UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No.: 1-5270
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-1817252
-------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
650 Townsend Street, Suite 225, San Francisco, CA 94043
- ------------------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 365-2500
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.
(1) Yes X No
--- ---
(2) Yes X No
--- ---
As of April 30, 1999, there were 15,880,098 shares of the Registrant's common
stock, par value $0.01 per share outstanding.
This document (excluding Exhibits)
contains 50 pages.
<PAGE>
SOFTNET SYSTEMS, INC.
FORM 10-Q
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets as of June 30, 1999
and September 30, 1998................................................3
Consolidated Condensed Statements of Operations for the
three months and nine months ended June 30, 1999 and 1998.............4
Consolidated Condensed Statements of Cash Flows for the
nine months ended June 30, 1999 and 1998..............................5
Notes to Consolidated Condensed Financial Statements..................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................16
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - Not applicable
Item 2. Changes in Securities...........................................27
Item 3. Defaults upon Senior Securities - Not applicable
Item 4. Submission of Matters to a Vote of Security Holders.............28
Item 5. Other Information...............................................28
Item 6. Exhibits and Reports on Form 8-K................................49
<PAGE>
Part I. Financial Information
<TABLE>
<CAPTION>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
As of June 30, 1999 and September 30, 1998
(In thousands, except share data)
(Unaudited)
June 30, September 30,
1999 1998
--------------- ------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents..................................................... $ 151,954 $ 12,504
Accounts receivable, net...................................................... 828 110
Notes receivable.............................................................. 2,956 --
Inventories................................................................... 1,644 268
Other current assets.......................................................... 2,081 571
--------------- ------------------
Total current assets....................................................... 159,463 13,453
Restricted cash.................................................................. 872 800
Property and equipment, net...................................................... 16,097 5,981
Acquired technology and other intangibles, net................................... 25,627 311
Net assets associated with discontinued operations............................... 4,795 8,930
Other assets..................................................................... 6,025 150
=============== ==================
Total assets................................................................. $ 212,879 $ 29,625
=============== ==================
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable and accrued expenses......................................... $ 10,833 $ 6,938
Deferred gain................................................................. 2,304 --
Current portion of capital leases............................................. 1,772 613
Current portion of long-term debt............................................. 3,017 541
--------------- ------------------
Total current liabilities.................................................. 17,926 8,092
Capital lease obligations, net of current portion................................ 2,287 297
Long-term debt, net of current portion........................................... 18,446 9,220
--------------- ------------------
Total liabilities............................................................ 38,659 17,609
--------------- ------------------
Redeemable convertible preferred stock; $0.10 par value; 37,610 shares
designated; no shares and 20,757 shares issued and outstanding, respectively.. -- 18,187
--------------- ------------------
Stockholders' equity (deficit):
Preferred stock; $0.10 par value; 3,962,390 shares designated; no shares
issued and outstanding..................................................... -- --
Common stock; $0.01 par value; 100,000,000 and 25,000,000 shares authorized,
respectively; 16,840,440 and 8,191,550 shares issued and outstanding,
respectively............................................................... 168 82
Additional paid-in capital.................................................... 328,942 43,700
Deferred stock compensation................................................... (71,908) (188)
Accumulated deficit........................................................... (82,982) (49,765)
--------------- ------------------
Total stockholders' equity (deficit)....................................... 174,220 (6,171)
=============== ==================
Total liabilities, redeemable convertible preferred stock and
stockholders' equity (deficit)......................................... $ 212,879 $ 29,625
=============== ==================
</TABLE>
The accompanying notes are an integral part of these
consolidated condensed financial statements.
<PAGE>
<TABLE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
For the Three Months and Nine Months Ended June 30, 1999 and 1998
(In thousands, except per share data)
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------------- -------------------------------
1999 1998 1999 1998
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net sales....................................... $ 1,317 $ 298 $ 2,788 $ 764
Cost of sales................................... 1,460 335 2,758 585
-------------- ------------- -------------- -------------
Gross profit (loss)......................... (143) (37) 30 179
-------------- ------------- -------------- -------------
Operating expenses:
Selling and marketing....................... 4,197 869 8,567 1,256
Engineering................................. 1,856 172 3,325 387
General and administrative.................. 2,439 1,452 6,616 2,778
Depreciation................................ 938 130 2,140 269
Amortization................................ 872 104 1,597 311
Compensation expense related to stock
options................................. 5,680 -- 6,721 --
-------------- ------------- -------------- -------------
Total operating expenses................ 15,982 2,727 28,966 5,001
-------------- ------------- -------------- -------------
Loss from continuing operations................. (16,125) (2,764) (28,936) (4,822)
Other income (expense):
Interest expense............................ (2,453) (244) (3,580) (676)
Interest income............................. 1,336 32 1,576 40
Other....................................... (1,373) (49) (1,405) (48)
-------------- ------------- -------------- -------------
Loss from continuing operations before income
taxes (18,615) (3,025) (32,345) (5,506)
Income taxes.................................... -- -- -- --
-------------- ------------- -------------- -------------
Loss from continuing operations................. (18,615) (3,025) (32,345) (5,506)
Loss from discontinued operations............... (15) (32) (399) (1,142)
-------------- ------------- -------------- -------------
Net loss........................................ (18,630) (3,057) (32,744) (6,648)
Preferred dividends............................. (59) (85) (473) (148)
-------------- ------------- -------------- -------------
Net loss applicable to common shares............ $ (18,689) $ (3,142) $ (33,217) $ (6,796)
============== ============= ============== =============
Basic and diluted loss per share:
Continuing operations....................... $ (1.26) $ (0.40) $ (2.99) $ (0.77)
Discontinued operations..................... (0.00) (0.01) (0.04) (0.16)
Preferred dividends......................... (0.01) (0.01) (0.04) (0.02)
============== ============= ============== =============
Net loss applicable to common shares........ $ (1.27) $ (0.42) $ (3.07) $ (0.95)
============== ============= ============== =============
Shares used to compute basic and diluted loss
per share................................... 14,764 7,502 10,806 7,144
============== ============= ============== =============
</TABLE>
The accompanying notes are an integral part of these
consolidated condensed financial statements.
<PAGE>
<TABLE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
For the Nine Months Ended June 30, 1999 and 1998
(In thousands)
(Unaudited)
<CAPTION>
For the Nine Months Ended
June 30,
------------------------------------
1999 1998
----------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss....................................................................... $ (32,744) $ (6,648)
Adjustments to reconcile net loss to net cash used in operating
activities:
Loss from discontinued operations....................................... 399 1,142
Depreciation and amortization........................................... 3,737 580
Amortization of deferred stock compensation............................. 6,721 --
Amortization of deferred debt issuance costs............................ 2,335 --
Provision for bad debts................................................. 186 45
Loss on disposition of short-term investment............................ 600 --
Penalty paid on redeemable convertible preferred stock.................. 498 --
Changes in operating assets and liabilities:
Accounts receivable................................................. (718) (164)
Inventories......................................................... (1,376) (108)
Other current assets................................................ (1,320) 26
Accounts payable and accrued expenses............................... 2,088 2,062
----------------- --------------
Net cash used in operating activities of continuing operations...................... (19,594) (3,065)
----------------- --------------
Net cash provided by (used in) operating activities of discontinued operations...... 842 (171)
----------------- --------------
Cash flows from investing activities:
Purchase of short-term investment.............................................. (600) --
Purchase of property and equipment............................................. (7,518) (1,929)
Purchase of Intellicom including acquisition costs, net of cash acquired....... (803) --
Sale of net assets of telecommunications segment, net of selling costs......... 2,694 --
Acquired technology and other intangibles...................................... (1,913) --
Other assets................................................................... (777) (106)
----------------- --------------
Net cash used in investing activities of continuing operations...................... (8,917) (2,035)
----------------- --------------
Net cash used in investing activities of discontinued operations.................... (98) (168)
----------------- --------------
Cash flows from financing activities:
Repayment of short-term debt................................................... (612) --
Proceeds from issuance of long-term debt, net of cash issuance costs........... 13,358 --
Repayment of long-term debt.................................................... (955) (196)
Borrowings under revolving credit facility..................................... 18,285 8,647
Payments under revolving credit facility....................................... (21,215) (9,111)
Additional costs of issuance of redeemable convertible preferred stock......... (152) --
Net proceeds from issuance of redeemable convertible preferred stock........... -- 14,100
Proceeds from sale of common stock, net of selling costs....................... 156,492 --
Proceeds from exercise of options.............................................. 2,454 553
Proceeds from exercise of warrants............................................. 1,671 2,168
Preferred dividends paid in cash............................................... (95) --
Additional restricted cash..................................................... (72) --
Capitalized lease obligations paid............................................. (904) (84)
----------------- --------------
Net cash provided by financing activities of continuing operations.................. 168,255 16,077
----------------- --------------
Net cash used in financing activities of discontinued operations.................... (1,038) (857)
----------------- --------------
Increase in cash and cash equivalents............................................... 139,450 9,781
Cash and cash equivalents, beginning of period...................................... 12,504 37
--------------
=================
Cash and cash equivalents, end of period............................................ $ 151,954 $ 9,818
================= ==============
</TABLE>
The accompanying notes are an integral part of these
consolidated condensed financial statements.
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
1. Basis of Presentation
The financial information, except for the balance sheet as of September 30,
1998, included herein is unaudited; however, such information reflects all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the condensed
consolidated statements of financial position, results of operations and cash
flows as of and for the interim periods ended June 30, 1999 and 1998.
The Company's annual report on Form 10-K/A for the fiscal year ended September
30, 1998, as filed with the Securities and Exchange Commission, should be read
in conjunction with the accompanying Consolidated Condensed Financial
Statements. The Consolidated Condensed Balance Sheet as of September 30, 1998
was derived from the Company's audited Consolidated Financial Statements.
The results of operations for the three and nine months ended June 30, 1999 are
based in part on estimates that may be subject to year-end adjustments and are
not necessarily indicative of the results to be expected for the full year.
The balance sheet as of September 30, 1998 and the statements of operations and
cash flow for the three and nine months ended June 30, 1998 have been restated
for the effects of discontinued operations (see Note 3). Certain
reclassifications have been made to conform with the current presentation.
2. Cash and Cash Equivalents
Upon closing of the Secondary Offering (see Note 7), the Company invested the
net proceeds in a standard interest-bearing bank account. Subsequent to June 30,
1999, the Company began investing the net proceeds in a variety of short-term,
highly liquid investments, with various maturity dates.
3. Discontinued Operations
Document Management Segment
On November 5, 1998, we agreed to sell our document management business,
Micrographic Technology Corporation ("MTC") to Global Information Distribution
GmbH ("GID") for an aggregate purchase price of approximately $5.1 million. GID
paid $100,000 as a non-refundable deposit upon acceptance of the GID term sheet.
GID will pay us the remaining $5.0 million at the closing. In April 1999, the
Company's stockholders formally approved the plan to discontinue operations of
its document management segment. Accordingly, the operating results of the
document management 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.
Operating results of the discontinued document management segment are as follows
(in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
-------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net sales.................. $ 3,329 $ 3,223 $ 10,949 $ 9,870
Loss before income taxes... (15) (285) (568) (1,510)
Income taxes............... -- -- -- --
Net loss................... (15) (285) (568) (1,510)
<PAGE>
Assets and liabilities of the discontinued document management segment are as
follows (in thousands):
June 30, September
1999 30, 1998
----------- ----------
Current assets:
Cash and cash equivalents........................ $ -- $ --
Accounts receivable, net......................... 3,687 2,995
Current portion of gross investment in leases.... 1,077 1,579
Inventories...................................... 721 1,078
Other current assets............................. 383 310
----------- ---------
5,868 5,962
Gross investment in leases, net of current portion... 1,697 1,863
Property and equipment, net.......................... 451 541
Goodwill, net........................................ 225 644
Other assets......................................... 655 974
----------- ---------
8,896 9,984
----------- ---------
Current liabilities:
Accounts payable and accrued expenses............ 2,418 2,485
Deferred revenue................................. 366 100
Current portion of capital leases................ 20 19
Current portion of long-term debt................ 1,283 1,280
----------- ---------
4,087 3,884
Capital lease obligation, net of current portion..... 14 30
Long-term debt, net of current portion............... -- 1,015
----------- ---------
4,101 4,929
=========== =========
Net assets associated with discontinued operations... $ 4,795 $ 5,055
=========== =========
Telecommunications Segment
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
were reflected as a net asset as of September 30, 1998.
On February 12, 1999, substantially all of the assets of KCI were sold to
Convergent Communications Services, Inc. ("Convergent Communications") for an
aggregate purchase price of approximately $6.3 million subject to adjustment in
certain events. Convergent Communications paid $100,000 in cash in November 1998
upon execution of the letter of intent to purchase and paid the remainder of the
purchase price on the closing date as follows: (i) $1.4 million in cash; (ii)
approximately 30,000 shares of Convergent Communications' parent company common
stock with an agreed value of approximately $300,000 ($10.00 per share) (the
"Convergent Shares"); (iii) a promissory note in the amount of $2.0 million
which is payable on July 1, 1999 and bears simple interest at the rate of 11%
per annum (the "First Convergent Note"); (iv) a promissory note in the amount of
$1.0 million which is payable on the date that is 12 months following the
closing date and bears simple interest at the rate of 8% per annum (the "Second
Convergent Note"); and (v) a promissory note in an amount of $1.5 million which
is payable on the date which is 12 months following the closing date and bears
simple interest at the rate of 8% per annum and is subject to mandatory
prepayment in certain events (the "Third Convergent Note"). Furthermore, a
purchase price adjustment subsequent to closing provided the Company with
additional Convergent Shares with an agreed value of $198,000 for a total
investment in Convergent Shares of $498,000, which is classified as other assets
on the accompanying consolidated condensed balance sheet. The sale of KCI's
assets resulted in a gain of $2.3 million, which is being deferred until the
Company has collected the $4.5 million of notes receivable issued in connection
with this sale. On April 6, 1999, Convergent Communications paid $1.5 million of
the First Convergent Note. In July 1999, the Third Convergent Note was paid in
full, as well as the remaining amount due on the First Convergent Note.
<PAGE>
Operating results of the discontinued telecommunications segment are as follows
(in thousands):
Three Months Ended Nine Months Ended
June 30, (1) June 30, (1)
------------------------ -----------------------
1999 1998 1999 1998
------------ ---------- ----------- ----------
Net sales...................... $ -- $ 4,425 $ 4,730 $ 12,817
Income before income taxes..... -- 253 216 368
Income taxes................... -- -- (73) --
Net income..................... -- 253 169 368
- ------------------------
(1) Operating results for KCI are only through the date of disposition.
Assets and liabilities of the discontinued telecommunications segment were as
follows (in thousands):
September 30,
1998
---------------
Current assets:
Cash and cash equivalents........................... $ --
Accounts receivable, net............................ 1,734
Inventories......................................... 2,248
Other current assets................................ 36
---------------
4,018
Property and equipment, net............................. 427
Goodwill, net........................................... 1,663
Other assets............................................ 21
---------------
6,129
---------------
Current liabilities:
Accounts payable and accrued expenses............... 1,582
Current portion of capital leases................... 32
Deferred revenue.................................... 593
---------------
2,207
Capital lease obligation, net of current portion........ 47
---------------
2,254
---------------
Net assets associated with discontinued operations...... $ 3,875
===============
4. Acquisition of Intellicom
On February 9, 1999, a wholly-owned subsidiary of the Company merged with and
into Intelligent Communications, Inc. ("Intellicom", the "Intellicom
Acquisition"). Intellicom is a provider of two-way satellite Internet access
options using very small aperture terminal technology ("VSAT"). The purchase
price of $14.5 million was comprised of: (i) a cash component of $500,000 (the
"Cash Consideration"); (ii) a promissory note in the amount of $1.0 million
bearing interest at 7.5% per annum and due one year after closing (the "First
Promissory Note"); (iii) a promissory note in the amount of $2.0 million bearing
interest at 8.5% per annum and due two years after closing (the "Second
Promissory Note", together with the First Promissory Note, the "Debt
Consideration"); (iv) the issuance of 500,000 shares of the Company's common
stock (adjustable upwards after one year in certain circumstances), valued at
$14.938 per share, for a total value of $7.5 million (the "Closing Shares"); and
(v) additional shares of the Company's common stock issuable upon the first,
second and third anniversaries of the closing, valued at a total of $3.5 million
(the "Anniversary Shares", together with the Closing Shares, the "Equity
Consideration"). In addition, a demonstration bonus of $1.0 million payable in
cash or shares of the Company's common stock at the Company's option within one
year after closing if certain conditions are met is also a part of the purchase
price; however, due to the uncertainty as to whether or not such performance
criteria will be met, the Company has not accrued for such contingent
consideration. To the extent such conditions are met, the payment will increase
intangible assets associated with acquired technology.
<PAGE>
The purchase price, including direct merger costs, has been allocated to assets
acquired and liabilities assumed based on fair market value at the date of
acquisition. The fair value of assets and liabilities assumed is summarized as
follows (in thousands):
Current assets..........................................$ 503
Property and equipment.................................. 684
Acquired technology..................................... 16,075
Other assets............................................ 77
Current liabilities..................................... 2,470
The Company accounted for the Intellicom Acquisition using the purchase method
and allocated the entire purchase price of $14.5 million to acquired technology.
Additionally, due to the negative fair value of Intellicom net assets at the
time of acquisition, the Company recognized additional acquired technology in
Intellicom totaling $1.2 million. Furthermore, in connection with the Intellicom
Acquisition, the Company incurred certain fees and expenses. Such costs, which
total $400,000, were capitalized and have also been allocated to acquired
technology, bringing the total amount allocated to acquired technology to $16.1
million. The results of operations of Intellicom are included in the
accompanying financial statements from the date of acquisition.
The nature of the developed technology acquired provides the Company with a
proprietary satellite system, involving both hardware and software, which
provides a high-performance, two-way satellite-based Internet access service.
The nature of the acquired technology will, among other things, allow the
Company to lower the costs of bringing the Internet to small- and medium-sized
independent cable operators. The technology acquired has already been tested and
proven to be a viable business. Therefore, the Company believes that the
underlying technology acquired in the Intellicom Acquisition is not subject to
rapid change, and such acquired technology will support the Company's business
plan over the typical length of its contracts without having to significantly
change or enhance the acquired technology. The Company's contracts with its
cable affiliates typically run from five to ten years. In determining how much
of the purchase price in excess of the tangible book value of Intellicom to
allocate to acquired technology, the Company considered that there was little
value ascribable to other intangible assets, such as customer lists or
workforce. Rather, the Company, after careful consideration, determined that the
fair market value of the acquired technology is equivalent to the intangible
assets acquired in this acquisition. The Company, therefore, will be amortizing
this amount by the straightline method over a period of seven years, the average
term of a typical cable affiliate contract as well as the anticipated useful
life of this acquired technology.
The following unaudited pro forma financial information presents the
consolidated results of the Company as if the Intellicom Acquisition had
occurred as of October 1, 1997, and includes adjustments for amortization of
acquired technology and interest expense related to the Debt Consideration. This
pro forma financial information does not necessarily reflect the results of
operations as they would have been if the Company had acquired the entities as
of October 1, 1997. Unaudited pro forma consolidated results of operations are
as follows (in thousands, except per share data):
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------ --------------------
1999 1998 1999 1998
---------- ---------- --------- --------
Net sales......................... $ 1,317 $ 846 $ 3,602 $ 2,690
Net loss applicable to common
shares....................... (18,689) (3,999) (35,719) (8,949)
Basic and diluted net loss
applicable to common shares... (1.27) (0.53) (3.31) (1.25)
In April 1999, the Company paid the First Promissory Note and related interest
in full with a combination of cash and equity. The Company paid $634,000 in cash
and the remainder with 11,725 shares of common stock, which had a value of
$388,000.
<PAGE>
5. Acquired Technology and Other Intangibles
Acquired technology and other intangibles consist of the following (in
thousands):
June 30, September 30,
1999 1998
---------------- ------------------
Acquired technology.................. $ 16,075 $ --
Cable affiliate launch incentives.... 11,088 --
Goodwill............................. -- 1,244
---------------- ------------------
27,163 1,244
Accumulated amortization............. (1,536) (933)
================ ==================
$ 25,627 $ 311
================ ==================
In July 1998, the Company adopted its Cable Affiliate Incentive Program (the
"Program"). This Program provides an additional incentive to the Company's cable
affiliates to launch the Company's ISP Channel, Inc. ("ISP Channel") Internet
services. Under the Program, the Company offers to pay incentive bonuses, in
cash or shares of common stock, to qualifying cable affiliates who enter into
exclusive, multiple-year contracts with ISP Channel. These launch incentives are
paid out over the life of the contract in relation to the roll-out of ISP
Channel services at each installed cable head-end. In accordance with these
terms, the Company capitalizes these cable affiliate launch incentives and
amortizes them over the life of each respective contract, typically five to ten
years.
On March 24, 1999, the Company entered into an agreement with Teleponce Cable
TV, ("Teleponce", the "Teleponce Agreement"), a cable operator in Puerto Rico,
in which the Company would issue 660,000 shares of common stock to an investor
in exchange for $15.0 million in cash and a modification of the affiliate
agreement between the Company and Teleponce, which is controlled by that
investor. During the quarter, the Company issued these shares, and recognized an
intangible asset, a cable affiliate launch incentive, in the amount of $8.9
million. This intangible asset represents the difference between the market
value per common share as of the date the Teleponce Agreement was entered into
and the cash consideration provided in the Teleponce Agreement.
During the quarter ended June 30, 1999, goodwill became fully-amortized.
6. Long-Term Debt and Debt Issuance Costs
On January 12, 1999, the Company executed an agreement with two institutional
investors whereby the Company issued $12.0 million in senior subordinated
convertible notes (the "Notes"). Such Notes bear an interest rate of 9% per year
and mature in 2001. These Notes are convertible into the Company's common stock
with an initial conversion price of $17.00 per share until July 1, 1999 and,
thereafter, at the lower of $17.00 per share (the "Initial Conversion Price")
and the lowest five-day average closing bid price of the Company's common stock
during the 30-day trading period ending one day prior to the applicable
conversion date (the "Conversion Price"). Upon issuance of the Notes, the
Company's market price of its common stock exceeded the Conversion Price,
thereby creating a beneficial conversion feature (the "Note Conversion
Benefit"). Thus, the Company has recorded additional interest expense of $1.2
million, representing the value of the Note Conversion Benefit. In connection
with these Notes, the Company issued to these investors warrants to purchase an
aggregate of 300,000 shares of the Company's common stock. These warrants have
an exercise price of $17.00 per share and expire in 2003. The fair value of
these warrants of $4.3 million is treated as issuance costs of the Notes (see
below).
In April 1999, as a result of the Secondary Offering (see Note 7), and in
conjunction with an anti-dilution provision associated with the Notes, the
Initial Conversion Price was reduced from $17.00 to $16.49 per share.
Furthermore, in order to secure three month lock-up agreements from the holders
of the Notes in conjunction with the Company's Secondary Offering (see Note 6),
the Company entered into a new arrangement with the holders of the Notes to
issue all future interest payments, beginning with the third fiscal quarter of
1999, in the form of convertible notes with substantially the same form and
features as the original Notes. Therefore, the Company has issued an additional
$270,000 in notes, representing interest for the quarter, as of June 30, 1999
(the "Interest Notes"). The issuance of these Interest Notes also resulted in a
Note Conversion Benefit. As a result, an additional $173,000 will be recognized
as additional interest expense due to this additional Note Conversion Benefit.
<PAGE>
The costs related to the issuance of the Notes and other miscellaneous
financings, including the value of the warrants issued in connection with the
Notes and other financings, were capitalized and are being amortized to interest
expense using the effective interest method over the life of the debt. These
debt issuance costs are presented as other assets, net of amortization, of $3.5
million on the accompanying consolidated condensed balance sheet as of June 30,
1999.
In February 1999, the Company issued the $2.0 million Second Promissory Note in
conjunction with the Intellicom Acquisition (see Note 4).
On February 5, 1999, a single holder of the Company's 9% convertible debentures
due 2000 converted a debenture in the face amount of $402,000 into 59,483 shares
of the Company's common stock. These 9% debentures have a conversion price of
$6.75 per share of common stock. In April 1999, additional convertible
subordinated notes, having an aggregate face amount of $86,000, were converted
into 11,268 shares of the Company's common stock. These debentures had
conversion prices ranging from $6.75 and $8.10 per share of common stock.
Long-term debt is summarized as follows (in thousands):
June 30, September 30,
1999 1998
---------------- ------------------
Revolving credit facility................ $ 2,167 $ 5,120
Senior subordinated convertible notes.... 12,270 --
Convertible subordinated notes........... 3,463 3,951
Promissory note.......................... 2,000 --
Other.................................... 1,563 690
---------------- ------------------
21,463 9,761
Less current portion..................... (3,017) (541)
----------------
==================
$ 18,446 $ 9,220
================ ==================
7. Redeemable Convertible Preferred Stock and Common Stock
Redeemable Convertible Preferred Stock
In November 1998, the Company issued an aggregate of 413,018 shares of common
stock pursuant to the conversion of the remaining 3,100.78 shares of the
Company's outstanding Series A redeemable convertible preferred stock. The
Series A redeemable convertible preferred stock, including accrued dividends,
was converted into common shares at the conversion price of $7.56 per share.
In February 1999, the Company issued an aggregate of 782,352 shares of common
stock pursuant to the conversion of the 10,251.56 shares of the Company's
outstanding Series B redeemable convertible preferred stock. The Series B
redeemable convertible preferred stock, including accrued dividends, was
converted into common shares at the conversion price of $13.20 per share.
In May 1999, the Company issued an aggregate of 853,770 shares of common stock
pursuant to the conversion of the 7,625.39 shares of the Company's outstanding
Series C redeemable convertible preferred stock, representing the last of the
Company's redeemable convertible preferred stock. The Series C redeemable
convertible preferred stock, including accrued dividends, was converted into
common shares at the conversion price of $9.00 per share. In addition, the
Company incurred a penalty of $498,000, presented as other expense on the
accompanying consolidated condensed statements of operations for the three and
nine months ended June 30, 1999, as a result of a delay in its ability to
register the underlying common stock of the Series C redeemable convertible
preferred stock with the Securities and Exchange Commission. This penalty was
paid to the holders of the Series C redeemable convertible preferred stock
through the issuance of an additional 55,378 shares of common stock.
<PAGE>
Dividends
During the quarter ended December 31, 1998, the Company declared a dividend on
both its outstanding Series B redeemable convertible preferred stock and its
outstanding Series C redeemable convertible preferred stock, payable on December
31, 1998 to the respective stockholders of record at the close of business on
December 28, 1998. Dividends for the Series B redeemable convertible preferred
stock, payable at an annual rate of 5%, were paid at the Company's option in the
form of 126.56 additional shares of the Company's Series B redeemable
convertible preferred stock. Dividends for the Series C redeemable convertible
preferred stock, payable at an annual rate of 5%, were paid at the Company's
option in the form of 94.14 additional shares of the Company's Series C
redeemable convertible preferred stock. In addition, the Company accrued for
dividends on its Series A redeemable convertible preferred stock through the
date of conversion at an annual rate of 5%. Dividends for the quarter ended
December 31, 1998, were valued at $243,000.
During the quarter ended March 31, 1999, the Company declared a dividend on its
outstanding Series C redeemable convertible preferred stock, payable on March
31, 1999 to the respective stockholders of record at the close of business on
March 26, 1999. Dividends for the Series C redeemable convertible preferred
stock, payable at an annual rate of 5%, were paid at the Company's option in
cash. In addition, the Company accrued for dividends on its Series B redeemable
convertible preferred stock through the date of conversion at an annual rate of
5%. Dividends for the quarter ended March 31, 1999, were valued at $171,000.
During the quarter ended June 30, 1999, the Company accrued for dividends on its
Series C redeemable convertible preferred stock through the date of conversion
at an annual rate of 5%. Dividends for the quarter ended June 30, 1999, were
valued at $59,000.
Common Stock
In February 1999, the Company entered into a license agreement with Inktomi
Corporation ("Inktomi", the "Inktomi Licensing Agreement") allowing the Company
rights to install certain Inktomi caching technology into the Company's cable
and satellite network infrastructure. The Inktomi Licensing Agreement is valued
at $4.0 million for a total of 500 licenses, of which the first $1.0 million was
paid with 65,843 shares of the Company's common stock and the remaining amount
is payable in cash in eight subsequent quarterly payments of $375,000 ($750,000
having been paid through June 30, 1999). The Inktomi Licensing Agreement allows
the Company to purchase up to 500 additional licenses during the first four
years of the agreement. The first licenses are expected to be installed in the
fourth quarter of fiscal 1999. These prepaid license fees of $1.75 million are
presented as other assets on the accompanying consolidated condensed balance
sheet as of June 30, 1999.
On April 12, 1999, the Company issued 660,000 shares of common stock to an
investor in exchange for $15.0 million in cash and a modification of the
affiliate agreement between the Company and Teleponce (see Note 4).
On April 13, 1999, the Company held its annual stockholders' meeting (the
"Annual Stockholders' Meeting"). At this meeting, the following proposals, among
others, were approved: (i) an increase in the number of common shares authorized
was increased from 25,000,000 to 100,000,000; (ii) the Company's 1998 Stock
Incentive Plan (the "1998 Plan") under which 3,350,668 shares of common stock
were reserved for issuance; (iii) the sale of the Company's document management
segment (see Note 2); and (iv) the Company's reincorporation in Delaware.
On April 28, 1999, the Company completed a secondary public offering (the
"Secondary Offering"), in which it sold 4,600,000 shares of common stock at
$33.00 per share. The Company received $142.0 million in cash, net of
underwriting discounts, commissions and other offering costs.
<PAGE>
8. Stock Options and Warrants
The following table summarizes the outstanding options and warrants to purchase
shares of common stock for the nine months ended June 30, 1999:
<TABLE>
<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, 1998... 1,370,125 $7.42 832,399 $9.27 2,202,524 $8.12
Granted................. 2,175,550 $15.48 303,013 $17.13 2,478,563 $15.68
Exercised............... (387,445) $6.33 (254,207) $7.62 (641,652) $6.84
Canceled................ (84,219) $11.62 (28,142) $10.12 (112,361) $11.24
----------- --------- ----------
Outstanding as of
June 30, 1999...... 3,074,011 $13.16 853,063 $12.52 3,927,074 $13.02
=========== ========= ==========
</TABLE>
In April 1999, the Company adopted the 1998 Plan and reserved 3,350,668 shares
for issuance thereunder. The 1998 Plan provides for the grants of non-qualified
and incentive stock option grants to officers, employees and other individuals.
Under the terms of the 1998 Plan, options have a maximum term of ten years from
the date of grant. The granted options have various vesting criteria depending
on the grantee; however, most grants having a vesting period of four years.
During the period from October 1998 to April 1999, the Company granted to
certain employees, pending stockholder approval, an aggregate of 1,618,550
incentive and non-qualified common stock options at a weighted average exercise
price of $12.74 per share, net of employee terminations. Primarily as a result
of the adoption of the 1998 Plan (see Note 6), and in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, the
Company will recognize a non-cash compensatory charge over the remaining vesting
period on a straightline basis totaling approximately $76.6 million relating to
the issuance of these stock options. Although all of the options issued under
the 1998 Plan were granted at what was then the fair market value of the
Company's common stock on the date of grant, the Company must recognize a
non-cash compensation charge for the difference between the various grant prices
and $59.875, the closing price of the Company's common stock on the date of
stockholder approval of the plan. Accordingly, the Company will record a total
charge of approximately $76.6 million, which will be amortized as a non-cash
compensation expense over the remaining vesting period of such stock options. As
a result, the Company recognized $5.4 million as compensation expense related to
stock options for the quarter ended June 30, 1999 for employee stock options.
In addition to employee stock options, the Company has granted stock options to
certain non-employees. In accordance with Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation, the Company
recognizes deferred compensation charges with respect to the 118,000 option
shares it has issued to certain consultants. These deferred compensation charges
are being amortized, on an accelerated basis, in accordance with Financial
Accounting Standards Board Interpretation No. 28, Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans, over the
vesting period of such options. The Company has recognized $331,000 of these
charges for the quarter ended June 30, 1999 and has $706,000 remaining as
deferred compensation related to these non-employee options as of June 30, 1999.
<PAGE>
9. Segment Information
The Company operates principally in two business segments: (i) cable-based
Internet services through its wholly-owned subsidiary, ISP Channel, and (ii)
satellite-based Internet services through its wholly-owned subsidiary,
Intellicom. The Company previously reported two other business segments:
document management and telecommunications. However, these two segments are now
reported as discontinued operations (see Note 3). Segment information for
continuing operations is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales:
Subscriber fees........................ $ 295 $ 88 $ 678 $ 193
Modem fees and other................... 196 17 459 32
Dial-up fees........................... 230 193 577 539
------------ ------------ ------------ ------------
ISP Channel......................... 721 298 1,714 764
Intellicom............................. 596 -- 1,074 --
============ ============ ============ ============
$ 1,317 $ 298 $ 2,788 $ 764
============ ============ ============ ============
Operating expenses:
Sales and marketing.................... $ 3,979 $ 869 $ 8,304 $ 1,256
Engineering............................ 1,697 172 3,162 387
General and administrative............. 2,007 695 5,785 1,149
------------ ------------ ------------ ------------
ISP Channel......................... 7,683 1,736 17,251 2,792
Intellicom............................. 714 -- 1,059 --
Corporate.............................. 95 757 198 1,629
Compensation expense related to stock
options............................. 5,680 -- 6,721 --
Depreciation and amortization.......... 1,810 234 3,737 580
============ ============ ============ ============
$ 15,982 $ 2,727 $ 28,966 $ 5,001
============ ============ ============ ============
Loss from continuing operations:
ISP Channel............................ $ (9,186) $ (1,986) $(20,248) $ (3,130)
Intellicom............................. (1,164) -- (1,769) --
Corporate.............................. (5,775) (778) (6,919) (1,692)
============ ============ ============ ============
$(16,125) $ (2,764) $(28,936) $ (4,822)
============ ============ ============ ============
</TABLE>
<PAGE>
10. Supplemental Cash Flow Information
The following is supplemental cash flow information for the nine months ended
June 30 (in thousands):
1999 1998
-------- -------
Cash paid during the period for:
Interest.................................................. $ 1,189 $ 717
Supplemental non-cash transactions:
Acquisition of Intellicom-Equity Consideration............ $ 10,819 $ --
Acquisition of Intellicom-Debt Consideration.............. 3,000 --
Acquisition of Intellicom-debt acquired................... 600 --
Notes receivable received in connection with
disposal of telecommunications segment................. 4,500 --
Shares of purchaser received in connection with
disposal of telecommunications segment................. 498 --
Common stock issued for the conversion of
redeemable convertible preferred stock................. 18,254 2,000
Common stock issued for the conversion of
subordinated notes..................................... 488 1,046
Convertible debt issued for acquisition of
equipment leases....................................... -- 1,444
Value assigned to common stock warrants issued
upon the issuance of long-term debt.................... 4,334 --
Value assigned to common stock warrants issued
upon the issuance of redeemable convertible
preferred stock........................................ -- 435
Value assigned to common stock issued in
connection with cable affiliate launch incentives ..... 8,925 --
Value assigned to conversion feature of new debt.......... 1,408 --
Repayment of short-term debt with common stock............ 388 --
Equipment acquired by capital lease....................... 4,053 326
Prepaid license fees paid with issuance of common stock... 1,000 --
Deferred compensation associated with the
issuance of common stock options....................... 78,441 --
Preferred dividends paid with the issuance of
additional redeemable convertible preferred stock...... 221 62
Preferred dividends paid with the issuance of common stock 157 6
11. Subsequent Events
On July 7, 1999, the Company and Mediacom LLC ("Mediacom"), a cable operator
based in New York, announced an exclusive agreement to deploy the Company's
Internet services throughout Medicacom's cable properties. Subject to completion
of final documents, the agreement is for ten years, with a minimum of five years
guaranteed. As compensation for Mediacom's upgrade costs, rollout commitments
and for the exclusive long-term rights to deliver the Company's Internet
services to Mediacom's customers, the Company will issue to Mediacom 3.5 million
shares of common stock, the value of which will be capitalized as an additional
intangible asset, a cable affiliate launch incentive.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. The actual results of SoftNet Systems, Inc. and its subsidiaries
could differ significantly from those set forth herein. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in "Factors Affecting the Company's Operating Results" as set forth in
the Company's annual report on Form 10-K/A for the year ended September 30,
1998, as filed with the Securities and Exchange Commission, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" as
well as those discussed elsewhere in this quarterly report. Statements contained
herein that are not historical facts are forward-looking statements that are
subject to the safe harbor created by the Private Securities Litigation Reform
Act of 1995. Words such as "believes", "anticipates", "expects", "intends" and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. A number of important
factors could cause our actual results for fiscal 1999 and beyond to differ
materially from past results and those expressed in any forward-looking
statements made by us, or on our behalf. We undertake no obligation to release
publicly the results of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
The following discussion of our financial condition and results of operations
should be read in conjunction with, and is qualified in its entirety by
reference to, our Consolidated Financial Statements and the related Notes
thereto appearing in our annual report on Form 10-K/A for the year ended
September 30, 1998, as filed with the Securities and Exchange Commission and our
Consolidated Condensed Financial Statements and related Notes thereto appearing
elsewhere in this quarterly report. Our fiscal year ends September 30 and the
first quarter of the fiscal year ends December 31. "Fiscal 1999" refers to the
twelve months ending September 30, 1999 with similar references to other twelve
month periods ending September 30.
Overview
During fiscal 1998, we made a strategic decision to focus on becoming, through
our wholly-owned subsidiary, ISP Channel, (which was formerly known as MediaCity
World, Inc.), the dominant cable-based provider of high-speed Internet access,
as well as of other digital communications services, to homes and businesses in
the franchise areas of certain small- and medium-sized cable systems. As part of
this new focus, on February 9, 1999 we completed the purchase of Intellicom, the
former Xerox Skyway Network. We believe that integrating this new technology
into our existing business plan will allow us to cost effectively provide our
ISP Channel service to smaller systems in more remote areas as well as to
certain other markets including apartment buildings, hotels, hospitals, and
schools, thereby decreasing our cost structure and increasing our potential
market size. Also in line with this strategy, we determined in 1998 to divest
our two other businesses: MTC, a wholly-owned subsidiary offering document
management solutions, and KCI, a wholly-owned subsidiary which sold and serviced
telephone systems, third party computer hardware and application-oriented
peripheral products. On February 12, 1999, we completed the divestiture of KCI.
In addition, on November 5, 1998, we entered into a letter of intent for the
sale of MTC, which we modified in March 1999. Since July 27, 1998, we have
reclassified and reported KCI in discontinued operations. On April 13, 1999, we
obtained stockholder approval to divest MTC and therefore are now treating MTC
as a discontinued operation. We have accordingly restated the Consolidated
Condensed Financial Statements appearing elsewhere in this quarterly report. On
April 28, 1999, we received $142.0 million in net proceeds from the underwritten
public sale of 4,600,000 shares of our common stock (the "Secondary Offering").
We began providing Internet services following our acquisition of ISP Channel in
June 1996. While we continue to offer the traditional dial-up Internet access
business acquired at, and built up since that time, our 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 small- and medium-sized cable television systems. We seek to enter into
exclusive multi-year agreements with cable affiliates that permit ISP Channel to
provide high-speed Internet access and other services to homes and businesses
served by these cable systems through cable modems and, in the future, through
television set-top boxes.
On February 9, 1999, we completed the purchase of Intellicom. Through use of a
proprietary satellite system that utilizes VSAT technology, 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 network provides coverage and thus allows connectivity,
throughout the 48 lower states as well as in southern Canada, southern Alaska,
Puerto Rico, Latin America and the Caribbean. Intellicom offers a wide range of
Internet services based on its proprietary service called T1 Plus, that
presently offers users up to 2 Mbps data transfer rates.
<PAGE>
Additionally, while Intellicom will continue to market its services to its
current market business, Intellicom also provides 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 its own network operations center. As of July 31, 1999, there
were 11 VSATs installed at ISP Channel's 43 operational head-ends. We believe
that integrating this new technology into our existing business plan will allow
us to cost effectively provide our ISP Channel service to smaller systems in
more remote areas as well as to certain other markets including apartment
buildings, hotels, hospitals, and schools, thereby decreasing our cost structure
and increasing our potential market size.
ISP Channel Affiliates. As of July 31, 1999, ISP Channel had contracts for
service with 42 cable operators representing over 170 cable systems and
approximately 1.79 million homes passed. A total of 43 of these systems,
representing approximately 467,000 homes passed, have been equipped and have
begun offering our services. As of July 31, 1999, the Company had over 4,700
residential and business subscribers on its ISP Channel service. On July 7,
1999, we announced an exclusive ten-year agreement to deploy ISP Channel
services throughout Mediacom's cable properties. Mediacom is one of the top ten
independent cable operators in the country whose systems, upon completion of
certain acquisitions, will pass over one million homes.
In order to further expand our cable-based Internet subscriber base, we continue
to aggressively pursue affiliation agreements with other cable operators under
which we obtain the exclusive right to market cable-based Internet services to
existing cable television subscribers in such cable operators' systems. We
anticipate that this policy of rapid deployment will result in substantial
capital expenditures, operating losses and negative cash flow in the near term.
While we believe that we currently have sufficient cash and financing sources
available to fund our operations through the year 2000, we cannot assure you,
however, that we will be able to access additional capital to finance our
strategy in the longer term or to implement our strategy or achieve positive
cash flow or profitability in a timely fashion, or at all.
ISP Channel Revenue Sources. In providing Internet services, we receive revenue
from the provision of (i) cable modem-based Internet access services and (ii)
traditional dial-up Internet access services. Currently, we or, in certain
cases, our local cable affiliate, typically charge new cable modem-based
Internet access subscribers a one-time connection fee of $99, which fee 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 $29.95 per month, and it is our expectation that such rates will decrease
over time. We currently purchase a majority of the cable modems used by
subscribers, who are charged a nominal lease or rental charge. We anticipate,
however, that the percentage of customers purchasing their own modems will
increase as modem prices continue to decrease and standardization becomes more
prevalent. We do not charge new dial-up subscribers a connection fee, but we do
charge them a monthly access fee of approximately $20.
For our cable-based Internet services, we typically give 25% of monthly access
revenues to 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, we expect to give between 25% and 50% of these revenues to the
cable affiliates. We report these revenues net of the percentage we give to our
cable affiliates. We expect to retain all revenue from cable modem lease and
rental income. Depending on competitive market conditions, these pricing and
revenue sharing parameters could change over time.
In addition to connection fees and monthly access fees, we intend to pursue
additional revenue opportunities from Internet advertising, e-commerce and
Internet-based telephony. We also intend to pursue long distance telephone
services and telephony debit and credit cards.
In the future, as digital set-top boxes become available and are introduced into
our affiliated cable systems, we expect to charge those subscribers monthly
access fees comparable to those now charged to traditional dial-up subscribers.
We also expect to charge customers a set-top connection fee to help defray
installation expenses.
<PAGE>
Intellicom Revenue Sources. Intellicom provides a comprehensive range of
products and services, supported by a stable, low-cost VSAT system, based on
two-way satellite technology, that are primarily intended to provide high-speed
access to the Internet. Connectivity services are provided through a range of
VSAT options for customers requiring broadband access to the Internet. These
customers execute term service agreements and are typically charged a one-time
installation fee of $3,000 per site. Intellicom then receives monthly recurring
access fees typically ranging from $1,350 to $3,300 per month per site based on
data transfer rates. These customers then provide dial-up connectivity to their
end-user base using Intellicom as their primary gateway to the Internet and rely
on Intellicom to connect, secure and maintain their network integrity. Unlike
its competitors, Intellicom designs and out-sources the manufacture of its VSAT
equipment specifically for its applications.
Intellicom also sells a variety of products and services, including the Edge
Connector (TM) which is a turnkey Internet server with an integrated series of
application software packages and CachePlus (TM), Intellicom's network caching
solution. All of these products and services are integrated to provide customers
with a total solution to their Internet application needs.
Finally, Intellicom also provides traditional data processing services to a
number of large commercial users. This business is considered a legacy business
and is expected to end in the fourth fiscal quarter of 1999.
Cost of Services. Costs to us include installation costs, connectivity costs and
in the case of cable modems that are sold or financed, the cost of such modems.
Installation costs vary by type of connectivity and type of customer. We charge
new cable modem 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 us, we expect over time that installation
costs will decline as cable modems become more standardized and as they become
commercially available both through retail outlets and eventually as standard
equipment bundled in new personal computers.
Connectivity costs include the cost of connection to the public switch telephone
network. Such connections are required, among other reasons, to service our
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 our equipment located
at the cable operator's head-end. Accordingly, we incur higher costs associated
with providing our services through one-way cable systems. Consequently, the
rate at which our cable affiliates upgrade their cable systems to two-way
capability will have a direct impact on our profit margins.
In addition, we incur telecommunications costs associated with our Internet
backbone connectivity as well as costs associated with leasing
telecommunications capacity such as fiber where such capacity is used, among
other things, to link our equipment at the cable system head-end back to our
network operations center in Mountain View, California. We also incur expenses
associated with satellite capacity required for Intellicom, which is leased from
GE Americom and Satmex. We anticipate that the utilization of Intellicom's
network as a substitute for third party terrestrial links will provide
significant cost savings to us as it grows. There are two major cost benefits to
us in using Intellicom's VSAT capacity to supplement or replace our current
landline-based communications infrastructure. First, for downstream Internet
traffic, it enables us to simultaneously broadcast data from one single source
to our entire network of head-end-based receivers which, in conjunction with
other factors including "caching" produces significant efficiencies over
comparable landline systems. Second, for upstream traffic, it permits us to
allocate the necessary capacity required by each head-end in smaller increments
(and consequently lower cost) than would be available using terrestrial links,
such as T1 lines.
Operating Expenses. Operating expenses include (i) sales and marketing expense,
which consists primarily of salaries, commission, and promotional expenses
associated with the direct marketing and sales effort, as well as the expenses
associated with telemarketing, customer care and new business development; (ii)
engineering expense, which consists primarily of salaries and related costs
associated with our network operations center, field engineering and research
staff; and (iii) general and administrative expense, which consists primarily of
salaries and associated professional costs related to our executive, finance,
legal, human resources and other administrative functions. We expect operating
expenses to continue to increase as we ramp-up our efforts associated with
increasing cable modem customer penetration in our existing markets, and as we
grow our business by introducing our services in new markets.
<PAGE>
Also included in operating expenses is depreciation and amortization.
Amortization expense includes the capitalized costs associated with our cable
affiliate incentive program, as well as the costs associated with goodwill and
other intangible assets. As a result of the Intellicom acquisition, we recorded
a significant amount of intangible assets, classified as acquired technology,
which will adversely affect our earnings and profitability for the foreseeable
future. If the amount of such recorded acquired technology is increased or we
have future losses and are unable to demonstrate our ability to recover the
amount of acquired technology recorded during such time periods, the period of
amortization could be shortened, which may further increase amortization
charges.
Compensation Expense Related to Stock Options. We record non-cash compensation
expense related to the value attributed to common stock options granted to
non-employees. The non-vested portions of these option grants are revalued on a
quarterly basis with respect to the then current fair market value of our common
stock using the Black-Scholes method. These non-cash compensation expenses are
then amortized over their respective vesting periods, which is typically three
years.
In addition to the above, during the period from October 1998 to April 1999, the
Company granted to certain employees, pending stockholder approval, an aggregate
of 1,618,550 incentive and non-qualified common stock options at a weighted
average exercise price of $12.74 per share, net of employee terminations.
Following approval of the 1998 Stock Incentive Plan at the annual stockholders'
meeting, the Company will recognize a non-cash compensatory charge over the
remaining vesting period totaling approximately $76.6 million relating to the
issuance of these stock options. Although all of the options issued under the
1998 Stock Incentive Plan were granted at what was then the fair market value of
the Company's common stock on the date of grant, the Company must recognize a
non-cash compensation charge for the difference between the various grant prices
and $59.875, the closing price of the Company's common stock on the date of the
annual stockholders' meeting.
Capital Expenditures. In order to pursue our business plan, we expect to incur
significant capital expenditures to provide our turnkey solution for cable
operators, principally relating to the installation of head-end equipment and
the purchase of customer premise equipment such as cable modems and satellite
service related equipment. The cost of cable modems is expected to decline over
time as economies of scale in production and the advent of new market entrants
in manufacturing cable modems push prices down. However, we recognize that, in
line with experience in other subscription service industries, we may need to
subsidize both the cost of installation and the cable modem equipment for the
customer. 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.
Results of operations for the Three Months Ended June 30, 1999 compared to the
Three Months Ended June 30, 1998
Net Sales. Consolidated net sales increased $1.0 million, or 342%, to $1.3
million for the three months ended June 30, 1999, as compared to $298,000 for
the same period in 1998. Net sales for ISP Channel increased $423,000, or 142%,
to $721,000 for the three months ended June 30, 1999, as compared to $298,000
for the same period in 1998, as a result of signing up new cable affiliates and
obtaining new cable modem customers. Net sales associated with ISP Channel's
subscriber fees increased $207,000, or 235%, to $295,000 for the three months
ended June 30, 1999, as compared to $88,000 for the same period in 1998. Net
sales associated with the installation of cable modems to ISP Channel
subscribers increased $179,000 to $196,000 for the three months ended June 30,
1999, as compared to $17,000 for the same period in 1998. We believe that
subscriber fee and cable modem installation revenues will continue to increase
as ISP Channel continues to rollout its business plan. Net sales associated with
the segment's non-cable based dial-up and business-to-business Internet access
offerings increased $37,000, or 19%, to $230,000 as compared to $193,000 for the
same period in 1998.
In addition to the net sales of ISP Channel, our consolidated net sales for the
quarter ended June 30, 1999 now include the results of Intellicom, which we
acquired in February 1999. Net sales for Intellicom for the three months ended
June 30, 1999, were $596,000. Of this total, $314,000 represents net sales from
Intellicom's core business of satellite-based Internet services. The remaining
$282,000 represents other sources of revenue, of which the biggest component was
$196,000 from non-satellite-based data processing, a legacy business for
Intellicom. We believe that satellite-based revenues will grow in the future
while data processing revenues are expected to end during the fourth fiscal
quarter of 1999.
<PAGE>
Cost of Sales. Consolidated cost of sales increased $1.1 million, or 336%, to
$1.5 million for the three months ended June 30, 1999, as compared to $335,000
for the same period in 1998. Cost of sales for ISP Channel increased $665,000,
or 199%, to $1.0 million for the three months ended June 30, 1999, as compared
to $335,000 for the same period in 1998, as a result of the corresponding growth
in net sales. The single largest component of ISP Channel's cost of sales are
telephony costs, which amounted to $695,000 for the quarter ended June 30, 1999
as compared to $286,000 for the same period in 1998. We believe that these costs
will remain the same or decrease as a percentage of total net sales as ISP
Channel expects to realize some degree of cost savings in its telephony charges
due to the replacement of high cost terrestrial telephone links in certain areas
with Intellicom's satellite-based technology, which has a lower cost basis in
most cases.
In addition to the cost of sales of ISP Channel, our consolidated cost of sales
for the quarter ended June 30, 1999 now include the results of Intellicom, which
we acquired in February 1999. Cost of sales for Intellicom for the three months
ended June 30, 1999 were $460,000. The single largest component of Intellicom's
cost of sales are the transponder fees that it pays for leased satellite
capacity, which amounted to $266,000 for the quarter ended June 30, 1999. We
believe that these costs will increase as Intellicom has plans to lease segment
space on additional satellites in the future in anticipation of a more
aggressive roll-out of Intellicom's business plan.
Selling and Marketing. Consolidated selling and marketing expenses increased
$3.3 million, or 383%, to $4.2 million for the three months ended June 30, 1999,
as compared to $869,000 for the same period in 1998. Selling and marketing
expenses for ISP Channel increased $3.1 million, or 358%, to $4.0 million for
the three months ended June 30, 1999, as compared to $869,000 for the same
period in 1998. The significant growth in ISP Channel's selling and marketing
expense is a result of the significant hiring that we have done to properly
staff these departments. In addition, ISP Channel launched its first-ever
nationwide marketing campaign, "Run with the Fast Crowd" in an effort to add
subscribers, as well as to attract new cable affiliates. We believe that these
costs will continue to increase as ISP Channel continues to develop its business
and enhance its sales efforts with recurring nationwide marketing campaigns.
In addition to the selling and marketing expenses of ISP Channel, our
consolidated selling and marketing expenses now include the results of
Intellicom, which we acquired in February 1999. Selling and marketing expenses
for Intellicom for the three months ended June 30, 1999 were $217,000. We
believe that these costs will increase as Intellicom begins to staff these
functions in anticipation of rolling out its business plan to generate new
customers.
Engineering. Consolidated engineering expenses increased $1.7 million, or 979%,
to $1.9 million for the three months ended June 30, 1999, as compared to
$172,000 for the same period in 1998. Engineering expenses for ISP Channel
increased $1.5 million, or 886%, to $1.7 million for the three months ended June
30, 1999, as compared to $172,000 for the same period in 1998. The growth in ISP
Channel's engineering expense is a result of the hiring that we have done to
properly staff this department as ISP Channel continues to grow. We believe that
these costs will continue to increase as ISP Channel continues to develop its
business.
In addition to the engineering expenses of ISP Channel, our consolidated
engineering expenses now include the results of Intellicom, which we acquired in
February 1999. Engineering expenses for Intellicom for the three months ended
June 30, 1999 were $160,000. We believe that these costs will increase as
Intellicom begins to staff these functions in anticipation of rolling out its
business plan to generate new customers.
General and Administrative. Consolidated general and administrative expenses
increased $987,000, or 68%, to $2.4 million for the three months ended June 30,
1999, as compared to $1.5 million for the same period in 1998. Our corporate and
ISP Channel general and administrative expenses increased $650,000, or 45%, to
$2.1 million for the three months ended June 30, 1999, as compared to $1.5
million for the same period in 1998. The growth in our corporate and ISP Channel
general and administrative expense is a result of the hiring that we have done
to properly staff our administrative, executive and finance departments as we
continue to grow. We believe that these costs will continue to increase as a
result of the continued expansion of our administrative staff and facilities to
support growing operations.
In addition to the general and administrative expenses of ISP Channel and our
corporate operations, our consolidated general and administrative expenses now
include the results of Intellicom, which we acquired in February 1999. General
and administrative expenses for Intellicom for the three months ended June 30,
1999 were $337,000. We believe that these costs will increase as Intellicom
begins to staff these functions to support growing operations.
<PAGE>
Depreciation and Amortization. Consolidated depreciation and amortization
expenses increased $1.6 million, or 674%, to $1.8 million for the three months
ended June 30, 1999, as compared to $234,000 for the same period in 1998.
Depreciation and amortization for ISP Channel and our corporate operations
increased $939,000, or 401%, to $1.2 million for the three months ended June 30,
1999, as compared to $234,000 for the same period in 1998 as a result of
increased depreciation on expanded property, plant and equipment as well as
amortization of costs associated with ISP Channel's Cable Affiliates Incentive
Program. We believe that these expenses will increase as we continue to expand
our facilities and continue to offer additional incentives to acquire new cable
affiliates. In particular, we expect the amortization of the intangible asset
associated with ISP Channel's Cable Affiliates Incentive Program to increase
significantly as a result of the agreement with Mediacom and other new cable
affiliates.
In addition to the depreciation and amortization expenses of ISP Channel and our
corporate operations, our consolidated depreciation and amortization expenses
now include the results of Intellicom, which we acquired in February 1999.
Depreciation and amortization expenses for Intellicom for the three months ended
June 30, 1999 were $637,000, of which $574,000 represents amortization of
acquired technology, the intangible asset created by the acquisition of
Intellicom. We believe that depreciation will increase as Intellicom continues
to expand its facilities, while amortization is expected to remain the same.
Compensation Expense Related to Stock Options. For the three months ended June
30, 1999, we recognized a non-cash compensation expense related to stock options
of $5.7 million, of which $5.4 million related to employee stock options and
$300,000 to non-employees. Generally accepted accounting principles require that
options issued to non-employees be "marked-to-market" until such time as the
options have been earned. Therefore, we expect this amount to either increase or
decrease based on the fluctuations in the trading price of our common stock. The
amount related to employee stock options is expected to remain about the same in
future quarters.
Interest Expense. Consolidated interest expense increased $2.2 million, or 905%,
to $2.5 million for the three months ended June 30, 1999, as compared to
$244,000 for the same period in 1998. This was a result of increased lease
financing associated with the capital expansion needs of ISP Channel as well as
increased debt at the corporate level, including the $12.0 million of
convertible subordinated loan notes issued in January 1999, amortization of
deferred debt issuance costs associated with these loan notes, and finally the
promissory notes issued in connection with the acquisition of Intellicom in
February 1999.
Interest Income. Consolidated interest income was $1.3 million for the three
months ended June 30, 1999, as compared to $32,000 for the same period in 1998.
This increase was primarily due to the increased cash and cash equivalent
balances from the proceeds of the Secondary Offering.
Other. Other expense was $1.4 million for the three months ended June 30, 1999,
as compared to $49,000 for the same period in 1998. This increase was primarily
a result of the indirect expenses associated with the Company's financing
activities, including the Secondary Offering, as well as the penalty incurred in
connection with the Series C redeemable convertible preferred stock.
Income Taxes. We made no provision for income taxes for the three months ended
June 30, 1999, as a result of our continuing losses.
Loss from Discontinued Operations. We recognized a net loss of $15,000 from
discontinued operations for the three months ended June 30, 1999 as compared to
$32,000 for the same period in 1998. This consisted of a net loss in our
document management segment of $15,000 for the three months ended June 30, 1999,
as compared to a net loss of $285,000 in the document management segment and net
income of $253,000 in the telecommunications segment for the same period in
1998. Our telecommunications segment, KCI, sold substantially all of its assets
in February 1999. Operations from this discontinued operation ceased on the date
of disposition.
Net Loss. For the three months ended June 30, 1999, we had a net loss applicable
to common shares of $18.7 million, or a loss per share of $1.27, compared to a
net loss of $3.1 million for the same period in 1998, or a loss per share of
$0.42.
<PAGE>
Results of operations for the Nine Months Ended June 30, 1999 compared to the
Nine Months Ended June 30, 1998
Net Sales. Consolidated net sales increased $2.0 million, or 265%, to $2.8
million for the nine months ended June 30, 1999, as compared to $764,000 for the
same period in 1998. Net sales for ISP Channel increased $950,000, or 124%, to
$1.7 million for the nine months ended June 30, 1999, as compared to $764,000
for the same period in 1998, as a result of signing up new cable affiliates and
obtaining new subscribers. Net sales associated with ISP Channel's subscriber
fees increased $485,000, or 251%, to $678,000 for the nine months ended June 30,
1999, as compared to $193,000 for the same period in 1998. Net sales associated
with the installation of cable modems to ISP Channel subscribers increased
$427,000 to $459,000 for the nine months ended June 30, 1999, as compared to
$32,000 for the same period in 1998. We believe that subscriber fee and cable
modem installation revenues will continue to increase as ISP Channel continues
to rollout its business plan. Net sales associated with the segment's non-cable
based dial-up and business-to-business Internet access offerings increased
$38,000 to $577,000 as compared to $539,000 for the same period in 1998.
In addition to the net sales of ISP Channel, our consolidated net sales for the
quarter ended June 30, 1999 now include the results of Intellicom, which we
acquired in February 1999. Net sales for Intellicom from the date of acquisition
through June 30, 1999, were $1.1 million. Of this total, $527,000 represents net
sales from Intellicom's core business of satellite-based Internet services. The
remaining $547,000 represents other sources of revenue, of which the biggest
component was $324,000 from non-satellite-based data processing, a legacy
business for Intellicom. We believe that satellite-based revenues will grow in
the future while data processing revenues are expected to end in the fourth
fiscal quarter of 1999.
Cost of Sales. Consolidated cost of sales increased $2.2 million, or 371%, to
$2.8 million for the nine months ended June 30, 1999, as compared to $585,000
for the same period in 1998. Cost of sales for ISP Channel increased $1.4
million, or 238%, to $2.0 million for the nine months ended June 30, 1999, as
compared to $585,000 for the same period in 1998, as a result of the
corresponding growth in net sales. The single largest component of ISP Channel's
cost of sales are telephony costs, which amounted to $1.5 million for the nine
months ended June 30, 1999 as compared to $519,000 for the same period in 1998.
We believe that these costs will remain the same or decrease as a percentage of
total net sales as ISP Channel expects to realize some degree of cost savings in
its telephony charges due to the replacement of expensive T1 lines in certain
areas with Intellicom's satellite-based technology, which has a lower cost basis
in most cases.
In addition to the cost of sales of ISP Channel, our consolidated cost of sales
for the nine months ended June 30, 1999 now include the results of Intellicom,
which we acquired in February 1999. Cost of sales for Intellicom from the date
of acquisition through June 30, 1999 were $781,000. The single largest component
of Intellicom's cost of sales are the transponder fees that it pays for leased
satellite capacity, which amounted to $439,000 for the nine months ended June
30, 1999. We believe that these costs will increase as Intellicom has plans to
lease segment space on additional satellites in the future in anticipation of a
more aggressive roll-out of Intellicom's business plan.
Selling and Marketing. Consolidated selling and marketing expenses increased
$7.3 million to $8.6 million for the nine months ended June 30, 1999, as
compared to $1.3 million for the same period in 1998. Selling and marketing
expenses for ISP Channel increased $7.0 million to $8.3 million for the nine
months ended June 30, 1999, as compared to $1.3 million for the same period in
1998. The significant growth in ISP Channel's selling and marketing expense is a
result of the significant hiring that we have done to properly staff these
departments. In addition, ISP Channel launched its first-ever nationwide
marketing campaign, "Run with the Fast Crowd" in an effort to add subscribers,
as well as to attract new cable affiliates. We believe that these costs will
continue to increase as ISP Channel continues to develop its business and
enhance its sales efforts with recurring nationwide marketing campaigns.
In addition to the selling and marketing expenses of ISP Channel, our
consolidated selling and marketing expenses now include the results of
Intellicom, which we acquired in February 1999. Selling and marketing expenses
for Intellicom from the date of acquisition through June 30, 1999 were $262,000.
We believe that these costs will increase as Intellicom begins to staff these
functions in anticipation of rolling out its business plan to generate new
customers.
<PAGE>
Engineering. Consolidated engineering expenses increased $2.9 million, or 759%,
to $3.3 million for the nine months ended June 30, 1999, as compared to $387,000
for the same period in 1998. Engineering expenses for ISP Channel increased $2.8
million, or 717%, to $3.2 million for the nine months ended June 30, 1999, as
compared to $387,000 for the same period in 1998. The growth in ISP Channel's
engineering expense is a result of the hiring that we have done to properly
staff this department as we continue to grow. We believe that these costs will
continue to increase as ISP Channel continues to develop its business.
In addition to the engineering expenses of ISP Channel, our consolidated
engineering expenses now include the results of Intellicom, which we acquired in
February 1999. Engineering expenses for Intellicom from the date of acquisition
through June 30, 1999 were $163,000. We believe that these costs will increase
as Intellicom begins to staff these functions in anticipation of rolling out its
business plan to generate new customers.
General and Administrative. Consolidated general and administrative expenses
increased $3.8 million, or 138%, to $6.6 million for the nine months ended June
30, 1999, as compared to $2.8 million for the same period in 1998. Our corporate
and ISP Channel general and administrative expenses increased $3.2 million, or
115%, to $6.0 million for the nine months ended June 30, 1999, as compared to
$2.8 million for the same period in 1998. The growth in our corporate and ISP
Channel general and administrative expenses are a result of the hiring that the
we have done to properly staff our administrative, executive and finance
departments as we continue to grow. We believe that these costs will continue to
increase as a result of the continued expansion of our administrative staff and
facilities to support growing operations.
In addition to the general and administrative expenses of ISP Channel and our
corporate operations, our consolidated general and administrative expenses now
include the results of Intellicom, which we acquired in February 1999. General
and administrative expenses for Intellicom from the date of acquisition through
June 30, 1999 were $633,000. We believe that these costs will increase as
Intellicom begins to staff these functions to support growing operations.
Depreciation and Amortization. Consolidated depreciation and amortization
expenses increased $3.2 million, or 544%, to $3.7 million for the nine months
ended June 30, 1999, as compared to $580,000 for the same period in 1998.
Depreciation and amortization for ISP Channel and corporate overhead increased
$2.1 million, or 362%, to $2.7 million for the nine months ended June 30, 1999,
as compared to $580,000 for the same period in 1998 as a result of increased
depreciation on expanded property, plant and equipment as well as amortization
of costs associated with ISP Channel's Cable Affiliates Incentive Program. We
believe that these expenses will increase as we continue to expand our
facilities and continues to offer additional incentives to acquire new cable
affiliates. In particular, we expect the amortization of the intangible asset
associated with ISP Channel's Cable Affiliates Incentive Program to increase
significantly as a result of the agreement with Mediacom and other new cable
affiliates.
In addition to the depreciation and amortization expenses of ISP Channel and our
corporate operations, our consolidated depreciation and amortization expenses
now include the results of Intellicom, which we acquired in February 1999.
Depreciation and amortization expenses for Intellicom from the date of
acquisition through June 30, 1999 were $1.1 million, of which $957,000
represents amortization of acquired technology, the intangible asset created by
the acquisition of Intellicom. We believe that depreciation will increase as
Intellicom continues to expand its facilities, while amortization is expected to
remain the same.
Compensation Expense Related to Stock Options. For the nine months ended June
30, 1999, we recognized a non-cash compensation expense related to stock options
of $6.7 million, of which $5.4 million related to employee stock options and
$1.3 million to non-employees. Generally accepted accounting principles require
that options issued to non-employees be "marked-to-market" until such time as
the options have been earned. Therefore, we expect this amount to either
increase or decrease based on the fluctuations in the trading price of our
common stock. The amount related to employee stock options is also expected to
increase in future periods as this expense only began to be incurred in April of
1999.
Interest Expense. Consolidated interest expense increased $2.9 million, or 430%,
to $3.6 million for the nine months ended June 30, 1999, as compared to $676,000
for the same period in 1998. This was a result of increased lease financing
associated with the capital expansion needs of ISP Channel as well as increased
debt at the corporate level, including the $12.0 million of convertible
subordinated loan notes issued in January 1999, amortization of deferred debt
issuance costs associated with these loan notes including the value attributed
to the beneficial conversion feature of the loan notes, and finally the
promissory notes issued in connection with the acquisition of Intellicom in
February 1999.
Interest Income. Consolidated interest income was $1.6 million for the nine
months ended June 30, 1999, as compared to $40,000 for the same period in 1998.
This increase was primarily due to the increased cash and cash equivalent
balances from the proceeds of the Secondary Offering.
<PAGE>
Other. Other expense was $1.4 million for the nine months ended June 30, 1999,
as compared to $48,000 for the same period in 1998. This increase was primarily
a result of the indirect expenses associated with the Company's financing
activities, including the Secondary Offering, as well as the penalty incurred in
connection with the Series C redeemable convertible preferred stock.
Income Taxes. We made no provision for income taxes for the nine months ended
June 30, 1999, as a result of our continuing losses.
Loss from Discontinued Operations. We recognized a net loss of $399,000 from
operations of our discontinued telecommunications and document management
segments for the nine months ended June 30, 1999 as compared to a net loss of
$1.1 million for the same period in 1998. This consisted of a net loss in our
document management segment of $568,000 for the nine months ended June 30, 1999,
as compared to $1.5 million for the same period in 1998 and net income in our
telecommunications segment of $169,000 for the nine months ended June 30, 1999,
as compared to $368,000 for the same period in 1998. Our telecommunications
segment, KCI, sold substantially all of its assets in February 1999. Net income
from this discontinued operation is only through the date of disposition.
Net Loss. For the nine months ended June 30, 1999, we had a net loss applicable
to common shares of $33.2 million, or a loss per share of $3.07, compared to a
net loss of $6.8 million for the same period in 1998, or a loss per share of
$0.95.
Liquidity and Capital Resources
Prior to the third fiscal quarter of this year, our growth had been funded
through a combination of private equity, bank debt and lease financings.
However, in April 1999, we successfully completed both a $15.0 million equity
placement with one of our cable affiliates and a secondary public offering which
contributed an additional $142.0 million in net proceeds. As of June 30, 1999,
the Company had approximately $152.0 million of unrestricted cash. We believe,
as a result of this, that we currently have sufficient cash and financing
commitments to meet our funding requirements for our current business plan
through at least fiscal 2000. However, we have experienced and continue to
experience negative operating margins and negative cash flow from operations, as
well as an ongoing requirement for substantial additional capital investment. We
expect that we will need to raise additional capital to accomplish our business
plan beyond the next two years. Our future cash requirements for our business
plan expansion will depend on a number of factors including (i) the cost of
attracting and signing up new cable affiliates, (ii) cable modem and associated
costs of equipment, (iii) the rate at which subscribers purchase our Internet
service offering and the pricing of these services, (iv) the level of marketing
required to acquire and retain subscribers and to attain a competitive position
in the marketplace, (v) the rate at which we enter new markets and introduce new
services and (vi) the rate at which we invest in the upgrade of our network. In
addition, we may in the future wish to selectively pursue possible acquisitions
of businesses, technologies, content or products that complement our own in
order to expand and improve our Internet presence and achieve operating
efficiencies.
We recognize that the cable and Internet segments in which we operate are
rapidly evolving and converging, as evidenced by the high degree of recent
consolidation within the cable industry and the many acquisitions and strategic
alliances within both the cable and Internet sectors. We believe that we can
become a significant player in this process and that we have unique and
attractive attributes that differentiate us from other companies. However, to
fully exploit future opportunities, we also recognize that our present financial
position, though sufficient for our current business plan, may be insufficient
to avail ourselves of these opportunities.
<PAGE>
For the nine months ended June 30, 1999, cash flows used in operating activities
of continuing operations were $19.6 million, as compared to $3.1 million for the
same period in 1998. Cash flows used in investing activities of continuing
operations were $8.9 million for the nine months ended June 30, 1999, as
compared to $2.0 million for the same period in 1998. Cash flows provided by
financing activities of continuing operations were $168.3 million for the nine
months ended June 30, 1999, as compared to cash flows provided by financing
activities of continuing operations of $16.1 million for the same period in
1998.
During February 1999, a single holder of our 9% Convertible Subordinated
Debentures due September 2000 converted a debenture in the face amount of
$401,516 into 59,483 shares of our common stock. These 9% debentures have a
conversion price of $6.75 per share. In addition, during February 1999, the
Company issued an aggregate of 782,352 shares of common stock pursuant to the
conversion of the remaining 10,251.56 shares of the Company's outstanding Series
B redeemable convertible preferred stock. The Series B redeemable convertible
preferred stock, including accrued dividends, was converted into common shares
at the conversion price of $13.20 per share.
On March 24, 1999, we agreed to issue 660,000 shares of our common stock to an
investor for $15.0 million and a modification of the affiliate agreement between
us and a cable affiliate controlled by that investor. This transaction was
completed on April 12, 1999.
On April 28, 1999, we received $142.0 million in net proceeds from the
underwritten public sale of 4,600,000 shares of our common stock. This
transaction was lead managed by BT Alex. Brown and co-managed by BancBoston
Robertson Stephens and CIBC World Markets.
Wit Capital Corporation served as e-manager on this transaction.
In May 1999, the Company issued an aggregate of 909,148 shares of common stock
pursuant to the conversion of the 7,625.39 shares of the Company's outstanding
Series C redeemable convertible preferred stock, representing the last of the
Company's redeemable convertible preferred stock. The Series C redeemable
convertible preferred stock, including accrued dividends and penalties, was
converted into common shares at the conversion price of $9.00 per share. As of
June 30, 1999, there was no redeemable convertible preferred stock outstanding.
Acquisition of Intellicom. On February 9, 1999, we completed the purchase of
Intellicom. The purchase price was comprised of: (i) a cash component of
$500,000, less payment of certain expenses, paid at closing; (ii) a promissory
note in the amount of $1.0 million due one year after closing, which was paid in
full with a combination of cash and common stock in April 1999; (iii) a
promissory note in the amount of $2.0 million due two years after closing; (iv)
the issuance of 500,000 shares of our common stock (adjustable upwards after one
year in certain circumstances); and (v) a demonstration bonus of $1.0 million
payable in cash or shares of our common stock at our option within one year
after closing if certain conditions are met. Approximately $300,000 of the $1.0
million note is payable in cash or in our common stock at our option, while the
balance of this note is payable in cash or in our common stock at the option of
the holders. The entire amount of the $2.0 million note is payable in cash or in
our common stock at our option.
Sale of KCI. On February 12, 1999, substantially all of the assets of KCI were
sold to Convergent Communications for an aggregate purchase price of
approximately $6.3 million subject to adjustment in certain events. Convergent
Communications paid $100,000 in cash in November 1998 upon execution of the
letter of intent to purchase and paid the remainder of the purchase price on the
closing date as follows: (i) $1.4 million in cash; (ii) approximately 30,000
shares of Convergent Communications' parent company common stock with an agreed
value of approximately $300,000 (the "Convergent Shares"); (iii) a promissory
note in the amount of $2.0 million, bearing simple interest at the rate of
eleven percent per annum, which was paid in full in July 1999; (iv) a promissory
note in the amount of $1.0 million which is payable on the date that is 12
months following the closing date and bears simple interest at the rate of eight
percent per annum; and (v) a promissory note in an amount of $1.5 million,
bearing simple interest at the rate of eight percent per annum, which was paid
in full in July 1999. Furthermore, a purchase price adjustment subsequent to
closing provided the Company with additional Convergent Shares with an agreed
value of $198,000. The initial cash proceeds received from the sale of KCI were
used to pay down our revolving credit facility with West Suburban Bank.
Sale of MTC. On November 5, 1998, we agreed to sell our document management
business, MTC to Global Information Distribution GmbH ("GID") for an aggregate
purchase price of approximately $5.1 million. GID paid $100,000 as a
non-refundable deposit upon acceptance of the GID term sheet. GID will pay us
the remaining $5.0 million at the closing. The cash proceeds from the sale of
MTC will be used in part to repay our revolving credit facility with West
Suburban Bank. As of June 30, 1999 there was approximately $2.2 million
outstanding under this facility. The balance of the proceeds will be used to pay
for transaction costs associated with the sale of MTC and to increase our cash
position. We cannot assure, however, that the sale of MTC will close on the
terms described or at all.
<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 Information Systems 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 have completed the Inventory, Assessment and Planning Phases of substantially
all critical internal business systems. The Execution and Validation Phases will
be completed by the fourth quarter of fiscal 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 the fourth quarter of calendar 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.
<PAGE>
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.
Cost to Ad0dress 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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to
the increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of interest
expense we must pay with respect to our 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. We do not use derivative financial instruments in our
investment portfolio. We ensure the safety and preservation of our invested
principal funds by limiting default risks, market risk and reinvestment risk. We
mitigate default risk by investing in safe and high-credit quality securities.
PART II. OTHER INFORMATION
Item 2. Changes in Securities.
On March 24, 1999, we agreed to issue 660,000 shares of our common stock to an
investor for $15,000,000 and a modification of the affiliate agreement between
us and a cable affiliate that the investor controls. We issued these shares on
April 12, 1999. These securities were issued in a nonpublic offering pursuant to
Regulation D under the Securities Act.
On April 6, 1999, we issued 2,240 shares of common stock to one investor upon
the conversion of $15,120 principal amount of our 9% convertible debentures due
2000. These debentures have a conversion price of $6.75 per share. These
securities were issued pursuant to an exemption under Section 3(a)(9) of the
Securities Act.
On April 12, 1999, we issued 35 shares of common stock to one investor upon the
conversion of $240 principal amount of our 9% convertible debentures due 2000.
These debentures have a conversion price of $6.75 per share. These securities
were issued pursuant to an exemption under Section 3(a)(9) of the Securities
Act.
<PAGE>
On April 13, 1999, our stockholders approved our reincorporation from New York
to Delaware and approved an increase in our authorized number of shares of
common stock from 25,000,000 to 100,000,000. On April 14, 1999, we effectuated
the reincorporation by completing the merger of SoftNet Systems, Inc., a New
York corporation, into its wholly-owned subsidiary, SoftNet Systems, Inc., a
Delaware corporation. A discussion of the differences of the rights of
stockholders under Delaware and New York law and the effect of the increase in
our authorized shares of common stock is contained in proposals two and six of
our Definitive Proxy Statement on Form 14A for our 1999 annual meeting of
stockholders, which are incorporated by reference herein.
On April 13, 1999, we issued 7,407 shares of common stock to one investor upon
the conversion of $60,000 principal amount of our 6% convertible debentures due
2002. These debentures have a conversion price of $8.10 per share. These
securities were issued pursuant to an exemption under Section 3(a)(9) of the
Securities Act.
On April 29, 1999, we issued 1,586 shares of common stock to one investor upon
the conversion of $10,710 principal amount of our 9% convertible debentures due
2000. These debentures have a conversion price of $6.75 per share. These
securities were issued pursuant to an exemption under Section 3(a)(9) of the
Securities Act.
On May 12, 1999, we issued 6,118 shares of common stock to the former
shareholders of Intelligent Communications, Inc. ("Intellicom") in connection
with the accelerated payout of a $1.0 million promissory note issued to such
shareholders as part of the consideration paid upon acquiring Intellicom. These
securities were issued in a non-public offering pursuant to Section 4(2) of the
Securities Act.
On May 25, 1999, we issued 909,148 shares of common stock to two investors in
connection with the conversion of 7,625.39 shares, which were all of the
outstanding shares, of Series C redeemable convertible preferred stock. These
securities had a conversion price of $9.00 per share. These securities were
issued pursuant to an exemption under Section 3(a)(9) of the Securities Act.
Item 4. Submission of Matters to a Vote of Security Holders.
We held our annual meeting of stockholder's on April 13, 1999. The results of
such meeting were reported in our Quarterly Report on Form 10-Q for the period
ended March 31, 1999, as filed with the Securities and Exchange Commission on
May 17, 1999.
Item 5. Other Information
FACTORS AFFECTING THE COMPANY'S OPERATING RESULTS
The risks and uncertainties described below are not the only ones that we face.
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.
We cannot assure you that we will be profitable because we have operated our
Internet services business only for a short period of time
We are in the process of selling our one remaining non-Internet related
subsidiary to focus on substantial expansion of our Internet subsidiares, ISP
Channel and Intellicom. We cannot assure you that our ability to develop or
maintain strategies and business operations for our Internet services will
achieve positive cash flow and profitability. We acquired ISP Channel in June
1996 and Intellicom in February 1999. As such, we have very limited operating
history and experience in the Internet services business. The successful
expansion of both the ISP Channel and Intellicom services will require
strategies and business operations that differ from those we have historically
employed. 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.
Our business may fail if the industry as a whole fails or our products and
services do not gain commercial acceptance
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 and none of the companies offering
such services are currently profitable. It is currently very difficult to
predict whether providing cable-modem Internet services will become a viable
industry.
<PAGE>
The success of the ISP Channel service will depend upon the willingness of new
and existing cable 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, and prospects will be materially adversely affected.
Our continued negative cash flow and net losses may depress stock prices
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. 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 nine months ended June 30,
1999, we had a net loss of $33.2 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 inducing cable affiliates to enter into exclusive multi-year contracts
with us;
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 acquisition of
Intelligent Communications, Inc.
If we do not achieve cash flows sufficient to support our operations, we may be
unable 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 stockholders. In the event that equity securities are issued to raise
additional capital, the percentage ownership of our stockholders will be
reduced, stockholders 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, and prospects
would be materially adversely affected.
<PAGE>
The unpredictability of our quarter-to-quarter results may adversely affect the
trading price of our common stock
We cannot predict with any significant degree of certainty our
quarter-to-quarter operating results. 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 cause our quarter-to-quarter operating results to be unpredictable are
largely beyond our control. These factors include, among others:
o the number of subscribers who retain our Internet services;
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.
Existing contractual obligations allow for additional issuances of common stock
upon a market price decline, which could further adversely affect the market
price for our common stock
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, including common stock underlying unvested stock options
and grants made under our 1998 Stock Incentive Plan and 1999 Supplemental Stock
Incentive Plan, is 5,266,000, which would have been 23.8% of our outstanding
common stock as of June 30, 1999, assuming such shares would have been issued as
of such date. The issuance of common stock as a result of these obligations
could result in immediate and substantial dilution to the holders of our common
stock. We are obligated to issue up to 4,521,912 shares of our common stock on
the exercise of warrants and options and the conversion of certain of our
convertible debt. In addition, our 9% senior subordinated convertible notes due
2001 can convert into a minimum of 744,088 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 have
floating conversion prices based on the average market prices of the common
stock for a number of trading days immediately prior to conversion. 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 following table sets forth the number of shares of common stock issuable
upon conversion of our 9% senior subordinated convertible notes due 2001 and
percentage ownership (as determined in accordance with the rules of the SEC)
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 June 30, 1999, which was $27.88
per share;
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; and
o the 1,717,587 share limit with respect to the 9% senior subordinated
convertible notes was not in effect. See "Risks associated with 9%
senior subordinated convertible note financing."
On June 30, 1999, there were 16,840,440 shares of common stock and $12,270,000
principal amount under the 9% senior subordinated convertible notes due 2001
outstanding.
<PAGE>
9% Senior Subordinated
Convertible Notes
Percentage of Shares
Market Price Underlying %
25% ($6.97) 1,760,402 9.5
50% ($13.94) 880,201 5.0
75% ($20.91) 744,088 4.2
100% ($27.88) 744,088 4.2
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 our 9% senior
subordinated convertible notes 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 9% senior subordinated convertible notes
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. There are several factors that
influence the market price of our common stock. See " - Our stock price is
volatile."
The ownership limitations in the 9% Senior Subordinated Convertible Notes due
2001 may not protect against dilution
The terms of our 9% senior subordinated convertible notes due 2001 do not allow
us to issue shares of our common stock to holders of our 9% senior subordinated
convertible notes, if such issuance would result in such holders beneficially
owning more than 4.99% of 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.
Risks associated with 9% senior subordinated convertible note financing
The agreements with the purchasers of the 9% senior subordinated convertible
notes and warrants contain terms and covenants that could result in substantial
dilution to our stockholders. The financing could also make future financings
and loans and merger and acquisition activities more difficult and could require
us to expend substantial amounts of cash in order to satisfy our obligations
under the financing agreements.
Restrictions on Mergers and Consolidations
Certain provisions could discourage some potential purchasers by making an
acquisition of our Company or an asset sale more difficult and expensive,
including:
o participation by the holders of the 9% senior subordinated
convertible notes due 2001 with the holders of the common
stock in the proceeds of a merger or consolidation with a
public company as if the 9% senior subordinated convertible
notes due 2001 were fully converted into common stock on
the trading day immediately preceding the public
announcement of such merger or consolidation;
o similar participation by the holders of the related
warrants in the event our merger or consolidation with
another company would constitute a dilutive event under the
terms of the warrants; and
o prohibition against selling or transferring all or
substantially all of our assets without prior approval of
the holders of the 9% senior subordinated convertible notes
due 2001.
<PAGE>
Certain covenants made and default provisions agreed to, in connection with the
issuance of the 9% senior subordinated convertible notes may also have the
effect of limiting our ability to obtain additional financing and issue other
securities. In addition, we are prohibited from obtaining additional senior
indebtedness for borrowed money in excess of an aggregate of $12.0 million
unless such indebtedness expressly provides that it is not senior or superior to
the 9% senior subordinated convertible notes.
Conversion of the 9% senior subordinated convertible notes would result in
dilution to the holders of our common stock
The 9% senior subordinated convertible notes are convertible into shares of our
common stock at variable rates based on future trading prices of our common
stock and on events that may occur in the future. In addition, we have agreed to
pay future interest in additional 9% senior subordinated notes due 2001. The
number of shares of common stock that may ultimately be issued upon conversion
is therefore presently indeterminable and could fluctuate significantly based on
the issuance by us of other securities. The 9% senior subordinated convertible
notes and related warrants also have anti-dilution protection and may require
the issuance of more shares than originally anticipated. These factors may
result in substantial future dilution to the holders of our common stock.
Certain provisions of the 9% senior subordinated convertible notes may have
negative accounting consequences
In addition to the foregoing, the cross default provisions to our debt
instruments and other terms of the 9% senior subordinated convertible notes,
under certain circumstances, could lead to a significant accounting charge to
earnings and could materially adversely affect our business, results of
operations and condition. Such a charge and potential other future charges
relating to the provisions of the 9% senior subordinated convertible notes
financing agreements may negatively impact our earnings (loss) per share and the
market price of our common stock both currently and in future periods. The
convertibility features of such 9% senior subordinated convertible notes and
subsequent sales of the common stock underlying both it and the warrants could
materially adversely affect our valuation and the market trading price of our
shares of common stock.
We may be required to make cash payments to the holders of the 9% senior
subordinated convertible notes
In addition, the terms of the 9% senior subordinated convertible notes 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 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. We may be
required to prepay the 9% senior subordinated convertible notes if:
o the holders of the 9% senior subordinated convertible notes
have already converted into 1,717,587 shares of common
stock and there remains a balance of such notes
unconverted; or
o the holders of the 9% senior subordinated convertible notes
cannot otherwise convert or resell the common stock issued
upon conversion.
Such cash payments would adversely affect our financial condition and ability to
implement the business plan for ISP Channel, Inc. In addition, we would be
required to raise funds elsewhere, and we cannot assure you that we would be
able to obtain adequate sources of additional capital.
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
$7.14. In addition, if the holders of the 9% senior subordinated convertible
notes 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, in addition to other remedies, permit the
holders to require us to make cash payments. The maximum amount of such cash
payments, assuming the market price and the conversion price were equal, is
$13.7 million, 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.
<PAGE>
We may not be able to successfully implement our business plan if our
relationship with our cable affiliates is negatively impacted
The success of our business depends upon our relationship with our cable
affiliates. Therefore, our success and future business growth will be
substantially affected by 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 us) will substantially control the
customer relationship with the subscriber. For example, under many of 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.
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. Several cable operators have announced and begun
making 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, many 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
adversely affect the cable operator's ability to implement such upgrades.
In addition, many cable operators may emphasize increasing television
programming capacity to compete with other forms of entertainment delivery
systems, such as direct broadcast satellite, instead of upgrading 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. Any of these actions could have a material adverse effect on our
business, financial condition, and prospects.
The unavailability of two-way capability in certain markets may negatively
affect subscription levels
We provide Internet services to both one-way and two-way cable systems. For
one-way cable systems, subscribers receive Internet services over cable systems
and transmit data to the Internet using a telephone line return path. In those
circumstances, our services may not provide the high speed access, quality of
experience and availability of certain applications necessary to attract and
retain subscribers to the ISP Channel service. Subscribers using a conventional
telephone line return path will experience upstream data transmission speeds to
the Internet that are provided by their analog modems which is typically 56 kbps
or less. It is not clear what impact the lack of two-way capability will have on
subscription levels for the ISP Channel service.
If we do not obtain exclusive access to cable subscribers, we may not be able to
sustain any meaningful growth
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 affiliates. 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 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 between 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 and prospects could be materially adversely affected.
<PAGE>
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 and prospects
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 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 and prospects.
If we fail to manage our expanding business effectively, our business, financial
condition and prospects could be adversely affected
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 and prospects.
If cable affiliates are unable to renew their franchises or we are unable to
affiliate with replacement operators, our business, financial condition and
prospects could be materially adversely affected
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 and prospects could be materially adversely affected.
<PAGE>
We may lose cable affiliates through their acquisition which could have a
material adverse effect on our business, financial condition and prospects
Under many of our contracts, if a cable affiliate is acquired and the acquiring
company 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 and prospects.
We depend on third-party technology to develop and introduce technology we use
and 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 and prospects 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.
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 and prospects.
We depend on third-party suppliers for certain key products and services and any
inability to obtain sufficient key components or to develop alternative sources
for such components could result in delays or reductions in our product
shipments
We currently depend on a limited number of suppliers for certain key products
and services. In particular, we depend on 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. 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, and prospects.
<PAGE>
We depend on third-party carriers to maintain their cable systems which carry
our data and any interruption of our operations due to the failure to maintain
their cable systems would have a material adverse effect on our business,
financial condition and prospects
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, 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 and prospects.
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 and
prospects
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 online content than we can. Our ability to compete may be further impeded if,
as evidenced by the recent merger between AT&T and TCI and the pending merger
between AT&T and MediaOne, competitors utilizing different or the same
technologies seek to merge to enhance their competitive strengths. 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 and prospects. We face competition from many sources, which include:
o Other cable-based access providers;
o Telephone-based access providers; and
o Alternative technologies.
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 Excite@Home, Roadrunner and High Speed
Access Corp.; 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, Comcast, Cox, MediaOne, TCI and Time Warner. Comcast,
Cox and TCI market through Excite@Home, while Time Warner plans to market the
RoadRunner service through Time Warner's own cable systems as well as to other
cable system operators nationwide. In particular, Excite@Home has announced its
intention to compete directly in the small- to medium-sized cable system market,
where High Speed Access Corp. currently competes as well.
<PAGE>
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 local exchange carriers that use digital subscriber line
technologies. Some of these competitors are among the largest companies in the
country, including AT&T, MCIWorldCom, Sprint and Qwest. Other competitors
include BBN, Earthlink, Netcom, Concentric Network, and PSINet. 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 also
offer Internet access service, 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 security of transmission;
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 alternatives to
cable-modem service and conventional dial-up access. Competitive technologies
include telecom-related wireline technologies, such as integrated services
digital network ("ISDN") and digital subscriber line ("DSL") technologies, and
wireless technologies such as local multipoint distribution service,
multichannel multipoint distribution service and various types of satellite
services. Our prospects may be impaired by Federal Communications Commission
("FCC") 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.
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 and
prospects.
<PAGE>
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 and
prospects
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 online
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 and
prospects.
Any damage or failure that causes interruptions in our operations could have a
material adverse effect on our business, financial condition and prospects
Our operations are dependent upon our ability to support a highly complex
network and avoid damages from fires, earthquakes, floods, power losses,
telecommunications and satellite 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 and prospects.
We may be vulnerable to unauthorized access, computer viruses and other
disruptive problems which may result in our liability to our subscribers and may
deter others from becoming subscribers
<PAGE>
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 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 and prospects. 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 and prospects.
If the market for high-quality content fails to develop, or develops more slowly
than expected, our business, financial condition and prospects will be
materially adversely affected
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 and
prospects will be materially adversely affected.
Our failure to attract advertising revenues in quantities and at rates that are
satisfactory to us could have a material adverse effect on our business,
financial condition and prospects
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
and prospects.
If we are unsuccessful in establishing and maintaining the ISP Channel brand, or
if we incur excessive expenses in promoting and maintaining our brand, our
business, financial condition and prospects would be materially adversely
affected
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:
<PAGE>
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 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 and prospects would be materially adversely
affected.
If we encounter significant problems with our billing and collections process,
our business, financial condition and prospects could be materially adversely
affected
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 initiated 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 and
prospects could be materially adversely affected.
We may face potential liability for defamatory or indecent content, which may
cause us to modify the way we provide 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 and prospects. 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.
<PAGE>
We may face potential liability for information retrieved and replicated that
may not be covered by our insurance
Our liability insurance may not cover potential claims relating to providing
Internet services 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 and prospects. 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, 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 online 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 online transactions or online technology. As with other online service
providers, patent claims could be asserted against us based upon our services or
technologies.
Our success depends upon the development of new products and services in the
face of rapidly evolving technology
Our products and services may not be commercially successful
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 and
prospects 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.
Our suppliers' products may become obsolete, requiring us to purchase additional
inventory
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 and prospects.
<PAGE>
Our competitors' products may make our products less commercially viable
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 and
prospects.
In addition, we cannot assure you that we will have the financial and technical
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 and prospects.
Our purchase of Intellicom subjects us to risks in a new market in which we have
no experience
On February 9, 1999, we completed our purchase of Intellicom, a provider of
two-way satellite Internet access options using very small aperture terminal
("VSAT") technology. 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. Because we only recently completed the acquisition of
Intellicom, we cannot assure you that integration will be accomplished smoothly,
on time or successfully. Although the management teams of both SoftNet and
Intellicom believe that the merger will benefit both companies, we cannot assure
you that the merger will be successful.
The purchase of Intellicom involves other risks including potential negative
effects on our reported results of operations from acquisition-related charges
and amortization of acquired technology and other intangible assets. As a result
of the Intellicom acquisition, we anticipate recording a significant amount of
intangible assets in the second quarter of fiscal 1999 which will adversely
affect our earnings and profitability for the foreseeable future. If the amount
of such recorded intangible assets is increased or we have future losses and are
unable to demonstrate our ability to recover the amount of intangible assets
recorded during such time periods, the period of amortization could be
shortened, which may further increase annual amortization charges. In such
event, our business and financial condition could be materially and adversely
affected. In addition, the Intellicom acquisition was structured as a purchase
by us of all of the outstanding stock of Intellicom. As a result, we could be
adversely affected by direct and contingent liabilities of Intellicom. It is
possible that we are not aware of all of the liabilities of Intellicom and that
Intellicom has greater liabilities than we expected. In addition, we have very
little experience in the markets and technology in which Intellicom is focused.
As such, we are faced with risks that are new to us, including the following:
Dependence on VSAT market
One of the reasons we purchased Intellicom 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 and prospects.
<PAGE>
Risk of damage, loss or malfunction of satellite
The loss, damage or destruction of any of the satellites used by Intellicom, 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 and prospects.
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. In addition, such engineering changes
may require FCC approval, and we cannot assure you that the FCC would grant such
approval.
Equipment failure and interruption of service
Our operations will require that our network, including the satellite
connections, operate on a continuous basis. It is not unusual for networks,
including switching facilities and satellite connections, 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
equipment failures, which would negatively affect consumer confidence as well as
our business operations and reputation.
Dependence on leases for satellites
Intellicom currently leases satellite space from GE American and Satmex. If for
any reason, the leases were to be terminated, we cannot assure you that we could
renegotiate new leases with GE American, Satmex or another satellite provider 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.
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; and the timing and release of new products and services by Intellicom
and its competitors. We cannot assure you that Intellicom will be able to
successfully compete with respect to these factors.
Government regulation
The VSAT satellite industry is a highly regulated industry. In the United
States, operation and use of VSAT satellites requires licenses from the FCC. 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.
While we believe that our lessors will be able to obtain all U.S. 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
some or all necessary licenses or approvals could have a material adverse effect
on our business, financial condition and prospects.
If we are unable to successfully integrate future acquisitions into our
operations, then our results and financial condition may be adversely affected
In addition to the recent acquisition of Intellicom, 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:
<PAGE>
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.
Loss of key personnel may disrupt our operations
The loss of key personnel may disrupt our operations. 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 and
Intellicom services, 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 service 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 and prospects.
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 Internet access services provided by our
cable systems. However, any changes in law or regulation relating to Internet
connectivity, cable operators or 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
telecommunications companies or other Internet access providers.
Possibility of changes in law or regulation
Because the provision of Internet access services using cable networks is a
relatively recent development, the regulatory classification of such services
remains unsettled. Some parties have argued that providing Internet access
services over a cable network is a "telecommunications service" and that,
therefore, Internet access service providers should be subject to regulation
which, under the Communications Act of 1934, apply to telephone companies. Other
parties have argued that Internet access services over the cable system is a
cable service under the Communications Act, which would subject such services to
a different set of laws and regulations. It is unclear at this time whether
federal, state, or local governing bodies will adopt one classification over
another, or adopt another regulatory classification altogether, for Internet
access services provided over cable systems. The FCC recently decided to address
Internet access issuers in its February 17, 1999 order approving the merger
between AT&T and TCI, which was announced by the two companies on June 24, 1998.
<PAGE>
A number of parties had opposed the merger unless the FCC required the AT&T/TCI
combination to provide unaffiliated ISPs with unbundled, open access to the
cable platform whenever that platform is being used by an AT&T/TCI affiliate to
provide Internet service. Other parties argued that the FCC should examine
industry-wide issues surrounding open access to cable-provided Internet service
in a generic rulemaking, rather than in the specific, adjudicatory context of a
merger evaluation. The FCC decided that it would be imprudent to grant either
request for action at this time given the nascent stage in the development and
deployment of high-speed Internet access services. Certain local jurisdictions
that approved the AT&T/TCI merger have imposed open access conditions on such
approval, while other such local jurisdictions have rejected such conditions or
have reserved the right to impose such conditions in the future. At least one
federal district court has upheld the local jurisdiction's decision to mandate
open access. We cannot predict the ultimate outcome or scope of the local
approval process. Nor can we predict the impact, if any, that future federal,
state or local legal or regulatory changes, including open access conditions,
might have on our business.
Regulations affecting the cable industry may discourage cable operators from
upgrading their systems
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
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 and we or our cable affiliates could be subject
to common carrier regulation by federal and state regulators.
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 and prospects.
Failure to sell MTC in a timely manner could adversely affect our ability to
implement our business plan
We have announced the planned sale of MTC. 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 MTC. If a sale of MTC is delayed,
its value could be diminished. Moreover, 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 this division could have a material adverse effect on our
business, financial condition and prospects.
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 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.
<PAGE>
Our stock price is volatile
The volatility of our stock price may make it difficult for holders of the
common stock to transfer their shares at the prices they want. 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.
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 Delaware corporation. The Delaware General Corporation Law contains
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 certificate of incorporation and bylaws 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 stockholders 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 that could disrupt our business. We have formulated a Y2K
Plan to address our Y2K issues and have created a Y2K Task Force headed by the
Director of Information Systems 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.
<PAGE>
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:
1. Internal business systems
2. 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 completed the Inventory, Assessment and Planning Phases of substantially all
critical internal business systems. The Execution and Validation Phases will be
completed by the fourth quarter of fiscal 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
the our interface systems are susceptible to those third parties' failure to
remedy their own Y2K issues. We expect that assessment will be complete by the
fourth quarter of calendar 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 unique 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.
<PAGE>
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 the
financial position or results of our 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 suppliers, service providers and contractors, 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
our ability to conduct business, as well as our financial position and results
of operations.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
3.1 Amended and Restated Certificate of Incorporation
3.2 By-laws (this document is hereby incorporated by reference to our
Registration Statement on Form S-3/A filed with the SEC on April 22,
1999)
4.1 Article Fourth of the Certificate of Incorporation (see exhibit 3.1)
4.2 Articles II, VI and VII of the By-laws (see exhibit 3.2)
10.1 Securities Purchase Agreement by and among SoftNet Systems, Inc. and
Hector Gonzalez, dated April 12, 1999 (this document is hereby
incorporated by reference to our Current Report on Form 8-K, filed
with the SEC on April 27, 1999)
10.2 Registration Rights Agreement by and among SoftNet Systems, Inc. and
Hector Gonzalez, dated April 12, 1999 (this document is hereby
incorporated by reference to our Current Report on Form 8-K, filed
with the SEC on April 27, 1999)
27.1 Financial Data Schedule
99.1 Proposal Number Two Adopted at the 1999 Annual Meeting of Stockholders
(this document is hereby incorporated by reference to our definitive
proxy statement on Form 14A, filed with the SEC on March 17, 1999)
99.2 Proposal Number Six Adopted at the 1999 Annual Meeting of Stockholders
(this document is hereby incorporated by reference to our definitive
proxy statement on Form 14A, filed with the SEC on March 17, 1999)
(b) Reports on Form 8-K
On April 14, 1999, the Company filed a Current Report on Form 8-K
reporting the outcome of matters submitted to a vote of security
holders during the Company's annual shareholders' meeting.
On April 27, 1999, the Company filed a Current Report on Form 8-K
reporting the sale of 660,000 unregistered shares of the Company's
common stock to one of its cable affiliates.
<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
Dated: August 16, 1999
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION OF
SOFTNET SYSTEMS, INC.
(Pursuant to Sections 242 and 245 of the Delaware General Corporation Law)
Jason G. Wilson hereby certifies that:
A. He is the assistant secretary of SoftNet Systems, Inc., a
Delaware corporation.
B. The certificate of incorporation of this corporation was
originally filed in the Office of the Secretary of State of the State of
Delaware on April 7, 1999.
C. The text of the Certificate of Incorporation of this
corporation is amended and restated to read in its entirety as follows:
ARTICLE FIRST
The name of this corporation is SoftNet Systems, Inc. (the
"Corporation" or the "Company").
ARTICLE SECOND
The address of the registered office of the Corporation in the State
of Delaware is 1209 Orange Street, in the City of Wilmington, County of New
Castle. The name of its registered agent at such address is The Corporation
Trust Company.
ARTICLE THIRD
The purpose of the Corporation is to engage in any lawful act or
activity for which corporations may be organized under the General
Corporation Law of Delaware.
ARTICLE FOURTH
(A) This Corporation is authorized to issue two classes of
stock to be designated, respectively, "Common Stock" and "Preferred Stock." The
total number of shares which the Corporation is authorized to issue is
104,000,000 shares. 100,000,000 shares shall be Common Stock, $.01 par value,
and 4,000,000 shares shall be Preferred Stock, $.10 par value.
(B) The Board of Directors may issue Preferred Stock from time
to time in one or more series. The Board of Directors is hereby authorized to
adopt a resolution or resolutions from time to time, within the limitations and
restrictions stated in this Certificate of Incorporation, to fix or alter the
voting powers, designations, preferences, rights, qualifications, limitations
and restrictions of any wholly unissued class of Preferred Stock, or any wholly
unissued series of any such class, and the number of shares constituting any
such series and the designation thereof, or any of them, and to increase or
decrease the number of shares of any series subsequent to the issue of shares of
that series, but not below the number of shares of such series then outstanding.
In case the number of shares of any series shall be so decreased, the shares
constituting such decrease shall resume the status which they had prior to the
adoption of the resolution originally fixing the number of shares of such
series.
ARTICLE FIFTH
A director of the Corporation shall not be personally liable
to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability (i) for any breach of the
director's duty of loyalty to the corporation or its stockholders, (ii) for acts
or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the Delaware General
Corporation Law, or (iv) for any transaction from which the director derived any
improper personal benefit. If the Delaware General Corporation Law is amended
after approval by the stockholders of this Article to authorize corporation
action further eliminating or limiting the personal liability of directors then
the liability of a director of the corporation shall be eliminated or limited to
the fullest extent permitted by the Delaware General Corporation Law as so
amended.
Any repeal or modification of the foregoing provisions of this
Article Fifth by the stockholders of the corporation shall not adversely affect
any right or protection of a director of the corporation existing at the time of
such repeal or modification.
ARTICLE SIXTH
The Corporation reserves the right to amend, alter, change or
repeal any provision contained in this Certificate of Incorporation, in the
manner now or hereafter prescribed by statute, and all rights conferred upon
stockholders herein are granted subject to this reservation.
ARTICLE SEVENTH
Elections of directors need not be by written ballot unless
the Bylaws of the Corporation shall so provide.
ARTICLE EIGHTH
The number of directors which shall constitute the whole Board
of Directors shall be fixed from time to time by, or in the manner provided in,
the bylaws or amendment thereof duly adopted by the Board of Directors or by the
stockholders.
ARTICLE NINTH
Meetings of stockholders may be held within or without the
State of Delaware, as the Bylaws may provide. The books of the corporation may
be kept (subject to any provision contained in the statutes) outside the State
of Delaware at such place or places as may be designated from time to time by
the Board of Directors or in the Bylaws of the Corporation.
ARTICLE TENTH
Except as otherwise provided in this Certificate of
Incorporation, in furtherance and not in limitation of the powers conferred by
statute, the Board of Directors is expressly authorized to make, repeal, alter,
amend and rescind any or all of the Bylaws of the Corporation.
ARTICLE ELEVENTH
The Corporation expressly elects to be governed by Section 203
of the Delaware General Corporation Law.
D. The foregoing amendment and restatement of the Certificate
of Incorporation has been duly approved by the corporation's Board of Directors
and stockholders in accordance with the provisions of Section 242 and 245 of the
General Corporation Law of the State of Delaware.
IN WITNESS WHEREOF, the undersigned has signed this
Certificate this 29th day of July, 1999.
/s/ Jason G. Wilson
------------------------------------
Jason G. Wilson, Assistant Secretary
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
EXHIBIT 27.1
This schedule contains summary information extracted from SoftNet Systems,
Inc.'s quarterly report on Form 10-Q for the quarters ended June 30, 1999 and
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
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<NAME> SOFTNET SYSTEMS INC.
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