will choose to advertise through the ISP Channel.
Therefore, we cannot assure you that we will be able to attract advertising
revenues in quantities and at rates that are satisfactory to us. The failure to
do so could have a material adverse effect on our business, financial condition,
prospects and ability to repay our debts.
The ISP Channel Brand May Not Be a Commercial Success
We believe that establishing and maintaining the ISP Channel brand are
critical to attract and expand our subscriber base. Promotion of the ISP Channel
brand will depend on several factors, including:
o our success in providing high-speed, high-quality consumer and
business Internet products, services and content;
o the marketing efforts of our cable affiliates; and
o the reliability of our cable affiliates' networks and services.
We cannot assure you that any of these factors will be achieved. We have
little control over our cable affiliates' marketing efforts or the reliability
of their networks and services.
If consumers and businesses do not perceive our existing products and
services as high quality or we introduce new products or services or enter into
new business ventures that are not favorably received by consumers and
businesses, then we will be unsuccessful in building brand recognition and brand
loyalty in the marketplace. In addition, to the
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extent that the ISP Channel service is unavailable, we risk frustrating
potential subscribers who are unable to access our products and services.
Furthermore, we may need to devote substantial resources to create and
maintain a distinct brand loyalty among customers, to attract and retain
subscribers, and to promote and maintain the ISP Channel brand in a very
competitive market. If we are unsuccessful in establishing or maintaining the
ISP Channel brand or if we incur excessive expenses in promoting and maintaining
our brand, our business, financial condition, prospects and ability to repay our
debts would be materially adversely affected.
We Must Develop an Effective Billing and Collections System
We have recently begun the process of designing and implementing our
billing and collections system for the ISP Channel service. We intend to bill
for our services 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, we cannot assure you
that we will be successful in developing and launching the system in a timely
manner or that we will be able to scale the system quickly and efficiently if
the number of subscribers requiring such a billing format increases. Currently,
our cable affiliates are responsible for billing and collection for our Internet
access services. As a result, we have little or no control over the accuracy and
timeliness of the invoices or over collection efforts. Given our relatively
limited history with billing and collection for Internet services, we cannot
predict the extent to which we may experience bad debts or our ability to
minimize such bad debts. If we encounter significant problems with our billing
and collections process, our business, financial condition, prospects and
ability to repay our debts could be materially adversely affected.
We Depend on the Growth and Evolution of the Internet
Market acceptance of our Internet services substantially depends upon the
growth and evolution of the Internet in ways that are best suited for our
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 thus, we cannot assure you that
those applications most favorable to our services and technology will be widely
accepted by the marketplace.
Because the number of Internet users and level of use continue to grow
significantly, we cannot assure you that the Internet infrastructure will be
able to support this increased demand 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 to handle increased levels of Internet activity. In addition, we
cannot assure you 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 complementary services
or facilities are not developed, or if the Internet does not become a viable
commercial marketplace, our business, financial condition, prospects and ability
to repay our debts could be materially adversely affected.
We May Face Potential Liability for Defamatory or Indecent Content
The law relating to liability of Internet service providers and online
service providers 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. Congress has attempted
to impose such liability, in some circumstances, for transmission of obscene or
indecent materials. In one case, a court has held that an online service
providers 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. Because of the potential liability for
materials carried on or disseminated through our systems, we may have to
implement measures to reduce our exposure to such liability. Such measures may
require the expenditure of substantial resources or the discontinuation of
certain products or services. Any imposition of liability on our company for
information carried on the Internet could have a material adverse effect on our
business, financial condition, prospects and ability to repay our debts.
We May Face Potential Liability for Information Retrieved and Replicated
Because subscribers download and redistribute materials that are cached or
replicated by us in connection with our Internet services, claims could be made
against us or our cable affiliates under both U.S. and foreign law for
defamation,
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negligence, copyright or trademark infringement, or other theories based on the
nature and content of such materials. You should know that these types of claims
have been successfully brought against online service providers. In particular,
copyright and trademark laws are evolving both domestically and internationally,
and it is uncertain how broadly the rights provided under these laws will be
applied to on-line environments. It is impossible for us to determine who the
potential rights holders may be with respect to all materials available through
our 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 online service providers, patent claims could
be asserted against us based upon our services or technologies. Our liability
insurance may not cover these types of potential claims or may not be adequate
to indemnify us for all liability that may be imposed. Any liability not covered
by insurance or in excess of insurance coverage could have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
Our Business Depends Upon the Development of New Products and Services in the
Face of Rapidly Evolving Technology
Risks related to our products and services
Our future development efforts may not result in commercially successful
products and services or our products and services may be rendered obsolete by
changing technology, new industry standards or new product announcements by
competitors.
For example, we expect digital set-top boxes capable of supporting
high-speed Internet access services to be commercially available in the next 18
months. Set top boxes will enable subscribers to access the Internet without a
computer. Although the widespread availability of set-top boxes could increase
the demand for our Internet service, the demand for set-top boxes may never
reach the level we and industry experts have estimated. Even if set-top boxes do
reach this level of popularity, we cannot assure you that we will be able to
capitalize on such demand. If this scenario occurs or if other technologies or
standards applicable to our products or services become obsolete or fail to gain
widespread commercial acceptance, then our business, financial condition,
prospects and ability to repay our debts will be materially adversely affected.
Our ability to adapt to changes in technology and industry standards, and
to develop and introduce new and enhanced products and service offerings, will
determine whether we can maintain or improve our competitive position and our
prospects for growth. However, the following factors may hinder our efforts to
introduce and sell new products and services:
o rapid technological changes in the Internet and telecommunications
industries;
o the lengthy product approval and purchase process of our customers;
and
o our reliance on third-party technology for the development of new
products and services.
Risks relating to our suppliers' products
The technology underlying our capital equipment, such as headends and cable
modems, continues to evolve and, accordingly, our equipment could become
out-of-date or obsolete prior to the time we originally intended to replace it.
If this occurs, we may need to purchase substantial amounts of new capital
equipment, which could have a material adverse effect on our business, financial
condition, prospects and ability to repay our debts.
Risks relating to our competitors' products
The introduction by our competitors of products or services embodying, or
purporting to embody, new technology could also render our 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 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 our
services. The announcements can delay purchasing decisions by our customers and
confuse the marketplace regarding available alternatives. Such announcements
could, in the future, adversely impact our business, financial condition,
prospects and ability to repay our debts.
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In addition, we cannot assure you that we will have the financial and
manufacturing resources necessary to continue successful development of new
products or services based on emerging technologies. Moreover, due to intense
competition, there may be a time-limited market opportunity for our cable-based
consumer and business Internet services. Our services may not achieve widespread
acceptance before competitors offer products and services with speed and
performance similar to our current offerings. In addition, the widespread
adoption of new Internet or telecommuting technologies or standards, cable-based
or otherwise, could require substantial and costly modifications to our
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 our business, financial condition, prospects
and ability to repay our debts.
Our Purchase of Intelligent Communications, Inc. Subjects Us to Risks in a New
Market in Which We Have No Experience
On November 23, 1998, we signed an agreement to purchase Intelligent
Communications, Inc., a provider of two-way satellite Internet access options
using very small aperture terminal ("VSAT") technology. We expect to complete
the purchase of Intelligent Communications by June 30, 1999, although we cannot
assure you that we will complete the transaction on schedule, if at all.
Acquisitions involve many risks including potential negative effects on our
reported results of operations from acquisition-related charges and amortization
of goodwill and purchased technology. In addition, the Intelligent
Communications acquisition is structured as a purchase by us of all of the
outstanding stock of Intelligent Communications. As a result, upon completion of
the acquisition, we will assume all liabilities of Intelligent Communications.
It is possible that we are not aware of all of the liabilities of Intelligent
Communications and that upon completion of the acquisition, we will have assumed
greater liabilities that we expected. In addition, we have very little
experience in the markets and technology in which Intelligent Communications is
focused.
As with mergers generally, this merger presents important challenges and
risks. Achieving the anticipated benefits of the merger will depend, in part,
upon whether the integration of the two companies' businesses is achieved in an
efficient, cost-effective and timely manner, but we cannot assure that this will
occur. The successful combination of the two businesses will require, among
other things, the timely integration of the companies' product and service
offerings and the coordination of the companies' research and development
efforts. We cannot assure you that integration will be accomplished smoothly, on
time or successfully. Although the management teams of both SoftNet and
Intelligent Communications believe that the merger will benefit both companies,
we cannot assure you that the merger will be successful. In addition, the
purchase of Intelligent Communications, Inc. presents new risks to us, including
the following:
Dependence on VSAT market
One of the reasons we have agreed to purchase Intelligent Communications
was to be able to provide two-way satellite Internet access options to our
customers using VSAT satellite technology. However, the market for VSAT
communications networks and services may not continue to grow or VSAT technology
may be replaced by an alternative technology. A significant decline in this
market or the replacement of the existing VSAT technology by an alternative
technology could adversely affect our business, financial condition, prospects
and ability to repay our debts.
Risk of damage, loss or malfunction of satellite
The loss, damage or destruction of any of the satellites used by
Intelligent Communications as a result of military actions or acts of war,
anti-satellite devices, electrostatic storm or collision with space debris, or a
temporary or permanent malfunction of any of these satellites, would likely
result in interruption of Internet services we provide over the satellites which
could adversely affect our business, financial condition, prospects and ability
to repay our debts.
In addition, use of the satellites to provide Internet services requires a
direct line of sight between the satellite and the cable headend and is subject
to distance and rain attenuation. In certain markets which experience heavy
rainfall, transmission links must be engineered for shorter distances and
greater power to maintain transmission quality. Such engineering changes may
increase the cost of providing service.
Equipment failure and interruption of service
Our operations will require that its network, including the satellite
connections operate on a continuous basis. It is not unusual for networks,
including switching facilities to experience periodic service interruption and
equipment failures. It is therefore possible that the network facilities we use
may from time to time experience interruptions or
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equipment failures, which would negatively affect consumer confidence as well as
our business operations and reputation.
Dependence on leases for satellites
Intelligent Communications currently leases satellite space from General
Electric. If for any reason, the leases were to be terminated, we cannot assure
you that we could renew the leases for the satellites on favorable terms, if at
all. We have not identified alternative providers and believe that any new
leases would probably be more costly to us. In any case, we cannot assure you
that an alternative provider of satellite services would be available, or, if
available, would be available on terms favorable to us.
Government regulation
The VSAT satellite industry is a highly regulated industry, both
domestically and internationally. In the United States, operation and use of
VSAT satellites requires licenses from the Department of Commerce and the
Federal Communications Commission. In addition, in order to operate
internationally, VSAT satellites generally require licenses from governments of
foreign countries in which imagery will be directly downlinked.
United States regulation
The Department of Commerce is responsible for granting commercial imaging
satellite operating licenses, coordinating satellite imaging applications among
several governmental agencies to ensure that any license addresses all U.S.
national security concerns and complying with all international obligations of
the United States. The U.S. government generally reserves the right to interrupt
service during periods of national emergency when U.S. national security
interests are affected. The threat of such interruptions or service could
adversely affect our ability to market our Internet services to certain end-user
customers.
As a lessee of satellite space, we could in the future be indirectly
subject to new laws, policies or regulations or changes in the interpretation or
application of existing laws, policies or regulations, that modify the present
regulatory environment in the United States.
International regulation
All satellite systems operating internationally are subject to general
international regulations and the specific laws of the countries in which
satellite imagery is downlinked. Applicable regulations include:
o International Telecommunications Union regulations, which define for
each service the technical operating parameters (including maximum
transmitter power, maximum interference to other services and users,
and the minimum interference the user must operate under for that
service);
o the Intelsat and Inmarsat agreements which provide that in order to
conform with international treaties and obligations the operators of
international satellite systems must demonstrate that they will not
cause technical harm to Intelsat and Inmarsat; and
o regulations of foreign countries that require that satellite operators
secure appropriate licenses and operational authority for utilization
of the required spectrum in each country.
Within foreign countries, we expect that GE, as the lessor of the satellite
space, will secure appropriate licenses and operational authority for
utilization of the required spectrum in each country into which satellite
imagery will be downlinked.
While we believe that our lessors will be able to obtain and renew all U.S.
and international licenses and authorizations necessary to operate effectively,
we cannot assure you that we our lessors will be successful in doing so. Our
failure to indirectly obtain or renew some or all necessary licenses or
approvals could have a material adverse effect on our business, financial
condition, prospects and ability to repay our debts.
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Acquisition-Related Risks
In addition to the recent acquisition of Intelligent Communications, Inc.,
we may acquire other businesses that we believe will complement our existing
business. We cannot predict if or when any prospective acquisitions will occur
or the likelihood that they will be completed on favorable terms.
Acquiring a business involves many risks, including:
o potential disruption of our ongoing business and diversion of
resources and management time;
o incurrence of unforeseen obligations or liabilities;
o possible inability of management to maintain uniform standards,
controls, procedures and policies;
o difficulty assimilating the acquired operations and personnel;
o risks of entering markets in which we have little or no direct prior
experience; and
o potential impairment of relationships with employees or customers as a
result of changes in management.
We cannot assure that we will make any acquisitions or that we will be able
to obtain additional financing for such acquisitions, if necessary. If any
acquisitions are made, we cannot assure that we will be able to successfully
integrate the acquired business into our operations or that the acquired
business will perform as expected.
We Depend on Certain Key Personnel
Our success depends, in large part, on our ability to attract and retain
qualified technical, marketing, sales and management personnel. With the
expansion of the ISP Channel service, we are currently seeking new employees.
However, competition for such personnel is intense in our business, and thus, we
may be unsuccessful in our hiring efforts. To launch the ISP Channel concept on
a large-scale basis, we have recently assembled a new management team, most of
whom have been with us for less than six months. The loss of any member of the
new team, or failure to attract or retain other key employees, could have a
material adverse effect on our business, financial condition, prospects and
ability to repay our debts.
Direct and Indirect Government Regulation Can Significantly Impact Our Business
Currently, neither the FCC nor any other federal or state communications
regulatory agency directly regulates our services. However, any changes in law
or regulation relating to Internet connectivity and telecommunications markets
could affect the nature, scope and prices of our services. Such changes include
those that directly or indirectly affect costs, limit usage of
subscriber-related information or increase the likelihood or scope of
competition from the regional Bell operating companies or other
telecommunications companies.
Possibility of changes in law or regulation
For example, proceedings are pending at the FCC to determine whether, and
to what extent, Internet service providers 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 Internet service providers are not telecommunications carriers, that
decision is not yet final and is being challenged by various parties, including
the regional Bell operating companies. Some members of Congress have also
challenged the FCC's conclusion. Congressional dissatisfaction with the FCC's
conclusions could lead to further changes to the FCC's governing law. We cannot
predict the impact, if any, that future legal or regulatory changes might have
on our business.
Regulations affecting the cable industry may discourage cable operators
from upgrading their systems
In addition, regulation of cable television may affect the speed at which
our cable affiliates upgrade their cable infrastructures to two-way cable.
Currently, our cable affiliates have generally elected to classify the
distribution of our services as "additional cable services" under their
respective franchise agreements, and accordingly pay franchise fees. 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
change in the classification of service could have a potentially adverse impact
on our company.
Our cable affiliates may be subject to multiple franchise fees for
distributing our services
34
<PAGE>
Another possible risk is that local franchise authorities may subject the
cable affiliates to higher or additional franchise fees or taxes or otherwise
require them to obtain additional franchises in connection with distribution of
our services. There are thousands of franchise authorities in the United States
alone, and thus it will be difficult or impossible for us or our cable
affiliates to operate under a unified set of franchise requirements.
Possible negative consequences if cable operators are classified as common
carriers
If the FCC or another governmental agency classifies cable system operators
as "common carriers" or "telecommunications carriers" because they provide
Internet services, or if cable system operators themselves seek such
classification as a means of limiting their liability, we could lose our rights
as the exclusive ISP for some of our cable affiliates. In addition, if we or our
cable affiliates are classified as common carriers, we could be subject to
government-regulated tariff schedules for the amounts we charge for our
services. To the extent we increase the number of foreign jurisdictions in which
we offer our services, we will be subject to further governmental regulation.
Import restrictions may affect the delivery schedules and costs of supplies
from foreign shippers
In addition, we obtain some of the components for our products and services
from foreign suppliers which may be subject to tariffs, duties and other import
restrictions. Any changes in law or regulation including those discussed above,
whether in the United States or elsewhere, could materially adversely affect our
business, financial condition, prospects and ability to repay our debts.
Failure to Sell KCI and MTC in a Timely Manner Could Adversely Affect Our
Ability to Implement Our Business Plan
We have announced the planned sale of KCI and MTC to two separate buyers.
We intend to apply the proceeds of such a sale toward the repayment of debt and
the expansion of the ISP Channel service. However, we cannot assure you that
these efforts will be successful. In the absence of such a sale, management's
attention could be substantially diverted to operate or otherwise dispose of KCI
and MTC. If a sale of KCI or MTC is delayed, its value could be diminished.
Moreover, KCI or MTC could incur losses and operate on a negative cash flow
basis in the future. Thus, any delay in finding a buyer or failure to sell these
divisions could have a material adverse effect on our business, financial
condition, prospects and ability to repay our debts.
We Do Not Intend to Pay Dividends
We have not historically paid any cash dividends on our common stock and do
not expect to declare any such dividends in the foreseeable future. Payment of
any future dividends will depend upon our earnings and capital requirements, our
debt obligations and other factors the board of directors deems relevant. We
currently intend to retain our earnings, if any, to finance the development and
expansion of the ISP Channel service. Our certificate of incorporation (1)
prohibits the payment of cash dividends on our common stock, without the
approval of the holders of the convertible preferred stock and (2) upon
liquidation of our company, requires us to pay the holders of the convertible
preferred stock before we make any payments to the holders of our common stock.
You should also know that some of our financing agreements restrict our ability
to pay dividends on our common stock.
Our Stock Price is volatile
The market price for our common stock has been volatile in the past, and
several factors could cause the price to fluctuate substantially in the future.
These factors include:
o announcements of developments related to our business;
o fluctuations in our results of operations;
o sales of substantial amounts of our securities into the marketplace;
o general conditions in our industries or the worldwide economy;
o an outbreak of war or hostilities;
o a shortfall in revenues or earnings compared to securities analysts'
expectations;
o changes in analysts' recommendations or projections;
o announcements of new products or services by us or our competitors;
and
o changes in our relationships with our suppliers or customers.
35
<PAGE>
The market price of our common stock may fluctuate significantly in the
future, and these fluctuations may be unrelated to our performance. General
market price declines or market volatility in the future could adversely affect
the price of our common stock, and thus, the current market price may not be
indicative of future market prices.
Prospective Anti-Takeover Provisions Could Negatively Impact Our Stockholders
We are a New York corporation. We intend 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 discourage,
delay or make a change in control of our company more difficult or prevent the
removal of incumbent directors. In addition, our proposed certificate of
incorporation and bylaws for the Delaware corporation would have certain
provisions that have the same effect. These provisions may have a negative
impact on the price of our common stock and may discourage third-party bidders
from making a bid for our company or may reduce any premiums paid to
shareholders for their common stock.
The Year 2000 Issue Could Harm Our Operations
Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because such computer programs would not properly recognize a year that begins
with "20" instead of "19." This, in turn, could result in major system failures
or miscalculations, and is generally referred to as the "Year 2000 Issue" or
"Y2K Issue." We have formulated a Y2K Plan to address our Y2K issues and have
created a Y2K Task Force headed by the Director of I/S and Data Services to
implement the plan. Our Y2K Plan has six phases:
1) Organizational Awareness - educate our employees, senior management,
and the board of directors about the Y2K issue.
2) Inventory - complete inventory of internal business systems and their
relative priority to continuing business operations. In addition, this
phase includes a complete inventory of critical vendors, suppliers and
services providers and their Y2K compliance status.
3) Assessment - assessment of internal business systems and critical
vendors, suppliers and service providers and their Y2K compliance
status.
4) Planning - preparing the individual project plans and project teams
and other required internal and external resources to implement the
required solutions for Y2K compliance.
5) Execution - implementation of the solutions and fixes.
6) Validation - testing the solutions for Y2K compliance.
Our Y2K Plan will apply to two areas:
o Internal business systems
o Compliance by external customers and providers
Internal business systems
Our internal business systems and workstation business applications will be
a primary area of focus. We are in the unique position of completing the
implementation of new enterprise-wide business solutions to replace existing
manual processes and/or "home grown" applications during 1999. These solutions
are represented by their vendors as being fully Y2K compliant. We have few, if
any, "legacy" applications that will need to be evaluated for Y2K compliance.
We plan to have completed the Inventory and Assessment Phases of
substantially all critical internal business systems by January 31, 1999, with
the Planning Phase to be completed by March 31, 1999. The Execution and
Validation Phases will be completed by August 31, 1999. We expect to be Y2K
compliant on all critical systems, which rely on the calendar year before
December 31, 1999.
Some non-critical systems may not be addressed until after January 2000.
However, we believe such systems will not cause significant disruptions in our
operations.
36
<PAGE>
Compliance by external customers and suppliers
We are in the process of the inventory and assessment phases of our
critical suppliers, service providers and contractors to determine the extent to
which our interface systems are susceptible to those third parties' failure to
remedy their own Y2K issues. We expect that assessment will be complete by
mid-1999. To the extent that responses to Y2K readiness are unsatisfactory, we
intend to change suppliers, service providers or contractors to those that have
demonstrated Y2K readiness. We cannot be assured that we will be successful in
finding such alternative suppliers, service providers and contractors. We do not
currently have any formal information concerning the status of our customers but
have received indications that most of our customers are working on Y2K
compliance.
Risks associated with Y2K
We believe the major risk associated with the Y2K Issue is the ability of
our key business partners and vendors to resolve their own Y2K Issues. We will
spend a great deal of time over the next several months, working closely with
suppliers and vendors, to assure their compliance. Should a situation occur
where a key partner or vendor is unable to resolve their Y2K issue, we expect to
be in a position to change to Y2K compliant partners and vendors.
Costs to address Y2K issues
Because we are in the position of implementing new enterprise wide business
solutions to replace existing manual processes and/or "home grown" applications,
there will be little, if any, Y2K changes required to existing business
applications. All of the new business applications implemented (or in the
process of being implemented in 1999) are represented as being Y2K compliant. We
currently believe that implementing our Y2K Plan will not have a material effect
on our financial position.
Contingency plan
We have not formulated a contingency plan at this time but expect to have
specific contingency plans in place prior to September 31, 1999.
Summary
We anticipate that the Y2K Issue will not have a material adverse effect on
our financial position or results of operations. There can be no assurance,
however, that the systems of other companies or government entities, on which we
rely for supplies, cash payments, and future business, will be timely converted,
or that a failure to convert by another company or government entities, would
not have a material adverse effect on our financial position or results of
operations. If third party service providers and vendors, due to Y2K Issues,
fail to provide us with components, materials, or services which are necessary
to deliver our service and product offerings, with sufficient electrical power
and transportation infrastructure to deliver our service and product offerings,
then any such failure could have a material adverse effect on our ability to
conduct business, as well as our financial position and results of operations.
Item 2. Properties
The Company currently leases 35,550 square feet of office space in Mountain
View, California. The Company has signed a seven year lease for approximately
33,660 square feet in a state of the art facility at 650 Townsend Street, San
Francisco, California. The Company intends to move its corporate offices and
most of the operations associated with ISP Channel to 16,830 square feet of this
space in the first calendar quarter of 1999. The remaining 16,830 square feet
will be available in the third calendar quarter of 1999 to accommodate the
Company's anticipated expansion. Subsequent to this move, ISP Channel will
maintain 22,800 square feet of leased space in Mountain View, California to
accommodate its Internet network operation center and call center.
MTC currently leases approximately 25,700 square feet in Mountain View,
California.
Item 3. Legal Proceedings
The Company has no material pending litigation.
Item 4. Submission of Matters to a Vote of Security Holders
None
37
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The common stock of the Company is principally traded on the American Stock
Exchange ("AMEX: SOF"). The high and low sales prices for the stock reported on
AMEX for each quarterly period during the past two fiscal years were as follows:
Quarter Ending High Low
--------------- ------- --------
1997
----
December 31, 1996 6 4-5/16
March 31, 1997 7-1/4 4-1/4
June 30, 1997 6-3/8 4-1/8
September 30, 1997 6-3/4 5-1/8
1998
----
December 31, 1997 8-7/16 6-9/16
March 31, 1998 7-1/4 6-3/16
June 30, 1998 15-3/8 7-3/16
September 30, 1998 18-3/8 7-3/4
There were approximately 311 record holders of the stock as of November 30,
1998. The closing price for the stock on November 30, 1998 was $16-3/8. The
Company paid no dividends on its common stock during the period October 1, 1994
to September 30, 1998. Other than restrictions that may be part of various debt
instruments, the Company does not have any legal restriction on paying
dividends. However, the Company does not intend to pay dividends on its common
stock in the foreseeable future.
Recent Sales of Unregistered Securities
Since December 31, 1997, the Company has issued three series of its 5%
convertible preferred stock denominated Series A Convertible Preferred Stock
(the "Series A Preferred Stock"), Series B Convertible Preferred Stock (the
"Series B Preferred Stock") and Series C Convertible Preferred Stock (the
"Series C Preferred Stock"). In addition, the Company has agreed to issue,
pursuant to a mutually binding stock purchase agreement, a fourth series of its
5% convertible preferred stock denominated Series D Convertible Preferred Stock
(the "Series D Preferred Stock") with the Series A Preferred Stock, the Series B
Preferred Stock and the Series C Preferred Stock, the ("Preferred Stock"). In
connection with the issuance of the 5% Preferred Stock, the Company has also
issued (or, in the case of the Series D Preferred Stock, agreed to issue)
warrants to purchase its common stock (the "Preferred Warrants"). Proceeds from
the sale of the Preferred Stock and the Preferred Warrants are being used to
fund the expenditures incurred in the continuing expansion of the Company's
Internet business, particularly the ISP Channel service, and for general
corporate purposes.
On December 31, 1997, the Company issued to RGC International Investors, LDC
("RGC"), 5,000 shares of its Series A Preferred Stock and warrants to purchase
150,000 shares of common stock (the "Series A Warrants") for an aggregate
purchase price of $5,000,000. $435,000 of the purchase price has been allocated
to the value of the Series A Warrants. The conversion price of the Series A
Preferred Stock is equal to the lower of $8.28 per share and the lowest
consecutive two day average closing price of the common stock during the 20 day
trading period immediately prior to such conversion. The sale was arranged by
Shoreline Pacific Institutional Finance, the Institutional Division of Financial
West Group ("SPIF"), which received a fee of $250,000 plus warrants to purchase
20,000 shares of common stock, which are exercisable at $6.625 and expire on
December 31, 2000. The Series A Preferred Stock was issued in a nonpublic
offering pursuant to transactions exempt under Section 4(2) of the Securities
Act. During fiscal 1998, RGC received 101 shares of Series A Preferred Stock as
dividends paid in kind and converted 2,000 shares of the Series A Preferred
Stock, plus accrued dividends, into 299,946 shares of common stock. Subsequent
to September 30, 1998, RGC converted the remaining 3,101 shares of Series A
Preferred Stock, plus accrued dividends, into 413,018 shares of common stock.
On May 28, 1998, the Company issued to RGC and Shoreline Associates I, LLC
("Shoreline"), 9,000 and 1,000 shares, respectively, of its Series B Preferred
Stock and warrants to purchase 180,000 and 20,000 shares, respectively, of
common stock (the "Series B Warrants") for an aggregate purchase price of
$10,000,000. $900,000 of the purchase price has been allocated to the value of
the Series B Warrants. Prior to February 28, 1999, the conversion price of the
Series B Preferred Stock is equal to $13.20 per share. Thereafter, the
conversion price of the Series B Preferred Stock is
38
<PAGE>
equal to the lower of $13.20 per share and the lowest five day average closing
price of the common stock during the 20 day trading period immediately prior to
such conversion. The sale was arranged by SPIF, which received a fee of $500,000
plus warrants to purchase 50,000 shares of common stock, which are exercisable
at $11.00 and expire on May 28, 2002. The Series B Preferred Stock was issued in
a nonpublic offering pursuant to transactions exempt under Section 4(2) of the
Securities Act. During fiscal 1998, RGC and Shoreline received 112.5 and 12.5
shares, respectively, of Series B Preferred Stock as dividends paid in kind.
On August 31, 1998, the Company issued to RGC 7,500 shares of its Series C
Preferred Stock and warrants to purchase 93,750 shares of common stock (the
"Series C Warrants") for an aggregate purchase price of $7,500,000. $277,000 of
the purchase price has been allocated to the value of the Series C Warrants.
Prior to May 31, 1999, the conversion price of the Series C Preferred Stock is
equal to $9.00 per share. Thereafter, the conversion price of the Series C
Preferred Stock is equal to the lower of $9.00 per share and the lowest five day
average closing price of the common stock during the 30-day trading period
immediately prior to such conversion. The sale was arranged by SPIF, which
received a fee of $375,000 plus warrants to purchase 26,250 shares of common
stock, which are exercisable at $7.50 and expire on August 31, 2002. The Series
C Preferred Stock was issued in a nonpublic offering pursuant to transactions
exempt under Section 4(2) of the Securities Act. During fiscal 1998, RGC
received 31 shares of Series C Preferred Stock as dividends paid in kind.
Each series of the Preferred Stock has similar rights and privileges, and each
share of the Preferred Stock has a par value of $0.10 and a face amount of
$1,000. The Preferred Stock is convertible into the number of shares of common
stock determined by dividing the face amount of the Preferred Stock being
converted by the applicable conversion price. A holder of the Series A Preferred
Stock or the Series B Preferred Stock cannot convert its Series A Preferred
Stock or Series B Preferred Stock in the event such conversion would result in
its beneficially owning more than 4.99% of the Company's common stock, (not
including shares underlying the Series A Preferred Stock or the Series A
Warrants for the Series A Preferred Stock conversions, or the Series B Preferred
Stock or the Series B Warrants for the Series B Preferred Stock conversions),
but they may waive this prohibition by providing the Company a notice of
election to convert at least 61 days prior to such conversion. Similarly, a
holder of the Series C Preferred Stock or Series D Preferred Stock cannot
convert its Series C Preferred Stock or Series D Preferred Stock in the event
such conversion would result in beneficially owning more than 4.99% of the
Company's common stock (not including shares underlying the Series C Preferred
Stock or the Series C Warrants for the Series C Preferred stock conversion or
the shares underlying the Series D Preferred Stock or the Series D Warrants for
the Series D Preferred stock conversions). Notwithstanding this limitation, the
holders of the Preferred Stock cannot convert into an aggregate of more than
19.99% of the Company's common stock without the approval of the Company's
common shareholders or the American Stock Exchange. In addition, the Series B
Preferred Stock, Series C Preferred Stock and Series D Preferred Stock each
cannot convert into more than 2,000,000 shares of common stock.
In January 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to Mr. R. C. W.
Mauran, a beneficial owner of more than 5% of the Company's common stock, in
exchange for the assignment to the Company of certain equipment leases and other
consideration, all of which have been assimilated into the business of
Micrographic Technology Corporation. The debentures are convertible into common
stock of the Company, at $8.25 per share, after December 31, 1998. These
securities are exempt under Section 4(2) of the Securities Act of 1933, as
amended (the "Securities Act").
On July 31, 1997 and August 15, 1997, the Company issued 250,000 shares of
common stock and 1,000 shares of common stock, respectively, to two separate
warrant holders, upon the exercise of outstanding warrants at an exercise price
of $1.75 per share ($439,250 in the aggregate). These shares were issued in a
nonpublic offering pursuant to transactions exempt under Section 4(2) of the
Securities Act.
On December 20, 1996, the Company issued 10,000 shares of common stock to Cleary
Gull Reiland and McDevitt ("Cleary") in consideration for services rendered by
Cleary in the approximate amount of $44,000 in connection with certain
acquisitions made by the Company. These shares were issued in a nonpublic
offering pursuant to transactions exempt under Section 4(2) of the Securities
Act.
In September 1995, the Company issued $2,856,700 of its 9% Convertible
Subordinated Debentures due September 2000 in conjunction with the acquisition
of Micrographic Technology Corporation ("MTC"). The debentures were issued to
the shareholders of Micrographic Technology Corporation as partial consideration
for the acquisition. These 9% debentures have a conversion price of $6.75. These
securities are exempt under Section 4(2) of the Securities Act. During fiscal
1998, the Company issued 123,377 shares of common stock pursuant to the
conversion of $832,806 of convertible debt by seven separate holders of these
debentures. During fiscal 1997, the Company issued 35,104 shares of common stock
pursuant to the conversion of $236,952 of convertible debt by four separate
holders of these debentures.
39
<PAGE>
Also during September 1995, in association with the acquisition of MTC, the
Company assumed $1,800,000 of 6% Convertible Subordinated Secured Debentures due
February 2002. These 6% 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. These debentures are convertible into
the Company's common stock at $8.10 per share. These securities are exempt under
Section 4(2) of the Securities Act. During fiscal 1998, the Company issued 7,407
shares of the Company's common stock pursuant to the conversion of $60,000 of
these convertible debentures by a single holder of these debentures. During
fiscal 1996, the Company issued 125,925 shares of common stock pursuant to the
conversion of $1,020,000 of these convertible debentures by ten separate holders
of these debentures.
In December 1994, the Company issued $2,189,500 of its 9% Convertible
Subordinated Notes due December 1998 in a private placement transacted without
the use of an underwriter. The proceeds were used for general corporate
purposes. These 9% notes have a conversion price of $5.00. These securities are
exempt under Section 4(2) of the Securities Act. During fiscal 1998, the Company
issued 5,000 shares of common stock pursuant to the conversion of $25,000 of
these convertible notes by a single holder of these notes. During fiscal 1997,
the Company issued 10,000 shares of common stock pursuant to the conversion of
$50,000 of these convertible notes by a single holder of these notes. During
fiscal 1996, the Company issued 422,898 shares of common stock pursuant to the
conversion of $2,114,500 of these convertible notes by seventeen individual
holders of these notes.
In October 1994, the Company issued $1,250,000 of its 10% Convertible
Subordinated Notes due October 1999 in a private placement transacted without
the use of an underwriter. The notes were issued in association with the
Company's purchase of Communicate Direct, Inc. ("CDI"). The proceeds were used
to perfect the CDI acquisition and for general corporate purposes. These 10%
notes have a conversion price of $4.10. These securities are exempt under
Section 4(2) of the Securities Act. During fiscal 1998, the Company issued
48,780 shares of common stock pursuant to the conversion of $200,000 of these
convertible notes by a single holder of these notes. During fiscal 1997, the
Company issued 24,390 shares of common stock pursuant to the conversion of
$100,000 of these convertible notes by a single holder of these notes. During
fiscal 1996, the Company issued 231,708 shares of common stock pursuant to the
conversion of $950,000 of these convertible notes by a single holder of these
notes.
40
<PAGE>
<TABLE>
Item 6. Selected Financial Data
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 LLP. The selected consolidated
financial data should be read in conjunction with "Management's Discussions and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and the notes thereto included elsewhere in this report.
<CAPTION>
Fiscal years ended September 30,
1998 1997 1996 (b) 1995 (c) 1994
-------- -------- -------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statements of Operations Data (a):
Net sales $ 14,060 $ 21,338 $ 19,584 $ 1,088 $ 188
Cost of sales 10,628 11,935 11,375 783 172
-------- -------- -------- -------- --------
Gross Profit 3,432 9,403 8,209 305 16
-------- -------- -------- -------- --------
Operating expenses:
Selling, engineering and general and administrative 14,879 7,767 7,764 1,673 1,180
Amortization of goodwill and transaction costs 1,286 1,287 993 29 --
Loss on impairment of assets 3,100 -- -- -- --
Write-off of acquired in-process unproven technology -- -- -- 5,000 --
Cost associated with change in products and other -- 2,137 2,164 -- --
Acquisition costs and other -- -- -- 846 --
-------- -------- -------- -------- --------
Total operating expenses 19,265 11,191 10,921 7,548 1,180
-------- -------- -------- -------- --------
Loss from operations (15,833) (1,788) (2,712) (7,243) (1,164)
Interest expense (1,416) (1,145) (1,220) (456) (601)
Gain on sale of available-for-sale securities -- -- 5,689 -- --
Other income 320 49 19 5 2
-------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes (16,929) (2,884) 1,776 (7,694) (1,763)
Provision for income taxes -- -- -- -- --
-------- -------- -------- -------- --------
Income (loss) before discontinued operations
and extraordinary item (16,929) (2,884) 1,776 (7,694) (1,763)
Discontinued operations:
Gain (loss) from operations (73) 739 (1,812) (1,317) 335
Estimated loss on disposal -- -- -- (644) --
Extraordinary item - loss on sale of business -- (486) (6,061) -- --
-------- -------- -------- -------- --------
Net loss $(17,002) $ (2,631) $ (6,097) $ (9,656) $ (1,428)
======== ======== ======== ======== ========
Preferred dividends (343) -- -- -- --
-------- -------- -------- -------- --------
Net loss applicable to common shares $(17,345) $ (2,631) $ (6,097) $ (9,656) $ (1,428)
======== ======== ======== ======== ========
Basic and diluted loss per common share $ (2.35) $ (0.40) $ (1.05) $ (2.22) $ (0.38)
======== ======== ======== ======== ========
Balance Sheet Data (a):
Working capital $ 7,439 $ 298 $ 2,430 $ 3,044 $ (918)
Total assets 34,555 20,321 18,991 29,192 4,281
Long-term debt, net of current portion 10,236 11,727 10,247 11,795 --
Redeemable convertible preferred stock 18,187 -- -- -- --
Shareholders' equity (deficit) (6,171) 2,028 3,793 11,685 2,436
<FN>
- ----------
(a) Restated to reflect the telecommunications segment as discontinued
operations.
(b) Includes ISP Channel (formerly MediaCity World, Inc.) since its acquisition
on June 21, 1996.
(c) Includes Micrographic Technology Corporation since its acquisition on
September 15, 1995
</FN>
</TABLE>
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Item 7. 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 thereto appearing elsewhere in Form 10-K. 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," "Business" and elsewhere in this Form 10-K. The Company
disclaims any obligation to update information contained in any forward-looking
statement.
Overview
During fiscal 1998, the Company resolved to become, through its wholly owned
subsidiary, ISP Channel, Inc. (formerly known as MediaCity World, Inc.) ("ISP
Channel"), the dominant cable-based provider of high-speed Internet access, and
other Internet related services to homes and businesses in the franchise areas
of those cable systems unaffiliated with the six largest US cable operators. As
part of this new focus, on November 22, 1998 the Company announced its agreement
to acquire Intelligent Communications Inc. ("Intellicom"), the former Xerox
Skyway Network. The Company believes that this acquisition will give it the
ability, using satellite, to bypass telephone companies and thus dramatically
reduce the cost of bringing high-speed Internet service to customers of small
and mid-sized cable systems. Also in line with this strategy of becoming an
Internet access provider, the Company determined to divest its two other
businesses: Micrographic Technology Corporation ("MTC"), a wholly owned
subsidiary offering document management solutions, and Kansas Communications,
Inc. ("KCI"), a wholly owned subsidiary that sells and services telephone
systems, third party computer hardware and application oriented peripheral
products such as voice mail and video conferencing systems. The Company entered
into letters of intent for the sale of MTC and KCI on November 5, 1998 and
November 9, 1998, respectively. Since July 27, 1998, the Company has
reclassified and reported KCI as a discontinued operation. However, at this
time, pending shareholder approval of the sale of both MTC and KCI (which
together, comprise substantially all of the Company's assets), the Company
continues to classify and report MTC as a continuing business. It is the current
intent of the Company to conclude the sale of both KCI and MTC during fiscal
1999.
ISP Channel and Intellicom
The Company began providing Internet services following its acquisition of ISP
Channel in June 1996. While the Company seeks to maintain and build the
traditional dial-up Internet access business acquired at, and built up since,
that time, the Company's primary objective is 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 those cable systems unaffiliated
with the six largest US cable operators. The Company commenced marketing this
high-speed service, using cable modems, to select cable operators and potential
subscribers in March 1998. However, the Company believes that, as a result of
its limited financial resources, the Company has not fully implemented its
marketing strategies, and this business has, to date, generated only nominal
revenues.
The Company has signed a definitive agreement to acquire Intellicom and the
acquisition is currently pending regulatory approvals. The Company expects to
complete the acquisition during the second quarter of fiscal 1999. Through use
of its proprietary satellite system, Intellicom currently provides two-way
Internet connectivity to local Internet service providers ("ISPs"), school
systems and businesses, primarily located in remote and rural areas.
Intellicom's VSAT (very small aperture terminals) network allows connectivity
throughout the 48 lower states as well as in southern Canada and south Alaska.
Intellicom offers a wide range of Internet services based on its proprietary
T1Plus product that presently offers up to 2 Mbps data transfer rates. It is the
Company's intention that, while Intellicom will continue to market its services
to its traditional customer sectors, it will also provide ISP Channel with the
in-house ability to bypass many of the high cost terrestrial telephone links
that ISP Channel has historically used to connect the cable head-ends of its
affiliated cable operators to the network operating center of ISP Channel.
ISP Channel Affiliates. As of December 31, 1998, the Company had contracts for
its ISP Channel service with 28 cable operators, including Galaxy, Palo Alto
Cable Co-op and Coral Springs Cable, representing 119 cable systems and
approximately 1.4 million homes passed. Nineteen of these systems, representing
approximately 216,000 homes passed, have been equipped and have begun offering
the Company's services, in most cases during the past three months. In
42
<PAGE>
addition, the Company has non-binding letters of intent with ten cable
operators, including 39 systems, representing approximately 359,000 homes
passed. As of December 31, 1998, the Company had approximately 1,250 residential
and business subscribers to its ISP Channel service. 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 aggressively pursue 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 anticipates that this policy of rapid deployment
will result in substantial capital expenditures, operating losses and negative
cash flow in the near term. While the Company believes that it currently has
sufficient cash and financing sources available to fund its operations through
1999, there can be no assurance, however, that the Company will be able to
access additional capital to finance its strategy in the longer term or to
implement its strategy or achieve positive cash flow or profitability in a
timely fashion, or at all.
ISP Channel 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 or, in certain cases, its local cable affiliate, typically charges new
cable modem-based Internet access subscribers a one-time connection fee of $99,
which includes modem installation but excludes any required modification of the
existing cable television connection, which is usually performed by the local
cable affiliate. Thereafter, each subscriber pays a monthly access fee, which is
currently as low as $39 per month. It is the Company's expectation that such
rates will decrease over time. The Company anticipates that it will purchase a
majority of the cable modems used by subscribers, who will then be charged a
nominal lease fee. 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 Internet-based telephony. The Company also intends to pursue long distance
telephone services and telephony debit and credit cards. Intellicom is also
anticipated to generate continuing revenue from the sale of VSAT service.
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 to 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 monthly
access revenues with cable affiliates for the first 200 subscribers in each
system and 50% thereafter. For other services, such as Internet-based telephony,
e-commerce and advertising, the Company expects to share between 25% and 50% of
these revenues with the cable affiliates. The Company expects that all revenues
from cable modem lease income will be retained by the Company. Depending on
competitive market conditions, these pricing and revenue sharing parameters
could change over time.
Cost of Services. Costs to the Company include installation costs, network and
cable operation costs and personnel and other costs. Commissions paid to cable
affiliates 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 by the Company, the
Company expects over time that installation costs will decline as cable modems
become more standardized and are eventually bundled as standard equipment in new
personal computers.
Other network costs include the cost of connection to the public switch
telephone network. Such connections are required, among other reasons, to
service the Company's dial-up customers as well as to provide those cable modem
customers located on a one-way cable system, the return path (or upstream link)
to the Company's equipment located at the cable operator's system hub (or
headend). In addition, the Company incurs costs associated with leasing
telecommunications capacity such as fiber where such capacity is used, among
other things, to link the Company's equipment at the cable system headend back
to the Company's network operating center in Mountain View, California. The
Company anticipates that the utilization of Intellicom's network as a substitute
for third party terrestrial links will provide significant cost savings to the
Company as it grows. There are two major cost benefits to the Company in using
43
<PAGE>
Intellicom's VSAT capacity to supplement or replace its current landline-based
communications infrastructure. First, for downstream Internet traffic, it
enables the Company to simultaneously broadcast data from one single source to
its entire network of headend-based receivers which produces significant
efficiency improvements over comparable landline systems. Second, for upstream
traffic, it permits the Company to allocate the necessary capacity required by
each headend in smaller increments (and consequently lower cost) than would be
available using terrestrial links, such as T1 lines.
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.
Capital Expenditures. In order to pursue its business plan, the Company expects
to incur significant capital expenditures to provide 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 equipment (including installation) has averaged $45,000 per headend for
the 19 systems through which the Company currently provides service. The retail
costs of cable modems, currently approximately $179 to $349, is expected to
decline over time as economies of scale in production and new market entrants in
the cable modem market push down prices. However, the Company recognizes that,
in line with experience in other subscription service industries, it will need
to subsidize for the customer both the cost of installation and the cable modem
equipment. Such expenditures, however, are expected to be offset in part by the
savings resulting from decreased costs of installation and prices for such
equipment as equipment is standardized and production volumes increase
respectively.
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 Company has signed a letter of intent to sell MTC. Either
through the currently contemplated transaction or otherwise, the Company expects
to dispose of this business during fiscal 1999
44
<PAGE>
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. In July 1998,
the Company's Board of Directors adopted a plan to discontinue operations of the
telecommunications business. Accordingly, the operating results of the
telecommunications business have been segregated from continuing operations and
reported as a separate line item on the consolidated statements of operations.
The assets and liabilities of such operations have been reflected as a net asset
in the consolidated balance sheets.
The Company is in the process of negotiating the sale of both the MTC and KCI
operations and expects that these sales will be completed within a twelve month
period. Management does not anticipate a loss on these sales and intends to use
sale proceeds to reduce outstanding indebtedness and provide additional working
capital to ISP Channel. Until such time as the Company's shareholders approve
the disposition of these businesses, the Company will treat the MTC business as
part of its continuing operations.
<TABLE>
The discussion of the Company's consolidated results of operation below
therefore treats the telecommunication business as a discontinued operation. In
addition, the Company entered the Internet business in June 1996 with the
purchase of the Internet services business and only began offering cable-based
Internet services in the fourth quarter of fiscal 1997. Accordingly,
year-to-year comparisons may not be meaningful.
<CAPTION>
1998 1997 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Sales
MTC $ 13,042 $20,330 $19,417
ISP Channel 1,018 1,008 167
Cost of Sales
MTC 9,410 11,050 11,375
ISP Channel 1,218 885 -
Gross Profit
MTC 3,632 9,280 8,042
ISP Channel (200) 123 167
Operating Expenses
MTC 9,272 8,714 8,162
ISP Channel 8,016 1,273 478
Income (loss) from continuing operations
MTC (5,640) 566 (120)
ISP Channel (8,216) (1,150) (311)
Corporate Overhead (1,977) (1,204) (2,281)
-------- -------- --------
Consolidated $(15,833) $ (1,788) $ (2,712)
-------- -------- --------
</TABLE>
Fiscal 1998 compared to Fiscal 1997
Consolidated sales decreased $7.3 million, or 34.0%, to $14.1 million for fiscal
1998, as compared to $21.4 million for fiscal 1997. The decrease in consolidated
sales was the result of a decrease in the sales associated with the operations
of MTC. Sales in this business decreased $7.3 million, or 35.8%, to $13.0
million for fiscal 1998, as compared to sales of $20.3 million for fiscal 1997.
The decrease in MTC's sales was primarily the result of a significant decrease
in the domestic sales of the business's core product line: computer output
microfiche ("COM") equipment. Domestic orders for MTC's microfiche systems,
which typically range in price from $200,000 to $1 million, were delayed by a
purchasing slowdown brought about by a trend of corporate consolidation
occurring within the business's major markets, including such industries as the
document management service bureau industry and the banking and insurance
industries. Sales were further affected 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. MTC believes that this trend is reversing and that
the demand for its products will return at least to their historical levels.
Sales in the Company's Internet service business increased $10,000, or 1.0%, to
$1.0 million for fiscal 1998, as compared to fiscal 1997. Net sales for the
business's ISP Channel service increased $289,000 to $309,000 for fiscal 1998,
as compared to $20,000 for fiscal year 1997. ISP Channel introduced its
cable-based services to the market in the fourth quarter of fiscal 1997.
Traditional dial-up and dedicated Internet service sales increased $42,000, or
7.0%, to $644,000 for fiscal 1998, as compared to $602,000 for fiscal 1997. This
business
45
<PAGE>
also experienced a decrease in miscellaneous and one-time service sales of
$321,000, or 83.2% to $65,000 for fiscal 1998, as compared to $386,000 for
fiscal 1997. This decrease in miscellaneous and one-time service sales is the
result of the Company's decision to re-focus its sales efforts on its
cable-based ISP Channel services.
Consolidated gross profit decreased $6.0 million, or 63.5%, to $3.4 million for
fiscal 1998, as compared to $9.4 million for fiscal 1997, with profit margins
decreasing to 24.4% from 44.1% for the comparable period in 1997. The decrease
in gross profit is primarily the result of a decrease in gross profits of $5.6
million associated with the operations of MTC. Gross profit margins in this
business decreased to 27.9% in fiscal 1998, from 45.6% for the comparable period
in 1997. This decrease in profit margin is a direct result of the decrease in
MTC's COM equipment sales, which have historically contributed the highest
product profit margins for this business. Gross profit decreased $323,000 in the
Internet service business for fiscal 1998. ISP Channel experienced a negative
gross profit of $200,000 in fiscal 1998, primarily as the result of the
build-out of the segment's Internet operations used to support its cable-based
service offering. In addition, on a system by system deployment basis, the ISP
Channel cable-based service offering initially results in a negative gross
profit, until such time as subscriber sales exceed the up-front, recurring fixed
telephony and Internet connection fees.
Operating expenses (selling, engineering, general and administrative) increased
$7.1 million, or 91.6%, to $14.9 million for fiscal 1998, as compared to $7.8
million for fiscal 1997. Operating expenses associated with the operations of
MTC decreased approximately $400,000, or 7.1%, to $5.3 million for fiscal 1998,
as compared to $5.7 million for fiscal 1997. Operating expenses associated with
ISP Channel and corporate overhead increased a combined $7.5 million, with
expenses associated with ISP Channel increasing $6.7 million to $7.6 million for
fiscal 1998, as compared to $860,000 for fiscal 1997. This increase in operating
expense is primarily the result of the increase in ISP Channel's administrative,
sales and marketing efforts supporting the ISP Channel cable-based service
offering. Similarly, the increase in the corporate operating expenses are
directly related to the management changes and financing activities associated
with the Company's strategic refocusing towards the ISP Channel cable-based
service offering.
Amortization expense associated with goodwill remained constant in fiscal 1998.
In fiscal 1998, the Company recorded an impairment loss on the long-lived assets
of the document management business. Estimates based upon certain trends in the
document management business indicated that the undiscounted future cash flows
from this business would be less than the carrying value of the long-lived
assets related to this business. Accordingly, the Company recognized an asset
impairment loss of $3.1 million, all of which was reduced from the carrying
value of goodwill.
For fiscal 1998, the Company had a net loss from continuing operations of $15.8
million, as compared to a net loss from continuing operations of $1.8 million
for fiscal 1997.
Interest expense increased $271,000, or 23.7%, to $1.4 million for fiscal 1998
from $1.1 million for fiscal 1997, primarily as a result of fluctuations in the
Company's outstanding indebtedness with respect to its revolving line of credit
and the issuance of its 5% convertible subordinated debentures.
The Company made no provisions for income taxes for fiscal 1998 and 1997, as a
result of the Company's net operating loss carry-forward.
The Company recognized a loss from operations with respect to its discontinued
telecommunications business of $73,000 for fiscal 1998, as compared to a gain
from operations of $739,000 for the same period in 1997.
The Company paid aggregate dividends of $343,000 during fiscal 1998 on its
outstanding 5% Redeemable Convertible Preferred Stock.
For fiscal 1998, the Company had a net loss applicable to common shareholders of
$17.3 million, as compared to a net loss of $2.6 million for fiscal 1997.
Fiscal 1997 compared to Fiscal 1996
Consolidated sales increased $1.7 million, or 8.9%, 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 MTC's sales is primarily the result of
increased monthly rental revenues associated with its continued implementation
of alternative customer leasing arrangements for its core COM products. Sales in
the Internet
46
<PAGE>
services business increased $841,000 to $1.0 million for fiscal 1997 from
$167,000 for fiscal 1996. Sales in the Internet services business for fiscal
1996 consist only of fourth quarter sales, as the business 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 resulted from a strong equipment backlog and a steady, customer
order driven, manufacturing schedule. The Internet services business recorded
gross profits of $123,000 for fiscal 1997, however year to year comparisons are
not meaningful, given the fact that the business operated for only one quarter
in fiscal 1996 and allocated no expense to cost of goods sold during this one
quarter period.
Operating expenses (selling, engineering, general and administrative) decreased
$24,000 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 business'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 business
increased $483,000 to $858,000 for fiscal 1997, however year to year comparisons
are not meaningful given the fact that the business 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 business 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 6.1%, 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 business of $739,000 for fiscal 1997, as compared to a loss
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.
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.
Liquidity and Capital Resources
Over the past year, the Company's growth has been funded through a combination
of private equity, bank debt and lease financings. As of December 31, 1998, the
Company had approximately $3.5 million of unrestricted cash. In addition, on
January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes. These notes bear an interest rate of 9% per year and
mature in 2001. In connection with these notes, the Company issued to these
investors an aggregate of 300,000 warrants. These
47
<PAGE>
warrants, which have an exercise price of $17 per warrant, expire in 2003. The
Company has also received a commitment to provide, subject to final
documentation, a secured $3 million loan from a financial lender and is in
negotiations with a vendor with regard to a $6 million equipment lease line. The
Company believes that, as a result of this, it currently has sufficient cash and
financing commitments to meet its funding requirements over the next year.
However, the Company has experienced and continues to experience negative
operating margins and negative cash flow from operations, as well as an ongoing
requirement for substantial additional capital investment. The Company expects
that it will need to raise substantial additional capital to accomplish its
business plan over the next several years. 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 expects to seek to obtain additional
funding through the sale of public or private debt and/or equity securities or
through a bank credit facility. The Company expects it may raise as much as $150
million in debt and/or equity financing during fiscal 1999. If additional funds
are raised through the issuance of equity or convertible debt securities, the
percentage ownership of the stockholders of the Company will be reduced,
stockholders may experience additional dilution and such securities may have
rights, preferences or privileges senior to those of the Company's common stock.
There can be no assurance as to the availability or terms upon which such
financing might be available.
For fiscal 1998, cash flows used in operating activities of continuing
operations were $4.7 million, as compared to $1.4 million for fiscal 1997. The
Company used $5.6 million in investing activities of continuing operations
during fiscal 1998, as compared to $1.1 million used by investing activities of
continuing operations in fiscal 1997. Cash flow provided by financing activities
of continuing operations increased $20.4 million to $23.4 million for fiscal
1998, as compared $3.0 million for fiscal 1997. This increase in cash flow was
primarily the result of the issuance of the Company's 5% Redeemable Convertible
Preferred Stock.
On December 31, 1997, the Company sold 5,000 shares of its Series A Preferred
Stock and warrants to purchase 150,000 shares of common stock for $5 million.
The $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
its Series B Preferred Stock and warrants to purchase 200,000 shares of common
stock for $10 million and on August 31, 1998, the Company sold 7,500 shares of
its Series C Preferred Stock and warrants to purchase 93,750 shares of common
stock for $7.5 million. The proceeds of these last two sales were added to the
working capital of the Company. The Company has extended the maturity of its
Revolving Credit Facility, which has a maximum borrowing capacity of $9.5
million, through January 15, 2000.
On November 5, 1998, the Company entered into a letter of intent to sell MTC for
$5.125 million and on November 9, 1998, the Company entered into a letter of
intent to sell KCI for $6.6 million. In both cases, deposits of $100,000 were
paid to the Company on execution of the letters of intent and, in the case of
the sale of MTC, such deposit is non-refundable. Subject to the approval of the
Company's shareholders, the Company anticipates that both sales will be closed
in the second quarter of fiscal 1999 but there can be no assurance that the
transactions will close in this time frame, or at all.
The purchase price for MTC is anticipated to be $5.125 million (including the
$100,000 non-refundable deposit). The balance of $5.025 million will be paid at
closing in readily available funds.
The purchase price for KCI is anticipated to be $6 million (including the
$100,000 deposit) and the issuance to the Company of 60,000 shares of common
stock of the purchaser, Convergent Communications, Inc. At closing, the Company
expects to receive $3.4 million in readily available funds and two 12-month 8%
notes for an aggregate amount of $2.5 million.
The proceeds from the sale of MTC and KCI will be used in part to repay the
Company's bank credit facility with West Suburban Bank. As of December 31, 1998,
there was $4.8 million outstanding under this facility. The balance of the
proceeds will be used to pay for transaction costs associated with the sales and
to increase the Company's cash position. There can be no assurance however, that
both or either of the transactions will close on the terms described, or at all.
In aggregate, the sale of both MTC and KCI represents a substantial change in
the business of the Company and, as such, requires shareholder approval. While
KCI has been treated as a discontinued operation since July 27, 1998, and while
management of the Company intends to dispose of MTC, the Company has continued
to treat MTC as a continuing business pending such shareholder approval of its
sale. Set out below, however, are unaudited selected financial data for the
Company which reflect the effect on the Company had MTC been treated as a
discontinued operation.
48
<PAGE>
<TABLE>
<CAPTION>
Fiscal years ended September 30,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales $ 1,018 $ 1,008 $ 167 $ -- $ 188
Cost of sales 1,218 885 -- -- 172
-------- -------- -------- -------- --------
Gross Profit (200) 123 167 -- 16
-------- -------- -------- -------- --------
Operating expenses:
Selling, engineering and general and administrative 9,580 2,062 2,130 677 1,180
Amortization of goodwill and transaction costs 415 415 308 -- --
Cost associated with change in products and other -- -- 321 -- --
Acquisition costs and other -- -- -- 543 --
-------- -------- -------- -------- --------
Total operating expenses 9,995 2,477 2,759 1,220 1,180
-------- -------- -------- -------- --------
Loss from operations (10,195) (2,354) (2,592) (1,220) (1,164)
Interest expense (1,022) (1,030) (1,124) (448) (601)
Gain on sale of available-for-sale securities -- -- 5,689 -- --
Other income (60) (72) 30 3 2
-------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes (11,277) (3,456) 2,003 (1,665) (1,763)
Provision for income taxes -- -- -- -- --
-------- -------- -------- -------- --------
Income (loss) from continuing operations $(11,277) $ (3,456) $ 2,003 $ (1,665) $ (1,763)
======== ======== ======== ======== ========
Balance Sheet Data:
Working capital $ 5,361 $ (1,205) $ (1,129) $ 731 $ (918)
Total assets 29,627 12,611 15,299 25,091 4,281
Long-term debt, net of current portion 9,220 8,877 9,467 9,995 --
Redeemable convertible preferred stock 18,187 -- -- -- --
Shareholders' equity (deficit) (6,171) 2,028 3,793 11,685 2,436
</TABLE>
On November 22, 1998, the Company entered into a definitive agreement to acquire
all of the outstanding capital stock of Intelligent Communications, Inc.
("Intellicom"). The transaction will close upon Federal Communications
Commission approval of the transfer of Intellicom's licenses to the Company.
Such approval is expected to occur in the second quarter of fiscal 1999. The
agreed purchase price comprises (i) a cash component of $500,000 payable at
closing, (ii) a promissory note in the amount of $1 million due one year after
closing (and payable in cash or in the Company's common stock at the option of
the sellers), (iii) a promissory note in the amount of $2 million due two years
after closing (and payable in cash or in the Company's common stock at the
option of the Company), (iv) the issuance of 500,000 shares of the Company's
common stock (adjustable upwards after one year in certain circumstances), and
(v) a demonstration bonus of $1 million payable on the first anniversary of the
closing, if certain milestones are met, in cash or shares of the Company's
common stock at the option of the Company.
49
<PAGE>
Year 2000 Issues
Many computer programs have been written using two digits rather than four to
define the applicable year. This poses a problem at the end of the century
because such computer programs would not properly recognize a year that begins
with "20" instead of "19". This, in turn, could result in major system failures
or miscalculations, and is generally referred to as the "Year 2000 Issue" or
"Y2K Issue". We have formulated a Y2K Plan to address our Y2K issues and has
created a Y2K Task Force headed by the Director of I/S and Data Services to
implement the plan. Our Y2K Plan has six phases:
1) Organizational Awareness - educate our employees, senior management,
and the board of directors about the Y2K issue.
2) Inventory - complete inventory of internal business systems and their
relative priority to continuing business operations. In addition, this
phase includes a complete inventory of critical vendors, suppliers and
services providers and their Y2K compliance status.
3) Assessment - assessment of internal business systems and critical
vendors, suppliers and service providers and their Y2K compliance
status.
4) Planning - preparing the individual project plans and project teams
and other required internal and external resources to implement the
required solutions for Y2K compliance.
5) Execution - implementation of the solutions and fixes.
6) Validation - testing the solutions for Y2K compliance.
Our Y2K Plan will apply to two areas:
o internal business systems
o compliance by external customers and providers
Internal Business Systems
Our internal business systems and workstation business applications will be a
primary area of focus. We are in the unique position of completing the
implementation of new enterprise-wide business solutions to replace existing
manual processes and/or "home grown" applications during 1999. These solutions
are represented by their vendors as being fully Y2K compliant We have few, if
any, "legacy" applications that will need to be evaluated for Y2K compliance.
We plan to have completed the Inventory and Assessment Phases of substantially
all critical internal business systems by January 31, 1999, with the Planning
Phase to be completed by March 31, 1999. The Execution and Validation Phases
will be completed by August 31, 1999. We expect to be Y2K compliant on all
critical systems, which rely on the calendar year before December 31, 1999.
Some non-critical systems may not be addressed until after January 2000.
However, we believe such systems will not cause significant disruptions in our
operations.
Compliance by External Customers and Providers
We are in the process of the inventory and assessment phases of our critical
suppliers, service providers and contractors to determine the extent to which
our interface systems are susceptible to those third parties' failure to remedy
their own Y2K issues. We expect that assessment will be complete by May 1999. To
the extent that responses to Y2K readiness are unsatisfactory, we intend to
change suppliers, service providers or contractors to those that have
demonstrated Y2K readiness; but can not be assured that we will be successful in
finding such alternative suppliers, service providers and contractors. We do not
currently have any formal information concerning the status of our customers but
have received indications that most of our customers are working on Y2K
compliance.
Risks Associated with Y2K
We believe the major risk associated with the Y2K Issue is the ability of our
key business partners and vendors to resolve their own Y2K Issues. We will spend
a great deal of time over the next several months, working closely with
suppliers and vendors, to assure their compliance.
Should a situation occur where a key partner or vendor is unable to resolve
their Y2K issue, we will be in a position to change to Y2K compliant partners
and vendors.
50
<PAGE>
Cost to Address Y2K Issues
Since we are in the unique position implementing new enterprise wide business
solutions to replace existing manual processes and/or "home grown"
applications., there will be little, if any, Y2K changes required to existing
business applications. All of the new business applications implemented (or in
the process of being implemented in 1999) are represented as being Y2K
compliant.
We currently believe that implementing our Y2K Plan will not have a material
effect on our financial position.
Contingency Plan
We have not formulated a contingency plan at this time but expect to have
specific contingency plans in place prior to September 30, 1999.
Summary
We anticipate that the Y2K Issue will not have a material adverse effect on our
financial position or results of operations. There can be no assurance, however,
that the systems of other companies or government entities, on which we rely for
supplies, cash payments, and future business, will be timely converted, or that
a failure to convert by another company or government entities, would not have a
material adverse effect on our financial position or results of operations. If
third party service providers and vendors, due to Y2K Issues, fail to provide us
with components, materials, or services which are necessary to deliver our
services and product offerings, with sufficient electrical power and
transportation infrastructure to deliver our services and product offerings,
then any such failure could have a material adverse effect on our ability to
conduct business, as well as our financial position and results of operations.
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income the
Company can earn on its investment portfolio and on the increase or decrease in
the amount of interest expense the Company must pay with respect to its various
outstanding debt instruments. The risk associated with fluctuating interest
expense is limited, however, to the exposure related to those debt instruments
and credit facilities which are tied to market rates. The Company does not use
derivative financial instruments in its investment portfolio. The Company
ensures the safety and preservation of its invested principal funds by limiting
default risks, market risk and reinvestment risk. The Company mitigates default
risk by investing in safe and high-credit quality securities.
51
<PAGE>
Item 8. Financial Statements and Supplementary Data
SoftNet Systems, Inc. and Subsidiaries
Index To Consolidated Financial Statements
September 30, 1998
Report of Independent Accountants
Consolidated Balance Sheets as of September 30, 1998 and 1997
Consolidated Statements of Operations for the three years ended September 30,
1998
Consolidated Statements of Shareholders' Equity (Deficit) for the three years
ended September 30, 1998
Consolidated Statements of Cash Flows for the three years ended September 30,
1998
Notes to Consolidated Financial Statements
52
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of SoftNet Systems, Inc.:
In our opinion, the accompanying consolidated balance sheets and related
consolidated statements of operations, shareholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
SoftNet Systems, Inc. and its subsidiaries at September 30, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended September 30, 1998 in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
December 1, 1998, except for Note 18
which is dated January 13, 1999
53
<PAGE>
<TABLE>
SoftNet Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
As of September 30, 1998 and 1997
(In thousands, except share data)
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 12,504 $ 37
Accounts receivable, net of allowance of $721 and $320 3,105 3,929
Current portion of gross investment in leases 1,579 1,206
Inventories 1,345 1,326
Prepaid expenses 882 319
-------- --------
Total current assets 19,415 6,817
Restricted cash 800 --
Property and equipment, net 6,523 1,108
Gross investment in leases, net of current portion 1,863 3,054
Other assets 1,124 766
Costs in excess of fair value of net assets acquired, net 955 5,141
Net assets associated with discontinued operations 3,875 3,435
-------- --------
$ 34,555 $ 20,321
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 9,423 $ 4,969
Current portion of long-term debt 1,821 1,384
Current portion of capital leases 632 23
Deferred revenue 100 143
-------- --------
Total current liabilities 11,976 6,519
-------- --------
Long-term debt, net of current portion 10,236 11,727
-------- --------
Capital lease obligations, net of current portion 327 47
-------- --------
Commitments and contingencies
Redeemable convertible preferred stock, $.10 par value,
30,000 shares authorized, 20,757 shares issued and outstanding 18,187 --
-------- --------
Shareholders' equity (deficit):
Preferred stock, $.10 par value, 3,970,000 shares authorized,
none issued and outstanding -- --
Common stock, $.01 par value, 25,000,000 shares authorized,
8,191,550 and 6,870,559 shares issued and outstanding, respectively 82 69
Deferred stock compensation (188) --
Capital in excess of par value 43,700 34,379
Accumulated deficit (49,765) (32,420)
-------- --------
Total shareholders' equity (deficit) (6,171) 2,028
-------- --------
$ 34,555 $ 20,321
======== ========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
54
<PAGE>
<TABLE>
SoftNet Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
For the Three Years Ended September 30, 1998
(In thousands, except per share data)
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net sales $ 14,060 $ 21,338 $ 19,584
Cost of sales 10,628 11,935 11,375
-------- -------- --------
Gross profit 3,432 9,403 8,209
-------- -------- --------
Operating expenses:
Selling 4,162 1,905 1,794
Engineering 2,834 2,234 1,770
General and administrative 7,883 3,628 4,200
Amortization of goodwill and transaction costs 1,286 1,287 993
Loss on impairment of assets 3,100 -- --
Costs associated with change in product line and other -- 2,137 2,164
-------- -------- --------
Total operating expenses 19,265 11,191 10,921
-------- -------- --------
Loss from continuing operations (15,833) (1,788) (2,712)
Other income (expense):
Interest expense (1,416) (1,145) (1,220)
Gain on available-for-sale securities -- -- 5,689
Other income 320 49 19
-------- -------- --------
Income (loss) from continuing operations before income taxes (16,929) (2,884) 1,776
Provision for income taxes -- -- --
-------- -------- --------
Income (loss) from continuing operations before discontinued
operations and extraordinary item (16,929) (2,884) 1,776
Income (loss) from discontinued operations (73) 739 (1,812)
Extraordinary item - loss on sale of business -- (486) (6,061)
-------- -------- --------
Net loss $(17,002) $ (2,631) $ (6,097)
======== ======== ========
Preferred dividends (343) -- --
-------- -------- --------
Net loss applicable to common shares $(17,345) $ (2,631) $ (6,097)
======== ======== ========
Basic and diluted earnings (loss) per share:
For continuing operations $ (2.29) $ (0.44) $ 0.30
For discontinued operations (0.01) 0.11 (0.31)
For extraordinary item - sale of business -- (0.07) (1.04)
For preferred dividends (0.05) -- --
-------- -------- --------
Net loss applicable to common shares $ (2.35) $ (0.40) $ (1.05)
======== ======== ========
Shares used to compute basic and diluted loss per share 7,391 6,627 5,819
-------- -------- --------
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
55
<PAGE>
<TABLE>
SoftNet Systems, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity (Deficit)
For the Three Years ended September 30, 1998
(In thousands)
<CAPTION>
Unrealized Total
Deferred Capital in appreciation of shareholders'
Common stock stock excess of Accumulated available-for- equity
Shares Amount compensation par value deficit sale securities (deficit)
------ ------ ------------ --------- ------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, October 1, 1995 5,547 $ 55 $ -- $ 27,584 $(23,692) $ 7,738 $ 11,685
Exercise of warrants 12 -- -- 21 -- -- 21
Settlements of related party receivable -- -- -- 815 -- -- 815
Conversion of convertible subordinated notes 781 8 -- 4,077 -- -- 4,085
Common stock issued in connection with
acquisitions, net of acquisition costs 200 2 -- 1,020 -- -- 1,022
Unrealized appreciation of
available-for-sale securities -- -- -- -- -- (7,738) (7,738)
Net loss -- -- -- -- (6,097) -- (6,097)
----- -------- -------- -------- --------- -------- ---------
Balance, September 30, 1996 6,540 65 -- 33,517 (29,789) -- 3,793
Exercise of warrants 251 3 -- 432 -- -- 435
Conversion of convertible subordinated notes 70 1 -- 386 -- -- 387
Common stock issued to pay
acquisition costs 10 -- -- 44 -- -- 44
Net loss -- -- -- -- (2,631) -- (2,631)
----- -------- -------- -------- --------- -------- ---------
Balance, September 30, 1997 6,871 69 -- 34,379 (32,420) -- 2,028
Exercise of warrants 684 7 -- 3,879 -- -- 3,886
Exercise of options 152 1 -- 830 -- -- 831
Conversion of convertible subordinated notes 185 2 -- 1,116 -- -- 1,118
Common stock warrants issued with
preferred stock
Series A -- -- -- 435 -- -- 435
Series B -- -- -- 900 -- -- 900
Series C -- -- -- 277 -- -- 277
Conversion of preferred shares
to common stock 299 3 -- 1,663 -- -- 1,666
Dividends paid on preferred shares -
Common stock:
Series A 1 -- -- 6 (6) -- --
Additional preferred shares:
Series A -- -- -- -- (101) -- (101)
Series B -- -- -- -- (125) -- (125)
Series C -- -- -- -- (31) -- (31)
Cash:
Series A -- -- -- -- (38) -- (38)
Series B -- -- -- -- (42) -- (42)
Deferred stock compensation -- -- (215) 215 -- -- --
Amortization of deferred stock
compensation -- -- 27 -- -- -- 27
Net loss -- -- -- -- (17,002) -- (17,002)
----- -------- -------- -------- --------- -------- ---------
Balance, September 30, 1998 8,192 $ 82 $ (188) $ 43,700 $(49,765) $ -- $ (6,171)
===== ======== ======== ======== ========= ======== =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
56
<PAGE>
<TABLE>
SoftNet Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Three Years Ended September 30, 1998
(In thousands)
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(17,002) $ (2,631) $ (6,097)
Adjustments to reconcile net loss to net cash used in operating
activities:
(Income) loss from discontinued operations 73 (739) 1,812
Depreciation and amortization 2,153 1,798 1,374
Loss on impairment of assets 3,100 -- --
Amortization of deferred stock compensation 27 -- --
Write-off of prepaid software licenses -- 1,000 --
Write-off of capitalized product design costs -- 1,137 --
Loss on the disposal of property and equipment 118 40 --
Gain on sale of available-for-sale securities -- -- (5,689)
Debt discount and deferred financing amortization -- 19 95
Provision for bad debts 680 174 101
Loss on sale of business -- -- 6,061
Changes in operating assets and liabilities:
Accounts receivable 1,021 (1,471) (521)
Gross investment in leases 818 (3,054) --
Inventories 303 1,466 (1,076)
Prepaid expenses (494) (65) (25)
Accounts payable and accrued expenses 4,551 930 775
Deferred revenue (43) 17 (81)
-------- -------- --------
Net cash used in operating activities of continuing operations (4,695) (1,379) (3,271)
-------- -------- --------
Net cash used in operating activities of discontinued operations (223) (1,089) (1,132)
-------- -------- --------
Cash flows from investing activities:
Purchase of property and equipment (5,663) (510) (732)
Purchase of prepaid software licenses -- -- (1,000)
Additions to capitalized product design -- (654) (462)
Net cash paid in connection with acquisitions -- -- (195)
Settlement of remaining obligations to owners of discontinued operations -- -- (117)
Proceeds from sale of investment securities -- -- 7,678
Proceeds from sale of property and equipment -- 15 --
Other 49 15 --
-------- -------- --------
Net cash provided by (used in) investing activities of continuing operations (5,614) (1,134) 5,172
-------- -------- --------
Net cash used in investing activities of discontinued operations (112) (46) (2,073)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net of deferred
financing costs 730 3,665 --
Repayment of long-term debt (1,363) (753) (48)
Borrowings under revolving credit note 16,089 9,685 12,802
Net payments under revolving credit note (16,891) (9,884) (11,923)
Net proceeds from issuance of convertible preferred stock 21,208 -- --
Proceeds from exercise of warrants 3,886 435 22
Proceeds from exercise of options 831 -- --
Proceeds from settlement of related party receivable -- -- 815
Payment of put obligation -- -- (200)
Preferred dividends paid in cash (80) -- --
Restricted cash (800) -- --
Principal repayments of capital lease obligations (180) (85) (100)
-------- -------- --------
Net cash provided by financing activities of continuing operations 23,430 3,063 1,368
-------- -------- --------
Net cash provided by (used in) financing activities of discontinued operations (319) 196 (211)
-------- -------- --------
Net increase (decrease) in cash 12,467 (389) (147)
Cash, beginning of period 37 426 573
-------- -------- --------
Cash, end of period $ 12,504 $ 37 $ 426
======== ======== ========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
57
<PAGE>
SoftNet Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Nature of Business
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.
2. Summary of Significant Accounting Policies
Basis of Presentation
The Company has sustained recurring losses and negative cash flows from
operations. Over the past year, the Company's growth has been funded through a
combination of private equity, bank debt and lease financings. As of December
31, 1998, the Company had approximately $3.5 million of unrestricted cash. In
addition, on January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes (see Note 18). The Company has also received a
commitment to provide, subject to final documentation, a secured $3 million loan
from a financial lender and is in negotiations with a vendor with regard to a $6
million equipment lease line. The Company believes that, as a result of this, it
currently has sufficient cash and financing commitments to meet its funding
requirements over the next year. However, the Company has experienced and
continues to experience negative operating margins and negative cash flows from
operations, as well as an ongoing requirement for substantial additional capital
investment. The Company expects that it will need to raise substantial
additional capital to accomplish its business plan over the next several years.
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 expects to
seek to obtain additional funding through the sale of public or private debt
and/or equity securities or through a bank credit facility. If additional funds
are raised through the issuance of equity or convertible debt securities, the
percentage ownership of the stockholders of the Company will be reduced,
stockholders may experience additional dilution and such securities may have
rights, preferences or privileges senior to those of the Company's common stock.
There can be no assurance as to the availability or terms upon which such
financing might be available.
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.
Restatements and Reclassifications
58
<PAGE>
The financial statements have been restated for the effects of the discontinued
operations of the telecommunications segment. (see Note 3). Certain
reclassifications have been made in the 1997 financial statements to conform
with the 1998 presentation.
Use of Estimates and Assumptions
The preparation of consolidated 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.
Cash, Cash Equivalents and Restricted Cash
The Company considers cash equivalents to include all highly liquid financial
instruments purchased with maturities of three months or less at the time of
purchase to be cash equivalents.
In 1998, the Company pledged $800,000 as collateral on a Letter of Credit
relating to certain leased office space. This amount is classified as restricted
cash in the consolidated balance sheet as of September 30, 1998.
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, 1998, the Company had no significant concentrations of credit
risk.
Significant Customer
For the fiscal year ended September 30, 1998, one customer (GID GmbH) accounted
for 18% of the Company's consolidated revenue. For the fiscal year ended
September 30, 1997, three separate customers (Marshall & Ilsley Corp., NCR Corp.
and Bell & Howell Company) accounted for 19%, 13% and 12% respectively, of the
Company's consolidated revenue. For the fiscal year ended September 1996, one
customer (NCR Corp.) accounted for 27% of the Company's consolidated revenue.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method.
Property and Equipment
Property and equipment, including leasehold improvements and property and
equipment financed through capital leases, are recorded at cost. When property
and equipment is retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and the resulting gain or
loss is included in income. Depreciation and amortization is computed using the
straight-line method over the estimated useful lives of the assets generally
three to seven years or the life of the lease, whichever is shorter.
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 $392,000 and $592,000 at September 30, 1998 and
1997, respectively.
Capitalized Product Design
Capitalized product design costs include costs associated with enhancing
features on existing products, prior to their introduction to the market, but
after technological feasibility has been proven. Management evaluates the future
realization of capitalized product design costs quarterly and writes down any
amounts that management deems unlikely to be recovered through future products
sales. Any amounts deemed unrecoverable are written down to the estimated
recoverable amount at the time of evaluation.
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 3 to 10 years.
Amortization expense for fiscal 1998, 1997 and 1996 was $900,000, $1.1 million
and $813,000, 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 6). Accumulated amortization at
September 30, 1998 and 1997 was $2.4 million and $1.9 million, respectively.
59
<PAGE>
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. If the carrying amount of goodwill is not recoverable from undiscounted
cash flows, amounts unrecoverable from future product sales are written down in
the period in which the determination is made. In fiscal 1998, the Company
reduced its carrying amount of goodwill by $3.1 million as a result of an
impairment loss on the long-lived assets of the document management segment. The
write-down was based on the fair value of the document management segment as
determined in connection with its planned sale (see Note 18).
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.
Revenue Recognition
Revenue from the document management segment is generated from four primary
sources: 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
and their related costs for Internet access customers are deferred and amortized
over the estimated period of service. Monthly access fees are recognized in the
month of service.
Research and Development
Research and development is primarily incurred by the document management
segment. During fiscal 1998, 1997 and 1996, the Company expended $1.3 million,
$1.8 million and $1.1 million, respectively, for research and development.
Loss on Impairment of Assets
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company recorded an impairment loss on the long-lived
assets of the document management segment. The trends in the document management
segment indicate that the undiscounted future cash flows from this business
would be less than the carrying value of the long-lived assets related to the
document management segment. Accordingly, in fiscal 1998, the Company recognized
an asset impairment loss of $3.1 million, all of which was reduced from the
carrying value of goodwill. This loss is the difference between the carrying
value of the document management segment's property and equipment, gross
investment in leases to customers, other assets and goodwill and other
intangibles, and the fair value of these assets based on discounted estimated
future cash flows.
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.
Earnings (Loss) Per Share
The Company adopted Statement of Financial Accounting Standard (SFAS) No. 128,
"Earnings Per Share," in fiscal 1998. SFAS 128 requires the presentation of
basic earnings per share ("EPS") and diluted EPS, for companies with potentially
dilutive securities, such as options. Earnings per share for all prior periods
have been restated to conform with the provisions of SFAS 128.
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<PAGE>
Basic earnings per share is computed using the weighted average number of shares
of common stock. Diluted earnings per share is computed using the weighted
average number of shares of common stock and common equivalents shares
outstanding during the period. Common equivalents consist of convertible
preferred stock (using the if converted method) and stock options and warrants
(using the treasury stock method). Common equivalents shares are excluded from
the computation as their effect would have been anti-dilutive.
Recently Issued Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (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.
3. Discontinued Operations
In July 1998, the Company's Board of Directors adopted a plan to discontinue
operations of its telecommunications segment. This segment consists of the
Company's wholly owned subsidiary Kansas Communications, Inc. ("KCI"), along
with KCI's Milwaukee operations purchased from Executone Management Systems,
Inc. 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.
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.
Kansas Communications, Inc.
On September 15, 1995, a wholly owned subsidiary of the Company merged with
Kansas Communications, Inc., 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. 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.
On December 29, 1995, KCI 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. 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.
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Financial Information for the Telecommunications Segment
Operating results of the discontinued telecommunications segment are as follows
(in thousands):
1998 1997 1996
---- ---- ----
Revenues $ 16,065 $17,218 $21,803
Income (loss) before income taxes 277 739 (1,812)
Provision for income taxes (350) -- --
Net income (loss) (73) 739 (1,812)
Interest expense allocated to the discontinued telecommunications
segment totaled $5,000, $49,000 and $377,000 in 1998, 1997 and 1996
respectively.
The provision for income taxes recorded in 1998 is related to prior
period adjustments in deferred maintenance revenue for KCI.
Assets and liabilities of the discontinued telecommunications segment are as
follows at September 30 (in thousands):
1998 1997
---- ----
Current assets:
Cash $ -- $ --
Accounts receivable, net 1,734 1,848
Inventories 2,248 2,984
Prepaid expenses 36 154
------ ------
4,018 4,986
Property, plant and equipment, net 427 529
Goodwill, net 1,663 1,759
Other noncurrent assets 21 217
------ ------
$6,129 $7,491
Current liabilities:
Accounts payable $1,582 $2,295
Current portion, long term debt - 328
Current portion, capital lease obligation 32 23
Deferred revenue 593 1,336
------ ------
2,207 3,982
Long-term debt, net of current portion - 20
Capital lease obligation, net of current portion 47 54
------ ------
$2,254 $4,056
====== ======
Net assets associated with discontinued operations $3,875 $3,435
====== ======
4. ISP Channel, Inc. (formerly MediaCity World, Inc.)
On June 21, 1996, the Company acquired ISP Channel, Inc. (formerly MediaCity
World, Inc.) ("ISP Channel"), in a business combination accounted for as a
purchase. ISP Channel 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 ISP Channel have been included in the results of the Company since June 21,
1996. As a result of the acquisition of ISP Channel, 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.
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
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<PAGE>
technology. At the date of acquisition of MTC, the Company determined that the
technological feasibility of the acquired technology was unproven and that the
technology had no known future uses.
The Company determined prior to September 30, 1998 that it is more likely than
not to dispose of MTC within a one year period. The Company has received a
letter of intent from a potential buyer which has been approved by the Company's
Board of Directors, subject to shareholders' approval. The Company has reviewed
the discounted cash flow to determine the impairment of long-lived assets
resulting in an aggregate amount of $3.1 million loss which is included as part
of the Company's operating results (see Note 18).
6. Divestitures of Utilization Management Associates, Inc. and Communicate
Direct, Inc.
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.
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.
In June 1996, CDI sold its non-application oriented interconnect business
located in the Chicago, Illinois metropolitan area, which at this time comprised
substantially all of the business of CDI, 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. This loss includes 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 disposition of CDI was
not contemplated at the time of the pooling with KCI. 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. This extraordinary loss is net of taxes and the Company has not
recognized an income tax benefit associated with this write-off as the Company
has established a full valuation allowance for total deferred tax assets due to
the uncertainty of their ultimate realization.
During fiscal 1997, CDI sold its operations that support its Fujitsu maintenance
base, as well as all other remaining assets associated with CDI, 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
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<PAGE>
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. The Company
incurred an additional loss of $486,000 on the final disposition of the assets
of CDI. As was the case with the loss associated with the sale of assets to Next
Call, this was accounted for as an extraordinary loss.
7. Inventory and Property and Equipment
The components of inventories as of September 30, 1998 and 1997 are as follows
(in thousands):
1998 1997
------ ------
Raw materials $ 28 $ 126
Work-in-process 408 217
Finished goods 909 983
------ ------
$1,345 $1,326
====== ======
Balances of major classes of fixed assets and allowances for depreciation at
September 30, 1998 and 1997 are as follows (in thousands):
1998 1997
---- ----
Leasehold improvements $ 1,335 $ 155
Furniture and fixtures 83 276
Equipment 6,603 1,566
------- -------
Total 8,021 1,997
Less allowance for depreciation and amortization (1,498) (889)
------- -------
Property and equipment, net $ 6,523 $ 1,108
======= =======
Included in the above fixed assets are asset amounts representing capitalized
leases of $1,157,000 and $192,000 at September 30, 1998 and 1997, respectively.
The accumulated depreciation related to these assets was $126,000 and $60,000,
respectively.
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8. Debt
<TABLE>
Debt is summarized as follows (in thousands):
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
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 being 8.25% at September 30, 1998). The note matures on January
15, 2000 $ 5,098 $ 5,900
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 8.25% at September 30, 1998), principal and interest due
in 60 monthly payments with the final payment due May 2002 1,559 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
8.25% atSeptember 30, 1998) 737 675
9% Convertible Debentures due September 2000, interest payable quarterly,
convertible into the Company's common shares at $6.75 per share 1,787 2,619
5% Convertible Subordinated Debentures, due September 2002, interest payable
annually, convertible into the Company's common stock at $8.25 per share
after December 31, 1998 1,444 --
6% Convertible Subordinated Debentures, due February 2002 with semi-annual
interest payments, convertible into the Company's common stock at $8.10 per
share 720 780
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
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
Promissory note bearing interest at 12.24%, principal and interest due in 24 monthly
payments with final payment due October 1999 157 278
Promissory note bearing interest at 9.4%, principal and interest due in 5 quarterly
payments with final payment due February 2000 372 --
Non-interest bearing Promissory note due July 1998 (see Note 15) 161 161
Promissory notes due November 1997, interest payable in arrears on each principal
due date accruing at 8.75% -- 75
Other 22 --
------- -------
12,057 13,111
Less current portion debt (1,821) (1,384)
------- -------
Total long-term debt $10,236 $11,727
======= =======
</TABLE>
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 is 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 equipment financing
agreement and the draw note are both collaterized by the respective assets
underlying each specific lease. The leases are initiated by the Company acting
as lessor through the ordinary course of business.
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<PAGE>
In connection with the issuance of the 10% Convertible Subordinated Notes, the
Company issued warrants to purchase 297,500 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 1998, holders of the 9% and 10% Convertible Subordinated Notes
converted $25,000 and $200,000 face amount of notes into 5,000 and 48,780
shares, respectively, of the Company's common stock. During fiscal 1997, holders
of the 9% and 10% Convertible Subordinated Notes converted $50,000 and $100,000
face amount of notes into 10,000 and 24,390 shares, respectively, of the
Company's common stock.
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 1998, $832,806 face
amounts of these 9% debentures were converted into 123,377 shares of the
Company's common stock. During fiscal 1997, $236,952 of these 9% debentures were
converted into 35,104 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 1998, $60,000 face
amount of these Debentures were converted into 7,407 shares of the Company's
common stock.
In fiscal 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to Mr. R.C.W. Mauran,
a beneficial owner of more than 5% of the Company's common stock, 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.
Aggregate maturities of long-term debt for each of the next five fiscal years
are as follows (in thousands):
1999 $ 1,821
2000 7,654
2001 276
2002 2,306
2003 --
9. Lease Receivables and Obligations
Gross Investment in 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, 1998, the Company has entered into various sales-type leases
with its customers. Future minimum lease payments are as follows (in thousands):
1999 $ 1,611
2000 1,048
2001 604
2002 233
2003 64
-------
Total future minimum lease payments 3,560
Unearned interest (452)
Reserve for future costs (247)
-------
Present value of minimum payments 2,861
Equipment residual value 581
-------
Gross Investment in leases $ 3,442
=======
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<PAGE>
Capitalized Leases
The Company leases computer equipment and certain other office equipment under
leases which are capital in nature. The aggregate amount of the lease payments
under capitalized leases for the Company's continuing operations for each of the
five fiscal years ending September 30 is as follows (in thousands):
1999 $ 670
2000 311
2001 37
2002 --
2003 --
--------
Total minimum lease payments 1,018
Amount representing interest (59)
--------
Present value of net minimum payments 959
Less current portion (632)
--------
Capital lease obligation $ 327
========
Operating Leases
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, 1998, 1997 and 1996 was $760,000, $828,000 and
$755,000, respectively. The aggregate amount of the lease payments under
operating leases for the Company's continuing operations for each of the five
fiscal years ending September 30 is as follows (in thousands):
1999 $ 1,935
2000 1,701
2001 1,757
2002 1,668
2003 1,656
Thereafter 3,012
---------
Total lease payments $ 11,729
=========
10. 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. As of September 30, 1998
(as well as at 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 fiscal 1997 (see Note 15).
Also, in fiscal 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 wrote-off $1.1 million
of capitalized product design costs associated with this product in 1997. During
fiscal 1998, there has been minimal activity in the sale of this product due to
continued technological setbacks which the Company is trying to resolve.
In fiscal 1996, the Company made the decision to incorporate newer technologies
into its existing core product offerings in an attempt to diversify and enhance
its overall product offerings. In connection with this decision, the Company
signed an agreement to distribute Lucent Technologies, Inc. products in the
Chicago, Illinois metropolitan area, and incorporated a wider array of solutions
from existing vendors in its other markets. As a result of this decision, and
the resulting changes in its product lines, the Company incurred a one-time
charge of $1.3 million. The main components of this charge were a $670,000
write-down of inventories associated with the older technologies that the
Company no longer actively distributed, a $311,000 settlement with a terminated
employee, and a $321,000 write-off of associated capitalized expenses, including
such prepaid expenses as maintenance, warranty and professional fees which were
to be amortized during 1996.
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The fiscal 1996 results of operations include 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 15).
11. Income Taxes
The Company's provision for income taxes in fiscal 1998 of $350,000 relates
exclusively to the operations of KCI. 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 3). The Company made no provision for income taxes for the
Company's continuing businesses due to losses incurred.
The components of deferred taxes at September 30 are as follows (in thousands):
1998 1997
---- -----
Tax Effect Tax Effect
---------- ----------
Inventory and other operating reserves $ 352 $ 170
Allowance for doubtful accounts 282 35
Unpaid accruals 509 162
Deferred revenue 303 503
Other (17) (6)
Net operating loss carryforward 5,848 2,294
------- -------
Total deferred tax asset 7,277 3,158
Valuation allowance (7,277) (3,158)
------- -------
Net deferred tax asset $ -- $ --
======= =======
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 $17.2 million are available as
of September 30, 1998 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 2011
and are subject to certain annual limitations as a result of the changes in
equity ownership.
12. Significant Fourth Quarter Events
Operating results in the fourth quarter of fiscal 1998 include a $3.1 million
loss on the impairment of the assets of the document management segment (see
Note 2).
13. Stock Options and Warrants
Amended 1995 Long-Term Incentive Plan
The Company's Amended 1995 Long-Term Incentive Plan (the "Incentive Plan") is an
equity incentive program for officers and other employees of the Company or its
subsidiaries and the non-employee members of the Company's Board of Directors
(the "Board"). 1,500,000 shares of common stock have been authorized for
issuance over the term of the Incentive Plan, but no participant may receive
awards for more than 200,000 shares of common stock per fiscal year. The
Incentive Plan will be administered by either the Board or the Compensation
Committee of the Board.
Awards under the Incentive Plan may, in general, be made in the form of stock
option grants, stock appreciation rights, restricted stock awards or performance
shares. Each stock option grant will have an exercise price not less than the
fair market value of the option shares on the grant date and will generally
become exercisable in three successive equal annual installments over the
optionee's period of continued service with the Company.
As of September 30, 1998, options for 1,300,767 shares of common stock were
outstanding under the Incentive Plan, of which 382,954 option shares were
vested. 149,332 shares of common stock had been issued, and 49,901 shares of
common stock remained available for future option grants and other awards under
the Incentive Plan. As of September 30, 1998, no stock appreciation rights,
restricted share awards or performance shares were outstanding under the
Incentive Plan.
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<PAGE>
Employee Stock Option Plan
The Company's Employee Stock Option Plan (the "Option Plan") is an equity
incentive program which has been established for the employees of Micrographic
Technology Corporation. 40,000 shares of common stock have been authorized for
issuance over the term of the Option Plan, but no participant may be granted
stock options for more than 4,000 shares of common stock. The Option Plan is
administered by the Compensation Committee of the Company's Board of Directors.
All options granted under the Option Plan will have an exercise price per share
equal to the fair market value of the option shares on the grant date and will
be designed to qualify as incentive stock options under the federal tax laws.
Each granted option will become exercisable for the option shares in a series of
three successive equal annual installments over the optionee's period of
continued service with Micrographic Technology Corporation. The options will not
be assignable or transferable except by will or the laws of inheritance
following the optionee's death, and in the event the Company is acquired by
merger or sale of substantially all of its assets, each outstanding option will
be either be assumed by the successor corporation or replaced by the successor
corporation with an option with substantially the same economic value.
As of September 30, 1998, options for 19,358 shares of common stock were
outstanding under the Option Plan, of which all were vested. 3,208 shares of
common stock had been issued, and no shares of common stock remained available
for future options grants under the Option Plan.
Non-Plan Consultant Stock Options
During the year ended September 30, 1998, the Company's Board of Directors
approved the grant of stock options to an independent consultant to purchase an
aggregate of 50,000 shares of its common stock. These options have an exercise
price of $10.19 and as of September 30, 1998, none of these options shares were
vested. As a result, the Company has recorded $215,000 in deferred compensation
which will be amortized to expense over the three-year vesting period of the
options. $27,000 has been amortized to expense for the fiscal year ended
September 30, 1998. These options were not issued as part of any of the
Company's registered Stock Option Plans.
Common Stock Warrants
During fiscal year 1998, the Company issued warrants to purchase an aggregate of
566,250 shares of its common stock in association with three separate rounds of
financing through the issuance of its convertible preferred stock (see Note 14).
These warrants have a weighted average exercise price of $10.42. In addition,
the Company recognized and honored its commitment to issue a warrant to purchase
10,309 shares of its common stock in association with a financing arrangement
dating back to 1994. This warrant contained an exercise price of $4.85 and was
exercised via a cashless exercise provision into 7,182 shares in August 1998.
<TABLE>
The following table summarizes the outstanding options and warrants to purchase
shares of common stock for the three years ended September 30, 1998:
<CAPTION>
Outstanding
Outstanding Options Outstanding Warrants Options and Warrants
--------------------------- ------------------------ --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- ------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding as of September 30, 1995 215,000 $ 8.28 1,334,650 $ 5.03 1,549,650 $ 5.48
--------- -------- ------- -------- --------- --------
Granted 574,000 $ 8.27 - - 574,000 $ 8.27
Exercised - - (12,500) $ 1.75 (12,500) $ 1.75
Canceled (422,833) $ 8.25 (118,750) $ 4.04 (541,583) $ 7.33
Outstanding as of September 30, 1996 366,167 $ 8.30 1,203,400 $ 5.16 1,569,567 $ 5.89
--------- -------- ------- -------- --------- --------
Granted 400,000 $ 5.00 - - 400,000 $ 5.00
Exercised - - (251,000) $ 1.75 (251,000) $ 1.75
Canceled (283,215) $ 4.95 - - (283,215) $ 4.95
Outstanding as of September 30, 1997 482,952 $ 5.14 952,400 $ 6.06 1,435,352 $ 5.75
--------- -------- ------- -------- --------- --------
Granted 1,143,533 $ 8.07 576,559 $ 10.32 1,720,092 $ 8.82
Exercised (152,540) $ 5.47 (683,941) $ 5.81 (836,481) $ 5.75
Canceled (103,820) $ 6.76 (12,619) $ 2.52 (116,439) $ 6.30
Outstanding as of September 30, 1998 1,370,125 $ 7.42 832,399 $ 9.27 2,202,524 $ 8.12
--------- -------- ------- -------- --------- --------
</TABLE>
69
<PAGE>
On November 15, 1996, the Compensation/Stock Option Committee approved a stock
option repricing program to provide employee option holders additional
opportunity and incentive to achieve business plan goals. A total of 297,000
options held by employees on that date were repriced to $4.94 per share, which
was the market price on such date. All other terms of the options remained the
same and, accordingly, there was no change to the vesting or term of any option.
The Board of Directors took similar action earlier in the year on February 28,
1996, when it elected to reduce the exercise price on 117,000 options held by
employees to $8.25 per share, the market price on the day the board took such
action. All other terms of the options remained the same and, accordingly, there
was no change to the vesting or term of any option.
<TABLE>
The following table summarizes information regarding stock options outstanding
at September 30, 1998:
<CAPTION>
Outstanding Options Vested Options
------------------------------------------- -------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Contractual Life Exercise Exercise
Range of Exercise Prices Shares (Years) Price Shares Price
------------------------ ------ ------- ----- ------ -----
<S> <C> <C> <C> <C> <C>
$ 4.94 - $ 6.88 874,625 8.78 $ 6.17 392,312 $ 5.94
$ 7.19 - $ 9.75 237,800 9.52 $ 8.67 - -
$ 10.00 - $ 13.94 257,700 9.65 $ 10.68 10,000 $ 13.94
---------- --------
$ 4.94 - $ 13.94 1,370,125 9.07 $ 7.45 402,312 $ 6.14
--------- ---- -------- ------- --------
</TABLE>
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.
<TABLE>
Had compensation cost for the Company's LTIP been determined based on the fair
value at grant date for awards in fiscal 1998, 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 (in thousands, except per
share data):
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Net loss applicable to common shares, as reported $(17,345) $(2,631) $(6,097)
Net loss applicable to common shares, pro forma (18,889) (3,207) (6,348)
Basic and diluted loss per common share, as reported $ (2.35) $ (.40) $ (1.05)
Basic and diluted loss per common share, pro forma (2.56) (.48) (1.09)
</TABLE>
The fair value of each stock option grant on the date of grant was estimated
using the Black-Scholes option pricing model with the following average
assumptions:
Year Ended September 30,
1998 1997
---- ----
Volatility 63% 58%
Risk-free interest rate 5.28% 6.10%
Dividend yield - -
Expected lives 4 4
Weighted average fair value $4.62 $4.26
70
<PAGE>
14. Redeemable Convertible Preferred Stock
Outstanding redeemable convertible preferred stock at September 30, 1998
consists of the following (in thousands, except share data):
Redeemable Convertible Preferred Stock
30,000 shares authorized, $0.10 par value
Shares Issued and Proceeds Net of
Series Outstanding Issuance Costs
------ ----------- --------------
A 3,101 $ 4,600
B 10,125 9,500
C 7,531 7,108
D - -
------ ---------
20,757 $ 21,208
====== =========
Issuance
Since December 31, 1997, the Company has issued three series of its 5%
convertible preferred stock denominated Series A Convertible Preferred Stock
(the "Series A Preferred Stock"), Series B Convertible Preferred Stock (the
"Series B Preferred Stock") and Series C Convertible Preferred Stock (the
"Series C Preferred Stock"). In addition, the Company has agreed to issue,
pursuant to a mutually binding stock purchase agreement, a fourth series of its
5% convertible preferred stock denominated Series D Convertible Preferred Stock
(the "Series D Preferred Stock") with the Series A Preferred Stock, the Series B
Preferred Stock and the Series C Preferred Stock, the ("Preferred Stock"). In
connection with the issuance of the 5% Preferred Stock, the Company has also
issued (or, in the case of the Series D Preferred Stock, agreed to issue)
warrants to purchase its common stock (the "Preferred Warrants").
Each series of the Preferred Stock has similar rights and privileges, and each
share of the Preferred Stock has a par value of $0.10 and a face amount of
$1,000. The Preferred Stock is convertible into the number of shares of common
stock determined by dividing the face amount of the Preferred Stock being
converted by the applicable conversion price.
On December 31, 1997, the Company issued to RGC International Investors, LDC
("RGC"), 5,000 shares of its Series A Preferred Stock and warrants to purchase
150,000 shares of common stock (the "Series A Warrants") for an aggregate
purchase price of $5,000,000. $435,000 of the purchase price has been allocated
to the value of the Series A Warrants. The sale was arranged by Shoreline
Pacific Institutional Finance, the Institutional Division of Financial West
Group ("SPIF"), which received a fee of $250,000 plus warrants to purchase
20,000 shares of common stock, which are exercisable at $6.625 and expire on
December 31, 2000.
On May 28, 1998, the Company issued to RGC and Shoreline Associates I, LLC
("Shoreline"), 9,000 and 1,000 shares, respectively, of its Series B Preferred
Stock and warrants to purchase 180,000 and 20,000 shares, respectively, of
common stock (the "Series B Warrants") for an aggregate purchase price of
$10,000,000. $900,000 of the purchase price has been allocated to the value of
the Series B Warrants. The sale was arranged by SPIF, which received a fee of
$500,000 plus warrants to purchase 50,000 shares of common stock, which are
exercisable at $11.00 and expire on May 28, 2002.
On August 31, 1998, the Company issued to RGC 7,500 shares of its Series C
Preferred Stock and warrants to purchase 93,750 shares of common stock (the
"Series C Warrants") for an aggregate purchase price of $7,500,000. $277,000 of
the purchase price has been allocated to the value of the Series C Warrants. The
sale was arranged by SPIF, which received a fee of $375,000 plus warrants to
purchase 26,250 shares of common stock, which are exercisable at $7.50 and
expire on August 31, 2002.
Also on August 31, 1998, the Company entered into a stock purchase agreement
whereby the Company agreed, subject to certain conditions, including common
stock shareholder approval, to issue to RGC 7,500 shares of its Series D
Preferred Stock and warrants to purchase 93,750 shares of common stock (the
"Series D Warrants") for an aggregate purchase price of $7,500,000. As of
September 30, 1998, the Company has not issued the Series D Preferred Stock and
the Series D Warrants. This stock purchase agreement was arranged by SPIF, which
received warrants to purchase 26,250 shares of common stock, which are
exercisable at $7.50 and expire on August 31, 2002. The exercise of these
warrants is contingent upon the issuance of the Series D Preferred Stock, at
which time SPIF will receive an additional fee of $375,000. If the closing of
the Series D Preferred Stock has not occurred by September 1, 1999, the warrants
issued in conjunction with the Series D Preferred Stock shall automatically
expire.
Use of Proceeds
71
<PAGE>
Proceeds from the sale of the Preferred Stock and the Preferred Warrants are
being used to fund the expenditures incurred in the continuing expansion of the
Company's Internet segment, particularly the ISP Channel service, and for
general corporate purposes. Such expenditures include procuring the equipment
necessary to deliver high-speed, cable based Internet services to subscribers,
hiring additional personnel and expanding its associated sales and marketing
efforts.
Dividends
The Holders of the Preferred Stock are entitled to receive dividends at a rate
of 5% per annum, payable quarterly, at the Company's option, in cash or
additional shares of the applicable series of Preferred Stock. Unpaid dividends
are cumulative. Any accrued and unpaid dividends are payable only in the event
of a liquidation, dissolution or winding up of the Company. In addition, the
Holders of the Series B Preferred Stock are entitled to receive dividends of 10%
per annum in the event they are unable to convert their Series B Preferred Stock
because such conversions would result in greater than 19.99% of the common stock
being issued upon conversion of the Series B, unless stockholder approval is
obtained authorizing such conversions.
As of September 30, 1998, the Company had issued an additional 101 shares of
Series A Preferred Stock, 125 shares of Series B Preferred Stock and 31 shares
of Series C Preferred Stock as dividends.
Conversion Prices
The stated value of each series of outstanding preferred stock is $1,000 per
share. The actual number of shares of common stock issuable upon conversion of
each series of Preferred Stock will be determined by the following formula:
(The aggregate stated value of the shares of preferred stock thus being
converted at $1,000 per share)
divided by
(The applicable conversion price of the series of the preferred
stock being converted).
The conversion price of the Series A Preferred Stock is equal to the lower of
$8.28 per share and the lowest consecutive two day average closing price of the
common stock during the 20 day trading period immediately prior to such
conversion.
Prior to February 28, 1999, the conversion price of the Series B Preferred Stock
is equal to $13.20 per share. Thereafter, the conversion price of the Series B
Preferred Stock is equal to the lower of $13.20 per share and the lowest five
day average closing price of the common stock during the 20 day trading period
immediately prior to such conversion.
Prior to May 31, 1999, the conversion price of the Series C Preferred Stock is
equal to $9.00 per share. Thereafter, the conversion price of the Series C
Preferred Stock is equal to the lower of $9.00 per share and the lowest five day
average closing price of the common stock during the 30-day trading period
immediately prior to such conversion.
The conversion price of the Series D Preferred Stock (the "Series D Conversion
Price") will initially be a price equal to 120% of the average closing bid price
of the common stock on the five days prior to the date the Series D Preferred
Stock is issued (the "Initial Series D Conversion Price"). On the nine month
anniversary of such issuance, the Series D Conversion Price will be the lower of
the Initial Series D Conversion Price and a five day average market price within
the 30-day trading period immediately prior to conversion, subject to adjustment
upon certain conditions.
Conversion
A holder of the Series A Preferred Stock or the Series B Preferred Stock cannot
convert its Series A Preferred Stock or Series B Preferred Stock in the event
such conversion would result in its beneficially owning more than 4.99% of the
Company's common stock, (not including shares underlying the Series A Preferred
Stock or the Series A Warrants for the Series A Preferred Stock conversions, or
the Series B Preferred Stock or the Series B Warrants for the Series B Preferred
Stock conversions), but they may waive this prohibition by providing the Company
a notice of election to convert at least 61 days prior to such conversion.
Similarly, a holder of the Series C Preferred Stock or Series D Preferred Stock
cannot convert its Series C Preferred Stock or Series D Preferred Stock in the
event such conversion would result in beneficially owning more than 4.99% of the
Company's common stock (not including shares underlying the Series C Preferred
Stock or the Series C Warrants for the Series C Preferred stock conversion or
the shares underlying the Series D Preferred Stock or the Series D Warrants for
the Series D Preferred stock conversions). Notwithstanding this limitation, the
holders of the Preferred Stock cannot convert into an aggregate of more than
19.99% of the Company's common stock without the approval of the Company's
common shareholders or the American Stock Exchange. In addition, the Series B
Preferred Stock, Series C Preferred Stock and Series D Preferred Stock each
cannot convert into more than 2,000,000 shares of common stock. As of September
30, 1998, assuming that the holders of Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock attempt to convert into the maximum
number of shares of common stock available, the total cash payments would be
$11,699,171 after adjustment for the conversion of the remaining 3,101 shares of
the Company's outstanding Series A Preferred Stock subsequent to year end.
72
<PAGE>
The rules of the American Stock Exchange (the "AMEX") require us to obtain
common stock shareholder or AMEX approval to issue more than 20% of the
Company's outstanding common stock. Shares of common stock issued upon
conversion of the Preferred Stock or exercise of the Preferred Warrants would
count toward this 20%. As such, the AMEX rule operates as a further restriction
on the ability of the holders of the Preferred Stock and the Preferred Warrants
to convert their preferred stock or exercise their warrants.
During April 1998, the Company issued a combined total of 299,946 shares of
common stock, pursuant to the conversion of 2,000 shares of the Series A
Preferred Stock. The Series A Preferred Stock, including accrued dividends, was
converted into common shares at the conversion price of $6.69 per share.
Subsequent to the year ended September 30, 1998, the Company issued a combined
total of 413,018 shares of common stock, pursuant to the conversion of the
remaining 3,101 shares of the Company's outstanding Series A Preferred Stock.
The Series A Preferred Stock, including accrued dividends, was converted into
common shares at the conversion price of $7.56 per share.
Voting Rights
Holders of the Preferred Stock do not have voting rights, except for certain
protective provisions relating to changes in the rights of holders of the
Preferred Stock or otherwise required by law. Consent of a majority in interest
of each effected series of the Preferred Stock is required prior to (i) changing
the rights or privileges of such series; (ii) creating any new class or series
of stock with preferences above or on par with those of such series; (iii)
increasing the authorized number of such series; (iv) any act which would result
in a negative tax consequence to the holders of such series pursuant to Section
305 of the Internal Revenue Code.
Priority
Each series of the Preferred Stock is pari passu with each other series of
Preferred Stock, and ranks senior to the common stock as to dividends,
distributions and distribution of assets upon liquidation, dissolution or
winding up of the Company.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
holders of the Preferred Stock will be entitled to be paid out of the assets of
the Company legally available for distribution to its stockholders, an amount
equal to the liquidation value per share of the Preferred Stock, but only after
and subject to the payment in full of all amounts required to be distributed to
the holders of any other capital stock of the Company ranking in liquidations
senior to such Preferred Stock, but before any payment will be made to the
holders of the common stock. Certain mergers or consolidations of the Company
into or with another corporation or the sale of all or substantially all of the
assets of the Company may be deemed to be a liquidation of the Company
triggering the rights of the holders of the Preferred Stock.
Redemption
Each series of the Preferred Stock is subject to redemption upon certain
circumstances, including the Company's (i) failure to convert the Preferred
Stock when required and in the proper manner, (ii) lapse of effectiveness of the
registration statement covering the common stock underlying the Preferred Stock,
and (iii) suspension of the common stock from trading on the AMEX, New York
Stock Exchange or NASDAQ. In addition, the Series B Preferred Stock is subject
to redemption in the event the Company breaches the registration rights
agreement pursuant to which the common stock underlying the Series B Preferred
Stock was registered with the Commission; and the Series C (and Series D if
issued) is subject to redemption in the event the Company breaches the stock
purchase agreement pursuant to which the Series C Preferred Stock was issued or
the registration rights agreement pursuant to which the common stock underlying
the Series C Preferred Stock was registered with the Commission.
The Company will have the right to redeem the Series A Preferred Stock on or
after December 31, 1998 at a price equal to the greater of 130% of its face
value or the market price multiplied by the number of shares of common stock
into which the Convertible Preferred can be converted. The Company will have the
right to redeem the Series B Preferred Stock on the earlier of an underwritten
public offering of at least $10,000,000 or November 28, 1999 at a price equal to
the greater of (i) 120% of its face value plus accrued but unpaid dividends or
(ii) the market price of the common stock multiplied by the number of shares of
common stock into which the Series B Preferred Stock can be converted. The
Company will have the right to redeem the Series C Preferred Stock on or after
the earlier of (i) an underwritten public offering or a Rule 144A offering in
the amount of at least $10,000,000, or (ii) February 29, 2000, at a price equal
to 110% of its face value if such redemption is made prior to September 1, 1999
and 120% of the face value thereafter. Once issued, the Company will have the
right to redeem the Series D Preferred Stock on or after the earlier of (i) an
underwritten public offering or a Rule 144A offering in the amount of at least
$10,000,000, or (ii) the eighteen-month anniversary of the date of its issuance
at a price equal to 110% of its face value if such redemption is made in the
first 12 months that the Series D Preferred Stock is outstanding and 120% of the
face value thereafter.
73
<PAGE>
In the event of a change in control of the Company, including consolidations,
mergers, the sale of substantially all of the Company's assets, and transactions
in which 50% or more of the voting power of the Company is disposed of, the 5%
Preferred Stock is subject to redemption in cash.
Maturity
The Company, in its sole discretion, must either redeem or convert the 5%
Preferred Stock on the three year anniversaries of issuance (the "Maturity
Date"). The Company's ability to convert the 5% Preferred Stock on the Maturity
Date is subject to (i) shareholder approval in the event such conversion
(aggregated with all previous conversions of the 5% Preferred Stock) would
result in the issuance of more than 19.99% of the outstanding common stock as of
December 31, 1997 and (ii) the shares of common stock issuable upon such
conversion being authorized, registered and eligible for trading over AMEX or
NASDAQ. In the event shareholder approval is not obtained, or the common stock
issuable upon such conversion is not authorized, registered and eligible for
trading over the AMEX or NASDAQ, then the Company must redeem the 5% Preferred
Stock in cash. The Maturity Date of the Series B Preferred Stock is May 29,
2001. The Maturity Date of the Series C Preferred Stock is August 31, 2001.
The Preferred Warrants to Purchase Common Stock
The Preferred Warrants have a term of four years, and are currently exercisable.
The Preferred Warrants contain certain anti-dilution provisions and permit
cashless exercise. The Company can call the Series B Warrants and the Series C
Warrants any time after the first year anniversary of their issuance, but only
in the event the market price of the common stock over the twenty days prior to
such call is 150% of the exercise price of the warrants being called. The Series
A Warrants have an exercise price of $7.95 per share and expire on December 31,
2001. The Series B Warrants have an exercise price of $13.75 per share and
expire on May 28, 2002. The Series C Warrants have an exercise price of $9.375
per share and expire on August 31, 2002. The exercise price of the Series D
Warrants will be 125% of the market price of the common stock on the date of
issuance, and will expire four years after such issuance.
15. 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, this receivable, which dates back to 1988, was
written off and charged against earnings during fiscal 1991. 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
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 note 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
74
<PAGE>
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 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. In association
with these ongoing negotiations, the maturity date of the Company's $161,000
promissory note has been indefinitely extended.
During 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.
On January 2, 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to Mr. R. C. W.
Mauran, a beneficial owner of more than 5% of the Company's common stock, 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.
On May 29, 1998, the Company issued to RGC International Investors and Shoreline
Associates I, LLC, 9,000 and 1,000 shares, respectively, of its Series B
Preferred Stock and warrants to purchase 180,000 and 20,000 shares,
respectively, of common stock, for an aggregate purchase price of $10,000,000.
The warrants issued in connection with the Series B Preferred Stock have an
exercise price of $13.75 per share. On December 31, 1998, RGC International
Investors and Shoreline Associates I, LLC owned 9,226.40 and 1,025.16 shares,
respectively, of Series B Preferred Stock as a result of payment of additional
shares of Series B Preferred Stock as dividends, which was all of the Series B
Preferred Stock outstanding as of such date (see Note 18). Sean Doherty, a
director of the Company, is an owner of Shoreline Associates I, LLC.
<TABLE>
16. Supplemental Cash Flow Information
<CAPTION>
1998 1997 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Cash paid during the year for:
Interest $1,330 $1,220 $1,730
Non-cash investing and financing activities:
Common stock issued for acquisitions -- -- 1,022
Common stock issued for the conversion of subordinated notes 1,118 387 4,077
Common stock issued for the conversion of preferred stock 1,666 -- --
Value assigned to common warrants issued upon the issuance
of preferred stock 1,612
Convertible debt issued for acquisition of equipment leases 1,444 -- --
Preferred dividends paid with the issuance of -
Additional preferred stock 257 -- --
Common stock 6 -- --
Equipment acquired by capital lease 965 83 89
Note received in sale of a portion of CDI's operations -- 209 --
Common stock issued to pay acquisition costs -- 44 --
</TABLE>
75
<PAGE>
<TABLE>
17. 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 ISP
Channel, an Internet service provider, in June of 1996, its revenue and results
of operations in fiscal 1996 were 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 3 provides segment
data for telecommunications.
<CAPTION>
As of and for the Years Ended September 30,
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Net Sales
Document Management $ 13,042 $ 20,330 $ 19,417
Internet Services 1,018 988 167
---------- ----------- -----------
$ 14,060 $ 21,318 $ 19,584
========== ========== ===========
Income (loss) from continuing operations before income taxes
Document Management $ (5,653)(a) $ 572(b) $ (227)(c)
Internet Services (8,272) (1,152) -
Other (3,004) (2,304) 2,003 (d)
---------- ------------ -----------
$ (16,929) $ (2,884) $ 1,776
========== =========== ===========
Identifiable Assets
Document Management $ 10,070 $ 15,049 $ 14,426
Discontinued Business 6,129 7,491 8,373
Internet Services 7,443 1,364 -
Corporate 13,167 473 1,467
Other - - 1,320
---------- ----------- -----------
$ 36,809 $ 24,377 $ 25,586
========== =========== ===========
Depreciation and Amortization Expense
Document Management $ 1,148 $ 1,263 $ 958
Internet Services 921 458 -
Corporate 84 76 306
Other - 1 110
---------- ------------ -----------
$ 2,153 $ 1,798 $ 1,374
=========== =========== ===========
Capital Expenditures
Document Management $ 647 $ 137 $ 614
Internet Services 5,014 361 -
Corporate 2 11 100
Other - 1 18
---------- ----------- -----------
$ 5,663 $ 510 $ 732
========== =========== ===========
<FN>
(a) Includes $3.1 million charge for impairment of assets
(b) Includes $2.1 million charge for costs associated with change in product
line and other
(c) Includes $1.5 million charge for costs associated with change in product
(d) Includes $5.7 million gain on sale of available-for-sale securities
</FN>
</TABLE>
18. Subsequent Events
On November 5, 1998, the Company entered into a letter of intent to sell MTC for
$5.125 million and on November 9, 1998, the Company entered into a letter of
intent to sell KCI for $6.6 million. In both cases, deposits of $100,000 were
paid to the Company on execution of the letters of intent and, in the case of
the sale of MTC, such deposit is non-refundable. The purchase price for MTC is
anticipated to be $5.125 million (including the $100,000 non-refundable
deposit). The balance of $5.025 million will be paid at closing in readily
available funds. The purchase price for KCI is anticipated to be $6 million
(including the $100,000 deposit) and the issuance to the Company of 60,000
shares of common stock of the purchaser, Convergent Communications, Inc. At
closing, the Company expects to receive $3.4 million in readily available funds
and two 12-month 8% notes for an aggregate amount of $2.5 million.
76
<PAGE>
In aggregate, the sale of both MTC and KCI represents a substantial change in
the business of the Company and, as such, requires shareholder approval. While
KCI has been treated as a discontinued operation since July 27, 1998, and while
management of the Company intends to dispose of MTC, the Company has continued
to treat MTC as a continuing business pending such shareholder approval of its
sale.
On November 22, 1998, the Company entered into a definitive agreement to acquire
all of the outstanding capital stock of Intelligent Communications, Inc. The
transaction will close upon Federal Communications Commission approval of the
transfer of Intellicom's licenses to the Company. Such approval is expected to
occur in the second quarter of fiscal 1999. The agreed purchase price comprises
(i) a cash component of $500,000 payable at closing, (ii) a promissory note in
the amount of $1 million due one year after closing (and payable in cash or in
the Company's common stock at the option of the sellers), (iii) a promissory
note in the amount of $2 million due two years after closing (and payable in
cash or in the Company's common stock at the option of the Company), (iv) the
issuance of 500,000 shares of the Company's common stock (adjustable upwards
after one year in certain circumstances), and (v) a demonstration bonus of $1
million payable on the first anniversary of the closing, if certain milestones
are met, in cash or shares of the Company's common stock at the option of the
Company.
During November 1998, the Company issued a combined total of 413,018 shares of
common stock, pursuant to the conversion of the remaining 3,101 shares of the
Company's outstanding Series A Preferred Stock. The Series A Preferred Stock,
including accrued dividends, was converted into common shares at the conversion
price of $7.56 per share.
During the quarter ended December 31, 1998, the Company declared a dividend on
both its outstanding Series B Preferred Stock and its outstanding Series C
Preferred Stock, payable on December 31, 1998 to the respective stockholders of
record at the close of business on December 28, 1998. For the Series B Preferred
Stock, these dividends, payable at a rate of 5%, were paid at the Company's
option in the form of 126.56 additional shares of the Company's Series B
Preferred Stock. For the Series C Preferred Stock, these dividends, payable at a
rate of 5%, were paid at the Company's option in the form of 94.14 additional
shares of the Company's Series C Preferred Stock.
On January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes. These notes bear an interest rate of 9% per year and
mature in 2001. In connection with these notes, the Company issued to these
investors an aggregate of 300,000 warrants. These warrants, which have an
exercise price of $17 per warrant, expire in 2003.
77
<PAGE>
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of Registrant
The information required by this Item is set forth in the registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on March 16, 1999
under the captions "Election of Directors", "Executive Officers" and "Compliance
with Section 16(a) of the Exchange Act", which information is hereby
incorporated herein by reference.
Item 11. Executive Compensation
The information required by this Item is set forth in the registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on March 16, 1999
under the captions "Executive Compensation" and "Board of Directors", which
information is hereby incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is set forth in the registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on March 16, 1999
under the caption "Beneficial Security Ownership of Management and Certain
Beneficial Owners", which information is hereby incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is set forth in the registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on March 16, 1999
under the caption "Certain Relationships and Related Transactions", which
information is hereby incorporated herein by reference.
78
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Exhibits:
1. Consolidated Financial Statements
See Index to Consolidated Financial Statements
included in this Form 10-K/A.
2. Financial Statement Schedules
Included in Part IV of this Form 10-K are the
following:
Report of Independent Accountants on Financial
Statement Schedule
Financial Statement Schedule for the Three Years
Ended September 30, 1998
Schedule II - Valuation and Qualifying Accounts
3. Exhibits
See Index to Exhibits included in this Form 10-K/A.
(b) Reports on Form 8-K:
On July 28, 1998, the Company filed a Form 8-K reporting both the
adoption of a Cable Affiliates Incentive Program and the Board of
Director's decision to account for the Company's Telecommunications
Division as a discontinued operation.
On September 14, 1998, the Company filed a Form 8-K reporting the
designation and issuance of 7,500 shares of Series C Convertible
Preferred Stock and the designation of 7,500 shares of Series D
Convertible Preferred Stock.
79
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOFTNET SYSTEMS, INC.
/s/ Douglas S. Sinclair
- -------------------------------
Douglas S. Sinclair
Chief Financial Officer
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Ronald I. Simon
- -----------------------------------
Ronald I. Simon Chairman of the Board of February 1, 1999
Directors
/s/ Lawrence B. Brilliant
- -----------------------------------
Dr. Lawrence B. Brilliant Vice Chairman of the Board of Directors February 1, 1999
President, and Chief Executive Officer
/s/ Garrett J. Girvan
- -----------------------------------
Garrett J. Girvan Chief Operating Officer February 1, 1999
/s/ Ian B. Aaron
- -----------------------------------
Ian B. Aaron Director February 1, 1999
/s/ Edward A. Bennett
- -----------------------------------
Edward A. Bennett Director February 1, 1999
/s/ Sean P. Doherty
- -----------------------------------
Sean P. Doherty Director February 1, 1999
/s/ John G. Hamm
- -----------------------------------
John G. Hamm Director February 1, 1999
/s/ Robert C. Harris, Jr.
- -----------------------------------
Robert C. Harris, Jr. Director February 1, 1999
</TABLE>
80
<PAGE>
Schedule II
Valuation and Qualifying Accounts
(In thousands)
Beginning Ending
Balance Expensed Deductions Balance
------- -------- ---------- -------
Allowance for Doubtful Accounts (for continuing operations):
Fiscal Year 1998 $320 $680 $279 $721
Fiscal Year 1997 164 174 18 320
Fiscal Year 1996 156 101 93 164
81
<PAGE>
INDEX TO EXHIBITS
EXHIBIT 3 Articles of Incorporation and By-Laws
3.1 Restated Certificate of Incorporation of the
Registrant, filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
3.2 By-Laws of the Company included in Exhibit 3(b) to
the Company's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1993.
EXHIBIT 4 Instruments Defining the Rights of Security Holders including
Indentures
4.1 Article Third of the Registrant's Restated
Certificate of Incorporation, filed as exhibit 3.1 to
this Annual Report on Form 10-K.
4.2 Form of Indenture between SoftNet Systems, Inc. and
U.S. Trust Company of California, as Trustee,
including Form of Note, relating to the 9%
Debentures. Incorporated by reference to Exhibit 4.2
to the Company's Registration Statement on Form S-4,
as amended, Registration No. 33-95542.
EXHIBIT 10 Material Contracts
10.1 Letter confirming employment of Dr. Lawrence B.
Brilliant, dated April 7, 1998. Incorporated by
reference to the Company's Form 10-Q for the quarter
ended June 30, 1998.
10.2 Loan Modification Agreement (Incorporation of
Equipment Loan Facility) made and entered on the 14th
day of May, 1997, by and between SoftNet Systems,
Inc., a New York Corporation, Communicate Direct,
Inc., an Illinois Corporation , Micrographic
Technology Corporation, a Delaware Corporation,
Kansas Communications, Inc., a Kansas Corporation and
West Suburban Bank. Incorporated by reference to
exhibit 10.2 to the Company's Annual Report on Form
10-K for the fiscal year ended September 30, 1997.
10.3 Draw Note, in the face amount of $1,500,000 made and
entered on the 14th day of May, 1997, by and between
SoftNet Systems, Inc., a New York Corporation,
Communicate Direct, Inc., an Illinois Corporation ,
Micrographic Technology Corporation, a Delaware
Corporation, Kansas Communications, Inc., a Kansas
Corporation and West Suburban Bank. Incorporated by
reference to exhibit 10.3 to the Company's Annual
Report on Form 10-K for the fiscal year ended
September 30, 1997.
10.4 Purchase Agreement (in regards to certain equipment
leases) made and entered on the 14th day of May,
1997, by and between SoftNet Systems, Inc., a New
York Corporation, Communicate Direct, Inc., an
Illinois Corporation , Micrographic Technology
Corporation, a Delaware Corporation, Kansas
Communications, Inc., a Kansas Corporation and West
Suburban Bank. Incorporated by reference to exhibit
10.4 to the Company's Annual Report on Form 10-K for
the fiscal year ended September 30, 1997.
10.5 Amendment "A" to Purchase Agreement (in regards to
certain equipment leases) made and entered on the
15th day of November, 1997, by and between SoftNet
Systems, Inc., a New York Corporation, Communicate
Direct, Inc., an Illinois Corporation , Micrographic
Technology Corporation, a Delaware Corporation,
Kansas Communications, Inc., a Kansas Corporation and
West Suburban Bank. Incorporated by reference to
exhibit 10.5 to the Company's Annual Report on Form
10-K for the fiscal year ended September 30, 1997.
10.6 Loan Modification Agreement (Extension of Maturity
Date) made and entered on the 14th day of August,
1997, by and between SoftNet Systems, Inc., a New
York Corporation, Communicate Direct, Inc., an
Illinois Corporation , Micrographic Technology
Corporation, a Delaware Corporation, Kansas
Communications, Inc., a Kansas Corporation and West
82
<PAGE>
Suburban Bank. Incorporated by reference to exhibit
10.6 to the Company's Annual Report on Form 10-K for
the fiscal year ended September 30, 1997.
10.7 Loan Modification Agreement made and entered on the
14th day of March, 1996, by and between SoftNet
Systems, Inc., a New York Corporation, Communicate
Direct, Inc., an Illinois Corporation , Micrographic
Technology Corporation, a Delaware Corporation,
Kansas Communications, Inc., a Kansas Corporation and
West Suburban Bank. Incorporated by reference to
exhibit 10.3 to the Company's Annual Report on Form
10-K for the fiscal year ended September 30, 1996.
10.8 Loan Modification Agreement (Modification of
Borrowing Base Definition) made and entered into this
27th day of November, 1996, by and between SoftNet
Systems, Inc., a New York Corporation , Communicate
Direct, Inc., an Illinois Corporation, Micrographic
Technology Corporation, a Delaware Corporation,
Kansas Communications, Inc., a Kansas Corporation and
West Suburban Bank. Incorporated by reference to
exhibit 10.6 to the Company's Annual Report on Form
10-K for the fiscal year ended September 30, 1996.
10.9 Manufacturing and Distribution Licensing Agreement,
dated July 12, 1996 by and among Imnet Systems, Inc.,
a Delaware corporation, having its principal place of
business in Atlanta, Georgia , SoftNet Systems, Inc.,
a New York corporation, having its principal place of
business in Lake Forest, Illinois and SoftNet's
wholly-owned subsidiary, Micrographic Technology
Corporation, a Delaware corporation having its
principal place of business in Mountain View,
California. Incorporated by reference to exhibit 10.2
to the Company's Annual Report on Form 10-K for the
fiscal year ended September 30, 1996.
10.10 Loan and Security Agreement, dated September 15,
1995, by and between West Suburban Bank and SoftNet
Systems, Inc. Incorporated by reference to exhibit
10.1 to the Company's Annual Report on Form 10-KSB
for the fiscal year ended September 30, 1995.
10.11 Revolving Credit Note, dated September 15, 1995, in
the original principal amount of $6,500,000 from
SoftNet Systems, in favor of West Suburban Bank
Incorporated by reference to exhibit 10.2 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended September 30, 1995.
10.12 SoftNet Systems, Inc. 1995 Long Term Incentive Plan.
Incorporated by reference to exhibit 10.3 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended September 30, 1995.
10.13 Registration Rights Agreement dated September 15,
1995 by and among R.C.W. Mauran, A.J.R. Oosthuizen
and SoftNet Systems, Inc. Incorporated by reference
to exhibit 10.6 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended September 30,
1995.
10.14 SoftNet Systems, Inc. Employee Stock Option Plan for
employees of Micrographic Technology Corporation.
Incorporated by reference to exhibit 10.8 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended September 30, 1995.
10.15 Form of SoftNet Systems, Inc. 9% Convertible
Subordinated Debentures due 2000. Incorporated by
reference to exhibit 10.9 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended
September 30, 1995.
10.16 $660,000 principal amount of Micrographic Technology
Corporation 6% Convertible Subordinated Secured
Debentures due 2002 issued to R.C.W. Mauran.
Incorporated by reference to exhibit 10.10 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended September 30, 1995.
10.17 Registration Rights Agreement, dated as of October
28, 1994, by and among SoftNet Systems, Inc., Marc
Zionts and Ian Aaron. Incorporated by reference to
the Company's Current Report on Form 8-K dated
October 31, 1994.
83
<PAGE>
10.18 Registration Rights Agreement, dated as of October
28, 1994, by and among SoftNet Systems, Inc.,
Forsythe/McArthur Associates, Inc., BWJ Partnership,
Willard Aaron and D&K Stores, Inc. Incorporated by
reference to the Company's Current
Report on Form 8-K dated October 31, 1994.
10.19 Registration Rights Agreement, dated as of November
1, 1994, by and among SoftNet Systems, Inc., Michael
Cleary, Tim Reiland, Dave Prokupek, Christopher
Barnes and CGRM Limited Partnership I. Incorporated
by reference to the Company's Current Report on Form
8-K dated October 31, 1994.
10.20 SoftNet Systems, Inc. Common Stock Purchase Warrant
expiring October 31, 1999 held by Michael Cleary, Tim
Reiland, Dave Prokupek, Christopher Barnes and CGRM
Limited Partnership. Incorporated by reference to the
Company's Current Report on Form 8-K dated October
31, 1994.
10.21 SoftNet Systems, Inc. Common Stock Purchase Warrant
expiring October 27, 1999 held by Willard Aaron.
Incorporated by reference to the Company's Current
Report on Form 8-K dated October 31, 1994.
10.22 Form of SoftNet Systems, Inc. Common Stock Purchase
Warrant. Incorporated by reference to exhibit 10.39
to the Company's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1995.
10.23 Form of SoftNet Systems, Inc. Promissory Note.
Incorporated by reference to exhibit 10.40 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended September 30, 1995.
10.24 Form of SoftNet Systems, Inc. Note Extension
Agreement. Incorporated by reference to exhibit 10.41
to the Company's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1995.
10.25 Form of SoftNet Systems, Inc. Warrant to Purchase
Common Stock granted to holders of SoftNet Systems,
Inc. Promissory Notes. Incorporated by reference to
exhibit 10.42 to the Company's Annual Report on Form
10-KSB for the fiscal year ended September 30, 1995.
10.26 Form of 9% Convertible Subordinated Note.
Incorporated by reference to the Company's
Registration Statement on Form S-4, as amended,
Registration No. 33-95542.
10.27 Stockholders Agreement dated March 24, 1995 among
SoftNet Systems, Inc., A.J.R. Oosthuizen and R.C.W.
Mauran. Incorporated by reference to the Company's
Registration Statement on Form S-4, as amended,
Registration No. 33-95542.
10.28 First Amendment dated September 15, 1995 to
Stockholders Agreement dated March 24, 1995 among
SoftNet Systems, Inc., A.J.R. Oosthuizen and R.C.W.
Mauran. Incorporated by reference to exhibit 10.45 to
the Company's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1995.
EXHIBIT 21 Subsidiaries
EXHIBIT 23 Consent of Independent Accountants
EXHIBIT 27 Financial Data Schedule
EXHIBIT 99 Additional Exhibits
99.1 Common Stock Purchase Warrant Certificate issued to
RGC International Investors, LDC dated August 31,
1998 (Series C), filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
84
<PAGE>
99.2 Common Stock Purchase Warrant Certificate issued to
Shoreline Pacific Equity, Ltd. dated August 31, 1998
(Series C), filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
99.3 Common Stock Purchase Warrant Certificate issued to
Steven M. Lamar dated August 31, 1998 (Series C),
filed as an exhibit to the Company's Registration
Statement on Form S-3 (No. 333-65593).
99.4 Securities Purchase Agreement by and among the
Company and the Buyers (as defined therein), dated as
of August 31, 1998 (Series C and Series D), filed as
an exhibit to the Company's Registration Statement on
Form S-3 (No. 333-65593).
99.5 Registration Rights Agreement by and among the
Company and the Initial Investors (as defined
therein) dated as of August 31, 1998 (Series C and
Series D), filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
99.6 Escrow Agreement by and among the Company, the Buyers
(as defined therein), Shoreline Pacific Institutional
Finance and the Escrow Holder (as defined therein),
dated as of August 31, 1998 (Series C), filed as an
exhibit to the Company's Registration Statement on
Form S-3 (No. 333-65593).
99.7 Common Stock Purchase Warrant Certificate issued to
Shoreline Pacific Equity, Ltd. dated August 31, 1998
(Series D), filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
99.8 Common Stock Purchase Warrant Certificate issued to
Steven M. Lamar dated August 31, 1998 (Series D),
filed as an exhibit to the Company's Registration
Statement on Form S-3 (No. 333-65593).
99.9 Securities Purchase Agreement by and among the
Company and the Buyers (as defined therein), dated as
of May 28, 1998 (Series B), filed as an exhibit to
the Company's Registration Statement on Form S-3 (No.
333-57337).
99.10 Registration Rights Agreement by and among the
Company and the Initial Investors (as defined
therein), dated as of May 28, 1998 (Series B), filed
as an exhibit to the Company's Registration Statement
on Form S-3 (No. 333-57337)..
99.11 Escrow Agreement by and among the Buyers (as defined
therein), Shoreline Pacific Institutional Finance and
the Escrow Holder (as defined therein), dated as of
May 28, 1998 (Series D), filed as an exhibit to the
Company's Registration Statement on Form S-3 (No.
333-57337).
99.12 Form of Common Stock Purchase Warrant Certificate
issued to purchasers of the Series B Preferred Stock,
dated May 28, 1998, filed as an exhibit to the
Company's Registration Statement on Form S-3 (No.
333-57337).
99.13 Form of Common Stock Purchase Warrant Certificate
issued to assignees of Shoreline Pacific
Institutional Finance, dated May 28, 1998 (Series B),
filed as an exhibit to the Company's Registration
Statement on Form S-3 (No. 333-57337)..
99.14 List of recipients of Common Stock Purchase Warrants
issued in connection with Series B Preferred Stock
transaction, filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
99.15 Securities Purchase Agreement by and among the
Company and the Buyers (as defined therein), dated as
of December 31, 1997 (Series A), filed as an exhibit
to the Company's Form 8-K, dated January 12, 1998.
85
<PAGE>
99.16 Registration Rights Agreement by and among the
Company and the Initial Investors (as defined
therein), dated as of December 31, 1997 (Series A) ,
filed as an exhibit to the Company's Form 8-K, dated
January 12, 1998.
99.17 Form of common Stock Purchase Warrant Certificate
issued to purchasers of the Series A Preferred Stock,
dated December 31, 1997, filed as an exhibit to the
Company's Form 8-K, dated January 12, 1998..
99.18 Form of Common Stock Purchase Warrant Certificate
issued to assignees of Shoreline Pacific
Institutional Finance, dated December 31, 1997
(Series A), filed as an exhibit to the Company's Form
8-K, dated January 12, 1998.
99.19 List of recipients of Common Stock Purchase Warrants
issued in connection with Series A Preferred Stock
transaction, filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
99.20 Action by Written Consent of the Sole Holder of the
Series E Convertible Preferred Stock of SoftNet
Systems, Inc., filed as an exhibit to the Company's
Registration Statement on Form S-3 (No. 333-65593).
86
EXHIBIT 21 Subsidiaries
SoftNet Systems, Inc.
List of Subsidiaries of the Registrant
September 30, 1998
MediaCity World, Inc. (Delaware)
Communicate Direct, Inc. (Illinois)
Kansas Communications, Inc. (Kansas)
Micrographic Technology Corporation (Delaware)
87
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 1, 1998, except
for Note 18 as to which the date is January 13, 1999, 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."
/s/ PricewaterhouseCoopers LLP
February 1, 1999
San Jose, California
88
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
EXHIBIT 27 Financial Data Schedule Form 10-K
This schedule contains summary information extracted from Form 10-K for the year
ended September 30, 1998 and is qualified in its entirety by reference to such
Form 10-K.
</LEGEND>
<CIK> 0000097196
<NAME> SOFTNET SYSTEMS INC.
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<S> <C>
<PERIOD-TYPE> 12-mos
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<PERIOD-END> SEP-30-1998
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18,187
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