<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 22, 1999
REGISTRATION NO. 333-74767
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 11-1817252
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
</TABLE>
------------------------------
650 TOWNSEND STREET, SUITE 225
SAN FRANCISCO, CA 94103
(415) 365-2500
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
DR. LAWRENCE B. BRILLIANT
VICE CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
SOFTNET SYSTEMS, INC.
650 TOWNSEND STREET, SUITE 225
SAN FRANCISCO, CA 94103
(415) 365-2500
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
<TABLE>
<S> <C>
NORA L. GIBSON, ESQ. GREGORY K. MILLER, ESQ.
Brobeck, Phleger & Harrison LLP Latham & Watkins
One Market, Spear Street Tower 505 Montgomery Street, Suite 1900
San Francisco, CA 94105 San Francisco, CA 94111
(415) 442-0900 (415) 391-0600
</TABLE>
------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this registration statement becomes effective.
------------------------------
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. / /
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box / /
------------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED BE REGISTERED(1) PER SHARE(1) OFFERING PRICE FEE(2)(3)
<S> <C> <C> <C> <C>
Common Stock, $0.01 par value......... 4,025,000 $32.375 $130,309,375 $36,226
</TABLE>
(1) Includes 525,000 shares of common stock which the underwriters have an
option to purchase from SoftNet to cover over-allotments, if any.
(2) Estimated solely for purposes of calculating the amount of the registration
fee pursuant to Rule 457(c) of the Securities Act of 1933, based on the
average of the high and low sales price of a share of common stock of the
Registrant on the Nasdaq National Market as reported in the consolidated
reporting system on April 20, 1999.
(3) $19,063 of this fee was paid on March 19, 1999.
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SEC, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
EXPLANATORY NOTE
This registration statement (File No. 333-74767) was originally filed by
SoftNet Systems, Inc., a New York corporation. On April 14, 1999, we
reincorporated in the State of Delaware. SoftNet Systems, Inc., a Delaware
corporation is the successor corporation to the original registrant. Pursuant to
the requirements of Rule 414 of the Securities Act of 1933, as amended, we
hereby expressly adopt this registration statement as our own registration
statement for all purposes of the Securities Act of 1933, as amended and the
Securities Exchange Act of 1934, as amended.
<PAGE>
SUBJECT TO COMPLETION,
APRIL 22, 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
3,500,000 SHARES
[LOGO]
COMMON STOCK
-----------
This is a public offering of 3,500,000 shares of common stock of SoftNet
Systems, Inc. We are selling all of the 3,500,000 shares of common stock offered
under this prospectus.
Our common stock is quoted on the Nasdaq National Market under the symbol
"SOFN."
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 5.
<TABLE>
<CAPTION>
PER
SHARE TOTAL
--------- -----------
<S> <C> <C>
Public offering price............................................. $ $
Underwriting discounts............................................ $ $
Proceeds, before expenses, to SoftNet............................. $ $
</TABLE>
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
SoftNet has granted the underwriters the right to purchase up to 525,000 shares
to cover any over-allotments.
--------------
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares against payment in Baltimore, Maryland
on , 1999.
BT ALEX. BROWN
BANCBOSTON ROBERTSON STEPHENS
CIBC WORLD MARKETS
WIT CAPITAL CORPORATION
AS E-MANAGER-TM-
, 1999
<PAGE>
INSIDE FRONT COVER
[GRAPHIC: Schematic of connection between ISP channel customer and the Internet]
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY CONTAINS BASIC INFORMATION ABOUT US AND THIS OFFERING. BECAUSE
IT IS A SUMMARY, IT DOES NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD
CONSIDER BEFORE INVESTING. YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY,
INCLUDING THE SECTION ENTITLED "RISK FACTORS" AND THE CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES TO THOSE STATEMENTS INCLUDED IN THIS
PROSPECTUS. EXCEPT AS OTHERWISE REQUIRED BY THE CONTEXT, REFERENCES IN THIS
PROSPECTUS TO "WE," "US," "OUR" OR "SOFTNET" REFER TO THE COMBINED BUSINESS OF
SOFTNET SYSTEMS, INC. AND ITS SUBSIDIARIES. THE TERM "YOU" REFERS TO PROSPECTIVE
INVESTORS IN THE COMMON STOCK. OUR FISCAL YEAR ENDS ON SEPTEMBER 30. UNLESS
OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF
THE UNDERWRITERS' OVERALLOTMENT OPTION.
SOFTNET
OUR BUSINESS
We seek to become the dominant cable-based provider of high-speed Internet
access and other Internet-related services to homes and businesses in the
franchise areas of those cable systems unaffiliated with the seven largest U.S.
cable operators and certain other smaller systems. We estimate that our target
market comprises over 2,200 systems passing approximately 24.6 million U.S.
homes. As of March 3, 1999, we had contracts with 31 cable operators
representing 126 cable systems and approximately 1.6 million homes passed. We
also plan to target certain other markets including apartment buildings, hotels,
hospitals and schools, which significantly increases the size of our market.
Though actual speeds may vary, our Internet service, which is marketed using the
brand name "ISP Channel," provides residential and business subscribers access
to the Internet over the existing cable television infrastructure at speeds up
to 50 times faster than 28.8 kilobits per second ("kbps") dial-up access. For
example, this increased speed would reduce the required download time for a 10
megabyte file from approximately 46 minutes to under one minute and allow
subscribers to benefit from sophisticated multimedia applications and
programming. The ISP Channel also offers an intuitive user interface provided
through a co-branding agreement with Excite, and local information, news and
entertainment customized for each community served.
OUR MARKET OPPORTUNITY
Many Internet industry analysts believe that cable-based solutions, by
virtue of their high performance and relatively low prices, will become the
leading method of high-speed Internet access for residential Internet users.
Forrester Research estimated in February 1999 that 13 million U.S. households
will connect to the Internet via cable modem by 2002. By 2005, Forrester
estimates that cable modem subscribers will total 26 million. Annual revenues
for the U.S. residential cable-based Internet access market in 2005 are
estimated by Forrester to be approximately $11 billion, up from virtually zero
in 1997.
According to Claritas, an independent industry research consultant, in 1997,
approximately 92.2 million U.S. households were passed by cable from
approximately 11,400 franchised cable systems, virtually all of which we believe
can be equipped to provide high-speed Internet access. Approximately 70% of
these households are cable subscribers. We estimate that approximately 2,500 of
these systems, representing more than 60 million homes passed, are under
exclusive contract with competing cable-based Internet access services such as
@Home and RoadRunner, both of which are affiliated with large multiple systems
operators ("MSOs") including, among others, Cablevision, Comcast, Cox, Media
One, TCI and Time Warner. Of the remaining 8,900 systems, our target market
comprises over 2,200 systems passing approximately 24.6 million U.S. homes.
1
<PAGE>
OUR STRATEGY
Our strategy is to enter into exclusive multi-year agreements with cable
operators, which enable us to provide high-speed Internet access and other
services over the cable operators' networks. We then purchase and install our
own networking equipment and servers in the headends of these affiliated cable
systems, enabling us to deliver high-speed Internet access to homes and
businesses through cable modems and, in the future, through television set-top
boxes. In conjunction with our cable affiliates, we market high-speed data
services as a premium offering to homes and businesses passed by these
affiliates' cable systems. Connectivity from the headend to the Internet is
currently provided over a network leased primarily from major telecommunications
carriers and is managed by our Network Operations Center ("NOC") located in
Mountain View, California.
OUR SERVICES
Our ISP Channel offering includes the following products and services for
residential subscribers: high-speed Internet access using cable modems;
directory and search services through our relationship with Excite; video
conferencing and other collaborative multimedia applications using our servers;
and local content, including planned online communities. Our products and
services for businesses include: T1 and fractional T1 high-speed Internet
access; remote local area networks ("RLANs") and dial-up Internet access; Web
hosting and co-location; online commerce applications; and virtual private
networks ("VPNs"). Using the ISP Channel platform, we plan to market additional
cable-based services, including IP telephony and high-speed Internet access
using television set-top boxes. Our agreements with cable affiliates generally
give us the right to offer these additional services over the cable affiliates'
networks.
OUR HISTORY
We began offering dial-up and dedicated Internet services in June 1996 and
cable-based Internet services in the fourth calendar quarter of 1997. As of
March 3, 1999, we had contracts for our ISP Channel service with 31 cable
operators representing 126 cable systems and approximately 1.6 million homes
passed. Twenty-three of these systems, representing over 264,000 homes passed,
have been equipped and have begun offering our services. As of March 3, 1999, we
had approximately 2,200 residential and business subscribers to our ISP Channel
service and we also provided dial-up and dedicated Internet access to
approximately 1,100 residential and business subscribers.
RECENT EVENTS
We are in the process of implementing a new strategy focusing solely on our
ISP Channel services. On February 12, 1999, we completed the divestiture of our
telecommunications business, Kansas Communications, Inc. ("KCI"), for an
aggregate sale price of approximately $6.3 million. In addition, on February 9,
1999, we acquired Intelligent Communications, Inc., a two-way satellite based
Internet access company, for an aggregate purchase price of approximately $15.5
million. We have also agreed to sell our document management business,
Micrographic Technology Corporation ("MTC"), for an aggregate sale price of
approximately $4.9 million. In addition, in March 1999 we agreed to issue
660,000 shares of common stock to Teleponce Cable TV, Inc. for $15,000,000.
--------------
We were incorporated in the State of New York in 1956. We reincorporated in
the State of Delaware in April, 1999. Our address is 650 Townsend Street, Suite
225, San Francisco, California, 94103, and our telephone number is (415)
365-2500.
2
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by SoftNet.............. 3,500,000 shares
Shares of common stock to be outstanding 13,912,866 shares
after the offering(1)......................
Use of proceeds.............................. To fund expenditures in connection with the
growth of the ISP Channel business, and for
general corporate purposes. See "Use of
Proceeds."
Nasdaq National Market symbol................ SOFN
</TABLE>
- ------------------------
(1) The number of shares of common stock to be outstanding after this offering
is based on the number of shares outstanding as of March 26, 1999 and does
not include the following:
- 2,835,062 shares of common stock subject to options issued at a weighted
average exercise price of $9.69 per share, with 419,551 shares of common
stock reserved for future issuance;
- warrants to purchase 925,063 shares of common stock at a weighted average
exercise price of $12.27 per share;
- 847,266 shares of common stock to be issued upon conversion of the Series
C Preferred Stock assuming a conversion price of $9.00 per share;
- 88,889 shares of common stock to be issued upon conversion of the 6%
convertible debentures due 2002 assuming a conversion price of $8.10 per
share;
- 205,247 shares of common stock to be issued upon conversion of the 9%
convertible debentures due 2000 assuming a conversion price of $6.75 per
share;
- 175,000 shares of common stock to be issued upon conversion of the 5%
convertible debentures due 2002 assuming a conversion price of $8.25 per
share;
- 705,882 shares of common stock to be issued upon conversion of the 9%
senior subordinated convertible notes due 2001 assuming a conversion price
of $17.00 per share; and
- 1,448,042 shares of common stock reserved under our Cable Affiliates Plan.
On August 31, 1998, we agreed to issue 7,500 shares of Series D
Preferred Stock and warrants to purchase an additional 93,750 shares of
common stock. Such stock and warrants have not been issued as of the date
hereof. In addition, we issued warrants to purchase an additional 26,250
shares of common stock as a financial advisory fee in connection with
certain financings. On March 24, 1999, we entered into an agreement to
sell 660,000 shares of our common stock to Teleponce Cable TV, Inc. for
$15 million. The offer and sale of the shares of common stock was
completed pursuant to the exemption from registration provided by
Regulation D under the Securities Act of 1933, as amended. See
"Description of Capital Stock" for a more detailed description of our
securities.
3
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary consolidated financial data should be read in
conjunction with our consolidated financial statements and their related notes
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this prospectus. The consolidated statement of
operations data for the five years ended September 30 is derived from, and is
qualified by reference to, the audited consolidated financial statements and
their related notes, the past three years of which are included in this
prospectus. The consolidated statement of operations data for the three months
ended December 31, 1997 and 1998 and the consolidated balance sheet data as at
December 31, 1998 are derived from, and qualified by reference to, our unaudited
consolidated financial statements and their related notes included in this
prospectus. While we intend to sell MTC, MTC has not been accounted for as a
discontinued operation because its sale is dependent on shareholder approval.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Internet services........................... $ -- $ -- $ 167 $ 1,008 $ 1,018 $ 215 $ 444
MTC......................................... -- 1,088 19,417 20,330 13,042 2,660 3,852
Other....................................... 188 -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Total revenues.......................... 188 1,088 19,584 21,338 14,060 2,875 4,296
--------- --------- --------- --------- --------- --------- ---------
Cost of revenues.............................. 172 783 11,375 11,935 10,628 2,249 2,967
Selling, engineering, general and
administrative.............................. 1,180 7,548 10,921 11,191 19,265 2,638 7,339
--------- --------- --------- --------- --------- --------- ---------
Loss from continuing operations............... (1,164) (7,243) (2,712) (1,788) (15,833) (2,012) (6,010)
Interest expense.............................. (601) (456) (1,220) (1,145) (1,416) (330) (569)
Other income.................................. 2 5 5,708 49 320 72 217
Income (loss) from discontinued operations.... 335 (1,962) (1,812) 739 (73) (108) 139
Loss from extraordinary items................. -- -- (6,061) (486) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss...................................... (1,428) (9,656) (6,097) (2,631) (17,002) (2,378) (6,223)
Preferred dividends........................... -- -- -- -- (343) -- (243)
--------- --------- --------- --------- --------- --------- ---------
Net loss applicable to common shares.......... $ (1,428) $ (9,656) $ (6,097) $ (2,631) $ (17,345) $ (2,378) $ (6,466)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net loss per share:
Diluted..................................... $ (0.38) $ (2.22) $ (1.05) $ (0.40) $ (2.35) $ (0.34) $ (0.77)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Shares used in per share calculations:
Diluted..................................... 3,802 4,353 5,819 6,627 7,391 6,941 8,374
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-------------------------
ACTUAL AS ADJUSTED(1)
--------- --------------
(UNAUDITED) (IN
THOUSANDS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash................................................................................. $ 4,329 $ 121,981
Total assets......................................................................... 29,710 147,362
Total long-term liabilities.......................................................... 9,948 9,948
Redeemable convertible preferred stock............................................... 15,754 15,754
Total shareholders' equity (deficit)................................................. (9,795) 107,857
</TABLE>
- ------------------------------
(1) Reflects, after deducting commissions and estimated offering expenses, the
net proceeds of the sale of the common stock in this offering at an assumed
public offering price of $36.13 per share.
4
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE
ONLY ONES FACING US. 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, AND YOU MAY LOSE
ALL OR PART OF YOUR INVESTMENT.
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 non-Internet related subsidiaries to
focus on substantial expansion of our Internet subsidiary, ISP Channel, Inc. We
cannot assure you that our ability to develop or maintain strategies and
business operations for the ISP Channel services will achieve positive cash flow
and profitability. We acquired ISP Channel, Inc. in June 1996. As such, we have
very limited operating history and experience in the Internet services business.
The successful expansion of the ISP Channel 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.
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 three months
ended December 31, 1998, we had a net loss of $6.5 million. As of December 31,
1998, we had an accumulated shareholders' deficit of approximately $9.8 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:
- inducing cable affiliates to enter into exclusive multi-year contracts
with us;
- installing the equipment necessary to enable our cable affiliates to offer
our services;
- research and development of new product and service offerings;
5
<PAGE>
- the continued development of our direct and indirect selling and marketing
efforts; and
- 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:
- our need to enhance and expand product and service offerings to maintain
our competitive position and increase market share; and
- the substantial investment in equipment and corporate resources required
by the continued national launching of the ISP Channel service.
In addition, we anticipate that the majority of cable affiliates with
one-way cable systems will eventually upgrade their cable infrastructure to
two-way cable systems, at which time we will have to upgrade our equipment on
any affected cable system to handle two-way transmissions. We cannot accurately
predict whether or when we will ultimately achieve cash flow levels sufficient
to support our operations, development of new products and services, and
expansion of the ISP Channel service. Unless we reach such cash flow levels, we
will require additional financing to provide funding for operations. In the
event we complete a long-term debt financing, we will be highly leveraged and
such debt securities will have rights or privileges senior to those of our
current shareholders. In the event that equity securities are issued to raise
additional capital, the percentage ownership of our shareholders will be
reduced, shareholders may experience additional dilution and such securities may
have rights, preferences and privileges senior to those of our common stock. In
the event that we cannot generate sufficient cash flow from operations, or are
unable to borrow or otherwise obtain additional funds on favorable terms to
finance operations when needed, our business, financial condition, and prospects
would be materially adversely affected.
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:
- the number of subscribers who retain our Internet services;
- 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;
- the rate at which our cable affiliates can complete the installations
required to initiate service for new subscribers;
- the amount and timing of capital expenditures and other costs relating to
the expansion of the ISP Channel service;
- competition in the Internet or cable industries; and
6
<PAGE>
- changes in law and regulation.
WE WILL RECORD AN EXPENSE RELATED TO OUR ISSUANCE OF STOCK OPTIONS PURSUANT TO
OUR 1998 STOCK INCENTIVE PLAN THAT MAY HAVE A NEGATIVE IMPACT ON OUR FINANCIAL
CONDITION
Between October 1998 and March 1999, we granted stock options under our 1998
Stock Option Plan. Because the 1998 Stock Option Plan was not adopted until our
Annual Meeting of Stockholders held in April 1999, we are required to recognize
a compensation expense equal to the excess of the fair market price on the date
of stockholder approval over the exercise price of the committed option grants.
The compensation expense is approximately $80 million and will be recognized
over the vesting period of the options. The expense may have a negative impact
on our financial condition.
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, is 6,175,993, which would have been 38.8% of our
outstanding common stock as of March 2, 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 2,758,406 shares of our common
stock on the exercise of warrants and options and the conversion of certain of
our convertible debt. Our preferred stock and 9% senior subordinated convertible
notes due 2001 could convert into an additional 3,417,587 shares of common stock
without our consent. However, we do not know the exact number of shares of our
common stock that we will issue upon conversion of these securities because they
potentially have floating conversion prices based on the average market prices
of the common stock for a number of trading days immediately prior to
conversion.
The floating conversion price feature of the Series C Preferred Stock, and
9% senior subordinated convertible notes due 2001 begin May 29, 1999 and July 1,
1999, respectively. Generally, decreases in the market price of the common stock
below their initial conversion prices would result in more shares of common
stock being issued upon their conversion. The 3,417,587 shares underlying our
preferred stock and 9% senior subordinated convertible notes due 2001 reflects
that the stockholders approved the issuance of in excess of 19.99% of our
outstanding common stock in connection with conversion of our preferred stock.
The following table sets forth the number of shares of common stock issuable
upon conversion of the outstanding preferred stock and our 9% senior
subordinated convertible notes due 2001 and percentage ownership (as determined
in accordance with the rules of the SEC) that each represents assuming:
- the market price of the common stock is 25%, 50%, 75% and 100% of the
market price of the common stock on March 2, 1999, which was $21.06 per
share;
- the floating conversion price feature of the preferred stock and 9% senior
subordinated convertible notes due 2001 was in effect;
- the maximum conversion prices of the preferred stock was not adjusted as
provided in our certificate of incorporation;
- 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
- 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."
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On March 2, 1999, there were 9,741,931 shares of common stock, 7,625.39
shares of Series C Preferred Stock and $12,000,000 principal amount under the 9%
senior subordinated convertible notes due 2001 outstanding. In the event that
more than 2,000,000 shares of common stock would be required to fully convert
the Series C Preferred Stock, we must either honor conversion requests over the
2,000,000 share limit or redeem the remaining Series C Preferred Stock for cash,
at its stated value of $1,000 per share plus accrued but unpaid dividends.
<TABLE>
<CAPTION>
9% SENIOR
SERIES C SUBORDINATED
PREFERRED STOCK CONVERTIBLE NOTES TOTAL
-------------------- -------------------- --------------------
PERCENTAGE OF SHARES SHARES SHARES
MARKET PRICE UNDERLYING % UNDERLYING % UNDERLYING %
- ------------------------------------------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
25% ($5.27)................................ 1,448,317 12.9 2,279,202 19.0 3,727,519 27.7
50% ($10.53)............................... 847,266 8.0 1,139,601 10.5 1,986,867 16.9
75% ($15.80)............................... 847,266 8.0 759,734 7.2 1,607,000 14.2
100% ($21.06).............................. 847,266 8.0 705,882 6.8 1,553,148 13.8
</TABLE>
DILUTION MAY RESULT IN A DECREASE IN THE MARKET PRICE OF OUR COMMON STOCK
To the extent any of these shares of common stock are issued, the market
price of our common stock may decrease because of the additional shares on the
market. If the actual price of the common stock decreases, the holders of our
preferred stock and 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 preferred stock or
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 OUR CERTIFICATE OF INCORPORATION MAY NOT
PROTECT AGAINST DILUTION
Our certificate of incorporation does not allow us to issue shares of our
common stock to holders of our preferred stock or 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. See "Description of Certain Indebtedness--9%
Senior Subordinated Convertible Notes and Related Warrants."
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:
- 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
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common stock on the trading day immediately preceding the public
announcement of such merger or consolidation;
- 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
- 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.
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. We have also agreed, until July 1, 1999, to grant the holders of the
9% senior subordinated convertible notes a right of first refusal with respect
to certain issuances of common stock or securities convertible, exchangeable or
exercisable for common stock. 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
After six months from the date of issuance, 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. 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.
9
<PAGE>
We may be required to prepay the 9% senior subordinated convertible notes
if:
- 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
- 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
$6.99. If the market price of the common stock was $5.27, which is 25% of the
market price of the common stock as of March 2, 1999, we would be required to
make cash payments of $2,948,317. This amount does not take into account any
interest that accrues on the outstanding principal amount of the 9% senior
subordinated convertible notes. This amount also assumes that the market price
at the time of conversion and the conversion price were equal. The market price
at the time of conversion and the conversion price potentially could not be
equal because the conversion price is calculated using market prices during the
thirty days prior to conversion.
In addition, if the holders of the 9% senior subordinated convertible notes
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 redeem the notes at up to 112% of the then outstanding
principal amount plus accrued interest. The maximum amount of such cash
payments, assuming the market price and the conversion price were equal, is
$13,440,000, without taking into account any interest that would accrue. If the
market price and the conversion price are not equal, then the maximum amount of
such cash payments could be significantly higher.
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 SoftNet) 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.
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<PAGE>
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.
FAILURE TO INCREASE REVENUES FROM NEW PRODUCTS AND SERVICES, WHETHER DUE TO LACK
OF MARKET ACCEPTENCE, 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
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<PAGE>
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:
- continue to develop and improve our operational, financial and management
information systems;
- hire and train additional qualified personnel;
- continue to expand and upgrade core technologies; and
- effectively manage multiple relationships with various customers,
suppliers and other third parties.
Consequently, such expansion could place a significant strain on 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.
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.
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<PAGE>
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:
- intense competition;
- rapid technological advances;
- evolving industry standards;
- changes in subscriber requirements;
- frequent new product introductions and enhancements; and
- 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 Excite, Inc. for national
content aggregation, 3Com Corporation and Com21, Inc. for headend and cable
modem equipment, Cisco Systems, Inc. for specific network routing and switching
equipment, and, among others, MCIWorldCom, Inc. for national Internet backbone
services. Excite recently announced that it is being acquired by one of our
primary competitors, @Home. If, due to this acquisition, Excite were to
terminate its contract with us prior to the contract's expiration in November
1999, or not to extend the contract at that time, we would need to find a new
provider of national content aggregation. Additionally, certain of our cable
modem and headend equipment suppliers are in litigation over their patents. We
could experience disruptions in the delivery or increases in the prices of
products and services purchased from vendors as a result of this intellectual
property litigation. We cannot predict when delays in the delivery of key
components and other products may occur due to shortages resulting from the
limited number of suppliers, the financial or other difficulties of such
suppliers or the possible limited availability in the suppliers' underlying raw
materials. In addition, we may not have adequate remedies against such third
parties as a result of breaches of their agreements with us. The inability to
obtain sufficient key components or to develop alternative sources for such
components could result in delays or reductions in our product shipments. If
that were to happen, it could have a material adverse effect on our customer
relationships, business, financial condition, and prospects.
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.
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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, 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:
- Other cable-based access providers;
- Telephone-based access providers; and
- 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:
- systems integrators such as Convergence.com, Online System Services,
HSAnet and Frontier Communications' Global Center business; and
- 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, Media One, TCI and Time Warner.
Comcast, Cox and TCI market through @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, @Home has announced its
intention to compete directly in the small- to medium-sized cable system market.
TELEPHONE-BASED ACCESS PROVIDERS
Some of our most direct competitors in the access markets are
telephone-based access providers, including incumbent local exchange carriers,
national interexchange or long distance carriers, fiber-based competitive local
exchange carriers, ISPs, online service providers, wireless and satellite data
service providers, and 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.
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<PAGE>
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:
- transmission speed;
- security of transmission;
- reliability of service;
- ease of access;
- ratio of price to performance;
- ease of use;
- content quality;
- quality of presentation;
- timeliness of content;
- customer support;
- brand recognition; and
- 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.
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
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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:
- actual speed provisioned for the subscriber's cable modem;
- quality of the server used to deliver content;
- overall Internet traffic congestion;
- the number of active subscribers on a given 6 MHz channel at the same
time;
- the capability of cable modems used; and
- 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 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
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
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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:
- our ability to develop a customer base large enough to justify investments
in the development of such content;
- the ability of content providers to create and support high-quality
multimedia content; and
- 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.
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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:
- our success in providing high-speed, high-quality consumer and business
Internet products, services and content;
- the marketing efforts of our cable affiliates; and
- 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
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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.
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:
- rapid technological changes in the Internet and telecommunications
industries;
- the lengthy product approval and purchase process of our customers; and
- our reliance on third-party technology for the development of new products
and services.
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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.
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 INTELLIGENT COMMUNICATIONS, INC. SUBJECTS US TO RISKS IN A NEW
MARKET IN WHICH WE HAVE NO EXPERIENCE
On February 9, 1999, we completed our purchase of Intelligent
Communications, Inc., 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 Intelligent Communications, we cannot
assure you that integration will be accomplished smoothly, on time or
successfully. Although the management teams of both SoftNet and Intelligent
Communications believe that the merger will benefit both companies, we cannot
assure you that the merger will be successful.
The purchase of Intelligent Communications 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 Intelligent Communications 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
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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 Intelligent Communications acquisition was structured as a purchase by us of
all of the outstanding stock of Intelligent Communications. As a result, we
could be adversely affected by direct and contingent liabilities of Intelligent
Communications. It is possible that we are not aware of all of the liabilities
of Intelligent Communications and that Intelligent Communications has greater
liabilities than we expected. In addition, we have very little experience in the
markets and technology in which Intelligent Communications 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 Intelligent Communications was to be able to
provide two-way satellite Internet access options to our customers using VSAT
satellite technology. However, the market for VSAT communications networks and
services may not continue to grow or VSAT technology may be replaced by an
alternative technology. A significant decline in this market or the replacement
of the existing VSAT technology by an alternative technology could adversely
affect our business, financial condition and prospects.
RISK OF DAMAGE, LOSS OR MALFUNCTION OF SATELLITE
The loss, damage or destruction of any of the satellites used by Intelligent
Communications, 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
Intelligent Communications currently leases satellite space from General
Electric. If for any reason, the leases were to be terminated, we cannot assure
you that we could renegotiate new leases with General Electric 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.
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COMPETITION
The market for Internet access services is extremely competitive.
Intelligent Communications 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 Intelligent Communications and its competitors. We cannot assure
that Intelligent Communications will be able to successfully compete with
respect to these factors. See "Business--Intelligent Communications, Inc.--
Competition."
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 Intelligent Communications, Inc.,
we may acquire other businesses that we believe will complement our existing
business. We cannot predict if or when any prospective acquisitions will occur
or the likelihood that they will be completed on favorable terms.
Acquiring a business involves many risks, including:
- potential disruption of our ongoing business and diversion of resources
and management time;
- incurrence of unforeseen obligations or liabilities;
- possible inability of management to maintain uniform standards, controls,
procedures and policies;
- difficulty assimilating the acquired operations and personnel;
- risks of entering markets in which we have little or no direct prior
experience; and
- 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
service, we are currently seeking new employees. However, competition for such
personnel is intense in our business, and thus, we may be unsuccessful in our
hiring efforts. To
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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.
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. We cannot
predict the 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
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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.
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:
- announcements of developments related to our business;
- fluctuations in our results of operations;
- sales of substantial amounts of our securities into the marketplace;
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- general conditions in our industries or the worldwide economy;
- an outbreak of war or hostilities;
- a shortfall in revenues or earnings compared to securities analysts'
expectations;
- changes in analysts' recommendations or projections;
- announcements of new products or services by us or our competitors; and
- 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.
ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT OUR SHAREHOLDERS
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 shareholders for their
common stock.
THE YEAR 2000 ISSUE COULD HARM OUR OPERATIONS
Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because such computer programs would not properly recognize a year that begins
with "20" instead of "19." This, in turn, could result in major system failures
or miscalculations 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.
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
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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 August 31, 1999. We expect to be Y2K
compliant on all critical systems, which rely on the calendar year, before
December 31, 1999.
Some non-critical systems may not be addressed until after January 2000.
However, we believe such systems will not cause significant disruptions in our
operations.
COMPLIANCE BY EXTERNAL CUSTOMERS AND PROVIDERS
We are in the process of the inventory and assessment phases of our critical
suppliers, service providers and contractors to determine the extent to which
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
mid-1999. To the extent that responses to Y2K readiness are unsatisfactory, we
intend to change suppliers, service providers or contractors to those that have
demonstrated Y2K readiness. We cannot be assured that we will be successful in
finding such alternative suppliers, service providers and contractors. We do not
currently have any formal information concerning the status of our customers but
have received indications that most of our customers are working on Y2K
compliance.
RISKS ASSOCIATED WITH Y2K
We believe the major risk associated with the Y2K issue is the ability of
our key business partners and vendors to resolve their own Y2K issues. We will
spend a great deal of time over the next several months, working closely with
suppliers and vendors, to assure their compliance.
Should a situation occur where a key partner or vendor is unable to resolve
their Y2K issue, we expect to be in a position to change to Y2K compliant
partners and vendors.
COSTS TO ADDRESS Y2K ISSUES
Because we are in the 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.
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
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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.
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES
This prospectus contains "forward-looking" statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
the risks faced by us described above and elsewhere in this prospectus.
27
<PAGE>
USE OF PROCEEDS
The net proceeds to us from the offering will be approximately $117.7
million, assuming a public offering price of $36.13 per share and net of the
estimated expenses payable by us incurred in connection with the offering
($135.4 million, if the overallotment option is exercised). We intend to use
approximately $90.0 million to fund the expenditures incurred in the continuing
expansion of our ISP Channel service, and the remainder for general corporate
purposes. The amounts actually expended by us for these purposes will vary
significantly depending upon a number of factors, including future revenue
growth, if any, capital expenditures and the amount of cash generated by our
operations. Accordingly, our management will retain broad discretion in the
allocation of such net proceeds. Although we may use a portion of the net
proceeds to pursue possible acquisitions of businesses, technologies or products
complementary to ours in the future, there are no present understandings,
commitments or agreements with respect to any such acquisitions. Pending such
uses, the proceeds of the offering will be invested in short-term,
investment-grade investments. See "Risk Factors--We cannot assure you that we
will be profitable because we have operated our Internet services business only
for a short period of time," "--Our continued negative cash flow and net losses
may depress stock prices," "--The unpredictability of our quarter-to-quarter
results may adversely affect the trading price of our common stock," "--If we do
not achieve cash flows sufficient to support our operations, we may be unable to
implement our business plan" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
28
<PAGE>
CAPITALIZATION
The following table sets forth our consolidated capitalization at December
31, 1998 and as adjusted, as of December 31, 1998, to give effect to the sale of
3,500,000 shares of common stock offered by this prospectus at an assumed public
offering price of $36.13 per share and the application of the estimated net
proceeds from this offering. See "Selected Consolidated Historical Financial
Data" and "Use of Proceeds." The information below should be read in conjunction
with our consolidated financial statements and notes to those statements, and
other financial information included elsewhere herein.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1998
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(UNAUDITED, EXCEPT
SHARE AND PER SHARE
DATA)
<S> <C> <C>
Cash................................................................... $ 4,329 $ 121,981
--------- -----------
--------- -----------
Long-term debt (net of current portion):............................... 9,430 9,430
--------- -----------
Redeemable convertible preferred stock, $.10 par value, 25,000 shares
authorized, 17,877 shares issued and outstanding and 17,877 shares,
as adjusted (1)...................................................... 15,754 15,754
--------- -----------
Shareholders' equity (deficit):
Preferred stock, $.10 par value, 3,975,000 shares authorized;
none issued or outstanding actual and as adjusted.................. -- --
Common stock, $.01 par value; 25,000,000 shares authorized; 8,631,087
shares issued and outstanding, actual, and 12,131,087 shares issued
and outstanding, as adjusted (2)................................... 86 121
Deferred stock compensation.......................................... (303) (303)
Capital in excess of par value....................................... 46,653 164,270
Accumulated deficit.................................................. (56,231) (56,231)
--------- -----------
Total shareholders' equity (deficit)............................... (9,795) 107,857
--------- -----------
Total capitalization................................................... $ 15,389 $ 133,041
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) Comprises 10,251.56 shares of Series B Preferred Stock and 7,625.39 shares
of Series C Preferred Stock issued and outstanding as of December 31, 1998.
On August 31, 1998, we agreed to issue 7,500 shares of Series D Preferred
Stock and warrants to purchase an additional 93,750 shares of common stock,
subject to shareholder approval and other closing conditions. Such shares
are not included in the table above. In February 1999, all shares of Series
B Preferred Stock were converted into 782,352 shares of common stock.
(2) Does not include:
- 2,835,062 shares of common stock subject to options issued at a weighted
average exercise price of $9.69 per share, with 419,551 shares of common
stock reserved for future issuance;
- warrants to purchase 778,725 shares of common stock at a weighted average
exercise price of $9.39 per share;
- 847,266 shares of common stock to be issued upon conversion of the Series
C Preferred Stock assuming a conversion price of $9.00 per share;
- 88,889 shares of common stock to be issued upon conversion of the 6%
convertible debentures due 2002 assuming a conversion price of $8.10 per
share;
29
<PAGE>
- 264,730 shares of common stock to be issued upon conversion of the 9%
convertible debentures due 2000 assuming a conversion price of $6.75 per
share;
- 175,000 shares of common stock to be issued upon conversion of the 5%
convertible debentures due 2002 assuming a conversion price of $8.25 per
share; and
- 1,513,885 shares of common stock reserved under our Cable Affiliates Plan.
On April 13, 1999, our stockholders agreed to increase the number of
authorized shares of our common stock from 25 million to 100 million.
On August 31, 1998, we agreed to issue 7,500 shares of Series D Preferred
Stock and warrants to purchase an additional 93,750 shares of common stock. Such
stock and warrants have not been issued as of December 31, 1998. In addition, we
issued warrants to purchase an additional 26,250 shares of common stock as a
financial advisory fee in connection with certain financings. On March 24, 1999,
we entered into an agreement to sell 660,000 shares of our common stock to
Teleponce Cable TV, Inc. for $15 million. The offer and sale of the shares of
common stock was completed pursuant to the exemption from registration provided
by Regulation D under the Securities Act of 1933, as amended. See "Description
of Capital Stock" for a more detailed description of our securities.
30
<PAGE>
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
Our common stock is quoted on the Nasdaq National Market. Prior to April 14,
1999, our common stock was traded on the American Stock Exchange ("AMEX") under
the symbol "SOF." The following table sets forth, for the period indicated, the
highest and lowest closing sale prices for the common stock, as reported on
AMEX, or the Nasdaq National Market, as applicable for the periods presented.
<TABLE>
<CAPTION>
QUARTER ENDING HIGH LOW
- ---------------------------------------- --------- ---------
<S> <C> <C>
1997
December 31, 1996....................... $ 6 $ 4 5/16
March 31, 1997.......................... 7 1/4 4 1/4
June 30, 1997........................... 6 3/8 4 1/8
September 30, 1997...................... 6 3/4 5 1/8
1998
December 31, 1997....................... 8 7/16 6 9/16
March 31, 1998.......................... 7 1/4 6 3/16
June 30, 1998........................... 15 3/8 7 3/16
September 30, 1998...................... 18 3/8 7 3/4
1999
December 31, 1998....................... 18 3/4 7 3/8
March 31, 1999.......................... 39 14 15/16
June 30, 1999 (through April 21,
1999)................................. 60 1/4 33
</TABLE>
There were approximately 340 record holders of the stock as of March 26,
1999. The closing price for the common stock on April 21, 1999 was $36.13 per
share. We paid no dividends on our common stock during the period October 1,
1994 to December 31, 1998. Other than restrictions that may be part of various
debt instruments and our preferred stock, we do not have any legal restriction
on paying dividends. However, we anticipate retaining any available funds for
the operation and expansion of our business and do not intend to pay dividends
on our common stock in the foreseeable future.
31
<PAGE>
DILUTION
Our net tangible book deficit at December 31, 1998 was approximately
$12,559,000 or $1.46 per share. Net tangible book deficit per share is
determined by dividing our tangible net worth (tangible assets less liabilities)
by the number of shares of common stock outstanding. After giving effect to our
sale of the 3,500,000 shares of common stock offered by this prospectus at an
assumed public offering price of $36.13 per share, after deducting underwriting
discounts and commissions and estimated offering expenses, our net tangible book
value as of December 31, 1998 would have been $105,093,000 or $8.66 per share.
This represents an immediate increase in net tangible book value of $10.12 per
share to existing shareholders and an immediate dilution in net tangible book
value of $27.47 per share to new investors purchasing shares at the assumed
public offering price. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed public offering price per share.................... $ 36.13
---------
Net tangible book deficit per share as of December 31,
1998................................................... $ (1.46)
Increase per share attributable to this offering......... 10.12
---------
Net tangible book value per share after offering........... 8.66
---------
Dilution per share to new investors........................ $ 27.47
---------
---------
</TABLE>
32
<PAGE>
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
The selected consolidated historical statement of operations data below for
the five years ended September 30 have been derived from our audited
consolidated financial statements. The selected consolidated historical
statement of operations data set forth below for the three months ended December
31, 1997 and 1998 and the consolidated balance sheet data at December 31, 1998
are derived from our unaudited consolidated financial statements. In the opinion
of management, the unaudited consolidated financial statements have been
prepared on the same basis as the audited financial statements and contain all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of our results of operations for such periods and financial
conditions at such date. The results of operations for the three months ended
December 31, 1998 are not necessarily indicative of the results to be expected
for the full year or future periods. While we intend to sell MTC, MTC has not
been accounted for as a discontinued operation because its sale was dependent on
shareholder approval which we only recently received. Because of our sale of KCI
and our intended disposition of MTC, we believe our historical financial results
are not comparable from year to year. The following selected consolidated
financial data should be read in conjunction with the consolidated financial
statements and their related notes appearing elsewhere in this prospectus, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Internet services:................................ $ -- $ -- $ 167 $ 1,008 $ 1,018 $ 215 $ 444
MTC............................................... -- 1,088 19,417 20,330 13,042 2,660 3,852
Other............................................. 188 -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Total revenues................................ 188 1,088 19,584 21,338 14,060 2,875 4,296
--------- --------- --------- --------- --------- --------- ---------
Cost of revenues.................................... 172 783 11,375 11,935 10,628 2,249 2,967
Selling, engineering, general and administrative.... 1,180 7,548 10,921 11,191 19,265 2,638 7,339
--------- --------- --------- --------- --------- --------- ---------
Loss from continuing operations..................... (1,164) (7,243) (2,712) (1,788) (15,833) (2,012) (6,010)
Interest expense.................................... (601) (456) (1,220) (1,145) (1,416) (330) (569)
Other income........................................ 2 5 5,708 49 320 72 217
Income (loss) from discontinued operations.......... 335 (1,962) (1,812) 739 (73) (108) 139
Loss from extraordinary items....................... -- -- (6,061) (486) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss............................................ (1,428) (9,656) (6,097) (2,631) (17,002) (2,378) (6,223)
Preferred dividends................................. -- -- -- -- (343) -- (243)
--------- --------- --------- --------- --------- --------- ---------
Net loss applicable to common shares................ $ (1,428) $ (9,656) $ (6,097) $ (2,631) $ (17,345) $ (2,378) $ (6,466)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net loss per share:
Diluted........................................... $ (0.38) $ (2.22) $ (1.05) $ (0.40) $ (2.35) $ (0.34) $ (0.77)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Shares used in per share calculations:
Diluted........................................... 3,802 4,353 5,819 6,627 7,391 6,941 8,374
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-----------------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash.................................................................... $ 4,329
Total assets............................................................ 29,710
Total long-term liabilities............................................. 9,948
Redeemable convertible preferred stock.................................. 15,754
Total shareholders' deficit............................................. (9,795)
</TABLE>
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 ELSEWHERE IN THIS PROSPECTUS. OUR FISCAL YEAR ENDS ON
SEPTEMBER 30TH OF EACH YEAR. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS
THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS,"
"BUSINESS" AND ELSEWHERE IN THIS PROSPECTUS. WE DISCLAIM ANY OBLIGATION TO
UPDATE INFORMATION CONTAINED IN ANY FORWARD-LOOKING STATEMENT.
OVERVIEW
During fiscal 1998, we made a strategic decision to focus on becoming,
through our wholly-owned subsidiary, ISP Channel, Inc. (formerly known as
MediaCity World, Inc.) ("ISP Channel"), the dominant cable-based provider of
high-speed Internet access, as well as other digital communications services, to
homes and businesses in the franchise areas of those cable systems unaffiliated
with the seven largest U.S. cable operators and certain other smaller systems.
As part of this new focus, on February 9, 1999 we acquired Intelligent
Communications Inc., the former Xerox Skyway Network. We believe that
integrating this new technology into our existing business plan will allow us to
provide cost effectively 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 basis and increasing
our potential market size. Also in line with this strategy, we determined to
divest our two other businesses (which, together, comprise substantially all of
our assets): Micrographic Technology Corporation ("MTC"), a wholly-owned
subsidiary offering document management solutions, and Kansas Communications,
Inc. ("KCI"), a wholly-owned subsidiary which sells and services telephone
systems, third-party computer hardware and application oriented peripheral
products such as voice mail and video conferencing systems. On February 12,
1999, we completed the divestiture of KCI. In addition, we entered into a letter
of intent for the sale of MTC on November 5, 1998. Since July 27, 1998, we have
reclassified and reported KCI in discontinued operations but, at this time, we
continue to classify and report MTC as a continuing business though it is our
current intent to conclude the sale of MTC during 1999.
ISP CHANNEL AND INTELLIGENT COMMUNICATIONS, INC. We began providing
Internet services following our acquisition of ISP Channel, in June 1996. While
we seek to maintain and build 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 commenced marketing this
high-speed service, using cable modems, to select cable operators and potential
subscribers in March 1998. However, we believe that, as a result of our limited
financial resources, we have not been able to fully implement our marketing
strategies, and this business has, to date, generated only nominal revenues.
On February 9, 1999, we completed the purchase of Intelligent
Communications, Inc. ("Intelligent Communications"). The purchase price for this
acquisition is decribed below. Through use of its proprietary satellite system,
Intelligent Communications currently provides two-way Internet connectivity to
local Internet service providers ("ISPs"), school systems and businesses,
primarily located in remote and rural areas. Intelligent Communications' VSAT
(very small aperture terminals) network allows connectivity throughout the 48
lower states as well as in southern Canada and southern Alaska. Intelligent
Communications offers a wide range of Internet services based on its proprietary
T1Plus product that presently offers up to 2 Mbps data transfer rates. It is our
intention that, while Intelligent Communications will continue to market its
services to its current market business, it will
34
<PAGE>
also provide ISP Channel with the in-house ability to bypass many of the high
cost terrestrial telephone links that ISP Channel has historically used to
connect the cable headends of its affiliated cable operators to the network
operating center of ISP Channel. As a result of the Intelligent Communications
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
ISP CHANNEL AFFILIATES. As of March 3, 1999, we had contracts for our ISP
Channel service with 31 cable operators, representing 126 cable systems and
approximately 1.6 million homes passed. Twenty-three of these systems,
representing approximately 264,000 homes passed, have been equipped and have
begun offering our services. As of March 3, 1999, we had approximately 2,200
residential and business subscribers to our ISP Channel service. See "Risk
Factors--We may not be able to successfully implement our business plan if our
relationship with our cable affiliates is negatively impacted" and "--If we do
not obtain exclusive access to cable subscribers, we may not be able to sustain
any meaningful growth."
In order to expand our cable-based Internet subscriber base significantly,
we expect to pursue aggressively affiliation agreements with cable operators
which will provide us with 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 1999, we cannot assure,
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 our 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 ranges from $39 per
month to $69 per month though it is our expectation that such rates will
decrease over time. We anticipate that we will purchase a majority of cable
modems used by subscribers, who will be charged a nominal lease or rental
charge. We do not charge new dial-up subscribers a connection fee, but do charge
a monthly access fee of approximately $20.
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. Intelligent Communications is
also anticipated to generate continuing revenue from the sale of VSAT service.
In the future, as digital set-top boxes become available and are introduced
into our affiliated cable systems, we expect to charge those subscribers monthly
access fees comparable to those now charged traditional dial-up subscribers. We
also expect to charge customers a set-top connection fee to help defray
installation expenses.
For cable-based Internet services, we typically share 25% of monthly access
revenues with cable affiliates for the first 200 subscribers in each system and
50% thereafter. For other services, such as Internet-based telephony, e-commerce
and advertising, we expect to share between 25% and 50% of
35
<PAGE>
these revenues with the 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.
COST OF SERVICES. Costs to us include installation costs, network and cable
operation costs and personnel and other costs. Commissions paid to cable
affiliates vary by type of connectivity and size of contract.
Installation costs are expected to vary by type of connectivity and type of
customer. We charge new subscribers a one-time fee to defray the costs of
installation, which includes labor and overhead. While currently the
installation fee does not cover the entire cost incurred by us, we expect over
time that installation costs will decline as cable modems become more
standardized and are eventually bundled as standard equipment in new personal
computers.
Other network costs include the cost of connection to the public switch
telephone network. Such connections are required, among other reasons, to
service our dial-up customers as well as 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 system hub (or headend). In addition,
we incur 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 headend back to our network operating center in Mountain View,
California. We anticipate that the utilization of Intelligent Communications'
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 Intelligent Communications's VSAT capacity to supplement or replace
its 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 headend-based receivers which, in conjunction
with other factors, including "caching", produces significant efficiency
improvement over comparable landline systems. Second, for upstream traffic, it
permits us to allocate the necessary capacity required by each headend in
smaller increments (and consequently lower cost) than would be available using
terrestrial links, such as T1 lines.
SALES, MARKETING AND OPERATING EXPENSES. Sales, marketing and operating
expenses include the costs of our cable affiliate program, maintenance of our
infrastructure, customer care, content and new business development in addition
to sales and marketing expenses.
STOCK OPTION EXPENSES. Between October 1998 and March 1999, we granted
stock options under our 1998 Stock Option Plan. Because the 1998 Stock Option
Plan was not adopted until our Annual Meeting of Stockholders held in April
1999, we are required to recognize a compensation expense equal to the excess of
the fair market price on the date of stockholder approval over the exercise
price of the committed option grants. The compensation expense is approximately
$80 million and will be recognized over the vesting period of the options.
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 headend equipment and the
purchase of customer premise equipment such as cable modems. The cost of headend
equipment has averaged $45,000 per headend for the 23 systems through which we
currently provide service. The costs of cable modems, currently approximately
$179 to $349, is expected to decline over time as economies of scale in
production and new market entrants in the cable modem market push down prices.
However, we recognize that, in line with experience in other subscription
service industries, we will need to subsidize for the customer both the cost of
installation and the cable modem equipment. Such expenditures, however, are
expected to be offset in part by the savings resulting from decreased costs of
installation and prices for such equipment as equipment is standardized and
production volumes increase, respectively.
MTC. We have signed a letter of intent to sell MTC. Either through the
currently contemplated transaction or otherwise, we expect to dispose of this
business during 1999. MTC develops and
36
<PAGE>
manufactures sophisticated, automated electronic document management and
film-based imaging solutions for customers with large-scale, complex,
document-intensive requirements. MTC's hardware and software products are based
on an industry standard client-server architecture, providing flexibility to
connect to a wide variety of information systems and produce output to various
storage media, including optical disk, magnetic disk and tape, CD-ROM, and
microfilm and microfiche, spanning the entire document lifecycle. MTC's
electronic and film-based imaging hardware systems typically range in price
between $200,000 and $1,000,000, and may represent a significant capital
commitment by MTC's customers, leading to a lengthy sales cycle of up to 24
months. Accordingly, MTC's operating results may fluctuate significantly from
period to period.
HISTORICAL RESULTS OF OPERATION
We have changed significantly over the last several years as we have entered
certain businesses and exited or prepared to exit, others. In July 1998, our
Board of Directors adopted a plan to discontinue operations of the
telecommunications business. Accordingly, the operating results of our
telecommunications business have been segregated from continuing operations and
reported as a separate line item on the consolidated statements of operations.
The assets and liabilities of such operations have been reflected as a net asset
in the consolidated balance sheets.
We are in the process of negotiating the sale of MTC and expect that this
sale will be completed within a twelve month period. Management does not
anticipate a loss on the sale of MTC and intends to use sale proceeds to reduce
outstanding indebtedness and provide additional working capital to ISP Channel.
The discussion of our consolidated results of operation below therefore
treats the telecommunication business as a discontinued operation. In addition,
we entered the Internet business in June 1996 with the purchase of the Internet
services business and began offering cable-based Internet services in the fourth
quarter of fiscal 1997. Accordingly, year-to-year comparisons may not be
meaningful.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL YEAR ENDED SEPTEMBER 30, DECEMBER 31,
-------------------------------- --------------------
1996 1997 1998 1997 1998
--------- --------- ---------- --------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales
MTC...................................................... $ 19,417 $ 20,330 $ 13,042 $ 2,660 $ 3,852
ISP Channel.............................................. 167 1,008 1,018 215 444
Cost of sales
MTC...................................................... 11,375 11,050 9,410 2,003 2,560
ISP Channel.............................................. -- 885 1,218 246 407
--------- --------- ---------- --------- ---------
Gross profit (deficit)
MTC...................................................... 8,042 9,280 3,632 657 1,292
ISP Channel.............................................. 167 123 (200) (31) 37
Operating expenses
MTC...................................................... 8,162 8,714 9,272 1,665 1,586
ISP Channel.............................................. 478 1,273 8,016 490 5,597
--------- --------- ---------- --------- ---------
Income (loss) from continuing operations
MTC...................................................... (120) 566 (5,640) (1,008) (294)
ISP Channel.............................................. (311) (1,150) (8,216) (521) (5,560)
Corporate Overhead....................................... (2,281) (1,204) (1,978) (484) (156)
--------- --------- ---------- --------- ---------
Consolidated........................................... $ (2,712) $ (1,788) $ (15,834) $ (2,013) $ (6,010)
--------- --------- ---------- --------- ---------
--------- --------- ---------- --------- ---------
</TABLE>
37
<PAGE>
THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
1997
Consolidated net sales increased $1.4 million, or 49.4%, to $4.3 million for
the three months ended December 31, 1998, as compared to $2.9 million for the
same period in 1997. For the three months ended December 31, 1998, sales in the
document management segment increased $1.2 million, or 44.9%, to $3.9 million,
as compared to $2.7 million for the same period in 1997. For the document
management segment, sales of its computer output microfiche equipment ("COM")
increased $836,000 to $994,000 for the three months ended December 31, 1998 and
sales of its consumable product lines, such as spare parts and film supplies,
increased $323,000 to $2.3 million for the three months ended December 31, 1998.
Domestic COM sales contributed $474,000, or 47.7%, of the total COM sales for
the three months ended December 31, 1998, representing an increase of $472,000
in domestic COM sales, as compared to the same period in 1997. Net sales in the
Internet segment increased $229,000, or 106.5%, to $444,000 for the three months
ended December 31, 1998, as compared to $215,000 for the same period in 1997.
Net sales associated with the Internet segment's cable based services increased
$223,000 to $270,000 for the three months ended December 31, 1998, as compared
to $47,000 for the same period in 1997. Net sales associated with the segment's
non-cable based dial-up and business-to-business Internet access offerings
increased $6,000 to $174,000 as compared to $168,000 for the same period in
1997.
Consolidated gross profit increased $703,000, or 112.3%, to $1.3 million for
the three months ended December 31, 1998, as compared to $626,000 for the same
period in 1997, with profit margins increasing to 30.9% from 21.8% for the same
period in 1997. The percentage increase is primarily related to the increase in
the document management segment's COM sales, which historically have contributed
the highest product profit margins. For the three months ended December 31,
1998, gross profit in the document management segment increased $635,000, or
96.7%, to $1.3 million, as compared to gross profit of $657,000 for the same
period in 1997. For the three months ended December 31, 1998, gross profit
margins in the document management segment increased to 33.5%, from 24.7% for
the same period in 1997. Gross profit in the Internet segment increased $68,000
to $37,000 for the three months ended December 31, 1998, as compared to a gross
deficit of $31,000 for the same period in 1997. For the three months ended
December 31, 1998, gross profit margins for the Internet segment were 8.2%.
Operating expenses (selling, engineering, general and administrative)
increased $4.7 million to $7.0 million for the three months ended December 31,
1998, as compared to $2.3 million for the same period in 1997. The increase in
operating expenses is entirely related to the increase in the administrative,
engineering, sales and marketing efforts associated with the Internet segment's
ISP Channel cable based service offering. The expenses associated with these
operations increased $4.8 million for the three months ended December 31, 1998,
as compared to the same period in 1997. This increase includes our corporate
operating expenses, as these expenses are now directly related to the operations
of the Internet segment, given management's strategic refocusing towards the ISP
Channel cable based service offering.
Amortization expense associated with goodwill remained constant in the
comparative periods.
Consolidated interest expense increased $239,000, or 72.4%, to $569,000 for
the three months ended December 31, 1998, as compared to $330,000 for the same
period in 1997. Interest expense associated with the operations of the Internet
segment increased $291,000 to $296,000 for the three months ended December 31,
1998, as compared to $5,000 for the same period in 1997, primarily due to lease
financing associated with the capital expansion needs of the segment's ISP
Channel cable based service offering. Interest expense associated with our
outstanding indebtedness decreased by $52,000, primarily as the result of lower
outstanding bank debt.
We made no provision for income taxes for the three months ended December
31, 1998, as a result of our net operating loss carry-forward.
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<PAGE>
We recognized income from operations with respect to our discontinued
telecommunications segment of $139,000 for the three months ended December 31,
1998, as compared to a loss from operations of $108,000 for the same period in
1997.
For the three months ended December 31, 1998, we had a net loss applicable
to common shares of $6.5 million, or a loss per share of $0.77, compared to a
net loss of $2.4 million for the same period in 1997, or a loss per share of
$0.34.
FISCAL 1998 COMPARED TO FISCAL 1997
Consolidated sales decreased $7.3 million, or 34.0%, to $14.1 million for
fiscal 1998, as compared to $21.4 million for fiscal 1997. The decrease in
consolidated sales was the result of a decrease in sales associated with the
operations of MTC. Sales in this business decreased $7.3 million, or 35.8%, to
$13.0 million for fiscal 1998, as compared to sales of $20.3 million for fiscal
1997. The decrease in MTC's sales was primarily the result of a significant
decrease in the domestic sales of the business's core product line: COM
equipment. Domestic orders for MTC's microfiche systems, which typically range
in price from $200,000 to $1.0 million, were delayed by a purchasing slowdown
brought about by a trend of corporate consolidation occurring within the
business's major markets, including such industries as the document management
service bureau industry and the banking and insurance industries. Sales were
further affected by the fact that MTC entered the year with an order backlog of
$1.4 million, as compared to an order backlog of $3.4 million in the prior
period. MTC believes that this trend is reversing and that the demand for its
products will return at least to their historical levels. ISP Channel sales
increased $10,000, or 1.0%, to $1.0 million for fiscal 1998, as compared to
fiscal 1997. Net sales for ISP Channel's cable-based services increased $289,000
to $309,000 for fiscal 1998, as compared to $20,000 for fiscal 1997. ISP Channel
introduced its cable-based services to the market in the fourth quarter of
fiscal 1997. Traditional dial-up and dedicated ISP Channel sales increased
$42,000, or 7.0%, to $644,000 for fiscal 1998, as compared to $602,000 for
fiscal 1997. This business also experienced a decrease in miscellaneous and
one-time service sales of $321,000, or 83.2% to $65,000 for fiscal 1998, as
compared to $386,000 for fiscal 1997. This decrease in miscellaneous and
one-time service sales is the result of our decision to re-focus our sales
efforts on our cable-based ISP Channel services.
Consolidated gross profit decreased $6.0 million, or 63.5%, to $3.4 million
for fiscal 1998, as compared to $9.4 million for fiscal 1997, with profit
margins decreasing to 24.4% from 44.1% for the comparable period in 1997. The
decrease in gross profit is primarily the result of a decrease in gross profits
of $5.6 million associated with the operations of MTC. Gross profit margins in
this business decreased to 27.9% in fiscal 1998, from 45.6% for the comparable
period in 1997. This decrease in profit margin is a direct result of the
decrease in MTC's COM equipment sales, which have historically contributed the
highest product profit margins for this business. Gross profit decreased
$323,000 in the Internet service business for fiscal 1998. ISP Channel
experienced a negative gross profit of $200,000 in fiscal 1998, primarily as the
result of the build-out of the segment's Internet operations used to support its
cable-based service offering. In addition, on a system by system deployment
basis, the ISP Channel cable-based service offering initially results in a
negative gross profit, until such time as subscriber sales exceed the up-front,
recurring fixed telephony and Internet connection fees.
Consolidated operating expenses (selling, engineering, general and
administrative) increased $7.1 million, or 91.6%, to $14.9 million for fiscal
1998, as compared to $7.8 million for fiscal 1997. Operating expenses associated
with the operations of MTC decreased approximately $400,000, or 7.1%, to $5.3
million for fiscal 1998, as compared to $5.7 million for fiscal 1997. Operating
expenses associated with ISP Channel and corporate overhead increased a combined
$7.5 million, with expenses associated with ISP Channel increasing $6.7 million
to $7.6 million for fiscal 1998, as compared to $860,000 for fiscal 1997. This
increase in operating expense is primarily the result of the increase in ISP
Channel's administrative, sales and marketing efforts supporting the ISP Channel
cable-based service
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<PAGE>
offering. Similarly, the increase in the corporate operating expenses are
directly related to the management changes and financing activities associated
with our strategic refocusing towards the ISP Channel cable-based service
offering.
Amortization expense associated with goodwill remained constant in fiscal
1998.
In fiscal 1998, we recorded an impairment loss on the long-lived assets of
the document management business. Estimates based upon certain trends in the
document management business indicated that the undiscounted future cash flows
from this business would be less than the carrying value of the long-lived
assets related to this business. Accordingly, we recognized an asset impairment
loss of $3.1 million, all of which was reduced from the carrying value of
goodwill.
For fiscal 1998, we had a net loss from continuing operations of $15.8
million, as compared to a net loss from continuing operations of $1.8 million
for fiscal 1997.
Interest expense increased $271,000, or 23.7%, to $1.4 million for fiscal
1998 from $1.1 million for fiscal 1997, primarily as a result of fluctuations in
our outstanding indebtedness with respect to our revolving line of credit and
the issuance of our 5% convertible subordinated debentures.
We made no provisions for income taxes for fiscal 1998 and 1997 as a result
of our net operating loss carry-forward.
We recognized a loss from operations with respect to our discontinued
telecommunications business of $73,000 for fiscal 1998, as compared to a gain
from operations of $739,000 for the same period in 1997.
We paid aggregate dividends of $343,000 in fiscal 1998 on our outstanding
redeemable convertible preferred stock.
For fiscal 1998, we had a net loss applicable to common shareholders of
$17.3 million, as compared to a net loss of $2.6 million for fiscal 1997.
FISCAL 1997 COMPARED TO FISCAL 1996
Consolidated sales increased $1.7 million, or 8.9%, to $21.3 million for
fiscal 1997, as compared to $19.6 million for fiscal 1996. MTC's sales increased
$913,000, or 4.7%, to $20.3 million for fiscal 1997 as compared to $19.4 million
for fiscal 1996. This increase in sales is primarily the result of increased
monthly rental streams associated with the business' continued implementation of
alternative customer leasing arrangements for its core COM products. ISP Channel
sales increased $841,000 to $1.0 million for fiscal 1997 from $167,000 for
fiscal 1996. ISP Channel sales for fiscal 1996 consist only of fourth quarter
sales, as the business was acquired in June 1996.
Consolidated gross profit increased $1.2 million, or 14.6%, to $9.4 million
for fiscal 1997, as compared to $8.2 million for fiscal 1996, with profit
margins increasing to 44.1% from 41.9% for the same period in 1996. Gross profit
increased $1.3 million, or 15.4%, in MTC to $9.3 million for fiscal 1997 from
$8.0 million for fiscal 1996, with gross profit margins increasing to 45.7% from
41.4% for the same period in 1996. The increase in gross profit margin was
primarily the result of increased productivity efficiencies in the manufacturing
operation, which in turn resulted from a strong equipment backlog and a steady,
customer order driven, manufacturing schedule. ISP Channel recorded gross
profits of $123,000 for fiscal 1997, however, year to year comparisons are not
meaningful, given the fact that the business operated for only one quarter in
fiscal 1996 and allocated no expense to cost of goods sold during this one
quarter period.
Consolidated operating expenses (selling, engineering, general and
administrative) decreased $24,000, or 0.2%, to $9.9 million for fiscal 1997 as
compared to $9.9 million for fiscal 1996. General and administrative expenses
associated with MTC and corporate overhead decreased a combined
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<PAGE>
$810,000, or 20.2%, to $3.2 million for fiscal 1997, as compared to $4.0 million
in the same period in 1996. The decrease in these combined general and
administrative expenses was the result of certain overhead cost cutting measures
implemented to achieve back office efficiencies throughout SoftNet. For MTC,
engineering expenses increased $324,000, or 19.1%, to $2.0 million for fiscal
1997, as compared to $1.7 million for fiscal 1996, as a result of the business's
continued effort to expand and improve the products offered to its customers.
Included in the consolidated operating expenses are two separate, one-time
charges associated with changes in our product lines, in the amounts of $2.1
million for fiscal 1997 and $2.2 million for fiscal 1996. ISP Channel operating
expenses increased $483,000 to $858,000 for fiscal 1997, however, year to year
comparisons are not meaningful given the fact that the business operated for
only one quarter in fiscal 1996.
Amortization expense increased $294,000, or 29.6%, to $1.3 million for
fiscal 1997 from $993,000 for fiscal 1996. This increase in amortization expense
is primarily the result of the additional amortization expense associated with
the acquisition of ISP Channel in June 1996.
We had a net loss from continuing operations of $1.8 million for fiscal
1997, as compared to a net loss from continuing operations of $2.7 million for
fiscal 1996.
Consolidated interest expense decreased $75,000, or 6.1%, to $1.1 million
for fiscal 1997 as compared to $1.2 million for fiscal 1996, primarily as a
result of the conversion of $4.5 million of convertible subordinated notes since
June 1996.
We recognized a gain on the sale of securities of $5.7 million in fiscal
1996. This gain was the result of the sale of all shares of IMNET Systems, Inc.
("IMNET") held by us.
We made no provisions for income taxes for fiscal 1997 and fiscal 1996 as a
result of our net operating loss carry-forward.
We recognized a gain from operations with respect to its discontinued
telecommunications business of $739,000 for fiscal 1997, as compared to a loss
from operations of $1.8 million for the same period in 1996. The loss incurred
in fiscal 1996 includes a loss from operations of $2.5 million associated with
the disposal of our wholly-owned subsidiary, Communicate Direct, Inc.
We recognized a loss from extraordinary item of $486,000 for fiscal 1997, as
compared to a loss from extraordinary item of $6.1 million for the same period
in 1996. The losses are associated with the disposal of our wholly-owned
subsidiary, Communicate Direct, Inc.
For fiscal 1997, we had a net loss applicable to common shareholders of $2.6
million, as compared to a net loss of $6.1 million for fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
Over the past year, our growth has been funded through a combination of
private equity, bank debt and lease financings. As of December 31, 1998, we had
approximately $4.3 million of unrestricted cash. In addition, on January 12,
1999, we executed an agreement with a group of institutional investors whereby
we issued $12.0 million in senior subordinated convertible notes. These notes
bear an interest rate of 9% per year and mature in 2001. In connection with
these notes, we issued to these investors an aggregate of 300,000 warrants.
These warrants, which have an exercise price of $17.00 per warrant, expire in
2003. We have also received a commitment to provide a secured $3.0 million loan
from a financial lender and are in negotiations with two additional lenders with
regard to a $7.5 million senior secured credit facility. We believe, as a result
of this, that we currently have sufficient cash and financing commitments to
meet our funding requirements over the next year. 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 substantial additional
capital to accomplish our business plan over the next
41
<PAGE>
several years. Our future cash requirements for our business plan expansion will
depend on a number of factors including (i) the number of cable affiliate
contracts, (ii) cable modem and associated costs of equipment, (iii) the rate at
which subscribers purchase our Internet service offering and (iv) the level of
marketing required to acquire and retain subscribers and to attain a competitive
position in the marketplace. In addition, we may wish to selectively pursue
possible acquisitions of businesses, technologies, content or products
complementary to those of ours in the future in order to expand our Internet
presence and achieve operating efficiencies. We expect to seek to obtain
additional funding through the sale of public or private debt and/or equity
securities or through a bank credit facility. We expect we may raise as much as
$150.0 million in debt and/or equity financing during fiscal 1999. If additional
funds are raised through the issuance of equity or convertible debt securities,
the percentage ownership of our shareholders will be reduced, shareholders may
experience additional dilution and such securities may have rights, preferences
or privileges senior to those of our common stock. We can give no assurance as
to the availability or terms upon which such financing might be available.
For fiscal 1998, cash flows used in operating activities of continuing
operations were $4.7 million, as compared to $1.4 million for fiscal 1997. We
used $5.6 million in investing activities of continuing operations during fiscal
1998, as compared to $1.1 million used by investing activities of continuing
operations in fiscal 1997. Cash flows provided by financing activities of
continuing operations increased $20.4 million to $23.4 million for fiscal 1998,
as compared to $3.0 million for fiscal 1997. This increase in cash flows was
primarily the result of the issuance of our 5% redeemable convertible preferred
stock.
For the three months ended December 31, 1998, cash flows used in operating
activities of continuing operations were $4.3 million, as compared to $780,000
for the same period in 1997. Cash flows used in investing activities of
continuing operations were $3.2 million for the three months ended December 31,
1998, as compared to $76,000 for the same period in 1997. Cash flows used in
financing activities of continuing operations were $881,000 for the three months
ended December 31, 1998, as compared to cash flows provided by financing
activities of continuing operations of $1.1 million for the same period in 1997.
On December 31, 1997, we sold 5,000 shares of Series A Preferred Stock and
warrants to purchase 150,000 shares of common stock for $5.0 million. The $4.6
million in net proceeds from this sale were applied to our revolving credit
facility. On May 28, 1998, we sold 10,000 shares of Series B Preferred Stock and
warrants to purchase 200,000 shares of common stock for $10 million and on
August 31, 1998, we sold 7,500 shares of Series C Preferred Stock and warrants
to purchase 93,750 shares of common stock for $7.5 million. The proceeds of
these last two sales were added to our working capital. We have extended the
maturity of our revolving credit facility, which has a maximum borrowing
capacity of $9.5 million, through January 15, 2000.
ACQUISITION OF INTELLIGENT COMMUNICATIONS. On February 9, 1999, we
completed the purchase of Intelligent Communications. The purchase price was a
cash component of $500,000, less payment of certain expenses, paid at closing, a
promissory note in the amount of $1.0 million due one year after closing, a
promissory note in the amount of $2.0 million due two years after closing, the
issuance of 500,000 shares of our common stock (adjustable upwards after one
year in certain circumstances) and a demonstration bonus of $1.0 million payable
within one year after closing if certain conditions are met, and in cash or
shares of our common stock at our option. Approximately $300,000 of the $1.0
million note is repayable in cash or in our common stock at our option, while
balance of this note is repayable in cash or in our common stock at the option
of the note holders. The $2.0 million note may be repaid in cash or in our
common stock at our option.
SALE OF KCI. On February 12, 1999, we sold KCI 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 us $100,000 in cash upon execution of a letter of intent.
Convergent Communications paid us the remainder of the purchase price on the
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<PAGE>
closing date as follows: (i) $1.4 million in cash; (ii) 30,000 shares of
Convergent Communications' parent company common stock with an agreed value of
approximately $300,000 ($10.00 per share); (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 eleven percent per annum; (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 which is payable on the
date which is 12 months following the closing date, bears simple interest at the
rate of eight percent per annum and is subject to mandatory prepayment in
certain events.
SALE OF MTC. On November 5, 1998, we also agreed to sell our document
management business, MTC, to Global Information Distribution GmbH ("GID") for an
aggregate purchase price of approximately $4.9 million. GID paid us $100,000 as
a non-refundable deposit upon acceptance of the GID term sheet. GID will pay to
us the remaining $4.8 million at the closing.
TELEPONCE. On March 24, 1999, we entered into an agreement to sell 660,000
shares of our common stock to Teleponce Cable TV, Inc. for $15 million. The
offer and sale of the shares of common stock was completed pursuant to the
exemption from registration provided by Regulation D under the Securities Act of
1933, as amended.
The proceeds from the sale of MTC and KCI will be used in part to repay our
bank credit facility with West Suburban Bank. As of December 31, 1998, there was
$4.8 million outstanding under this facility. The balance of the proceeds will
be used to pay for transaction costs associated with the sales and to increase
our cash position. We cannot assure, however, that the sale of MTC will close on
the terms described or at all.
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In aggregate, the sale of both MTC and KCI represents a radical change in
our business and, as such, require shareholder approval. While KCI has been
treated as a discontinued operation since July 27, 1998, and while our
management intends to dispose of MTC, we continued to treat MTC as a continuing
business pending such shareholder approval of its sale which we only recently
received. Set out below, however, are our unaudited selected financial data
which reflect the effect on us had MTC and all other non-ISP Channel businesses
been treated as discontinued operations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL YEAR ENDED SEPTEMBER 30, DEC. 31,
----------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1997 1998
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net sales........................................ $ -- $ -- $ 167 $ 1,008 $ 1,018 $ 215 $ 444
Cost of sales.................................... -- -- -- 885 1,218 246 407
--------- --------- --------- --------- --------- --------- ---------
Gross profit (deficit)........................... -- -- 167 123 (200) (31) 37
--------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Selling, engineering and general and
administrative................................. 707 676 2,130 2,062 9,579 870 5,649
Amortization of goodwill and transaction costs... -- -- 308 415 415 104 104
Cost associated with change in products and
other.......................................... -- -- 321 -- -- -- --
Acquisition costs and other...................... -- 543 -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Total operating expenses......................... 707 1,219 2,759 2,477 9,994 974 5,753
--------- --------- --------- --------- --------- --------- ---------
Loss from operations............................. (707) (1,219) (2,592) (2,354) (10,194) (1,005) (5,716)
Interest expense................................. (601) (448) (1,124) (1,030) (1,022) (246) (519)
Gain on sale of available-for-sale securities.... -- -- 5,689 -- -- -- --
Other income (expenses).......................... -- 3 30 (72) (60) 2 150
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations before
income taxes................................... (1,308) (1,664) 2,003 (3,456) (11,276) (1,249) (6,085)
Provision for income taxes....................... -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before discontinued operations and
extraordinary item............................. (1,308) (1,664) 2,003 (3,456) (11,276) (1,249) (6,085)
Discontinued operations:
Gain (loss) from operations...................... (120) (7,348) (2,039) 1,311 (5,726) (1,129) (138)
Estimated loss on disposal....................... -- (644) -- -- -- -- --
Extraordinary item--loss on sale of business..... -- -- (6,061) (486) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss......................................... (1,428) (9,656) (6,097) (2,631) (17,002) (2,378) (6,223)
Preferred dividends.............................. -- -- -- -- (343) -- (243)
--------- --------- --------- --------- --------- --------- ---------
Net loss applicable to common shares............. $ (1,428) $ (9,656) $ (6,097) $ (2,631) $ (17,345) $ (2,378) $ (6,466)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Basic and diluted loss per common share.......... $ (0.38) $ (2.22) $ (1.05) $ (0.40) $ (2.35) $ (0.34) $ (0.77)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
BALANCE SHEET DATA:
Working capital.................................. $ (918) $ 731 $ (1,129) $ (1,205) $ 5,281 $ 3,315 $ (3,940)
Total assets..................................... 4,281 25,091 15,299 12,609 29,625 16,504 25,017
Total long-term liabilities...................... 254 10,264 9,477 8,876 9,517 10,131 9,300
Redeemable convertible preferred stock........... -- -- -- -- 18,187 -- 15,754
Shareholders' equity (deficit)................... 2,436 11,685 3,793 2,028 (6,171) 4,499 (9,795)
</TABLE>
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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 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.
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 have completed the Inventory, Assessment and Planning Phases of
substantially all critical internal business systems. The Execution and
Validation Phases will be completed by August 31, 1999. We expect to be Y2K
compliant on all critical systems, which rely on the calendar year, before
December 31, 1999.
Some non-critical systems may not be addressed until after January 2000.
However, we believe such systems will not cause significant disruptions in our
operations.
COMPLIANCE BY EXTERNAL CUSTOMERS AND PROVIDERS
We are in the process of the inventory and assessment phases of our critical
suppliers, service providers and contractors to determine the extent to which
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
mid-1999. To the extent that responses to Y2K readiness are unsatisfactory, we
intend to change suppliers, service providers or contractors to those that have
demonstrated Y2K readiness. We cannot be assured that we will be successful in
finding such alternative suppliers, service providers and contractors. We do not
currently have any formal information concerning the status of our customers but
have received indications that most of our customers are working on Y2K
compliance.
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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.
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.
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 its various outstanding debt instruments.
The risk associated with fluctuating interest expense is limited, however, to
the exposure related to those debt instruments and credit facilities which are
tied to market rates. We do not use derivative financial instruments in our
investment portfolio. We ensure the safety and preservation of its 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.
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UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
We have prepared the following unaudited pro forma consolidated condensed
financial statements from our historical financial statements included elsewhere
in this prospectus and from the historical financial statements of Intelligent
Communications included in our reports on Form 8-K/A as filed with the SEC on
February 26 and March 12, 1999. The unaudited pro forma consolidated condensed
statements of operations for the year ended September 30, 1998 and the three
months ended December 31, 1998 reflect adjustments as if we had (i) acquired
Intelligent Communications (the "Intelligent Communications Acquisition") and
(ii) sold substantially all of the assets of the Company's wholly-owned
subsidiary, KCI (the "KCI Disposition"), as described in the accompanying notes,
as of October 1, 1997. The unaudited pro forma consolidated condensed balance
sheet as of December 31, 1998 reflect adjustments as if the Intelligent
Communications Acquisition and KCI Disposition, as described in the accompanying
notes, had occurred as of December 31, 1998.
The unaudited pro forma consolidated condensed financial statements should
be read in conjunction with the notes included herewith, our audited
consolidated financial statements and notes to those statements as of September
30, 1998 and 1997 and for the three years ended September 30, 1998, our
unaudited consolidated condensed financial statements as of, and for the three
months ended, December 31, 1998 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
prospectus and the Intellicom financial statements incorporated by reference in
this prospectus from our Forms 8-K/A as filed with the SEC on February 26 and
March 12, 1999.
The unaudited pro forma consolidated condensed financial statements do not
purport to represent what our results of operations or financial position would
have been had the Intelligent Communications Acquisition and the KCI Disposition
occurred on the dates specified, or to project our results of operations or
financial position for any future period or date. The pro forma adjustments are
based upon available information and certain assumptions that we believe are
reasonable under the circumstances. In our opinion, all adjustments have been
made that are necessary to present fairly the pro forma data. Actual amounts
could differ from those set forth below.
47
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998(1)
----------------------------------------------
ACQUISITION DISPOSITION PRO
HISTORICAL ADJUSTMENTS ADJUSTMENTS FORMA
--------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash............................................. $ 4,329 $ 134(a) $ 1,400(e) $ 5,363
(500)(b)
Accounts receivable, net......................... 3,819 294(a) 4,113
Current portion of gross investment in leases.... 1,239 1,239
Inventories...................................... 1,195 1,195
Other current assets............................. 1,146 93(a) 4,500(e) 5,739
--------- ----------- ----------- ---------
Total current assets........................... 11,728 21 5,900 17,649
Restricted cash.................................... 800 800
Property and equipment, net........................ 9,880 639(a) 10,519
Gross investment in leases, net of current
portion.......................................... 1,717 1,717
Acquired technology and other intangibles, net..... 683 15,056(c) 15,739
Other assets....................................... 1,089 104(a) 300(e) 1,493
Net assets associated with discontinued
operations....................................... 3,813 -- (3,813)(d) --
--------- ----------- ----------- ---------
Total assets................................... $ 29,710 $ 15,820 $ 2,387 $ 47,917
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses............ $ 10,862 $ 1,218(a) $ (100)(e) $ 11,980
Short-term debt.................................. 1,000(b) 1,000
Current portion of long-term debt................ 1,855 609(a) 2,464
Other current liabilities........................ 1,086 -- -- 1,086
--------- ----------- ----------- ---------
Total current liabilities...................... 13,803 2,827 (100) 16,530
Long-term debt, net of current portion............. 9,430 2,000(b) 11,430
Other long-term liabilities........................ 518 24(a) 542
Redeemable convertible preferred stock............. 15,754 15,754
Shareholders' deficit:
Common stock and capital in excess of par value.... 46,739 10,969(b) 57,708
Deferred stock compensation........................ (303) (303)
Accumulated deficit................................ (56,231) 2,487(f) (53,744)
--------- ----------- ----------- ---------
Total shareholders' equity (deficit)........... (9,795) 10,969 2,487 3,661
--------- ----------- ----------- ---------
Total liabilities, redeemable convertible
preferred stock and shareholders' equity
(deficit).................................... $ 29,710 $ 15,820 $ 2,387 $ 47,917
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
</TABLE>
- ------------------------
(1) References in parenthetical are to Note 3 to the unaudited pro forma
consolidated condensed financial statements.
See accompanying notes to unaudited pro forma consolidated condensed financial
statements.
48
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SEPTEMBER 30, 1998(1)
----------------------------------------------
ACQUISITION DISPOSITION PRO
HISTORICAL ADJUSTMENTS ADJUSTMENTS FORMA
--------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales......................................... $ 14,060 $ 2,533(g) $ -- $ 16,593
Cost of sales..................................... 10,628 1,450(g) 12,078
--------- ----------- ----------- ---------
Gross profit.................................... 3,432 1,083 4,515
Operating expenses................................ 19,265 1,888(g) 23,304
2,151(i)
--------- ----------- ----------- ---------
Loss from continuing operations................... (15,833) (2,956) (18,789)
Other income (expense):
Interest expense................................ (1,416) (53)(g) (1,714)
(245)(h)
Other income.................................... 320 2(g) 284(l) 606
--------- ----------- ----------- ---------
Income (loss) from continuing operations before
discontinued operations......................... (16,929) (3,252) 284 (19,897)
Income (loss) from discontinued operations........ (73) 73(k) --
Extraordinary item--gain on sale of business...... -- 2,865(m) 2,865
--------- ----------- ----------- ---------
Net income (loss)................................. (17,002) (3,252) 3,222 (17,032)
Preferred dividends............................... (343) (343)
--------- ----------- ----------- ---------
Net income (loss) applicable to common shares..... $ (17,345) $ (3,252) $ 3,222 $ (17,375)
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
Basic and diluted earnings (loss) per share:
Continuing operations........................... $ (2.29) $ (2.52)
Discontinued operations......................... (0.01) --
Extraordinary item.............................. -- 0.36
Preferred dividends............................. (0.05) (0.04)
--------- ---------
Net loss applicable to common shares.......... $ (2.35) $ (2.20)
--------- ---------
--------- ---------
Shares used to compute basic and diluted earnings
(loss) per share................................ 7,391 500(j) 7,891
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
</TABLE>
- ------------------------
(1) References in parenthetical are to Note 3 to the unaudited pro forma
consolidated condensed financial statements.
See accompanying notes to unaudited pro forma consolidated condensed financial
statements.
49
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998(1)
------------------------------------------------
ACQUISITION DISPOSITION PRO
HISTORICAL ADJUSTMENTS ADJUSTMENTS FORMA
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales........................................... $ 4,296 $ 577(g) $ -- $ 4,873
Cost of sales....................................... 2,967 396(g) 3,363
----------- ----------- ----------- ---------
Gross profit...................................... 1,329 181 1,510
Operating expenses.................................. 7,339 585(g) 8,462
538(i)
----------- ----------- ----------- ---------
Loss from continuing operations..................... (6,010) (942) (6,952)
Other income (expense):
Interest expense.................................. (569) (37)(g) (649)
(43)(h)
Other income...................................... 217 217
----------- ----------- ----------- ---------
Loss from continuing operations before discontinued
operations........................................ (6,362) (1,022) (7,384)
Income (loss) from discontinued operations.......... 139 (139)(k) --
----------- ----------- ----------- ---------
Net loss............................................ (6,223) (1,022) (139) (7,384)
Preferred dividends................................. (243) (243)
----------- ----------- ----------- ---------
Net loss applicable to common shares................ $ (6,466) $ (1,022) $ (139) $ (7,627)
----------- ----------- ----------- ---------
----------- ----------- ----------- ---------
Basic and diluted earnings (loss) per share:
Continuing operations............................. $ (0.76) $ (0.82)
Discontinued operations........................... 0.02 --
Preferred dividends............................... (0.03) (0.03)
----------- ---------
Net loss applicable to common shares............ $ (0.77) $ (0.85)
----------- ---------
----------- ---------
Shares used to compute basic and diluted earnings
(loss) per share.................................. 8,374 600(j) 8,974
----------- ----------- ----------- ---------
----------- ----------- ----------- ---------
</TABLE>
- ------------------------
(1) References in parenthetical are to Note 3 to the unaudited pro forma
consolidated condensed financial statements.
See accompanying notes to unaudited pro forma consolidated condensed financial
statements.
50
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1) THE INTELLIGENT COMMUNICATIONS ACQUISITION
The unaudited pro forma consolidated condensed financial statements reflect
adjustments for the Intelligent Communications Acquisition, in which Intelligent
Communications became a wholly-owned subsidiary of the Company for Total
Consideration (as defined below) of $15,469,000, consisting of:
- Cash paid at closing of $500,000 (the "Cash Consideration");
- Issuance of 500,000 shares of the Company's common stock at closing (the
"Closing Shares"), at which time the Company's common stock was trading at
$14.938 per share, for a total value of $7,469,000;
- A second tranche of Closing Shares of up to 150,000 shares issuable upon
the first anniversary date of the closing if the total amount of shares
issued to date does not exceed a total value of $5,000,000 as of the first
anniversary date. For purposes of the pro forma financial information
presented herein, the second tranche of Closing Shares has not been
factored in as the market value of the Closing Shares currently exceeds
$5,000,000;
- Additional shares of the Company's common stock issuable upon the first,
second and third anniversaries of the closing, valued at a total of
$3,500,000 (together with the Closing Shares, the "Equity Consideration"),
of which $1,500,000 is allotted for the first and second anniversaries and
$500,000 for the third;
- Issuance of a $1,000,000 secured promissory note payable upon the first
anniversary date of the closing, which bears interest at 7.5% per annum
(the "First Promissory Note");
- Issuance of a $2,000,000 secured promissory note payable upon the second
anniversary date of the closing, which bears interest at 8.5% per annum
(the "Second Promissory Note", together with the First Promissory Note,
the "Debt Consideration"); and
- A demonstration bonus of $1,000,000 payable to all Intelligent
Communications shareholders upon the first anniversary date of the closing
upon successful demonstration of certain cable technology (the "Bonus
Consideration", together with the Cash Consideration, the Equity
Consideration and the Debt Consideration, the "Total Consideration").
The Company is in the process of evaluating and finalizing the effects of
the Intelligent Communications Acquisition on its business and financial
statements on a going-forward basis. As the outcome of such analysis is unknown
at this time, certain assumptions and conclusions made for purposes of the pro
forma financial information provided herein are considered preliminary and
subject to change at the discretion of the Company's management. However, the
Company believes that any possible variations from the assumptions applied
should not have a material effect on the pro forma financial statements.
(2) THE KCI DISPOSITION
The unaudited pro forma consolidated condensed financial statements reflect
adjustments for the KCI Disposition, in which the Company sold substantially all
of the assets of its wholly-owned subsidiary for Total Proceeds (as defined
below) of $6,300,000, consisting of:
- Cash paid at closing of $1,500,000, of which $100,000 had previously been
paid in the form of a deposit in November 1998 (the "Cash Proceeds");
51
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
- Receipt of a $2,000,000 secured promissory note payable within 138 days of
the closing date, which bears interest at 11.0% per annum (the "First
Promissory Note");
- Receipt of a $1,000,000 secured promissory note payable upon the first
anniversary date of the closing, which bears interest at 8.0% per annum
(the "Second Promissory Note");
- Receipt of a $1,500,000 secured promissory note payable upon the first
anniversary date of the closing, which bears interest at 8.0% per annum
(the "Third Promissory Note", together with the First Promissory Note and
Second Promissory Note, the "Notes");
- Receipt of 30,000 shares of common stock of the acquiring company's parent
company, Convergent Communications, Inc., valued at $10 per share, or
$300,000 (the "Equity Proceeds", together with the Cash Proceeds and
Notes, the "Total Proceeds").
(3) PRO FORMA ADJUSTMENTS
THE INTELLIGENT COMMUNICATIONS ACQUISITION
The unaudited pro forma consolidated condensed balance sheet gives effect to
the following acquisition adjustments:
(a) Represents the addition of the tangible net assets of Intelligent
Communications derived from financial statements of Intelligent
Communications as if the acquisition had occurred as of December 31, 1998
consisting of the following (in thousands):
<TABLE>
<S> <C>
Cash....................................................... $ 134
Accounts receivable, net................................... 294
Prepaid expenses........................................... 93
Property and equipment, net................................ 639
Other assets............................................... 104
Accounts payable and accrued expenses...................... (1,218)
Short-term debt............................................ (609)
Other long-term liabilities................................ (24)
</TABLE>
(b) Represents the Total Consideration paid by the Company, less the Bonus
Consideration (see below), for the Intelligent Communications Acquisition
consisting of a reduction of cash of $500,000 for the Cash Consideration;
an increase in common stock and capital in excess of par value of
$10,969,000 for the Equity Consideration and an increase in short-term
debt and long-term debt of $1,000,000 and $2,000,000, respectively, for
the Debt Consideration. Because the Bonus Consideration is contingent
upon successful demonstration of certain performance criteria (as
defined) being met, the Company has not accrued for such contingent Bonus
Consideration as there is significant uncertainty as to whether or not
such performance criteria will be met.
(c) Represents the intangible asset recorded by the Company for the
acquisition as the Total Consideration paid by the Company, less the
Bonus Consideration (refer to pro forma adjustment 3(b) above, exceeded
the negative tangible book value of Intelligent Communications as of
December 31, 1998 by $15,056,000. 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
52
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
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
Intelligent Communications Acquisition is not subject to rapid change,
and the Company feels 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 seven
years. In determining how much of the purchase price in excess of the
tangible book value of Intelligent Communications 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 (a
typical contract's duration), the anticipated useful life of this
acquired technology.
THE KCI DISPOSITION
The unaudited pro forma consolidated condensed balance sheet gives effect to
the following disposition adjustments:
(d) Represents the removal of the net assets of KCI, which the Company
previously identified as discontinued operations in its historical
financial statements, consisting of the following (in thousands):
<TABLE>
<S> <C>
Accounts receivable, net................................... $ 1,847
Inventories................................................ 2,490
Prepaid expenses........................................... 99
Property and equipment, net................................ 398
Other assets............................................... 22
Accounts payable and accrued expenses...................... (1,710)
Capital lease obligation................................... (71)
Deferred revenue........................................... (901)
---------
Subtotal................................................... 2,174
Goodwill, net.............................................. 1,639
---------
Total net assets associated with discontinued
operations............................................. $ 3,813
---------
---------
</TABLE>
All such assets were sold in the KCI Disposition with the exception of
goodwill, which the Company has written-off in conjunction with the KCI
Disposition. The cash of KCI has also been excluded from the sale;
however, the Company has appropriately reflected the cash of KCI with the
Company's other cash balances in its historical balance sheet.
(e) Represents the Total Proceeds received by the Company for the KCI
Disposition consisting of an increase in cash of $1,400,000 and a
reduction of accounts payable and accrued liabilities of $100,000 for the
Cash Proceeds; an increase in other current assets of $4,500,000 for the
Notes and an increase in other assets of $300,000 for the Equity
Proceeds, which the Company plans to hold as a long-term investment.
(f) Represents the gain on sale for the KCI Disposition of $2,487,000.
53
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
THE INTELLIGENT COMMUNICATIONS ACQUISITION
The unaudited pro forma consolidated condensed statements of operations give
effect to the following acquisition adjustments:
(g) Represents the results of operations of Intellicom derived from
financial statements of Intelligent Communications for the following
periods (in thousands):
<TABLE>
<CAPTION>
FOR THE FOR THE THREE
YEAR ENDED MONTHS ENDED
SEPTEMBER 30, DECEMBER 31,
1998(1) 1998
------------- ---------------
<S> <C> <C>
Net Sales............................................. $ 2,533 $ 577
Cost of sales......................................... (1,450) (396)
Operating expenses.................................... (1,888) (585)
Interest expense...................................... (53) (37)
Other income.......................................... 2 --
------------- -----
Net loss.............................................. $ (856) $ (441)
------------- -----
------------- -----
</TABLE>
-------------------------------
(1) Includes the results of operations for the period from October 1,
1997 through December 31, 1997, which have been derived from
unaudited management accounts of Intelligent Communications.
(h) Represents the additional interest expense due to the Debt Consideration
of $245,000 and $43,000 for the year ended September 30, 1998 and the
three months ended December 31, 1998, respectively. For purposes of the
pro forma financial information presented herein, the First Promissory
Note is assumed to be repaid in full as of October 1, 1998.
(i) Represents the amortization of the intangible asset acquired in the
Intelligent Communications Acquisition, which is recorded as acquired
technology, of $2,151,000 and $538,000 for the year ended September 30,
1998 and the three months ended December 31, 1998, respectively. This
acquired technology is being amortized on a straightline basis over seven
years, the anticipated useful life of the acquired technology for
purposes of the pro forma financial information provided herein.
(j) Represents the addition to shares used in computing basic and diluted
loss per share of 500,000 and 600,000 for the year ended September 30,
1998 and the three months ended December 31, 1998, respectively. For
purposes of the pro forma financial information presented herein, the
shares issuable upon the first anniversary date, valued at $1,500,000,
are based on the same value per share as the Closing Shares, that is,
$14.938 per share, which results in an additional 100,000 shares of
common stock issued upon the first anniversary date of the closing,
which, for purposes of the pro forma financial information presented
herein, is deemed to be October 1, 1998. The Company has excluded the
effect of any of the other authorized but unissued shares related to the
Equity Consideration, as the effect would be anti-dilutive.
54
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
THE KCI DISPOSITION
The unaudited pro forma consolidated condensed statements of operations give
effect to the following disposition adjustments:
(k) Represents the removal of KCI's profits and losses, which the Company
previously identified as discontinued operations in its historical
financial statements.
(l) Represents the additional interest income due to the Notes of $284,000
for the year ended September 30, 1998. For purposes of the pro forma
financial information presented herein, the Notes are assumed to be
repaid in full as of October 1, 1998.
(m) Represents the recognition of the gain related to the KCI Disposition.
As of September 30, 1997, the net assets associated with the discontinued
operations of KCI were $3,435,000, resulting in a gain of $2,865,000 as
of October 1, 1997.
55
<PAGE>
BUSINESS
EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED IN
THIS PROSPECTUS CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
ANTICIPATED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A
DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE RISKS DISCUSSED UNDER THE
CAPTION "RISK FACTORS." WE OPERATE PRINCIPALLY IN TWO INDUSTRY SEGMENTS:
DOCUMENT MANAGEMENT AND INTERNET SERVICES. SEE NOTE 17 TO OUR FINANCIAL
STATEMENTS
We are in the process of implementing a new strategy emphasizing our
Internet services business (the "ISP Channel"). Currently, we own three
businesses: our satellite Internet service business (Intelligent
Communications), our document management business (MTC) and ISP Channel. Each
business operates through one of our wholly-owned subsidiaries. As part of our
new focus, on February 12, 1999, we completed the divestiture of our
telecommunications business, KCI. In addition, we have signed a letter of intent
to sell MTC. We accounted for MTC as a continuing business rather than a
discontinued operation because its sale was subject to stockholder approval. On
April 13, 1999 we received stockholder approval to sell the MTC business. The
sale of MTC and KCI is intended to enable us to aggressively expand our ISP
Channel. See "--Micrographic Technology Corporation."
On February 9, 1999, we completed the purchase of Intelligent Communications
Inc., the former Xerox Skyway Network. Intelligent Communications has a
proprietary two-way satellite technology that can be used to provide Internet
access while bypassing the often expensive telephony costs involved in
connecting to the Internet. 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 basis and increasing our potential market size. See
"--Intelligent Communications, Inc."
In connection with our increased emphasis on cable-based Internet services,
we have built a highly experienced management team to grow our Internet
business, including Vice Chairman of the Board, President and Chief Executive
Officer, Dr. Lawrence B. Brilliant (co-founder of The Well, one of the first
online communities); Director, Vice President and President of ISP Channel,
Inc., Ian B. Aaron (former Director of Marketing, Sales and Product Development
of GTE Business Communications); Chief Operating Officer, Garrett J. Girvan
(former Chief Operating Officer and Chief Financial Officer of Viacom Cable);
Chief Financial Officer, Douglas S. Sinclair (formerly Chief Financial Officer
of Silicon Valley Networks, Inc.); Vice President, External Affairs, Secretary,
and General Counsel, Steven M. Harris (formerly Vice President, Broadband
Services, Pacific Telesis Group); Senior Vice President, Marketing of ISP
Channel, Inc., Kevin Gavin (formerly Regional Vice President of Teligent, Inc.);
Director, Edward A. Bennett (former President of Prodigy Services, President and
Chief Executive Officer of VH-1 Networks and Chief Operating Officer of Viacom
Cable); and Director, Sean P. Doherty (former Chief Operating Officer of @Home).
In addition, we have recruited a number of key employees and consultants with
significant industry experience, including Atam Lalchandani (former Chief
Financial Officer of @Home) and Howard Rheingold (author of VIRTUAL
COMMUNITIES).
ISP CHANNEL, INC.
We seek to become the dominant cable-based provider of high-speed Internet
access and other Internet-related services to homes and businesses in the
franchise areas of those cable systems unaffiliated with the seven largest U.S.
cable operators and certain other smaller systems. We estimate that our target
market comprises over 2,200 systems passing approximately 24.6 million U.S.
homes. As of March 3, 1999, we had contracts with cable operators representing
approximately 1.6 million homes passed. In addition, we have letters of intent
with eight cable operators, representing 35 systems and approximately 339,000
homes passed. We also plan to target certain other markets including apartment
buildings, hotels, hospitals and schools, which significantly increases the size
of our market. Though actual speeds may vary, our Internet service, which is
marketed using the brand name "ISP Channel,"
56
<PAGE>
provides residential and business subscribers access to the Internet over the
existing cable television infrastructure at speeds up to 50 times faster than
28.8 kbps dial-up access. For example, this increased speed reduces the required
download time for a 10 megabyte file from approximately 46 minutes to under one
minute and allows subscribers to benefit from sophisticated multimedia
applications and programming. The ISP Channel also offers an intuitive user
interface provided through a co-branding agreement with Excite, and local
information, news and entertainment customized for each community served.
INDUSTRY BACKGROUND
THE INTERNET. The Internet has emerged as a global communications medium
enabling millions of people to share information, to enjoy entertainment and to
conduct business. Consumers and businesses are increasingly using
readily-available, low-cost access to the Internet to benefit from such
applications as electronic mail, corporate intranets, telecommuting or other
remote access, online advertising and electronic commerce. If the growth of the
Internet continues to accelerate and the number of bandwidth-intensive
multimedia applications continues to grow, we believe consumers will
increasingly demand a higher-speed alternative to currently available dial-up
Internet access. We believe that cable networks are well-positioned to address
this rapidly growing demand. First, cable networks already pass nearly all U.S.
homes. Second, many cable operators are upgrading their networks to provide
two-way communications to their subscribers, which will enable an "always on"
connection to the Internet. Third, newly-developed technologies, including cable
modems, specialized routers and caching servers, now enable cable networks to be
directly linked to the Internet, providing high-speed Internet access.
There has been a substantial increase in the number of Internet users in
recent years, as well as in the availability of, and the demand for, multimedia
and other bandwidth-intensive information over the Internet, consisting of data,
voice and video in the form of value-added services and applications. Both of
these trends have resulted in an increasing demand from users for higher speed
access to the Internet at reasonable prices. With the increasing dependence on
communications networks and the growing demand for bandwidth-intensive
information, we believe that consumers will demand greater transmission speeds.
Moreover, many multimedia applications such as video on demand, video
teleconferencing, multi-site computer game playing, streaming video and high
quality audio over the Internet are not practical at transmission speeds typical
of dial-up access.
THE ADVANTAGES OF DELIVERING HIGH-SPEED INTERNET ACCESS OVER THE EXISTING
CABLE INFRASTRUCTURE. The full potential of Internet applications cannot be
realized without removing the performance bottlenecks inherent in the "last
mile" of the telecommunications infrastructure. Consisting primarily of copper
twisted-pair wire or coaxial cable, this infrastructure was originally designed
for analog transmission, such as analog voice or one-way analog video signals,
rather than high-speed two-way broadband digital transmission. Today, there are
multiple technologies that attempt to address the need for high-speed last mile
connections, including (i) wireline telephone infrastructure technologies; (ii)
wireless infrastructure technologies; and (iii) hybrid fiber coaxial ("HFC")
cable infrastructure technologies utilizing cable modems. While each of these
technologies has certain advantages, the cable infrastructure currently provides
the highest generally available potential transmission speeds, with data
transmission speeds of up to 50 times faster than 28.8 kbps dial-up access and,
in two-way cable systems, "always on" availability. In addition, cable
infrastructure passes over 90% of U.S. homes.
The advantages of using the existing cable infrastructure to bring Internet,
Web, IP telephony and other similar services to homes and businesses are: (i)
ease of deployment, (ii) ease of Internet access, (iii) relatively high speed of
transmission, (iv) relatively low cost of service and (v) high security.
- Cable lends itself to ease of deployment because the cable infrastructure
is already in place and relatively small technical enhancements at the
headend and at the home or business location allow rapid service
deployment.
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- From the user's point of view, a two-way cable connection to either a
television or a computer, unlike a dial-up modem, is "always on," allowing
for faster access to e-mail, information services and other Internet or
Web-based material. We believe that this ease of access will translate
into widespread consumer acceptance of this access option.
- Cable modems access the Internet at speeds up to 50 times faster than a
28.8 kbps dial-up modem, which is the most widely used Internet access
method. The speed afforded by cable-based access allows subscribers to
take advantage of the increasing availability of bandwidth-intensive
multimedia applications (such as video on demand, high quality audio and
distance learning), online commerce applications (such as retailing,
financial services and online software distribution) and interactive
games.
- Cable-based Internet access gives subscribers high-speed Internet access
at prices comparable to technologies providing less capacity, such as
digital subscriber line ("DSL") services.
- Recent developments in encryption technology allow the transmission of
data over the Internet using the cable infrastructure to have a high level
of security.
READINESS OF THE CABLE INFRASTRUCTURE AND OF CABLE OPERATORS FOR THE
INTERNET, TELEPHONY AND RELATED SERVICES. Many cable operators are currently
upgrading their cable infrastructures to permit two-way transmission. With cable
systems that do not currently facilitate two-way services, cable subscribers can
use conventional dial-up telephone service for upstream communications, albeit
with the loss of the "always on" feature and the broadband path from the home to
the Internet.
Many cable operators are increasingly making the commitment to one or
another method of delivering Internet-related services to the homes and business
in their franchise areas. Several domestic cable operators have recently
cooperated to create the Multimedia Cable Network System ("MCNS") specification
to define multi-vendor interoperable cable modems. This specification is
expected to be widely adopted for the North American consumer market, which
would result in wider availability and lower prices for cable modem equipment.
THE CABLE INDUSTRY. The cable industry consists of thousands of cable
operators, most of whom operate more than one cable system. Franchised cable
operators enjoy high barriers to entry because the economics of providing cable
services require a relatively high level of penetration in a local market for a
cable operator to be successful. According to Claritas, in 1997 approximately
92.2 million U.S. households were passed by cable from approximately 11,400
franchised cable systems, virtually all of which we believe can be equipped to
enable high-speed Internet access. Approximately 70% of these households are
cable subscribers.
Many cable operators are currently investing in new technologies to increase
their bandwidth (and thereby offer more channels) to permit two-way transmission
of data and to reduce the amount of distortion over their lines. These upgrades
to their infrastructure can provide cable-based Internet users with faster and
more cost-effective access to Internet content. We believe that most independent
MSOs and cable operators generally do not want to offer Internet services
directly because of the required investment in equipment, network and
knowledgeable staff to provide such services to their subscribers.
SOFTNET'S SOLUTION
We believe that the ISP Channel can provide the following benefits to
consumers and businesses:
HIGH-SPEED ACCESS. The speed afforded by cable-based access allows
subscribers to enjoy current graphic oriented Internet content in a much more
natural and enjoyable way and also to take advantage of the proliferation of new
bandwidth-intensive multimedia applications (such as video on demand,
high-quality audio and distance learning), online commerce applications (such as
retailing, financial services and online software distribution) and interactive
games. Additionally, in those cable systems that are upgraded to two-way
service, the end user customer benefits from the "always on"
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nature of the Internet connection. Similar to the experience of a business user
on a corporate LAN, the Internet connection for two-way cable modem users
remains available on a constant basis and does not require the user to go
through the time consuming dial up sequence that includes dialing a phone
number, then waiting for the modems to synchronize and logging on to the
network.
HIGH PERFORMANCE/PRICE RATIO. Cable-based Internet access currently
provides greater downstream speeds and is generally less costly to the
subscriber than alternative high-speed technologies such as Integrated Services
Digital Network ("ISDN") or Digital Subscriber Line ("DSL"). Moreover, where the
cable system has two-way capability (i.e., can use the cable network for both
upstream and downstream Internet access rather than having to employ a telephone
line return path), the cost of the ISP Channel service to the subscriber is
initially expected to be approximately equivalent to the cost of dial-up
Internet access plus the cost of an additional telephone line.
CO-BRANDING AGREEMENT WITH EXCITE. Our co-branding agreement with Excite
offers subscribers an intuitive, user-friendly portal to the Internet allowing
for a high degree of personalization and tailoring of the experience to the
user's individual areas of interest, including sports, news, weather, local
television listings and investment portfolio analysis.
LOCAL CONTENT AND ONLINE COMMUNITIES. Local content and online communities
that we develop in concert with our cable affiliates are expected to address
highly localized user interests such as education, local government, local
merchants and other groups, using Web hosting, chat and conferencing
technologies.
We believe the ISP Channel can provide the following benefits to cable
operators:
ADDITIONAL REVENUES WITH LIMITED CAPITAL OUTLAYS. As part of the ISP
Channel offering, we provide all of the equipment necessary to link a cable
network to the Internet. Accordingly, the ISP Channel provides an opportunity
for cable operators to obtain revenues from providing Internet services without
the associated capital costs.
TURNKEY SOLUTION. In addition to installing the equipment and providing the
data transport facilities necessary to offer ISP Channel services, we also
provide 24-hour, seven-days-a-week network monitoring and customer service,
dedicated Internet technicians, personalized sales, telemarketing, local event
marketing and, where requested, billing services. We produce printed advertising
materials to be inserted in cable bills or sent as direct mail, as well as video
commercials to be broadcast on selected channels by our affiliated cable
operators.
PROVIDER OF ADDITIONAL VALUE-ADDED SERVICES. The ISP Channel offers cable
operators a low-cost means of increasing their revenues by providing popular
content, Internet and, eventually, telephony services that have the added
benefits of building the operator's local brand in addition to maintaining or
increasing the penetration of its core video business. Additionally, partnering
with ISP Channel may make it easier for the cable operator to obtain renewal of
its cable franchise.
CABLE AFFILIATE INCENTIVE PROGRAM. Consistent with industry practice, we
offer an incentive bonus in our common stock on a per-subscriber basis to larger
targeted cable operators in consideration for their entering into long-term
arrangements providing for us to be the exclusive provider of Internet-based
high-speed data, video and telephony services over their networks. See "--ISP
Channel, Inc.--Sales and Marketing."
ABILITY TO SERVICE SMALL CABLE SYSTEMS. While most of our competitors have
been targeting the larger cable systems, we believe that the satellite
technology acquired as part of the Intelligent Communications transaction will
enable us to broaden our target market to cost effectively include systems with
as few as 1,000 homes passed. Our ability to serve these target markets may
appeal to those smaller cable operators and multiple system operators with a
large number of smaller systems who are not currently able to provide high speed
Internet access.
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BUSINESS STRATEGY
We are pursuing a strategy with the following key elements:
FOCUS ON SMALL- AND MEDIUM-SIZED INDEPENDENT CABLE OPERATORS. We are
seeking to become the exclusive provider of high-speed Internet access and other
Internet-related services to those cable systems unaffiliated with the seven
largest U.S. cable operators. These typically consist of one to three systems
and are often located in secondary and tertiary markets, which may be peripheral
to larger markets.
RAPIDLY SIGN UP CABLE OPERATORS. There is typically only one franchised
cable operator serving any home or business in a given cable area. Once such
cable operator executes an exclusive arrangement with us or another Internet
provider, any competitor subsequently seeking to offer comparable cable-based
services has a competitive advantage in that franchise area. Accordingly, we
plan to enter into as many affiliation agreements with cable operators as
possible over the next few years, install our systems rapidly and market our
services aggressively to potential subscribers. We anticipate that this policy
of rapid deployment and aggressive marketing will result in substantial capital
expenditures and operating losses in the near term.
RAPIDLY MARKET AND LAUNCH SERVICES. The more rapidly we are able to launch
our services, the less likely potential subscribers will be to use alternative
technologies to obtain high-speed Internet services. We believe the satellite
technology and capabilities that we acquired through Intelligent Communications,
Inc. will help us install systems quickly; this technology enables us to share
spectrum among sites thereby reducing the capital costs of rolling out and
operating new systems.
PROVIDE COMPELLING VALUE PROPOSITION TO AFFILIATED CABLE OPERATORS. We
believe we offer a compelling value proposition to cable operators by providing
them an opportunity for early and low-cost entry into the high-speed Internet
access market. In a typical contract, we will offer the cable operator a turnkey
service, including headend and modem equipment installation, provision of
Internet access, leased local access lines, marketing materials and ongoing
related customer support, as well as a variety of locally focused content and
advertising. We expect to offer cable operators between 25% and 50% of monthly
subscriber revenue and a portion of net revenues from advertising, sales
commissions from online commerce transactions and Internet-based telephony.
Operators may also be offered financial or equity incentives on a per-subscriber
basis in consideration for entering into exclusive long-term affiliation
agreements. See "--ISP Channel, Inc.--Sales and Marketing."
PROVIDE BROAD RANGE OF PRODUCTS AND SERVICES TO RESIDENTIAL AND BUSINESS
CUSTOMERS. We strive to offer residential and business subscribers an
attractive array of products and services based on high-speed access to the
Internet. High-speed access is highly desirable and often essential for
residential customers to access sophisticated multimedia content services,
including video on demand, high-quality audio, videoconferencing, next
generation online commerce and online interactive computer games. We also offer
a broad range of business-specific services including Internet access, RLAN
access for telecommuters, Web site hosting and server co-location and online
commerce applications.
BUILD NATIONAL BRAND WITH LOCAL PRESENCE. Through our agreement with
Excite, we will seek to build a strong national brand by creating a uniform
"look and feel" for our service, supported by a high degree of local content and
cable affiliate branding. For example, we plan to build virtual communities in
the areas we serve that will focus on matters of local interest. Such virtual
communities are expected to include online commerce for local merchants,
multimedia town hall meetings and multimedia distance learning, among other
applications.
LEVERAGE INFRASTRUCTURE, CUSTOMER BASE AND MARKETING CHANNEL TO INCREASE
REVENUES. Over time, we will actively seek to leverage our infrastructure,
customer base and the marketing channel provided by our cable affiliates to
develop new revenue sources. Such revenue sources are expected to include
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products and services such as low-cost long distance, calling card products,
Internet-based telephony, the sale of local and national advertising and online
commerce.
PURSUE STRATEGIC ALLIANCES AND ACQUISITIONS. We continually evaluate
selective opportunities that will enhance our ability to sign exclusive
contracts with cable operators. We believe there will be numerous opportunities
to take advantage of consolidation within the industry and, where appropriate,
may seek to acquire the operations of other market participants. In addition, we
believe that our strategy of focusing on smaller and independent cable operators
will enable us to enter into attractive joint venture relationships with other
key providers of related products and services.
SERVICES
HIGH-SPEED INTERNET ACCESS. Our ISP Channel offering utilizes the cable
television infrastructure and our network and content technologies to provide a
rapidly deployable, relatively inexpensive method of access to the Internet for
residential and business subscribers at speeds up to 1.5 megabits per second
("mbps"). The ISP Channel service enables subscribers to experience graphically
rich, interactive, and multimedia applications thereby improving the Internet
experience. As of March 3, 1999, we had contracts for our ISP Channel service
with 31 cable operators, representing 126 cable systems and approximately 1.6
million homes passed. Twenty-three of these systems, representing over 264,000
homes passed, have been equipped and have begun offering our services. As of
March 3, 1999, we had approximately 2,200 residential and business subscribers
to our ISP Channel service, plus approximately 500 customer orders in backlog,
and provided non-cable based dial-up and dedicated Internet access to
approximately 1,100 residential and business subscribers. For areas where
two-way cable is not yet available, we deploy a telephone return solution, which
uses the cable infrastructure for high-speed downstream transmission and
telephone dial-up access for upstream transmission. To use the ISP Channel via
cable modem, residential and business subscribers need a personal computer with
at least a 66 MHz 486 or equivalent microprocessor and 16 megabytes of main
memory. When compatible set-top boxes become widely available, we plan to
deliver its high-speed Internet access through televisions.
RESIDENTIAL. All ISP Channel subscribers are provided an e-mail address,
roaming services, access to unique newsgroups and chat services and personal Web
space as part of their monthly fee. Additionally, we provide a co-branded "cable
affiliate/ISP Channel/Excite" default home page that allows each subscriber to
personalize his or her portal to the Internet. Monthly service charges currently
range from $39 to $69 for flat rate residential service, with installation
charges of $99. The price of cable modems currently ranges from $179 to $349.
BUSINESS. Our business solutions include Internet and intranet services
over existing cable infrastructure and traditional telephone data lines when
necessary. We provide our cable affiliates the ability to offer local
telecommuters, small office/home office subscribers and business customers a
comprehensive selection of Internet and corporate local area network ("LAN")
access for employees in the office, and virtual private network ("VPN") and
remote local area network ("RLAN") applications, which extend corporate network
access to remote employees and external organizations, including business
partners, suppliers and customers. Our future business services are expected to
include online software distribution, secure high-speed data storage facilities,
international roaming services and office-to-office IP telephony. Prices vary
significantly depending on functionality and speed.
ONLINE SERVICES. Our content and programming services enhance the
subscriber's online experience by aggregating local and national content through
a national co-branding agreement with Excite. Our network architecture and local
cable headend caching and collaborative server functionality facilitate the
distribution of multimedia applications, including multi-player games, video
conferencing and multicast video applications, as well as local and national
advertising.
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NATIONAL CONTENT AGGREGATION. We have entered into a joint venture with
Excite to provide co-branded ISP Channel/Excite content aggregation, directory
and search services. The co-branded content incorporates a custom online
presence for the cable affiliate, including online cable schedules, pay-per-view
and, in the future, bill payment options. Personalization also allows a
subscriber to use the co-branded ISP Channel/Excite "push" technology to create
a customized default page incorporating the subscriber's interests, including
local and national news, weather, sports, stock portfolio, horoscope, local city
information and hundreds of other selections. In addition, the co-branded "cable
affiliate/ISP Channel/Excite" user interface provides a simplified, intuitive
navigation tool for the subscriber.
LOCAL ONLINE COMMUNITIES. We plan to develop and deploy local online
communities that target the interests of local residents, including civic,
commercial and education issues. The online communities provide a graphical
directory of local services, including shops, restaurants and events currently
not focused on by national, regional or city-wide content aggregation services.
As part of the local content strategy, we are developing local online community
conferencing forums under the name the "Benjamin Franklin Project" to expand
local interests. Local online community conferencing forums include an online
PTA to foster better communications between parents and teachers and an online
town hall to provide residents a more timely method to communicate with city
officials. We also provide subscribers the ability for subscribers to create
their own online conferencing forums.
VIDEO CONFERENCING AND COLLABORATIVE COMPUTING. Each of our local cable
affiliate collaborative servers facilitates high-speed desktop video
conferencing (15-30 frames per second) and collaborative computing not feasible
using traditional Internet dial-up access methods. The local collaborative
server allows users to work on documents over the network while engaged in voice
and videoconferences. We provide an intuitive user interface that is integrated
into the browser to facilitate "single-click" conferencing to individuals or
groups.
WEB HOSTING SERVICES. We provide a full complement of Web hosting and
server co-location. Our Virtual Merchant hosting service allows businesses to
create an online storefront using available software and receive orders over the
Internet in a matter of hours. Cost-effective Web hosting packages target small
business and are deployed in 24 to 48 hours. Commercial extranet applications
allow a business to let their customers or vendors access their LANs using cable
modems or dial-up facilities. Monthly charges for Web hosting and co-location
range from $25 to $1,500 per month depending on bandwidth usage, number of
inquiries (or "hits") per month and scripting and database requirements.
LOCAL AND NATIONAL ADVERTISING. Through our cable affiliates, we plan to
offer the ability to bundle local Internet banner and multimedia advertising
with the existing cable video advertising sales efforts. Through our network
architecture, local and national advertising content will be stored in the NOC
and replicated at the local cable affiliate headend to enhance performance. Our
network architecture utilizes multicast routing to enable the efficient
distribution of Internet-based advertising, and video and audio content services
from content providers and the NOC to many ISP Channel subscribers
simultaneously.
DEVELOPMENT OF NEW SERVICES. As the Internet continues to evolve and
encompass additional applications, we plan to develop new products and services
targeted to this marketplace for the future. Such products and services may
include set-top box applications, IP telephony services, enhancements to the ISP
Channel/Excite portal and improved online communities.
NETWORK ARCHITECTURE
Our scalable, distributed network architecture links the high-bandwidth
capacity of the local cable infrastructure with leased nationwide Internet
backbone facilities from major telecommunications carriers, including MCI, MFS
and Sprint. We have designed our network to move content closer to the
subscriber (thereby increasing speed of access) and provide end-to-end network
management. Our
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backbone vendors provide it with scalable Internet backbone capacity, and
thereby enable us to respond quickly to increases in demand, avoiding the need
to build and maintain a parallel Internet network.
NETWORK OPERATIONS CENTER. Our NOC, which includes a network of highly
redundant servers, network management systems and broadband Internet access
facilities, manages core subscriber services, such as e-mail, newsgroups,
conferencing and chat facilities, and local content replication. The NOC
provides nationwide provisioning for all subscriber services, whether the
customer registers at the local cable affiliate's business office, via a cable
affiliate personalized toll-free telephone number, or through an automated
online provisioning system. We are in the process of building a new
state-of-the-art facility to support the activities of a growing number of cable
affiliates and provide the maximum service availability that consumers and
commercial subscribers demand. To date, we have deployed one NOC in Mountain
View, California and plan to deploy regional data centers ("RDCs") as justified
by the geographic concentration of cable affiliates in order to reduce operating
and capital expenditures and to provide a level of network redundancy.
LOCAL CONTENT REPLICATION. Our network architecture utilizes content
replication technologies to enhance the speed at which content is delivered to
subscribers and makes more efficient use of the cable affiliates' local headend
Internet connectivity by moving the requested information closer to subscribers.
By replicating frequently accessed content in storage servers located in each
cable affiliate's headend, we deliver large multimedia files, including
graphically rich Web pages and multimedia content, to numerous local cable modem
subscribers without frequent re-transmission over the Internet.
TOTAL NETWORK MANAGEMENT. We utilize a network of dedicated servers to
monitor connectivity and performance from the NOC to each online cable affiliate
headend and its respective cable modem subscribers. In addition, our NOC
currently monitors over 250 independent routers and servers on the Internet,
including major backbone providers, major ISPs, frequently accessed Web sites,
and major peering and routing facilities across the country. The NOC allows us
to automatically reroute Internet traffic to maintain subscriber cable modem
performance despite regional Internet congestion and backbone outages.
REDUNDANT LEASED BACKBONE FACILITIES. We connect cable affiliate headends
to the Internet via facilities leased from MCI, MFS, Sprint and others. By
utilizing multiple providers, we can assure maximum network availability while
enhancing the routing efficiency of cable modem subscribers' Internet requests.
National network agreements allow us to provide scalable local connections to
our cable affiliates. Our network architecture facilitates high performance,
rapid cost-effective deployment independent of location and software scalability
for responsive additions to network capacities.
CABLE AFFILIATE HEADENDS. Affiliated cable system headends are connected to
the Internet and in turn the NOC through our leased backbone facilities. Each
Internet connection utilizes a high performance router supporting speeds up to
45 mbps, which can be upgraded to 155 mbps as required. Currently, we are
deploying headend equipment from 3Com and Com21. In addition, we purchase
telephone access lines to support local dial-up Internet access services or
dial-up return for one-way cable systems. We actively monitor our dial-up
facilities and purchase additional lines as necessary to meet subscriber demand.
We install servers into the cable affiliate headend to support local caching,
collaborative and IP telephony functions. Local collaborative servers facilitate
desktop video conferencing and collaborative document sharing. We have been
evaluating technology from several IP telephony vendors and plans to deploy IP
telephony servers to facilitate IP telephony services through our network.
CABLE MODEMS AND TELEVISION SET-TOP BOXES. Residential subscribers can
connect to the Internet over the local cable infrastructure using a cable modem
and, in the future will be able to connect via an integrated television set-top
box. In the case of cable modems, the coaxial cable is connected to the cable
modem and the cable modem is connected to an Ethernet card installed in a
subscriber's PC. Internal cable modem PC cards do not require the Ethernet card
installation. In the case of television
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based high-speed Internet access, the coaxial cable is attached directly to the
set-top box. We currently provide a custom installation CD that allows a cable
modem subscriber to choose either Microsoft Internet Explorer or Netscape
Navigator, along with a selection of popular utility programs. We currently use
cable modems manufactured by 3Com and Com21.
SALES AND MARKETING
TO CABLE OPERATORS
We market our services through the establishment of exclusive relationships
with cable operators whose systems are primarily located in secondary and
tertiary markets and bedroom communities of major metropolitan areas. We use our
seven person sales force with offices in Bethesda, Maryland, Chicago, Illinois,
and Los Angeles and Mountain View, California to market the ISP Channel. This
sales force targets the corporate offices of national and regional MSOs. The
sales force employs a team-selling approach targeting key management, marketing
and engineering personnel within each cable system. We participate in three
national industry trade shows including the Atlantic, NCTA and Western, in
addition to 17 state-sponsored local cable industry trade shows.
We have a revenue sharing arrangement with our cable affiliates pursuant to
which a cable affiliate generally receives 25% of Internet services revenue for
the first 200 ISP Channel subscribers on a cable system and approximately 50% of
such revenues thereafter. In addition, we have adopted an affiliate incentive
program whereby certain cable operators have been offered either cash or shares
of common stock as an incentive to sign an exclusive contract with us for the
provision of Internet services to their cable systems. It is our intention,
however, that the affiliate incentive program will offer only common stock after
January 1, 1999. We have reserved up to 19.9% of our outstanding common stock as
of May 29, 1998 for issuance to cable affiliates under this program. The number
of shares of common stock that may be paid to any individual cable affiliate
will depend on a variety of factors, including the number and size of the cable
systems covered by a contract with an MSO, the number of homes passed and the
number of cable subscribers in a system, the services provided by us and the
length of exclusivity of the contract. These incentive payments are expected to
range between $2.00 and $5.00 worth of common stock per home passed, based on
the fair market value of the common stock at the time a letter of intent or
definitive agreement is entered into with a cable affiliate, depending upon the
various factors described above. We may issue stock or pay cash incentives at
the time a contract is entered into, or we may place the stock or cash incentive
amounts in escrow to be disbursed as cable systems are deployed.
TO INTERNET SUBSCRIBERS
THROUGH CABLE AFFILIATES. Our agreements with our cable affiliates provide
us a conduit to reach potential subscribers. Cable affiliates provide SoftNet
with television advertising time and the ability to include material describing
our services in bills mailed to cable subscribers. We create all of the content
to be included in such marketing efforts. We have produced an infomercial and
are planning to produce 30 and 60 second commercials to be aired by cable
operators.
DIRECT TO THE PUBLIC. We market directly to homes and businesses in its
cable affiliates' franchise areas through telemarketing, direct mail, door
hangers, and local event marketing. In addition, we telemarket to existing cable
subscribers using the cable affiliate's current subscriber list.
AGREEMENT WITH EXCITE
Our agreement with Excite creates a strategic relationship between the
companies that we believe will promote our development and national presence.
Under the agreement, Excite designs, creates and promotes Web pages for its
"Excite Search" and "My Excite Channel" services that display the names of both
SoftNet and Excite to ISP Channel subscribers. Excite has sole responsibility
for providing and maintaining, at its expense, the resulting Web portal. We are
responsible for incorporating the
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co-branded My Excite Channel service as a default home page for, or display a
link to the co-branded My Excite Channel service on, the ISP Channel or any
personalized service application.
Excite will sell advertising on the co-branded pages, and will create at
least one promotional space within its service that may be sold by us or our
cable affiliates. Excite and our company will share a portion of the advertising
revenues received from banner advertising that appears on co-branded pages.
Under the terms of the agreement between us and our cable affiliates, we may, in
turn, share a portion of such revenue with our cable affiliates.
Excite recently announced that it is being acquired by one of our primary
competitors, @Home. If, due to this acquisition, Excite were to terminate its
contract with us prior to its expiration in November 1999 or not to extend the
contract at that time, we would need to find a new provider of national content
aggregation.
CUSTOMER CARE AND BILLING
As part of our strategy to leverage local cable affiliates' brand
identities, we are developing a comprehensive provisioning, billing and customer
care system that allows for our services to be individualized and co-branded for
each cable affiliate system. We have entered into contracts with PeopleSoft,
Inc. ("PeopleSoft") (a billing system vendor), Clarify Inc. ("Clarify") (a
customer care system vendor) and Aspect Telecommunications ("Aspect") (a call
center system vendor) to design and implement an integrated, flexible and
scalable solution. Our Customer Care Center ("CCC") is being designed to provide
customer service from a central care center located in Mountain View,
California. The CCC will provide individualized toll-free support for each
affiliated cable system for pre-sales information and through which subscribers
can coordinate all services including provisioning, billing and technical
support. Additionally, we will provide cable affiliates with the ability to
access individualized Web-based reporting and call monitoring for all customer
care service including telemarketing, sales and technical support.
PROVISIONING. We currently provision service by means of an individualized
toll-free number with personalized answering for each cable affiliate system. We
are in the process of implementing an online provisioning system using the
PeopleSoft billing platform that will enable a subscriber to purchase a cable
modem in a retail location or at the cable affiliate's business office and
register and provision the service online 24 hours per day. The online services
will include provisioning, Web-based or e-mail bill presentation and Web-based
service modification.
BILLING. We currently provide the ability for cable affiliates or us to be
responsible for billing and collection. If any cable affiliate elects to bill
ISP Channel subscribers within its franchise area, we maintain a duplicate
subscriber record in its system for provisioning and reconciliation. If we
provide the billing and collection services, we provide the bill delivery via
e-mail and settle accounts electronically via major credit cards, debit cards or
electronic check cashing services.
TECHNICAL SUPPORT. The CCC currently utilizes a state of the art digital
private telephone exchange ("PBX") and Automatic Call Distribution ("ACD")
system to provide full-time individualized technical support for each cable
affiliate system. We are currently implementing a new Aspect ACD system
accompanied by Clarify's customer care software allowing a subscriber's
information and history to be presented to a technical support representative in
conjunction with each call. Our "knowledge base system" facilitates expedient
trouble shooting and historical reporting on an individualized cable system
basis delivered to cable affiliates in real-time through a Web-based interface
or monthly via e-mail.
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VENDOR RELATIONSHIPS
In addition to the relationships that we have with Excite, MCI, MFS and
Sprint, we currently depend on a limited number of other suppliers for certain
key technologies used to provide Internet related services. In particular, we
depend on 3Com and Com21 for headend and cable modem technology and Cisco
Systems, Inc. for network routing and switching hardware.
COMPETITION
We face competition in two broad areas: (i) competition for partnerships
with cable operators from other cable modem-based providers of Internet access
services, and (ii) competition from other types of providers of Internet
services, including offerings directly by cable operators.
Even if a consumer believes that cable-based Internet access is the best
method of accessing the Internet, the consumer may not be able to obtain this
service from us unless the consumer lives in an area serviced by a cable
operator that has partnered with us. Thus, an additional and important class of
competition could come from companies which seek to partner with cable operators
and offer to equip these cable systems with Internet access capability or to
manage the cable operator's Internet services, or from cable operators who
decide not to choose a partner but rather to build their own Internet service
themselves.
NATIONAL CABLE MODEM SERVICE PROVIDERS. Competitive cable modem service
providers such as @Home and RoadRunner (and their respective cable partners) are
deploying high-speed Internet access services over HFC cable networks. Where
deployed, these networks provide similar services to those offered by us. These
providers and their MSO affiliates have substantially greater financial and
operational resources than us and may accordingly be able to deploy their
service more rapidly and aggregate content
more effectively than us. In addition, such competitive providers enjoy an
inherent advantage in marketing their services to their MSO affiliates by virtue
of such affiliations.
SYSTEM INTEGRATORS. Companies like Convergence.com, HSAnet, OSS and the
GlobalCenter service of Frontier Communications offer their services to cable
operators to assist these cable operators in upgrading their systems to carry
Internet and Web-based applications. These companies initially charged cable
operators for their technical services, but recently some have adopted a
partnership model similar to ours in which the systems integrator will absorb
the cost of the technical upgrading of the system and the integrator and the
cable operator will share revenues.
There are many competing technologies for delivering Internet access to
homes and businesses which compete with the ISP Channel. The number of such
competing technologies is growing, and we expect that competition will intensify
in the future. Our competitors comprise several categories of providers of
Internet services: incumbent local exchange carriers ("ILECs"), interexchange
carriers ("IXCs"), competitive local exchange carriers ("CLECs"), ISPs, OSPs,
wireless and satellite data service providers and DSL focused CLECs.
Many of these competitors are offering (or may soon offer) technologies and
services that will directly compete with the ISP Channel. Such technologies
include ISDN, DSL and wireless data. Certain bases of competition in our markets
include transmission speed, reliability of service, breadth of service
availability, price/performance, network security, ease of access and use,
content bundling, customer support, brand recognition, operating experience,
capital availability and exclusive contracts. We believe that we compare
unfavorably with our competitors with regard to, among other things, brand
recognition, operating experience, exclusive contracts, and capital
availability. Many of our competitors and potential competitors have
substantially greater resources than us and we cannot assure you that we will be
able to compete effectively in our target markets. Our ability to compete may be
further impeded if, as evidenced by the recent merger between AT&T and TCI,
competitors utilizing different or the same technologies seek to merge to
enhance their competitive strengths.
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Each of these classes of competitors is detailed below:
ILECS. All of the largest ILECs that are present in our target markets are
conducting technical and/or market trials of DSL-based data services. In
addition, the FCC has initiated a proceeding to determine the level of
regulation that will apply to ILEC provision of "advanced services" (of which
DSL-service is one type). In this proceeding, the FCC has proposed, among other
things, to permit ILECs to offer advanced services on a deregulated basis if the
ILEC provides advanced services through a separate affiliate that meets certain
specified separation requirements. While it is uncertain whether the FCC will
adopt this approach or some other approach, it is likely that any decision by
the FCC to grant ILECs any type of regulatory relief will increase the ILECs'
competitiveness, which in turn could decreased the competitiveness of our
services.
Under current laws and regulations, a Bell Operating Company ("BOCs") is
prohibited from offering any telecommunications service (including DSL service)
between certain specified geographic boundaries, known as LATAs until the FCC
determines that the BOC has met a statutory checklist designed to promote
competition in local markets. The FCC recently has rejected requests by certain
regional BOCs to waive this restriction for data services, although the FCC has
proposed to modify this restriction on a case-by-case basis to allow BOCs to
engage in limited inter-LATA services. If the BOCs are permitted to provide data
services on a limited inter-LATA basis, if a court overturns the FCC's decision
not to grant a general waiver of the inter-LATA, or if the FCC determines that a
BOC has met the statutory checklist then the resulting ability of the BOCs to
provide inter-LATA service may adversely affect our competitiveness.
As they move forward in implementing DSL-based data services (and secure any
additional needed regulatory approvals), the RBOCs and other ILECs will
represent strong competition in all of our target service areas. The ILECs have
an established brand name and reputation for high quality in their service
areas, possess sufficient capital to deploy DSL equipment rapidly, have their
own copper lines and can bundle digital data services with their existing analog
voice services to achieve economies of scale in serving customers.
NATIONAL LONG DISTANCE CARRIERS. IXCs, such as AT&T, Sprint and WorldCom
have deployed large-scale Internet access networks, sell connectivity to
businesses and residential customers and have high brand recognition. They also
have interconnection agreements with many of the ILECs from which they could
begin to offer DSL services competitive with the ISP Channel. The recent
AT&T/TCI merger allows AT&T to provide Internet services using TCI's cable
infrastructure and gives AT&T a significant economic and voting interest in
@Home.
FIBER-BASED CLECS ("FCLECS"). FCLECs such as Intermedia Communications
Group and ICG Communications have extensive fiber networks in many metropolitan
areas primarily providing high-speed digital and voice circuits to large
customers. Some FCLECs have announced plans to offer DSL services competitive
with the ISP Channel in many markets targeted by us. These companies could
modify their current business focuses to include residential and small business
customers using cable-based access or DSL in combination with their current
fiber networks.
INTERNET SERVICE PROVIDERS. ISPs such as BBN (acquired by GTE Corporation),
UUNET (acquired by WorldCom), Earthlink, Concentric Network, MindSpring, Netcom
and PSINet provide Internet access to residential and business customers,
generally using the existing public switched telephone network at ISDN speeds or
below. Some ISPs such as HarvardNet in Massachusetts, InterAccess in Illinois
and Vitts Corporation in New Hampshire have begun offering DSL-based services.
Additional ISPs could become DSL service providers competitive with us.
ONLINE SERVICE PROVIDERS. OSPs include companies such as AOL, Compuserve
(acquired by AOL), MSN (a subsidiary of Microsoft Corp.), Prodigy, WorldGate and
WebTV (acquired by Microsoft Corp.) that provide, over the Internet and on
proprietary online services, content and applications ranging from news and
sports to consumer video conferencing. These services are designed for broad
consumer
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access over telecommunications-based transmission media, which enable the
provision of digital services to the significant number of consumers who have
personal computers with modems. In addition, they provide Internet connectivity,
ease of use and consistency of environment. Many of these OSPs have developed
their own access networks for modem connections. If these OSPs were to extend
their access networks to cable-based access or DSL, they would compete with us.
WIRELESS AND SATELLITE DATA SERVICE PROVIDERS ("WSDSPS"). WSDSPs are
developing wireless and satellite-based Internet connectivity. We may face
competition from terrestrial wireless services, including two Gigahertz ("GHz")
and 28 GHz wireless cable systems, multichannel multipoint distribution service
("MMDS") and local multipoint distribution service ("LMDS"), and 18 GHz and 39
GHz point-to-point microwave systems. For example, the FCC has amended its rules
to permit MMDS licensees to use their systems to offer two-way services,
including high-speed data, rather than solely to provide one-way video services.
The FCC also recently awarded LMDS licenses, which can be used for high-speed
data services as well. In addition, companies such as Teligent, Inc., Advanced
Radio Telecom Corp. and WinStar Communications, Inc. hold point-to-point
microwave licenses to provide fixed wireless services such as voice, data and
videoconferencing.
We also may face competition from satellite-based systems. Motorola
Satellite Systems, Inc., Hughes Space and Communications Group (a subsidiary of
General Motors Corporation), Teledesic and others have filed applications with
the FCC for global satellite networks which can be used to provide broadband
voice and data services.
In January 1997, the FCC allocated 300 MHz of spectrum in the 5 GHz band for
unlicensed devices to provide short-range, high-speed wireless digital
communications. These frequencies must be shared with incumbent users without
causing interference. Although the allocation is designed to facilitate the
creation of new wireless LANs, it is too early to predict whether users of these
frequencies could become competitors of the ISP Channel.
DSL-FOCUSED CLECS. Certain companies, such as Covad and Rhythms
NetConnections have obtained CLEC certification and are offering high-speed data
services using a strategy of co-locating in ILEC central offices. The 1996 Act
specifically grants any and all CLECs the right to negotiate interconnection
agreements with the ILEC providing for such co-location.
FEDERAL REGULATION
INTERNET REGULATION. Our Internet services are not currently subject to
direct regulation by the FCC or any other governmental agency. However, it is
possible that new laws and regulations may be adopted that would subject the
provision of our Internet services to government regulation. Certain other
legislative initiatives, including those involving taxation of Internet services
and payment of access charges by ISPs, are also possible. Any new laws regarding
the Internet, particularly those that impose regulatory or financial burdens,
could impact adversely our ability to provide various services and could have a
material adverse effect on our results of operations and financial condition. We
cannot predict the impact, if any, that any future laws or regulatory changes
may have on our business.
The introduction of, or changes to, regulations that directly or indirectly
affect the regulatory status of Internet services, affect telecommunications
costs (including the application of reciprocal compensation requirements, access
charges or universal service contribution obligations to Internet services), or
increase the competition from regional telecommunications companies or others,
could have a material adverse effect on our results of operations and financial
condition. For instance, if the FCC determines, through any one of its ongoing
or future proceedings, that the Internet is subject to regulation, or that cable
facilities used to provide Internet access must be opened to competitors, we or
our cable partners could be required to comply with a number of FCC regulations,
including but not limited to rules relating to entry/exit, facility access by
competitors, reporting, fee, and record-keeping requirements, marketing
restrictions, access charge obligations, and universal service contribution
obligations, which could adversely impact our ability to provide various planned
services and have a
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material adverse effect on our results of operations and financial condition. We
cannot predict the impact, if any, that regulations or regulatory changes may
have on our business. A final determination by the FCC that providing Internet
transport or telephony services to customers over an IP-based network is subject
to regulation also could impact adversely our ability to provide various planned
services and could have a material adverse effect on our results of operations
and financial condition.
One issue that could have a material effect on us is the continued
classification by the FCC of Internet access services as an "Information
Service." In the FCC's April 10, 1998 Report to Congress (the "April Report"),
the FCC discussed whether ISPs should be classified as telecommunications
carriers, and, on that basis, be required to contribute to the USF. The April
Report concluded that Internet access service-which the FCC defined as an
offering combining computer processing, information storage, protocol
conversion, and routing transmissions-is an "information service" under the
Telecommunications Act of 1996 and thus not subject to regulation. In contrast,
the FCC found that the provision of transmission capabilities to ISPs and other
information services providers do constitute "telecommunications services" under
the Telecommunications Act of 1996. Consequently, parties providing those
telecommunications services are subject to current FCC regulation (and the
corresponding USF obligations).
Another significant regulatory issue concerns the obligation of ISPs to pay
access charges to ILECs. Unlike "basic services," "enhanced services," which are
generally analogous to "information services" and include Internet access
services, have been exempt from interstate access charges. In 1997, the FCC
declined to modify the exemption, and the FCC's decision was affirmed by the
United States Court of Appeals for the Eighth Circuit. Recently, the FCC has
determined that dial-up calls to ISPs are interstate, not local, calls for
regulatory purposes. It is uncertain whether this decision will have an adverse
affect on the ISP exemption from access charges. We cannot assure you, however,
that the FCC or the courts will not revisit this issue in the future and decide
to eliminate the access charge exemption applicable to ISPs.
Another major regulatory issue concerns Internet-based telephony. In the
April Report, the FCC observed that Internet-based telephone service (which the
FCC called "IP telephony") appears to be a telecommunications service rather
than an unregulated information service. For example, in the April Report, the
FCC stated its intention to consider whether to regulate voice and fax telephony
services provided over the Internet as "telecommunications" even though Internet
access itself would not be regulated. The FCC is also considering whether such
Internet-based telephone services should be subject to the universal service
support obligations discussed above, or pay carrier access charges on the same
basis as traditional telecommunications companies. We cannot predict how the FCC
will resolve this issue, or the effect that the FCC's resolution would have on
our business.
We could also be affected in a material adverse way by federal and state
laws and regulations relating to the liability of online services companies and
Internet access providers for information carried on or disseminated through
their networks. Several private lawsuits seeking to impose such liability upon
online services companies and Internet access providers are currently pending.
In addition, legislation has been enacted and new legislation has been proposed
that imposes liability for the transmission of or prohibits the transmission of
certain types of information on the Internet, including sexually explicit and
gambling information. The United States Supreme Court has already held
unconstitutional certain sections of the Communications Decency Act of 1996 that
would have proposed to impose criminal penalties on persons distributing
"indecent" materials to minors over the Internet. Congress subsequently enacted
legislation that imposes both criminal and civil penalties on persons who
knowingly or intentionally make available materials through the Internet that
are "harmful" to minors. However, that new law generally excludes from the
definition of "person" ISPs that are not involved in the selection of content
disseminated through their networks. Congress also enacted legislation recently
that limits liability for online copyright infringement. That latter law
includes exemptions which enable ISPs to avoid copyright infringement if they
merely transmit material produced and requested by others. It is possible that
other laws and regulations could be enacted in the
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future that would place copyright infringement liability more directly on ISPs.
The imposition of potential liability on us and other Internet access providers
for information carried on or disseminated through their systems could require
us to implement measures to reduce our exposure to such liability, which may
require us to expend substantial resources or to discontinue certain service or
product offerings. The increased attention to liability issues as a result of
lawsuits and legislative actions and proposals could impact the growth of
Internet use. While we carry professional liability insurance, it may not be
adequate to compensate claimants or may not cover us in the event we become
liable for information carried on or disseminated through our networks. Any
costs not covered by insurance incurred as a result of such liability or
asserted liability could have a material adverse effect on our results of
operations and financial condition.
STATE REGULATION
As use of the Internet has proliferated in the past several years, state
legislators and regulators have increasingly shown interest in regulating
various aspects of the Internet. Much of the legislation that has been proposed
to date may, if enacted, handicap further growth in the use of the Internet. It
is possible that the state legislatures and regulators will attempt to regulate
the Internet in the future, either by regulating transactions or by restricting
the content of the available information and services. Enactment of such
legislation or adoption of such regulations could have a material adverse impact
on us.
One area of potential state regulation concerns taxes. The United States
Congress recently enacted a three-year moratorium on new state and local taxes
on the Internet (those not generally imposed or actually enforced prior to
October 1, 1998) as well as on taxes that discriminate against commerce through
the Internet. Congress also established an advisory commission to study and make
recommendations on the federal, state, and local taxation of Internet-related
commerce. These recommendations are due to Congress by April 2000 and could
serve as the basis for additional legislation. Previous to the enactment of the
tax moratorium, a significant number of bills had been introduced in state
legislatures that would have taxed commercial transactions on the Internet.
Future laws or regulatory changes that lead to state taxation of Internet
transactions could have a material adverse impact on us.
Although customer-level use of the Internet to conduct commercial
transactions is still in its infancy, a growing number of corporate entities are
engaging in Internet transactions. This Internet commerce has given rise to a
number of legal and regulatory issues, such as (i) whether and how certain
provisions of the Uniform Commercial Code (adopted by 49 states) apply to
transactions carried out on the Internet and (ii) how to decide which
jurisdiction's laws are to be applied to a particular transaction. It is not
possible to predict how state law will evolve to address new transactional
circumstances created by Internet commerce, or whether the evolution of such
laws will have a material adverse impact on us.
State legislators and regulators have also sought to restrict the
transmission or limit access to certain materials on the Internet. For example,
in the past several years, various state legislators have sought to limit or
prohibit: (i) certain communications between adults and minors, (ii) anonymous
and pseudonymous use of the Internet, (iii) on-line gambling, and (iv) the
offering of securities on the Internet. Enforcement of such limitations or
prohibitions in some states could affect transmission in other states. State
laws and regulations that restrict access to certain materials on the Web could
inadvertently block access to other permissible sites. We cannot predict the
impact, if any, that any future laws or regulatory changes in this area may have
on our business. Some states have also sought to impose tort liability or
criminal penalties on various conduct involving the Internet, such as the use of
"hate" speech, invasion of privacy, and fraud. The adoption of such laws could
adversely impact the transmission of non-offensive material on the Internet and,
to that extent, possibly have a material adverse impact on our business.
We anticipate that we may in the future seek to offer telecommunications
service as a CLEC. All states in which we operate require a certification or
other authorization from the state regulatory
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commission to offer intrastate telecommunications services. Many of the states
in which we operate are in the process of addressing issues relating to the
regulation of CLECs. Some states may require authorization to provide enhanced
services.
The Telecommunications Act contains provisions that prohibit states and
localities from adopting or imposing any legal requirement that may prohibit, or
have the effect of prohibiting, the ability of any entity to provide any
interstate or intrastate telecommunications service. The FCC is required to
preempt any such state or local requirements to the extent necessary to enforce
the Telecommunications Act's open market entry requirements. States and
localities may, however, continue to regulate the provision of intrastate
telecommunications services and require carriers to obtain certificates or
licenses before providing service.
In states where we operate, rulemaking proceedings, arbitration proceedings
and other state regulatory proceedings that may affect our ability to compete
with ILECs are now underway or may be instituted in the future. These
proceedings involve a variety of telecommunications issues, including but not
limited to: pricing and pricing methodologies of local exchange and intrastate
interexchange services; development and approval of resale agreements between
ILECs and CLECs and among CLECs; terms and conditions governing the provision of
telecommunications services; customer service and unauthorized changes in
customer-selected telephone service providers; complaints regarding
anticompetitive practices and transactions between affiliated telecommunications
companies; denial of entry into telecommunications markets; discount levels for
resale of local exchange and toll services; treatment of and compensation for
calls to Internet service providers; charges for access to ILEC networks; cost
sharing and implementation of interim and permanent number portability; dialing
parity; access to and responsibility for universal service funding; and review
and recommendation to the FCC concerning RBOC authorization to offer in-region
long distance service. To the extent we decide in the future to install our own
transmission facilities, rulemaking proceedings, arbitration proceedings and
other state regulatory proceedings may also affect our ability to compete with
ILECs. These proceedings may involve issues including but not limited to:
co-location of ILEC and CLEC facilities; interconnection agreements between
ILECs and CLECs; and access to unbundled and combined network elements of ILECs.
In addition, states in which we operate may consider legislation that involves
issues including but not limited to: any of the aforementioned issues in
rulemaking proceedings, arbitration proceedings and other state regulatory
proceedings; alternative forms of regulation; and limitations on the provision
of competitive telecommunications services.
LOCAL REGULATION
Although local jurisdictions generally have not sought to regulate the
Internet, it is possible that such jurisdictions will seek to impose regulations
in the future. In particular, local jurisdictions may attempt to tax various
aspects of Internet access or services, such as transactions handled through the
Internet or subscriber access, as a way of generating municipal revenue. The
imposition of local taxes and other regulatory burdens by local jurisdictions
could have a material adverse impact on us.
In the context of the AT&T/TCI merger, several local jurisdictions are
considering requiring open access to the cable platform for competitive ISPs.
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. While any such conditions apply only to cable systems operated by
TCI, continued debate over this issue may cause new laws or regulations to be
enacted that would directly effect our business, including our ability to enter
into exclusive arrangements with our cable affiliates.
Our networks may also be subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city by city and county
by county basis. To the extent we decide in the future to install our own
transmission facilities, we will need to obtain rights-of-way over private and
publicly owned land. We cannot assure that such rights-of-way will be available
to us on economically reasonable or advantageous terms.
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FOREIGN REGULATION
If our services become available over the Internet in foreign countries, and
if we facilitate sales by our affiliates to end users located in such foreign
countries, such jurisdictions may claim that we are required to qualify to do
business in the particular foreign country. Qualification to do business in a
foreign jurisdiction could subject us to taxes, regulations, and other legal
requirements which could have a material adverse impact on our results of
operations and financial condition. Conversely, failure by us to qualify as a
foreign corporation in a jurisdiction where we are required to do so could
subject us to taxes, interest and penalties and could impair our ability to
enforce contracts in such jurisdictions. It is also possible that the statutes
and regulations of any applicable foreign jurisdiction could allow claims to be
made against ISPs for defamation, negligence, copyright or trademark
infringement, or other theories based on the nature and content of the materials
disseminated through their networks. Any such legislation or regulation, or the
application of laws or regulations from jurisdictions whose laws do not
currently apply to our business, could have a material adverse effect on our
results of operations and financial condition.
OTHER REGULATIONS
The foregoing discussion of regulatory factors does not describe all laws,
regulations, or restrictions that may apply to us. Nor does it review all laws
or regulations under consideration by federal and state governmental bodies that
may affect our operations. It is possible that present and future laws and
regulations not discussed here could have a material adverse effect on our
results of operations and financial condition.
BACKLOG
As of March 3, 1999, the ISP Channel had 31 signed contracts representing
126 cable systems and approximately 1.6 million homes passed. Twenty-three of
these systems, representing over 264,000 homes passed, have been equipped and
have begun offering our services. Approximately one hundred of these systems,
representing approximately 1.3 million homes passed, are in backlog. As of March
3, 1999, we had approximately 2,200 residential and business subscribers to our
ISP Channel service, plus approximately 500 customer orders in backlog.
EMPLOYEES
As of February 28, 1999 we had eight full-time employees at our corporate
headquarters. The ISP Channel had 86 employees.
FACILITIES
Our corporate offices and some of the operations associated with our ISP
Channel operations occupy approximately 33,660 square feet of office space in
San Francisco, California, pursuant to a lease expiring in 2006. We intend to
increase our leased space in Mountain View, California, where our Network
Operations Center is located, from 8,300 square feet to approximately 22,800
square feet.
LEGAL PROCEEDINGS
We have no material pending litigation related to the ISP Channel.
INTELLIGENT COMMUNICATIONS, INC.
Intelligent Communications provides two-way satellite Internet access
options utilizing VSAT technology. Intelligent Communications focuses its sales
penetration efforts on rural markets, particularly ISPs, educational
institutions and small businesses. In addition to providing Internet access
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options, Intelligent Communications provides Internet-based applications,
consulting services and full Internet services to the marketplaces it serves.
Intelligent Communications' access options include both VSAT dedicated and
dial-up Internet access (including ISDN and direct network connectivity).
Intelligent Communications' other products and services include Web server
hosting and integration services, client software development and maintenance
services, training and network integration and consulting services. Intelligent
Communications' VSAT network infrastructure currently allows network
connectivity throughout North America. Intelligent Communications' VSAT-based
point of presence ("POP") locations can be placed throughout the 48 lower states
as well as Southern Canada and Southern Alaska. Intelligent Communications may
provide its Internet services in the C-band satellite arena in addition to its
Ku-band offering. Many international satellites utilize the C-band architecture
and Intelligent Communications expects to retrofit its equipment for C-band
coverage areas with little difficulty.
Intelligent Communications' objective is to become the leading provider of
complete communications solutions using Internet and VSAT-related technologies
to rural, suburban and urban educational institutions, ISPs and private
corporate intranets. As a national ISP, Intelligent Communications provides a
cost-effective alternative for Internet services and solutions to rapidly
growing Internet customer networks. Intelligent Communications has worked toward
achieving this position by focusing on building a high performance network
infrastructure, integrating and expanding its suite of value-added products and
services, investing in its network operations and technical support
infrastructure, expanding and tailoring its sales and marketing efforts to reach
its targeted customers more effectively, and building and leveraging
relationships with strategic partners.
PRODUCTS AND SERVICES
Intelligent Communications provides its customers with a comprehensive range
of Internet access options, applications and consulting services. Intelligent
Communications believes that, over time, its strategic focus on business
applications for the Internet and its niche network connectivity options will
play a larger role in differentiating Intelligent Communications from its
competitors. Intelligent Communications' options and services include a stable,
low-cost VSAT system based on two-way satellite technology, providing high-speed
access to the Internet. Early in 1998, Intelligent Communications introduced the
T1 Plus product line as a solution to the marketplace. In addition, Intelligent
Communications developed the Edge Connector server to enhance the VSAT network
connectivity system. This comprehensive package of Internet applications is
customized to work within the VSAT network, specifically for the ISP industry.
Cache Plus, similar to the Edge Connector, was created as Intelligent
Communications' answer to internet backbone congestion. The objective of Cache
Plus is to move a substantial amount of the Web, FTP and NNTP traffic from the
internet backbone to the 'network edge' via a local proxy server. This proxy
server is a 'child' to a large 'parent' proxy server at Intelligent
Communications' data center in Fremont, California. Connectivity between the
child and parent is accomplished by utilizing Intelligent Communications'
satellite based TCP/IP network and a VSAT antenna at the remote location. This
VSAT connection is accomplished with either a two-way VSAT solution or a
receive-only VSAT antenna. The child proxy server is benefited by the proxy
activity from other users on the satellite carrier. The major benefit of such
technology lies in its ability to cache a majority of the web's most popular
sites.
The proxy server connection is available through three different VSAT
service options and pricing packages. Each solution requires a local proxy
server utilizing the ICP protocol standard. Intelligent Communications makes its
Edge Connector server solution available and delivers it pre-configured to
operate as a DNS, Web, Telnet, FTP, E-Mail and Proxy server. This system is
based on the Unix operating system and is available in numerous configurations.
Network address translation is also a configuration option for this server.
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Additionally, Intelligent Communications offers connectivity services based
on a range of VSAT, ISDN and dedicated leased circuit options for customers
ranging from 115 kbps to 2 mbps data transfer speeds. The majority of customers
use Intelligent Communications as their primary gateway to the Internet and rely
on Intelligent Communications to connect, secure and maintain their network
integrity. Intelligent Communications designs and out-source manufactures VSAT
equipment specifically for its applications.
Intelligent Communications makes a variety of other products and services
available, including Web server hosting and content development services, client
software products and training. All of these products and services are
integrated to provide customers with a total solution to their Internet
application needs. Intelligent Communications enables Internet users to purchase
access, applications, products and services, including network integration
services, through a single source. Intelligent Communications' NOC continually
monitors traffic across its network. In addition to network monitoring,
Intelligent Communications also provides technical support to its customers via
a toll-free telephone number 24 hours a day, 7 days a week.
SALES AND MARKETING
Intelligent Communications coordinates national advertising campaigns using
intensified direct mailings focusing on ISPs, educational institutions and
corporate intranets. Intelligent Communications will soon begin marketing
activities in Central and South America as well as other new markets and
geographies. The corporate sales and marketing staff will be broken into the
following three divisions: (i) network sales, (ii) reseller network sales and
(iii) content and hosting sales. The sales staff is supervised by Intelligent
Communications' corporate headquarters in Fremont, California. Intelligent
Communications has begun negotiating international alliances and/or partnering
arrangements with other larger telecommunications company's for international
marketing and satellite capacity.
Intelligent Communications is also focusing on building and leveraging
relationships with its strategic partners. This involves expanding market
coverage by partnering into new POP locations and building new relationships
with other Internet products and service providers. This focus will extend the
reach of the Intelligent Communications network to virtually all major cities
and locations throughout the United States. By expanding Intelligent
Communications' network coverage, Intelligent Communications is positioning
itself to create new partnerships in developing economies and marketing
relationships with corporations and membership based organizations (e.g. Rural
Electric Associations, Credit Unions, etc.). Expanded network coverage will also
allow Intelligent Communications to provide private labeled network connectivity
to its partners.
COMPETITION
The market for Internet access services is extremely competitive.
Intelligent Communications believes that its ability to compete successfully
depends upon a number of factors, including: market presence; the capacity,
reliability, and security of its network infrastructure; the pricing policies of
its competitors and suppliers; the timing and release of new products and
services by Intelligent Communications and its competitors; and industry and
general economic trends.
The competitors of Intelligent Communications are broken into three groups:
(i) other Internet access providers including Netcom, PSINet, BBN, Prodigy and
AOL, (ii) Telecommunications companies, including MCI, AT&T and Sprint, and
(iii) other VSAT-based network connectivity companies, including NSN, CyberSat
and Hughes Satellite Service.
While Intelligent Communications believes that the price and performance
characteristics of its products and services are currently competitive,
increased competition may result in price reductions, reduced gross margin and
loss of market share, any of which could materially affect Intelligent
Communications. Many of Intelligent Communications' current and potential
competitors have
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significantly greater financial, technical, marketing, and other resources than
Intelligent Communications. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements, or
to devote greater resources to the development, promotion, sale, and support of
their products than Intelligent Communications. The introduction of products
embodying new technologies and the emergence of new industry standards could
render Intelligent Communications' existing products obsolete and unmarketable.
In addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties. Accordingly,
it is possible that new competitors or alliances among competitors may emerge
and rapidly acquire significant market share. We cannot assure you that
Intelligent Communications will be able to compete successfully against current
or future competitors or that the pressures faced by Intelligent Communications
will not materially adversely affect Intelligent Communications.
Although most of the established online services and telecommunications
companies currently offer only limited Internet access, many have announced
plans to offer expanded Internet access capabilities. Intelligent Communications
expects that all of the major online services and telecommunications companies
will compete fully in the Internet access market and expand the availability of
terrestrial based dedicated circuits, such as ISDN and fiber optics. Intelligent
Communications believes that new competitors, including large networking,
software, media, and other technology and telecommunications companies will
enter the wireless based Internet access markets, resulting in even greater
competition for Intelligent Communications. Certain companies have obtain or
expanded their Internet access products and services as a result of acquisitions
which may permit Intelligent Communications' competitors to devote greater
resources to the development and marketing of new competitive products and
services and the marketing of existing products and services. Also, the ability
of some of Intelligent Communications' competitors to bundle other services and
products with Internet access services could place Intelligent Communications at
a competitive disadvantage. Intelligent Communications' competitors are
primarily using equipment made by other third party firms, whereas, Intelligent
Communications develops its equipment specifically for its target markets. The
majority of Intelligent Communications competitors are also focused offshore at
the international markets.
Due to increased competition, Intelligent Communications expects to
encounter pricing pressures which could result in significant reductions in the
average selling price of Intelligent Communications' many services. This may
include the cost of Internet access services. We cannot assure you that
Intelligent Communications will be able to offset the effects of price
reductions with an increase in its customer base, its revenues, cost reductions,
or otherwise. Also, Intelligent Communications believes that the industry will
see mergers and consolidation in the near future, which could result in greater
price and other competition in the industry. Increase price or other competition
could also result from erosion of Intelligent Communications' market share and
could have a material adverse effect on Intelligent Communications. We cannot
assure you that Intelligent Communications will have the financial resources,
technical expertise, or marketing and support capacity to continue to compete
successfully.
EMPLOYEES AND FACILITIES
As of February 28, 1999, Intelligent Communications had 20 employees plus
four contract workers. None of Intelligent Communications' employees is
currently subject to any collective bargaining agreement.
Intelligent Communications operates from three principal facilities.
Corporate headquarters are located in a 9,000 square foot office space rented in
Fremont, California. Intelligent Communications leases a 6,300 square foot
warehouse in Hayward, California and a 1,400 square foot Customer Service Center
in Chippewa Falls, Wisconsin. Intelligent Communications' handles client-side
technical support issues and order fulfillment through its Customer Service
Center in Chippewa Falls, Wisconsin.
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LEGAL PROCEEDINGS
Intelligent Communications has no material pending litigation.
MICROGRAPHIC TECHNOLOGY CORPORATION
As part of our new focus, we have signed a letter of intent to sell MTC
which, because of its size in relation to our overall assets and because of the
concurrent sale of our telecommunications business, KCI, is subject to approval
of our stockholders. The sale of MTC has not been reflected herein as a
discontinued business because it was subject to stockholder approval. On April
13, 1999 we received stockholder approval to sell the MTC business.
MTC designs, develops, and manufactures sophisticated, automated electronic
document management and film-based imaging solutions for customers with
large-scale, complex, document-intensive requirements. MTC's hardware and
software products are based on an industry standard client-server architecture,
providing flexibility to connect to a wide variety of information systems and
produce output to various storage media, including optical disk, magnetic disk
and tape, CD-ROM, and microfilm and microfiche, spanning the entire document
lifecycle. MTC manufactures a family of Computer Output to Microfilm ("COM")
production systems, from which it has historically derived the majority of its
revenues. MTC's proprietary software captures information from a variety of
sources, then intelligently indexes and directs the data for storage,
distribution and retrieval. MTC expects that its business will increasingly be
focused on the distribution and retrieval of electronically captured information
over a variety of communications media, such as the Internet, LANs and wide area
networks ("WANs"). To this end, MTC is pursuing a strategy of partnering with
providers of features or elements that enhance MTC's electronic data
distribution solutions.
PRODUCTS AND SERVICES
MTC's products consist of a variety of electronic and film-based solutions.
ELECTRONIC SOLUTIONS
INFORMATION DISTRIBUTION SYSTEM. The integrated IDS software solution
allows users to automatically collect, organize and transport information to the
print or storage media of choice, enhancing the productivity and cost efficiency
of computer output and storage operations. The following product options
comprise MTC's IDS solution:
INFORMATION DISTRIBUTION SYSTEM EXECUTIVE ("IDS EXEC"). The IDS EXEC
software product integrates input, management, execution and reporting
activities under a single point of control, improving efficiency. The IDS EXEC
console manages all data input, job resources, job prioritization and
production, tracks job status and reports audit and job statistics. The IDS EXEC
also intelligently indexes source information for convenient and timely
retrieval irrespective of the storage medium. Additionally, IDS EXEC makes it
possible to reorder images submitted in one sequence to any other logical
ordering sequence specified by the user. Finally, the IDS EXEC platform contains
a variety of Internet-specific applications that offer its users Internet-based
data input and document viewing.
DOCUMENT ORGANIZER. Document Organizer is a client/server-based bundling
system that analyzes documents and organizes them for production. Document
Organizer arranges large-scale print applications, such as bank statements or
insurance policies, according to the customer's distribution and retrieval
requirements. This allows customers to deliver their important information
according to priority, production process, and delivery schedule.
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PAGE HANDLER. Page Handler is a high-speed electronic page-print
interpreter that accepts mainframe print application input which it then
transforms into a variety of output formats, including Internet-compatible
formats, providing the customer with added flexibility as application needs
change.
COMPUTER OUTPUT TO LASER DISK ("COLD") INTEGRATION. MTC is a value-added
reseller of integrated COLD solutions for document management.
FILM-BASED SOLUTIONS
MTC's film-based imaging systems, an alternative to paper and long-term
electronic storage, convert scanned or digital information directly from a
computer or magnetic tape to an analog format for archiving on microfilm or
microfiche. MTC's film-based solutions include:
COM SYSTEMS. MTC is a leading manufacturer of automated "cut fiche"
recording and duplicating systems and related software. MTC's COM systems
provide an architectural platform that has universal capability to transfer any
data format to fiche. A key differentiating factor of MTC's COM system is its PC
based client-server architecture.
OTHER. MTC offers a complete line of original and duplicate microfilm and
chemicals for use in its COM printer and duplicator systems. MTC acquires a
significant portion of its microfilm and media supplies from Eastman Kodak and
sells them on a drop-ship basis. MTC also supplies spare parts for the worldwide
maintenance of its installed COM user base. Maintenance is subcontracted to
third party organizations, for which MTC receives a monthly royalty.
CUSTOMERS
MTC markets its products and services principally to high-volume
document-intensive organizations, such as banks, brokerages and other financial
services companies and document-based service providers. Other customers include
businesses primarily in the healthcare industry and government agencies who
desire to use imaging technology to archive large quantities of documents.
Current customers include over 50 service bureaus and organizations such as
Equifax Inc., the Federal Aviation Administration, the Deutsche Bundesbank,
Deutsche Bank AG, Royal Bank of Scotland Group plc, the United States Marine
Corps, and Xerox Corporation.
COMPETITION
The document management industry is highly competitive and rapidly changing.
MTC competes on the basis of breadth of offering, cost, flexibility and customer
service. MTC's strategy of designing its software solutions around an open
architecture has allowed its existing solutions to be more readily adaptable to
changes in the computer industry and more readily acceptable by new
technologies. MTC believes that these intelligent software platforms give its
overall document management solutions a competitive advantage.
MTC has two direct competitors to its hardware products: Agfa in Europe and
Anacomp worldwide. Indirect competitors include IBM, Fuji, Mobius Management
Systems, Inc., Storage Technology and others. In most cases, MTC's competitors
have longer operating histories, greater name recognition, and significantly
greater financial, technical and marketing resources than MTC. While MTC is not
aware of any direct competitors to its software product offerings, the industry
is rapidly evolving and MTC may face significant competition in the future.
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SALES AND MARKETING
MTC markets its document management solutions and services worldwide. In the
United States, MTC employs a six person direct sales force. Internationally, MTC
uses a network of exclusive distributors.
In order to increase its competitive advantage in certain markets, MTC has
developed a comprehensive leasing alternative for its customers. This leasing
alternative, commonly referred to as a price per fiche program ("PPF"), is a
bundled COM service solution that involves a monthly lease payment based upon
the customer's actual monthly microfiche production, a minimum monthly
production provision and lease terms of typically three to five years. In order
to meet the changing needs of its customers' financing requirements, MTC intends
to increase its emphasis on PPF programs. MTC is currently negotiating with its
international distributors, along with several institutions that have a global
financing presence, to develop similar PPF programs for international markets.
MTC's electronic and film-based imaging hardware systems typically range in
price between $200,000 and $1,000,000, and may represent a significant capital
commitment by MTC's customers, leading to a lengthy sales cycle of up to 24
months. Accordingly, MTC's operating results may fluctuate significantly from
period to period.
SUPPLIERS
MTC purchases the raw materials needed for both its manufacturing and spare
part supply operations from various third party vendors. MTC believes that it
can source these purchased parts from a variety of competing vendors and that no
single vendor possesses a critical component that cannot be purchased elsewhere.
MTC currently subcontracts its maintenance services to third party
organizations.
MTC purchases a significant amount of its microfilm and media supplies from
Eastman Kodak. MTC believes it has a strong partnership with Eastman Kodak and
the two parties are currently operating under a signed vendor agreement
extending through December 31, 2000. Alternative suppliers are available to MTC,
however, in the event of an interruption in the vendor relationship.
RESEARCH AND DEVELOPMENT
MTC believes that its future revenue growth and profitability will
principally depend on its success in developing new products, services and
distribution channels. MTC expects to continue to evaluate new product and
service opportunities and engage in extensive research and development
activities. For the year ended September 30, 1998, MTC spent approximately $1.8
million on research and development efforts.
EMPLOYEES
As of February 28, 1999, MTC had 66 full-time employees.
LEGAL PROCEEDINGS
We have no material pending litigation relating to MTC.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below are the names, ages and positions of our directors and
executive officers as of the date hereof. All directors hold office until their
successors are duly elected and qualified, and all executive officers hold
office at the pleasure of the Board of Directors.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------- --- -----------------------------------------------
<S> <C> <C>
Ronald I. Simon................................ 60 Chairman of the Board
Dr. Lawrence B. Brilliant...................... 54 Vice Chairman of the Board, President and Chief
Executive Officer
Ian B. Aaron................................... 38 Director, Vice President and President of ISP
Channel, Inc.
Garrett J. Girvan.............................. 53 Chief Operating Officer
Douglas S. Sinclair............................ 44 Chief Financial Officer
Steven M. Harris............................... 44 Vice President, External Affairs, General
Counsel and Secretary
Kevin Gavin.................................... 39 Senior Vice President, Marketing of ISP
Channel, Inc.
Edward A. Bennett.............................. 52 Director
Sean P. Doherty................................ 41 Director
Robert C. Harris, Jr........................... 52 Director
</TABLE>
RONALD I. SIMON has served as a member of our Board of Directors since
September 1995 and Chairman of the Board since August 1997. Mr. Simon has served
as Vice President and Chief Financial Officer of Western Water Company, a
developer and marketer of water supplies, since May 1997. Mr. Simon has also
served as Director of Westcorp Investments, a wholly-owned subsidiary of
Westcorp, Inc., a holding company for Western Financial Bank and as Director of
Citadel Corporation, a real estate investment company, since 1995. In addition,
Mr. Simon served as Chairman of Sonant Corporation, an interactive voice
response equipment company, from 1993 to 1997.
DR. LAWRENCE B. BRILLIANT has served as a member of our Board of Directors
since January 1998 and served as Vice Chairman of the Board, President and Chief
Executive Officer since April 1998. Prior to joining us, Dr. Brilliant served as
President and Chief Executive Officer of Brilliant Color Cards, a telephone
debit/calling card company, from 1989 to 1998. Dr. Brilliant is a founder of
MultiVox Communications, a switched telephone reseller. Dr. Brilliant is also a
founder of the International Telecard Association and has served as Director and
Chairman Emeritus since 1992. Dr. Brilliant was also a founder of The Well in
1984 when he was CEO of Network Technologies, Inc. Dr. Brilliant has also been a
professor at the University of Michigan and has served as a medical officer with
the United Nations.
IAN B. AARON has served as a member of our Board of Directors since October
1994. In addition, Mr. Aaron has served as President of ISP Channel since June
1996 and as our Vice President since December 1997. Prior to joining us, Mr.
Aaron served as President of Communicate Direct, Inc., a telecommunications
company, from 1988 to October 1994 and as Director of Marketing, Sales and
Product Development at GTE Business Communications.
GARRETT J. GIRVAN has served as our Chief Operating Officer since April 1998
and also served as our Chief Financial Officer from April 1998 to November 1998.
Prior to joining us, Mr. Girvan held various positions at Viacom Cable over a
13-year period, including Chief Financial Officer and Chief Operating Officer.
While at Viacom, Mr. Girvan was involved in the development of Viacom's
broadband services.
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DOUGLAS S. SINCLAIR has served as our Chief Financial Officer since November
1998. Prior to joining us, Mr. Sinclair served as Chief Financial Officer of
Silicon Valley Networks, Inc., a provider of test management software to
telecommunications and networking companies, from April 1998 to November 1998,
Chief Financial Officer of International Wireless Communications, Inc., an
international cellular business operator, from 1995 to 1998, Chief Financial
Officer of Pittencrieff Communications Inc. (PCI), then a leading provider of
trunked radio services in the southwest United States, from 1993 to 1995, and
Chief Financial Officer of Pittencrieff plc., an oil and gas company based in
the United Kingdom, from 1990 to 1993. Mr. Sinclair took both Pittencrieff plc
and PCI public during his tenures as Chief Financial Officer. International
Wireless Communications, Inc. filed for protection under the bankruptcy laws of
the United States in September 1998.
STEVEN M. HARRIS has served as our Vice President, Secretary and General
Counsel to SoftNet since August 1998. Prior to joining us, Mr. Harris worked at
Pacific Telesis Group, most recently as Vice President of Broadband Services,
where he was responsible for external affairs and policy planning for video
services and broadband networks. Previously, he was Executive Director of
Regulatory Planning and Policy for Pacific Bell with responsibility for federal
and state regulatory policies relating to competition, corporate structure,
interconnection, privacy and new technologies. He began with Pacific Telesis
Group in 1983 as Executive Director of Regulatory Relations, in Washington, D.C.
Mr. Harris was Commissioner's Assistant and Special Assistant to the General
Counsel at the FCC and was previously in private practice.
KEVIN GAVIN has served as our Senior Vice President, Marketing since
November 1998. Prior to joining us, he served as Regional Vice President of
Teligent, Inc. From November 1991 to January 1996, he was Vice President of
Marketing and Product Development at Nextel Communications. From 1981 to 1991,
Mr. Gavin held various marketing and sales positions at Warner Cable
Communications, Inc., American Cablesystems, Inc., and McCaw Cellular
Communications, Inc.
EDWARD A. BENNETT has served as a member of our Board of Directors since
January 1998. Mr. Bennett has served as President and Chief Executive Officer of
Bennett Media Collaborative, a new media/Internet/technology consulting company,
since June 1997, Director and Vice Chairman of methodfive LLC, an Internet
services company, since June 1997, Director of Spinner Networks, an Internet
music service since December 1997, and as Director of MY-CD, an Internet-based
custom CD marketing company, since May 1998. Mr. Bennett has also served as
President and Chief Executive Officer of Prodigy Ventures, an
Internet/technology investment firm from June 1996 to June 1997 and as President
and Chief Executive Officer of Prodigy Services Corporation, an Internet
services company from 1995 to June 1996. Furthermore, Mr. Bennett has served as
President and Chief Executive Officer of VH-1 Network, a television programming
company, from 1989 to 1994.
SEAN P. DOHERTY has served as a member of our Board of Directors since May
1998. Mr. Doherty is currently an owner and Managing Partner of Shoreline
Associates I, LLC ("Shoreline Associates"), a private Silicon Valley investment
firm. Shoreline Associates invests in management buyouts, special equity and
venture capital for companies in the telecommunications and broadcasting
industries. Shoreline Associates is unaffiliated with Shoreline Pacific
Institutional Finance ("SPIF"), the entity that arranged the Convertible
Preferred offerings. From 1995 to 1997, Mr. Doherty was a co-founder of @Home,
serving as @Home's Chief Operating Officer and later as the President of @Home's
business-to-business services division, @Work. Mr. Doherty was previously the
founder of TEAM Software, a developer of workgroup applications for the Internet
and corporate networks, and served as Chief Executive Officer from 1990 to 1995.
From 1992 to 1995, Mr. Doherty has also served as President of TradeNet, Inc.,
an online transaction network for commodities traders.
ROBERT C. HARRIS, JR. has served as a member of our Board of Directors
since May 1998. Mr. Harris has served as a Senior Managing Director and Head of
Investment Banking in the San Francisco office of Bear, Stearns & Co. Inc. since
November 1997. Mr. Harris also serves as Director of
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MDSI Mobile Data Solutions, Inc., N2K, Inc., and Xoom.com, Inc. Prior to joining
Bear Stearns, Mr. Harris was a co-founder and a Managing Director of Unterberg
Harris, a registered broker-dealer and investment advisory firm. From 1984 to
1989, Mr. Harris was a General Partner, Managing Director, and Director of Alex.
Brown & Sons.
BOARD COMMITTEES
We have an Audit Committee, a Compensation/Stock Option Committee and an
Executive Committee of the Board of Directors. There is no nominating committee
or committee performing the functions of such committee. The Audit Committee
meets with our financial management and its independent accountants and reviews
internal control conditions, audit plans and results, and financial reporting
procedures. This committee currently consists of Messrs. Simon and Bennett. The
Compensation/Stock Option Committee reviews and approves our compensation
arrangements for key employees and administers our 1995 Long Term Incentive Plan
and the 1998 Stock Incentive Plan. This committee currently consists of Messrs.
Simon, Harris and Doherty. The Executive Committee has all the authority of the
Board, except with respect to items requiring shareholder approval or
submission, the filling of Board or Committee vacancies, fixing director
compensation, amending or adopting bylaws or amending or appealing Board
resolutions that are not amendable or repealable. This committee currently
consists of Dr. Brilliant and Mr. Simon.
DIRECTOR COMPENSATION
Members of the Board who are not employees of us or of one of our
subsidiaries are each paid a monthly retainer fee of $1,000 in connection with
their attendance and participation at Board meetings. Mr. Simon is paid an
additional $1,500 per month for his services as Chairman of the Board. In
addition, Board members are reimbursed for certain reasonable expenses incurred
in attending Board or committee meetings. Upon joining the Board, each
non-employee Board member also receives a purchase option grant for shares of
common stock under our 1995 Long Term Incentive Plan or the 1998 Stock Incentive
Plan. Dr. Brilliant and Mr. Aaron each receive compensation for their services
as our executive officers, but do not receive additional compensation for their
service on the Board.
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information known to us regarding
beneficial ownership of our common stock as of March 2, 1999 by (i) each person
known by us to be the beneficial owner of more than five percent of the
outstanding shares of the common stock, (ii) each director, (iii) certain
executive officers and (iv) all executive officers and directors as a group.
<TABLE>
<CAPTION>
PERCENT OF SHARES
BENEFICIALLY OWNED(1)
NUMBER OF SHARES ------------------------
BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OFFERING OFFERING
- ---------------------------------------------------------------------- -------------------- ----------- -----------
<S> <C> <C> <C>
RGC International Investors, LDC...................................... 1,520,484(2)(12) 13.8% 10.4%
c/o Rose Glen Capital Management, L.P.
3 Bala Plaza East, Suite 200
251 St. Asaphs Road
Bala Cynwyd, PA 19004
White Rock Capital Partners, L.P...................................... 930,300(3) 9.6% 7.0%
3131 Turtle Creek Boulevard, Suite 800
Dallas, TX 75219
R. C. W. Mauran....................................................... 694,128(4) 6.8% 5.1%
47 Eaton Place, Flat A
London SWI, England.................................................
Stark International................................................... 732,514(12) 13) 7.0% 5.3%
Shepherd Investment International LTD................................. 391,168(12) 14) 3.9% 2.9%
Ronald I. Simon....................................................... 15,167(5) * *
Dr. Lawrence B. Brilliant............................................. 103,333(6) 1.1% *
Ian B. Aaron.......................................................... 297,262(7) 3.0% 2.2%
Garrett J. Girvan..................................................... 35,000(10) * *
Douglas S. Sinclair................................................... -- -- --
Steven M. Harris...................................................... 4,000 * *
Edward A. Bennett..................................................... 77,667(8) * *
Sean P. Doherty....................................................... 118,260(9) 1.2% *
Kevin Gavin........................................................... -- -- --
Robert C. Harris, Jr.................................................. -- -- --
All directors and executive officers as a group (10 persons).......... 650,689(11) 6.4% 4.8%
</TABLE>
- ------------------------
* Less than one percent
(1) This table is based in part upon information supplied by Schedules 13G filed
by principal shareholders with the Securities and Exchange Commission.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities, except with respect to RGC (see
footnote 2). Shares of common stock subject to options, warrants and
convertible notes currently exercisable or convertible, or exercisable or
convertible within 60 days after a specified date, are deemed outstanding
for computing the percentage of the person holding such options but are not
deemed outstanding for computing the percentagae of any other person. Except
as indicated by footnote, and subject to community property laws where
applicable, the persons named in the table have sole voting and investment
power with respect to all shares of common stock shown as beneficially owned
by them. The number of shares of common stock outstanding as of March 2,
1999 was 9,741,931.
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(2) Consists of (i) 249,468 shares of common stock, (ii) 423,750 shares issuable
upon the exercise of stock purchase warrants, (iii) 847,266 shares issuable
upon conversion of the shares of Series C Preferred Stock at the current
conversion price in effect as of March 2, 1999, which is $9.00 per share.
The actual number of shares of common stock issuable upon conversion of the
convertible preferred stock is indeterminable and is subject to adjustment
based on various factors, including the floating rate conversion price
mechanism contained in the terms of the convertible preferred stock.
However, the Series C Preferred Stock cannot convert into more than
2,000,000 shares of common stock. See "Description of Capital
Stock--Preferred Stock."
(3) Consists of shares of common stock (i) held for the accounts of certain
institutional clients of White Rock Capital Management, L.P., (ii) held by
White Rock Capital Partners, L.P., and (iii) held by White Rock Capital
Management, L.P.
(4) Includes (i) 179,640 shares issuable upon the conversion of our 9%
convertible notes due 2000, (ii) 81,481 shares issuable upon conversion of
6% convertible subordinated secured debentures due 2002 issued by MTC and
assumed by us, and (iii) 175,000 shares issuable upon the conversion of our
5% subordinated convertible debentures due 2002. Shares listed reflect
shares held by Eurocredit Investments, Ltd., a Maltese company that is
wholly-owned by Mr. Mauran.
(5) Includes 9,167 shares of common stock issuable upon the exercise of options
that are exercisable within 60 days of March 2, 1999.
(6) Includes 103,333 shares of common stock issuable upon the exercise of
options that are exercisable within 60 days of March 2, 1999.
(7) Includes 150,833 shares of common stock issuable upon the exercise of
options that are exercisable within 60 days of March 2, 1999.
(8) Includes 61,667 shares of common stock issuable upon the exercise of options
that are exercisable within 60 days of March 2, 1999.
(9) Includes 20,000 shares of common stock issuable upon the exercise of stock
purchase warrants held by Shoreline Associates, of which Mr. Doherty is an
owner.
(10) Includes 25,000 shares issuable pursuant to options exercisable within 60
days of March 2, 1999.
(11) Includes shares issuable upon the exercise of options that are exercisable
within 60 days of March 2, 1999 as described in footnotes (5) through (10).
(12) The number of shares into which RGC can convert and the manner of such
conversion is limited by SoftNet's certificate of incorporation. Similarly,
the number of shares into which Stark International and Shepherd Investment
International can convert and the manner of such conversion is limited by
the 9% senior subordinated convertible notes due 2001. A holder of the
Series C Preferred Stock or 9% senior subordinated convertible notes due
2001 cannot convert its Series C Preferred Stock or 9% senior subordinated
convertible notes due 2001 in the event such conversion would result in
beneficial ownership of more than 4.99% of the common stock (not including
shares underlying such securities).
Accordingly, the number of shares of common stock and percentage ownership
set forth for RGC, Stark International and Shepherd Investment International
may exceed the number of shares of common stock it beneficially own as of
the date of this prospectus. In that regard, the table may not adequately
represent the beneficial ownership of RGC, Stark International and Shepherd
Investment International.
(13) Includes (i) 61,926 shares of common stock, (ii) 200,000 shares of common
stock issuable upon warrants, and (iii) 470,588 shares of common stock
issuable upon conversion of the 9% senior subordinated convertible notes due
2001 at the conversion price in effect as of March 2, 1999,
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which is $17.00 per share. The actual number of shares of common stock
issuable upon conversion of the 9% senior subordinated convertible notes due
2001 is indeterminable and is subject to adjustment based on various
factors, including the floating rate conversion price mechanism contained in
the terms of the 9% senior subordinated convertible notes due 2001.
(14) Includes (i) 55,874 shares of common stock, (ii) 100,000 shares of common
stock issuable upon warrants, and (iii) 235,294 shares of common stock
issuable upon conversion of the 9% senior subordinated convertible notes due
2001 at the conversion price in effect as of March 2, 1999, which is $17.00
per share. The actual number of shares of common stock issuable upon
conversion of the 9% senior subordinated convertible notes due 2001 is
indeterminable and is subject to adjustment based on various factors,
including the floating rate conversion mechanism contained in the terms of
the 9% senior subordinated convertible notes due 2001.
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DESCRIPTION OF CAPITAL STOCK
THE FOLLOWING SUMMARY OF THE TERMS OF OUR CAPITAL STOCK DOES NOT PURPORT TO
BE COMPLETE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE ACTUAL TERMS OF
THE CAPITAL STOCK CONTAINED IN OUR CERTIFICATE OF INCORPORATION AND OTHER
AGREEMENTS REFERENCED BELOW.
Our certificate of incorporation authorizes the issuance of up to
100,000,000 shares of common stock, par value $0.01 per share and 4,000,000
shares of preferred stock, par value $0.10 per share, of which 5,110 shares are
designated as Series A Preferred Stock, 12,500 shares are designated as Series B
Preferred Stock, 10,000 shares are designated as Series C Preferred Stock and
10,000 shares are designated as Series D Preferred Stock. As of March 26, 1999,
we had outstanding 10,412,866 shares of common stock, no shares of Series A
Preferred Stock, no shares of Series B Preferred Stock and 7,625.39 shares of
Series C Preferred Stock. No shares of undesignated preferred stock are
currently outstanding. On August 31, 1998, we agreed to issue 7,500 shares of
Series D Preferred Stock and warrants to purchase an additional 93,750 shares of
common stock on terms similar to the Series C Preferred Stock issuance. In
addition, we issued warrants to purchase an additional 26,250 shares of common
stock as a financial advisory fee in connection with certain financings.
Conversions subject to the issuance of the Series D Preferred Stock and warrants
are subject to shareholder approval and other closing conditions. As of the date
hereof, there are no shares of Series D Preferred Stock issued or outstanding.
As of March 26, 1999, we had outstanding options to purchase 2,835,062 shares of
common stock (of which options to purchase 1,626,050 shares of common stock are
subject to stockholder approval). We also had outstanding warrants to purchase
an aggregate 925,063 shares of common stock.
COMMON STOCK
The holders of common stock are entitled to receive dividends when and if
declared by the Board of Directors, except that no dividend or distribution may
be paid on any shares of common stock during any fiscal year unless all dividend
preferences of the convertible preferred stock have been paid or declared and
set aside during that fiscal year and any prior year in which dividends
accumulated but remain unpaid. Upon liquidation, dissolution, merger or sale of
all or substantially all of our assets, after paying in full the preferential
amounts due the holders of the convertible preferred stock, all remaining assets
will be distributed ratably among the holders of convertible preferred stock and
common stock based upon the number of shares of common stock then held by each
holder on an as-converted basis. The holders of common stock are entitled to one
vote for each share held of record on all matters submitted to a vote of
shareholders. The common stock has no preemptive or other subscription rights,
and there are no redemption or sinking fund provisions applicable to the common
stock. All outstanding shares of common stock are fully paid and non-assessable.
PREFERRED STOCK
SERIES A CONVERTIBLE PREFERRED
All shares of Series A Preferred Stock have been converted, and there are no
shares outstanding.
SERIES B CONVERTIBLE PREFERRED
All shares of Series B Preferred Stock have been converted, and there are no
shares outstanding.
SERIES C CONVERTIBLE PREFERRED
DIVIDENDS. The holders of Series C Preferred Stock are entitled to receive
dividends at a rate of 5% per annum, payable quarterly, at our option, in cash
or additional shares of Series C Preferred Stock. Unpaid dividends are
cumulative. Any accrued and unpaid dividends are payable only in the event of
our liquidation, dissolution or winding up. We have paid non-cash dividends of
125.39 shares of Series C Preferred Stock.
85
<PAGE>
CONVERSION. Each share of Series C Preferred Stock is convertible, at the
option of the holder, into the number of shares of our common stock as defined
by the stated value of the Series C Preferred Stock multiplied by 5% per annum,
less any dividends paid, divided by the conversion price. The stated value of
the Series C Preferred Stock is $1,000 per share. Prior to May 31, 1999, the
conversion price is $9.00. After May 31, 1999, the conversion price is the lower
of $9.00 (subject to an escalation provision pending certain market conditions
in the 20-day trading period prior to May 31, 1999) or a five-day average market
price within a 20-day trading period prior to the conversion. Pursuant to our
certificate of incorporation, as amended, the holders of the Series C Preferred
Stock may only convert their outstanding Series C Preferred Stock into an
aggregate amount of common stock that does not exceed 19.99% of the outstanding
common stock. Any excess shares of common stock that are issuable upon
conversion of outstanding Series C Preferred Stock that exceed this 19.99%
limitation are subject to mandatory redemption at the option of the holder of
the convertible preferred stock, unless we either obtain shareholder approval
for the additional conversions over 19.99%, or we receive permission to allow
such issuances from the AMEX, or Nasdaq. All outstanding shares of convertible
preferred, subject to the above restrictions, automatically convert to common
stock on August 31, 2001.
VOTING RIGHTS. Holders of Series C Preferred Stock do not have voting
rights, except for certain protective provisions relating to changes in the
rights of holders of Series C Preferred Stock. A vote by a majority of
outstanding shares of Series C Preferred Stock is required prior to (i) changing
the rights or privileges of the Series C Preferred Stock or changing the rights
or privileges of any of our capital stock so as to affect adversely the Series C
Preferred Stock; (ii) creating any new class or series of stock with preferences
PARI PASSU with, or senior to, those of the Series C Preferred Stock; (iii)
increasing the authorized number of shares of Series C Preferred Stock; (iv) any
act that would result in a negative tax consequence to the holders of Series C
Preferred Stock pursuant to Section 305 of the Code; (v) increasing the par
value of our common stock; or (vi) declaring a dividend for or paying a dividend
to holders of common stock.
PRIORITY. The Series C Preferred Stock ranks senior to our common stock,
and PARI PASSU with the Series A Preferred Stock, Series B Preferred Stock and
Series D Preferred Stock, as to dividends, distributions and distribution of
assets upon our liquidation, dissolution or winding up.
REDEMPTION. The Series C Preferred Stock is subject to redemption upon
certain circumstances, including our (i) failure to convert the convertible
preferred when required, (ii) failure to fulfill obligations under the
registration rights agreement among us and holders of the Series C Preferred
Stock, and (iii) suspension of the common stock from trading on the AMEX, New
York Stock Exchange or the Nasdaq Stock Market. We shall have the right to
redeem the Series C Preferred Stock on the earlier of an underwritten public
offering or a private placement pursuant to Rule 144A of at least $10,000,000 or
February 29, 2000 at a price equal to the greater of (i) 120% of the stated
value plus accrued but unpaid dividends or (ii) the market price of the common
stock multiplied by the number of shares of common stock into which the Series C
Preferred Stock can be converted.
SERIES D PREFERRED STOCK
The Series D Preferred Stock has similar provisions as the Series C
Preferred Stock. The conversion price of the Series D Preferred Stock will be at
a 20% premium of the market price of our common stock prior to its issuance. The
Series D Preferred Stock ranks senior to our common stock, and PARI PASSU with
the Series B Preferred Stock and Series C Preferred Stock as to dividends,
distributions and distribution of assets upon our liquidation, dissolution or
winding up.
86
<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
9% SENIOR SUBORDINATED CONVERTIBLE NOTES AND RELATED WARRANTS
9% SENIOR SUBORDINATED CONVERTIBLE NOTES DUE 2001
INTEREST RATE. Interest on the outstanding principal amount of our 9%
senior subordinated convertible notes is payable at the rate of 9% per annum,
quarterly in arrears. Any amount of principal that is not paid when due shall
bear interest from the day when such principal payment amount was due until paid
at a rate of 18% per annum.
LIMITATIONS ON CONVERSION. A holder of our 9% senior subordinated
convertible notes cannot convert its 9% senior subordinated convertible notes in
the event such conversion would result in its beneficially owning more than
4.99% of our common stock as beneficial ownership is determined under the rules
of the Securities and Exchange Commission. We obtained stockholder approval for
issuance of more than 19.99% of our common stock upon conversion of the 9%
senior subordinated convertible notes and exercise of the warrants.
CONVERSION PRICES. The actual number of shares of common stock issuable
upon conversion of our 9% senior subordinated convertible notes will be
determined by the following formula:
(The principal amount of our 9% senior subordinated convertible notes, and any
accrued but unpaid interest thus being converted)
DIVIDED BY
(The applicable conversion price at the time of conversion).
The conversion price is subject to adjustment as set forth in our 9% senior
subordinated convertible notes. Prior to July 1, 1999, the conversion price of
our 9% senior subordinated convertible notes is equal to $17.00 per share.
Thereafter, the conversion price of our 9% senior subordinated convertible notes
is equal to the lower of $17.00 per share and the lowest five-day average
closing bid price of the common stock during the 30-day trading period ending
one day prior to the applicable conversion date. The following table sets forth
the number of shares of common stock issuable upon conversion of our 9% senior
subordinated convertible notes assuming the market price of the common stock is
25%, 50%, 75% and 100% of the market price of the common stock on March 2, 1999,
which was $21.06 per share. The table also assumes that the 19.99% limitation
was no longer in effect.
<TABLE>
<CAPTION>
NUMBER OF SHARES
PERCENT OF ISSUABLE
MARKET PRICE UPON CONVERSION
- -------------------------------------------------------------------- ------------------------
<S> <C>
25%................................................................. 2,277,040
50%................................................................. 1,139,601
75%................................................................. 759,494
100%................................................................ 705,882
</TABLE>
WARRANTS
The warrants issued in connection with our 9% senior subordinated
convertible notes have an exercise price of $17.00 per share and expire on
January 1, 2003. On July 1, 1999, the exercise price of the warrants is subject
to adjustment to the amount equal to the lesser of the then current exercise
price and 110% of the five-day average closing bid prices for the five trading
days immediately preceding July 1, 1999. The number of shares issuable upon
exercise of the warrants is subject to anti-dilution adjustment upon certain
events, including, with some exceptions, our sale of common stock or securities
convertible into or exercisable for our common stock at a price per share less
than the exercise price of the warrants. The warrants may be exercised through a
cashless exercise either by:
- cancellation of a portion of the unpaid principal amount of our 9% senior
subordinated convertible notes held by the selling shareholder seeking to
exercise such warrants;
- cancellation of that number of shares of our common stock that would have
been issued with an aggregate market price equal to the aggregate exercise
price of the warrants being exercise; or
- surrender of that number of shares of our common stock with an aggregate
market price equal to the aggregate exercise price of the warrants being
exercised.
Please see our Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 26, 1999 for a description of the 9% senior
subordinated convertible notes and the warrants and the transaction documents
relating to their issuance.
87
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
dated , 1999 among us and the underwriters, we have agreed to sell
to each of the underwriters and each of the underwriters has severally agreed to
purchase from us the number of shares of common stock set forth beside their
respective names below.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ----------------------------------------------------------------- ---------
<S> <C>
BT Alex. Brown Incorporated......................................
BancBoston Robertson Stephens Inc................................
CIBC Oppenheimer Corp............................................
Wit Capital Corporation..........................................
---------
Total Number of Shares......................................... 3,500,000
---------
---------
</TABLE>
The obligation of the underwriters to purchase the common stock is subject
to the terms and conditions set forth in the underwriting agreement. The
underwriting agreement requires the underwriters to purchase all of the shares
of the common stock offered by this prospectus, if any are purchased. The shares
of common stock offered by the underwriters pursuant to this prospectus are
subject to prior sale, when, as and if delivered to and accepted by the
underwriters, and subject to the underwriters' right to reject any order in
whole or in part. The underwriters have advised us that they propose to offer
the shares of common stock to the public at the public offering price of
$ per share and to certain dealers at the public offering price less a
concession not in excess of $ per share. The underwriters may allow, and
such dealers may reallow, a concession not in excess of $ per share for
certain other dealers. The underwriters may change the public offering price
after the common stock is released for sale to the public. The expenses of the
offering are estimated to be $900,000. The following table sets forth the public
offering price and all discounts and commissions to be allowed to the
underwriters:
<TABLE>
<CAPTION>
UNDERWRITING DISCOUNTS
PUBLIC OFFERING AND PROCEEDS TO SOFTNET
PRICE COMMISSIONS (1) (2)
------------------- ------------------------- ---------------------
<S> <C> <C> <C>
Per Share............ $ $ $
Total................ $ $ $
</TABLE>
The underwriters, at our request, have reserved for sale at the public
offering price up to shares of common stock to certain individuals and
entities who express an interest in purchasing such shares. The sale of such
shares will be made by Wit Capital Corporation acting as E-MANAGER-TM- in the
offering. Purchases of reserved shares are to be made through an account at Wit
Capital Corporation in accordance with Wit Capital Corporation's procedures for
opening an account and transacting in securities. Any reserved shares not so
purchased will be offered by the underwriters to the general public on the same
basis as other shares offered hereby.
Wit Capital Corporation will be paid a fee of $100,000 for participating in
the underwriting as an e-manager. Wit Capital Corporation will not receive any
portion of the underwriting discounts or commissions.
A prospectus in electronic format is being made available on an Internet Web
site maintained by Wit Capital Corporation. In addition, pursuant to an e-Dealer
Agreement, all dealers purchasing shares from Wit Capital Corporation in the
offering (the "e-Dealers") similarly have agreed to make a prospectus in
electronic format available on Web sites maintained by each of the e-Dealers.
The underwriters may sell more shares than the total number set forth in the
table above. To cover these sales, the underwriters have an option to purchase
up to 525,000 additional shares of common
89
<PAGE>
stock from us at the public offering price less the underwriting discounts and
commissions set forth in the table above. The underwriters may exercise this
option for 30 days after the date of this prospectus only to cover these sales.
To the extent that the underwriters purchase shares pursuant to this option, the
underwriters will purchase shares in approximately the same proportion as the
number of shares of common stock to be purchased by it shown in the above table
and we will be obligated, pursuant to the option, to sell such shares to the
underwriters. If purchased, the underwriters will offer such additional shares
on the same terms as those on which the 3,500,000 shares are being offered.
We have agreed to indemnify the underwriters with respect to certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
To facilitate the offering of the common stock, the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the market price of
the common stock. Specifically, the underwriters may overallot shares of the
common stock in connection with this offering, thereby creating a short position
in the underwriters' account. A short position results when an underwriter sells
more shares of common stock than such underwriter committed to purchase.
Additionally, to cover such overallotments or to stabilize the market price of
the common stock, the underwriters may bid for, and purchase, shares of the
common stock at a level above that which might otherwise prevail in the open
market. The underwriters are not required to engage in these activities and, if
commenced, any such activities may be discontinued at any time. The underwriters
also may reclaim selling concessions allowed to an underwriter or dealer if the
underwriters repurchase shares distributed by that underwriters or dealers.
We have agreed not to offer, issue, sell, contract to sell, grant any option
for the sale of, or otherwise dispose of (collectively, "Transfer"), directly or
indirectly, any shares of our common stock or any securities convertible into or
exchangeable or exercisable for our common stock or any rights to acquire common
stock for a period of 90 days after the date of the underwriting agreement,
without the prior written consent of the underwriters, other than common stock
or options granted pursuant to existing stock option and other compensation
plans, the convertible preferred stock or to cable affiliates. In addition, each
of our directors and executive officers has agreed not to Transfer, directly or
indirectly, any shares of common stock or any securities convertible into or
exchangeable or exercisable for common stock or any rights to acquire common
stock for a period of 90 days after the date of the underwriting agreement,
without prior written consent of BT Alex. Brown Incorporated.
In connection with this offering, certain underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in the common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended, during the business day prior to
the pricing of the offering before the commencement of offers or sales of the
common stock. Passive market makers must comply with applicable volume and price
limitations and must be identified as such. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid of
such security; if all independent bids are lowered below the passive market
makers' bid, however, such bid must then be lowered when certain purchase limits
are exceeded.
The underwriters have sole discretion not to accept any purchase offer or
make any sale of shares offered by this prospectus if they deem the purchase
price to be unsatisfactory. Any broker or dealer participating in any such sale
may be deemed to be an "underwriter" within the meaning of the Securities Act
and will be required to deliver a copy of this prospectus to any person who
purchases any of the shares offered by this prospectus from or through such
broker or dealer.
BT Alex. Brown from time to time provides, and in the future may provide,
financial advisory services to the Company for which it is paid a customary fee.
90
<PAGE>
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for us by
Brobeck, Phleger & Harrison LLP, Palo Alto and San Francisco, California, and
Dickstein Shapiro Morin & Oshinsky LLP, Washington, D.C. (as to certain
regulatory matters). Certain legal matters will be passed upon for the
underwriters by Latham & Watkins, San Francisco, California.
EXPERTS
Our consolidated financial statements, as of September 30, 1997 and 1998 and
for each of the three fiscal years in the period ended September 30, 1998
included in this prospectus, and the Intelligent Communications, Inc. financial
statements as of September 30, 1998 and for the 9 months ended September 30,
1998 included in the Company's Forms 8-K/A dated February 26 and March 12, 1999,
have been audited by PricewaterhouseCoopers LLP, independent accountants, as
stated in their reports. The financial statements of Intelligent Communications,
Inc. as of December 31, 1997 and for the two years then ended included in the
Company's Form 8-K/A dated February 26 and March 12, 1999, have been audited by
Blanding, Boyer & Rockwell LLP, as stated in their reports.
The financial statements incorporated in this prospectus by reference to the
Annual Report on Form 10-K for the year ended September 30, 1998, have been so
incorporated in reliance on the reports of PricewaterhouseCoopers LLP and the
financial statements of Intelligent Communications, Inc. incorporated in this
prospectus by reference to the Company's Forms 8-K/A dated February 26 and March
12, 1999 for the nine months ended September 30, 1998 and for the years ended
December 31, 1997 and 1996, have been so incorporated in reliance on the reports
of PricewaterhouseCoopers LLP and Blanding, Boyer & Rockwell LLP, independent
accountants, collectively given on authority of such firms as experts in
auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission (the "SEC"). You may
read and copy any document we file at the public reference facilities of the SEC
located at 450 Fifth Street N.W., Washington D.C. 20549. You may obtain
information on the operation of the SEC's public reference facilities by calling
the SEC at 1-800-SEC-0330. You can also access copies of such material
electronically on the SEC's home page on the World Wide Web at
http://www.sec.gov. Information concerning us is also available for inspection
at the offices of the National Association of Securities Dealers, Inc. at 1735 K
Street, N.W. Washington, D.C. 20006, upon which our common stock is traded.
This prospectus is part of a registration statement (Registration No.
333-74767) we filed with the SEC. The SEC permits us to "incorporate by
reference" the information we file with them, which means that we can disclose
important information to you by referring you to those documents. The
information incorporated by reference is considered to be part of this
prospectus, and information that we file with the SEC after the date of this
prospectus will automatically update and supersede this information. We
incorporate by reference the following documents filed by us with the SEC (File
No. 1-5270). We also incorporate by reference any future filings made with the
SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of
1934, as amended, after the date of this prospectus until the termination of
this offering.
1. Our Annual Report on Form 10-K for the fiscal year ended September 30,
1998, as amended, filed with the SEC on February 2, 1999, and as further
amended, filed with the SEC on March 4, 1999.
2. Our Quarterly Report on Form 10-Q for the quarterly period ended
December 31, 1998, filed with the SEC on February 16, 1999.
91
<PAGE>
3. Our Current Report on Form 8-K filed with the SEC on January 26, 1999.
4. Our Current Report on Form 8-K filed with the SEC on February 24, 1999.
5. Our Current Report on Form 8-K/A filed with the SEC on February 26,
1999.
6. Our Current Report on Form 8-K filed with the SEC on February 26, 1999.
7. Our Current Report on Form 8-K filed with the SEC on March 5, 1999.
8. Our Current Report on Form 8-K/A filed with the SEC on March 12, 1999.
9. Our Current Report on Form 8-K filed with the SEC on April 14, 1999.
If you request a copy of any or all of the documents incorporated by
reference, then we will send to you the copies you requested at no charge.
However, we will not send exhibits to such documents, unless such exhibits are
specifically incorporated by reference in such documents. You should direct
requests for such copies to Mr. Steven M. Harris, Secretary, SoftNet Systems,
Inc., 650 Townsend Street, Suite 225, San Francisco, California 94103, (415)
365-2500.
You should rely only on the information contained in this prospectus and
incorporated by reference into this prospectus. We have not authorized anyone to
provide you with information different from that contained in this prospectus.
We are offering to sell, and seeking offers to buy, shares of our common stock
only in jurisdictions where offers and sales are permitted. The information
contained in this prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of this prospectus or of any sale of the
shares.
92
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Accountants.......................................................................... F-2
Consolidated Balance Sheets as of September 30, 1997 and 1998.............................................. F-3
Consolidated Statements of Operations for the three years ended September 30, 1998......................... F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the three years ended September 30, 1998..... F-5
Consolidated Statements of Cash Flows for the three years ended September 30, 1998......................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1998 (unaudited)........... F-36
Condensed Consolidated Statements of Operations for the three months ended December 31, 1997 and 1998
(unaudited).............................................................................................. F-37
Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 1997 and 1998
(unaudited).............................................................................................. F-38
Notes to Condensed Consolidated Financial Statements (unaudited)........................................... F-39
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of SoftNet Systems, Inc.:
In our opinion, the accompanying consolidated balance sheets and related
consolidated statements of operations, shareholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
SoftNet Systems, Inc. and its subsidiaries at September 30, 1997 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended September 30, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Jose, California
December 1, 1998, except for Note 18
which is dated January 13, 1999
F-2
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash.................................................................................... $ 37 $ 12,504
Accounts receivable, net of allowance of $320 and $721 ................................. 3,929 3,105
Current portion of gross investment in leases........................................... 1,206 1,579
Inventories............................................................................. 1,326 1,345
Prepaid expenses........................................................................ 319 882
---------- ----------
Total current assets.................................................................. 6,817 19,415
Restricted cash........................................................................... -- 800
Property and equipment, net............................................................... 1,108 6,523
Gross investment in leases, net of current portion........................................ 3,054 1,863
Other assets.............................................................................. 766 1,124
Costs in excess of fair value of net assets acquired, net................................. 5,141 955
Net assets associated with discontinued operations........................................ 3,435 3,875
---------- ----------
$ 20,321 $ 34,555
---------- ----------
---------- ----------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses................................................... $ 4,969 $ 9,423
Current portion of long-term debt....................................................... 1,384 1,821
Current portion of capital leases....................................................... 23 632
Deferred revenue........................................................................ 143 100
---------- ----------
Total current liabilities............................................................. 6,519 11,976
---------- ----------
Long-term debt, net of current portion.................................................... 11,727 10,236
---------- ----------
Capital lease obligations, net of current portion......................................... 47 327
---------- ----------
Commitments and contingencies
Redeemable convertible preferred stock, $.10 par value, 30,000 shares authorized, none and
20,757 shares issued and outstanding in 1997 and 1998, respectively..................... -- 18,187
---------- ----------
Shareholders' equity (deficit):
Preferred stock, $.10 par value, 3,970,000 shares authorized, none issued and
outstanding........................................................................... -- --
Common stock, $.01 par value, 25,000,000 shares authorized, 6,870,559 and 8,191,550
shares issued and outstanding in 1997 and 1998, respectively.......................... 69 82
Deferred stock compensation............................................................. -- (188)
Capital in excess of par value.......................................................... 34,379 43,700
Accumulated deficit..................................................................... (32,420) (49,765)
---------- ----------
Total shareholders' equity (deficit)................................................ 2,028 (6,171)
---------- ----------
$ 20,321 $ 34,555
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Net sales....................................................................... $ 19,584 $ 21,338 $ 14,060
Cost of sales................................................................... 11,375 11,935 10,628
--------- --------- ----------
Gross profit.................................................................. 8,209 9,403 3,432
--------- --------- ----------
Operating expenses:
Selling....................................................................... 1,794 1,905 4,162
Engineering................................................................... 1,770 2,234 2,834
General and administrative.................................................... 4,200 3,628 7,883
Amortization of goodwill and transaction costs................................ 993 1,287 1,286
Loss on impairment of assets.................................................. -- -- 3,100
Costs associated with change in product line and other........................ 2,164 2,137 --
--------- --------- ----------
Total operating expenses.................................................... 10,921 11,191 19,265
--------- --------- ----------
Loss from continuing operations................................................. (2,712) (1,788) (15,833)
Other income (expense):
Interest expense.............................................................. (1,220) (1,145) (1,416)
Gain on available-for-sale securities......................................... 5,689 -- --
Other income.................................................................. 19 49 320
--------- --------- ----------
Income (loss) from continuing operations before income taxes.................... 1,776 (2,884) (16,929)
Provision for income taxes...................................................... -- -- --
--------- --------- ----------
Income (loss) from continuing operations before discontinued operations and
extraordinary item............................................................ 1,776 (2,884) (16,929)
Income (loss) from discontinued operations...................................... (1,812) 739 (73)
Extraordinary item--loss on sale of business.................................... (6,061) (486) --
--------- --------- ----------
Net loss........................................................................ (6,097) (2,631) (17,002)
Preferred dividends............................................................. -- -- (343)
--------- --------- ----------
Net loss applicable to common shares............................................ $ (6,097) $ (2,631) $ (17,345)
--------- --------- ----------
--------- --------- ----------
Basic and diluted earnings (loss) per share:
For continuing operations..................................................... $ 0.30 $ (0.44) $ (2.29)
For discontinued operations................................................... (0.31) 0.11 (0.01)
For extraordinary item--sale of business (1.04) (0.07) --
For preferred dividends....................................................... -- -- (0.05)
--------- --------- ----------
Net loss applicable to common shares.......................................... $ (1.05) $ (0.40) $ (2.35)
--------- --------- ----------
--------- --------- ----------
Shares used to compute basic and diluted loss per share....................... 5,819 6,627 7,391
--------- --------- ----------
--------- --------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK DEFERRED CAPITAL IN APPRECIATION OF
---------------------- STOCK EXCESS OF ACCUMULATED AVAILABLE-FOR-
SHARES AMOUNT COMPENSATION PAR VALUE DEFICIT SALE SECURITIES
--------- ----------- ------------- ----------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Balance, October 1, 1995......................... 5,547 $ 55 $ -- $ 27,584 $ (23,692) $ 7,738
Exercise of warrants........................... 12 -- -- 21 -- --
Settlements of related party receivable........ -- -- -- 815 -- --
Conversion of convertible subordinated
notes........................................ 781 8 -- 4,077 -- --
Common stock issued in connection with
acquisitions, net of acquisition costs....... 200 2 -- 1,020 -- --
Unrealized appreciation of available-for-sale
securities................................... -- -- -- -- -- (7,738)
Net loss......................................... -- -- -- -- (6,097)
--------- ----------- ------------- ----------- ------------ ------
Balance, September 30, 1996...................... 6,540 65 -- 33,517 (29,789) --
Exercise of warrants........................... 251 3 -- 432 -- --
Conversion of convertible subordinated
notes........................................ 70 1 -- 386 -- --
Common stock issued to pay acquisition
costs........................................ 10 -- -- 44 -- --
Net loss....................................... -- -- -- -- (2,631) --
--------- ----------- ------------- ----------- ------------ ------
Balance, September 30, 1997...................... 6,871 69 -- 34,379 (32,420) --
Exercise of warrants........................... 684 7 -- 3,879 -- --
Exercise of options............................ 152 1 -- 830 -- --
Conversion of convertible subordinated
notes........................................ 185 2 -- 1,116 -- --
Common stock warrants issued with preferred
stock--
Series A..................................... -- -- -- 435 -- --
Series B..................................... -- -- -- 900 -- --
Series C..................................... -- -- -- 277 -- --
Conversion of preferred shares to common
stock........................................ 299 3 -- 1,663 -- --
Dividends paid on preferred shares-- Common
stock:
Series A..................................... 1 -- -- 6 (6) --
Additional preferred shares:
Series A..................................... -- -- -- -- (101) --
Series B..................................... -- -- -- -- (125) --
Series C..................................... -- -- -- -- (31) --
Cash:
Series A..................................... -- -- -- -- (38) --
Series B..................................... -- -- -- -- (42) --
Deferred stock compensation.................. -- -- (215) 215 -- --
Amortization of deferred stock
compensation............................... -- -- 27 -- -- --
Net loss....................................... -- -- -- -- (17,002) --
--------- ----------- ------------- ----------- ------------ ------
Balance, September 30, 1998...................... 8,192 $ 82 $ (188) $ 43,700 $ (49,765) $ --
--------- ----------- ------------- ----------- ------------ ------
--------- ----------- ------------- ----------- ------------ ------
<CAPTION>
TOTAL
SHAREHOLDERS'
EQUITY
(DEFICIT)
-------------
<S> <C>
Balance, October 1, 1995......................... $ 11,685
Exercise of warrants........................... 21
Settlements of related party receivable........ 815
Conversion of convertible subordinated
notes........................................ 4,085
Common stock issued in connection with
acquisitions, net of acquisition costs....... 1,022
Unrealized appreciation of available-for-sale
securities................................... (7,738)
Net loss......................................... (6,097)
-------------
Balance, September 30, 1996...................... 3,793
Exercise of warrants........................... 435
Conversion of convertible subordinated
notes........................................ 387
Common stock issued to pay acquisition
costs........................................ 44
Net loss....................................... (2,631)
-------------
Balance, September 30, 1997...................... 2,028
Exercise of warrants........................... 3,886
Exercise of options............................ 831
Conversion of convertible subordinated
notes........................................ 1,118
Common stock warrants issued with preferred
stock--
Series A..................................... 435
Series B..................................... 900
Series C..................................... 277
Conversion of preferred shares to common
stock........................................ 1,666
Dividends paid on preferred shares-- Common
stock:
Series A..................................... --
Additional preferred shares:
Series A..................................... (101)
Series B..................................... (125)
Series C..................................... (31)
Cash:
Series A..................................... (38)
Series B..................................... (42)
Deferred stock compensation.................. --
Amortization of deferred stock
compensation............................... 27
Net loss....................................... (17,002)
-------------
Balance, September 30, 1998...................... $ (6,171)
-------------
-------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss....................................................................................... $ (6,097) $ (2,631) $ (17,002)
Adjustments to reconcile net loss to net cash used in operating activities:
(Income) loss from discontinued operations................................................... 1,812 (739) 73
Depreciation and amortization................................................................ 1,374 1,798 2,153
Loss on impairment of assets................................................................. -- -- 3,100
Amortization of deferred stock compensation.................................................. -- -- 27
Write-off of prepaid software licenses....................................................... -- 1,000 --
Write-off of capitalized product design costs................................................ -- 1,137 --
Loss on the disposal of property and equipment............................................... -- 40 118
Gain on sale of available-for-sale securities................................................ (5,689) -- --
Debt discount and deferred financing amortization............................................ 95 19 --
Provision for bad debts...................................................................... 101 174 680
Loss on sale of business..................................................................... 6,061 -- --
Changes in operating assets and liabilities:
Accounts receivable........................................................................ (521) (1,471) 1,021
Gross investment in leases................................................................. -- (3,054) 818
Inventories................................................................................ (1,076) 1,466 303
Prepaid expenses........................................................................... (25) (65) (494)
Accounts payable and accrued expenses...................................................... 775 930 4,551
Deferred revenue........................................................................... (81) 17 (43)
--------- --------- ---------
Net cash used in operating activities of continuing operations................................... (3,271) (1,379) (4,695)
--------- --------- ---------
Net cash used in operating activities of discontinued operations................................. (1,132) (1,089) (223)
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment............................................................. (732) (510) (5,663)
Purchase of prepaid software licenses.......................................................... (1,000) -- --
Additions to capitalized product design........................................................ (462) (654) --
Net cash paid in connection with acquisitions.................................................. (195) -- --
Settlement of remaining obligations to owners of discontinued operations....................... (117) -- --
Proceeds from sale of investment securities.................................................... 7,678 -- --
Proceeds from sale of property and equipment................................................... -- 15 --
Other.......................................................................................... -- 15 49
--------- --------- ---------
Net cash provided by (used in) investing activities of continuing operations..................... 5,172 (1,134) (5,614)
--------- --------- ---------
Net cash used in investing activities of discontinued operations................................. (2,073) (46) (112)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net of deferred financing costs...................... -- 3,665 730
Repayment of long-term debt.................................................................... (48) (753) (1,363)
Borrowings under revolving credit note......................................................... 12,802 9,685 16,089
Net payments under revolving credit note....................................................... (11,923) (9,884) (16,891)
Net proceeds from issuance of convertible preferred stock...................................... -- -- 21,208
Proceeds from exercise of warrants............................................................. 22 435 3,886
Proceeds from exercise of options.............................................................. -- -- 831
Proceeds from settlement of related party receivable........................................... 815 -- --
Payment of put obligation...................................................................... (200) -- --
Preferred dividends paid in cash............................................................... -- -- (80)
Restricted cash................................................................................ -- -- (800)
Principal repayments of capital lease obligations.............................................. (100) (85) (180)
--------- --------- ---------
Net cash provided by financing activities of continuing operations............................... 1,368 3,063 23,430
Net cash provided by (used in) financing activities of discontinued operations................... (211) 196 (319)
--------- --------- ---------
Net increase (decrease) in cash.................................................................. (147) (389) 12,467
Cash, beginning of period........................................................................ 573 426 37
--------- --------- ---------
Cash, end of period.............................................................................. $ 426 $ 37 $ 12,504
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
SoftNet Systems, Inc. and Subsidiaries (the "Company") is engaged in the
business of developing, marketing, installing and servicing electronic
information and document management systems that allow customers to
electronically request and electronically receive information. The Company
operates through three segments: document management, telecommunications, and
Internet services. The document management segment designs, develops,
manufactures and integrates comprehensive, non-paper based systems and
components that enable the Company to deliver to its customers cost-effective
solutions for the storage, indexing and/or distribution of high-volume computer
generated or entered information. The telecommunications segment sells and
services telephone and computer hardware manufactured by others to provide
communications solutions through the design, implementation, maintenance and
integration of voice, data and video communications equipment and services.
Additionally, the telecommunications segment sells and installs local and long
distance network services. The Internet services segment provides Internet
access, World Wide Web and database development.
On September 15, 1995, a wholly owned subsidiary of the Company merged with
Kansas Communications, Inc. ("KCI"), which was the surviving corporation in the
merger, pursuant to an Agreement and Plan of Reorganization dated March 24,
1995, by and between the Company and KCI (see Note 3). The transaction was
accounted for as a pooling of interests for financial reporting purposes and,
accordingly, the financial statements of the merged companies relating to all
periods presented had previously been restated and presented on a combined
basis. However, in July 1998, the Company's Board of Directors adopted a plan to
discontinue operations of the telecommunications segment (see Note 17), which
includes the operations of KCI. Accordingly, the operating results of the
telecommunications segment have been segregated from continuing operations and
reported as a separate line item on the statement of operations. The assets and
liabilities of such operations have been reflected as a net asset.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Company has sustained recurring losses and negative cash flows from
operations. Over the past year, the Company's growth has been funded through a
combination of private equity, bank debt and lease financings. As of December
31, 1998, the Company had approximately $3.5 million of unrestricted cash. In
addition, on January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes (see Note 18). The Company has also received a
commitment to provide, subject to final documentation, a secured $3 million loan
from a financial lender and is in negotiations with a vendor with regard to a $6
million equipment lease line. The Company believes that, as a result of this, it
currently has sufficient cash and financing commitments to meet its funding
requirements over the next year. However, the Company has experienced and
continues to experience negative operating margins and negative cash flows from
operations, as well as an ongoing requirement for substantial additional capital
investment. The Company expects that it will need to raise substantial
additional capital to accomplish its business plan over the next several years.
The Company's future cash requirements for its business plan expansion will
depend on a number of factors including (i) the number of cable affiliate
contracts, (ii) cable modem and associated costs of equipment, (iii) the rate at
which subscribers purchase the Company's Internet service offering and (iv) the
level of marketing required to acquire and retain subscribers and to attain a
competitive position in the marketplace. In addition, the Company may wish to
selectively pursue possible acquisitions of businesses, technologies, content or
F-7
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
products complementary to those of the Company in the future in order to expand
its Internet presence and achieve operating efficiencies. The Company expects to
seek to obtain additional funding through the sale of public or private debt
and/or equity securities or through a bank credit facility. If additional funds
are raised through the issuance of equity or convertible debt securities, the
percentage ownership of the stockholders of the Company will be reduced,
stockholders may experience additional dilution and such securities may have
rights, preferences or privileges senior to those of the Company's common stock.
There can be no assurance as to the availability or terms upon which such
financing might be available.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of SoftNet
Systems, Inc. ("SoftNet") and its subsidiaries ("Company"). All significant
intercompany accounts and transactions have been eliminated in preparation of
the consolidated financial statements.
RESTATEMENTS AND RECLASSIFICATIONS
The financial statements have been restated for the effects of the
discontinued operations of the telecommunications segment. (see Note 3). Certain
reclassifications have been made in the 1997 financial statements to conform
with the 1998 presentation.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of the revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS AND RESTRICTED CASH
The Company considers cash equivalents to include all highly liquid
financial instruments purchased with maturities of three months or less at the
time of purchase to be cash equivalents.
In 1998, the Company pledged $800,000 as collateral on a Letter of Credit
relating to certain leased office space. This amount is classified as restricted
cash in the consolidated balance sheet as of September 30, 1998.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of trade receivables. Credit risk is minimized
as a result of the large number and diverse nature of the Company's customers.
As of September 30, 1998, the Company had no significant concentrations of
credit risk.
SIGNIFICANT CUSTOMER
For the fiscal year ended September 1996, one customer (NCR Corp.) accounted
for 27% of the Company's consolidated revenue. For the fiscal year ended
September 30, 1997, three separate
F-8
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
customers (Marshall & Ilsley Corp., NCR Corp. and Bell & Howell Company)
accounted for 19%, 13% and 12% respectively, of the Company's consolidated
revenue. For the fiscal year ended September 30, 1998, one customer (GID GmbH)
accounted for 18% of the Company's consolidated revenue.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment, including leasehold improvements and property and
equipment financed through capital leases, are recorded at cost. When property
and equipment is retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and the resulting gain or
loss is included in income. Depreciation and amortization is computed using the
straight-line method over the estimated useful lives of the assets generally
three to seven years or the life of the lease, whichever is shorter.
CAPITALIZED SOFTWARE COSTS
Certain costs of acquired software to be sold, leased, or otherwise marketed
are capitalized and amortized over the economic useful life of the related
software product, which is generally five years. Net unamortized capitalized
software costs, which resulted from the acquisition of MTC, are included in
other non-current assets and were $592,000 and $392,000 at September 30, 1997
and 1998, respectively.
CAPITALIZED PRODUCT DESIGN
Capitalized product design costs include costs associated with enhancing
features on existing products, prior to their introduction to the market, but
after technological feasibility has been proven. Management evaluates the future
realization of capitalized product design costs quarterly and writes down any
amounts that management deems unlikely to be recovered through future products
sales. Any amounts deemed unrecoverable are written down to the estimated
recoverable amount at the time of evaluation.
COSTS IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED
The excess of costs of acquired companies over the fair value of net assets
acquired (goodwill) are amortized on a straight-line basis over 3 to 10 years.
Amortization expense for fiscal 1996, 1997 and 1998 was $813,000, $1.1 million
and $900,000, respectively. During fiscal 1996 the Company wrote off $3.6
million of net goodwill resulting from the sale of the non-application oriented
interconnect business in Chicago, IL (see Note 6). Accumulated amortization at
September 30, 1997 and 1998 was $1.9 million and $2.4 million, respectively.
The Company assesses the recoverability of unamortized goodwill by reviewing
the sufficiency of estimated future operating income and undiscounted cash flows
of the related entities to cover the amortization during the remaining
amortization period. If the carrying amount of goodwill is not
F-9
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recoverable from undiscounted cash flows, amounts unrecoverable from future
product sales are written down in the period in which the determination is made.
In fiscal 1998, the Company reduced its carrying amount of goodwill by $3.1
million as a result of an impairment loss on the long-lived assets of the
document management segment. The write-down was based on the fair value of the
document management segment as determined in connection with its planned sale
(see Note 18).
INVESTMENTS IN EQUITY SECURITIES
In 1995, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 115 "Accounting for Certain Investments in Debt and Equity
Securities." The adoption of SFAS No. 115 resulted in an increase to
shareholders' equity in the fourth quarter of 1995 of $7.7 million upon the
completion by IMNET Systems, Inc. of its initial public offering of common
stock. Prior to this offering, there had been no public market for this common
stock. At September 30, 1995, the Company's investment in marketable equity
securities was classified as available-for-sale and, as a result, was stated at
fair value. During fiscal 1996 the Company sold its entire holdings of IMNET
Systems, Inc. and realized a gain of $5.7 million.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's debt, current and long-term, is estimated to
approximate the carrying value of these liabilities based upon borrowing rates
currently available to the Company for borrowings with similar terms.
REVENUE RECOGNITION
Revenue from the document management segment is generated from four primary
sources: product sales, installations, royalty and on-going maintenance. Product
sales and installation revenue are recognized upon shipment, installation, or
final customer acceptance, depending on specific contract terms. Royalty revenue
is recognized monthly based upon estimated maintenance fees and is subject to
verification against actual fees on a semi-annual basis. Revenue from on-going
maintenance is recognized as services are completed.
Revenue from the Internet services segment is generated from initial and
recurring monthly Internet access and Web and database development. Set-up fees
for Internet access customers, net of related, direct and incremental costs are
deferred and amortized over the estimated period of service. Monthly access fees
are recognized in the month of service.
RESEARCH AND DEVELOPMENT
Research and development is primarily incurred by the document management
segment. During fiscal 1996, 1997 and 1998, the Company expended $1.1 million,
$1.8 million and $1.3 million, respectively, for research and development.
LOSS ON IMPAIRMENT OF ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company recorded an impairment loss on the long-lived
assets of the document management segment. The
F-10
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
trends in the document management segment indicate that the undiscounted future
cash flows from this business would be less than the carrying value of the
long-lived assets related to the document management segment. Accordingly, in
fiscal 1998, the Company recognized an asset impairment loss of $3.1 million,
all of which was reduced from the carrying value of goodwill. This loss is the
difference between the carrying value of the document management segment's
property and equipment, gross investment in leases to customers, other assets
and goodwill and other intangibles, and the fair value of these assets based on
discounted estimated future cash flows.
INCOME TAXES
The Company recognizes the amount of taxes payable or refundable for the
current year and recognizes deferred tax liabilities and assets for the expected
future tax consequences of events and transactions that have been recognized in
the Company's financial statements or tax returns. The Company currently has
substantial net operating loss carryforwards. The Company has recorded a 100%
valuation allowance against net deferred tax assets due to uncertainty of their
ultimate realization.
EARNINGS (LOSS) PER SHARE
The Company adopted Statement of Financial Accounting Standard (SFAS) No.
128, "Earnings Per Share, " in fiscal 1998. SFAS 128 requires the presentation
of basic earnings per share ("EPS") and diluted EPS, for companies with
potentially dilutive securities, such as options. Earnings per share for all
prior periods have been restated to conform with the provisions of SFAS 128.
Basic earnings per share is computed using the weighted average number of
shares of common stock. Diluted earnings per share is computed using the
weighted average number of shares of common stock and common equivalents shares
outstanding during the period. Common equivalents consist of convertible
preferred stock (using the if converted method) and stock options and warrants
(using the treasury stock method). Common equivalents shares are excluded from
the computation as their effect would have been anti-dilutive.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued FAS
130, "Reporting Comprehensive Income." This statement, effective for fiscal
years beginning after December 15, 1997, would require the Company to report
components of comprehensive income in a financial statement that is displayed
with the same prominence as other financial statements. Comprehensive income is
defined by Concepts Statement No. 6, Elements of Financial Statements, as the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from nonowner sources. It includes all changes in
equity during a period except those resulting from investments by owners and
distributions to owners. The Company has not yet determined its comprehensive
income.
Also in June 1997, the FASB issued FAS 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement, effective for financial
statements for periods beginning after December 15, 1997, requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Generally, financial information is required to
be reported on the basis that it is used internally for evaluating segment
performance and deciding how to
F-11
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
allocate resources to segments. The adoption of FAS 131 is not expected to have
a material impact on the Company's financial statements.
3. DISCONTINUED OPERATIONS
In July 1998, the Company's Board of Directors adopted a plan to discontinue
operations of its telecommunications segment. This segment consists of the
Company's wholly owned subsidiary Kansas Communications, Inc. ("KCI"), along
with KCI's Milwaukee operations purchased from Executone Management Systems,
Inc. Accordingly, the operating results of the telecommunications segment have
been segregated from continuing operations and reported as a separate line item
on the statement of operations. The assets and liabilities of such operations
have been reflected as a net asset.
The Company is in the process of negotiating the sale of these operations
and expects that the sale will be completed within a twelve month period.
Management does not anticipate a loss on the sale and intends to use sale
proceeds to reduce outstanding indebtedness and provide additional working
capital.
KANSAS COMMUNICATIONS, INC.
On September 15, 1995, a wholly owned subsidiary of the Company merged with
Kansas Communications, Inc., pursuant to an Agreement and Plan of Reorganization
dated March 24, 1995, by and between the Company and KCI. The KCI shareholders
received 1.3 million shares of the Company's common stock in exchange for all of
the outstanding shares of KCI. The business combination was accounted for as a
pooling of interests and, accordingly, the operations of KCI had been included
with the results of the Company for all periods presented. KCI is a Kansas
City-based company which sells and services telephone systems, third-party
computer hardware and application oriented peripheral products such as voice
mail, automated attendant systems, interactive voice response (IVR) and video
conferencing systems.
On December 29, 1995, KCI acquired the Milwaukee operations of Executone
Information Systems, Inc. ("Executone-Milwaukee"), in a business combination
accounted for as a purchase. Executone-Milwaukee sells and services proprietary
voice processing systems. The purchase price of approximately $1.9 million
consisted of $100,000 of cash and a note payable for $1.8 million. The note was
paid in February 1996. The operations of Executone-Milwaukee have been included
in the results of the Company since December 29, 1995. As a result of the
acquisition, the Company recorded costs in excess of fair value of net assets
acquired of $1.8 million, an amount which is being amortized on a straight-line
basis over twenty years.
F-12
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DISCONTINUED OPERATIONS (CONTINUED)
FINANCIAL INFORMATION FOR THE TELECOMMUNICATIONS SEGMENT
Operating results of the discontinued telecommunications segment are as
follows (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED
SEPTEMBER 30,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Revenues..................................................... $ 21,803 $ 17,218 $ 16,065
Income (loss) before income taxes............................ (1,812) 739 277
Provision for income taxes................................... -- -- (350)
Net income (loss)............................................ (1,812) 739 (73)
</TABLE>
Interest expense allocated to the discontinued telecommunications segment
totaled $377,000, $49,000 and $5,000 in fiscal 1996, 1997 and 1998 respectively.
The provision for income taxes recorded in 1998 is related to prior period
adjustments in deferred maintenance revenue for KCI.
Assets and liabilities of the discontinued telecommunications segment are as
follows at September 30 (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Current assets:
Cash..................................................................... $ -- $ --
Accounts receivable, net................................................. 1,848 1,734
Inventories.............................................................. 2,984 2,248
Prepaid expenses......................................................... 154 36
--------- ---------
4,986 4,018
Property, plant and equipment, net......................................... 529 427
Goodwill, net.............................................................. 1,759 1,663
Other noncurrent assets.................................................... 217 21
--------- ---------
7,491 6,129
--------- ---------
Current liabilities:
Accounts payable......................................................... 2,295 1,582
Current portion, long term debt.......................................... 328 --
Current portion, capital lease obligation................................ 23 32
Deferred revenue......................................................... 1,336 593
--------- ---------
3,982 2,207
Long-term debt, net of current portion..................................... 20 --
Capital lease obligation, net of current portion........................... 54 47
--------- ---------
4,056 2,254
--------- ---------
Net assets associated with discontinued operations......................... $ 3,435 $ 3,875
--------- ---------
--------- ---------
</TABLE>
F-13
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ISP CHANNEL, INC. (FORMERLY MEDIACITY WORLD, INC.)
On June 21, 1996, the Company acquired ISP Channel, Inc. (formerly MediaCity
World, Inc.) ("ISP Channel"), in a business combination accounted for as a
purchase. ISP Channel is an Internet Service Provider with operations in the San
Francisco Bay Area and Reno, Nevada. The purchase price consisted of 200,000
shares of the Company's common stock valued at $5.11 per share. The operations
of ISP Channel have been included in the results of the Company since June 21,
1996. As a result of the acquisition of ISP Channel, the Company recorded costs
in excess of fair value of net assets acquired of $1.2 million, being amortized
on a straight line basis over three years.
5. MICROGRAPHIC TECHNOLOGY CORPORATION
On September 15, 1995, the Company acquired Micrographic Technology
Corporation ("MTC") pursuant to an Agreement and Plan of Reorganization dated
March 24, 1995 in a business combination accounted for as a purchase
transaction. MTC is a designer, developer, manufacturer and integrator of
comprehensive, non-paper based systems and components that enable MTC to deliver
to its customers cost-effective solutions for storage, indexing and/or
distribution of high-volume output data streams. The MTC shareholders' received
778,000 shares of the Company's common stock valued at $6.95 per share, $1.1
million in cash and $2.8 million principal amount of the Company's debentures.
The operations of MTC have been included with the results of the Company since
September 16, 1995.
The cost in excess of fair value of net assets acquired incurred in
connection with the acquisition of MTC of $6.1 million is being amortized on a
straight-line basis over ten years. Additionally, in connection with the
acquisition of MTC, the Company incurred a one-time charge in fiscal 1995 of
$5.0 million for the write-off of acquired in-process unproven technology. At
the date of acquisition of MTC, the Company determined that the technological
feasibility of the acquired technology was unproven and that the technology had
no known future uses.
The Company determined prior to September 30, 1998 that it is more likely
than not to dispose of MTC within a one year period. The Company has received a
letter of intent from a potential buyer which has been approved by the Company's
Board of Directors, subject to shareholders' approval. The Company has reviewed
the discounted cash flow to determine the impairment of long-lived assets
resulting in an aggregate amount of $3.1 million loss which is included as part
of the Company's operating results (see Note 18).
6. DIVESTITURES OF UTILIZATION MANAGEMENT ASSOCIATES, INC. AND COMMUNICATE
DIRECT, INC.
UTILIZATION MANAGEMENT ASSOCIATES, INC.
During September 1995, the Company's Board of Directors approved a plan to
rescind its November 1993 acquisition of Utilization Management Associates, Inc.
("UMA"). The plan provided for the exchange of the Company's interest in UMA for
all common shares of the Company held by the former shareholders of UMA,
including related put options, and the cancellation of SoftNet stock options
held by the former shareholders of UMA.
Effective November 20, 1995, the plan was executed such that the Company
paid the former shareholders of UMA $200,000 in satisfaction of it's common
stock put obligation and received in exchange 29,630 shares of SoftNet common
stock. In addition, the Company paid approximately $300,000 in cash and notes
for the termination of non-compete, employment, and earn-out agreements
F-14
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DIVESTITURES OF UTILIZATION MANAGEMENT ASSOCIATES, INC. AND COMMUNICATE
DIRECT, INC. (CONTINUED)
and an irrevocable and unconditional release of the Company from any outstanding
obligations and liabilities to UMA or the shareholders of UMA.
COMMUNICATE DIRECT, INC.
On October 31, 1994, the Company acquired Communicate Direct, Inc. ("CDI")
in a business combination accounted for as a purchase. CDI, a Chicago-based
company, sold and serviced telephone systems, third-party computer hardware and
application oriented peripheral products such as voice mail, automated attendant
systems, interactive voice response ("IVR") and video conferencing systems. The
operations of CDI have been included with the results of the Company from
November 1, 1994 until they were subsequently sold. During fiscal 1996, the
Company sold a significant portion of the CDI business and, during fiscal 1997,
all of the remaining operation was sold. The Company acquired all of the
outstanding stock of CDI for $1.9 million, such consideration consisting of
290,858 shares of the Company's Series A Convertible Preferred Stock ("Preferred
Shares") valued at $6.00 per share and cash. In April 1995, the Preferred Shares
were converted into common shares on a one-to-one basis following the approval
of the Company's shareholders. The acquisition price has been adjusted for
settlement of an earn-out agreement and resolution of certain post-closing
purchase adjustments. The cost in excess of fair value of net assets acquired
incurred in connection with the acquisition of CDI of $4.2 million was
originally to be amortized on a straight-line basis over ten years. As a result
of the 1996 sale, the Company wrote off the unamortized balance of the goodwill
which arose from the original acquisition.
In June 1996, CDI sold its non-application oriented interconnect business
located in the Chicago, Illinois metropolitan area, which at this time comprised
substantially all of the business of CDI, to Next Call, Inc. ("Next Call") for a
$600,000 ten year note receivable. In connection with the sale, CDI agreed to
lend Next Call up to $1.0 million to fund operating losses, as defined, for the
first twelve months of operations. The loan agreement required CDI to advance
cash to Next Call on a monthly basis to cover operating cash short fall. Next
Call was required to repay such advances when it became profitable on a
cumulative basis. After the first twelve months, any amount still outstanding
from Next Call was to be forgiven. As of September 30, 1996, the Company had
made $189,000 in advances pursuant to this agreement. Subsequent to September
30, 1996, Next Call ceased operations.
As a result of the sale to Next Call and the uncertainty resulting from Next
Call's subsequent shut down, the Company incurred an extraordinary charge of
$6.0 million for the loss on the sale of this business. This loss includes the
write-off of unamortized goodwill which resulted from the initial purchase of
CDI in October 1994, deferred acquisition costs associated with the purchase of
CDI, severance payments, inventory, leasehold improvements, the notes receivable
from Next Call and all amounts loaned to the buyer. The disposition of CDI was
not contemplated at the time of the pooling with KCI. The loss resulting from
the disposition of certain assets and the assumption of certain liabilities of
CDI, within a two year period following a pooling of interests has been
classified as an extraordinary item as required by generally accepted accounting
principles. This extraordinary loss is net of taxes and the Company has not
recognized an income tax benefit associated with this write-off as the Company
has established a full valuation allowance for total deferred tax assets due to
the uncertainty of their ultimate realization.
During fiscal 1997, CDI sold its operations that support its Fujitsu
maintenance base, as well as all other remaining assets associated with CDI, to
a new company formed by John I. Jellinek, the
F-15
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DIVESTITURES OF UTILIZATION MANAGEMENT ASSOCIATES, INC. AND COMMUNICATE
DIRECT, INC. (CONTINUED)
Company's former president, chief executive officer and director and Philip
Kenny, a former SoftNet director. The buyer acquired certain assets in exchange
for a $209,000 promissory note and the assumption of current liabilities of
approximately $750,000. In addition, at the closing the buyer paid off $438,000
of existing Company bank debt and entered into a sub-lease of CDI's facility in
Buffalo Grove, Illinois. At the closing, the buyer merged with Telcom Midwest,
LLC., and the two former directors and the other two shareholders of the merged
company personally guaranteed obligations arising out of the promissory note,
the sub-lease arrangement and the assumption of certain liabilities. The
personal guarantees of the promissory note are several. The personal guarantees
of the sub-lease are limited to $400,000 and are on a joint and several basis.
The personal guarantees of assumed liabilities are on a joint and several basis
but are limited to the two former directors. Concurrent with this transaction,
Messrs. Jellinek and Kenny resigned from the Company's board. The Company
incurred an additional loss of $486,000 on the final disposition of the assets
of CDI. As was the case with the loss associated with the sale of assets to Next
Call, this was accounted for as an extraordinary loss.
7. INVENTORY AND PROPERTY AND EQUIPMENT
The components of inventories as of September 30, 1997 and 1998 are as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Raw materials.............................................................. $ 126 $ 28
Work-in-process............................................................ 217 408
Finished goods............................................................. 983 909
--------- ---------
$ 1,326 $ 1,345
--------- ---------
--------- ---------
</TABLE>
Balances of major classes of fixed assets and allowances for depreciation at
September 30, 1997 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Leasehold improvements..................................................... $ 155 $ 1,335
Furniture and fixtures..................................................... 276 83
Equipment.................................................................. 1,566 6,603
--------- ---------
Total.................................................................... 1,997 8,021
Less allowance for depreciation and amortization........................... (889) (1,498)
--------- ---------
Property and equipment, net................................................ $ 1,108 $ 6,523
--------- ---------
--------- ---------
</TABLE>
Included in the above fixed assets are asset amounts representing
capitalized leases of $192,000 and $1,157,000 at September 30, 1997 and 1998,
respectively. The accumulated depreciation related to these assets was $60,000
and $126,000, respectively.
F-16
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT
Debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Revolving Credit Note with maximum borrowings of $9.5 million bearing interest, payable
monthly, at the bank's prime rate plus 1% (the bank's prime rate being 8.25% at September
30, 1998). The note matures on January 15, 2000........................................... $ 5,900 $ 5,098
Equipment Financing Agreement with a maximum borrowing limit of $3.15 million, bearing
interest at the bank's prime rate plus 1% (the bank's prime rate being 8.25% at September
30, 1998), principal and interest due in 60 monthly payments with the final payment due
May 2002.................................................................................. 2,398 1,559
Draw Note with maximum borrowings for $1.5 million bearing interest, payable monthly, at the
bank's prime rate plus 1% (the bank's prime rate being 8.25% at September 30, 1998)....... 675 737
9% Convertible Debentures due September 2000, interest payable quarterly, convertible into
the Company's common shares at $6.75 per share............................................ 2,619 1,787
5% Convertible Subordinated Debentures, due September 2002, interest payable annually,
convertible into the Company's common stock at $8.25 per share after December 31, 1998.... -- 1,444
6% Convertible Subordinated Debentures, due February 2002 with semi-annual interest
payments, convertible into the Company's common stock at $8.10 per share.................. 780 720
9% Convertible Subordinated Notes due December 1998, interest payable quarterly,
subordinated to all other liabilities of the Company, convertible into the Company's
common shares at $5.00 per share.......................................................... 25 --
10% Convertible Subordinated Notes due October 1999, bearing interest, payable quarterly, at
10% for the first two years only and no interest thereafter, subordinated to all other
liabilities of the Company, convertible into the Company's common shares at $4.10 per
share..................................................................................... 200 --
Promissory note bearing interest at 12.24%, principal and interest due in 24 monthly
payments with final payment due October 1999.............................................. 278 157
Promissory note bearing interest at 9.4%, principal and interest due in 5 quarterly payments
with final payment due February 2000...................................................... -- 372
Non-interest bearing Promissory note due July 1998 (see Note 15)............................ 161 161
Promissory notes due November 1997, interest payable in arrears on each principal due date
accruing at 8.75%......................................................................... 75 --
Other....................................................................................... -- 22
--------- ---------
13,111 12,057
Less current portion debt................................................................... (1,384) (1,821)
--------- ---------
Total long-term debt........................................................................ $ 11,727 $ 10,236
--------- ---------
--------- ---------
</TABLE>
The availability under the revolving credit note is subject to revisions on
a monthly basis based upon available assets (as defined). The revolving credit
note is collateralized by substantially all of the assets of the Company.
F-17
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT (CONTINUED)
The equipment financing agreement and the draw note were obtained from the
same bank as the revolving credit note and the assets collateralizing each
financing facility are excluded from the collateral associated with the
revolving credit note. The equipment financing agreement covers a specific lease
agreement and the draw note covers certain bank approved leases. The equipment
financing agreement and the draw note are both collaterized by the respective
assets underlying each specific lease. The leases are initiated by the Company
acting as lessor through the ordinary course of business.
In connection with the issuance of the 10% Convertible Subordinated Notes,
the Company issued warrants to purchase 297,500 shares of the Company's common
stock exercisable for five years expiring in 1999 at an exercise price of $6.875
per share.
During fiscal 1998, holders of the 9% and 10% Convertible Subordinated Notes
converted $25,000 and $200,000 face amount of notes into 5,000 and 48,780
shares, respectively, of the Company's common stock. During fiscal 1997, holders
of the 9% and 10% Convertible Subordinated Notes converted $50,000 and $100,000
face amount of notes into 10,000 and 24,390 shares, respectively, of the
Company's common stock.
In connection with the acquisition of MTC, the Company issued $2.9 million
of its 9% Convertible Subordinated Debentures (the "MTC 9% Debentures") due
September 2000. The MTC 9% Debentures are subordinated to senior indebtedness of
the Company and are convertible after September 15, 1996, into the Company's
common shares at $6.75 per share. The MTC 9% Debentures may be prepaid by the
Company in whole or in part at face value. During fiscal 1998, $832,806 face
amounts of these 9% debentures were converted into 123,377 shares of the
Company's common stock. During fiscal 1997, $236,952 of these 9% debentures were
converted into 35,104 shares of the Company's common stock.
Also in connection with the acquisition of MTC, the Company assumed $1.8
million of 6% Convertible Subordinated Secured Debentures (the "Debentures") due
February 2002. The Debentures are convertible into the Company's common stock at
$8.10 per share. The Debentures are subject to redemption at the option of the
Company at face value, provided, however, that the Company issues common share
purchase warrants to purchase the same number of shares as would have been
issuable if the Debentures were converted. During fiscal 1998, $60,000 face
amount of these Debentures were converted into 7,407 shares of the Company's
common stock.
In fiscal 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to Mr. R.C.W. Mauran,
a beneficial owner of more than 5% of the Company's common stock, in exchange
for the assignment to the Company of certain equipment leases and other
consideration. The debentures are convertible into common stock of the Company
at $8.25 per share, after December 31, 1998.
F-18
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT (CONTINUED)
Aggregate maturities of long-term debt for each of the next five fiscal
years are as follows (in thousands):
<TABLE>
<S> <C>
1999..... $ 1,821
2000..... 7,654
2001..... 276
2002..... 2,306
2003..... --
---------
$ 12,057
---------
---------
</TABLE>
9. LEASE RECEIVABLES AND OBLIGATIONS
GROSS INVESTMENT IN LEASES TO CUSTOMERS
The Company's equipment lease transactions with its customers primarily
involve the leasing of Computer Output Microfiche ("COM") equipment. Lease terms
are typically for periods of 3 to 5 years. The Company typically leases its COM
equipment on a "price per fiche" basis, in which monthly rents are driven by
actual monthly microfiche production by the lessee. Leases contain minimum
monthly rents by establishing provisions for minimum production volumes per
month.
At September 30, 1998, the Company has entered into various sales-type
leases with its customers. Future minimum lease payments are as follows (in
thousands):
<TABLE>
<S> <C>
1999................................................................ $ 1,611
2000................................................................ 1,048
2001................................................................ 604
2002................................................................ 233
2003................................................................ 64
---------
Total future minimum lease payments................................. 3,560
Unearned interest................................................. (452)
Reserve for future costs.......................................... (247)
---------
Present value of minimum payments................................... 2,861
Equipment residual value.......................................... 581
---------
Gross investment in leases.......................................... $ 3,442
---------
---------
</TABLE>
CAPITALIZED LEASES
The Company leases computer equipment and certain other office equipment
under leases which are capital in nature. The aggregate amount of the lease
payments under capitalized leases for the
F-19
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LEASE RECEIVABLES AND OBLIGATIONS (CONTINUED)
Company's continuing operations for each of the five fiscal years ending
September 30 is as follows (in thousands):
<TABLE>
<S> <C>
1999................................................................ $ 670
2000................................................................ 311
2001................................................................ 37
2002................................................................ --
2003................................................................ --
---------
Total minimum lease payments........................................ 1,018
Amount representing interest........................................ (59)
---------
Present value of net minimum payments............................... 959
Less current portion................................................ (632)
---------
Capital lease obligation............................................ $ 327
---------
---------
</TABLE>
OPERATING LEASES
The Company has entered into operating leases for office space and
manufacturing facilities. These leases provide for minimum rents. These leases
generally include options to renew for additional periods. The Company's rent
expense for the years ended September 30, 1996, 1997 and 1998 was $755,000,
$828,000 and $760,000, respectively. The aggregate amount of the lease payments
under operating leases for the Company's continuing operations for each of the
five fiscal years ending September 30 is as follows (in thousands):
<TABLE>
<S> <C>
1999............................................................... $ 1,935
2000............................................................... 1,701
2001............................................................... 1,757
2002............................................................... 1,668
2003............................................................... 1,656
Thereafter......................................................... 3,012
---------
Total lease payments............................................... $ 11,729
---------
---------
</TABLE>
10. CHANGE IN PRODUCTS
During fiscal 1996, the Company acquired from IMNET an exclusive worldwide
manufacturing right to certain microfilm retrieval technology, partially in
exchange for the prepayment of fees for 250 software licenses. Accordingly, the
Company recorded a prepaid license fee of $1.0 million. As of September 30, 1998
(as well as at September 30, 1997), the transfer to the Company of the technical
and manufacturing know-how for this technology has continued to be delayed.
Despite the ongoing negotiation and cooperation between the parties, the Company
determined there was a potential material risk in completing the transfer and
getting the product to market. As a result, the Company wrote-off the prepaid
license fee of $1.0 million in fiscal 1997 (see Note 15).
F-20
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CHANGE IN PRODUCTS (CONTINUED)
Also, in fiscal 1997, the Company reevaluated the development and timely
offering of its RAPID (Rapid Archiving Peripheral for Images and Documents)
product. Market driven product enhancements, and the resulting technological
setbacks, delayed the estimated product offering date at least one year to the
second quarter of fiscal 1998. As a result, the Company wrote-off $1.1 million
of capitalized product design costs associated with this product in 1997. During
fiscal 1998, there has been minimal activity in the sale of this product due to
continued technological setbacks which the Company is trying to resolve.
In fiscal 1996, the Company made the decision to incorporate newer
technologies into its existing core product offerings in an attempt to diversify
and enhance its overall product offerings. In connection with this decision, the
Company signed an agreement to distribute Lucent Technologies, Inc. products in
the Chicago, Illinois metropolitan area, and incorporated a wider array of
solutions from existing vendors in its other markets. As a result of this
decision, and the resulting changes in its product lines, the Company incurred a
one-time charge of $1.3 million. The main components of this charge were a
$670,000 write-down of inventories associated with the older technologies that
the Company no longer actively distributed, a $311,000 settlement with a
terminated employee, and a $321,000 write-off of associated capitalized
expenses, including such prepaid expenses as maintenance, warranty and
professional fees which were to be amortized during 1996.
The fiscal 1996 results of operations include a charge of $1.5 million for
the write-down of certain software inventory resulting from the Company's
decision to discontinue the distribution of certain imaging products in favor of
others (see Note 15).
11. INCOME TAXES
The Company's provision for income taxes in fiscal 1998 of $350,000 relates
exclusively to the operations of KCI. These amounts are included in "Loss from
operations" for discontinued operations in the accompanying statement of
operations due to the Company's decision to discontinue the telecommunications
segment (see Note 3). The Company made no provision for income taxes for the
Company's continuing businesses due to losses incurred.
The components of deferred taxes at September 30 are as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1998
----------- -----------
TAX EFFECT TAX EFFECT
----------- -----------
<S> <C> <C> <C>
Inventory and other operating reserves.................................................. $ 170 $ 352
Allowance for doubtful accounts......................................................... 35 282
Unpaid accruals......................................................................... 162 509
Deferred revenue........................................................................ 503 303
Other................................................................................... (6) (17)
Net operating loss carryforward......................................................... 2,294 5,848
-
----------- -----------
Total deferred tax asset................................................................ 3,158 7,277
Valuation allowance..................................................................... (3,158) (7,277)
-
----------- -----------
Net deferred tax asset.................................................................. $ -- $ --
-
-
----------- -----------
----------- -----------
</TABLE>
A valuation allowance was recorded as a reduction to the deferred tax assets
due to the uncertainty of the ultimate realization of future benefits from such
deferred taxes.
F-21
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
Net operating loss carryforwards of approximately $17.2 million are
available as of September 30, 1998 to be applied against future taxable income.
In addition, net operating loss carryforwards of approximately $750,000 acquired
in connection with the acquisition of MTC are available to reduce recorded
goodwill when utilized. The net operating loss carryforwards expire between 1999
and 2011 and are subject to certain annual limitations as a result of the
changes in equity ownership.
12. SIGNIFICANT FOURTH QUARTER EVENTS
Operating results in the fourth quarter of fiscal 1998 include a $3.1
million loss on the impairment of the assets of the document management segment
(see Note 2).
13. STOCK OPTIONS AND WARRANTS
AMENDED 1995 LONG-TERM INCENTIVE PLAN
The Company's Amended 1995 Long-Term Incentive Plan (the "Incentive Plan")
is an equity incentive program for officers and other employees of the Company
or its subsidiaries and the non-employee members of the Company's Board of
Directors (the "Board"). A total of 1,500,000 shares of common stock have been
authorized for issuance over the term of the Incentive Plan, but no participant
may receive awards for more than 200,000 shares of common stock per fiscal year.
The Incentive Plan will be administered by either the Board or the Compensation
Committee of the Board.
Awards under the Incentive Plan may, in general, be made in the form of
stock option grants, stock appreciation rights, restricted stock awards or
performance shares. Each stock option grant will have an exercise price not less
than the fair market value of the option shares on the grant date and will
generally become exercisable in three successive equal annual installments over
the optionee's period of continued service with the Company.
As of September 30, 1998, options for 1,300,767 shares of common stock were
outstanding under the Incentive Plan, of which 382,954 option shares were
vested. A total of 149,332 shares of common stock had been issued, and 49,901
shares of common stock remained available for future option grants and other
awards under the Incentive Plan. As of September 30, 1998, no stock appreciation
rights, restricted share awards or performance shares were outstanding under the
Incentive Plan.
EMPLOYEE STOCK OPTION PLAN
The Company's Employee Stock Option Plan (the "Option Plan") is an equity
incentive program which has been established for the employees of Micrographic
Technology Corporation. A total of 40,000 shares of common stock have been
authorized for issuance over the term of the Option Plan, but no participant may
be granted stock options for more than 4,000 shares of common stock. The Option
Plan is administered by the Compensation Committee of the Company's Board of
Directors.
All options granted under the Option Plan will have an exercise price per
share equal to the fair market value of the option shares on the grant date and
will be designed to qualify as incentive stock options under the federal tax
laws. Each granted option will become exercisable for the option shares in a
series of three successive equal annual installments over the optionee's period
of continued service with Micrographic Technology Corporation. The options will
not be assignable or transferable except by will or the laws of inheritance
following the optionee's death, and in the event the Company is acquired by
merger or sale of substantially all of its assets, each outstanding option will
be either be assumed by
F-22
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
the successor corporation or replaced by the successor corporation with an
option with substantially the same economic value.
As of September 30, 1998, options for 19,358 shares of common stock were
outstanding under the Option Plan, of which all were vested. A total of 3,208
shares of common stock had been issued, and no shares of common stock remained
available for future options grants under the Option Plan.
NON-PLAN CONSULTANT STOCK OPTIONS
During the year ended September 30, 1998, the Company's Board of Directors
approved the grant of stock options to an independent consultant to purchase an
aggregate of 50,000 shares of its common stock. These options have an exercise
price of $10.19 and as of September 30, 1998, none of these options shares were
vested. As a result, the Company has recorded $215,000 in deferred compensation
which will be amortized to expense over the three-year vesting period of the
options. A total of $27,000 has been amortized to expense for the fiscal year
ended September 30, 1998. These options were not issued as part of any of the
Company's registered Stock Option Plans.
COMMON STOCK WARRANTS
During fiscal year 1998, the Company issued warrants to purchase an
aggregate of 566,250 shares of its common stock in association with three
separate rounds of financing through the issuance of its convertible preferred
stock (see Note 14). These warrants have a weighted average exercise price of
$10.42. In addition, the Company recognized and honored its commitment to issue
a warrant to purchase 10,309 shares of its common stock in association with a
financing arrangement dating back to 1994. This warrant contained an exercise
price of $4.85 and was exercised via a cashless exercise provision into 7,182
shares in August 1998.
F-23
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes the outstanding options and warrants to
purchase shares of common stock for the three years ended September 30, 1998:
<TABLE>
<CAPTION>
OUTSTANDING WARRANTS OUTSTANDING
OUTSTANDING OPTIONS ------------------------- OPTIONS AND WARRANTS
--------------------------- WEIGHTED ---------------------------
WEIGHTED AVERAGE WEIGHTED
AVERAGE EXERCISE AVERAGE
SHARES EXERCISE PRICE SHARES PRICE SHARES EXERCISE PRICE
---------- --------------- ---------- ------------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding as of September 30,
1995................................ 215,000 $ 8.28 1,334,650 $ 5.03 1,549,650 $ 5.48
Granted............................. 574,000 $ 8.27 -- -- 574,000 $ 8.27
Exercised........................... -- -- (12,500) $ 1.75 (12,500) $ 1.75
Canceled............................ (422,833) $ 8.25 (118,750) $ 4.04 (541,583) $ 7.33
---------- ---------- ----------
Outstanding as of September 30,
1996................................ 366,167 $ 8.30 1,203,400 $ 5.16 1,569,567 $ 5.89
Granted............................. 400,000 $ 5.00 -- -- 400,000 $ 5.00
Exercised........................... -- -- (251,000) $ 1.75 (251,000) $ 1.75
Canceled............................ (283,215) $ 4.95 -- -- (283,215) $ 4.95
---------- ---------- ----------
Outstanding as of September 30,
1997................................ 482,952 $ 5.14 952,400 $ 6.06 1,435,352 $ 5.75
Granted............................. 1,143,533 $ 8.07 576,559 $ 10.32 1,720,092 $ 8.82
Exercised........................... (152,540) $ 5.47 (683,941) $ 5.81 (836,481) $ 5.75
Canceled............................ (103,820) $ 6.76 (12,619) $ 2.52 (116,439) $ 6.30
---------- ---------- ----------
Outstanding as of September 30,
1998................................ 1,370,125 $ 7.42 832,399 $ 9.27 2,202,524 $ 8.12
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
On November 15, 1996, the Compensation/Stock Option Committee approved a
stock option repricing program to provide employee option holders additional
opportunity and incentive to achieve business plan goals. A total of 297,000
options held by employees on that date were repriced to $4.94 per share, which
was the market price on such date. All other terms of the options remained the
same and, accordingly, there was no change to the vesting or term of any option.
The Board of Directors took similar action earlier in the year on February
28, 1996, when it elected to reduce the exercise price on 117,000 options held
by employees to $8.25 per share, the market price on the day the board took such
action. All other terms of the options remained the same and, accordingly, there
was no change to the vesting or term of any option.
F-24
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes information regarding stock options
outstanding at September 30, 1998:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS VESTED OPTIONS
------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
LIFE EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES (YEARS) PRICE SHARES PRICE
- -------------------------- ----------- ----------- ----------- --------- ---------
$ 4.94--$ 6.88............ 874,625 8.78 $ 6.17 392,312 $ 5.94
$ 7.19--$ 9.75............ 237,800 9.52 $ 8.67 -- --
$10.00--$13.94............ 257,700 9.65 $ 10.68 10,000 $ 13.94
----------- ---------
$ 4.94--$13.94............ 1,370,125 9.07 $ 7.45 402,312 $ 6.14
----------- ---------
----------- ---------
</TABLE>
During fiscal 1997, the Company was required to adopt Statement of Financial
Standards No. 123, Accounting for Stock-Based Compensation (FAS 123), which
encourages entities to adopt a fair value based method of accounting for stock
based compensation plans in place of the provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), for all
arrangements under which employees receive shares of stock or other equity
instruments of the employer.
As allowed by FAS 123, the Company will continue to apply the provisions of
APB 25 in accounting for its stock based employee compensation arrangements, and
will disclose the pro forma net loss and loss per share information in its
footnotes as if the fair value method suggested in FAS 123 had been applied.
Had compensation cost for the Company's LTIP been determined based on the
fair value at grant date for awards in fiscal 1998, 1997 and 1996 consistent
with the provisions of FAS 123, the Company's net loss and loss per share would
have been increased to the pro forma amounts indicated below (in thousands,
except per share data):
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Net loss applicable to common shares, as reported................................ $ (6,097) $ (2,631) $ (17,345)
Net loss applicable to common shares, pro forma.................................. (6,348) (3,207) (18,889)
Basic and diluted loss per common share, as reported............................. (1.05) (.40) (2.35)
Basic and diluted loss per common share, pro forma............................... (1.09) (.48) (2.56)
</TABLE>
The fair value of each stock option grant on the date of grant was estimated
using the Black-Scholes option pricing model with the following average
assumptions for the year ended September 30:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Volatility.................................................... 58% 63%
Risk-free interest rate....................................... 6.10% 5.28%
Dividend yield................................................ -- --
Expected lives................................................ 4 4
Weighted average fair value................................... $ 4.26 $ 4.62
</TABLE>
F-25
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Outstanding redeemable convertible preferred stock at September 30, 1998
consists of the following (in thousands, except share data):
<TABLE>
<CAPTION>
REDEEMABLE CONVERTIBLE PREFERRED STOCK
30,000 SHARES AUTHORIZED, $0.10 PAR
VALUE
- ----------------------------------------
<S> <C> <C>
SHARES ISSUED PROCEEDS NET
AND OF ISSUANCE
SERIES OUTSTANDING COSTS
- --------- ------------- --------------
A........ 3,101 $ 4,600
B........ 10,125 9,500
C........ 7,531 7,108
D........ -- --
------ -------
20,757 $ 21,208
------ -------
------ -------
</TABLE>
ISSUANCE
Since December 31, 1997, the Company has issued three series of its 5%
convertible preferred stock denominated Series A Convertible Preferred Stock
(the "Series A Preferred Stock"), Series B Convertible Preferred Stock (the
"Series B Preferred Stock") and Series C Convertible Preferred Stock (the
"Series C Preferred Stock"). In addition, the Company has agreed to issue,
pursuant to a mutually binding stock purchase agreement, a fourth series of its
5% convertible preferred stock denominated Series D Convertible Preferred Stock
(the "Series D Preferred Stock") with the Series A Preferred Stock, the Series B
Preferred Stock and the Series C Preferred Stock, the ("Preferred Stock"). In
connection with the issuance of the 5% Preferred Stock, the Company has also
issued (or, in the case of the Series D Preferred Stock, agreed to issue)
warrants to purchase its common stock (the "Preferred Warrants").
Each series of the Preferred Stock has similar rights and privileges, and
each share of the Preferred Stock has a par value of $0.10 and a face amount of
$1,000. The Preferred Stock is convertible into the number of shares of common
stock determined by dividing the face amount of the Preferred Stock being
converted by the applicable conversion price.
On December 31, 1997, the Company issued to RGC International Investors, LDC
("RGC"), 5,000 shares of its Series A Preferred Stock and warrants to purchase
150,000 shares of common stock (the "Series A Warrants") for an aggregate
purchase price of $5,000,000. $435,000 of the purchase price has been allocated
to the value of the Series A Warrants. The sale was arranged by Shoreline
Pacific Institutional Finance, the Institutional Division of Financial West
Group ("SPIF"), which received a fee of $250,000 plus warrants to purchase
20,000 shares of common stock, which are exercisable at $6.625 and expire on
December 31, 2000.
On May 28, 1998, the Company issued to RGC and Shoreline Associates I, LLC
("Shoreline"), 9,000 and 1,000 shares, respectively, of its Series B Preferred
Stock and warrants to purchase 180,000 and 20,000 shares, respectively, of
common stock (the "Series B Warrants") for an aggregate purchase price of
$10,000,000. $900,000 of the purchase price has been allocated to the value of
the Series B Warrants. The sale was arranged by SPIF, which received a fee of
$500,000 plus warrants to purchase 50,000 shares of common stock, which are
exercisable at $11.00 and expire on May 28, 2002.
On August 31, 1998, the Company issued to RGC 7,500 shares of its Series C
Preferred Stock and warrants to purchase 93,750 shares of common stock (the
"Series C Warrants") for an aggregate
F-26
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
purchase price of $7,500,000. $277,000 of the purchase price has been allocated
to the value of the Series C Warrants. The sale was arranged by SPIF, which
received a fee of $375,000 plus warrants to purchase 26,250 shares of common
stock, which are exercisable at $7.50 and expire on August 31, 2002.
Also on August 31, 1998, the Company entered into a stock purchase agreement
whereby the Company agreed, subject to certain conditions, including common
stock shareholder approval, to issue to RGC 7,500 shares of its Series D
Preferred Stock and warrants to purchase 93,750 shares of common stock (the
"Series D Warrants") for an aggregate purchase price of $7,500,000. As of
September 30, 1998, the Company has not issued the Series D Preferred Stock and
the Series D Warrants. This stock purchase agreement was arranged by SPIF, which
received warrants to purchase 26,250 shares of common stock, which are
exercisable at $7.50 and expire on August 31, 2002. The exercise of these
warrants is contingent upon the issuance of the Series D Preferred Stock, at
which time SPIF will receive an additional fee of $375,000. If the closing of
the Series D Preferred Stock has not occurred by September 1, 1999, the warrants
issued in conjunction with the Series D Preferred Stock shall automatically
expire.
USE OF PROCEEDS
Proceeds from the sale of the Preferred Stock and the Preferred Warrants are
being used to fund the expenditures incurred in the continuing expansion of the
Company's Internet segment, particularly the ISP Channel service, and for
general corporate purposes. Such expenditures include procuring the equipment
necessary to deliver high-speed, cable based Internet services to subscribers,
hiring additional personnel and expanding its associated sales and marketing
efforts.
DIVIDENDS
The Holders of the Preferred Stock are entitled to receive dividends at a
rate of 5% per annum, payable quarterly, at the Company's option, in cash or
additional shares of the applicable series of Preferred Stock. Unpaid dividends
are cumulative. Any accrued and unpaid dividends are payable only in the event
of a liquidation, dissolution or winding up of the Company. In addition, the
Holders of the Series B Preferred Stock are entitled to receive dividends of 10%
per annum in the event they are unable to convert their Series B Preferred Stock
because such conversions would result in greater than 19.99% of the common stock
being issued upon conversion of the Series B, unless stockholder approval is
obtained authorizing such conversions.
As of September 30, 1998, the Company had issued an additional 101 shares of
Series A Preferred Stock, 125 shares of Series B Preferred Stock and 31 shares
of Series C Preferred Stock as dividends.
CONVERSION PRICES
The stated value of each series of outstanding preferred stock is $1,000 per
share. The actual number of shares of common stock issuable upon conversion of
each series of Preferred Stock will be determined by the following formula:
(The aggregate stated value of the shares of preferred stock thus being
converted at $1,000 per share)
DIVIDED BY
(The applicable conversion price of the series of the preferred stock being
converted).
F-27
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
The conversion price of the Series A Preferred Stock is equal to the lower
of $8.28 per share and the lowest consecutive two day average closing price of
the common stock during the 20 day trading period immediately prior to such
conversion.
Prior to February 28, 1999, the conversion price of the Series B Preferred
Stock is equal to $13.20 per share. Thereafter, the conversion price of the
Series B Preferred Stock is equal to the lower of $13.20 per share and the
lowest five day average closing price of the common stock during the 20 day
trading period immediately prior to such conversion.
Prior to May 31, 1999, the conversion price of the Series C Preferred Stock
is equal to $9.00 per share. Thereafter, the conversion price of the Series C
Preferred Stock is equal to the lower of $9.00 per share and the lowest five day
average closing price of the common stock during the 30-day trading period
immediately prior to such conversion.
The conversion price of the Series D Preferred Stock (the "Series D
Conversion Price") will initially be a price equal to 120% of the average
closing bid price of the common stock on the five days prior to the date the
Series D Preferred Stock is issued (the "Initial Series D Conversion Price"). On
the nine month anniversary of such issuance, the Series D Conversion Price will
be the lower of the Initial Series D Conversion Price and a five day average
market price within the 30-day trading period immediately prior to conversion,
subject to adjustment upon certain conditions.
CONVERSION
A holder of the Series A Preferred Stock or the Series B Preferred Stock
cannot convert its Series A Preferred Stock or Series B Preferred Stock in the
event such conversion would result in its beneficially owning more than 4.99% of
the Company's common stock, (not including shares underlying the Series A
Preferred Stock or the Series A Warrants for the Series A Preferred Stock
conversions, or the Series B Preferred Stock or the Series B Warrants for the
Series B Preferred Stock conversions), but they may waive this prohibition by
providing the Company a notice of election to convert at least 61 days prior to
such conversion. Similarly, a holder of the Series C Preferred Stock or Series D
Preferred Stock cannot convert its Series C Preferred Stock or Series D
Preferred Stock in the event such conversion would result in beneficially owning
more than 4.99% of the Company's common stock (not including shares underlying
the Series C Preferred Stock or the Series C Warrants for the Series C Preferred
stock conversion or the shares underlying the Series D Preferred Stock or the
Series D Warrants for the Series D Preferred stock conversions). Notwithstanding
this limitation, the holders of the Preferred Stock cannot convert into an
aggregate of more than 19.99% of the Company's common stock without the approval
of the Company's common shareholders or the American Stock Exchange. In
addition, the Series B Preferred Stock, Series C Preferred Stock and Series D
Preferred Stock each cannot convert into more than 2,000,000 shares of common
stock. As of September 30, 1998, assuming that the holders of Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock attempt to convert
into the maximum number of shares of common stock available, the total cash
payments would be $11,699,171 after adjustment for the conversion of the
remaining 3,101 shares of the Company's outstanding Series A Preferred Stock
subsequent to year end.
The rules of the American Stock Exchange (the "AMEX") require us to obtain
common stock shareholder or AMEX approval to issue more than 20% of the
Company's outstanding common stock. Shares of common stock issued upon
conversion of the Preferred Stock or exercise of the Preferred Warrants would
count toward this 20%. As such, the AMEX rule operates as a further restriction
on
F-28
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
the ability of the holders of the Preferred Stock and the Preferred Warrants to
convert their preferred stock or exercise their warrants.
During April 1998, the Company issued a combined total of 299,946 shares of
common stock, pursuant to the conversion of 2,000 shares of the Series A
Preferred Stock. The Series A Preferred Stock, including accrued dividends, was
converted into common shares at the conversion price of $6.69 per share.
Subsequent to the year ended September 30, 1998, the Company issued a
combined total of 413,018 shares of common stock, pursuant to the conversion of
the remaining 3,101 shares of the Company's outstanding Series A Preferred
Stock. The Series A Preferred Stock, including accrued dividends, was converted
into common shares at the conversion price of $7.56 per share.
VOTING RIGHTS
Holders of the Preferred Stock do not have voting rights, except for certain
protective provisions relating to changes in the rights of holders of the
Preferred Stock or otherwise required by law. Consent of a majority in interest
of each effected series of the Preferred Stock is required prior to (i) changing
the rights or privileges of such series; (ii) creating any new class or series
of stock with preferences above or on par with those of such series; (iii)
increasing the authorized number of such series; (iv) any act which would result
in a negative tax consequence to the holders of such series pursuant to Section
305 of the Internal Revenue Code.
PRIORITY
Each series of the Preferred Stock is pari passu with each other series of
Preferred Stock, and ranks senior to the common stock as to dividends,
distributions and distribution of assets upon liquidation, dissolution or
winding up of the Company.
LIQUIDATION
In the event of any liquidation, dissolution or winding up of the Company,
holders of the Preferred Stock will be entitled to be paid out of the assets of
the Company legally available for distribution to its stockholders, an amount
equal to the liquidation value per share of the Preferred Stock, but only after
and subject to the payment in full of all amounts required to be distributed to
the holders of any other capital stock of the Company ranking in liquidations
senior to such Preferred Stock, but before any payment will be made to the
holders of the common stock. Certain mergers or consolidations of the Company
into or with another corporation or the sale of all or substantially all of the
assets of the Company may be deemed to be a liquidation of the Company
triggering the rights of the holders of the Preferred Stock.
REDEMPTION
Each series of the Preferred Stock is subject to redemption upon certain
circumstances, including the Company's (i) failure to convert the Preferred
Stock when required and in the proper manner, (ii) lapse of effectiveness of the
registration statement covering the common stock underlying the Preferred Stock,
and (iii) suspension of the common stock from trading on the AMEX, New York
Stock Exchange or NASDAQ. In addition, the Series B Preferred Stock is subject
to redemption in the event the Company breaches the registration rights
agreement pursuant to which the common stock
F-29
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
underlying the Series B Preferred Stock was registered with the Commission; and
the Series C (and Series D if issued) is subject to redemption in the event the
Company breaches the stock purchase agreement pursuant to which the Series C
Preferred Stock was issued or the registration rights agreement pursuant to
which the common stock underlying the Series C Preferred Stock was registered
with the Commission.
The Company will have the right to redeem the Series A Preferred Stock on or
after December 31, 1998 at a price equal to the greater of 130% of its face
value or the market price multiplied by the number of shares of common stock
into which the Convertible Preferred can be converted. The Company will have the
right to redeem the Series B Preferred Stock on the earlier of an underwritten
public offering of at least $10,000,000 or November 28, 1999 at a price equal to
the greater of (i) 120% of its face value plus accrued but unpaid dividends or
(ii) the market price of the common stock multiplied by the number of shares of
common stock into which the Series B Preferred Stock can be converted. The
Company will have the right to redeem the Series C Preferred Stock on or after
the earlier of (i) an underwritten public offering or a Rule 144A offering in
the amount of at least $10,000,000, or (ii) February 29, 2000, at a price equal
to 110% of its face value if such redemption is made prior to September 1, 1999
and 120% of the face value thereafter. Once issued, the Company will have the
right to redeem the Series D Preferred Stock on or after the earlier of (i) an
underwritten public offering or a Rule 144A offering in the amount of at least
$10,000,000, or (ii) the eighteen-month anniversary of the date of its issuance
at a price equal to 110% of its face value if such redemption is made in the
first 12 months that the Series D Preferred Stock is outstanding and 120% of the
face value thereafter.
In the event of a change in control of the Company, including
consolidations, mergers, the sale of substantially all of the Company's assets,
and transactions in which 50% or more of the voting power of the Company is
disposed of, the 5% Preferred Stock is subject to redemption in cash.
MATURITY
The Company, in its sole discretion, must either redeem or convert the 5%
Preferred Stock on the three year anniversaries of issuance (the "Maturity
Date"). The Company's ability to convert the 5% Preferred Stock on the Maturity
Date is subject to (i) shareholder approval in the event such conversion
(aggregated with all previous conversions of the 5% Preferred Stock) would
result in the issuance of more than 19.99% of the outstanding common stock as of
December 31, 1997 and (ii) the shares of common stock issuable upon such
conversion being authorized, registered and eligible for trading over AMEX or
NASDAQ. In the event shareholder approval is not obtained, or the common stock
issuable upon such conversion is not authorized, registered and eligible for
trading over the AMEX or NASDAQ, then the Company must redeem the 5% Preferred
Stock in cash. The Maturity Date of the Series B Preferred Stock is May 29,
2001. The Maturity Date of the Series C Preferred Stock is August 31, 2001.
F-30
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
THE PREFERRED WARRANTS TO PURCHASE COMMON STOCK
The Preferred Warrants have a term of four years, and are currently
exercisable. The Preferred Warrants contain certain anti-dilution provisions and
permit cashless exercise. The Company can call the Series B Warrants and the
Series C Warrants any time after the first year anniversary of their issuance,
but only in the event the market price of the common stock over the twenty days
prior to such call is 150% of the exercise price of the warrants being called.
The Series A Warrants have an exercise price of $7.95 per share and expire on
December 31, 2001. The Series B Warrants have an exercise price of $13.75 per
share and expire on May 28, 2002. The Series C Warrants have an exercise price
of $9.375 per share and expire on August 31, 2002. The exercise price of the
Series D Warrants will be 125% of the market price of the common stock on the
date of issuance, and will expire four years after such issuance.
15. RELATED PARTY TRANSACTIONS
As of September 30, 1994, the Company was owed $4.2 million plus accrued
interest by Ozite Corporation (Ozite). A Director of the Company and the former
Chairman of the Board held substantial interests in Ozite. Due to uncertainties
about collecting these funds, this receivable, which dates back to 1988, was
written off and charged against earnings during fiscal 1991. Accordingly no
amount related to this receivable is recorded on the Company's consolidated
financial statements. On July 26, 1995, Ozite shareholders approved a merger of
Ozite with Pure Tech with Pure Tech being the surviving corporation. As a
condition of the merger, Ozite was required to secure a general release from the
Company and to surrender certain securities in satisfaction of the amount owed
to the Company. As a result, the Company received 311,000 shares of Pure Tech
common stock, 267,000 shares of Artra Group Incorporated (ARTRA) common stock
and 932 shares of Artra Preferred Stock. Subsequently, the Company sold all
311,025 shares of Pure Tech for net proceeds of $1.0 million, which was recorded
as a capital contribution during fiscal 1995. During fiscal 1996, the remaining
securities were sold for net proceeds of $815,000, which was recorded as a
capital contribution.
During fiscal 1997, CDI sold its operations that support its Fujitsu
maintenance base in the Chicago metropolitan area to a new company formed by
John I. Jellinek, the Company's former president, chief executive officer, and
director and Philip Kenny, a former SoftNet director. The buyer acquired certain
assets in exchange for a $209,000 promissory note and the assumption of current
liabilities of approximately $750,000. In addition, at the closing the buyer
paid off $438,000 of Company bank debt and entered into a sub-lease of CDI's
facility in Buffalo Grove, Illinois. At the closing, the buyer merged with
Telcom Midwest, LLC., and the two former directors and the other two
shareholders of the merged company personally guaranteed obligations arising out
of the promissory note, the sub-lease arrangement and the assumption of certain
liabilities. The personal guarantees of the promissory note are several. The
personal guarantees of the sub-lease are limited to $400,000 and are on a joint
and several basis. The personal guarantees of assumed liabilities are on a joint
and several basis but are limited to the two former directors. Concurrent with
this transaction, Messrs. Jellinek and Kenny resigned from the Company's board.
In June 1996, the Company acquired the exclusive worldwide manufacturing
rights to IMNET's MegaSAR Microfilm Jukebox and completed and amended its
obligations under a previous agreement. The Company issued a $2.9 million note
for prepaid license fees, software inventory, the manufacturing rights, and
certain other payables. Approximately $2.5 million was paid on this note during
the fourth
F-31
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. RELATED PARTY TRANSACTIONS (CONTINUED)
quarter of fiscal 1996. Subsequently, in fiscal 1997, the outstanding $410,000
promissory note was further reduced by $249,000, and a new promissory note in
the face amount of $161,000 was executed.
In July 1997, due to a delay in the transfer to the Company of the technical
and manufacturing know-how for the MegaSAR product, the Company and IMNET
further amended the June 1996 Agreement. In an attempt to facilitate the
technology transfer, the Company accepted an order from IMNET for the first 14
MegaSAR units to be manufactured by the Company. A portion of the payment for
these initial units would be applied against the outstanding promissory note.
The transfer of the technology and the parts needed for production was to have
occurred no later than September 1, 1997.
As of September 30, 1997, the transfer to the Company of the technical and
manufacturing know-how for this product offering has continued to be delayed.
Despite the ongoing negotiation and cooperation between the two parties, the
Company determined there was a potential material risk in completing the
technology transfer and getting the product to market. As a result, in fiscal
1997, the Company recorded a one-time charge of $1.0 million to write-off the
associated prepaid licenses. The Company is currently negotiating with IMNET to
either complete the transfer or seek an alternative solution. In association
with these ongoing negotiations, the maturity date of the Company's $161,000
promissory note has been indefinitely extended.
During fiscal 1996, the Company decided to discontinue its plans for
distributing the IMNET microfilm retrieval software in favor of another software
developer's product. As a result, the Company recorded a one-time charge of $1.5
million to write-off software inventory which is included under the caption
costs associated with change in product lines and other in the accompanying
consolidate statements of operations.
During fiscal 1996, the Company sold its entire holdings in IMNET for net
proceeds of $7.7 million. Accordingly, the Company recorded a gain on sale of
the securities of $5.7 million.
On January 2, 1998, the Company issued $1,443,750 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002 to Mr. R. C. W.
Mauran, a beneficial owner of more than 5% of the Company's common stock, in
exchange for the assignment to the Company of certain equipment leases and other
consideration. The debentures are convertible into common stock of the Company,
at $8.25 per share, after December 31, 1998.
On May 29, 1998, the Company issued to RGC International Investors and
Shoreline Associates I, LLC, 9,000 and 1,000 shares, respectively, of its Series
B Preferred Stock and warrants to purchase 180,000 and 20,000 shares,
respectively, of common stock, for an aggregate purchase price of $10,000,000.
The warrants issued in connection with the Series B Preferred Stock have an
exercise price of $13.75 per share. On December 31, 1998, RGC International
Investors and Shoreline Associates I, LLC owned 9,226.40 and 1,025.16 shares,
respectively, of Series B Preferred Stock as a result of payment of additional
shares of Series B Preferred Stock as dividends, which was all of the Series B
Preferred Stock outstanding as of such date (see Note 18). Sean Doherty, a
director of the Company, is an owner of Shoreline Associates I, LLC.
F-32
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid during the year for:
Interest.......................................................... $ 1,730 $ 1,220 $ 1,330
Non-cash investing and financing activities:
Common stock issued for acquisitions.............................. 1,022 -- --
Common stock issued for the conversion of subordinated notes...... 4,077 387 1,118
Common stock issued for the conversion of preferred stock......... -- -- 1,666
Value assigned to common warrants issued upon the issuance of
preferred stock................................................. 1,612
Convertible debt issued for acquisition of equipment leases....... -- -- 1,444
Preferred dividends paid with the issuance of--
Additional preferred stock...................................... -- -- 257
Common stock.................................................... -- -- 6
Equipment acquired by capital lease............................... 89 83 965
Note received in sale of a portion of CDI's operations.......... -- 209 --
Common stock issued to pay acquisition costs.................... -- 44 --
</TABLE>
17. SEGMENT INFORMATION
The Company operates principally in three industry segments: document
management, telecommunications and Internet services. The Company's acquisition
of MTC in September, 1995, significantly broadened its operations in the
document management industry. Prior to the acquisition, the Company's document
management operations were not material. Although the Company acquired ISP
Channel, an Internet service provider, in June of 1996, its revenue and results
of operations in fiscal 1996 were immaterial. In July 1998, the Company decided
to discontinue its telecommunications
F-33
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
operations and therefore, the data relating to this segment is included as
discontinued. Note 3 provides segment data for telecommunications.
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED
SEPTEMBER 30,
-------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Net sales:
Document management........................................ $ 19,417 $ 20,330 $ 13,042
Internet services.......................................... 167 988 1,018
--------- --------- ---------
$ 19,584 $ 21,318 $ 14,060
--------- --------- ---------
--------- --------- ---------
Income (loss) from continuing operations before income taxes:
Document management........................................ $ (227 (c) $ 572(b) $ (5,653)(a)
Internet services.......................................... -- (1,152) (8,272)
Other...................................................... 2,003(d) (2,304) (3,004)
--------- --------- ---------
$ 1,776 $ (2,884) $ (16,929)
--------- --------- ---------
--------- --------- ---------
Identifiable assets:
Document management........................................ $ 14,426 $ 15,049 $ 10,070
Discontinued business...................................... 8,373 7,491 6,129
Internet services.......................................... -- 1,364 7,443
Corporate.................................................. 1,467 473 13,167
Other...................................................... 1,320 -- --
--------- --------- ---------
$ 25,586 $ 24,377 $ 36,809
--------- --------- ---------
--------- --------- ---------
Depreciation and amortization expense:
Document management........................................ $ 958 $ 1,263 $ 1,148
Internet services.......................................... -- 458 921
Corporate.................................................. 306 76 84
Other...................................................... 110 1 --
--------- --------- ---------
$ 1,374 $ 1,798 $ 2,153
--------- --------- ---------
--------- --------- ---------
Capital expenditures:
Document management........................................ $ 614 $ 137 $ 647
Internet services.......................................... -- 361 5,014
Corporate.................................................. 100 11 2
Other...................................................... 18 1 --
--------- --------- ---------
$ 732 $ 510 $ 5,663
--------- --------- ---------
--------- --------- ---------
</TABLE>
- ------------------------
(a) Includes $3.1 million charge for impairment of assets.
(b) Includes $2.1 million charge for costs associated with change in product
line and other.
(c) Includes $1.5 million charge for costs associated with change in product.
(d) Includes $5.7 million gain on sale of available-for-sale securities.
F-34
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SUBSEQUENT EVENTS
On November 5, 1998, the Company entered into a letter of intent to sell MTC
for $5.125 million and on November 9, 1998, the Company entered into a letter of
intent to sell KCI for $6.6 million. In both cases, deposits of $100,000 were
paid to the Company on execution of the letters of intent and, in the case of
the sale of MTC, such deposit is non-refundable. The purchase price for MTC is
anticipated to be $5.125 million (including the $100,000 non-refundable
deposit). The balance of $5.025 million will be paid at closing in readily
available funds. The purchase price for KCI is anticipated to be $6 million
(including the $100,000 deposit) and the issuance to the Company of 60,000
shares of common stock of the purchaser, Convergent Communications, Inc. At
closing, the Company expects to receive $3.4 million in readily available funds
and two 12-month 8% notes for an aggregate amount of $2.5 million.
In aggregate, the sale of both MTC and KCI represents a substantial change
in the business of the Company and, as such, requires shareholder approval.
While KCI has been treated as a discontinued operation since July 27, 1998, and
while management of the Company intends to dispose of MTC, the Company has
continued to treat MTC as a continuing business pending such shareholder
approval of its sale.
On November 22, 1998, the Company entered into a definitive agreement to
acquire all of the outstanding capital stock of Intelligent Communications, Inc.
The transaction will close upon Federal Communications Commission approval of
the transfer of Intellicom's licenses to the Company. Such approval is expected
to occur in the second quarter of fiscal 1999. The agreed purchase price
comprises (i) a cash component of $500,000 payable at closing, (ii) a promissory
note in the amount of $1 million due one year after closing (and payable in cash
or in the Company's common stock at the option of the sellers), (iii) a
promissory note in the amount of $2 million due two years after closing (and
payable in cash or in the Company's common stock at the option of the Company),
(iv) the issuance of 500,000 shares of the Company's common stock (adjustable
upwards after one year in certain circumstances), and (v) a demonstration bonus
of $1 million payable on the first anniversary of the closing, if certain
milestones are met, in cash or shares of the Company's common stock at the
option of the Company.
During November 1998, the Company issued a combined total of 413,018 shares
of common stock, pursuant to the conversion of the remaining 3,101 shares of the
Company's outstanding Series A Preferred Stock. The Series A Preferred Stock,
including accrued dividends, was converted into common shares at the conversion
price of $7.56 per share.
During the quarter ended December 31, 1998, the Company declared a dividend
on both its outstanding Series B Preferred Stock and its outstanding Series C
Preferred Stock, payable on December 31, 1998 to the respective stockholders of
record at the close of business on December 28, 1998. For the Series B Preferred
Stock, these dividends, payable at a rate of 5%, were paid at the Company's
option in the form of 126.56 additional shares of the Company's Series B
Preferred Stock. For the Series C Preferred Stock, these dividends, payable at a
rate of 5%, were paid at the Company's option in the form of 94.14 additional
shares of the Company's Series C Preferred Stock.
On January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes. These notes bear an interest rate of 9% per year and
mature in 2001. In connection with these notes, the Company issued to these
investors an aggregate of 300,000 warrants. These warrants, which have an
exercise price of $17 per warrant, expire in 2003.
F-35
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
------------- DECEMBER 31,
1998
------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash.............................................................................. $ 12,504 $ 4,329
Accounts receivables, net......................................................... 3,105 3,819
Current portion of gross investment in leases..................................... 1,579 1,239
Inventories....................................................................... 1,345 1,195
Prepaid expenses.................................................................. 882 1,146
------------- ------------
Total current assets............................................................ 19,415 11,728
Restricted cash..................................................................... 800 800
Property and equipment, net......................................................... 6,523 9,880
Gross investment in leases, net of current portion.................................. 1,863 1,717
Other assets........................................................................ 1,124 1,089
Costs in excess of fair value of net assets acquired, net........................... 955 683
Net assets associated with discontinued operations.................................. 3,875 3,813
------------- ------------
$ 34,555 $ 29,710
------------- ------------
------------- ------------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses............................................. $ 9,423 $ 10,862
Current portion of long-term debt................................................. 1,821 1,855
Current portion of capital leases................................................. 632 913
Deferred revenue.................................................................. 100 173
------------- ------------
Total current liabilities....................................................... 11,976 13,803
------------- ------------
Long-term debt, net of current portion.............................................. 10,236 9,430
------------- ------------
Capital lease obligations, net of current portion................................... 327 518
------------- ------------
Commitments and contingencies
Redeemable convertible preferred stock, $.10 par value 25,000 shares authorized,
20,757 and 17,877 shares issued and outstanding at September 30, and December 31,
respectively...................................................................... 18,187 15,754
------------- ------------
Shareholders' deficit:
Preferred stock, $.10 par value, 3,975,000 shares authorized, none issued and
outstanding..................................................................... -- --
Common stock, $.01 par value, 25,000,000 shares authorized, 8,191,550 and
8,631,087 shares outstanding, respectively...................................... 82 86
Deferred stock compensation....................................................... (188) (303)
Capital in excess of par value.................................................... 43,700 46,653
Accumulated deficit............................................................... (49,765) (56,231)
------------- ------------
Total shareholders' deficit..................................................... (6,171) (9,795)
------------- ------------
$ 34,555 $ 29,710
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-36
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Net sales.................................................................................... $ 2,875 $ 4,296
Cost of sales................................................................................ 2,249 2,967
--------- ---------
Gross profit............................................................................... 626 1,329
--------- ---------
Operating expenses:
Selling.................................................................................... 557 3,009
Engineering................................................................................ 581 1,146
General and administrative................................................................. 1,178 2,862
Amortization of goodwill and transaction costs............................................. 322 322
--------- ---------
Total operating expenses................................................................. 2,638 7,339
--------- ---------
Loss from continuing operations.............................................................. (2,012) (6,010)
Other income (expense):
Interest expense........................................................................... (330) (569)
Other income............................................................................... 72 217
--------- ---------
Loss from continuing operations before income taxes.......................................... (2,270) (6,362)
Provision for income taxes................................................................... -- --
--------- ---------
Loss from continuing operations before discontinued operations............................... (2,270) (6,362)
Income (loss) from discontinued operations................................................... (108) 139
--------- ---------
Net loss..................................................................................... (2,378) (6,223)
Preferred dividends.......................................................................... -- (243)
--------- ---------
Net loss applicable to common shares......................................................... $ (2,378) $ (6,466)
--------- ---------
--------- ---------
Basic and diluted earnings (loss) per share:
Continuing operations...................................................................... $ (0.33) $ (0.76)
Discontinued operations.................................................................... (0.01) 0.02
Preferred dividends........................................................................ -- (0.03)
--------- ---------
Net loss applicable to common shares....................................................... $ (0.34) $ (0.77)
--------- ---------
--------- ---------
Shares used to compute basic and diluted earnings (loss) per share......................... 6,941 8,374
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-37
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss...................................................................................... $ (2,378) $ (6,223)
Adjustments to reconcile net loss to net cash used in operating activities:
(Income) loss from discontinued operations................................................ 108 (139)
Depreciation and amortization............................................................. 469 850
Amortization of deferred stock compensation............................................... -- 30
Provision for bad debts................................................................... 10 60
Changes in operating assets and liabilities:
Accounts receivable..................................................................... 270 (774)
Gross investment in leases.............................................................. 244 486
Inventories............................................................................. (102) 150
Prepaid expenses........................................................................ (152) (264)
Accounts payable and accrued expenses................................................... 439 1,439
Deferred revenue........................................................................ 312 73
--------- ---------
Net cash used in operating activities of continuing operations.................................. (780) (4,312)
--------- ---------
Net cash provided by operating activities of discontinued operations............................ 54 222
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment............................................................ (76) (3,084)
Other......................................................................................... -- (100)
--------- ---------
Net cash used in investing activities of continuing operations.................................. (76) (3,184)
--------- ---------
Net cash used in investing activities of discontinued operations................................ (26) (12)
--------- ---------
Cash flows from financing activities:
Repayment of long-term debt................................................................... (424) (439)
Borrowings under revolving credit note........................................................ 2,017 8,697
Payments under revolving credit note.......................................................... (475) (9,030)
Additional costs of issuance of convertible preferred stock................................... -- (54)
Net proceeds from issuance of convertible preferred stock..................................... 4,600 --
Restricted cash............................................................................... (4,600) --
Proceeds from exercise of warrants............................................................ 42 190
Capitalized lease obligations paid............................................................ (15) (245)
--------- ---------
Net cash provided by (used in) financing activities of continuing operations.................... 1,145 (881)
--------- ---------
Net cash used in financing activities of discontinued operations................................ (304) (8)
--------- ---------
Increase (decrease) in cash..................................................................... 13 (8,175)
Cash, beginning of period....................................................................... 37 12,504
--------- ---------
Cash, end of period............................................................................. $ 50 $ 4,329
--------- ---------
--------- ---------
Cash paid during the period for:
Interest...................................................................................... $ 420 $ 308
Income taxes.................................................................................. -- --
Supplemental non-cash transactions
Common stock issued for the conversion of preferred stock..................................... -- 2,600
Common stock issued for the conversion of subordinated notes.................................. 208 --
Value assigned to common warrants issued upon the issuance of preferred stock................. 435 --
Preferred dividends paid with the issuance of--
Additional preferred stock.................................................................. -- 221
Common stock................................................................................ -- 22
Equipment acquired by capital lease........................................................... -- 717
Deferred compensation associated with the issuance of common stock options.................... -- 146
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-38
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The financial information, except for the balance sheet as of September 30,
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 December 31, 1998 and 1997.
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 Condensed Consolidated Financial
Statements. The Condensed Consolidated Balance Sheet as of September 30, 1998
was derived from the Company's audited Consolidated Financial Statements.
The results of operations for the three months ended December 31, 1998 are
based in part on estimates that may be subject to year-end adjustments and are
not necessarily indicative of the results to be expected for the full year.
The financial statements for the three months ended December 31, 1997 have
been restated for the effects of the discontinued operations of the
telecommunications segment (see Note 2). Certain reclassifications have been
made to conform with the current presentation.
2. DISCONTINUED OPERATIONS
In July 1998, the Company's Board of Directors adopted a plan to discontinue
operations of its telecommunications segment. This segment consists of the
Company's wholly owned subsidiary Kansas Communications, Inc. ("KCI"), along
with KCI's Milwaukee operations purchased from Executone Management Systems,
Inc. Accordingly, the operating results of the telecommunications segment have
been segregated from continuing operations and reported as a separate line item
on the statement of operations. The assets and liabilities of such operations
have been reflected as a net asset.
On February 12, 1999, KCI was sold to Convergent Communications Services,
Inc. for an aggregate purchase price of approximately $6.3 million, subject to
adjustment in certain events. Proceeds from the sale consist of cash, notes and
shares of Convergent Communications Services, Inc.'s parent company common stock
(see Note 6).
Operating results of the discontinued telecommunications segment are as
follows for the three months ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Revenues................................................................... $ 3,949 $ 3,633
Income (loss) before income taxes.......................................... (108) 194
Provision for income taxes................................................. -- (55)
Net income (loss).......................................................... (108) 139
</TABLE>
F-39
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. DISCONTINUED OPERATIONS (CONTINUED)
Assets and liabilities of the discontinued telecommunications segment are as
follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1998
------------- -------------
<S> <C> <C>
Current assets:
Cash.......................................................... $ -- $ --
Accounts receivable, net...................................... 1,734 1,847
Inventories................................................... 2,248 2,490
Prepaid expenses.............................................. 36 99
------ ------
4,018 4,436
Property, plant and equipment, net.............................. 427 398
Goodwill, net................................................... 1,663 1,639
Other noncurrent assets......................................... 21 22
------ ------
6,129 6,495
------ ------
Current liabilities:
Accounts payable.............................................. 1,582 1,710
Current portion, capital lease obligation..................... 32 30
Deferred revenue.............................................. 593 901
------ ------
2,207 2,641
Capital lease obligation, net of current portion................ 47 41
------ ------
2,254 2,682
------ ------
Net assets associated with discontinued operations.............. $ 3,875 $ 3,813
------ ------
------ ------
</TABLE>
3. DEBT
Long-term debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1998
------------- ------------
<S> <C> <C>
Bank debt....................................................... $ 7,416 $ 6,667
Convertible subordinated notes.................................. 3,951 3,951
Other........................................................... 690 667
------------- ------------
12,057 11,285
Less current portion............................................ (1,821) (1,855)
------------- ------------
$ 10,236 $ 9,430
------------- ------------
------------- ------------
</TABLE>
4. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On November 23, 1998 and November 24, 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 Convertible Preferred
Stock. The Series A Convertible Preferred
F-40
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
Stock, including accrued dividends, was converted into common shares at the
conversion price of $7.56 per share.
During the quarter ended December 31, 1998, the Company declared a dividend
on both its outstanding Series B Convertible Preferred Stock and its outstanding
Series C 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 Convertible Preferred Stock, payable at a rate of 5%,
were paid at the Company's option in the form of 126.56 additional shares of the
Company's Series B Preferred Stock. Dividends for the Series C Convertible
Preferred Stock, payable at a rate of 5%, were paid at the Company's option in
the form of 94.14 additional shares of the Company's Series C Convertible
Preferred Stock.
5. STOCK OPTIONS AND WARRANTS
The following table summarizes the outstanding options and warrants to
purchase shares of common stock for the three months ended December 31, 1998:
<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....................... 65,000 $ 7.38 -- -- 65,000 $ 7.38
Exercised..................... -- -- (26,519) $ 7.39 (26,519) $ 7.39
Canceled...................... (20,700) $ 6.88 (905) $ 6.63 (21,605) $ 6.87
--------- --------- ---------
Outstanding as of December 31,
1998.......................... 1,414,425 $ 7.45 804,975 $ 9.33 2,219,400 $ 8.13
--------- --------- ---------
--------- --------- ---------
</TABLE>
6. SUBSEQUENT EVENTS
On January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes. These notes bear an interest rate of 9% per year and
mature in 2001. 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 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. 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, which have an
exercise price of $17 per share, expire in 2003.
On February 5, 1999, a single holder of the Company's 9% Convertible
Subordinated Debentures due September 2000 converted a debenture in the face
amount of $401,516 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.
F-41
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. SUBSEQUENT EVENTS (CONTINUED)
On February 9, 1999, the Company completed the purchase of Intelligent
Communications, Inc. 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; (iii)
a promissory note in the amount of $2.0 million due two years after closing;
(iv) the issuance of 500,000 shares of the Company's common stock (adjustable
upwards after one year in certain circumstances); (v) 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;
and (vi) the issuance of additional shares of the Company's common stock
issuable upon the first, second and third anniversaries of the closing, valued
at a total of $3,500,000.
On February 12, 1999, Kansas Communications, Inc. was 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)
30,000 shares of Convergent Communications' parent company common stock with an
agreed value of approximately $300,000 ($10.00 per share); (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 eleven percent per annum; (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 which
is payable on the date which is 12 months following the closing date, bears
simple interest at the rate of eight percent per annum and is subject to
mandatory prepayment in certain events.
F-42
<PAGE>
BACK INSIDE COVER
[GRAPHIC: ISP Channel Locale Partners:
trademarks for the following companies:
Zip2-TM- Yellow Pages; excite; prevue; Accuweather; Inktomi; DoubleClick;
when.com; Spinner; Caucus; Intershop Communications; Tribal Voice-TM-;
AtYourOffice.com; ZY Web; ZD University; and City Auction]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
YOU MAY RELY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS
PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK
MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE OF
THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN
OFFER TO BUY THESE SHARES OF THE COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH
THE OFFER OR SOLICITATION IS UNLAWFUL.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 5
Use of Proceeds........................................................... 28
Capitalization............................................................ 29
Price Range of Common Stock and Dividend Policy........................... 31
Dilution.................................................................. 32
Selected Consolidated Historical Financial Data........................... 33
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 34
Business.................................................................. 56
Management................................................................ 79
Principal Shareholders.................................................... 82
Description of Capital Stock.............................................. 85
Description of Certain Indebtedness....................................... 87
Underwriting.............................................................. 89
Legal Matters............................................................. 91
Experts................................................................... 91
Where You Can Find More Information....................................... 91
Index to Consolidated Financial Statements................................ F-1
</TABLE>
3,500,000 SHARES
[LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
BT ALEX. BROWN
BANCBOSTON
ROBERTSON STEPHENS
CIBC WORLD MARKETS
WIT CAPITAL CORPORATION
AS E-MANAGER-TM-
, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following are the expenses (estimated except for the SEC and NASD
registration fees) for the issuance and distribution of the securities being
registered, all of which will be paid by the Registrant.
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 36,226
NASD Filing Fee................................................... 11,670
Blue Sky fees and expenses........................................ 3,000
Fees and expenses of counsel...................................... 400,000
Fees and expenses of accountants.................................. 125,000
Fees and expenses of e-manager.................................... 100,000
Printing fees..................................................... 150,000
Listing fees...................................................... 17,500
Transfer agent fees............................................... 12,000
Miscellaneous expenses............................................ 44,604
---------
Total........................................................... $ 900,000
---------
---------
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Under Section 145 of the Delaware General Corporation Law, the Company has
broad powers to indemnify its directors and officers against liabilities they
may incur in such capacities, including liabilities under the Securities Act of
1933, as amended (the "Securities Act"). The Company's By-Laws also provide that
the Company will indemnify its directors and executive officers and may
indemnify its other officers, employees and other agents to the fullest extent
not prohibited by Delaware law.
The Company's Amended and Restated Certificate of Incorporation provides for
the elimination of liability for monetary damages for breach of the directors'
fiduciary duty of care to the Company and its stockholders. These provisions do
not eliminate the directors' duty of care and, in appropriate circumstances,
equitable remedies such as injunctive or other forms of non-monetary relief will
remain available under Delaware law. In addition, each director will continue to
be subject to liability for breach of the director's duty of loyalty to the
Company, for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for any transaction from which the
director derived an improper personal benefit and for payment of dividends or
approval of stock repurchases or redemptions that are unlawful under Delaware
law. These provisions do not affect a director's responsibilities under any
other laws, such as the federal securities laws or state or federal
environmental laws.
The Underwriting Agreement filed as Exhibit 1.1 to this Registration
Statement provides for indemnification by the Underwriters of the Company and
its officers and directors for certain liabilities arising under the Securities
Act or otherwise.
We maintain directors and officers liability insurance covering all of our
directors and officers against claims arising out of the performance of their
duties.
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- --------- ---------------------------------------------------------------------------------
<C> <S>
1.0**** Form of Underwriting Agreement
3.1(+ ) Restated Certificate of Incorporation.
3.1.1* Certificate of Incorporation of SoftNet Systems, Inc., a Delaware corporation, as
amended.
3.2**** Bylaws, as amended. (Incorporated herein by reference to Exhibit 3.2 to SoftNet's
Annual Report on Form 10-K for the year ended September 30, 1993).
3.2.1* By-Laws of SoftNet Systems, Inc. a Delaware corporation.
4.1(+ ) Article Third of Registrant's Restated Certificate of Incorporation
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- --------- ---------------------------------------------------------------------------------
<C> <S>
5.1**** Opinion of Brobeck, Phleger & Harrison LLP
15.1(+++) Review Report by Sarah A. Tull, CPA, of financial statements as of and for the
year ended December 31, 1995 for Intelligent Communications, Inc.
23.1**** Consent of Brobeck, Phleger & Harrison LLP (included as part of Exhibit 5.1).
23.2* Consent of PricewaterhouseCoopers, LLP
23.3**** Consent of Blanding, Boyer & Rockwell, L.L.P.
23.4**** Consent of Sarah A. Tull, CPA
24.1**** Powers of Attorney (included on signature page of the Registration Statement).
99.1(++) Common Stock Purchase Warrant Certificate issued to RGC International Investors,
LDC dated August 31, 1998 (Series C).
99.2(++) Common Stock Purchase Warrant Certificate issued to Shoreline Pacific Equity,
Ltd. dated August 31, 1998 (Series C).
99.3(++) Common Stock Purchase Warrant Certificate issued to Steven M. Lamar dated August
31, 1998 (Series C).
99.4(++) Securities Purchase Agreement by and among SoftNet and the Buyers (as defined
therein), dated as of August 31, 1998 (Series C and Series D).
99.5(++) Registration Rights Agreement by and among SoftNet and the Initial Investors (as
defined therein) dated as of August 31, 1998 (Series C and Series D).
99.6(++) Escrow Agreement by and among SoftNet, the Buyers (as defined therein), Shoreline
Pacific Institutional Finance and the Escrow Holder (as defined therein), dated
as of August 31, 1998 (Series C).
99.7(++) Common Stock Purchase Warrant Certificate issued to Shoreline Pacific Equity,
Ltd. dated August 31, 1998 (Series D).
99.8(++) Common Stock Purchase Warrant Certificate issued to Steven M. Lamar dated August
31, 1998 (Series D).
99.9** Securities Purchase Agreement by and among SoftNet and the Buyers (as defined
therein), dated as of May 28, 1998 (Series B).
99.10** Registration Rights Agreement by and among SoftNet and the Initial Investors (as
defined therein), dated as of May 28, 1998 (Series B).
99.11** Escrow Agreement by and among the Buyers (as defined therein), Shoreline Pacific
Institutional Finance and the Escrow Holder (as defined therein), dated as of
May 28, 1998 (Series D).
99.12** Form of Common Stock Purchase Warrant Certificate issued to purchasers of the
Series B Preferred Stock, dated May 28, 1998.
99.13** Form of Common Stock Purchase Warrant Certificate issued to assignees of
Shoreline Pacific Institutional Finance, dated May 28, 1998 (Series B).
99.14(++) List of recipients of Common Stock Purchase Warrants issued in connection with
Series B Preferred Stock transaction.
99.15*** Securities Purchase Agreement by and among SoftNet and the Buyers (as defined
therein), dated as of December 31, 1997 (Series A).
99.16*** Registration Rights Agreement by and among SoftNet and the Initial Investors (as
defined therein), dated as of December 31, 1997 (Series A).
99.17*** Escrow Agreement by and among the Buyers (as defined therein), Shoreline Pacific
Institutional Finances and the Escrow Holder (as defined therein), dated as of
December 31, 1997 (Series A).
99.18*** Form of Common Stock Purchase Warrant Certificate issued to purchasers of the
Series A Preferred Stock, dated December 31, 1997.
99.19*** Form of Common Stock Purchase Warrant Certificate issued to assignees of
Shoreline Pacific Institutional Finance, dated December 31, 1997 (Series A).
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- --------- ---------------------------------------------------------------------------------
<C> <S>
99.20(++) List of recipients of Common Stock Purchase Warrants issued in connection with
Series A Preferred Stock transaction.
99.21(++) Action by Written Consent of the Sole Holder of the Series E Convertible
Preferred Stock of SoftNet Systems, Inc.
</TABLE>
- ------------------------
(+ ) Incorporated herein by reference to Softnet's Registration Statement on
Form S-3 (No. 333-65593)
(++ ) Incorporated herein by reference to Additional Exhibits of SoftNet's
Registration Statement on Form S-3 (No. 333-65593)
(+++) Incoporated herein by reference to Softnet's Form 8-K/A, dated March 12,
1999.
* Filed herewith.
** Incorporated herein by reference to Additional Exhibits of the SoftNet's
Form 8-K dated January 12, 1998
*** Incorporated herein by reference to Additional Exhibits of SoftNet's
Registration Statement on Form S-3 (No. 333-45335)
****Filed previously.
ITEM 17. UNDERTAKINGS.
1. The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (and, where applicable, each filing of an employee benefit
plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of
1934) that is incorporated by reference in the registration statement shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial BONA FIDE offering thereof.
2. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
undersigned registrant pursuant to the foregoing provisions, or otherwise, the
undersigned registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the undersigned registrant of expenses incurred or paid by a
director, officer or controlling person of the undersigned registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the undersigned registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
3. The undersigned registrant hereby undertakes that:
(i) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4)
or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(ii) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial BONA FIDE offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3, and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized in San Francisco, California on April 21, 1999.
<TABLE>
<S> <C> <C>
SOFTNET SYSTEMS, INC.
By: /s/ DOUGLAS S. SINCLAIR
-----------------------------------------
Douglas S. Sinclair
CHIEF FINANCIAL OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ RONALD I. SIMON*
- ------------------------------ Chairman of the Board April 21, 1999
Ronald I. Simon
/s/ DR. LAWRENCE B.
BRILLIANT* Vice Chairman of the
- ------------------------------ Board, President and April 21, 1999
Dr. Lawrence B. Brilliant Chief Executive Officer
/s/ IAN B. AARON* Vice President, President
- ------------------------------ of ISP Channel, Inc. and April 21, 1999
Ian B. Aaron Director
/s/ DOUGLAS S. SINCLAIR
- ------------------------------ Chief Financial Officer April 21, 1999
Douglas S. Sinclair
/s/ MARK A. PHILLIPS*
- ------------------------------ Treasurer and Chief April 21, 1999
Mark A. Phillips Accounting Officer
/s/ EDWARD A. BENNETT*
- ------------------------------ Director April 21, 1999
Edward A. Bennett
/s/ SEAN P. DOHERTY*
- ------------------------------ Director April 21, 1999
Sean P. Doherty
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ ROBERT C. HARRIS, JR.*
- ------------------------------ Director April 21, 1999
Robert C. Harris, Jr.
</TABLE>
<TABLE>
<S> <C>
By: /s/ DOUGLAS S. SINCLAIR
---------------------------------------
Attorney-in-Fact
</TABLE>
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
1.0**** Form of Underwriting Agreement
3.1(+) Restated Certificate of Incorporation.
3.1.1* Certificate of Incorporation of SoftNet Systems, Inc., a Delaware corporation, as amended.
3.2**** Bylaws, as amended. (Incorporated herein by reference to Exhibit 3.2 to SoftNet's Annual Report on
Form 10-K for the year ended September 30, 1993).
3.2.1* By-Laws of SoftNet Systems, Inc. a Delaware corporation.
4.1(+) Article Third of Registrant's Restated Certificate of Incorporation
5.1**** Opinion of Brobeck, Phleger & Harrison L.L.P.
15.1(+++) Review Report by Sarah A. Tull, CPA, of financial statements as of and for the year ended December 31,
1995 for Intelligent Communications, Inc.
23.1**** Consent of Brobeck, Phleger & Harrison L.L.P. (included as part of Exhibit 5.1)
23.2* Consent of PricewaterhouseCoopers, L.L.P.
23.3**** Consent of Blanding, Boyer & Rockwell L.L.P.
23.4**** Consent of Sarah A. Tull, CPA
24.1**** Powers of Attorney (included on signature page of the Registration Statement).
99.1(++) Common Stock Purchase Warrant Certificate issued to RGC International Investors, LDC dated August 31,
1998 (Series C).
99.2(++) Common Stock Purchase Warrant Certificate issued to Shoreline Pacific Equity, Ltd. dated August 31,
1998 (Series C).
99.3(++) Common Stock Purchase Warrant Certificate issued to Steven M. Lamar dated August 31, 1998 (Series C).
99.4(++) Securities Purchase Agreement by and among SoftNet and the Buyers (as defined therein), dated as of
August 31, 1998 (Series C and Series D).
99.5(++) Registration Rights Agreement by and among SoftNet and the Initial Investors (as defined therein)
dated as of August 31, 1998 (Series C and Series D).
99.6(++) Escrow Agreement by and among SoftNet, the Buyers (as defined therein), Shoreline Pacific
Institutional Finance and the Escrow Holder (as defined therein), dated as of August 31, 1998 (Series
C).
99.7(++) Common Stock Purchase Warrant Certificate issued to Shoreline Pacific Equity, Ltd. dated August 31,
1998 (Series D).
99.8(++) Common Stock Purchase Warrant Certificate issued to Steven M. Lamar dated August 31, 1998 (Series D).
99.9** Securities Purchase Agreement by and among SoftNet and the Buyers (as defined therein), dated as of
May 28, 1998 (Series B).
99.10** Registration Rights Agreement by and among SoftNet and the Initial Investors (as defined therein),
dated as of May 28, 1998 (Series B).
99.11** Escrow Agreement by and among the Buyers (as defined therein), Shoreline Pacific Institutional Finance
and the Escrow Holder (as defined therein), dated as of May 28, 1998 (Series D).
99.12** Form of Common Stock Purchase Warrant Certificate issued to purchasers of the Series B Preferred
Stock, dated May 28, 1998.
99.13** Form of Common Stock Purchase Warrant Certificate issued to assignees of Shoreline Pacific
Institutional Finance, dated May 28, 1998 (Series B).
99.14(++) List of recipients of Common Stock Purchase Warrants issued in connection with Series B Preferred
Stock transaction.
99.15*** Securities Purchase Agreement by and among SoftNet and the Buyers (as defined therein), dated as of
December 31, 1997 (Series A).
99.16*** Registration Rights Agreement by and among SoftNet and the Initial Investors (as defined therein),
dated as of December 31, 1997 (Series A).
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
99.17*** Escrow Agreement by and among the Buyers (as defined therein), Shoreline Pacific Institutional
Finances and the Escrow Holder (as defined therein), dated as of December 31, 1997 (Series A).
99.18*** Form of Common Stock Purchase Warrant Certificate issued to purchasers of the Series A Preferred
Stock, dated December 31, 1997.
99.19*** Form of Common Stock Purchase Warrant Certificate issued to assignees of Shoreline Pacific
Institutional Finance, dated December 31, 1997 (Series A).
99.20(++) List of recipients of Common Stock Purchase Warrants issued in connection with Series A Preferred
Stock transaction.
99.21(++) Action by Written Consent of the Sole Holder of the Series E Convertible Preferred Stock of SoftNet
Systems, Inc.
</TABLE>
- ------------------------
(+) Incorporated herein by reference to SoftNet's Registration Statement on
Form S-3 (No. 333-65593)
(++) Incorporated herein by reference to Additional Exhibits of SoftNet's
Registration Statement on Form S-3 (No. 333-65593)
(+++) Incorporated herein by reference to SoftNet's Form 8-K/A dated March 12,
1999.
* Filed herewith.
** Incorporated herein by reference to Additional Exhibits of the SoftNet's
Form 8-K dated January 12, 1998
*** Incorporated herein by reference to Additional Exhibits of SoftNet's
Registration Statement on Form S-3 (No. 333-45335)
****Filed previously.
<PAGE>
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
SOFTNET SYSTEMS, INC.
(Pursuant to Sections 241 and 245 of the Delaware General Corporation Law)
Steven M. Harris hereby certifies that:
A. He is the sole incorporator of SoftNet Systems, Inc, a Delaware
corporation.
B. The Certificate of Incorporation of said 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 the 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.
The name of the Corporation's incorporator is Steven M. Harris and the
incorporator's mailing address is 650 Townsend Street, Suite 225, San Francisco,
California 94103.
<PAGE>
ARTICLE FIFTH.
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, $0.01 par value and 4,000,000 shares
shall be Preferred Stock, $0.10 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 issuance 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 SIXTH.
1. [RESERVED]
2. [RESERVED]
3. The rights and privileges of the Series C Convertible Preferred Stock
are as follows. All references to Articles and Sections within this Article
Sixth, Section 3 are solely to Articles and Sections within this Article Sixth,
Section 3.
I. DESIGNATION AND AMOUNT
The designation of this series, which consists of 10,000 shares of
Preferred Stock, is the Series C Convertible Preferred Stock (the "Series C
Preferred Stock" or "Series C Preferred Shares") and the face amount per share
shall equal $1,000 (the "Face Amount").
II. CERTAIN DEFINITIONS
For purposes of this Article Sixth, Section 3, the following terms shall
have the following meanings:
"Anniversary Date" means the date that is 9 months following the Closing
Date.
"Business Day" means any day other than a Saturday, Sunday or a day on
which banks in New York, New York are permitted or required by law to be closed.
"Closing Bid Price" means, for any security as of any date, the closing bid
price of such security on the principal securities exchange or trading market
where such security is listed or
2.
<PAGE>
traded as reported by Bloomberg Financial Markets or a comparable reporting
service of national reputation selected by the Company and reasonably acceptable
to the Holders then holding a majority of the outstanding shares of Series C
Preferred Stock ("Majority Holders"), if Bloomberg Financial Markets is not then
reporting closing bid prices of such security (collectively, "Bloomberg"), or if
the foregoing does not apply, the last reported sale price of such security in
the over-the-counter market on the electronic bulletin board of such security as
reported by Bloomberg, or, if no sale price is reported for such security by
Bloomberg, the average of the bid prices of any market makers for such security
that are listed in the "pink sheets" by the National Quotation Bureau, Inc. If
the Closing Bid Price cannot be calculated for such security on such date on any
of the foregoing bases, the Closing Bid Price of such security on such date
shall be the fair market value as mutually determined by the Company and the
Majority Holders, or, if they are unable to agree on such value, it shall be
determined by an investment banking firm selected by the Company and reasonably
acceptable to the Majority Holders.
"Closing Date" means August 31, 1998.
Closing Price" means the Closing Bid Price of the Common Stock on the
Closing Date.
"Common Stock" means the common stock, $0.01 par value, of the Company.
"Conversion Price", subject to the adjustments provided for in Article X
hereof, means (1) on and prior to the Anniversary Date, 120% of the Closing
Price and (2) beginning on the day following the Anniversary Date, the lesser of
(I) 120% of the Closing Price and (ii) the Market Price at the time of
conversion.
"Effective Date" means the date the Registration Statement registering the
resale of the shares of Common Stock into which the Series C Preferred Shares
are convertible is declared effective by the Securities and Exchange Commission.
"Holders" means the initial Holders of the Series C Preferred Stock and
their permitted transferees.
"majority of the outstanding shares of Series C Preferred Stock" means
greater than 66.6% of the outstanding shares of Series C Preferred Stock.
"Market Price" means the volume weighted average price of the Common Stock
over any five trading days, selected by the Holder, in the 30 trading days
ending on the day prior to the Conversion Date.
"Registration Deadline" means the 90th day following the Closing Date.
"Registration Statement" means a registration statement filed with the
Securities and Exchange Commission under the Securities Act of 1933, as amended.
"Securities Purchase Agreement" means the Securities Purchase Agreement
referencing this Article Sixth, Section 3, among the Company and the purchasers
named therein, as amended from time to time in accordance with the terms
thereof.
3.
<PAGE>
"Warrants" means certain stock purchase warrants to acquire shares of
Common Stock issued by the Company to the initial Holders in connection with the
transactions contemplated by the Securities Purchase Agreement.
III. DIVIDENDS
A. GENERAL. Each Holder of the Series C Preferred Stock shall be
entitled to receive cumulative dividends at the rate of five percent (5%) of the
Face Amount per annum (the "Dividend") of the Series C Preferred Stock held by
such Holder commencing on the Closing Date and continuing through the date that
no shares of Series C Preferred Stock are held by such Holder. Such cumulative
Dividends shall be payable at the end of each fiscal quarter of the Company in
arrears in cash or additional Series C Preferred Shares, at the Company's
option; provided however, that the Company's option to pay such Dividends in
additional Series C Preferred Shares shall be subject to and contingent upon the
effectiveness of a Registration Statement for the Common Shares underlying the
Series C Preferred Shares and Warrants, and provided further that if the Maximum
Share Amount is reached, the Company shall be required to pay such Dividends in
cash. Dividends on the Series C Preferred Stock shall accrue and be cumulative
on a daily basis from the date payable (with appropriate proration for any
partial dividend period), whether or not earned and whether or not in any
dividend period there shall be surplus or net profits of the Company legally
available for the payment of such dividends. In no event, so long as any
Series C Preferred Stock shall remain outstanding, shall any dividend whatsoever
be declared or paid upon, nor shall any distribution be made upon, any Junior
Securities (as defined below), nor shall any shares of Junior Securities be
purchased or redeemed by the Company nor shall any moneys be paid to or made
available for a sinking fund for the purchase or redemption of any Junior
Securities, without, in each such case, the written consent of the Holders of a
majority of the outstanding shares of Series C Preferred Stock, voting together
as a class.
B. PAYMENT OF DIVIDEND IN SERIES C PREFERRED SHARES. Should the Company
elect to pay accrued but unpaid Dividends in additional shares of Series C
Preferred Stock, the number of Series C Preferred Shares to which the Holder
shall be entitled will be equal to the aggregate cash value of such unpaid
Dividends, divided by the Face Amount.
IV. CONVERSION
A. CONVERSION AT THE OPTION OF HOLDER. Subject to Article V(B),
beginning on the date of issuance of the Series C Preferred Shares, each Holder
may, at any time and from time to time, convert each of its shares of Series C
Preferred Stock into a number of fully paid and nonassessable shares of Common
Stock determined by dividing the aggregate Face Amount of the Series C Preferred
Shares being converted (plus any other amounts payable thereon including,
without limitation, payments due under Section 2(c) of the Registration Rights
Agreement and Conversion Default Payments) by the then applicable Conversion
Price, subject to adjustment as provided in Article X; provided, however, that,
in no event shall a Holder of shares of Series C Preferred Stock be entitled to
convert any such shares to the extent, but only to the extent, that (x) the
number of shares of Common Stock beneficially owned by the Holder and its
affiliates (other than shares of Common Stock which may be deemed beneficially
owned through the ownership of the unconverted portion of the shares of Series C
Preferred Stock or
4.
<PAGE>
unexercised portion of Warrants or any other securities containing analogous
limitations) plus (y) the number of shares of Common Stock issuable upon the
conversion of the shares of Series C Preferred Stock with respect to which the
determination of this proviso is being made, would result in beneficial
ownership by a Holder and such Holder's affiliates of more than 4.99% of the
outstanding shares of Common Stock. For purposes of the proviso to the
immediately preceding sentence, beneficial ownership shall be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and Rules 13(d) through (g) thereunder, except as otherwise provided in
clause (x) of such proviso.
B. MECHANICS OF CONVERSION. To convert the Series C Preferred Shares, a
Holder shall: (i) fax (or deliver by other means resulting in notice) to the
Company a copy of the fully executed Notice of Conversion in the form of Exhibit
H to the Securities Purchase Agreement, and (ii) surrender or cause to be
surrendered to the Company (or satisfy the provisions of Article XIII(A), if
applicable) the certificates representing the Series C Preferred Stock being
converted (the "Series C Preferred Stock Certificates") and the original
executed version of the Notice of Conversion as soon as practicable thereafter.
The date the Holder delivers to the Company the Notice of Conversion described
in clause (i) or such later date specified in the Notice of Conversion shall be
the "Conversion Date." In the case of fax or messenger delivery, delivery shall
be deemed made on the date of such fax or messenger delivery. In the case of
Federal Express, or other overnight mail service, delivery shall be deemed made
the day after the Notice of Conversion is sent. In the case of U.S. Mail,
delivery shall be deemed to be five (5) days after the Notice of Conversion is
deposited in the U.S. Mail.
C. TIMING OF CONVERSION. No later than the third Business Day following
the Conversion Date (the "Delivery Date"), provided that the Company has
received prior to such date the Series C Preferred Stock Certificates (or the
Holder has satisfied the provisions of Article XIII(A), if applicable), the
Company shall issue and deliver to the Holder (or otherwise at such Holder's
direction) that number of shares of Common Stock issuable upon conversion of the
number of Series C Preferred Shares being converted and, if applicable, a new
certificate representing the Series C Preferred Stock not converted by such
Holder. The person or persons entitled to receive shares of Common Stock
issuable upon such conversion shall be treated for all purposes as the record
holder or holders of such shares at the close of business on the Conversion
Date, unless the Notice of Conversion is revoked as provided in Article IV(D).
If the Series C Preferred Stock Certificates are not received (or the provisions
of Article XIII(A) are not satisfied) prior to the Delivery Date, The Delivery
Date shall be extended until the Business Day following the date of surrender to
the Company of Series C Preferred Stock Certificates to be converted or
satisfaction of the provisions of Article XIII(A), if applicable.
D. CONTINUING RIGHTS. In addition to any other remedies which may be
available to the Holder, in the event the Company fails for any reason to effect
delivery to the Holder of certificates representing the shares of Common Stock
receivable upon conversion of the Series C Preferred Shares by the Business Day
following the Delivery Date (which certificates shall be unlegended as and when
required pursuant to the Securities Purchase Agreement, Registration Rights
Agreement referencing this Article Sixth, Section 3, by and among the Company
and the other signatories thereto (the "Registration Rights Agreement") and this
Article Sixth, Section 3), the Holder shall, unless the Holder otherwise elects
to retain its status as a holder of Common Stock by so notifying the Company,
regain the rights of a Holder with respect to such
5.
<PAGE>
unconverted shares of Series C Preferred Stock and the Company shall immediately
return the subject Series C Preferred Stock certificates and other conversion
documents, if any, delivered by Holder, to the Holder, or, if shares of Series C
Preferred Stock have not been surrendered, adjust its records to reflect that
such shares of Series C Preferred Stock have not been converted; provided,
however, that the Company shall remain liable for payment of the amounts
determined pursuant to Article VI(A) hereof for each day falling between the
trading day following the Delivery Date and the date of the revocation notice is
received by the Company, and shall also remain liable for any damages suffered
by Holder.
E. STAMP, DOCUMENTARY AND OTHER SIMILAR TAXES. The Company shall pay all
stamp, documentary, issuance and other similar taxes which may be imposed with
respect to the issuance and delivery of the shares of Common Stock pursuant to
conversion of the Series C Preferred Stock; provided that the Company will not
be obligated to pay stamp, transfer or other taxes resulting from the issuance
of Common Stock to any person other than the registered holder of the Series C
Preferred Stock.
F. NO FRACTIONAL SHARES. No fractional shares of Common Stock are to be
issued upon the conversion of Series C Preferred Stock, but the Company shall
make a cash payment equal to such fraction multiplied by the last sale price of
the Common Stock in respect of any fractional share which would otherwise be
issuable; provided that in the event that sufficient funds are not legally
available for the payment of such cash adjustment any fractional shares of
Common Stock shall be rounded up to the next whole number.
G. ELECTRONIC TRANSMISSION. In lieu of delivering physical certificates
representing the Common Stock issuable upon conversion, provided the Company's
transfer agent is participating in the Depository Trust Company ("DTC") Fast
Automated Securities Transfer program, upon request of a Holder the Company
shall use its best efforts to cause its transfer agent to electronically
transmit the Common Stock issuable upon conversion to the Holder by crediting
the account of Holder's prime broker with DTC through its Deposit Withdrawal
Agent Commission ("DWAC") system. In the case of electronic transmission of
such Common Stock, the Company shall, if applicable, within three (3) Business
Days issue a new certificate representing the Series C Preferred Stock not
converted pursuant to any Notice of Conversion.
V. RESERVATION OF AUTHORIZED SHARES OF COMMON STOCK;
LIMITATION ON NUMBER OF CONVERSION SHARES
A. RESERVATION OF COMMON STOCK. Subject to the provisions of this
Article V, the Company shall at all times reserve and keep available out of its
authorized but unissued shares of Common Stock a sufficient number of shares of
Common Stock to provide for the conversion of all outstanding Series C Preferred
Shares upon issuance of shares of Common Stock and the exercise of all Warrants
(at the then current Conversion Price or Exercise Price) in accordance with
Section 4(g) of the Securities Purchase Agreement (the "Reserved Amount"). The
Reserved Amount shall be increased from time to time in accordance with the
Company's obligations pursuant to Section 4(g) of the Securities Purchase
Agreement. In addition, if the Company shall issue any securities or make any
change in its capital structure which would change the number of shares of
Common Stock into which each share of the Series C Preferred Stock shall be
convertible at the then current Conversion Price, the Company shall at the same
6.
<PAGE>
time also make proper provision so that thereafter there shall be a sufficient
number of shares of Common Stock authorized and reserved, free from preemptive
rights, for conversion of the outstanding Series C Preferred Stock.
B. LIMITATION ON NUMBER OF COMMON SHARES TO BE ISSUED.
(i) Notwithstanding anything to the contrary contained herein, if, at any time,
the aggregate number of shares of Common Stock then issued upon conversion of
the Series C Preferred Stock equals 19.99% of the outstanding Common Stock on
the Closing Date, subject to adjustments for stock dividends, stock splits,
combinations or similar events, the Series C Preferred Stock shall, from that
time forward, cease to be convertible into Common Stock in accordance with the
terms of Article IV, unless the Company (x) has obtained approval of the
issuance of the Series C Preferred Stock by a majority of the total votes
eligible to be cast on such proposal, in person or by proxy, by the holders of
the then-outstanding Common Stock (the "Stockholder Approval"), (y) shall have
otherwise obtained permission to allow such issuances from the American Stock
Exchange or such other principal exchange upon which the Common Stock is then
trading (the "Common Stock Exchange"); or (z) is no longer governed by a rule
promulgated by a stock exchange, Nasdaq or other applicable body prohibiting the
issuance of Common Stock upon conversion of the Series C Preferred Stock in
excess of 19.99% of the outstanding Common Stock without shareholder approval.
The maximum number of shares of Common Stock issuable as a result of the
limitation set forth in the first sentence of this Article V(B) is hereinafter
referred to as the "Maximum Share Amount." With respect to each Holder of
Series C Preferred Stock, the Maximum Share Amount shall refer to such Holder's
pro rata share thereof determined in accordance with Article X below.
Notwithstanding anything in this Article Sixth, Section 3 to the contrary, for
purposes of determining the aggregate number of shares of Common Stock issuable
upon conversion of the Series C Preferred Stock, if the issuance of Common Stock
hereunder is aggregated with the issuance of Common Stock in conversion of the
Series A Convertible Preferred Stock and/or the Series B Convertible Preferred
Stock (collectively, the "Other Series") pursuant to the regulations of the
American Stock Exchange, the shares of Common Stock issuable upon conversion of
the Other Series shall be aggregated with the shares of Common Stock issuable in
conversion of the Series C Preferred Stock in determining the Maximum Share
Amount. The Company will use its best efforts to seek and obtain Stockholder
Approval (or obtain such other relief as will allow conversions hereunder in
excess of the Maximum Share Amount) no later than 120 days following the Closing
Date. In the event that the Company obtains Stockholder Approval, the approval
of the Common Stock Exchange or otherwise concludes that it is able to increase
the number of shares to be issued above the Maximum Share Amount (such increased
number being the "New Maximum Share Amount"), the references to Maximum Share
Amount, above, shall be deemed to be instead, references to the greater New
Maximum Share Amount. In the event that Stockholder Approval is obtained, but
there are insufficient reserved or authorized shares or a registration statement
covering the additional shares of Common Stock which constitute the New Maximum
Share Amount is not effective prior to the Maximum Share Amount being issued (if
such registration statement is necessary to allow for the public resale of such
securities), the Maximum Share Amount shall remain unchanged; provided, however,
that the Holder may grant an extension to obtain a sufficient reserved or
authorized amount of shares or of the period for obtaining effectiveness of such
registration statement. Notwithstanding anything in this Article V(B)(i) to the
contrary, and subject to Article V(B)(ii) below, the Company shall only be
required to issue a number of shares of Common Stock upon conversion of the
Series C Preferred Stock equal to (p) the
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original aggregate Face Amount of all Series C Preferred Stock issued on the
Closing Date divided by (q) 50% of the Closing Price (exclusive of any shares of
Common Stock issuable upon conversion of the Other Series), subject to
adjustments for stock dividends, stock splits, combinations or similar events
(the "Maximum Share Amount Cap").
(ii) Notwithstanding anything in this Article Sixth, Section 3 to
the contrary, in the event the Maximum Share Amount is reached as a result of
conversions of the Series C Preferred Stock or any Other Series, the Company
shall honor any request for conversion of the Series C with a payment in cash
equal to the number of shares of Common Stock that would have otherwise been
issued upon such conversion multiplied by the five day average Closing Bid Price
of the Common Stock on the date of delivery of the Conversion Notice; provided
that, no such payment shall be made in the event the Maximum Share Amount Cap is
reached. Any cash payment made pursuant to this paragraph shall be counted
toward the Maximum Share Amount Cap as if such conversion was effected by the
issuance of shares of Common Stock. If the Maximum Share Amount Cap is reached
the Company must within ten (10) business days either (x) provide irrevocable
notice to the Company that it will redeem all of the outstanding shares of
Series C Preferred Stock at the Face Amount thereof plus any accrued and unpaid
dividends and other payments thereon as provided by Article VII(C)(ii), and so
redeem the Series C Preferred Stock within one hundred eighty (180) days
following such notice, or (y) so long as the Stockholder Approval has been
obtained, provide irrevocable notice to the Holders that the Company will honor
Notices of Conversion that will result in the issuance of shares of Common Stock
in excess of the Maximum Share Amount Cap, and thereafter honor such conversions
without reference to the Maximum Share Amount Cap or (z) if Shareholder Approval
has not been obtained within 120 days of the issuance of the Series C Preferred
Stock, provide irrevocable notice to the Holders that the Company will honor
Notice of Conversion in excess of the Maximum Share Amount Cap if such
conversions do not violate the rules and regulations of the applicable stock
exchange or quotation system on which the Common Stock is then traded (but only
to the extent such rules or regulations would not be violated); provided,
however, that for purposes of this clause (z), in the event the Maximum Share
Amount is reached, the Company will redeem the Series C Preferred Stock in
accordance with Article (V)(B)(ii)(x) above.
C. ALLOCATION OF RESERVED AMOUNT, MAXIMUM SHARE AMOUNT. The Reserved
Amount and the Maximum Share Amount shall be allocated among the initial Holders
according to the number of Series C Preferred Shares issued to each such Holder
on the Closing Date. Any Common Shares which were initially allocated to any
Holder remaining after such Holder no longer owns any Series C Preferred Shares
shall be allocated among the remaining Holders pro rata, based on the number of
Series C Preferred Shares then held by such Holders.
VI. FAILURE TO CONVERT
A. If, at any time, (x) a Notice of Conversion has been sent to the
Company and the Company fails for any reason to deliver, on or prior to the
third Business Day following the expiration of the Delivery Date for such
conversion (said period of time being the "Extended Delivery Period"), such
number of shares of Common Stock to which such Holder is entitled (taking into
account the limitations on conversions imposed by such Holder's allocated
portion of the Maximum Share Amount) upon such conversion, or (y) the Company
provides notice
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(including by way of public announcement) (the "Refusal Notice") to any Holder
at any time of its intention not to issue shares of Common Stock upon exercise
by any Holder of its conversion rights in accordance with the terms of this
Article Sixth, Section 3 (each of (x) and (y) being a "Conversion Default"),
then the Company shall pay to the affected Holder, in the case of a Conversion
Default described in clause (x) above, and to all Holders, in the case of a
Conversion Default described in clause (y) above, an amount equal to 1% of the
Face Amount of the Series C Preferred Stock held by such Holder with respect to
which the Conversion Default exists (which amount shall be deemed to be the
aggregate Face Amount of all outstanding Series C Preferred Stock in the case of
a Conversion Default described in clause (y) above) for each day thereafter
until the Cure Date. "Cure Date" means (i) with respect to a Conversion Default
described in clause (x) of its definition or if a Conversion Notice has been
submitted and the Company has issued a Refusal Notice, the date the Company
effects the conversion of the portion of the Series C Preferred Stock submitted
for conversion and (ii) if no Conversion Notices have been submitted, with
respect to a Conversion Default described in clause (y) of its definition, the
date the Company undertakes in writing to issue Common Stock in satisfaction of
all conversions of Series C Preferred Stock in accordance with the terms of this
Article Sixth, Section 3. The Company shall promptly provide each Holder with
notice of the occurrence of a Conversion Default with respect to any of the
other Holders.
The payments to which a Holder shall be entitled pursuant to this Section
VI(A) are referred to herein as "Conversion Default Payments." Conversion
Default Payments shall be paid in cash. Such payment shall be made in
accordance with and be subject to the provisions of Article XIII(B).
VII. REDEMPTION DUE TO CERTAIN EVENTS
A. REDEMPTION EVENTS. A "Redemption Event" means any one of the
following (after expiration of any applicable cure period):
(i) the Company fails, and any such failure continues uncured for
seven (7) Business Days after the Company has been notified thereof in writing
by the Holder, to (x) remove any restrictive legend on any certificate for any
shares of Common Stock issued after the Effective Date to the Holders upon
conversion of the Series C Preferred Stock or upon exercise of the Warrants, or
(y) to transfer or cause its transfer agent to transfer any certificate for
shares of Common Stock issued to a Holder upon conversion of the Series C
Preferred Stock, in each case as and when required by this Article Sixth,
Section 3, the Warrants, the Securities Purchase Agreement or the Registration
Rights Agreement; or
(ii) the Company fails to fulfill it obligations pursuant to
Sections 4(c), 4(g), 4(i) or 5 of the Purchase Agreement (or makes any
announcement, statement or threat that it does not intend to honor the
obligations described in this paragraph) and any such failure shall continue
uncured (or any announcement, statement or threat not to honor its obligations
hall not be rescinded in writing) for ten (10) days after the Corporation shall
have been notified thereof in writing by any holder of Series C Preferred Stock;
or
(iii) the Company fails to make any payment due pursuant to Article
VII(C) when due; or
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(iv) the Company fails to fulfill any of its obligations pursuant
to the Registration Rights Agreement (or makes any statement that it does not
intend to honor such obligations) and any such failure shall continue uncured
(or any statement not to honor its obligations shall not be rescinded) for ten
(10) business days; or
(v) the Company (x) fails to cause the Registration Statement to
be declared effective on or before the date that is one hundred eighty (180)
days following the Closing Date, or (y) such Registration Statement lapses in
effect (or sales cannot be made by the Holders thereunder, whether by reason of
the Company's failure to amend or supplement the prospectus included therein in
accordance with the Registration Rights Agreement or otherwise) for more then
forty-five (45) consecutive days or seventy-five (75) days in any twelve (12)
month period after such Registration Statement becomes effective, or (z) the
Common Stock is not listed or included for quotation on the Nasdaq, NYSE, AMEX
or that trading is halted after the Registration Statement has been declared
effective for more than an aggregate of twenty (20) trading days or more in any
twelve (12) month period.
B. REDEMPTION OF HOLDER'S SHARES. Upon the occurrence and during the
continuation of any Redemption Event, the Company shall, as to each Holder of
the then outstanding shares of Series C Preferred Stock who have given written
notice (the "Optional Redemption Notice") to the Company of such Redemption
Event, purchase each such Holder's shares of Series C Preferred Stock for an
amount per share equal to the greater of (1) 120% multiplied by the sum of (a)
the Face Amount of the shares to be redeemed, plus (b) accrued and unpaid
dividends and any other amounts payable thereon (including without limitation
payments due under Section 2 of the Registration Rights Agreement and Conversion
Default Payments) through the date of payment of the Optional Redemption Amount
(as defined herein) (the "Optional Redemption Date") and (2) the "Parity Value"
of the shares to be redeemed (the greater of such amounts being the "Optional
Redemption Amount"); provided that if such Redemption Event is pursuant to
Article VII(A)(v), the Company may, at its sole option, in lieu of the foregoing
purchase, pay the Holder an amount equal to the Default Amount (as defined
below) multiplied by the number of shares of Series C Preferred Stock held by
such holder on the date of the Optional Redemption Notice. "Parity Value" means
the product of (a) the highest number of shares of Common Stock issuable upon
conversion of such shares at such time (treating the Trading Day immediately
preceding the Optional Redemption Date as the "Conversion Date" (as hereinafter
defined), unless the Redemption Event arises as a result of a breach in respect
of a specific Conversion Date in which case such Conversion Date shall be the
Conversion Date), multiplied by (b) the highest closing sale price for the
Common Stock on the principal trading market for such shares during the period
beginning on the date of first occurrence of the Redemption Event and ending on
such "Conversion Date." "Default Amount" shall mean Fifty U.S. Dollars ($50).
In the case of a Redemption Event, if the Company fails to pay the Default
Amount or the Optional Redemption Amount, as applicable, for each share within
five (5) business days of written notice that such amount is due and payable,
then (assuming there are sufficient authorized shares) in addition to all other
available remedies, each holder of Series C Preferred Stock shall have the right
at any time, so long as the Redemption Event continues, to require the Company,
upon written notice, to immediately issue (in accordance with and subject to the
terms of Article V above), in lieu of the Default Amount or the Optional
Redemption Amount, as applicable, with respect to each outstanding share of
Series C Preferred Stock held by such
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holder, the number of shares of Common Stock of the Company equal to the Default
Amount or the Optional Redemption Amount, as applicable, divided by any
Conversion Price, as chosen in the sole discretion of the Holder, in effect from
the date of the Redemption Event until the date such Holder elects to exercise
its rights pursuant to this paragraph. Payment of the Default Amount shall not
affect the holders ongoing rights with respect to the then outstanding shares of
Series C Preferred Stock or the rights of such holders to pursue alternate
damages in respect of the events giving rise to such payments.
C. REDEMPTION OF HOLDER'S SHARES. Upon the occurrence and during the
Optional Redemption by the Company. So long as (i) all of the shares of Common
Stock issuable upon conversion of all outstanding shares of Series C Preferred
Stock, for a period of twenty (20) days prior to the date of delivery of any
written notice of redemption pursuant to Article VII(C), are then (x) authorized
and reserved for issuance, (y) registered for re-sale under the 1933 Act by the
Holders (or may otherwise be resold publicly without restriction); provided,
however, that this clause (y) shall not apply to any redemption made with the
proceeds from a Qualified Offering (as defined), and (z) eligible to be traded
on Nasdaq, the NYSE, the AMEX or Nasdaq SmallCap and (ii) there is not then a
continuing Redemption Event in effect the Company may, at its option, upon
twenty (20) Business Days' irrevocable written notice, redeem the Series C
Preferred Stock, as follows:
(i) Beginning upon the earlier to occur of (a) the date that the
Company completes an underwritten public offering of its Common Stock or Rule
144A offering to "qualified institutional buyers" and "accredited institutional
investors" in an amount of at least $10,000,000 (a "Qualified Offering"), or (b)
the date that is eighteen months following the Closing Date, the Company may, at
its option, redeem for cash out of funds legally available therefor, all (but
not less than all) of the outstanding Series C Preferred Shares at 110% of the
Face Amount of the Series C Preferred Shares during the first 12 months
following issuance, and thereafter 120% of the Face Amount of the Series C
Preferred Shares, in each case plus accrued and unpaid dividends, if any, and
any other amounts payable thereon.
(ii) Beginning on the date any Holder reaches such Holder's Maximum
Share Amount, the Company may, at its option, redeem for cash out of funds
legally available therefor, all (but not less than all) of the outstanding
shares of Series C Preferred Stock held by the Holder who has reached its
Maximum Share Amount at a price per share equal to 100% of the Face Amount such
shares of Series C Preferred Stock plus accrued and unpaid dividends, if any,
and any other amounts payable thereon.
Nothing in this Article VII(C) shall prohibit conversions of Series C
Preferred Stock otherwise permitted pursuant to the terms of this Article Sixth,
Section 3 during the pendency of any notice of optional redemption by the
Company hereunder.
D. MATURITY; REQUIRED REDEMPTION. Subject to the limitations contained
in Article VII(F) and so long as there is not then a continuing Redemption
Event, hereof each share of Series C Preferred Stock outstanding on the third
anniversary of the Closing Date (the "Maturity Date") will be redeemed at the
Company's sole option, (a) so long as the Company has provided the Holders ten
(10) business days prior written notice of its election to pay cash on the
Maturity Date, in cash equal to the aggregate face value thereof plus accrued
and unpaid dividends, if any,
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and any other amounts payable thereon or, (b) by delivery of a number of shares
of Common Stock issuable upon conversion of all of the Series C Preferred Stock
at the lesser of the then-applicable Conversion Price and the five trading day
average closing bid price on the Maturity Date, including any adjustment under
Article X; provided that (i) any necessary approval for the issuance of
additional shares has been obtained if the Maximum Share Amount has been reached
(or will be exceeded as a result of any conversion at maturity), and (ii) all
shares of Common Stock issuable upon conversion of all outstanding shares of
Series C Preferred Stock are then (x) authorized and reserved for issuance, (y)
registered under the Securities Act for resale by all Holders of such Series C
Preferred Shares and (z) eligible to be traded on either the Nasdaq, Nasdaq
Small Cap Market, the New York Stock Exchange or the American Stock Exchange.
The Maturity Date shall be delayed by one (1) Trading Day each for each Trading
Day occurring prior thereto and prior to the full conversion of the Series C
Preferred Stock that (i) sales cannot be made pursuant to the Registration
Statement (whether by reason of the Company's failure to properly supplement or
amend the prospectus included therein in accordance with the terms of the
Registration Rights Agreement or otherwise), (ii) any Redemption Event (as
defined in Article V(A) exists, without regard to whether any cure periods shall
have run or (iii) that the Company is in breach of any of its obligations
pursuant to Section 4(g) of the Purchase Agreement.
E. REDEMPTION DEFAULTS. If the Company fails to pay any Holder the
redemption consideration with respect to any share of Series C Preferred Stock,
as provided in this Article VII, within five (5) Business Days of its receipt or
delivery, as applicable, of a notice requiring such redemption (the "Redemption
Notice"), then each Holder (i) shall be entitled to interest on the redemption
consideration not paid at a per annum rate equal to the lower of (x) the sum of
prime rate published from time to time by the Wall Street Journal plus three
percent (3%) and (y) the highest interest rate permitted by applicable law from
the date of the Redemption Notice until the date of redemption hereunder. In
the event the Company is not able to redeem all of the shares of Series C
Preferred Stock subject to Redemption Notices, the Company shall redeem shares
of Series C Preferred Stock from each Holder, pro rata, based on the total
number of shares of Series C Preferred Stock included in the Redemption Notice
relative to the total number of shares of Series C Preferred Stock in all of the
Redemption Notices. In the case of a Redemption Event, if the Company fails to
pay the Optional Redemption Amount for each share for any reason (including,
without limitation, the circumstances specified in Article VII(F)), within five
(5) Business Days of the applicable Redemption Notice then (assuming there are
sufficient authorized shares) in addition to all other available remedies, each
Holder of Series C Preferred Stock shall have the right at any time, so long as
the Redemption Event continues, to convert, upon written notice, in lieu of the
Redemption Amount, each outstanding share of Series C Preferred Stock held by
such Holder, into the number of shares of Common Stock of the Company equal to
the Redemption Amount, divided by the Conversion Price then in effect, subject
in all cases to each such Holder's Maximum Share Amount.
F. CAPITAL IMPAIRMENT. In the event that any section of the
DelawareGeneral Corporation Law ("DGCL"), would be violated by the redemption of
any shares of Series C Preferred Stock that are otherwise subject to redemption
pursuant to this Article VII, the Company: (i) will redeem the greatest number
of shares of Series C Preferred Stock possible without violation of said
Article; (ii) the Company thereafter shall use its best efforts to take all
necessary steps permitted pursuant to this Article Sixth, Section 3 and the
agreements entered
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into in connection with the issuance of Series C Preferred Stock pursuant hereto
in order to remedy its capital structure in order to allow further redemptions
without violation of said Article; and (iii) from time to time thereafter as
promptly as possible the Company shall redeem shares of Series C Preferred Stock
at the request of the Holders to the greatest extent possible without causing a
violation of the DGCL.
VIII. RANK; PARTICIPATION
A. RANK. All shares of the Series C Preferred Stock shall rank (i) prior
to the Common Stock; (ii) prior to any class or series of capital stock of the
Company hereafter created (unless, with the consent of the Holders of a majority
of the outstanding shares of Series C Preferred Stock obtained in accordance
with Article XII hereof, such class or series of capital stock specifically, by
its terms, ranks senior to or pari passu with the Series C Preferred Stock)
(collectively, with the Common Stock, "Junior Securities"); (iii) pari passu
with the Other Series, and any class or series of capital stock of the Company
hereafter created (with the consent of the Holders of a majority of the
outstanding shares of Series C Preferred Stock obtained in accordance with
Article XII hereof, if required) specifically ranking, by its terms, on parity
with the Series C Preferred Stock (the "Pari Passu Securities"); and (iv) junior
to any class or series of capital stock of the Company hereafter created (with
the consent of the Holders of a majority of the outstanding shares of Series C
Preferred Stock obtained in accordance with Article XII hereof) specifically
ranking, by its terms, senior to the Series C Preferred Stock (the "Senior
Securities"), in each case as to distribution of assets upon liquidation,
dissolution or winding up of the Company, whether voluntary or involuntary.
B. PARTICIPATION. Subject to the rights of the Holders (if any) of Pari
Passu Securities and Senior Securities, the Holders shall, as such Holders, be
entitled to such dividends paid and distributions made to the Holders of Common
Stock to the same extent as if such Holders had converted their shares of
Series C Preferred Stock into Common Stock (without regard to any limitations on
conversion herein or elsewhere contained) and had been issued such Common Stock
on the day before the record date for said dividend or distribution. Payments
under the preceding sentence shall be made concurrently with the dividend or
distribution to the Holders of Common Stock.
IX. LIQUIDATION PREFERENCE
A. LIQUIDATION OF THE COMPANY. If the Company shall commence a voluntary
case under the U.S. Federal bankruptcy laws or any other applicable bankruptcy,
insolvency or similar law, or consent to the entry of an order for relief in an
involuntary case under any law or to the appointment of a receiver, liquidator,
assignee, custodian, trustee, sequestrator (or other similar official) of the
Company or of any substantial part of its property, or make an assignment for
the benefit of its creditors, or admit in writing its inability to pay its debts
generally as they become due, or if a decree or order for relief in respect of
the Company shall be entered by a court having jurisdiction in the premises in
an involuntary case under the U.S. Federal bankruptcy laws or any other
applicable bankruptcy, insolvency or similar law resulting in the appointment of
a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other
similar official) of the Company or of any substantial part of its property, or
ordering the winding up or liquidation of its affairs, and any such decree or
order shall be unstayed and in effect for a period of sixty (60) consecutive
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days and, on account of any such event, the Company shall liquidate, dissolve or
wind up, or if the Company shall otherwise liquidate, dissolve or wind up (a
"Liquidation Event"), no distribution shall be made to the Holders of any shares
of capital stock of the Company (other than Senior Securities and, together with
the Holders of Series C Preferred Stock the Pari Passu Securities) upon
liquidation, dissolution or winding up unless prior thereto the Holders shall
have received the Liquidation Preference (as herein defined) with respect to
each Series C Preferred Share. If, upon the occurrence of a Liquidation Event,
the assets and funds available for distribution among the Holders and holders of
Pari Passu Securities shall be insufficient to permit the payment to such
Holders of the preferential amounts payable thereon, then the entire assets and
funds of the Company legally available for distribution to the Series C
Preferred Stock and the Pari Passu Securities shall be distributed ratably among
such shares in proportion to the ratio that the Liquidation Preference payable
on each such share bears to the aggregate Liquidation Preference payable on all
such shares.
B. CERTAIN ACTS NOT A LIQUIDATION. The purchase or redemption by the
Company of stock of any class, in any manner permitted by law, shall not, for
the purposes hereof, be regarded as a liquidation, dissolution or winding up of
the Company. Neither the consolidation or merger of the Company with or into
any other entity nor the sale or transfer by the Company of less than
substantially all of its assets shall, for the purposes hereof, be deemed to be
a liquidation, dissolution or winding up of the Company.
C. DEFINITION OF LIQUIDATION PREFERENCE. The "Liquidation Preference"
with respect to a share of Series C Preferred Stock means an amount equal to the
Face Amount thereof plus any other amounts that may be due from the Company with
respect thereto, including any accrued and unpaid dividends, pursuant to this
Article Sixth, Section 3 or the Registration Rights Agreement through the date
of final distribution. The Liquidation Preference with respect to any Pari
Passu Securities shall be as set forth in the Article Sixth, Section 3 filed in
respect thereof.
X. ADJUSTMENTS TO THE CONVERSION PRICE; CERTAIN PROTECTIONS
The Conversion Price shall be subject to adjustment from time to time as
follows:
A. STOCK SPLITS, STOCK DIVIDENDS, ETC. If at any time on or after the
Closing Date, the number of outstanding shares of Common Stock is increased by a
stock split, stock dividend, reclassification or other similar event, the number
of shares of Common Stock issuable upon conversion of the Series C Preferred
Shares shall be proportionately increased, or if the number of outstanding
shares of Common Stock is decreased by a reverse stock split, combination or
reclassification of shares, or other similar event, the number of shares of
Common Stock issuable upon conversion of the Series C Preferred Shares shall be
proportionately reduced. In such event, the Company shall notify the Company's
transfer agent of such change on or before the effective date thereof.
B. MAJOR TRANSACTIONS. If the Company shall consolidate with or merge
into any corporation, sell all or substantially all of its assets, effectuate a
transaction or series of transactions in which 50% or more of the voting power
of the Company is disposed of or reclassify its outstanding shares of Common
Stock (other than by way of subdivision or reduction of such shares) (each a
"Major Transaction"), then each Holder shall thereafter be
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entitled to receive consideration, in exchange for each share of Series C
Preferred Stock held by it, equal to the greater of, as determined in the sole
discretion of the Holders of at least 50.1% of the outstanding shares of
Series C Preferred Stock: (i) the number of shares of stock or securities or
property of the Company, or of the entity resulting from such consolidation or
merger (the "Major Transaction Consideration"), to which a Holder of the number
of shares of Common Stock delivered upon conversion of such shares of Series C
Preferred Stock would have been entitled upon such Major Transaction (without
regard to any limitations on conversion herein contained) and had such Common
Stock been issued and outstanding and had such Holder been the holder of record
of such Common Stock at the time of such Major Transaction, and the Company
shall make lawful provision therefore as a part of such consolidation, merger or
reclassification; and (ii) the Redemption Amount, in cash. No sooner than ten
(10) days nor later than five (5) days prior to the consummation of the Major
Transaction, but not prior to the public announcement of such Major Transaction,
the Company shall deliver written notice ("Notice of Major Transaction") to each
Holder, which Notice of Major Transaction shall be deemed to have been delivered
one (1) Business Day after the Company's sending such notice by telecopy
(provided that the Company sends a confirming copy of such notice on the same
day by overnight courier). Such Notice of Major Transaction shall indicate the
amount and type of the Major Transaction Consideration which such Holder would
receive under clause (i) of this Article X(B). If the Major Transaction
Consideration does not consist entirely of United States dollars, the value of
such other property shall be determined by a reputable accounting firm selected
by the Company that is reasonably acceptable the Holders of a majority of the
outstanding shares of Series C Preferred Stock.
C. ADJUSTMENT DUE TO DISTRIBUTION. If at any time after the Closing
Date, the Company shall declare or make any distribution of its assets (or
rights to acquire its assets) to holders of Common Stock as a partial
liquidating dividend, by way of return of capital or otherwise (including any
dividend or distribution to the Company's stockholders in cash or shares (or
rights to acquire shares) of capital stock of a subsidiary (i.e. a spin-off)) (a
"Distribution"), then the minimum Conversion Price per share shall be reduced by
the value of such Distribution per share. If the Distribution does not consist
entirely of U.S. Dollars, the value of such other property shall be determined
by a reputable accounting firms selected by the Company that is reasonably
acceptable to the Holders of a majority of the outstanding shares of Series C
Preferred Stock.
D. PURCHASE RIGHTS. If at any time after the Closing Date, the Company
issues any Convertible Securities or rights to purchase stock, warrants,
securities or other property (the "Purchase Rights") pro rata to the record
holders of any class of Common Stock, then the Holders will be entitled to
acquire, upon the terms applicable to such Purchase Rights, the aggregate
Purchase Rights which such Holder could have acquired if such Holder had held
the number of shares of Common Stock acquirable upon complete conversion of the
Series C Preferred Stock (without regard to any limitations on conversion or
exercise herein or elsewhere contained) immediately before the date on which a
record is taken for the grant, issuance or sale of such Purchase Rights, or, if
no such record is taken, the date as of which the record holders of Common Stock
are to be determined for the grant, issue or sale of such Purchase Rights.
E. ADJUSTMENT TO CONVERSION PRICE. If at any time when Series C
Preferred Stock is issued and outstanding, the number of outstanding shares of
Common Stock is increased or
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decreased by a stock split, stock dividend, combination, reclassification,
below-market price rights offering to all holders of Common Stock or other
similar event, which event shall have taken place during the reference period
for determination of the Conversion Price for the Series C Preferred Stock, then
the Conversion Price shall be calculated giving appropriate effect to the stock
split, stock dividend, combination, reclassification or other similar event
during the calculation period preceding the Conversion Date. In such event, the
Company shall notify the Transfer Agent of such change on or before the
effective date thereof.
F. ADJUSTMENT FOR RESTRICTED PERIODS. If (i) the Company fails to obtain
effectiveness of the Registration Statement prior to ninety (90) days following
the Closing Date, or (ii) the Registration Statement, once effective, lapses in
effect, or sales cannot otherwise be made thereunder, whether by reason of the
Company's failure or inability to amend or supplement the prospectus included
therein ("Prospectus") in accordance with the Registration Rights Agreement or
otherwise, then the 20 trading days period ("Lookback Period") used for
determining the "Market Price" shall be extended to include (x) in the case of
an event described in clause (i), the 20 trading days immediately preceding the
90th day following the Closing Date plus all Trading Days through and including
the date of effectiveness of the Registration Statement, and (y) in the case of
an event described in clause (ii), the number of trading days preceding the date
on which the Holder is first notified that sales may not be made under the
Prospectus, which would otherwise then be included in the Lookback Period plus
all trading days through and including the date on which the Holder is notified
that sales may again be made under the Prospectus. If a Holder of the Series C
Preferred Stock reasonably determines that sales may not be made pursuant to the
Prospectus, it shall notify the Company in writing and, unless the Company
provides Holder with an opinion of Company's counsel to the contrary, such
determination shall be binding for purposes of this paragraph.
G. ADJUSTMENT TO CONVERSION PRICE UPON ANNIVERSARY DATE. If the average
of the Closing Bid Prices of the Common Stock over the twenty (20) consecutive
trading days immediately preceding the Anniversary Date is greater than 130% of
the Closing Price, then beginning on the Anniversary Date, the Conversion Price
will be reset to 130% of the Closing Price.
H. ADJUSTMENT TO CONVERSION PRICE FOR MAJOR ANNOUNCEMENTS. In the event
the Company (i) makes a public announcement that it intends to consolidate or
merge with any other corporation (other than a merger in which the Company is
the surviving or continuing corporation and its capital stock is unchanged) or
sell or transfer all or substantially all of the assets of the Company or (ii)
any person, group or entity (including the Company) publicly announces a tender
offer to purchase 50% or more of the Company's Common Stock or otherwise
publicly announces an intention to replace a majority of the Company's Board of
Directors by waging a proxy battle or otherwise (the date of the announcement
referred to in clause (i) or (ii) is hereinafter referred to as the
"Announcement Date"), then the Conversion Price shall, effective upon the
Announcement Date and continuing through the Adjusted Conversion Price
Termination Date (as defined below), be equal to the lower of (x) the Conversion
Price which would have been applicable for an Optional Conversion occurring on
the Announcement Date and (y) the Conversion Price that would otherwise be in
effect. From and after the Adjusted Conversion Price Termination Date, the
Conversion Price shall be determined as set forth in Article II. For purposes
hereof, "Adjusted Conversion Price
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Termination Date" shall mean, with respect to any proposed transaction, tender
offer or removal of the majority of the Board of Directors which a public
announcement as contemplated by this Article X(H) has been made, the date upon
which the Company (in the case of clause (i) above) or the person, group or
entity (in the case of clause (ii) above) consummates or publicly announces the
termination or abandonment of the proposed transaction or tender offer which
caused this Article X(H) to become operative. Adjustment to Conversion Price for
Major Announcements.
I. NOTICE OF ADJUSTMENTS. Upon the occurrence of each adjustment or
readjustment of the Conversion Price pursuant to this Section X, the Company, at
its expense, shall promptly compute such adjustment or readjustment and prepare
and furnish to each Holder a certificate setting forth such adjustment or
readjustment and showing in detail the facts upon which such adjustment or
readjustment is based. The Company shall, upon the written request at any time
of any Holder, furnish to such Holder a like certificate setting forth (i) such
adjustment or readjustment, (ii) the Conversion Price at the time in effect and
(iii) the number of shares of Common Stock and the amount, if any, of other
securities or property which at the time would be received upon conversion of a
share of Series C Preferred Stock.
XI. VOTING RIGHTS
No Holder of the Series C Preferred Stock shall be entitled to vote on any
matter submitted to the shareholders of the Company for their vote, waiver,
release or other action, except as may be otherwise expressly required by law.
XII. PROTECTION PROVISIONS
So long as any Series C Preferred Shares are outstanding, the Company shall
not, without first obtaining the approval of the Holders of majority of the
outstanding shares of Series C Preferred Stock: (a) alter or change the rights,
preferences or privileges of the Series C Preferred Stock; (b) alter or change
the rights, preferences or privileges of any capital stock of the Company so as
to affect adversely the Series C Preferred Stock; (c) create or issue any Senior
Securities; (d) create or issue any Pari Passu Securities (except for Pari Passu
Securities that are convertible preferred securities with a fixed conversion
price at a premium to the market price of the Common Stock at the date of
issuance), (e) increase the authorized number of shares of Series C Preferred
Stock; (f) increase the par value of the Common Stock; or (g) do any act or
thing not authorized or contemplated by this Article Sixth, Section 3 which
would result in any taxation with respect to the Series C Preferred Stock under
Section 305 of the Internal Revenue Code of 1986, as amended, or any comparable
provision of the Internal Revenue Code as hereafter from time to time amended,
(or otherwise suffer to exist any such taxation as a result thereof).
XIII. MISCELLANEOUS
A. LOST OR STOLEN CERTIFICATES. Upon receipt by the Company of (i)
evidence of the loss, theft, destruction or mutilation of any Series C Preferred
Stock Certificate(s) and (ii) (y) in the case of loss, theft or destruction, of
indemnity reasonably satisfactory to the Company, or (z) in the case of
mutilation, upon surrender and cancellation of the Series C Preferred Stock
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Certificate(s), the Company shall execute and deliver new Series C Preferred
Stock Certificate(s) of like tenor and date. However, the Company shall not be
obligated to reissue such lost, stolen, destroyed or mutilated Series C
Preferred Stock Certificate(s) if the Holder contemporaneously requests the
Company to convert such Series C Preferred Stock.
B. PAYMENT OF CASH; DEFAULTS. Whenever the Company is required to make
any cash payment to a Holder under this Article Sixth, Section 3 (as a
Conversion Default Payment, Redemption Amount or otherwise), such cash payment
shall be made to the Holder by the method (by certified or cashier's check or
wire transfer of immediately available funds) elected by such Holder. If such
payment is not delivered when due such Holder shall thereafter be entitled to
interest on the unpaid amount until such amount is paid in full to the Holder at
a per annum rate equal to the lower of (x) the sum of prime rate published from
time to time by the Wall Street Journal plus three percent (3%) and (y) the
highest interest rate permitted by applicable law.
C. REMEDIES, CHARACTERIZATIONS, OTHER OBLIGATIONS, BREACHES AND
INJUNCTIVE RELIEF. The remedies provided in this Article Sixth, Section 3 shall
be cumulative and in addition to all other remedies available under this Article
Sixth, Section 3, at law or in equity (including a decree of specific
performance and/or other injunctive relief), no remedy contained herein shall be
deemed a waiver of compliance with the provisions giving rise to such remedy and
nothing herein shall limit a Holder's right to pursue actual damages for any
failure by the Company to comply with the terms of this Article Sixth,
Section 3. Company covenants to each Holder that there shall be no
characterization concerning this instrument other than as expressly provided
herein; provided, however, that the Company shall be entitled to prepare
summaries of this Article Sixth, Section 3 for purposes of complying with its
disclosure obligations and in connection with bona fide disputes as to the
operations of the provisions of this Article Sixth, Section 3.
D. FAILURE OR INDULGENCY NOT WAIVER. No failure or delay on the part of
a Holder in the exercise of any power, right or privilege hereunder shall
operate as a waiver thereof, nor shall any single or partial exercise of any
such power, right or privilege preclude other or further exercise thereof or of
any other right, power or privilege.
E. NOTICES. Any notice from a Holder to the Company hereunder shall be
given to the Company in accordance with Section 8(f) of the Securities Purchase
Agreement. Any notices from the Company to a Holder shall be given to such
Holder at such Holder's address as shown in the stock register of the Company
and otherwise in accordance with Section 8(f) of the Securities Purchase
Agreement.
4. The rights and privileges of the Series D Convertible Preferred Stock
are as follows. All references to Articles and Sections within this Article
Sixth, Section 4 are solely to Articles and Sections within this Article Sixth,
Section 4.
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I. DESIGNATION AND AMOUNT
The designation of this series, which consists of 10,000 shares of
Preferred Stock, is the Series D Convertible Preferred Stock (the "Series D
Preferred Stock" or "Series D Preferred Shares") and the face amount per share
shall equal $1,000 (the "Face Amount").
II. CERTAIN DEFINITIONS
For purposes of this Article Sixth, Section 4, the following terms shall
have the following meanings:
"Anniversary Date" means the date that is 9 months following the Closing
Date.
"Business Day" means any day other than a Saturday, Sunday or a day on
which banks in New York, New York are permitted or required by law to be closed.
"Closing Bid Price" means, for any security as of any date, the closing bid
price of such security on the principal securities exchange or trading market
where such security is listed or traded as reported by Bloomberg Financial
Markets or a comparable reporting service of national reputation selected by the
Company and reasonably acceptable to the Holders then holding a majority of the
outstanding shares of Series D Preferred Stock ("Majority Holders"), if
Bloomberg Financial Markets is not then reporting closing bid prices of such
security (collectively, "Bloomberg"), or if the foregoing does not apply, the
last reported sale price of such security in the over-the-counter market on the
electronic bulletin board of such security as reported by Bloomberg, or, if no
sale price is reported for such security by Bloomberg, the average of the bid
prices of any market makers for such security that are listed in the "pink
sheets" by the National Quotation Bureau, Inc. If the Closing Bid Price cannot
be calculated for such security on such date on any of the foregoing bases, the
Closing Bid Price of such security on such date shall be the fair market value
as mutually determined by the Company and the Majority Holders, or, if they are
unable to agree on such value, it shall be determined by an investment banking
firm selected by the Company and reasonably acceptable to the Majority Holders.
"Closing Date" means the date on which the Series D Preferred Shares are
initially issued.
"Closing Price" means the average Closing Bid Price of the Common Stock
over the five trading days immediately preceding the Closing Date.
"Common Stock" means the common stock, $0.01 par value, of the Company.
"Conversion Price", subject to the adjustments provided for in Article X
hereof, means (1) on and prior to the Anniversary Date, 120% of the Closing
Price and (2) beginning on the day following the Anniversary Date, the lesser of
(i) 120% of the Closing Price and (ii) the Market Price at the time of
conversion.
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"Effective Date" means the date the Registration Statement registering the
resale of the shares of Common Stock into which the Series D Preferred Shares
are convertible is declared effective by the Securities and Exchange Commission.
"Holders" means the initial Holders of the Series D Preferred Stock and
their permitted transferees.
"majority of the outstanding shares of Series D Preferred Stock" means
greater than 66.6% of the outstanding shares of Series D Preferred Stock.
"Market Price" means the volume weighted average price of the Common Stock
over any five trading days, selected by the Holder, in the 30 trading days
ending on the day prior to the Conversion Date.
"Registration Deadline" means the 90th day following the Closing Date.
"Registration Statement" means a registration statement filed with the
Securities and Exchange Commission under the Securities Act of 1933, as amended.
"Securities Purchase Agreement" means the Securities Purchase Agreement
referencing this Article Sixth, Section 4, among the Company and the purchasers
named therein, as amended from time to time in accordance with the terms
thereof.
"Warrants" means certain stock purchase warrants to acquire shares of
Common Stock issued by the Company to the initial Holders in connection with the
transactions contemplated by the Securities Purchase Agreement.
III. DIVIDENDS
A. GENERAL. Each Holder of the Series D Preferred Stock shall be
entitled to receive cumulative dividends at the rate of five percent (5%) of the
Face Amount per annum (the "Dividend") of the Series D Preferred Stock held by
such Holder commencing on the Closing Date and continuing through the date that
no shares of Series D Preferred Stock are held by such Holder. Such cumulative
Dividends shall be payable at the end of each fiscal quarter of the Company in
arrears in cash or additional Series D Preferred Shares, at the Company's
option; provided however, that the Company's option to pay such Dividends in
additional Series D Preferred Shares shall be subject to and contingent upon the
effectiveness of a Registration Statement for the Common Shares underlying the
Series D Preferred Shares and Warrants, and provided further that if the Maximum
Share Amount is reached, the Company shall be required to pay such Dividends in
cash. Dividends on the Series D Preferred Stock shall accrue and be cumulative
on a daily basis from the date payable (with appropriate proration for any
partial dividend period), whether or not earned and whether or not in any
dividend period there shall be surplus or net profits of the Company legally
available for the payment of such dividends. In no event, so long as any Series
D Preferred Stock shall remain outstanding, shall any dividend whatsoever be
declared or paid upon, nor shall any distribution be made upon, any Junior
Securities (as defined below), nor shall any shares of Junior Securities be
purchased or redeemed by the Company nor shall any moneys be paid to or made
available for a sinking fund for the purchase or redemption of any Junior
Securities, without, in each such case, the written consent
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of the Holders of a majority of the outstanding shares of Series D Preferred
Stock, voting together as a class.
B. PAYMENT OF DIVIDEND IN SERIES D PREFERRED SHARES. Should the Company
elect to pay accrued but unpaid Dividends in additional shares of Series D
Preferred Stock, the number of Series D Preferred Shares to which the Holder
shall be entitled will be equal to the aggregate cash value of such unpaid
Dividends, divided by the Face Amount.
IV. CONVERSION
A. CONVERSION AT THE OPTION OF HOLDER. Subject to Article V(B),
beginning on the date of issuance of the Series D Preferred Shares, each Holder
may, at any time and from time to time, convert each of its shares of Series D
Preferred Stock into a number of fully paid and nonassessable shares of Common
Stock determined by dividing the aggregate Face Amount of the Series D Preferred
Shares being converted (plus any other amounts payable thereon including,
without limitation, payments due under Section 2(c) of the Registration Rights
Agreement and Conversion Default Payments) by the then applicable Conversion
Price, subject to adjustment as provided in Article X; provided, however, that,
in no event shall a Holder of shares of Series D Preferred Stock be entitled to
convert any such shares to the extent, but only to the extent, that (x) the
number of shares of Common Stock beneficially owned by the Holder and its
affiliates (other than shares of Common Stock which may be deemed beneficially
owned through the ownership of the unconverted portion of the shares of Series D
Preferred Stock or unexercised portion of Warrants or any other securities
containing analogous limitations) plus (y) the number of shares of Common Stock
issuable upon the conversion of the shares of Series D Preferred Stock with
respect to which the determination of this proviso is being made, would result
in beneficial ownership by a Holder and such Holder's affiliates of more than
4.99% of the outstanding shares of Common Stock. For purposes of the proviso to
the immediately preceding sentence, beneficial ownership shall be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and Rules 13(d) through (g) thereunder, except as otherwise provided in
clause (x) of such proviso.
B. MECHANICS OF CONVERSION. To convert the Series D Preferred Shares, a
Holder shall: (i) fax (or deliver by other means resulting in notice) to the
Company a copy of the fully executed Notice of Conversion in the form of Exhibit
H to the Securities Purchase Agreement, and (ii) surrender or cause to be
surrendered to the Company (or satisfy the provisions of Article XIII(A), if
applicable) the certificates representing the Series D Preferred Stock being
converted (the "Series D Preferred Stock Certificates") and the original
executed version of the Notice of Conversion as soon as practicable thereafter.
The date the Holder delivers to the Company the Notice of Conversion described
in clause (i) or such later date specified in the Notice of Conversion shall be
the "Conversion Date." In the case of fax or messenger delivery, delivery shall
be deemed made on the date of such fax or messenger delivery. In the case of
Federal Express, or other overnight mail service, delivery shall be deemed made
the day after the Notice of Conversion is sent. In the case of U.S. Mail,
delivery shall be deemed to be five (5) days after the Notice of Conversion is
deposited in the U.S. Mail.
C. TIMING OF CONVERSION. No later than the third Business Day following
the Conversion Date (the "Delivery Date"), provided that the Company has
received prior to such
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date the Series D Preferred Stock Certificates (or the Holder has satisfied the
provisions of Article XIII(A), if applicable), the Company shall issue and
deliver to the Holder (or otherwise at such Holder's direction) that number of
shares of Common Stock issuable upon conversion of the number of Series D
Preferred Shares being converted and, if applicable, a new certificate
representing the Series D Preferred Stock not converted by such Holder. The
person or persons entitled to receive shares of Common Stock issuable upon such
conversion shall be treated for all purposes as the record holder or holders of
such shares at the close of business on the Conversion Date, unless the Notice
of Conversion is revoked as provided in Article IV(D). If the Series D
Preferred Stock Certificates are not received (or the provisions of Article
XIII(A) are not satisfied) prior to the Delivery Date, The Delivery Date shall
be extended until the Business Day following the date of surrender to the
Company of Series D Preferred Stock Certificates to be converted or satisfaction
of the provisions of Article XIII(A), if applicable.
D. CONTINUING RIGHTS. In addition to any other remedies which may be
available to the Holder, in the event the Company fails for any reason to effect
delivery to the Holder of certificates representing the shares of Common Stock
receivable upon conversion of the Series D Preferred Shares by the Business Day
following the Delivery Date (which certificates shall be unlegended as and when
required pursuant to the Securities Purchase Agreement, Registration Rights
Agreement referencing this Article Sixth, Section 4, by and among the Company
and the other signatories thereto (the "Registration Rights Agreement") and this
Article Sixth, Section 4), the Holder shall, unless the Holder otherwise elects
to retain its status as a holder of Common Stock by so notifying the Company,
regain the rights of a Holder with respect to such unconverted shares of Series
D Preferred Stock and the Company shall immediately return the subject Series D
Preferred Stock certificates and other conversion documents, if any, delivered
by Holder, to the Holder, or, if shares of Series D Preferred Stock have not
been surrendered, adjust its records to reflect that such shares of Series D
Preferred Stock have not been converted; provided, however, that the Company
shall remain liable for payment of the amounts determined pursuant to Article
VI(A) hereof for each day falling between the trading day following the Delivery
Date and the date of the revocation notice is received by the Company, and shall
also remain liable for any damages suffered by Holder.
E. STAMP, DOCUMENTARY AND OTHER SIMILAR TAXES. The Company shall pay all
stamp, documentary, issuance and other similar taxes which may be imposed with
respect to the issuance and delivery of the shares of Common Stock pursuant to
conversion of the Series D Preferred Stock; provided that the Company will not
be obligated to pay stamp, transfer or other taxes resulting from the issuance
of Common Stock to any person other than the registered holder of the Series D
Preferred Stock.
F. NO FRACTIONAL SHARES. No fractional shares of Common Stock are to be
issued upon the conversion of Series D Preferred Stock, but the Company shall
make a cash payment equal to such fraction multiplied by the last sale price of
the Common Stock in respect of any fractional share which would otherwise be
issuable; provided that in the event that sufficient funds are not legally
available for the payment of such cash adjustment any fractional shares of
Common Stock shall be rounded up to the next whole number.
G. ELECTRONIC TRANSMISSION. In lieu of delivering physical certificates
representing the Common Stock issuable upon conversion, provided the Company's
transfer agent is
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participating in the Depository Trust Company ("DTC") Fast Automated Securities
Transfer program, upon request of a Holder the Company shall use its best
efforts to cause its transfer agent to electronically transmit the Common Stock
issuable upon conversion to the Holder by crediting the account of Holder's
prime broker with DTC through its Deposit Withdrawal Agent Commission ("DWAC")
system. In the case of electronic transmission of such Common Stock, the
Company shall, if applicable, within three (3) Business Days issue a new
certificate representing the Series D Preferred Stock not converted pursuant to
any Notice of Conversion.
V. RESERVATION OF AUTHORIZED SHARES OF COMMON STOCK;
LIMITATION ON NUMBER OF CONVERSION SHARES
A. RESERVATION OF COMMON STOCK. Subject to the provisions of this
Article V, the Company shall at all times reserve and keep available out of its
authorized but unissued shares of Common Stock a sufficient number of shares of
Common Stock to provide for the conversion of all outstanding Series D Preferred
Shares upon issuance of shares of Common Stock and the exercise of all Warrants
(at the then current Conversion Price or Exercise Price) in accordance with
Section 4(g) of the Securities Purchase Agreement (the "Reserved Amount"). The
Reserved Amount shall be increased from time to time in accordance with the
Company's obligations pursuant to Section 4(g) of the Securities Purchase
Agreement. In addition, if the Company shall issue any securities or make any
change in its capital structure which would change the number of shares of
Common Stock into which each share of the Series D Preferred Stock shall be
convertible at the then current Conversion Price, the Company shall at the same
time also make proper provision so that thereafter there shall be a sufficient
number of shares of Common Stock authorized and reserved, free from preemptive
rights, for conversion of the outstanding Series D Preferred Stock.
B. LIMITATION ON NUMBER OF COMMON SHARES TO BE ISSUED.
(i) Notwithstanding anything to the contrary contained herein, if, at any time,
the aggregate number of shares of Common Stock then issued upon conversion of
the Series D Preferred Stock equals 19.99% of the outstanding Common Stock on
the Closing Date, subject to adjustments for stock dividends, stock splits,
combinations or similar events, the Series D Preferred Stock shall, from that
time forward, cease to be convertible into Common Stock in accordance with the
terms of Article IV, unless the Company (x) has obtained approval of the
issuance of the Series D Preferred Stock by a majority of the total votes
eligible to be cast on such proposal, in person or by proxy, by the holders of
the then-outstanding Common Stock (the "Stockholder Approval"), (y) shall have
otherwise obtained permission to allow such issuances from the American Stock
Exchange or such other principal exchange upon which the Common Stock is then
trading (the "Common Stock Exchange"); or (z) is no longer governed by a rule
promulgated by a stock exchange, Nasdaq or other applicable body prohibiting the
issuance of Common Stock upon conversion of the Series D Preferred Stock in
excess of 19.99% of the outstanding Common Stock without shareholder approval.
The maximum number of shares of Common Stock issuable as a result of the
limitation set forth in the first sentence of this Article V(B) is hereinafter
referred to as the "Maximum Share Amount." With respect to each Holder of
Series D Preferred Stock, the Maximum Share Amount shall refer to such Holder's
pro rata share thereof determined in accordance with Article X below.
Notwithstanding anything in this Article Sixth, Section 4 to the contrary, for
purposes of determining the aggregate number of shares of Common Stock issuable
upon conversion of the Series D Preferred Stock, if the issuance of Common Stock
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hereunder is aggregated with the issuance of Common Stock in conversion of the
Series A Convertible Preferred Stock and/or the Series B Convertible Preferred
Stock and/or the Series C Convertible Preferred Stock (collectively, the "Other
Series") pursuant to the regulations of the American Stock Exchange, the shares
of Common Stock issuable upon conversion of the Other Series shall be aggregated
with the shares of Common Stock issuable in conversion of the Series D Preferred
Stock in determining the Maximum Share Amount. The Company will use its best
efforts to seek and obtain Stockholder Approval (or obtain such other relief as
will allow conversions hereunder in excess of the Maximum Share Amount) no later
than 120 days following the Closing Date. In the event that the Company obtains
Stockholder Approval, the approval of the Common Stock Exchange or otherwise
concludes that it is able to increase the number of shares to be issued above
the Maximum Share Amount (such increased number being the "New Maximum Share
Amount"), the references to Maximum Share Amount, above, shall be deemed to be
instead, references to the greater New Maximum Share Amount. In the event that
Stockholder Approval is obtained, but there are insufficient reserved or
authorized shares or a registration statement covering the additional shares of
Common Stock which constitute the New Maximum Share Amount is not effective
prior to the Maximum Share Amount being issued (if such registration statement
is necessary to allow for the public resale of such securities), the Maximum
Share Amount shall remain unchanged; provided, however, that the Holder may
grant an extension to obtain a sufficient reserved or authorized amount of
shares or of the period for obtaining effectiveness of such registration
statement. Notwithstanding anything in this Article V(B)(i) to the contrary,
and subject to Article V(B)(ii) below, the Company shall only be required to
issue a number of shares of Common Stock upon conversion of the Series D
Preferred Stock equal to (p) the original aggregate Face Amount of all Series D
Preferred Stock issued on the Closing Date divided by (q) 50% of the Closing
Price (exclusive of any shares of Common Stock issuable upon conversion of the
Other Series), subject to adjustments for stock dividends, stock splits,
combinations or similar events (the "Maximum Share Amount Cap").
(ii) Notwithstanding anything in this Article Sixth, Section 4 to
the contrary, in the event the Maximum Share Amount is reached as a result of
conversions of the Series D Preferred Stock or any Other Series, the Company
shall honor any request for conversion of the Series D Preferred Stock with a
payment in cash equal to the number of shares of Common Stock that would have
otherwise been issued upon such conversion multiplied by the five day average
Closing Bid Price of the Common Stock on the date of delivery of the Conversion
Notice; provided that, no such payment shall be made in the event the Maximum
Share Amount Cap is reached. Any cash payment made pursuant to this paragraph
shall be counted toward the Maximum Share Amount Cap as if such conversion was
effected by the issuance of shares of Common Stock. If the Maximum Share Amount
Cap is reached the Company must within ten (10) business days either (x) provide
irrevocable notice to the Company that it will redeem all of the outstanding
shares of Series D Preferred Stock at the Face Amount thereof plus any accrued
and unpaid dividends and other payments thereon as provided by Article
VII(C)(ii), and so redeem the Series D Preferred Stock within one hundred eighty
(180) days following such notice, or (y) so long as the Stockholder Approval has
been obtained, provide irrevocable notice to the Holders that the Company will
honor Notices of Conversion that will result in the issuance of shares of Common
Stock in excess of the Maximum Share Amount Cap, and thereafter honor such
conversions without reference to the Maximum Share Amount Cap or (z) if
Shareholder Approval has not been obtained within 120 days of the issuance of
the Series D Preferred Stock, provide irrevocable notice to the Holders that the
Company will honor Notice of Conversion in
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excess of the Maximum Share Amount Cap if such conversions do not violate the
rules and regulations of the applicable stock exchange or quotation system on
which the Common Stock is then traded (but only to the extent suchrules or
regulations would not be violated); provided, however, that for purposes of this
clause (z), in the event the Maximum Share Amount is reached, the Company will
redeem the Series D Preferred Stock in accordance with Article (V)(B)(ii)(x)
above.
C. ALLOCATION OF RESERVED AMOUNT, MAXIMUM SHARE AMOUNT. The Reserved
Amount and the Maximum Share Amount shall be allocated among the initial Holders
according to the number of Series D Preferred Shares issued to each such Holder
on the Closing Date. Any Common Shares which were initially allocated to any
Holder remaining after such Holder no longer owns any Series D Preferred Shares
shall be allocated among the remaining Holders pro rata, based on the number of
Series D Preferred Shares then held by such Holders.
VI. FAILURE TO CONVERT
A. If, at any time, (x) a Notice of Conversion has been sent to the
Company and the Company fails for any reason to deliver, on or prior to the
third Business Day following the expiration of the Delivery Date for such
conversion (said period of time being the "Extended Delivery Period"), such
number of shares of Common Stock to which such Holder is entitled (taking into
account the limitations on conversions imposed by such Holder's allocated
portion of the Maximum Share Amount) upon such conversion, or (y) the Company
provides notice (including by way of public announcement) (the "Refusal Notice")
to any Holder at any time of its intention not to issue shares of Common Stock
upon exercise by any Holder of its conversion rights in accordance with the
terms of this Article Sixth, Section 4 (each of (x) and (y) being a "Conversion
Default"), then the Company shall pay to the affected Holder, in the case of a
Conversion Default described in clause (x) above, and to all Holders, in the
case of a Conversion Default described in clause (y) above, an amount equal to
1% of the Face Amount of the Series D Preferred Stock held by such Holder with
respect to which the Conversion Default exists (which amount shall be deemed to
be the aggregate Face Amount of all outstanding Series D Preferred Stock in the
case of a Conversion Default described in clause (y) above) for each day
thereafter until the Cure Date. "Cure Date" means (i) with respect to a
Conversion Default described in clause (x) of its definition or if a Conversion
Notice has been submitted and the Company has issued a Refusal Notice, the date
the Company effects the conversion of the portion of the Series D Preferred
Stock submitted for conversion and (ii) if no Conversion Notices have been
submitted, with respect to a Conversion Default described in clause (y) of its
definition, the date the Company undertakes in writing to issue Common Stock in
satisfaction of all conversions of Series D Preferred Stock in accordance with
the terms of this Article Sixth, Section 4. The Company shall promptly provide
each Holder with notice of the occurrence of a Conversion Default with respect
to any of the other Holders.
The payments to which a Holder shall be entitled pursuant to this Section
VI(A) are referred to herein as "Conversion Default Payments." Conversion
Default Payments shall be paid in cash. Such payment shall be made in
accordance with and be subject to the provisions of Article XIII(B).
VII. REDEMPTION DUE TO CERTAIN EVENTS
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A. REDEMPTION EVENTS. A "Redemption Event" means any one of the
following (after expiration of any applicable cure period):
(i) the Company fails, and any such failure continues uncured for
seven (7) Business Days after the Company has been notified thereof in writing
by the Holder, to (x) remove any restrictive legend on any certificate for any
shares of Common Stock issued after the Effective Date to the Holders upon
conversion of the Series D Preferred Stock or upon exercise of the Warrants, or
(y) to transfer or cause its transfer agent to transfer any certificate for
shares of Common Stock issued to a Holder upon conversion of the Series D
Preferred Stock, in each case as and when required by this Article Sixth,
Section 4, the Warrants, the Securities Purchase Agreement or the Registration
Rights Agreement; or
(ii) the Company fails to fulfill it obligations pursuant to
Sections 4(c), 4(g), 4(i) or 5 of the Purchase Agreement (or makes any
announcement, statement or threat that it does not intend to honor the
obligations described in this paragraph) and any such failure shall continue
uncured (or any announcement, statement or threat not to honor its obligations
hall not be rescinded in writing) for ten (10) days after the Corporation shall
have been notified thereof in writing by any holder of Series D Preferred Stock;
or
(iii) the Company fails to make any payment due pursuant to Article
VII(C) when due; or
(iv) the Company fails to fulfill any of its obligations pursuant
to the Registration Rights Agreement (or makes any statement that it does not
intend to honor such obligations) and any such failure shall continue uncured
(or any statement not to honor its obligations shall not be rescinded) for ten
(10) business days; or
(v) the Company (x) fails to cause the Registration Statement to
be declared effective on or before the date that is one hundred eighty (180)
days following the Closing Date, or (y) such Registration Statement lapses in
effect (or sales cannot be made by the Holders thereunder, whether by reason of
the Company's failure to amend or supplement the prospectus included therein in
accordance with the Registration Rights Agreement or otherwise) for more then
forty-five (45) consecutive days or seventy-five (75) days in any twelve (12)
month period after such Registration Statement becomes effective, or (z) the
Common Stock is not listed or included for quotation on the Nasdaq, NYSE, AMEX
or that trading is halted after the Registration Statement has been declared
effective for more than an aggregate of twenty (20) trading days or more in any
twelve (12) month period.
B. REDEMPTION OF HOLDER'S SHARES. Upon the occurrence and during the
continuation of any Redemption Event, the Company shall, as to each Holder of
the then outstanding shares of Series D Preferred Stock who have given written
notice (the "Optional Redemption Notice") to the Company of such Redemption
Event, purchase each such Holder's shares of Series D Preferred Stock for an
amount per share equal to the greater of (1) 120% multiplied by the sum of (a)
the Face Amount of the shares to be redeemed, plus (b) accrued and unpaid
dividends and any other amounts payable thereon (including without limitation
payments due under Section 2 of the Registration Rights Agreement and Conversion
Default Payments) through the date of payment of the Optional Redemption Amount
(as defined herein) (the "Optional Redemption
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Date") and (2) the "Parity Value" of the shares to be redeemed (the greater of
such amounts being the "Optional Redemption Amount"); provided that if such
Redemption Event is pursuant to Article VII(A)( iv), the Company may, at its
sole option, in lieu of the foregoing purchase, pay the Holder an amount equal
to the Default Amount (as defined below) multiplied by the number of shares of
Series D Preferred Stock held by such holder on the date of the Optional
Redemption Notice. "Parity Value" means the product of (a) the highest number of
shares of Common Stock issuable upon conversion of such shares at such time
(treating the Trading Day immediately preceding the Optional Redemption Date as
the "Conversion Date" (as hereinafter defined), unless the Redemption Event
arises as a result of a breach in respect of a specific Conversion Date in which
case such Conversion Date shall be the Conversion Date), multiplied by (b) the
highest closing sale price for the Common Stock on the principal trading market
for such shares during the period beginning on the date of first occurrence of
the Redemption Event and ending on such "Conversion Date." "Default Amount"
shall mean Fifty U.S. Dollars ($50).
In the case of a Redemption Event, if the Company fails to pay the Default
Amount or the Optional Redemption Amount, as applicable, for each share within
five (5) business days of written notice that such amount is due and payable,
then (assuming there are sufficient authorized shares) in addition to all other
available remedies, each holder of Series D Preferred Stock shall have the right
at any time, so long as the Redemption Event continues, to require the Company,
upon written notice, to immediately issue (in accordance with and subject to the
terms of Article V above), in lieu of the Default Amount or the Optional
Redemption Amount, as applicable, with respect to each outstanding share of
Series D Preferred Stock held by such holder, the number of shares of Common
Stock of the Company equal to the Default Amount or the Optional Redemption
Amount, as applicable, divided by any Conversion Price, as chosen in the sole
discretion of the Holder, in effect from the date of the Redemption Event until
the date such Holder elects to exercise its rights pursuant to this paragraph.
Payment of the Default Amount shall not affect the holders ongoing rights with
respect to the then outstanding shares of Series D Preferred Stock or the rights
of such holders to pursue alternate damages in respect of the events giving rise
to such payments.
C. OPTIONAL REDEMPTION BY THE COMPANY. So long as (i) all of the shares
of Common Stock issuable upon conversion of all outstanding shares of Series D
Preferred Stock, for a period of twenty (20) days prior to the date of delivery
of any written notice of redemption pursuant to Article VII(C), are then (x)
authorized and reserved for issuance, (y) registered for re-sale under the 1933
Act by the Holders (or may otherwise be resold publicly without restriction);
provided, however, that this clause (y) shall not apply to any redemption made
with the proceeds from a Qualified Offering (as defined), and (z) eligible to be
traded on Nasdaq, the NYSE, the AMEX or Nasdaq SmallCap and (ii) there is not
then a continuing Redemption Event in effect the Company may, at its option,
upon twenty (20) Business Days' irrevocable written notice, redeem the Series D
Preferred Stock, as follows:
(i) Beginning upon the earlier to occur of (a) the date that the
Company completes an underwritten public offering of its Common Stock or Rule
144A offering to "qualified institutional buyers" and "accredited institutional
investors" in an amount of at least $10,000,000 (a "Qualified Offering"), or (b)
the date that is eighteen months following the Closing Date, the Company may, at
its option, redeem for cash out of funds legally available therefor, all (but
not less than all) of the outstanding Series D Preferred Shares at 110% of the
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Face Amount of the Series D Preferred Shares during the first 12 months
following issuance, and thereafter 120% of the Face Amount of the Series D
Preferred Shares, in each case plus accrued and unpaid dividends, if any, and
any other amounts payable thereon.
(ii) Beginning on the date any Holder reaches such Holder's Maximum
Share Amount, the Company may, at its option, redeem for cash out of funds
legally available therefor, all (but not less than all) of the outstanding
shares of Series D Preferred Stock held by the Holder who has reached its
Maximum Share Amount at a price per share equal to 100% of the Face Amount such
shares of Series D Preferred Stock plus accrued and unpaid dividends, if any,
and any other amounts payable thereon.
Nothing in this Article VII(C) shall prohibit conversions of Series D
Preferred Stock otherwise permitted pursuant to the terms of this Article Sixth,
Section 4 during the pendency of any notice of optional redemption by the
Company hereunder.
D. MATURITY; REQUIRED REDEMPTION. Subject to the limitations contained
in Article VII(F) and so long as there is not then a continuing Redemption
Event, hereof each share of Series D Preferred Stock outstanding on the third
anniversary of the Closing Date (the "Maturity Date") will be redeemed at the
Company's sole option, (a) so long as the Company has provided the Holders ten
(10) business days prior written notice of its election to pay cash on the
Maturity Date, in cash equal to the aggregate face value thereof plus accrued
and unpaid dividends, if any, and any other amounts payable thereon or, (b) by
delivery of a number of shares of Common Stock issuable upon conversion of all
of the Series D Preferred Stock at the lesser of the then-applicable Conversion
Price and the five trading day average closing bid price on the Maturity Date,
including any adjustment under Article X; provided that (i) any necessary
approval for the issuance of additional shares has been obtained if the Maximum
Share Amount has been reached (or will be exceeded as a result of any conversion
at maturity), and (ii) all shares of Common Stock issuable upon conversion of
all outstanding shares of Series D Preferred Stock are then (x) authorized and
reserved for issuance, (y) registered under the Securities Act for resale by all
Holders of such Series D Preferred Shares and (z) eligible to be traded on
either the Nasdaq, Nasdaq Small Cap Market, the New York Stock Exchange or the
American Stock Exchange. The Maturity Date shall be delayed by one (1) Trading
Day each for each Trading Day occurring prior thereto and prior to the full
conversion of the Series D Preferred Stock that (i) sales cannot be made
pursuant to the Registration Statement (whether by reason of the Company's
failure to properly supplement or amend the prospectus included therein in
accordance with the terms of the Registration Rights Agreement or otherwise),
(ii) any Redemption Event (as defined in Article V(A) exists, without regard to
whether any cure periods shall have run or (iii) that the Company is in breach
of any of its obligations pursuant to Section 4(g) of the Purchase Agreement.
E. REDEMPTION DEFAULTS. If the Company fails to pay any Holder the
redemption consideration with respect to any share of Series D Preferred Stock,
as provided in this Article VII, within five (5) Business Days of its receipt or
delivery, as applicable, of a notice requiring such redemption (the "Redemption
Notice"), then each Holder (i) shall be entitled to interest on the redemption
consideration not paid at a per annum rate equal to the lower of (x) the sum of
prime rate published from time to time by the Wall Street Journal plus three
percent (3%) and (y) the highest interest rate permitted by applicable law from
the date of the Redemption Notice until
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the date of redemption hereunder. In the event the Company is not able to
redeem all of the shares of Series D Preferred Stock subject to Redemption
Notices, the Company shall redeem shares of Series D Preferred Stock from each
Holder, pro rata, based on the total number of shares of Series D Preferred
Stock included in the Redemption Notice relative to the total number of shares
of Series D Preferred Stock in all of the Redemption Notices. In the case of a
Redemption Event, if the Company fails to pay the Optional Redemption Amount for
each share for any reason (including, without limitation, the circumstances
specified in Article VII(F)), within five (5) Business Days of the applicable
Redemption Notice then (assuming there are sufficient authorized shares) in
addition to all other available remedies, each Holder of Series D Preferred
Stock shall have the right at any time, so long as the Redemption Event
continues, to convert, upon written notice, in lieu of the Redemption Amount,
each outstanding share of Series D Preferred Stock held by such Holder, into the
number of shares of Common Stock of the Company equal to the Redemption Amount,
divided by the Conversion Price then in effect, subject in all cases to each
such Holder's Maximum Share Amount.
F. CAPITAL IMPAIRMENT. In the event that any section of the Delaware
General Corporation Law ("DGCL"), would be violated by the redemption of any
shares of Series D Preferred Stock that are otherwise subject to redemption
pursuant to this Article VII, the Company: (i) will redeem the greatest number
of shares of Series D Preferred Stock possible without violation of said
Article; (ii) the Company thereafter shall use its best efforts to take all
necessary steps permitted pursuant to this Article Sixth, Section 4 and the
agreements entered into in connection with the issuance of Series D Preferred
Stock pursuant hereto in order to remedy its capital structure in order to allow
further redemptions without violation of said Article; and (iii) from time to
time thereafter as promptly as possible the Company shall redeem shares of
Series D Preferred Stock at the request of the Holders to the greatest extent
possible without causing a violation of the DGCL.
VIII. RANK; PARTICIPATION
A. RANK. All shares of the Series D Preferred Stock shall rank (i) prior
to the Common Stock; (ii) prior to any class or series of capital stock of the
Company hereafter created (unless, with the consent of the Holders of a majority
of the outstanding shares of Series D Preferred Stock obtained in accordance
with Article XII hereof, such class or series of capital stock specifically, by
its terms, ranks senior to or pari passu with the Series D Preferred Stock)
(collectively, with the Common Stock, "Junior Securities"); (iii) pari passu
with the Series A Convertible Preferred Stock, Series B Convertible Preferred
Stock, Series C Convertible Preferred Stock, and any class or series of capital
stock of the Company hereafter created (with the consent of the Holders of a
majority of the outstanding shares of Series D Preferred Stock obtained in
accordance with Article XII hereof, if required) specifically ranking, by its
terms, on parity with the Series D Preferred Stock (the "Pari Passu
Securities"); and (iv) junior to any class or series of capital stock of the
Company hereafter created (with the consent of the Holders of a majority of the
outstanding shares of Series D Preferred Stock obtained in accordance with
Article XII hereof) specifically ranking, by its terms, senior to the Series D
Preferred Stock (the "Senior Securities"), in each case as to distribution of
assets upon liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary.
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B. PARTICIPATION. Subject to the rights of the Holders (if any) of Pari
Passu Securities and Senior Securities, the Holders shall, as such Holders, be
entitled to such dividends paid and distributions made to the Holders of Common
Stock to the same extent as if such Holders had converted their shares of Series
D Preferred Stock into Common Stock (without regard to any limitations on
conversion herein or elsewhere contained) and had been issued such Common Stock
on the day before the record date for said dividend or distribution. Payments
under the preceding sentence shall be made concurrently with the dividend or
distribution to the Holders of Common Stock.
IX. LIQUIDATION PREFERENCE
A. LIQUIDATION OF THE COMPANY. If the Company shall commence a voluntary
case under the U.S. Federal bankruptcy laws or any other applicable bankruptcy,
insolvency or similar law, or consent to the entry of an order for relief in an
involuntary case under any law or to the appointment of a receiver, liquidator,
assignee, custodian, trustee, sequestrator (or other similar official) of the
Company or of any substantial part of its property, or make an assignment for
the benefit of its creditors, or admit in writing its inability to pay its debts
generally as they become due, or if a decree or order for relief in respect of
the Company shall be entered by a court having jurisdiction in the premises in
an involuntary case under the U.S. Federal bankruptcy laws or any other
applicable bankruptcy, insolvency or similar law resulting in the appointment of
a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other
similar official) of the Company or of any substantial part of its property, or
ordering the winding up or liquidation of its affairs, and any such decree or
order shall be unstayed and in effect for a period of sixty (60) consecutive
days and, on account of any such event, the Company shall liquidate, dissolve or
wind up, or if the Company shall otherwise liquidate, dissolve or wind up (a
"Liquidation Event"), no distribution shall be made to the Holders of any shares
of capital stock of the Company (other than Senior Securities and, together with
the Holders of Series D Preferred Stock the Pari Passu Securities) upon
liquidation, dissolution or winding up unless prior thereto the Holders shall
have received the Liquidation Preference (as herein defined) with respect to
each Series D Preferred Share. If, upon the occurrence of a Liquidation Event,
the assets and funds available for distribution among the Holders and holders of
Pari Passu Securities shall be insufficient to permit the payment to such
Holders of the preferential amounts payable thereon, then the entire assets and
funds of the Company legally available for distribution to the Series D
Preferred Stock and the Pari Passu Securities shall be distributed ratably among
such shares in proportion to the ratio that the Liquidation Preference payable
on each such share bears to the aggregate Liquidation Preference payable on all
such shares.
B. CERTAIN ACTS NOT A LIQUIDATION. The purchase or redemption by the
Company of stock of any class, in any manner permitted by law, shall not, for
the purposes hereof, be regarded as a liquidation, dissolution or winding up of
the Company. Neither the consolidation or merger of the Company with or into
any other entity nor the sale or transfer by the Company of less than
substantially all of its assets shall, for the purposes hereof, be deemed to be
a liquidation, dissolution or winding up of the Company.
C. DEFINITION OF LIQUIDATION PREFERENCE. The "Liquidation Preference"
with respect to a share of Series D Preferred Stock means an amount equal to the
Face Amount thereof plus any other amounts that may be due from the Company with
respect thereto, including any
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accrued and unpaid dividends, pursuant to this Article Sixth, Section 4 or the
Registration Rights Agreement through the date of final distribution. The
Liquidation Preference with respect to any Pari Passu Securities shall be as set
forth in the Article Sixth, Section 4 filed in respect thereof.
X. ADJUSTMENTS TO THE CONVERSION PRICE; CERTAIN PROTECTIONS
The Conversion Price shall be subject to adjustment from time to time as
follows:
A. STOCK SPLITS, STOCK DIVIDENDS, ETC. If at any time on or after the
Closing Date, the number of outstanding shares of Common Stock is increased by a
stock split, stock dividend, reclassification or other similar event, the number
of shares of Common Stock issuable upon conversion of the Series D Preferred
Shares shall be proportionately increased, or if the number of outstanding
shares of Common Stock is decreased by a reverse stock split, combination or
reclassification of shares, or other similar event, the number of shares of
Common Stock issuable upon conversion of the Series D Preferred Shares shall be
proportionately reduced. In such event, the Company shall notify the Company's
transfer agent of such change on or before the effective date thereof.
B. MAJOR TRANSACTIONS. If the Company shall consolidate with or merge
into any corporation, sell all or substantially all of its assets, effectuate a
transaction or series of transactions in which 50% or more of the voting power
of the Company is disposed of or reclassify its outstanding shares of Common
Stock (other than by way of subdivision or reduction of such shares) (each a
"Major Transaction"), then each Holder shall thereafter be entitled to receive
consideration, in exchange for each share of Series D Preferred Stock held by
it, equal to the greater of, as determined in the sole discretion of the Holders
of at least 50.1% of the outstanding shares of Series D Preferred Stock: (i) the
number of shares of stock or securities or property of the Company, or of the
entity resulting from such consolidation or merger (the "Major Transaction
Consideration"), to which a Holder of the number of shares of Common Stock
delivered upon conversion of such shares of Series D Preferred Stock would have
been entitled upon such Major Transaction (without regard to any limitations on
conversion herein contained) and had such Common Stock been issued and
outstanding and had such Holder been the holder of record of such Common Stock
at the time of such Major Transaction, and the Company shall make lawful
provision therefore as a part of such consolidation, merger or reclassification;
and (ii) the Redemption Amount, in cash. No sooner than ten (10) days nor later
than five (5) days prior to the consummation of the Major Transaction, but not
prior to the public announcement of such Major Transaction, the Company shall
deliver written notice ("Notice of Major Transaction") to each Holder, which
Notice of Major Transaction shall be deemed to have been delivered one (1)
Business Day after the Company's sending such notice by telecopy (provided that
the Company sends a confirming copy of such notice on the same day by overnight
courier). Such Notice of Major Transaction shall indicate the amount and type
of the Major Transaction Consideration which such Holder would receive under
clause (i) of this Article X(B). If the Major Transaction Consideration does
not consist entirely of United States dollars, the value of such other property
shall be determined by a reputable accounting firm selected by the Company that
is reasonably acceptable the Holders of a majority of the outstanding shares of
Series D Preferred Stock.
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C. ADJUSTMENT DUE TO DISTRIBUTION. If at any time after the Closing
Date, the Company shall declare or make any distribution of its assets (or
rights to acquire its assets) to holders of Common Stock as a partial
liquidating dividend, by way of return of capital or otherwise (including any
dividend or distribution to the Company's stockholders in cash or shares (or
rights to acquire shares) of capital stock of a subsidiary (i.e. a spin-off)) (a
"Distribution"), then the minimum Conversion Price per share shall be reduced by
the value of such Distribution per share. If the Distribution does not consist
entirely of U.S. Dollars, the value of such other property shall be determined
by a reputable accounting firms selected by the Company that is reasonably
acceptable to the Holders of a majority of the outstanding shares of Series D
Preferred Stock.
D. PURCHASE RIGHTS. If at any time after the Closing Date, the Company
issues any Convertible Securities or rights to purchase stock, warrants,
securities or other property (the "Purchase Rights") pro rata to the record
holders of any class of Common Stock, then the Holders will be entitled to
acquire, upon the terms applicable to such Purchase Rights, the aggregate
Purchase Rights which such Holder could have acquired if such Holder had held
the number of shares of Common Stock acquirable upon complete conversion of the
Series D Preferred Stock (without regard to any limitations on conversion or
exercise herein or elsewhere contained) immediately before the date on which a
record is taken for the grant, issuance or sale of such Purchase Rights, or, if
no such record is taken, the date as of which the record holders of Common Stock
are to be determined for the grant, issue or sale of such Purchase Rights.
E. ADJUSTMENT TO CONVERSION PRICE. If at any time when Series D
Preferred Stock is issued and outstanding, the number of outstanding shares of
Common Stock is increased or decreased by a stock split, stock dividend,
combination, reclassification, below-market price rights offering to all holders
of Common Stock or other similar event, which event shall have taken place
during the reference period for determination of the Conversion Price for the
Series D Preferred Stock, then the Conversion Price shall be calculated giving
appropriate effect to the stock split, stock dividend, combination,
reclassification or other similar event during the calculation period preceding
the Conversion Date. In such event, the Company shall notify the Transfer Agent
of such change on or before the effective date thereof.
F. ADJUSTMENT FOR RESTRICTED PERIODS. If (i) the Company fails to obtain
effectiveness of the Registration Statement prior to ninety (90) days following
the Closing Date, or (ii) the Registration Statement, once effective, lapses in
effect, or sales cannot otherwise be made thereunder, whether by reason of the
Company's failure or inability to amend or supplement the prospectus included
therein ("Prospectus") in accordance with the Registration Rights Agreement or
otherwise, then the 20 trading days period ("Lookback Period") used for
determining the "Market Price" shall be extended to include (x) in the case of
an event described in clause (i), the 20 trading days immediately preceding the
90th day following the Closing Date plus all Trading Days through and including
the date of effectiveness of the Registration Statement, and (y) in the case of
an event described in clause (ii), the number of trading days preceding the date
on which the Holder is first notified that sales may not be made under the
Prospectus, which would otherwise then be included in the Lookback Period plus
all trading days through and including the date on which the Holder is notified
that sales may again be made under the Prospectus. If a Holder of the Series D
Preferred Stock reasonably determines that sales may not be made pursuant to the
Prospectus, it shall notify the Company in writing and,
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unless the Company provides Holder with an opinion of Company's counsel to the
contrary, such determination shall be binding for purposes of this paragraph.
G. ADJUSTMENT TO CONVERSION PRICE UPON ANNIVERSARY DATE. If the average
of the Closing Bid Prices of the Common Stock over the twenty (20) consecutive
trading days immediately preceding the Anniversary Date is greater than 130% of
the Closing Price, then beginning on the Anniversary Date, the Conversion Price
will be reset to 130% of the Closing Price.
H. ADJUSTMENT TO CONVERSION PRICE FOR MAJOR ANNOUNCEMENTS. In the event
the Company (i) makes a public announcement that it intends to consolidate or
merge with any other corporation (other than a merger in which the Company is
the surviving or continuing corporation and its capital stock is unchanged) or
sell or transfer all or substantially all of the assets of the Company or (ii)
any person, group or entity (including the Company) publicly announces a tender
offer to purchase 50% or more of the Company's Common Stock or otherwise
publicly announces an intention to replace a majority of the Company's Board of
Directors by waging a proxy battle or otherwise (the date of the announcement
referred to in clause (i) or (ii) is hereinafter referred to as the
"Announcement Date"), then the Conversion Price shall, effective upon the
Announcement Date and continuing through the Adjusted Conversion Price
Termination Date (as defined below), be equal to the lower of (x) the Conversion
Price which would have been applicable for an Optional Conversion occurring on
the Announcement Date and (y) the Conversion Price that would otherwise be in
effect. From and after the Adjusted Conversion Price Termination Date, the
Conversion Price shall be determined as set forth in Article II. For purposes
hereof, "Adjusted Conversion Price Termination Date" shall mean, with respect to
any proposed transaction, tender offer or removal of the majority of the Board
of Directors which a public announcement as contemplated by this Article X(H)
has been made, the date upon which the Company (in the case of clause (i) above)
or the person, group or entity (in the case of clause (ii) above) consummates or
publicly announces the termination or abandonment of the proposed transaction or
tender offer which caused this Article X(H) to become operative. Adjustment to
Conversion Price for Major Announcements.
I. NOTICE OF ADJUSTMENTS. Upon the occurrence of each adjustment or
readjustment of the Conversion Price pursuant to this Section X, the Company, at
its expense, shall promptly compute such adjustment or readjustment and prepare
and furnish to each Holder a certificate setting forth such adjustment or
readjustment and showing in detail the facts upon which such adjustment or
readjustment is based. The Company shall, upon the written request at any time
of any Holder, furnish to such Holder a like certificate setting forth (i) such
adjustment or readjustment, (ii) the Conversion Price at the time in effect and
(iii) the number of shares of Common Stock and the amount, if any, of other
securities or property which at the time would be received upon conversion of a
share of Series D Preferred Stock.
XI. VOTING RIGHTS
No Holder of the Series D Preferred Stock shall be entitled to vote on any
matter submitted to the shareholders of the Company for their vote, waiver,
release or other action, except as may be otherwise expressly required by law.
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XII. PROTECTION PROVISIONS
So long as any Series D Preferred Shares are outstanding, the Company shall
not, without first obtaining the approval of the Holders of majority of the
outstanding shares of Series D Preferred Stock: (a) alter or change the rights,
preferences or privileges of the Series D Preferred Stock; (b) alter or change
the rights, preferences or privileges of any capital stock of the Company so as
to affect adversely the Series D Preferred Stock; (c) create or issue any Senior
Securities; (d) create or issue any Pari Passu Securities (except for Pari Passu
Securities that are convertible preferred securities with a fixed conversion
price at a premium to the market price of the Common Stock at the date of
issuance), (e) increase the authorized number of shares of Series D Preferred
Stock; (f) increase the par value of the Common Stock; or (g) do any act or
thing not authorized or contemplated by this Article Sixth, Section 4 which
would result in any taxation with respect to the Series D Preferred Stock under
Section 305 of the Internal Revenue Code of 1986, as amended, or any comparable
provision of the Internal Revenue Code as hereafter from time to time amended,
(or otherwise suffer to exist any such taxation as a result thereof).
XIII. MISCELLANEOUS
A. LOST OR STOLEN CERTIFICATES. Upon receipt by the Company of (i)
evidence of the loss, theft, destruction or mutilation of any Series D Preferred
Stock Certificate(s) and (ii) (y) in the case of loss, theft or destruction, of
indemnity reasonably satisfactory to the Company, or (z) in the case of
mutilation, upon surrender and cancellation of the Series D Preferred Stock
Certificate(s), the Company shall execute and deliver new Series D Preferred
Stock Certificate(s) of like tenor and date. However, the Company shall not be
obligated to reissue such lost, stolen, destroyed or mutilated Series D
Preferred Stock Certificate(s) if the Holder contemporaneously requests the
Company to convert such Series D Preferred Stock.
B. PAYMENT OF CASH; DEFAULTS. Whenever the Company is required to make
any cash payment to a Holder under this Article Sixth, Section 4 (as a
Conversion Default Payment, Redemption Amount or otherwise), such cash payment
shall be made to the Holder by the method (by certified or cashier's check or
wire transfer of immediately available funds) elected by such Holder. If such
payment is not delivered when due such Holder shall thereafter be entitled to
interest on the unpaid amount until such amount is paid in full to the Holder at
a per annum rate equal to the lower of (x) the sum of prime rate published from
time to time by the Wall Street Journal plus three percent (3%) and (y) the
highest interest rate permitted by applicable law.
C. REMEDIES, CHARACTERIZATIONS, OTHER OBLIGATIONS, BREACHES AND
INJUNCTIVE RELIEF. The remedies provided in this Article Sixth, Section 4 shall
be cumulative and in addition to all other remedies available under this Article
Sixth, Section 4, at law or in equity (including a decree of specific
performance and/or other injunctive relief), no remedy contained herein shall be
deemed a waiver of compliance with the provisions giving rise to such remedy and
nothing herein shall limit a Holder's right to pursue actual damages for any
failure by the Company to comply with the terms of this Article Sixth, Section
4. Company covenants to each Holder that there shall be no characterization
concerning this instrument other than as expressly provided herein; provided,
however, that the Company shall be entitled to prepare summaries of this
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Article Sixth, Section 4 for purposes of complying with its disclosure
obligations and in connection with bona fide disputes as to the operations of
the provisions of this Article Sixth, Section 4.
D. FAILURE OR INDULGENCY NOT WAIVER. No failure or delay on the part of
a Holder in the exercise of any power, right or privilege hereunder shall
operate as a waiver thereof, nor shall any single or partial exercise of any
such power, right or privilege preclude other or further exercise thereof or of
any other right, power or privilege.
E. NOTICES. Any notice from a Holder to the Company hereunder shall be
given to the Company in accordance with Section 8(f) of the Securities Purchase
Agreement. Any notices from the Company to a Holder shall be given to such
Holder at such Holder's address as shown in the stock register of the Company
and otherwise in accordance with Section 8(f) of the Securities Purchase
Agreement.
ARTICLE SEVENTH.
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 VII
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 EIGHTH.
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 on stockholders herein
are granted subject to this reservation.
ARTICLE NINTH.
Election of directors need not be by written ballot unless the Bylaws of
the Corporation shall so provide.
35.
<PAGE>
ARTICLE TENTH.
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
in an amendment thereof duly adopted by the Board of Directors or by the
stockholders.
ARTICLE ELEVENTH.
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 TWELFTH.
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 THIRTEENTH.
The Corporation expressly elects not 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 sole incorporator
in accordance with the provisions of Sections 241 and 245 of the General
Corporation Law of the State of Delaware. None of the Shares of the
Corporation have been issued and none of the capital has been paid in.
IN WITNESS WHEREOF, the undersigned has executed this Certificate on April
13th, 1999.
/s/ Steven M. Harris
-----------------------------------
Steven M. Harris,
Incorporator
<PAGE>
CERTIFICATE OF MERGER
OF
SOFTNET SYSTEMS, INC.
(A NEW YORK CORPORATION)
INTO
SOFTNET SYSTEMS, INC.
(A DELAWARE CORPORATION)
Pursuant to Section 252 of the Delaware General Corporation Law, SoftNet
Systems, Inc., a Delaware corporation ("SoftNet - DE" or the "Surviving
Corporation"), the surviving corporation in a merger with SoftNet Systems, Inc.,
a New York corporation ("SoftNet - NY" or the "Disappearing Corporation"),
certifies as follows:
1. That the name and state of incorporation of each of the constituent
corporations of the merger is as follows:
Name State of Incorporation
---- ----------------------
SoftNet -- DE Delaware
SoftNet -- NY New York
2. That the Agreement and Plan of Merger dated as of April 14, 1999, by
and among SoftNet -- DE and SoftNet -- NY (the "Agreement") has been approved,
adopted, certified, executed and acknowledged by each of the constituent
corporations in accordance with the requirements of Section 252 of the General
Corporation Law of Delaware.
3. That the name of the surviving corporation is SoftNet Systems, Inc.
(Softnet -- DE)
4. That the Amended and Restated Certificate of Incorporation of SoftNet
- -- DE shall continue in full force and effect as the Amended and Restated
Certificate of Incorporation of the Surviving Corporation.
5. That the executed Agreement is on file at the principal place of
business of the Surviving Corporation, the address of which is 650 Townsend
Street, Suite 225, San Francisco, CA 94103.
6. That a copy of the Agreement will be furnished upon request and
without charge, to any stockholder of any constituent corporation.
7. The authorized capital stock of SoftNet -- NY is 25,000,000 shares of
common stock par value $0.01 and 4,000,000 shares of preferred stock $0.10 par
value.
8. That the Certificate of Merger shall be effective upon filing.
<PAGE>
IN WITNESS WHEREOF, the undersigned has caused this Certificate to be
executed this 14th day of April, 1999.
SOFTNET SYSTEMS, INC,
a Delaware Corporation
By: /s/ Garrett Girvan
-------------------------------
Its: Chief Operating Officer
----------------------------
ATTEST:
By: /s/ Steven M. Harris
-------------------------------
Its: Secretary
---------------------------
-2-
<PAGE>
SECRETARY'S CERTIFICATE
I, Steven M. Harris, Secretary of SoftNet Systems, Inc., a corporation
organized and existing under the laws of the State of Delaware, (the surviving
corporation) hereby certify, as such Secretary, that the Agreement and Plan of
Merger to which this Certificate is attached, after having been first duly
signed on behalf of said corporation and having been signed on behalf of SoftNet
Systems, Inc., corporation of the State of New York, (the merged corporation)
was duly submitted to the stockholders of said corporation, at an annual meeting
of said stockholders, duly called and held separately from the meeting of
Stockholders of any other corporation, for the purpose of among other things,
considering and taking action upon said Agreement and Plan of Merger; that
8,844,736 shares of stock of said corporation were on said date issued and
outstanding having voting power and that the proposed Agreement of and Plan of
Merger was approved by the stockholders by an affirmative vote representing at
least a majority of the outstanding stock of said corporation entitled to vote
thereon, and that thereby the Agreement and Plan of Merger was at said meeting
duly adopted as the act of the stockholders of said SoftNet Systems, Inc.,
Delaware corporation, and the duly adopted agreement of the said corporation.
WITNESS may hand on this 14th day of April 1999.
/s/ Steven M. Harris
-------------------------------
Steven M. Harris, Secretary
<PAGE>
BY-LAWS OF
SOFTNET SYSTEMS, INC.
ARTICLE 1 -- OFFICES
Section 1. SoftNet Systems, Inc. (the "Corporation") shall have its
registered office in Wilmington, County of New Castle, Delaware.
Section 2. The Corporation may also have offices at such other places both
in and out of Delaware as the Board of Directors (the "Board") may determine
or the business of the Corporation requires.
ARTICLE II -- MEETINGS OF STOCKHOLDERS
Section 1. All meetings of the stockholders for the election of directors
shall be held in San Francisco, California, at such place as may be fixed by
the Board, or at such other place either in or out of Delaware as shall be
designated by the Board and stated in the notice of the meeting. Meetings of
stockholders for any other purpose may be held at such time and place, in or
out of Delaware, as shall be stated in the notice of the meeting or in a
waiver of notice thereof.
Section 2. Annual meetings of stockholders, commencing with the year 2000,
shall be held at such date and time as shall be designated by the Board and
stated in the notice of the meeting, at which they shall elect by a plurality
vote a Board, and transact such other business as may properly be brought
before the meeting.
Section 3. The officer who has charge of the stock ledger of the Corporation
shall prepare and make, at least ten days before every meeting of
stockholders, a complete list of the stockholders entitled to vote at the
meeting, arranged in alphabetical order, and showing the address of each
stockholder and the number of shares registered in the name of each
stockholder. Such list shall be open to the examination of any stockholder,
for any purpose germane to the meeting, during ordinary business hours, for a
period of at least ten days prior to the meeting, either at a place in
<PAGE>
the city where the meeting is to be held, which place shall be specified in
the notice of the meeting, or, if not so specified, at the place where the
meeting is to be held. The list shall also be produced and kept at the time
and place of the meeting during the whole time thereof, and may be inspected
by any stockholder who is present.
Section 4. Special meetings of the stockholders, for any purpose or
purposes, unless otherwise prescribed by statute or by the certificate of
incorporation, may be called by the Chief Executive Officer and shall be
called by the Chief Executive Officer or Secretary at the request in writing
of a majority of the Board, or at the request in writing of stockholders
owning a majority in amount of the entire capital stock of the Corporation
issued and outstanding and entitled to vote. Such request shall state the
purpose or purposes of the proposed meeting.
Section 5. Written notice of an annual or a special meeting stating the
place, date and hour of the meeting and the purpose or purposes for which the
meeting is called, shall be given not fewer than ten nor more than sixty days
before the date of the meeting, to each stockholder entitled to vote at such
meeting.
Section 6. Business transacted at any special meeting of stockholders shall
be limited to the purposes stated in the notice.
Section 7. The holders of fifty percent of the stock issued and outstanding
and entitled to vote thereat, present in person or represented by proxy,
shall constitute a quorum at all meetings of the stockholders for the
transaction of business except as otherwise provided by statute or by the
certificate of incorporation. In the absence of such quorum, the stockholders
entitled to vote thereat, present in person or represented by proxy, shall
have power to adjourn the meeting, without notice other than announcement at
the meeting, until a quorum shall be present or represented. At such
adjourned meeting at which a quorum shall be present or represented any
business may be transacted which might have been transacted at the meeting as
originally notified. If the adjournment is for more than thirty days, or if
after the adjournment a new record
2.
<PAGE>
date is fixed for the adjourned meeting, a notice of the adjourned meeting
shall be given to each stockholder of record entitled to vote at the meeting.
Section 8. When a quorum is present at any meeting, the vote of the holders
of a majority of the stock having voting power present in person or
represented by proxy shall decide any question brought before such meeting,
unless the question is one upon which by express provision of the statutes or
of the certificate of incorporation, a different vote is required, in which
case such express provision shall govern and control the decision of such
question.
Section 9. Unless otherwise provided in the certificate of incorporation
each stockholder shall be entitled to one vote in person or by proxy for each
share of the capital stock having voting power held by such stockholder, but
no proxy shall be voted on after three years from its date, unless the proxy
provides for a longer period.
Section 10. Unless otherwise provided in the certificate of incorporation,
any action required to be taken or which may be taken at any annual or
special meeting of stockholders of the Corporation, may be taken without a
meeting, without prior notice and without a vote, if a consent in writing,
setting forth the action so taken, shall be signed by the holders of
outstanding stock having not less than the minimum number of votes that would
be necessary to authorize or take such action at a meeting at which all
shares entitled to vote thereon were present and voted. Prompt notice of the
taking of the corporate action without a meeting by less than unanimous
written consent shall be given to those stockholders who have not consented
in writing.
ARTICLE III -- DIRECTORS
Section 1. The number of directors which shall constitute the whole board
shall be determined by resolution of the Board or by the stockholders at the
annual meeting of the stockholders, except as provided in Section 2 of this
Article, and each director elected shall hold office until his successor is
elected and qualified. Directors need not be stockholders.
3.
<PAGE>
Section 2. Vacancies and new created directorships resulting from any
increase in the authorized number of directors may be filled by a majority of
the directors then in office, though less than a quorum, or by a sole
remaining director, and the directors so chosen shall hold office until the
next annual election and until their successors are duly elected and shall
qualify, unless sooner displaced. If there are no directors in office, then
an election of directors may be held in the manner provided by statute. If,
at the time of filling any vacancy or any newly created directorship, the
directors then in office shall constitute less than a majority of the whole
board (as constituted immediately prior to any such increase), the Court of
Chancery may, upon application of any stockholder or stockholders holding at
least ten percent of the total number of the shares at the time outstanding
having the right to vote for such directors, summarily order an election to
be held to fill any such vacancies or newly created directorships, or to
replace the directors chosen by the directors then in office.
Section 3. The business of the Corporation shall be managed by or under the
direction of its Board which may exercise all such powers of the Corporation
and do all such lawful acts and things as are not by statute or by the
certificate of incorporation or by these bylaws directed or required to be
exercised or done by the stockholders.
Section 4. The Board of the Corporation may hold meetings, both regular and
special, either in or out of Delaware.
Section 5. The first meeting of each newly elected Board shall be held at
such time and place as shall be fixed by the vote of the stockholders at the
annual meeting and no notice of such meeting shall be necessary to the newly
elected directors in order legally to constitute the meeting, provided a
quorum shall be present. In the event of the failure of the stockholders to
fix the time or place of such first meeting of the newly elected Board, or in
the event such meeting is not held at the time and place so fixed by the
stockholders, the meeting may be held at such time and place as shall be
specified in a notice given as hereinafter provided for special meetings of
the Board, or as shall be specified in a written waiver signed by all of the
directors.
4.
<PAGE>
Section 6. Regular meetings of the Board may be held without notice at such
time and at such place as shall be determined by the Board.
Section 7. Special meetings of the Board may be called by the Chief
Executive Officer on two days' notice to each director by mail or forty-eight
hours notice to each director either personally or by electronic mail or
telegram; special meetings shall be called by the Chief Executive Officer or
Secretary in like manner and on like notice on the written request of two
directors unless the board consists of only one director, in which case
special meetings shall be called in like manner and on like notice on the
written request of the sole director.
Section 8. At all meetings of the Board a majority of the directors shall
constitute a quorum for the transaction of business and the act of a majority
of the directors present at any meeting at which there is a quorum shall be
the act of the Board, except as may be otherwise specifically provided by
statute or by the certificate of incorporation. If a quorum shall not be
present at any meeting of the Board, the directors present thereat may adjourn
the meeting, without notice other than announcement at the meeting, until a
quorum shall be present.
Section 9. Unless otherwise restricted by the certificate of incorporation,
any action required or permitted to be taken at any meeting of the Board or
of any committee thereof may be taken without a meeting, if all members of
the board or committee, as the case may be, consent thereto in writing, and
the writings are filed with the minutes of proceedings of the board or
committee.
Section 10. Unless otherwise restricted by the certificate of incorporation
or these bylaws, members of the Board, or any committee designated by the
Board, may participate in a meeting of the Board, or any committee, by means
of conference telephone or similar communications equipment by means of
which all persons participating in the meeting can hear each other, and such
participation in a meeting shall constitute presence in person at the meeting.
5.
<PAGE>
Section 11. The Board may, by resolution passed by a majority of the whole
board, designate one or more committees, each committee to consist of one or
more of the directors of the Corporation. The Board may designate one or more
directors as alternate members of any committee, who may replace any absent
or disqualified member at any meeting of the committee. In the absence of
disqualification of a member of a committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not
constituting a quorum, may unanimously appoint another member of the Board to
act at the meeting in the place of any such absent or disqualified member.
Any such committee, to the extent provided in the resolution of the Board,
shall have and may exercise all the powers and authority of the Board in the
management of the business and affairs of the Corporation, and may authorize
the seal of the Corporation to be affixed to all papers which may require it;
but no such committee shall have the power or authority in reference to
amending the certificate of incorporation, adopting an agreement of merger or
consolidation, recommending to the stockholders the sale, lease or exchange
of all or substantially all of the Corporations's property and assets,
recommending to the stockholders a dissolution of the Corporation or a
revocation of a dissolution, or amending the bylaws of the Corporation; and,
unless the resolution or the certificate of incorporation expressly so
provide, no such committee shall have the power or authority to declare a
dividend or to authorize the issuance of stock. Such committee or committees
shall have such name or names as may be determined by resolution adopted by
the Board.
Section 12. Each committee shall keep regular minutes of its meetings and
report the same to the Board when required.
6.
<PAGE>
Section 13. Unless otherwise restricted by the certificate of incorporation,
the Board shall have the authority to fix the compensation of directors. The
directors may be paid their expenses, if any, of attendance at each meeting
of the Board or a committee thereof and may be paid a fixed sum for
attendance at each meeting of the Board or a committee thereof or a stated
salary as director. No such payment shall preclude any director from serving
the Corporation in any other capacity and receiving compensation therefor.
Section 14. Unless otherwise restricted by the certificate of incorporation
or bylaw, any director or the entire Board may be removed, with or without
cause, by the holders of a majority of shares entitled to vote at an election
of directors.
ARTICLE IV -- NOTICES
Section 1. Whenever, under the provisions of the statutes or of the
certificate of incorporation or of these bylaws, notice is required to be
given to any director or stockholder, it shall not be construed to mean
personal notice, but such notice may be given in writing, by mail, addressed
to such director or stockholder, at his address as it appears on the records
of the Corporation, with postage thereon prepaid, and such notice shall be
deemed to be given at the time when the same shall be deposited in the United
States mail. Notice to directors may also be given by telegram or electronic
mail. Such Notice shall state the place, date and time of the meeting and in
the case of a special meetings the purpose or purpose for which the meeting
is called.
Section 2. A waiver of such notice in writing, signed by the person or
persons entitled to said notice, whether before or after the time stated
therein, shall be deemed equivalent thereto.
7.
<PAGE>
ARTICLE V -- OFFICERS
Section 1. The officers of the Corporation shall be chosen by the Board and
shall be a Chief Executive Officer, a Chief Financial Officer and a Secretary.
The Board may elect from among its members a Chairman of the Board and a
Vice-Chairman of the Board. The Board may appoint such other officers and
agents as it shall deem necessary. Any number of offices may be held by the
same person, unless the certificate of incorporation or these bylaws otherwise
provide.
Section 2. The Board at its first meeting after each annual meeting of
stockholders shall choose a president or Chief Executive Officer, a Chief
Financial Officer, and a Secretary and may choose vice presidents and such
other officers they deem necessary to carry out the business of the
Corporation.
Section 3. Each officer shall hold their office for such terms and shall
exercise such powers and perform such duties as shall be determined by the
board.
Section 4. The salaries of all officers and agents of the Corporation shall be
fixed by the Board.
Section 5. The officers of the Corporation shall hold office until their
successors are chosen and qualified. Any officer elected or appointed by the
Board may be removed at any time by the affirmative vote of a majority of the
Board. Any vacancy occurring in any office of the Corporation shall be filled
by the Board.
Section 6. The Chairman of the Board, if any, shall preside at all meetings of
the Board and of the stockholders at which he shall be present. The Chairman of
the Board shall have and may exercise such powers as are assigned to him by the
Board and as may be provided by law.
Section 7. In the absence of the Chairman of the Board, the Vice Chairman of
the Board, if any,
8.
<PAGE>
shall preside at all meetings of the Board and of the stockholders at which he
shall be present. The Vice Chairman shall have and may exercise such powers as
are assigned to him by the Board and as may be provided by law.
Section 8. The Chief Executive Officer shall have general and active management
of the business of the Corporation and shall see that all orders and resolutions
of the Board are carried into effect. In the absence of the Chairman and Vice
Chairman of the Board, the Chief Executive Officer shall preside at all meetings
of the stockholders and the Board.
Section 9. The Chief Executive Officer shall execute bonds, mortgages and other
contracts requiring a seal, under the seal of the Corporation, except where
required or permitted by law to be otherwise signed and executed and except
where the signing and execution thereof shall be expressly delegated by the
Board to some other officer or agent of the Corporation.
Section 10. In the absence of the Chief Executive Officer or in the event of
his inability or refusal to act, the vice-president, if any, (or in the event
there be more than one vice-president, the vice-presidents in the order
designated by the directors, or in the absence of any designation, then in the
order of their election) shall perform the duties of the Chief Executive
Officer, and when so acting, shall have all the powers of and be subject to all
the restrictions upon the president. The vice-presidents shall perform such
other duties and have such other powers as the Board may prescribe.
Section 11. Chief Financial Officer. Subject to the direction of the Board Of
Directors and the Chief Executive Officer, the Chief Financial officer shall
perform all duties and have all powers that are commonly incident to the office
of Chief Financial Officer.
Section 12. The Secretary shall attend all meetings of the Board and all
meetings of the stockholders and record all the proceedings of the meetings of
the Corporation and of the Board in a book to be kept for that purpose and shall
perform like duties for the standing committees
9.
<PAGE>
when required. The Secretary shall give, or cause to be given, notice of all
meetings of the stockholders and special meetings of the Board, and shall
perform such other duties as may be prescribed by the Board or Chief Executive
Officer, under whose supervision he shall be. The Secretary shall have custody
of the corporate seal of the Corporation and he, or an Assistant Secretary,
shall have authority to affix the same to any instrument requiring it and when
so affixed, it may be attested by his signature or by the signature of such
Assistant Secretary. The Board may give general authority to any other officer
to affix the seal of the Corporation and to attest the affixing by his
signature.
Section 13. The Assistant Secretary, or if there be more than one, the
Assistant Secretaries in the order determined by the Board (or if there be no
such determination, then in the order of their election) shall, in the absence
of the Secretary or in the event of his inability or refusal to act, perform the
duties and exercise the powers of the Secretary and shall perform such other
duties and have such other powers as the Board may prescribe.
Section 14. The Chief Financial Officer shall have the custody of the corporate
funds and securities and shall keep full and accurate accounts of receipts and
disbursements in books belonging to the Corporation and shall deposit all moneys
and other valuable effects in the name and to the credit of the Corporation in
such depositories as may be designated by the Board.
Section 15. The Chief Financial Officer shall disburse the funds of the
Corporation as may be ordered by the Board, taking proper vouchers for such
disbursements, and shall render to the Chief Executive Officer and the Board, at
its regular meetings, or when the Board so requires, an account of all the
transactions and the financial condition of the Corporation.
Section 16. If required by the Board, the Chief Financial Officer shall give
the Corporation a bond (which shall be renewed every six years) in such sum and
with such surety as shall be satisfactory to the Board for the faithful
performance of the duties of his office and for the restoration to the
Corporation, in case of his death, resignation, retirement or removal from
10.
<PAGE>
office, of all books, papers, vouchers, money and other property of whatever
kind in his possession or under his control belonging to the Corporation.
Section 17. The Treasurer or the Assistant Treasurers in the order determined
by the Board (or if there be no such determination, then in the order of their
election) shall, in the absence of the Chief Financial Officer or in the event
of his inability or refusal to act, perform the duties and exercise the powers
of the Chief Financial Officer and shall perform such other duties and have such
other powers as the Board may prescribe.
ARTICLE VI -- CERTIFICATE OF STOCK
Section 1. Every holder of stock in the Corporation shall be entitled to have a
certificate, signed by, or in the name of the Corporation by, the Chairman or
Vice-Chairman of the Board, or other authorized Officer of the Corporation,
certifying the number of shares owned by him in the Corporation. Certificates
may be issued for partly paid shares and in such case upon the face or back of
the certificates issued to represent any such partly paid shares, the total
amount of the consideration to be paid therefor, and the amount paid thereon
shall be specified.
Section 2. If the Corporation shall be authorized to issue more than one class
of stock or more than one series of any class, the powers, designations,
preferences and relative, participating, optional or other special rights of
each class of stock or series thereof and the qualification, limitations or
restrictions of such preferences and/or rights shall be set forth in full or
summarized on the face or back of the certificate, provided that, except as
otherwise provided in section 202 of the General Corporation Law of Delaware, in
lieu of the foregoing requirements, there may be set forth on the face or back
of the, a statement that the Corporation will furnish without charge to each
stockholder who so requests the powers, designations, preferences and relative,
participating, optional or other special rights of each class of stock or series
thereof and the qualifications, limitations or restrictions of such preferences
and/or rights.
Section 3. Any of or all the signatures on the certificate may be facsimile.
In case any officer,
11.
<PAGE>
transfer agent or registrar who has signed or whose facsimile signature has been
placed upon a certificate shall have ceased to be such officer, transfer agent
or registrar before such certificate is issued, it may be issued by the
Corporation with the same effect as if he were such officer, transfer agent or
registrar at the date of issue.
Section 4. The Board may direct a new certificate or certificates to be issued
in place of any certificate or certificates theretofore issued by the
Corporation alleged to have been lost, stolen or destroyed, upon the making of
an affidavit of that fact by the person claiming the certificate of stock to be
lost, stolen or destroyed. When authorizing such issue of a new certificate,
the Board may, in its discretion and as a condition precedent to the issuance
thereof, require the owner of such lost, stolen or destroyed certificate, or his
legal representative, to advertise the same in such manner as it shall require
and/or to give the Corporation a bond in such sum as it may direct as indemnity
against any claim that may be made against the Corporation with respect to the
certificate alleged to have been lost, stolen or destroyed.
Section 5. Upon surrender to the Corporation of a certificate for shares duly
endorsed or accompanied by proper evidence of succession, assignation or
authority to transfer, the Corporation shall issue a new certificate to the
person entitled thereto, cancel the old certificate and record the transaction
upon its books.
12.
<PAGE>
Section 6. In order that the Corporation may determine the stockholders
entitled to notice of or to vote at any meeting of stockholder or any
adjournment thereof, or to express consent to corporate action in writing
without a meeting, or entitled to receive payment of any dividend or other
distribution or allotment of any rights, or entitled to exercise any rights in
respect of any change, conversion or exchange of stock or for the purpose of any
other lawful action, the Board may fix, in advance, a record date, which shall
not be more than sixty nor less than ten days before the date of such meeting,
nor more than sixty days prior to any other action. A determination of
stockholders of record entitled to notice of or to vote at a meeting of
stockholders shall apply to any adjournment of the meeting; provided, however,
that the Board may fix a new record date for the adjourned meeting.
Section 7. The Corporation shall be entitled to recognize the exclusive right
of a person registered on its books as the owner of shares the receive
dividends, and to vote as such owner, and to hold liable for calls and
assessments a person registered on its books as the owner of shares and shall
not be bound to recognize any equitable or other claim to or interest in such
share or shares on the part of any other person, whether or not it shall have
express or other notice thereof, except as otherwise provided by the laws of
Delaware.
ARTICLE VII -- GENERAL PROVISIONS
Section 1. Dividends upon the capital stock of the Corporation, subject to the
provisions of the certificate of incorporation, if any, may be declared by the
Board at any regular or special meeting, pursuant to law. Dividends may be paid
in cash, in property, or in shares of the capital stock, subject to the
provisions of the certificate of incorporation.
Section 2. Before payment of any dividend, there may be set aside out of any
funds of the Corporation available for dividends such sum or sums as the
directors, in their absolute discretion, think proper as a reserve or reserves
to meet contingencies, or for equalizing dividends, or for repairing or
maintaining any property of the Corporation, or for such other purposes as the
directors shall think conducive to the interest of the Corporation, and the
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<PAGE>
directors may modify or abolish any such reserve in the manner in which it was
created.
Section 3. All checks or demands for money and notes of the Corporation shall
be signed by such officer or officers or such other person or persons as the
Board may designate.
Section 4. The fiscal year of the Corporation shall be fixed by resolution of
the Board.
Section 5. The Board may adopt a corporate seal having inscribed thereon the
name of the Corporation, the year of its organization and the words "Corporate
Seal, Delaware". The seal may be used by causing it or a facsimile thereof to be
impressed, reproduced, or otherwise.
Section 6. The Corporation shall, to the fullest extent authorized under the
laws of the State of Delaware, as those laws may be amended, indemnify any
director made, or threatened to be made, a party to an action or proceeding,
whether criminal, civil, administrative or investigative, by reason of being a
director of the Corporation or a predecessor corporation or, at the
Corporation's request, a director or officer of another corporation, provided
however, that the Corporation shall indemnify any such agent in connection with
a proceeding initiated by such agent only if such proceeding was authorized by
the Board of the Corporation. The indemnification provided for in this Section 6
shall: (i) not be deemed exclusive of any other rights to which those
indemnified may be entitled under any bylaw, agreement or vote of stockholders
or disinterested directors or otherwise, both as to action in their official
capacities and as to action in another capacity while holding such office, (ii)
continue as to a person who has ceased to be a director, and (iii) inure to the
benefit of heirs, executors and administrators of such a person. The
Corporation's obligation to provide indemnification under this Section 6 shall
be offset to the extent of any other source of indemnification or any otherwise
applicable insurance coverage under a policy maintained by the Corporation or
any other person. Expenses incurred by a director of the Corporation in
defending a civil or criminal action, suit or proceeding by reason of the fact
that he is or was a director of the Corporation (or was serving at the
Corporation's request as a director or officer of another corporation) shall be
paid by the
14.
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Corporation in advance of the final disposition of such action, suit or
proceeding upon receipt of an undertaking by or on behalf of such director to
repay such amount if it shall ultimately be determined that he is not entitled
to be indemnified by the Corporation as authorized by relevant sections of the
General Corporation Law of Delaware. Notwithstanding the foregoing, the
Corporation shall not by required to advance such expenses to an agent who is a
party to an action, suit or proceeding brought by the Corporation and approved
by a majority of the Board of the Corporation which alleges willful
misappropriation of corporate assets by such agent, disclosure of confidential
information in violation of such agent's fiduciary or contractual obligations to
the Corporation or any other willful and deliberate breach in bad faith of such
agent's duty to the Corporation or its stockholders. The foregoing provisions of
this Section 6 shall be deemed to be a contract between the Corporation and each
director who serves in such capacity at any time while this bylaw is in effect,
and any repeal or modification thereof shall not affect any rights or
obligations then existing with respect to any state of facts then or theretofore
existing or any action, suit or proceeding theretofore or thereafter brought
based in whole or in part upon any such state of facts. The Board in its
discretion shall have power on behalf of the Corporation to indemnify any
person, other than a director, made party to any action, suit or proceeding by
reason of the fact that he, his testator or intestate, is or was an officer or
employee of the Corporation. To assure indemnification under this Section 6 of
all directors, officers and employees who are determined by the Corporation or
otherwise to be or to have been "fiduciaries" of any employee benefit plan of
the Corporation which may exist, Section 145 of the General Corporation Law of
Delaware shall, for the purposes of this Section 6, be interpreted as follows:
an "other enterprise" shall be deemed to include such an employee benefit plan,
including without limitation, any plan of the Corporation which is governed by
the Act of Congress entitled "Employee Retirement Income Security Act of 1974,"
as amended; the Corporation shall be deemed to have requested a person to
serve an employee benefit plan where the performance by such person of his
duties to the Corporation also imposes duties on, or otherwise involves services
by, such person to the plan or participants or beneficiaries of the plan; excise
taxes assessed on a person with respect to an employee benefit plan pursuant to
such Act of Congress shall be deemed "fines".
15.
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ARTICLE VIII -- AMENDMENTS
Section 1. Theses bylaws may be altered, amended or repealed or new bylaws may
be adopted by the stockholders or by the Board, at any regular meeting of the
stockholders or of the Board or at any special meeting of the stockholders or of
the Board if notice of such alteration, amendment, repeal or adoption of new
bylaws be contained in the notice of such special meeting. The power to adopt,
amend or repeal bylaws conferred upon the Board by the certificate of
incorporation shall not divest or limit the power of the stockholders to adopt,
amend or repeal bylaws.
16.
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the prospectus
constituting part of this Registration Statement of SoftNet Systems, Inc. on
Form S-3 (File No. 333-74767) of our report dated December 1, 1998, except for
Note 18 which is dated January 13, 1999, which appears on the 1998 Annual Report
to Shareholders of SoftNet Systems, Inc., which is incorporated by reference in
SoftNet's Annual Report on Form 10-K for the year ended September 30, 1998. We
hereby further consent to the incorporation by reference in the prospectus
constituting part of this Registration Statement on Form S-3 of our report on
Intelligent Communications, Inc. Financial Statements dated February 9, 1999,
which is incorporated by reference in SoftNet's Report on Form 8-K/A as of March
12, 1999. We also consent to the reference to us under the heading "Experts" in
such prospectus and Form 8-K/A.
/s/ PRICEWATERHOUSECOOPERS
April 22, 1999
San Jose, California
