SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No.: 1-5270
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-1817252
-------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
650 Townsend Street, Suite 225, San Francisco, CA 94103
------------------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 365-2500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 2000
------------------------------- -----------------------------
Common stock, $0.01 par value 28,506,891
<PAGE>
SoftNet Systems, Inc. and Subsidiaries
Index
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2000 and
September 30, 1999 ............................................. 2
Condensed Consolidated Statements of Operations for the three
months and nine months ended June 30, 2000 and 1999 ............ 3
Condensed Consolidated Statements of Cash Flows for the nine months
ended June 30, 2000 and 1999 ................................... 4
Notes to Condensed Consolidated Financial Statements .............. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk..... 21
PART II- OTHER INFORMATION
Item 1 Legal Proceedings.............................................. 22
Item 2 Changes in Securities.......................................... 22
Item 3 Defaults Upon Senior Securities................................ 22
Item 4 Submission of Matters to a Vote of Security Holders............ 22
Item 5 Other Information.............................................. 23
Item 6 Exhibits and Reports on Form 8-K............................... 40
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SoftNet Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
June 30, September 30,
2000 1999
---- ----
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents................................................... $ 41,966 $ 89,499
Short-term investments...................................................... 154,841 52,586
Accounts receivable, net.................................................... 2,897 935
Notes receivable............................................................ - 1,000
Inventory................................................................... 5,735 1,991
Other current assets........................................................ 5,145 1,776
------------- -------------
Total current assets........................................................... 210,584 147,787
Restricted cash................................................................ 992 922
Property and equipment, net.................................................... 44,886 26,743
Acquired technology and other intangibles, net................................. 66,592 24,500
Other assets................................................................... 13,882 5,872
------------- -------------
$ 336,936 $ 205,824
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses....................................... $ 18,932 $ 15,545
Current portion of long-term debt........................................... 4,933 2,084
Current portion of capital lease obligation................................. 4,926 1,760
------------- -------------
Total current liabilities...................................................... 28,791 19,389
Long-term debt, net of current portion......................................... 4,249 17,281
Capital lease obligation, net of current portion............................... 4,958 1,945
Business acquisition liability................................................. 2,000 3,500
------------- -------------
Total Liabilities.............................................................. 39,998 42,115
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.10 par value, 3,970,000 shares designated, no shares
issued and outstanding...................................................... - -
Common stock, $0.01 par value, 100,000,000 shares authorized;
28,254,723 and 17,225,523 shares issued and outstanding, respectively ...... 256 172
Additional-paid-in capital.................................................. 498,856 327,445
Deferred stock compensation................................................. (32,472) (63,346)
Accumulated comprehensive loss.............................................. (729) (315)
Accumulated deficit......................................................... (168,973) (100,247)
-------------- -------------
Total stockholders' equity..................................................... 296,938 163,709
------------- -------------
$ 336,936 $ 205,824
============= =============
<FN>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
</FN>
</TABLE>
2
<PAGE>
SoftNet Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30, Ended June 30,
-------------------- --------------------
2000 1999 2000 1999
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Net sales .................................................................. $ 8,574 $ 1,317 $ 11,541 $ 2,788
Cost of sales .............................................................. 6,931 1,460 10,474 2,758
-------- -------- -------- -------
Gross profit (loss) ........................................................ 1,643 (143) 1,067 30
-------- -------- -------- -------
Operating expenses:
Selling and marketing, exclusive of non-cash
compensation expense (see table below) ................................... 6,919 4,197 18,991 8,567
Engineering, exclusive of non-cash compensation
expense (see table below) ................................................ 6,222 1,856 15,478 3,325
General and administrative, exclusive of non-cash
compensation expense (see table below) ................................... 5,596 2,439 12,586 6,616
Depreciation ............................................................. 3,565 938 8,484 2,140
Amortization ............................................................. 3,117 872 5,509 1,597
Compensation related to stock options (see table below)................... 5,039 5,680 16,318 6,721
-------- -------- -------- -------
Total operating expenses ................................................... 30,458 15,982 77,366 28,966
-------- -------- -------- -------
Loss from continuing operations before other income
(expense), income taxes and discontinued
operations, net of tax...................................................... (28,815) (16,125) (76,299) (28,936)
Other income (expense):
Interest expense ........................................................ (381) (2,453) (1,159) (3,580)
Interest income ......................................................... 3,331 1,336 8,894 1,576
Other expense, net ...................................................... (125) (1,373) (162) (1,405)
-------- -------- -------- -------
Loss from continuing operations before income taxes
and discontinued operations, net of tax.................................. (25,990) (18,615) (68,726) (32,345)
Provision for income taxes ................................................. -- -- -- --
-------- -------- -------- -------
Loss from continuing operations ............................................ (25,990) (18,615) (68,726) (32,345)
Loss from discontinued operations, net of tax .............................. -- (15) -- (399)
-------- -------- -------- -------
Net loss ................................................................... (25,990) (18,630) (68,726) (32,744)
Preferred dividends ........................................................ -- (59) -- (473)
-------- -------- -------- -------
Net loss applicable to common shares ....................................... $(25,990) $(18,689) $(68,726) $(33,217)
======== ======== ======== =======
Basic and diluted loss per common share:
Loss from continuing operations........................................... $ (1.02) $ (1.26) $ (3.02) $ (2.99)
Loss from discontinued operations......................................... -- -- -- (0.04)
Preferred dividends....................................................... -- (0.01 -- (0.04)
-------- -------- -------- -------
Net loss applicable to common shares........................................ $ (1.02) $ (1.27) $ (3.02) $ (3.07)
======== ======== ======== =======
Shares used to compute basic and diluted loss per
common share.............................................................. 25,368 14,764 22,742 10,806
======== ======== ======== =======
Compensation related to stock options:
Selling and marketing......................................................... $ 249 $ 1,252 $ 2,154 $ 1,252
Engineering................................................................... 605 954 1,998 954
General and administrative.................................................... 4,185 3,474 12,166 4,515
-------- -------- -------- -------
$ 5,039 $ 5,680 $ 16,318 $ 6,721
======== ======== ======== =======
<FN>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
SoftNet Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended June 30,
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................................... $ (68,726) $ (32,744)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss from discontinued operations ............................................... -- 399
Depreciation and amortization ................................................... 13,993 3,737
Amortization of deferred stock compensation ..................................... 16,318 6,721
Loss in equity investment ....................................................... 191 --
Loss on disposition of short-term investments ................................... -- 600
Amortization of deferred debt issuance costs .................................... 53 2,335
Interest paid with additional convertible notes ................................. 69 --
Provision for doubtful accounts ................................................. 552 186
Provision for inventory losses .................................................. 85 --
Charges incurred upon conversion of redeemable convertible preferred stock
into common stock ............................................................. -- 498
Changes in operating assets and liabilities (net of effect of acquisitions
and discontinued operations):
Increase in accounts receivable, net ........................................ (2,374) (718)
Increase in inventory ....................................................... (3,271) (1,376)
Increase in other current assets ............................................ (3,457) (1,441)
Increase in other assets .................................................... (2,764) (849)
Increase (decrease) in accounts payable and accrued expenses ................ (1,070) 2,209
--------- ---------
Net cash used in operating activities of continuing operations ....................... (50,401) (20,443)
--------- ---------
Net cash provided by operating activities of discontinued operations ................. -- 842
--------- ---------
Cash flows from investing activities:
Payment for purchase of short-term investments .................................... (102,669) (600)
Payment for purchase of Laptop Lane Limited, net of cash acquired ................. (1,166) --
Payment for purchase of Intelligent Communications, Inc., net of cash acquired .... -- (803)
Proceeds from sale of net assets from discontinued operations, net of selling costs -- 2,694
Payments for purchase of long-term equity investments ............................. (7,530) --
Payment for purchase of property and equipment .................................... (13,926) (7,518)
Payment for purchase of acquired technology and other intangibles ................. (231) (1,913)
Disbursement for promissory notes issued .......................................... (6,600) --
Payment received on note receivable ............................................... 1,000 --
--------- ---------
Net cash used in investing activities of continuing operations ....................... (131,122) (8,140)
--------- ---------
Net cash provided by investing activities of discontinued operations ................. -- (98)
--------- ---------
Cash flows from financing activities:
Proceeds from sale of common stock, net of selling costs .......................... 128,643 156,492
Proceeds from exercise of warrants ................................................ 1,538 2,454
Proceeds from exercise of options ................................................. 3,655 1,671
Payment for fractional shares related to anniversary issuance of
common stock to former Intelligent Communications, Inc. stockholders ............ (1) --
Payments for additional costs of issuance of redeemable convertible
preferred stock ................................................................. -- (152)
Payment of preferred dividend ..................................................... -- (95)
Proceeds from issuance of long-term debt, net of deferred financing costs ......... 3,128 13,358
Borrowings under revolving credit facility ........................................ -- 18,285
Payments under revolving credit facility .......................................... -- (21,215)
Principal payments of short term and long-term debt ............................... (929) (1,567)
Principal payments of capital lease obligations ................................... (2,044) (904)
--------- ---------
Net cash provided by financing activities of continuing operations ................... 133,990 168,327
--------- ---------
Net cash used in financing activities of discontinued operations ..................... -- (1,038)
--------- ---------
Net decrease in cash and cash equivalents ............................................ (47,533) 139,450
Cash and cash equivalents, beginning of period ....................................... 89,499 12,504
--------- ---------
Cash and cash equivalents, end of period ............................................. $ 41,966 $ 151,954
========= =========
<FN>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
</FN>
</TABLE>
4
<PAGE>
SoftNet Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
1. Basis of Presentation
The financial information included herein is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the condensed consolidated statements of financial position,
results of operations and cash flows as of and for the interim periods ended
June 30, 2000 and 1999.
SoftNet Systems, Inc.'s annual report on Form 10-K for the fiscal year ended
September 30, 1999, 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, 1999
was derived from SoftNet Systems, Inc. and Subsidiaries (the "Company") audited
consolidated financial statements.
The results of operations for the three months and nine months ended June 30,
2000 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.
Certain reclassifications have been made to prior year financial statements in
order to conform to the current year presentation.
2. Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements".
Implementation is scheduled for fiscal years beginning after December 15, 1999,
which would be effective for the Company beginning in fiscal year 2001. SAB 101
addresses various topics in revenue recognition including the recognition of
revenue for contracts involving multiple deliverables. The Company is currently
analyzing SAB 101, however, based on Management's current understanding and
interpretation, SAB 101 is not expected to have a material impact on the
Company's cosolidated financial statements.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions involving
Stock Compensation - an Interpretation of Accounting Principles Board ("APB")
Opinion No. 25". FIN 44 clarifies the application of APB 25 and is effective
July 1, 2000. The Company believes that FIN 44 will not have a material effect
on the Company's financial position or results of operations.
In June 2000, the FASB issued Statement of Financial Accounting Standards No.
138 ("FASB 138"), "Accounting for Certain Derivative Instruments and Certain
Hedging Activities", an amendment to FASB Statement No. 133 ("FASB 133"). FASB
138 addresses a limited number of issues causing implementation difficulties for
companies that are required to apply FASB 133. FASB 133, as amended by FASB
Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities
- Deferral of the effective date of FASB Statement No. 133", is effective for
all fiscal quarters of all fiscal years beginning after June 15, 2000. The
Company believes that SFAS 133 and SFAS 138 will not have a material impact on
its financial position, results of operations or cash flows.
3. Acquisition of Laptop Lane Limited and Formation of SoftNet Zone
On April 21, 2000, the Company acquired Laptop Lane Limited ("Laptop Lane"), a
Washington corporation, under the purchase method of accounting and the results
of Laptop Lane are included in the consolidated financial statements since the
date of acquisition. Laptop Lane is a leading provider of business center
services in airports. The Company paid approximately $20,859,000 consisting of
(i) 972,266 common stock shares of the Company valued at $15,107,000, net of
adjustment for expenses paid by the Company on behalf of Laptop Lane, exchanged
for all outstanding common stock shares of Laptop Lane, (ii) direct acquisition
costs of approximately $2,100,000, which includes a bonus payment to Laptop Lane
employees for $431,000 in lieu of Laptop Lane stock options, and (iii) 250,000
common stock shares of the Company valued at $3,652,000 to be issued to former
Laptop Lane stockholders in payment for achieving certain performance criteria.
As part of the acquisition, an additional 333,333 common stock shares of the
Company will be distributed to former Laptop Lane stockholders if certain
performance goals are met. As of June 30, 2000, Laptop Lane has achieved three
of the four performance goals, as a result 250,000 common stock shares of the
Company amounting to $3,652,000 was accrued for and will be issued to the former
Laptop Lane stockholders. The remaining 83,333 common stock shares were unearned
as of June 30, 2000 and accordingly no liability has been accrued. Additionally,
prior to the acquisition the Company provided $6,000,000 in working capital to
Laptop Lane under a secured promissory note.
5
<PAGE>
The purchase price, including direct acquisition costs, has been allocated to
assets acquired and liabilities assumed based on fair value at the date of
acquisition. The allocation of purchase price includes goodwill, which is
amortized on a straight-line basis over four years. The fair value of assets and
liabilities assumed is summarized as follows (in thousands):
Current assets........................ $ 1,707
Property and equipment, net........... 4,478
Goodwill.............................. 23,195
Other assets.......................... 128
Current liabilities................... 806
Other liabilities..................... 7,843
The following unaudited pro forma financial information presents the
consolidated results of the Company as if the Laptop Lane acquisition had
occurred as of October 1, 1998, and includes adjustments for amortization of
goodwill. The pro forma financial results are not necessarily indicative of what
actually would have occurred if the acquisition had been completed as of October
1, 1998, nor are they necessarily indicative of future consolidated results.
Unaudited pro forma consolidated results of operations are as follows (in
thousands, except per share data):
Nine Months
Ended June 30,
--------------------------
2000 1999
---- ----
Net Sales................... $ 13,176 $ 7,079
=========== =========
Net loss applicable
to common shares........ $ (77,373) $ (40,132)
=========== =========
Basic and diluted net
loss applicable
to common shares......... $ (3.23) $ (3.34)
=========== =========
In connection with the Company's proposed purchase of Laptop Lane, the Company
announced on February 9, 2000 that it, together with CMGI, Inc. and Compaq
Computer Corporation, has signed letters of intent to provide equity funding and
services to a new initiative called SoftNet Zone, contingent on completing the
Laptop Lane acquisition and other customary closing conditions. In addition to
its contribution of funding and services, the Company also announced that it
plans to contribute its interest in Laptop Lane to this new venture. It is the
Company's intention to maintain a majority interest in SoftNet Zone. The
proposed strategy of SoftNet Zone is to offer mobile computing and Internet
services, both wired and wireless, to global business travelers.
On April 20, 2000, the Company announced a letter of intent has been signed with
Delta Air Lines Inc. ("Delta") to provide wireless Internet access and business
services to Delta customers at Delta's gates and Crown Room Clubs. As a part of
this alliance, Delta will gain a minority equity position in SoftNet Zone. The
Company is in the process of completing definitive agreements with Delta.
6
<PAGE>
4. Cash, Cash Equivalents and Short-Term Investments
Cash equivalents consist of securities with maturities of three months or less
at the date of purchase. Short-term investments as of June 30, 2000 consisted of
$106,663,000 of securities that mature in less than one year and $48,178,000 of
securities that mature between one to five years. Cash and cash equivalents, and
short-term investments consisted of the following as of June 30, 2000 (in
thousands):
<TABLE>
<CAPTION>
Unrealized Unrealized
Cost gain loss Market
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Cash and cash equivalents:
Cash.............................. $ 9,675 $ - $ - $ 9,675
Municipal securities.............. 31,084 58 - 31,142
Money market funds................ 1,149 - - 1,149
------------- ------------- ------------- -------------
$ 41,908 $ 58 $ - $ 41,966
============= ============= ============= =============
Short-term investments:
Municipal securities.............. $ 95,915 $ - $ (339) $ 95,576
US Treasury securities............ 35,834 - (81) 35,753
Auction market preferreds......... 3,206 - - 3,206
Foreign debt securities........... 20,174 - (68) 20,106
Common stock...................... 499 - (299) 200
------------- ------------- ------------- -------------
$ 155,628 $ - $ (787) $ 154,841
============= ============ ============ ============
</TABLE>
5. Notes Receivable
During November 1999, Convergent Communications Services, Inc. paid its note
outstanding in the amount of $1,000,000.
6. Long-Term Equity Investments
During January 2000, the Company acquired 337,496 series B preferred stock
shares of Dotcast.com, a California corporation, for $1,000,000. Dotcast.com
provides high-speed data transmission technology.
On February 23, 2000, the Company entered into an agreement to provide
management consulting advice on strategy, operations, marketing, technology and
content; and training related to high speed Internet services through cable
television networks to Big Sky Network Canada, Ltd. ("Big Sky"), a British
Virgin Islands international business company. As part of the agreement the
Company acquired 10,000 common stock shares of Big Sky for $500,000. On April
24, 2000, the Company acquired an additional 40,000 common stock shares of Big
Sky for $2,000,000.
On March 24, 2000, the Company entered into an agreement to provide management
consulting advice on strategy, operations, marketing, technology and content;
and training related to high speed Internet services through cable television
networks to Interactive Cable Communications Incorporated. As part of this
agreement, the Company acquired 4,600 common stock shares of Interactive Cable
Communications Incorporated for $3,763,000, and formed a joint venture with
Marubeni Corporation, a Japan corporation.
All of these investments are accounted for under the equity method and are
included with other assets.
7. Long-Term Debt and Debt Issuance Costs
On October 22, 1999, all of the 9% Senior Subordinated Convertible Notes,
related interest notes resulting from the secondary offering and accrued
interest, net of unamortized debt issuance costs of $2,732,000, were converted
into 765,201 shares of the Company's common stock valued at $9,886,000.
On December 30, 1999, the Company issued a promissory note to Finova Capital
Corporation for $3,128,000. The promissory note bears interest at 15.26%, and is
payable in 36 monthly installments of $110,000, consisting of principal and
interest, with the final payment due November 30, 2002.
7
<PAGE>
Long-term debt is summarized as follows (in thousands):
June 30, September 30,
2000 1999
---- ----
Senior subordinated convertible notes $ - $ 12,549
Convertible subordinated debentures 3,461 3,461
Promissory notes 5,560 3,194
Other 161 161
-------------- --------------
9,182 19,365
Less current portion (4,933) (2,084)
-------------- --------------
$ 4,249 $ 17,281
============== ==============
8. Common Stock
On November 4, 1999, the Company entered into various definitive agreements with
Mediacom LLC ("Mediacom"). Under the terms of the Affiliate Agreement, Mediacom
agrees to use the Company's wholly owned subsidiary, ISP Channel, Inc. ("ISP
Channel"), as the exclusive provider of Internet access to customers passed by
Mediacom's cable television systems for 10 years, with an option for Mediacom to
terminate the Affiliate Agreement at 5 years. In exchange for the signing of the
Affiliate Agreement by Mediacom, the Company issued a total of 3,500,000 common
stock shares, consisting of 350,000 unrestricted common stock shares and
3,150,000 restricted common stock shares. The conversion of the 3,150,000
restricted common stock shares to unrestricted common stock shares is contingent
upon Mediacom fulfilling the requirements of the Stockholder Agreement. Under
the terms of the Stockholder Agreement, Mediacom is required to deliver 900,000
two-way capable homes passed in groups of at least 150,000 homes every 6 months
commencing May 4, 2000, and upon delivery of each group of 150,000 homes passed,
525,000 restricted common stock shares become unrestricted. In the event
Mediacom fails to make available for ISP Channel services the 150,000 homes
passed within one year of any applicable delivery date, then Mediacom is
required to return 525,000 restricted common stock shares to the Company. In the
event Mediacom delivers more than 900,000 two-way capable homes passed, the
Stock Purchase Agreement requires the Company to issue additional common stock
shares based on the calculation used for the original 900,000 two-way capable
homes passed. Additionally, Mediacom gained the right to nominate one member to
the Company's board of directors. The cable affiliate launch incentive resulting
from the issuance of the 350,000 unrestricted common stock shares on November 4,
1999 was valued at $8,531,000, and is being amortized on a straight-line basis
over the five year minimum life of the Affiliation Agreement. On March 29, 2000,
Mediacom delivered the first group of 150,000 homes passed; accordingly 525,000
restricted common stock shares valued at $15,225,000 converted to unrestricted
common stock shares, with a like amount recorded as launch incentives being
amortized over the remaining life of the Affiliation Agreement. No value has
been assigned to the remaining 2,625,000 restricted common stock shares at date
of issuance due to the requirement for Mediacom to earn the shares by delivering
900,000 two-way capable homes passed in groups of at least 150,000 homes every 6
months commencing May 4, 2000. The remaining 2,625,000 restricted common stock
shares will be valued and recorded as cable affiliate launch incentive upon
conversion to unrestricted common stock shares. Additionally, upon conversion of
restricted common stock shares to unrestricted common stock shares, the cable
launch incentive will be amortized on a straight-line basis over the remaining
minimum life of the Affiliation Agreement.
On October 12, 1999, the Company entered into memorandum of understanding with
Pacific Century CyberWorks Limited ("Pacific Century") to form a joint venture,
Pacific Century SoftNet, to market products and services to cable operators in
50 countries throughout Asia. On December 13, 1999 in conjunction with this
joint venture, the Company completed a private placement of 5,000,000 common
stock shares for net proceeds of $128,643,000 to Pacific Century, and entitled
Pacific Century to designate two persons for election to the Board of Directors.
The Company is in the process of drafting definitive agreements and establishing
the strategy, business plan and operational processes of this joint venture.
On the first anniversary date of the Intelligent Communications, Inc.
("Intellicom") acquisition, the Intellicom acquisition agreement requires the
Company to issue $1,500,000 of common stock shares. Accordingly, on February 8,
2000, the Company issued 43,314 common stock shares valued at $1,499,000 and
paid $1,000 for fractional shares to the former shareholders of Intellicom.
8
<PAGE>
9. Supplemental Cash Flow Information
The supplemental cash flow information is as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended June 30,
2000 1999
---- ----
Cash paid during the period for:
<S> <C> <C>
Interest............................................................. $ 1,005 $ 1,189
Income taxes......................................................... - -
Non-cash investing and financing activities:
Acquisition of Laptop Lane Limited:
Common stock issued ............................................... 16,620 -
Business acquisition liability..................................... 3,652 -
Acquisition of Intelligent Communications, Inc.:
Common stock issued................................................ - 10,819
Long -term debt issued............................................. - 3,000
Debt acquired...................................................... - 600
Sale of telecommunications segment:
Promissory notes received.......................................... - 4,500
Convergent Communications Services Inc. common stock received...... - 498
Equipment acquired by capital lease.................................. 8,222 4,053
Value assigned to debt conversion feature ........................... 35 1,408
Repayment of short-term debt with common stock....................... - 388
Common stock issued for-
Conversion of redeemable convertible preferred stock............... - 18,254
Conversion of subordinated notes................................... 9,886 488
Anniversary issuance of common stock to former Intelligent
Communications, Inc. stockholders............................... 1,500 -
Cable affiliate launch incentives.................................. 24,175 8,925
Prepayment of license fees......................................... - 1,000
Increase (decrease) in additional-paid-in capital associated
with common stock options.......................................... (14,556) 78,441
Value assigned to common stock warrants issued upon the
issuance of long-term debt......................................... - 4,334
Preferred dividends paid with the issuance of -
Additional redeemable convertible preferred stock.................. - 221
Common stock....................................................... - 157
Unrealized loss on short-term investments............................ 413 -
</TABLE>
9
<PAGE>
10. Segment Information
The Company operates principally in three business segments: (i) cable-based
Internet services through its wholly owned subsidiary, ISP Channel, (ii)
satellite-based Internet services and VSAT equipment sales through its wholly
owned subsidiary, Intellicom, and (iii) business center services, including
development of wireless broadband Internet services, through two of its wholly
owned subsidiaries, Laptop Lane and SoftNet Zone. The Company entered the
Internet business with the acquisition of ISP Channel on June 21, 1996 and began
offering cable-based Internet services during the fourth quarter of fiscal 1997.
The operating results of Intellicom have been included since its acquisition on
February 9, 1999, and Laptop Lane have been included since its acquisition on
April 21, 2000. Segment information for continuing operations for the three and
nine months ended June 30, 2000 and 1999 is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended June 30, Nine Months Ended June 30,
--------------------------- --------------------------
2000 1999 2000 1999
-------------- -------------- -------------- --------------
Net Sales:
<S> <C> <C> <C> <C>
Cable-based Internet services.................. $ 1,700 $ 721 $ 3,995 $ 1,714
Satellite-based Internet services and VSAT
equipment sales................................ 5,972 596 6,644 1,074
Business center services....................... 902 - 902 -
-------------- -------------- -------------- --------------
$ 8,574 1,317 11,541 2,788
============== ============== ============== ==============
Loss from continuing operations before income taxes
Cable-based Internet services.................. $ (14,277) $ (6,869) $ (38,742) $ (14,408)
Satellite-based Internet services and VSAT
equipment sales................................ (2,927) (1,343) (8,248) (1,948)
Business center services....................... (3,678) - (3,714) -
Corporate...................................... (2,894) (2,233) (9,277) (5,859)
Compensation related to stock options.......... (5,039) (5,680) (16,318) (6,721)
Other income (expense), net.................... 2,825 (2,490) 7,573 (3,409)
-------------- --------------- -------------- ---------------
(25,990) (18,615) (68,726) (32,345)
=============== =============== =============== ===============
</TABLE>
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. The actual results of SoftNet Systems, Inc. and its subsidiaries
could differ significantly from those set forth herein. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in "Factors Affecting the Company's Operating Results" as set forth in
the Company's annual report on Form 10-K for the year ended September 30, 1999,
as filed with the Securities and Exchange Commission, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" as
well as those discussed elsewhere in this quarterly report. Statements contained
herein that are not historical facts are forward-looking statements that are
subject to the safe harbor created by the Private Securities Litigation Reform
Act of 1995. Words such as "believes", "anticipates", "expects", "intends" and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. A number of important
factors could cause our actual results for fiscal 2000 and beyond to differ
materially from past results and those expressed or implied in any
forward-looking statements made by us, or on our behalf. We undertake no
obligation to release publicly the results of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with, and is qualified in its entirety
by reference to, the Consolidated Financial Statements of the Company and the
related Notes thereto appearing in our annual report on Form 10-K for the year
ended September 30, 1999, as filed with the Securities and Exchange Commission
and our Condensed Consolidated Financial Statements and related Notes thereto
appearing elsewhere in this quarterly report. The Company's fiscal year ends on
September 30 of each year and the first quarter of the fiscal year ends December
31. "Fiscal 2000" refers to the twelve months ended September 30, 2000.
Overview
The Company currently operates through three subsidiaries. The first, ISP
Channel, Inc. ("ISP Channel") is a leading provider of high speed Internet
access over cable to both residential and commercial customers. The second,
Intelligent Communications, Inc. ("Intellicom"), provides two-way broadband
satellite connectivity utilizing very small aperture terminal ("VSAT")
technology to a wide variety of business customers, the majority of whom are
rural Internet service providers ("ISPs"), which use Intellicom's service to
connect from remote points of presence, through Intellicom's network operations
center in Livermore, California, to the Internet. ISP Channel is currently one
of Intellicom's larger customers and, as of June 30, 2000, 10 of the 88 systems
deployed by ISP Channel, utilized Intellicom's service in preference to
terrestrial lines such as T1s.
The third of the Company's businesses is comprised of SoftNet Zone Inc.
("SoftNet Zone") and Laptop Lane Limited ("Laptop Lane"), which the Company
acquired on April 21, 2000. Laptop Lane is a leading provider of business center
services in airports. The purchase price for this acquisition is described in
"Liquidity and Capital Resources" section. The Company intends to use Laptop
Lane as the cornerstone of a new venture, SoftNet Zone, which intends to offer
global business travelers wireless broadband Internet services at airports,
hotels, convention centers, and other high traffic areas. The Company intends to
provide its services in conjunction with strategic partners CMGI, Compaq, Cisco,
Nokia and Delta Air Lines. As a result of the Laptop Lane acquisition, the
Company recorded $23,195,000 of goodwill in the third quarter of fiscal 2000,
the amortization of which will adversely affect our earnings and profitability
for the foreseeable future. If the amount of such recorded goodwill is increased
or we have future losses and are unable to demonstrate our ability to recover
the amount of goodwill recorded during such time periods, the period of
amortization could be shortened, which may further increase annual amortization
charges. Our business and financial condition could be materially and adversely
affected. As a result of this business venture, management's attention and
resources may be diverted from other business activities, which may materially
and adversely affect our business and financial condition.
Revenue for ISP Channel consists primarily of (i) monthly access fees received
from cable modem customers, (ii) revenue from cable modem rental and sales, and
(iii) revenue generated by traditional dial-up ISP services and business
services. Revenue generated through the cable modem business is generally split
equally with the cable operator (though ISP Channel usually takes a higher split
for the first 200 customers on any given system) and is reported in our
financial statements net of the portion paid to the cable operator.
Revenue for Intellicom consists of (i) monthly fees paid by users of the
satellite service on a per VSAT basis, (ii) VSAT-related equipment sales, (iii)
revenue from sub-leasing of excess satellite transponder space and (iv) data
center processing fees. The last category represents legacy business that
Intellicom exited September 30, 1999, to focus on its core business of providing
high-speed Internet access using two-way satellite technology. While Intellicom
receives revenue from ISP Channel in return for satellite services, such revenue
is eliminated in the consolidated financial statements.
11
<PAGE>
Revenue for SoftNet Zone consists of (i) workstation fees received from
mini-office rentals to travelers at airport sites, (ii) promotional and
sponsorship revenue, and (iii) retail sales.
Cost of sales for ISP Channel consists primarily of connectivity cost. ISP
Channel's connectivity costs include the links between the cable headends where
it has systems deployed and a central office of the public switched telephone
network; links between the central office and ISP Channel's network operations
center in Mountain View; and in the case of one-way cable systems, where the
return path from the customer to the cable headend is through a dial-up
connection, the cost of telephone lines into the headend. It is ISP Channel's
intention to minimize further deployments of one-way systems due to the higher
cost of providing such service and the fact that the customer offering is
substantially less compelling than in a two-way system.
Cost of sales for Intellicom consists primarily of connectivity cost and costs
of VSAT equipment sold. Intellicom's connectivity cost consists primarily of
satellite transponder fees. Currently, Intellicom has transponder space on two
satellites, GE-3 and SatMex 5, both of which provide coverage over the
continental United States and beyond.
Cost of sales for SoftNet Zone consists primarily of Laptop Lane's connectivity
cost, airport concession fees and costs of electronic peripheral equipment sold.
Laptop Lane's connectivity cost consists primarily of T1 line access costs to
telephone carriers at airport locations.
The Company reports operating expenses in several categories: (i) selling and
marketing, includes, in addition to the costs of selling and marketing the
Company's services to end users, customer care, content production, and cable
partnering costs; (ii) engineering, which includes the costs of maintaining and
manning the network operations center, field engineering and information
technology; and (iii) general and administrative costs. Also included in
operating expenses is depreciation, amortization and stock compensation expense.
Amortization expense comprises the write off of the cost of launch incentives,
developed technology acquired and goodwill. Launch incentives are paid to cable
operators, usually in the form of stock in the Company, as an enticement to
enter into long-term contracts with the Company. These payments are amortized
over the life of the contract between the cable operator and the Company.
Amortization of deferred stock compensation expense primarily relates to stock
options granted between October 1998 and March 1999.
Results of Operations for the Three Months Ended June 30, 2000 Compared to the
Three Months Ended June 30, 1999
Net Sales. Consolidated net sales increased $7,257,000, or 551%, to $8,574,000
for the three months ended June 30, 2000, as compared to $1,317,000 for the
three months ended June 30, 1999.
Net sales for ISP Channel increased $979,000, or 136%, to $1,700,000 for the
three months ended June 30, 2000, as compared to $721,000 for the three months
ended June 30, 1999, as a result of signing up new cable affiliates and
obtaining new subscribers. Net sales associated with ISP Channel's subscriber
fees increased $774,000, or 262%, to $1,069,000 for the three months ended June
30, 2000, as compared to $295,000 for the three months ended June 30, 1999. Net
sales associated with the installation of cable modems to ISP Channel
subscribers increased $285,000 to $480,000 for the three months ended June 30,
2000, as compared to $195,000 for the three months ended June 30, 1999. The
Company believes that subscriber fee and other revenues will continue to
increase, however, the Company will focus on contracts that improve the overall
profitability outlook for the business. Net sales associated with the segment's
non-cable based dial-up and business-to-business Internet access offerings
decreased $80,000 to $151,000 for the three months ended June 30, 2000, as
compared to $231,000 for the three months ended June 30, 1999.
Net sales for Intellicom increased $5,376,000, or 902%, to $5,972,000 for the
three months ended June 30, 2000, as compared to $596,000 for the three months
ended June 30, 1999, primarily as a result of equipment sales to Tricom, S.A.,
offset by no data processing fees due to Intellicom exiting from the data
processing service business on September 30, 1999 and no transponder sublease
income for the three months ended June 30, 2000. Net sales from Intellicom's
core business of satellite-based Internet services decreased $19,000, or 10%, to
$181,000 for the three months ended June 30, 2000, as compared to $200,000 for
the three months ended June 30, 1999. Equipment sales increased $5,501,000 to
$5,546,000 for the three months ended June 30, 2000, as compared to $45,000 for
the three months ended June 30, 1999, as a result of VSAT equipment sales to
Tricom, S.A. Other sources of net sales, excluding data processing service fees
and transponder sublease income, increased $205,000 to $245,000 for the three
months ended June 30, 2000, as compared to $40,000 for the three months ended
June 30, 1999.
12
<PAGE>
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated net sales. SoftNet
Zone's net sales for the seventy days ended June 30, 2000 was $902,000. Of this
total, $703,000 primarily represents Laptop Lane's core business of workstation
fees. The remaining $199,000 is promotional and sponsorship revenue. Although
the Company believes workstation fees will grow in the future as new sites are
opened, other revenue sources, including wireless broadband Internet service
fees, are expected to become SoftNet Zone's primary source of revenue.
Cost of Sales. Consolidated cost of sales increased $5,471,000, or 375%, to
$6,931,000 for the three months ended June 30, 2000, as compared to $1,460,000
for the three months ended June 30, 1999.
Cost of sales for ISP Channel increased $366,000, or 42%, to $1,239,000 for the
three months ended June 30, 2000, as compared to $873,000 for the three months
ended June 30, 1999, as a result of the corresponding growth in net sales. The
single largest component of ISP Channel's cost of sales are telephony costs,
which amounted to $1,195,000 for the three months ended June 30, 2000 as
compared to $696,000 for the three months ended June 30, 1999. The Company
believes that these costs will remain the same or decrease as a percentage of
total net sales as ISP Channel expects to realize some degree of cost savings in
its telephony charges due to better negotiated national contracts, scale, and
the replacement of expensive T1 lines in certain areas with Intellicom's
satellite-based technology, which is usually lower in cost.
Cost of sales for Intellicom increased $4,764,000, or 812%, to $5,351,000 for
the three months ended June 30, 2000, as compared to $587,000 for the three
months ended June 30, 1999, primarily as a result of primarily as a result of
VSAT equipment sales to Tricom, S.A. and the segment space leasing of a full
transponder beginning on December 1, 1999 in preparation for providing
satellite-based Internet services to fulfill several large sales agreements
recently entered into. The largest component of Intellicom's cost of sales for
the three months ended June 30, 2000, are equipment costs resulting from VSAT
equipment sales to Tricom, S.A. Another component of Intellicom's cost of sales
is transponder fees, which amounted to $847,000 for the three months ended June
30, 2000, as compared to $307,000 for the three months ended June 30, 1999. The
Company believes that transponder costs will continue to increase as Intellicom
leases segment space on additional satellites in the future corresponding to the
roll-out of Intellicom's business plan.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated cost of sales. SoftNet
Zone's cost of sales for the seventy days ended June 30, 2000 was $341,000. The
single largest component of SoftNet Zone's cost of sales is airport concession
fees, which amounted to $166,000 for the seventy days ended June 30, 2000. The
Company believes these costs will increase in the future as new sites are opened
and as SoftNet Zone expands into the wireless broadband Internet services
business.
Selling and Marketing. Consolidated selling and marketing expenses (exclusive of
non-cash compensation expense of $249,000 for 2000 and $1,252,000 for 1999)
increased $2,722,000, or 65%, to $6,919,000 for the three months ended June 30,
2000, as compared to $4,197,000 for the three months ended June 30, 1999.
The Company's corporate and ISP Channel selling and marketing expenses increased
$180,000, or 4%, to $4,159,000 for the three months ended June 30, 2000, as
compared to $3,979,000 for the three months ended June 30, 1999. The growth in
the Company's corporate and ISP Channel's selling and marketing expense is a
result of hiring that the Company has done to staff these departments. In
addition, ISP Channel launched numerous national and regional marketing
campaigns in an effort to add subscribers, as well as to attract new cable
affiliates. Going forward, ISP Channel will continue launching such campaigns
focused on carefully chosen target markets.
Selling and marketing expenses for Intellicom increased $659,000 to $877,000 for
the three months ended June 30, 2000, as compared to $218,000 for the three
months ended June 30, 1999, primarily as a result of hiring that the Company has
done to staff these departments. The Company believes that these costs will
continue to increase as Intellicom continues to develop its business.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated selling and marketing
expenses. SoftNet Zone's selling and marketing expenses for the seventy days
ended June 30, 2000 was $1,883,000, which are primarily personnel costs at
existing airport sites and costs of obtaining additional airport sites. The
Company believes these costs will increase in the future as new sites are opened
and as SoftNet Zone expands into the wireless broadband Internet services
business.
13
<PAGE>
Engineering. Consolidated engineering expenses (exclusive of non-cash
compensation expense of $605,000 for 2000 and $954,000 expense for 1999)
increased $4,366,000, or 235%, to $6,222,000 for the three months ended June 30,
2000, as compared to $1,856,000 for the three months ended June 30, 1999.
The Company's corporate and ISP Channel engineering expenses increased
$3,158,000, or 186%, to $4,854,000 for the three months ended June 30, 2000, as
compared to $1,696,000 for the three months ended June 30, 1999. The growth in
the Company's corporate and ISP Channel's engineering expense is largely a
result of round-the-clock staffing of the ISP Channel's Network Operating Center
and the introduction of field engineering services. The Company will explore all
opportunities to contain the expansion of these costs going forward.
Engineering expenses for Intellicom increased $1,208,000 to $1,368,000 for the
three months ended June 30, 2000, as compared to $160,000 for the three months
ended June 30, 1999, primarily as a result of hiring that the Company has done
to staff these departments. The Company believes that these costs will continue
to increase as Intellicom continues to develop its business.
To date, SoftNet Zone has incurred no significant engineering expenses. As the
Company's wireless broadband Internet services business develops, it is expected
that engineering expense will become a significant cost for SoftNet Zone.
General and Administrative. Consolidated general and administrative expenses
(exclusive of non-cash compensation expense of $4,185,000 for 2000 and
$3,474,000 for 1999) increased $3,157,000, or 129%, to $5,596,000 for the three
months ended June 30, 2000, as compared to $2,439,000 for the three months ended
June 30, 1999.
The Company's corporate and ISP Channel general and administrative expenses
increased $1,870,000, or 89%, to $3,972,000 for the three months ended June 30,
2000, as compared to $2,102,000 for the three months ended June 30, 1999. The
growth in the Company's corporate and ISP Channel general and administrative
expenses are a result of the hiring that the Company has done to staff the
Company's administrative, executive and finance departments as the Company
continues to grow. The Company believes that general and administrative costs
will continue to increase as a result of the continued expansion of the
Company's administrative staff and facilities to support growing operations.
General and administrative expenses for Intellicom increased $227,000, or 67%,
to $564,000 for the three months ended June 30, 2000, as compared to $337,000
for the three months ended June 30, 1999, primarily as a result of leasing an
additional office facility in Livermore, California; and the write off of a
customer receivable. The Company believes that these costs will continue to
increase as Intellicom continues to develop its business.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated general and
administrative expenses. SoftNet Zone's general and administrative expenses for
the seventy days ended June 30, 2000 was $1,060,000, which is primarily
personnel costs. The Company believes these costs will increase in the future as
SoftNet Zone begins to staff these functions to support growing operations.
Depreciation and Amortization. Consolidated depreciation and amortization
expenses increased $4,872,000, or 269%, to $6,682,000 for the three months ended
June 30, 2000, as compared to $1,810,000 for the three months ended June 30,
1999.
The Company's corporate and ISP Channel depreciation and amortization expense
increased $3,474,000, or 296%, to $4,647,000 for the three months ended June 30,
2000, as compared to $1,173,000 for the three months ended June 30, 1999 as a
result of increased depreciation on expanded property, plant and equipment as
well as amortization of costs associated with ISP Channel's Cable Affiliates
Incentive Program. The Company believes that these expenses will increase as the
Company continues to expand the Company's facilities and continues to offer
additional incentives to acquire new cable affiliates. The costs associated with
these incentives are carefully evaluated in the context of the profitability
outlook for each additional contract. In particular, the Company expects the
amortization of the intangible asset associated with ISP Channel's Cable
Affiliates Incentive Program to increase significantly as a result of increased
costs recorded in connection with the agreement with Mediacom and other new
cable affiliates. Additionally, the Company believes depreciation expense will
continue to increase as additional headends and cable modems are deployed.
Depreciation and amortization expense for Intellicom increased $102,000, or 16%,
to $739,000 for the three months ended June 30, 2000, as compared to $637,000
for the three months ended June 30, 1999, primarily as a result of additional
depreciation expense from leasehold improvements to additional office facilities
in Livermore, California, computer equipment for additional personnel, and
computer equipment for Network Operating Center.. The Company believes
depreciation expense will increase as Intellicom continues to expand its
facilities, while amortization expense is expected to remain the same.
14
<PAGE>
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated depreciation and
amortization expenses. SoftNet Zone's amortization and depreciation expenses for
the seventy days ended June 30, 2000 was $1,296,000, of which $937,000
represents amortization of goodwill as a result of the Laptop Lane acquisition.
The remaining $359,000 primarily represents depreciation expense related to
airport leasehold improvements, furniture and equipment. The Company believes
depreciation expense will increase in the future as new sites are opened and as
SoftNet Zone expands into the wireless broadband Internet services business.
Compensation Expense Related to Stock Options. For the three months ended June
30, 2000, the Company recognized a non-cash compensation expense related to
stock options of $5,039,000, of which $5,416,000 related to employee stock
options offset by $377,000 related to non-employees options. Generally accepted
accounting principles require that options issued to non-employees be valued at
the time that the options are earned. Therefore, the Company expects this amount
to either increase or decrease based on the fluctuations in the trading price of
the Company's common stock.
Interest Expense. Consolidated interest expense decreased $2,072,000, or 84%, to
$381,000 for the three months ended June 30, 2000, as compared to $2,453,000 for
the three months ended June 30, 1999. This decrease is primarily due to the
reduction of interest expense resulting from the conversion of the 9% senior
subordinated convertible notes, related interest notes resulting from the
secondary offering and accrued interest into 765,201 shares of the Company's
common stock, offset by increased interest expense resulting from increased
lease financing associated with the capital expansion needs of ISP Channel.
Interest Income. Consolidated interest income was $3,331,000 for the three
months ended June 30, 2000, as compared to $1,336,000 for the three months ended
June 30, 1999. This increase was primarily due to the increased cash, cash
equivalent and short-term investment balances from the proceeds of the secondary
offering and the sale of 5,000,000 common stock shares for $128,643,000 to
Pacific Century CyberWorks Limited on December 13, 1999.
Other Income (Expense). Other expense was $125,000 for the three months ended
June 30, 2000, as compared to $1,373,000 for the three months ended June 30,
1999. The decrease is primarily due to the three months ended June 30, 1999
include indirect expenses associated with the Company's financing activities,
including the secondary offering, as well as the penalty incurred in connection
with the Series C redeemable convertible preferred stock.
Income Taxes. The Company made no provision for income taxes for the three
months ended June 30, 2000 and the three months ended June 30, 1999, as a result
of the Company's continuing losses.
Loss from Discontinued Operations. The Company recognized a net loss of $15,000
from its document management segment for the three months ended June 30, 1999.
There is no income from discontinued operations for the three months ended June
30, 2000, due to the sale of substantially all of the assets of the Company's
telecommunications segment, Kansas Communications, Inc., on February 12, 1999
and the sale of the Company's document management segment, Micrographic
Technology Corporation, on September 30, 1999.
Preferred Dividends. The Company paid aggregate dividends of $59,000 during the
three months ended June 30, 1999 on its then outstanding 5% Redeemable
Convertible Preferred Stock.
Net Loss. For the three months ended June 30, 2000, the Company had a net loss
applicable to common shares of $25,990,000, or a loss per share of $1.02,
compared to a net loss of $18,689,000 for the three months ended June 30, 1999,
or a loss per share of $1.27.
Results of Operations for the Nine Months Ended June 30, 2000 Compared to the
Nine Months Ended June 30, 1999
Net Sales. Consolidated net sales increased $8,753,000, or 314%, to $11,541,000
for the nine months ended June 30, 2000, as compared to $2,788,000 for the nine
months ended June 30, 1999.
Net sales for ISP Channel increased $2,281,000, or 133%, to $3,995,000 for the
nine months ended June 30, 2000, as compared to $1,714,000 for the nine months
ended June 30, 1999, as a result of signing up new cable affiliates and
obtaining new subscribers. Net sales associated with ISP Channel's subscriber
fees increased $1,752,000, or 258%, to $2,430,000 for the nine months ended June
30, 2000, as compared to $678,000 for the nine months ended June 30, 1999. Net
sales associated with the installation of cable modems to ISP Channel
15
<PAGE>
subscribers increased $551,000 to $1,010,000 for the nine months ended June 30,
2000, as compared to $459,000 for the nine months ended June 30, 1999. The
Company believes that subscriber fee and other revenues will continue to
increase, however, the Company will focus on contracts that improve the overall
profitability outlook for the business. Net sales associated with the segment's
non-cable based dial-up and business-to-business Internet access offerings
decreased $22,000 to $555,000 for the nine months ended June 30, 2000, as
compared to $577,000 for the nine months ended June 30, 1999.
Net sales for Intellicom increased $5,570,000, or 519%, to $6,644,000 for the
three months ended June 30, 2000, as compared to $1,074,000 for the
one-hundred-forty-two days ended June 30, 1999, primarily as a result of
equipment sales to Tricom, S.A. and an additional one-hundred-thirty-one days of
net sales for nine months ended June 30, 2000 as compared to June 30, 1999 due
to the acquisition of Intellicom on February 9, 1999, offset by Intellicom
exiting from the data processing service business on September 30, 1999 and no
transponder sublease income for the nine months ended June 30, 2000. Net sales
from Intellicom's core business of satellite-based Internet services increased
$315,000, or 102%, to $622,000 for the nine months ended June 30, 2000, as
compared to $307,000 for the one-hundred-forty-two days ended June 30, 1999.
Equipment sales increased $5,542,000 to $5,643,000 for the nine months ended
June 30, 2000, as compared to $101,000 for the one-hundred-forty-two days ended
June 30, 1999, as a result of VSAT equipment sales to Tricom, S.A. Other sources
of sales, excluding data processing service fees and transponder sublease
income, increased $258,000 to $379,000 for the nine months ended June 30, 2000,
as compared to $121,000 for the one-hundred-forty-two days ended June 30, 1999.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated net sales. SoftNet
Zone's net sales for the seventy days ended June 30, 2000 was $902,000. Of this
total, $703,000 primarily represents Laptop Lane's core business of workstation
fees. The remaining $199,000 is promotional and sponsorship revenue. Although
the Company believes workstation fees will grow in the future as new sites are
opened, other revenue sources, including wireless broadband Internet service
fees, are expected to become SoftNet Zone's primary source of revenue.
Cost of Sales. Consolidated cost of sales increased $7,716,000, or 280%, to
$10,474,000 for the nine months ended June 30, 2000, as compared to $2,758,000
for the nine months ended June 30, 1999.
Cost of sales for ISP Channel increased $1,292,000, or 70%, to $3,142,000 for
the nine months ended June 30, 2000, as compared to $1,850,000 for the nine
months ended June 30, 1999, as a result of the corresponding growth in net
sales. The single largest component of ISP Channel's cost of sales are telephony
costs, which amounted to $2,957,000 for the nine months ended June 30, 2000 as
compared to $1,469,000 for the nine months ended June 30, 1999. The Company
believes that these costs will remain the same or decrease as a percentage of
total net sales as ISP Channel expects to realize some degree of cost savings in
its telephony charges due to better negotiated national contracts, scale, and
the replacement of expensive T1 lines in certain areas with Intellicom's
satellite-based technology, which is usually lower in cost.
Cost of sales for Intellicom increased $6,083,000, or 669%, to $6,991,000 for
the nine months ended June 30, 2000, as compared to $908,000 for the
one-hundred-forty-two days ended June 30, 1999, primarily as a result of VSAT
equipment sales to Tricom, S.A. and the segment space leasing of a full
transponder beginning on December 1, 1999 in preparation for providing
satellite-based Internet services to fulfill several large sales agreements
recently entered into. The largest component of Intellicom's cost of sales for
the nine months ended June 30, 2000, are equipment costs resulting from VSAT
equipment sales to Tricom, S.A. Another component of Intellicom's cost of sales
is transponder fees, which amounted to $2,203,000 for the nine months ended June
30, 2000, as compared to $480,000 for the one-hundred-forty-two days ended June
30, 1999. The Company believes that these costs will continue to increase as
Intellicom leases segment space on additional satellites in the future
corresponding to the roll-out of Intellicom's business plan.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated cost of sales. SoftNet
Zone's cost of sales for the seventy days ended June 30, 2000 was $341,000. The
single largest component of SoftNet Zone's cost of sales is airport concession
fees, which amounted to $166,000 for the seventy days ended June 30, 2000. The
Company believes these costs will increase in the future as new sites are opened
and as SoftNet Zone expands into the wireless broadband Internet services
business.
Selling and Marketing. Consolidated selling and marketing expenses (exclusive of
non-cash compensation expense of $2,154,000 for 2000 and $1,252,000 for 1999)
increased $10,424,000, or 122%, to $18,991,000 for the nine months ended June
30, 2000, as compared to $8,567,000 for the nine months ended June 30, 1999.
16
<PAGE>
The Company's corporate and ISP Channel selling and marketing expenses increased
$6,766,000, or 81%, to $15,070,000 for the nine months ended June 30, 2000, as
compared to $8,304,000 for the nine months ended June 30, 1999. The significant
growth in ISP Channel's selling and marketing expense is a result of hiring that
the Company has done to staff these departments. In addition, ISP Channel
launched numerous national and regional marketing campaigns in an effort to add
subscribers, as well as to attract new cable affiliates. Going forward, the
Company will continue launching such campaign focused on carefully chosen target
markets.
Selling and marketing expenses for Intellicom increased $1,775,000 to $2,038,000
for the nine months ended June 30, 2000, as compared to $263,000 for the
one-hundred-forty-two days ended June 30, 1999, primarily as a result of the
hiring that the Company has done to staff these departments. The Company
believes that these costs will continue to increase as Intellicom continues to
develop its business.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated selling and marketing
expenses. SoftNet Zone's selling and marketing expenses for the seventy days
ended June 30, 2000 was $1,883,000, which are primarily personnel costs at
existing airport sites and costs of obtaining additional airport sites. The
Company believes these costs will increase in the future as new sites are opened
and as SoftNet Zone expands into the wireless broadband Internet services
business.
Engineering. Consolidated engineering expenses (exclusive of non-cash
compensation expense of $1,998,000 for 2000 and $954,000 for 1999) increased
$12,153,000, or 365%, to $15,478,000 for the nine months ended June 30, 2000, as
compared to $3,325,000 for the nine months ended June 30, 1999.
The Company's corporate and ISP Channel engineering expenses increased
$9,817,000, or 310%, to $12,979,000 for the nine months ended June 30, 2000, as
compared to $3,162,000 for the nine months ended June 30, 1999. The growth in
ISP Channel's engineering expense is largely a result of round-the-clock
staffing of the ISP Channel's Network Operating Center and the introduction of
field engineering services. The Company will explore all opportunities to
contain the expansion of these costs going forward.
Engineering expenses for Intellicom increased $2,336,000 to $2,499,000 for the
nine months ended June 30, 2000, as compared to $163,000 for the
one-hundred-forty-two days ended June 30, 1999, primarily as a result of hiring
that the Company has done to staff these departments. The Company believes that
these costs will continue to increase as Intellicom continues to develop its
business.
To date, SoftNet Zone has incurred no significant engineering expenses. As the
Company's wireless broadband Internet services business develops, it is expected
that engineering expense will become a significant cost for SoftNet Zone.
General and Administrative. Consolidated general and administrative expenses
(exclusive of non-cash compensation expense of $12,166,000 for 2000 and
$4,515,000 for 1999) increased $5,970,000, or 90%, to $12,586,000 for the nine
months ended June 30, 2000, as compared to $6,616,000 for the nine months ended
June 30, 1999.
The Company's corporate and ISP Channel general and administrative expenses
increased $4,241,000, or 71%, to $10,224,000 for the nine months ended June 30,
2000, as compared to $5,983,000 for the nine months ended June 30, 1999. The
growth in the Company's corporate and ISP Channel general and administrative
expenses are a result of the hiring that the Company has done to staff the
Company's administrative, executive and finance departments as the Company
continues to grow. The Company believes that these costs will continue to
increase as a result of the continued expansion of the Company's administrative
staff and facilities to support growing operations.
General and administrative expenses for Intellicom increased $633,000, or 100%,
to $1,266,000 for the nine months ended June 30, 2000, as compared to $633,000
for the one-hundred-forty-two days ended June 30, 1999, primarily as a result of
leasing an additional office facility in Livermore, California; the write off of
a customer receivable; and an additional one-hundred-thirty-one days of general
and administrative expenses for June 30, 2000 as compared to June 30, 1999 due
to the acquisition of Intellicom on February 9, 1999. The Company believes that
these costs will continue to increase as Intellicom continues to develop its
business.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated general and
administrative expenses. SoftNet Zone's general and administrative expenses for
the seventy days ended June 30, 2000 was $1,096,000, which is primarily
personnel costs. The Company believes these costs will increase in the future as
SoftNet Zone begins to staff these functions to support growing operations and
as SoftNet Zone expands into the wireless broadband Internet services business.
17
<PAGE>
Depreciation and Amortization. Consolidated depreciation and amortization
expenses increased $10,256,000, or 274%, to $13,993,000 for the nine months
ended June 30, 2000, as compared to $3,737,000 for the nine months ended June
30, 1999.
Depreciation and amortization for ISP Channel and corporate increased
$7,917,000, or 295%, to $10,599,000 for the nine months ended June 30, 2000, as
compared to $2,682,000 for the nine months ended June 30, 1999 as a result of
increased depreciation on expanded property, plant and equipment as well as
amortization of costs associated with ISP Channel's Cable Affiliates Incentive
Program. The Company believes that these expenses will increase as the Company
continues to expand the Company's facilities and continues to offer additional
incentives to acquire new cable affiliates. The costs associated with these
incentives are carefully evaluated in the context of the profitability outlook
for each additional contract. In particular, the Company expects the
amortization of the intangible asset associated with ISP Channel's Cable
Affiliates Incentive Program to increase significantly as a result of increased
costs recorded in connection with the agreement with Mediacom and other new
cable affiliates. Additionally, the Company believes depreciation expense will
continue to increase as additional headends and cable modems are deployed.
Depreciation and amortization expense for Intellicom increased $1,043,000, or
99%, to $2,098,000 for the nine months ended June 30, 2000, as compared to
$1,055,000 for the one-hundred-forty-two days ended June 30, 1999, primarily as
a result of an additional one-hundred-thirty-one days of depreciation and
amortization expense for June 30, 2000 as compared to June 30, 1999 due to the
acquisition of Intellicom on February 9, 1999. The Company believes depreciation
expense will increase as Intellicom continues to expand its facilities, while
amortization expense is expected to remain the same.
SoftNet Zone, which includes the results of Laptop Lane since its acquisition on
April 21, 2000, is included in the Company's consolidated depreciation and
amortization expenses. SoftNet Zone's amortization and depreciation expenses for
the seventy days ended June 30, 2000 was $1,296,000, of which $937,000
represents amortization of goodwill as a result of the Laptop Lane acquisition.
The remaining $359,000 primarily represents depreciation expense related to
airport leasehold improvements, furniture and equipment. The Company believes
depreciation expense will increase in the future as new sites are opened and as
SoftNet Zone expands into the wireless broadband Internet services business.
Compensation Expense Related to Stock Options. For the nine months ended June
30, 2000, the Company recognized a non-cash compensation expense related to
stock options of $16,318,000, of which $16,009,000 related to employee stock
options and $309,000 related to non-employee options. Generally accepted
accounting principles require that options issued to non-employees be valued at
the time that the options are earned. Therefore, the Company expects this amount
to either increase or decrease based on the fluctuations in the trading price of
the Company's common stock.
Interest Expense. Consolidated interest expense decreased $2,421,000, or 68%, to
$1,159,000 for the nine months ended June 30, 2000, as compared to $3,580,000
for the nine months ended June 30, 1999. This decrease is primarily due to the
reduction of interest expense resulting from the conversion of the 9% senior
subordinated convertible notes, related interest notes resulting from the
secondary offering and accrued interest into 765,201 shares of the Company's
common stock, offset by increased interest expense resulting from increased
lease financing associated with the capital expansion needs of ISP Channel.
Interest Income. Consolidated interest income was $8,894,000 for the nine months
ended June 30, 2000, as compared to $1,576,000 for the nine months ended June
30, 1999. This increase was primarily due to the increased cash and cash
equivalent balances from the proceeds of the secondary offering and the sale of
5,000,000 common stock shares for $128,643,000 to Pacific Century CyberWorks
Limited on December 13, 1999.
Other Income (Expense). Other expense was $162,000 for the nine months ended
June 30, 2000, as compared to $1,405,000 for the nine months ended June 30,
1999. The decrease is primarily due to the three months ended June 30, 1999
include indirect expenses associated with the Company's financing activities,
including the secondary offering, as well as the penalty incurred in connection
with the Series C redeemable convertible preferred stock.
Income Taxes. The Company made no provision for income taxes for the nine months
ended June 30, 2000 and the nine months ended June 30, 1999, as a result of the
Company's continuing losses.
Loss from Discontinued Operations. The Company recognized a net loss of $399,000
for the nine months ended June 30, 1999. This consisted of a net loss from the
Company's document management segment of $568,000 and net income from the
Company's telecommunications segment of $169,000 for the nine months ended June
30, 1999. There is no income from discontinued operations for the nine months
ended June 30, 2000, due to the sale of substantially all of the assets of the
Company's telecommunications segment, Kansas Communications, Inc., on February
12, 1999 and the sale of the Company's document management segment, Micrographic
Technology Corporation, on September 30, 1999.
18
<PAGE>
Preferred Dividends. The Company paid aggregate dividends of $473,000 during the
nine months ended June 30, 1999 on its then outstanding 5% Redeemable
Convertible Preferred Stock.
Net Loss. For the nine months ended June 30, 2000, the Company had a net loss
applicable to common shares of $68,726,000, or a loss per share of $3.02,
compared to a net loss of $33,217,000 for the nine months ended June 30, 1999,
or a loss per share of $3.07.
19
<PAGE>
Liquidity and Capital Resources
Since September 1998, the Company has funded the significant negative cash flows
from its operating activities and the associated capital expenditures through a
combination of public and private equity sales, convertible debt issues and
equipment leases. On October 12, 1999, the Company entered into memorandum of
understanding with Pacific Century CyberWorks Limited ("Pacific Century") to
form a joint venture, Pacific Century SoftNet, to market products and services
to cable operators in 50 countries throughout Asia. On December 13, 1999 in
conjunction with this joint venture, the Company completed a private placement
of 5,000,000 common stock shares for net proceeds of $128,643,000 to Pacific
Century, and entitled Pacific Century to designate two persons for election to
the Board of Directors. As of June 30, 2000, the Company had $196,807,000 in
cash, cash equivalents and short-term investments compared with $151,954,000 one
year prior.
Net cash used in operating activities of continuing operations for the nine
months ended June 30, 2000 was $50,401,000. Of this amount, approximately
$68,726,000 million stemmed from the Company's net loss from continuing
operations as reduced by approximately $31,261,000, for non-cash charges,
primarily depreciation ($8,484,000), amortization ($5,509,000) and compensation
expense related to stock options ($16,318,000). This was offset in part by
approximately $12,936,000, which was generated from an increase in operating
assets and decrease in operating liabilities.
Net cash used in investing activities of continuing operations for the nine
months ended June 30, 2000 was approximately $131,122,000. Of this amount,
$102,669,000 was used to purchase short-term investments, $13,926,000 was used
to purchase property, plant and equipment, $7,530,000 was used to acquire
long-term equity investments, $6,000,000 was used to provide working capital to
Laptop Lane under a secured promissory note prior to the close of the
acquisition, and $1,166,000 (net of cash acquired) payment for the purchase of
Laptop Lane. Gross purchases of property, plant and equipment amounted to
$22,148,000, the difference being funded through capital lease lines and credit
facilities from various equipment vendors and financial sources.
Net cash provided by financing activities for the nine months ended June 30,
2000 was $133,990,000 primarily through the private placement sale of 5,000,000
common stock shares to Pacific Century Cyberworks Limited for net proceeds of
$128,643,000, proceeds from exercise of warrants and options for $5,193,000, and
issuance of promissory note for $3,128,000, offset by principal payments of debt
and capital lease obligations for $2,973,000.
On April 21, 2000, the Company acquired Laptop Lane Limited ("Laptop Lane"), a
Washington corporation, under the purchase method of accounting and the results
of Laptop Lane are included in the consolidated financial statements since the
date of acquisition. Laptop Lane is a leading provider of business center
services in airports. The Company paid approximately $20,859,000 consisting of
(i) 972,266 common stock shares of the Company valued at $15,107,000, net of
adjustment for expenses paid by the Company on behalf of Laptop Lane, exchanged
for all outstanding common stock shares of Laptop Lane, (ii) direct acquisition
costs of approximately of $2,100,000, which includes a bonus payment to Laptop
Lane employees for $431,000 in lieu of Laptop Lane stock options, and (iii)
250,000 common stock shares of the Company valued at $3,652,000 to be issued to
former Laptop Lane stockholders in payment for achieving certain performance
criteria. As part of the acquisition, an additional 333,333 common stock shares
of the Company would be distributed to former Laptop Lane stockholders if
certain performance goals are met. As of June 30, 2000, Laptop Lane has achieved
three of the four performance goals, as a result 250,000 common stock shares of
the Company amounting to $3,652,000 was accrued for and will be issued to the
former Laptop Lane stockholders. The remaining 83,333 common stock shares were
unearned as of June 30, 2000 and accordingly no liability has been accrued.
Additionally, in connection with the acquisition, the Company provided
$6,000,000 in working capital to Laptop Lane, under a secured promissory note.
In connection with the Company's proposed purchase of Laptop Lane, the Company
announced on February 9, 2000 that it, together with CMGI, Inc. and Compaq
Computer Corporation, has signed letters of intent to provide equity funding and
services to a new initiative called SoftNet Zone, contingent on completing the
Laptop Lane, acquisition and other customary closing conditions. In addition to
its contribution of funding and services, the Company also announced that it
plans to contribute its interest in Laptop Lane, to this new venture. It is the
Company's intention to maintain a majority interest in SoftNet Zone. The
proposed strategy of SoftNet Zone is to offer mobile computing and Internet
services, both wired and wireless, to global business travelers.
On April 20, 2000, the Company announced a letter of intent has been signed with
Delta Air Lines Inc. ("Delta") to provide wireless Internet access and business
services to Delta customers at Delta's gates and Crown Room Clubs. As a part of
this alliance, Delta will gain a minority equity position in SoftNet Zone. The
Company is in process of completing the definitive agreements with Delta.
20
<PAGE>
The Company believes it has sufficient cash and unutilized lease facilities to
meet its presently anticipated business requirements over the next twelve months
including the funding of net operating losses, working capital requirements,
capital investments and strategic investments.
Year 2000 Issues
In the past, many computer systems and software products were designed with a
two-digit format in the year portion of the date code field. This posed a
problem for dates after December 31, 1999, due to many computer systems and
software products would turnover to "00" in the year portion of the date code
field, and therefore not distinguish year 2000 from year 1900 (commonly referred
to as the "Year 2000" or "Y2K" issue). In order to distinguish twenty-first
century dates from twentieth century dates, the year portion of the date code
fields require a four-digit format. As a result, computer systems and software
products used by many companies were upgraded or modified to accept the four
digit format the in year portion of the date code field. Prior to December 31,
1999, the Company formulated and implemented a comprehensive Y2K Plan, as
described in the Company's Form 10-K for the fiscal year ended September 30,
1999, to comply with Y2K requirements. To date, and with the January 1, 2000
date rollover, the Company, to its knowledge, has not experienced any material
disruptions associated with the Y2K issue internally or externally through its
cable affiliates, critical suppliers, service providers and contractors.
However, the Company cannot determine if it will be subject to Y2K problems in
the future or if any Y2K problems have arisen that it has failed to detect. The
Company does not separately track the internal costs incurred for the Y2K
project, which costs are principally related to payroll costs for the Company's
information systems staff. The external cost, primarily consultants, is
approximately $350,000 through June 30, 2000. The failure of one or more systems
of the Company or its business partners due to the Y2K issue may have a material
adverse effect on the Company's ability to conduct business, as well as the
Company's financial position and results of operations.
21
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income the
Company can earn on its investment portfolio and on the increase or decrease in
the amount of interest expense the Company must pay with respect to its various
outstanding debt instruments. The risk associated with fluctuating interest
expense is limited, however, to the exposure related to those debt instruments
and credit facilities, which are tied to market rates. The Company does not use
derivative financial instruments in its investment portfolio. The Company
ensures the safety and preservation of its invested principal funds by limiting
default risks, market risk and reinvestment risk. The Company mitigates default
risk by investing in safe and high-credit quality securities.
We had short-term investments of $154,841,000 at June 30, 2000. These short-term
investments consist of highly liquid investments with original maturities at the
date of purchase of between three and eighteen months. These investments are
subject to interest rate risk and will fall in value if market interest rates
increase. The Company believes a hypothetical increase in market interest rates
by 10 percent from levels at June 30, 2000 would cause the fair value of these
short-term investments to fall by an immaterial amount. Since we are not
required to sell these investments before maturity, we have the ability to avoid
realizing losses on these investments due to a sudden change in market interest
rates. On the other hand, declines in the interest rates over time will reduce
our interest income.
We had outstanding convertible debt instruments of approximately $3,461,000 at
June 30, 2000. These instruments have fixed interest rates ranging from 5.0% to
9.0%. Because the interest rates of these instruments are fixed, a hypothetical
10 percent increase in interest rates will not have a material effect on us.
Increases in interest rates, however, increase the interest expense associated
with future borrowing by us, if any. We do not hedge against interest rate
fluctuations.
Equity Price Risk
We own 24,925 shares of common stock of Convergent Communications, Inc. These
shares were obtained as partial consideration with respect to the sale of our
wholly owned subsidiary, Kansas Communications, Inc. At June 30, 2000, the
closing price of Convergent Communications, Inc.'s common stock was $8.000, as
listed on the NASDAQ National Market. As a result, we valued this investment on
our balance sheet at June 30, 2000 at its market value of $199,000. Unrealized
gains and losses are excluded from earnings and are reported in the "Accumulated
Comprehensive Loss" component of stockholders' equity. We do not hedge against
equity price changes.
Currency Exchange Risk
The Company has historically had very low exposure to changes in foreign
currency exchange rates, and as such, has not used derivative financial
instruments to manage foreign currency fluctuation risk. As the Company expands
globally, the risk of foreign currency exchange rate fluctuation may
dramatically increase. Therefore, in the future, the Company may consider
utilizing derivative instruments to mitigate such risks.
22
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company has no material pending litigation
Item 2. Changes in Securities
On November 4, 1999, the Company entered into various definitive agreements with
Mediacom LLC ("Mediacom"). Under the terms of the Affiliate Agreement, Mediacom
agrees to use the Company's wholly owned subsidiary, ISP Channel, Inc. ("ISP
Channel"), as the exclusive provider of Internet access to customers passed by
Mediacom's cable television systems for 10 years, with an option for Mediacom to
terminate the Affiliate Agreement at 5 years. In exchange for the signing of the
Affiliate Agreement by Mediacom, the Company issued a total of 3,500,000 common
stock shares, consisting of 350,000 unrestricted common stock shares and
3,150,000 restricted common stock shares. The conversion of the 3,150,000
restricted common stock shares to unrestricted common stock shares is contingent
upon Mediacom fulfilling the requirements of the Stockholder Agreement. Under
the terms of the Stockholder Agreement, Mediacom is required to deliver 900,000
two-way capable homes passed in groups of at least 150,000 homes every 6 months
commencing May 4, 2000, and upon delivery of each group of 150,000 homes passed,
525,000 restricted common stock shares become unrestricted. In the event
Mediacom fails to make available for ISP Channel services the 150,000 homes
passed within one year of any applicable delivery date, then Mediacom is
required to return 525,000 restricted common stock shares to the Company. In the
event Mediacom delivers more than 900,000 two-way capable homes passed, the
Stock Purchase Agreement requires the Company to issue additional common stock
shares based on the calculation used for the original 900,000 two-way capable
homes passed. Additionally, Mediacom gained the right to nominate one member to
the Company's board of directors. The cable affiliate launch incentive resulting
from the issuance of the 350,000 unrestricted common stock shares on November 4,
1999 was valued at $8,531,000, and is being amortized on a straight-line basis
over the five year minimum life of the Affiliation Agreement. On March 29, 2000,
Mediacom delivered the first group of 150,000 homes passed; accordingly 525,000
restricted common stock shares valued at $15,225,000 converted to unrestricted
common stock shares, with a like amount recorded as launch incentives being
amortized over the remaining life of the Affiliation Agreement. No value has
been assigned to the remaining 2,625,000 restricted common stock shares at date
of issuance due to the requirement for Mediacom to earn the shares by delivering
900,000 two-way capable homes passed in groups of at least 150,000 homes every 6
months commencing May 4, 2000. The remaining 2,625,000 restricted common stock
shares will be valued and recorded as cable affiliate launch incentive upon
conversion to unrestricted common stock shares. Additionally, upon conversion of
restricted common stock shares to unrestricted common stock shares, the cable
launch incentive will be amortized on a straight-line basis over the remaining
minimum life of the Affiliation Agreement.
On October 12, 1999, the Company entered into memorandum of understanding with
Pacific Century CyberWorks Limited ("Pacific Century") to form a joint venture,
Pacific Century SoftNet, to market products and services to cable operators in
50 countries throughout Asia. On December 13, 1999 in conjunction with this
joint venture, the Company completed a private placement of 5,000,000 common
stock shares for net proceeds of $128,643,000 to Pacific Century, and entitled
Pacific Century to designate two persons for election to the Board of Directors.
The Company is in the process of drafting definitive agreements and establishing
the strategy, business plan and operational processes of this joint venture.
On the first anniversary date of the Intelligent Communications, Inc.
("Intellicom") acquisition, the Intellicom acquisition agreement requires the
Company to issue $1,500,000 of common stock shares. Accordingly, on February 8,
2000, the Company issued 43,314 common stock shares valued at $1,499,000 and
paid $1,000 for fractional shares to the former shareholders of Intellicom.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
23
<PAGE>
Item 5. Other Information
Factors Affecting The Company's Operating Results
The risks and uncertainties described below are not the only ones that the
Company faces. Additional risks and uncertainties not presently known to the
Company or that the Company currently deems immaterial may also impair the
Company's business operations. If any of the following risks actually occur, the
Company's business, financial condition or results of operations could be
materially adversely affected. In such case, the trading price of the Company's
common stock could decline, and you may lose all or part of your investment.
The Company Cannot Assure You That The Company Will Be Profitable Because The
Company Has Operated The Company's Internet Services Business Only For A Short
Period Of Time
The Company acquired ISP Channel, Inc. ("ISP Channel") on June 21, 1996,
Intelligent Communications, Inc. ("Intellicom") on February 9, 1999 and Laptop
Lane Limited ("Laptop Lane"), which will serve as the cornerstone of a new
wireless broadband internet venture called SoftNet Zone, on April 21, 2000. As
such, the Company has very limited operating history and experience in the
Internet services business and the Company cannot assure you that the Company's
ability to develop or maintain strategies and business operations for the
Company's Internet services will achieve positive cash flow and profitability.
The successful expansion of the Company's services will require strategies and
business operations that differ from those the Company has historically
employed. To be successful, the Company must develop and market products and
services that are widely accepted by consumers and businesses at prices that
provide cash flow sufficient to meet the Company's debt service, capital
expenditures and working capital requirements.
The Company's ISP Channel And Intellicom Businesses May Fail If Their Industries
As A Whole Fail Or The Company's Products And Services Do Not Gain Commercial
Acceptance
It has become feasible to offer Internet services wirelessly, over existing
cable lines and equipment, and using satellites on a broad scale only recently.
There is no proven commercial acceptance of cable-based or satellite-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 or satellite Internet services will become a viable industry.
The success of ISP Channel and Intellicom 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, the Company cannot predict
whether the Company's pricing model will prove to be viable, whether demand for
the Company's services will materialize at the prices the Company expect to
charge, or whether current or future pricing levels will be sustainable. If the
Company does not achieve or sustain such pricing levels or if the Company's
services do not achieve or sustain broad market acceptance, then the Company's
business, financial condition, and prospects will be materially adversely
affected.
The Company's Purchase Of Intellicom Subjects The Company To Risks In A New
Market
The Company has very little experience in the markets and technology in which
Intellicom is focused. As such, the Company is faced with risks that are new to
the Company, including the following:
Dependence on Very Small Aperture Terminal ("VSAT") market
One of the reasons the Company purchased Intellicom was to be able to
provide two-way satellite Internet access options to the Company's
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 the Company's 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
Intellicom, or a temporary or permanent malfunction of any of these
satellites, would likely result in interruption of Internet services the
Company provides over the satellites which could adversely affect the
Company's 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 that
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 the
Company cannot assure you that the FCC would grant such approval.
24
<PAGE>
Equipment failure and interruption of service
The Company's operations will require that the Company's 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 the Company uses may from
time to time experience interruptions or equipment failures, which would
negatively affect consumer confidence as well as the Company's business
operations and reputation.
Dependence on leases for satellites
Intellicom currently leases satellite space from GE Americom and SatMex. If
for any reason, the leases were to be terminated, the Company cannot assure
you that the Company could renegotiate new leases with GE Americom, SatMex
or another satellite provider on favorable terms, if at all. The Company
has not identified alternative providers and believes that any new leases
would probably be more costly to the Company. In any case, the Company
cannot assure you that an alternative provider of satellite services would
be available, or, if available, would be available on terms favorable to
the Company.
Competition
The market for Internet access services is extremely competitive.
Intellicom believes that its ability to compete successfully depends upon a
number of factors, including: market presence; the capacity, reliability,
and security of its network infrastructure; the pricing policies of its
competitors and suppliers; and the timing and release of new products and
services by Intellicom and its competitors. The Company cannot assure you
that Intellicom will be able to successfully compete with respect to these
factors.
Government regulation
The VSAT satellite industry is a highly regulated industry. In the United
States, operation and use of VSAT satellites requires licenses from the
FCC. SatMex is licensed by the government of Mexico. As a lessee of
satellite space, the Company 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.
While the Company believes that the Company's lessors will be able to
obtain all licenses and authorizations necessary to operate effectively,
the Company cannot assure you that the Company's lessors will be successful
in doing so. The Company's failure to indirectly obtain some or all
necessary licenses or approvals could have a material adverse effect on the
Company's business, financial condition and prospects.
The Company's Plan To Offer Broadband Wireless Internet Service To Business
Travelers Subjects The Company To Risks In A New Market
The Company purchased Laptop Lane to serve as the cornerstone of a business
called SoftNet Zone, which will provide mobile computing and Internet services,
both wired and wireless, to global business travelers. The Company has very
little experience in the markets and technology in which Laptop Lane is focused
and SoftNet Zone intends to be focused. As such, the Company is faced with risks
that are new to the Company and which may adversely affect the Company's
business, financial condition, and prospects. These risks include the following:
The wireless broadband Internet services industry may not gain commercial
acceptance
The ability to provide wireless broadband Internet access has only recently
be achieved. There is no proven commercial acceptance of wireless broadband
Internet services and none of the companies offering such services are
profitable on such offerings. It is currently very difficult to predict
whether providing wireless broadband Internet services will become a viable
industry. The failure of the wireless broadband Internet services industry
to evolve in the manner in which is it currently contemplated could
adversely affect the Company's business, financial condition and prospects.
The Company may not be able to enter into strategic relationships to gain
market share
To gain market share, the Company must partner with airports, airlines,
hotels, convention centers and companies in other industries serving the
25
<PAGE>
mobile consumer. The Company may not be able to compete with other
companies that are better financed or have longer operating histories in
the industry for these alliances. As a result, to gain market share the
Company may be forced to enter into arrangements that may not be ideal.
The Company faces intense competition in the wireless broadband Internet
services industry
The wireless broadband Internet services business is intensely competitive.
Many of the Company's competitors and potential competitors have
substantially greater financial, technical and marketing resources, longer
operating histories, greater name recognition and more established
relationships than the Company does. The Company cannot predict whether it
will be able to compete successfully against current or future competitors
or that competitive pressures faced by the Company will not adversely
affect the Company's business, financial condition or prospects.
The wireless Internet services industry does not have common standards
Currently, there are many technologies designed to provide wireless
Internet access. The Company may adopt a technology that does not prove to
be the industry standard or leader, which would force the Company to
replace equipment or risk not being competitive. The Company cannot predict
how industry standards will evolve.
It will be costly to build out a wireless network and support system
The Company intends to build the wireless infrastructure to support
broadband Internet access. In addition, the Company will either have to
build or contract with a third party to provide billing, network operations
and customer care systems. It will be costly to build such services and
provision such systems. The Company will incur many of the costs prior to
achieving meaningful revenue for wireless broadband Internet services. The
inability of the Company to achieve meaningful revenue to cover these
start-up costs would have an adverse effect on the Company's financial
condition and prospects.
Uneven usage may make it difficult to provide services.
The Company anticipates that demands for its services will fluctuate
throughout the day. For example, in airports, demand will be highest when
the airport is busiest. If too many users attempt to access the Internet
through the Company's infrastructure at one time, it could result in a poor
experience for such users, which may affect long-term demand. The Company
cannot accurately predict whether is will be able to keep pace with peak
demand.
The Company faces uncertainty because of government regulation
The Company proposes to provide wireless broadband Internet services using
unlicensed frequencies. There can be no assurance that the government will
not seek to license or otherwise regulate such frequencies in the future
and the Company cannot predict the terms by which the government would do
so. In addition, the airports, airlines, and convention centers with which
the Company seeks to partner in many cases are either owned by the
government or subject to heavy government regulation. As a result, the
Company will be subject to numerous local, state and federal rules and
regulations, which may change in the future. The Company cannot predict
whether such changes, if they occur, would have an adverse affect on the
business, financial condition or prospects of the Company.
The Company's Continued Negative Cash Flow And Net Losses May Depress Stock
Prices
The Company's continued negative cash flow and net losses may result in
depressed market prices for the Company's common stock. The Company cannot
assure you that the Company will ever achieve favorable operating results or
profitability. The Company has sustained substantial losses over the last five
fiscal years. For the nine months ended June 30, 2000, the Company had a net
loss of $68,726,000. As of June 30, 2000, the Company had an accumulated deficit
of $168,973,000. The Company expects to incur substantial additional losses and
experience substantial negative cash flows as the Company expands the Company's
Internet service offerings. The costs of expansion will include expenses
incurred in connection with:
o the cost to build out the infrastructure and provision the support systems
for wireless Internet access;
o the amount and timing of capital expenditures and other costs related to
the Company's operations;
o research and development of new product and service offerings;
o the continued development of the Company's direct and indirect selling and
marketing efforts; and
o possible charges related to acquisitions, divestitures, business alliances
or changing technologies.
In addition, the Company's expense levels are based in part on expectations of
future revenues and, to a large extent, are fixed. The Company may be unable to
26
<PAGE>
adjust spending quickly enough to compensate for any unexpected revenue
shortfall. The Company's revenues will be dependent upon the growth rates of ISP
Channel's subscribers, Intellicom's customers, and the Company's ability to
obtain wireless broadband Internet service customers.
If The Company Does Not Achieve Cash Flows Sufficient To Support The Company's
Operations, The Company May Be Unable To Implement The Company's Business Plan
The development of the Company's business will require substantial capital
infusions as a result of:
o the Company's need to enhance and expand product and service offerings to
maintain the Company's competitive position and increase market share; and
o the substantial investment in equipment and corporate resources required by
the continued national launching of the ISP Channel, Intellicom and SoftNet
Zone services.
In addition, the Company anticipates that the majority of cable affiliates with
one-way cable systems will eventually upgrade their cable infrastructure to
two-way cable systems, at which time the Company will have to upgrade the
Company's equipment on any affected cable system to handle two-way
transmissions. The Company cannot accurately predict whether or when the Company
will ultimately achieve cash flow levels sufficient to support the Company's
operations, development of new products and services, and expansion of the
Company's Internet services. Unless the Company reaches such cash flow levels,
the Company may require additional financing to provide funding for operations.
If the Company is required to raise capital through a long-term debt financing,
the Company will be highly leveraged and such debt securities may have rights or
privileges senior to those of the Company's current stockholders. If the Company
is required to raise capital by issuing equity securities, the percentage
ownership of the Company's stockholders will be reduced, stockholders may
experience additional dilution and such securities may have rights, preferences
and privileges senior to those of the Company's common stock. In the event that
the Company cannot generate sufficient cash flow from operations, or is unable
to borrow or otherwise obtain additional funds on favorable terms to finance
operations when needed, the Company's business, financial condition, and
prospects would be materially adversely affected.
The Unpredictability Of The Company's Quarter-To-Quarter Results May Adversely
Affect The Trading Price Of The Company's Common Stock
The Company cannot predict with any significant degree of certainty the
Company's quarter-to-quarter operating results. As a result, the Company
believes that period-to-period comparisons of the Company's revenues and results
of operations are not necessarily meaningful and should not be relied upon as
indicators of future performance. It is likely that in one or more future
quarters the Company's results may fall below the expectations of analysts and
investors. In such event, the trading price of the Company's common stock would
likely decrease. Many of the factors that cause the Company's quarter-to-quarter
operating results to be unpredictable are largely beyond the Company's control.
These factors include, among others:
o the number of ISP Channel subscribers, Intellicom customers and SoftNet
Zone customers;
o the Company's ability to coordinate timely and effective marketing
strategies;
o the rate at which ISP Channel and its cable affiliates, Intellicom and
SoftNet Zone can complete the installations required to initiate service;
o the amount and timing of capital expenditures and other costs related to
the expansion and provision of ISP Channel, Intellicom and SoftNet Zone
services;
o competition in the Internet or cable industries; and
o changes in law and regulation.
A New Accounting Pronouncement May Cause Our Operating Results to Fluctuate
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements".
Implementation is scheduled for fiscal years beginning after December 15, 1999,
which would be effective for the Company beginning in fiscal year 2001. SAB 101
addresses various topics in revenue recognition including the recognition of
revenue for contracts involving multiple deliverables. The Company is currently
analyzing SAB 101, however, based on Management's current understanding and
interpretation, SAB 101 is not expected to have a material impact on the
Company's cosolidated financial statements.
Existing Contractual Obligations Allow For Additional Issuances Of Common Stock,
Which Could Further Adversely Affect The Market Price For The Company's Common
Stock
As of June 30, 2000, the total number of shares of the Company's common stock
underlying all of the Company's convertible securities, including common stock
underlying unvested stock options and grants made under the Company's 1998 Stock
Incentive Plan and 1999 Supplemental Stock Incentive Plan, was approximately
7,023,000 shares. This would have been 19.9% of the Company's outstanding common
stock as of June 30, 2000, 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 the Company's
common stock. To the extent any of these shares of common stock are issued, the
market price of the Company's common stock may decrease because of the
additional shares on the market.
27
<PAGE>
The Company May Not Be Able To Successfully Implement The ISP Channel's Business
Plan If The Company's Cable Affiliates Are Adversely Impacted
The success of the Company's business depends upon the Company's relationship
with the Company's cable affiliates. Therefore, the Company's success and future
business growth will be substantially affected by economic and other factors
affecting the Company's cable affiliates.
The Company does not have direct contact with the Company's customers
Because customers to the ISP Channel service must subscribe through a cable
affiliate, in many cases the cable affiliate (and not the Company) will
substantially control the customer relationship with the end-user customers. For
example, under some of the Company's existing contracts, cable affiliates are
responsible for important functions, such as billing for and collecting ISP
Channel subscription fees and providing the labor and costs associated with
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 the Company's cable affiliates. Currently, some 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 back to the Internet.
These systems are called "one-way" cable systems. Several cable operators have
announced and begun making upgrades to their systems to increase the capacity of
their networks and to enable traffic both to and from the Internet over their
networks, so-called "two-way capability". However, cable system operators have
limited experience with implementing such upgrades. These investments have
placed a significant strain on the financial, managerial, operational and other
resources of cable system operators, many of which already maintain a
significant amount of debt.
Further, cable operators must periodically renew their franchises with city,
county or state governments. These governmental bodies may impose technical and
managerial conditions before granting a renewal, and these conditions may
adversely affect the cable operator's ability or willingness 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 the Company
expects 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 the Company's products
and services in any such operators' franchise area. In addition, cable operators
may rollout Internet access systems that are incompatible with the Company's
high-speed Internet access services. Any of these actions could have a material
adverse effect on the Company's business, financial condition, and prospects.
If The Company Does Not Obtain Exclusive Access To Cable Customers, The Company
May Not Be Able To Sustain Any Meaningful Growth
The success of the ISP Channel service is dependent, in part, on the Company's
ability to gain exclusive access to cable consumers. The Company's ability to
gain exclusive access to cable customers depends upon the Company's ability to
develop exclusive relationships with cable operators that are dominant within
their geographic markets. The Company cannot assure you that affiliated cable
operators will not face competition in the future or that the Company will be
able to establish and maintain exclusive relationships with cable affiliates.
Currently, a number of the Company's contracts with cable operators do not
contain exclusivity provisions. Even if the Company is able to establish and
maintain exclusive relationships with cable operators, the Company cannot assure
the ability to do so on favorable terms or in sufficient quantities to be
profitable. In addition, the Company will be excluded from providing
Internet-over-cable in those areas served by cable operators with exclusive
arrangements with other Internet service providers. The Company's contracts with
cable affiliates typically range from three to seven years, and the Company
cannot assure you that such contracts will be renewed on satisfactory terms. If
the exclusive relationship between either the Company and the Company's cable
affiliates or between the Company's cable affiliates and their cable subscribers
is impaired, if the Company does not become affiliated with a sufficient number
of cable operators, or if the Company is not able to continue the Company's
relationship with a cable affiliate once the initial term of its contract has
expired, the Company's business, financial condition and prospects could be
materially adversely affected.
28
<PAGE>
Failure To Increase Revenues From New Products And Services, Whether Due To Lack
Of Market Acceptance, Competition, Technological Change Or Otherwise, Would Have
A Material Adverse Effect On The Company's Business, Financial Condition And
Prospects
The Company expects to continue extensive research and development activities
and to evaluate new product and service opportunities. These activities will
require the Company's continued investment in research and development and sales
and marketing, which could adversely affect the Company's short-term results of
operations. The Company believes that future revenue growth and profitability
will depend in part on the Company's ability to develop and successfully market
new products and services. Failure to increase revenues from new products and
services, whether due to lack of market acceptance, competition, technological
change or otherwise, would have a material adverse effect on the Company's
business financial condition and prospects.
The Company's Purchases Of Intellicom And Laptop Lane May Adversely Affect the
Company's Financial Condition
The purchases of Intellicom and Laptop Lane involve other risks including
potential negative effects on the Company's reported results of operations from
acquisition-related charges and amortization of acquired technology and other
intangible assets. As a result of the Intellicom acquisition, the Company
recorded approximately $16,075,000 of intangible assets. As a result of the
Laptop Lane acquisition, the Company recorded approximately $23,195,000 of
intangible assets. The resulting amortization expense will adversely affect the
Company's earnings and profitability for the foreseeable future. If the amount
of such recorded intangible assets is increased or if the Company has future
losses and is unable to demonstrate the Company's 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, the Company's business and financial condition could be
materially and adversely affected. In addition, both the Intellicom and Laptop
Lane acquisitions were structured as purchases by the Company of all of the
outstanding stock of Intellicom and Laptop Lane. As a result, the Company could
be adversely affected by direct and contingent liabilities of Intellicom or
Laptop Lane. It is possible that the Company is not aware of all of the
liabilities of Intellicom and Laptop Lane and that Intellicom or Laptop Lane has
greater liabilities than the Company expected.
If The Company Fails To Manage The Company's Expanding Business Effectively, The
Company's Business, Financial Condition And Prospects Could Be Adversely
Affected
To exploit fully the market for the Company's products and services, the Company
must rapidly execute the Company's sales strategy while managing anticipated
growth through the use of effective planning and operating procedures. To manage
the Company's anticipated growth, the Company must, among other things:
o continue to develop and improve the Company's operational, financial and
management information systems;
o hire and train additional qualified personnel;
o continue to expand and upgrade core technologies; and
o effectively manage multiple relationships with various customers, suppliers
and other third parties.
Consequently, such expansion could place a significant strain on the Company's
services and support operations, sales and administrative personnel and other
resources. The Company may, in the future, also experience difficulties meeting
demand for the Company's products and services. Additionally, if the Company is
unable to provide training and support for the Company's products, it will take
longer to install the Company's products and customer satisfaction may be lower.
The Company cannot assure that the Company's systems, procedures or controls
will be adequate to support the Company's operations or that management will be
able to exploit fully the market for the Company's products and services. The
Company's failure to manage growth effectively could have a material adverse
effect on the Company's business, financial condition and prospects.
The Company's Limited Experience With International Operations May Prevent The
Company From Growing The Company's Business Outside The United States
A key component of the Company's strategy is to expand into international
markets and offer broadband services in those markets. The Company has limited
experience in developing localized versions of the Company's products and
services and in developing relationships with international cable system
operators. The Company may not be successful in expanding the Company's product
and service offerings into foreign markets. In addition to the uncertainty
29
<PAGE>
regarding the Company's ability to generate revenues from foreign operations and
expand the Company's international presence, the Company faces specific risks
related to providing broadband services in foreign jurisdictions, including:
o regulatory requirements, including the regulation of Internet access;
o legal uncertainty regarding liability for information retrieved and
replicated in foreign jurisdictions; and
o lack of a developed cable infrastructure in many international markets.
If Cable Affiliates Are Unable To Renew Their Franchises Or The Company Is
Unable To Affiliate With Replacement Operators, The Company's 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 (the "Cable
Act") prohibits franchising authorities from granting exclusive cable television
franchises and from unreasonably refusing to award additional competitive
franchises. The Cable Act also permits municipal authorities to operate cable
television systems in their communities without franchises. The Company cannot
assure that cable television companies having contracts with the Company will
retain or renew their franchises. Non-renewal or termination of any such
franchises would result in the termination of the Company's contract with the
applicable cable operator. If an affiliated cable operator were to lose its
franchise, the Company would seek to affiliate with the successor to the
franchisee. The Company cannot, however, assure that ISP Channel will be able to
affiliate with such successor. In addition, affiliation with a successor could
result in additional costs to the Company. If the Company cannot affiliate with
replacement cable operators, the Company's business, financial condition and
prospects could be materially adversely affected.
The Company May Lose Cable Affiliates Through Their Acquisition Which Could Have
A Material Adverse Effect On The Company's Business, Financial Condition And
Prospects
Under many of the Company's contracts, if a cable affiliate is acquired and the
acquiring company chooses not to enter into a contract with the Company, the
Company may lose the Company's 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 the Company's business, financial
condition and prospects.
The Company Depends On Third-Party Technology To Develop And Introduce
Technology The Company Uses And The Absence Of Or Any Significant Delay In The
Replacement Of Third-Party Technology Would Have A Material Adverse Effect On
The Company's Business, Financial Condition And Prospects The markets for the
products and services the Company uses are characterized by the following:
o intense competition;
o rapid technological advances;
o evolving industry standards;
o changes in subscriber requirements;
o frequent new product introductions and enhancements; and
o alternative service offerings.
Because of these factors, the Company has chosen to rely upon third parties to
develop and introduce technologies that enhance the Company's current product
and service offerings. If the Company's relationship with such third parties is
impaired or terminated, then the Company would have to find other developers on
a timely basis or develop the Company's own technology. The Company cannot
predict whether the Company will be able to obtain the third-party technology
necessary for continued development and introduction of new and enhanced
products and services or whether such technology will gain market acceptance. In
addition, the Company cannot predict whether the Company 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 the Company's products or services. The absence of or any
significant delay in the replacement of third-party technology would have a
material adverse effect on the Company's business, financial condition and
prospects.
30
<PAGE>
The Company Depends 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
The Company's Product Shipments
The Company currently depends on a limited number of suppliers for certain key
products and services. In particular, the Company depends on General Instrument
Corporation, 3Com Corporation and Com21, Inc. for headend and cable modem
equipment, Cisco Systems, Inc. for specific network routing and switching
equipment, Radyne Comstream Inc. for satellite equipment, Nokia and Lucent for
wireless LAN equipment, and, among others, MCIWorldCom, Inc. for national
Internet backbone services. Additionally, certain of the Company's cable modem
and headend equipment suppliers are in litigation over their patents. The
Company could experience disruptions in the delivery or increases in the prices
of products and services purchased from vendors as a result of this intellectual
property litigation. The Company 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, the Company may not have adequate remedies against such
third parties as a result of breaches of their agreements with the Company. The
inability to obtain sufficient key components or to develop alternative sources
for such components could result in delays or reductions in the Company's
product shipments. If that were to happen, it could have a material adverse
effect on the Company's customer relationships, business, financial condition,
and prospects.
If New Data Over Cable System Interface Specifications ("DOCSIS")-Compliant
Cable Modems Are Not Deployed Timely And Successfully, The Company's Subscriber
Growth Could Be Constrained
Each of the Company's subscribers currently obtains a cable modem from the
Company to access the ISP Channel. The North American cable industry has
recently adopted interface standards known as DOCSIS for hardware and software
to support the delivery of data services over the cable infrastructure utilizing
compatible cable modems. If the Company is not able to obtain a sufficient
quantity of DOCSIS-compliant modems, the Company's growth will be limited.
The Company also believes that in order to meet the Company's subscriber goals,
two-way cable modems must also become widely available in other channels, such
as through personal computer manufacturers and through retail outlets.
Currently, this widespread availability has not yet occurred. In addition, these
modems must be easy for consumers to install themselves, rather than requiring a
customer service representative to perform the installation. If two-way cable
modems do not become quickly available in outlets other than through cable
television companies, or if they cannot be installed easily by consumers, it
would be difficult for the Company to attract large numbers of additional
subscribers and the Company's business would be harmed.
The Company Depends On Third-Party Carriers To Maintain Their Cable Systems
Which Carry The Company's Data And Any Interruption Of The Company's Operations
Due To The Failure To Maintain Their Cable Systems Would Have A Material Adverse
Effect On The Company's Business, Financial Condition And Prospects
The Company's success will depend upon the capacity, reliability and security of
the network used to carry data between the Company's subscribers and the
Internet. A significant portion of such network is owned by third parties, and
accordingly the Company has no control over its quality and maintenance. The
Company relies on cable operators to maintain their cable systems. In addition,
the Company relies on other third parties to provide a connection from the cable
system to the Internet. Currently, the Company has transit agreements with
MCIWorldCom, Sprint, and others to support the exchange of traffic between the
Company's network operations center, cable system and the Internet. The failure
of any other link in the delivery chain resulting in an interruption of the
Company's operations would have a material adverse effect on the Company's
business, financial condition and prospects.
Any Increase In Competition Could Reduce The Company's Gross Margins, Require
Increased Spending By The Company On Research And Development And Sales And
Marketing, And Otherwise Materially Adversely Affect The Company's Business,
Financial Condition And Prospects
The markets for the Company's products and services are intensely competitive,
and the Company expects competition to increase in the future. Many of the
Company's competitors and potential competitors have substantially greater
financial, technical and marketing resources, larger subscriber bases, longer
operating histories, greater name recognition and more established relationships
with advertisers and content and application providers than the Company does.
Such competitors may be able to undertake more extensive marketing campaigns,
adopt more aggressive pricing policies and devote substantially more resources
31
<PAGE>
to developing Internet services or online content than the Company can. The
Company's ability to compete may be further impeded if, as evidenced by the
acquisitions of TCI and MediaOne by AT&T, competitors utilizing different or the
same technologies seek to acquire or merge to enhance their competitive
strengths. The Company cannot predict whether the Company will be able to
compete successfully against current or future competitors or that competitive
pressures faced by the Company will not materially adversely affect the
Company's business, financial condition, prospects or ability to repay the
Company's debts. Any increase in competition could reduce the Company's gross
margins, require increased spending by the Company on research and development
and sales and marketing, and otherwise materially adversely affect the Company's
business, financial condition and prospects.
ISP Channel face competition from many sources, which include:
o other cable-based access providers;
o telephone-based access providers; and
o alternative technologies.
Cable-based access providers
In the cable-based segment of the Internet access industry, the Company competes
with other cable-based data services that are seeking to contract with cable
system operators. These competitors include:
o systems integrators such as Excite@Home, Roadrunner and High Speed Access
Corp.; and
o Internet service providers such as Earthlink Network, Inc. and MindSpring
Enterprises, Inc. (which two companies are in the process of merging), and
IDT Corporation.
Most cable system operators have begun to provide high-speed Internet access
services over their existing networks. The largest of these cable system
operators are Adelphia, CableVision, Charter, Comcast, Cox, MediaOne, TCI and
Time Warner. Comcast, Cox and TCI market through Excite@Home, while Time Warner
plans to market the RoadRunner service through Time Warner's own cable systems
as well as to other cable system operators nationwide. Adelphia provides high
speed Internet access through a wholly owned subsidiary called Powerlink. In
particular, Excite@Home has announced its intention to compete directly in the
small- to medium-sized cable system market, where High Speed Access Corp., an
affiliate of Charter, currently competes as well.
Telephone-based access providers
Some of the Company's 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/MindSpring, Netcom, Concentric Network, and PSINet. The
result is a highly competitive and fragmented market.
Some of the Company's potential competitors are offering diversified packages of
telecommunications services to residential customers. If these companies also
offer Internet access service, then the Company 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 the Company's
Internet data service offerings. The bases of competition in these markets
include:
o transmission speed;
o security of transmission;
o reliability of service;
o ease of access and use;
o ratio of price to performance;
o quality of presentation and content;
o timeliness of content;
o customer support;
o brand recognition; and
o operating experience and revenue sharing.
Alternative technologies
In addition, the market for high-speed data transmission services is
characterized by several competing technologies that offer alternatives to
32
<PAGE>
cable-modem service and conventional dial-up access. Competitive technologies
include telecom-related wireline technologies, such as integrated services
digital network and digital subscriber line technologies, and wireless
technologies such as local multipoint distribution service, multichannel
multipoint distribution service and various types of satellite services. The
Company's prospects may be impaired by 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 the Company's business.
Significant market acceptance of alternative solutions for high-speed data
transmission could decrease the demand for the Company's services.
The Company cannot predict whether and to what extent technological developments
will have a material adverse effect on the Company's 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 the Company's products and services. If that were
to happen, it could have a material adverse effect on the Company's business,
financial condition and prospects.
A Perceived Or Actual Failure By The Company To Achieve Or Maintain High Speed
Data Transmission Could Significantly Reduce Consumer Demand For The Company's
Services And Have A Material Adverse Effect On The Company's Business, Financial
Condition And Prospects
Because ISP Channel and Intellicom services have been operational for a
relatively short period of time and because SoftNet Zone's wireless broadband
Internet services have not yet become operational, the Company's ability to
connect and manage a substantial number of online subscribers at high
transmission speeds is unknown. In addition, the Company faces risk related to
the Company's ability to scale up to expected subscriber levels while
maintaining superior performance. The actual downstream data transmission speeds
for each subscriber will be significantly slower and will depend on a variety of
factors, including:
o actual speed provisioned for the subscriber's modem;
o quality of the server used to deliver content;
o overall Internet traffic congestion;
o the number of active subscribers on a given channel at the same time;
o the capability of modems used; and
o the service quality of the cable networks of ISP Channel's cable
affiliates, the networks of Intellicom's customers and the networks of
SoftNet Zone's customers.
As the number of subscribers increases, it may be necessary for the Company's
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.
The Company cannot assure you that the Company's cable affiliates will provide
additional capacity for this purpose. On two-way cable systems, the transmission
data channel to the Internet (or return path) 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. The Company cannot assure you that the Company will
be able achieve or maintain data transmission speeds high enough to attract and
retain the Company's planned numbers of subscribers, especially as the number of
subscribers to the Company's services grows. Consequently, a perceived or actual
failure by the Company to achieve or maintain high speed data transmission could
significantly reduce consumer demand for the Company's services and have a
material adverse effect on the Company's business, financial condition and
prospects.
Any Damage Or Failure That Causes Interruptions In The Company's Operations
Could Have A Material Adverse Effect On The Company's Business, Financial
Condition And Prospects
The Company's operations are dependent upon the Company's ability to support a
highly complex network and avoid damages from fires, earthquakes, floods, power
losses, telecommunications and satellite failures, network software flaws,
transmission cable cuts and similar events. The occurrence of any one of these
events could cause interruptions in the services the Company provides. In
addition, the failure of an incumbent local exchange carrier or other service
provider to provide the communications capacity the Company requires, as a
result of a natural disaster, operational disruption or any other reason, could
cause interruptions in the services the Company provides. Any damage or failure
that causes interruptions in the Company's operations could have a material
adverse effect on the Company's business, financial condition and prospects.
33
<PAGE>
The Company May Be Vulnerable To Unauthorized Access, Computer Viruses And Other
Disruptive Problems, Which May Result In The Company's Liability To The
Company's Subscribers And May Deter Others From Becoming Subscribers
While the Company has taken substantial security measures, the Company's
networks or those of the Company's cable affiliates may be vulnerable to
unauthorized access, computer viruses and other disruptive problems. Internet
service providers and online service providers have experienced in the past, and
may experience in the future, interruptions in service as a result of the
accidental or intentional actions of Internet users. Unauthorized access by
current and former employees or others could also potentially jeopardize the
security of confidential information stored in the Company's computer systems
and those of the Company's subscribers. Such events may result in the Company's
liability to the Company's subscribers and may deter others from becoming
subscribers, which could have a material adverse effect on the Company's
business, financial condition and prospects. Although the Company intends to
continue using industry-standard security measures, such measures have been
circumvented in the past, and the Company cannot assure you that these measures
will not be circumvented in the future. Moreover, the Company has no control
over the security measures that the Company's cable affiliates adopt.
Eliminating computer viruses and alleviating other security problems may cause
the Company's subscribers delays due to interruptions or cessation of service.
Such delays could have a material adverse effect on the Company's business,
financial condition and prospects.
If The Market For High-Quality Content Fails To Develop, Or Develops More Slowly
Than Expected, The Company's Business, Financial Condition And Prospects Will Be
Materially Adversely Affected
A key part of the Company's 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. The Company
believes that, in addition to providing high-speed, high-performance Internet
access, to be successful the Company must also develop and aggregate
high-quality multimedia content. The Company's success in providing and
aggregating such content will depend in part on:
o the Company's ability to develop a customer base large enough to justify
investments in the development of such content;
o the ability of content providers to create and support high-quality
multimedia content; and
o the Company's ability to aggregate content offerings in a manner
subscribers find attractive.
The Company cannot assure you that the Company will be successful in these
endeavors. In addition, the market for high-quality multimedia Internet content
has only recently begun to develop and is rapidly evolving, and there is
significant competition among 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 the
Company's content offerings do not achieve or sustain market acceptance, the
Company's business, financial condition and prospects will be materially
adversely affected.
The Company's Failure To Attract Advertising Revenues In Quantities And At Rates
That Are Satisfactory To The Company Could Have A Material Adverse Effect On The
Company's Business, Financial Condition And Prospects
The success of the ISP Channel service depends in part on the Company's ability
to draw advertisers to the ISP Channel. The Company expects to derive
significant revenues from advertisements placed on co-branded and ISP Channel
web pages and "click through" revenues from products and services purchased
through links from the ISP Channel to vendors. The Company believes that the
Company can leverage the ISP Channel to provide demographic information to
advertisers to help them better target prospective customers. Nonetheless, the
Company has not generated any significant advertising revenue yet and the
Company cannot assure you that advertisers will find such information useful or
will choose to advertise through the ISP Channel. Therefore, the Company cannot
assure you that the Company will be able to attract advertising revenues in
quantities and at rates that are satisfactory to the Company. The failure to do
so could have a material adverse effect on the Company's business, financial
condition and prospects.
34
<PAGE>
If The Company Is Unsuccessful In Establishing And Maintaining The ISP Channel
Brand, Or If The Company Incurs Excessive Expenses In Promoting And Maintaining
The ISP Channel's Brand, The Company's Business, Financial Condition And
Prospects Would Be Materially Adversely Affected
The Company believes that establishing and maintaining the ISP Channel brand are
critical to attract and expand the Company's subscriber base. Promotion of the
ISP Channel brand will depend on several factors, including:
o the Company's success in providing high-speed, high-quality consumer and
business Internet products, services and content;
o the marketing efforts of the Company's cable affiliates; and
o the reliability of the Company's cable affiliates' networks and services.
The Company cannot assure you that any of these factors will be achieved. The
Company has little control over the Company's cable affiliates' marketing
efforts or the reliability of their networks and services.
If consumers and businesses do not perceive the Company's existing products and
services as high quality or the Company introduces new products or services or
enter into new business ventures that are not favorably received by consumers
and businesses, then the Company 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, the Company risks frustrating
potential subscribers who are unable to access the Company's products and
services.
Furthermore, the Company 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 the Company is unsuccessful in establishing or
maintaining the ISP Channel brand or if the Company incurs excessive expenses in
promoting and maintaining the Company's brand, the Company's business, financial
condition and prospects would be materially adversely affected.
If The Company Encounters Significant Problems With The Company's Billing And
Collections Process, The Company's Business, Financial Condition And Prospects
Could Be Materially Adversely Affected
The Company is in the process of designing and implementing the Company's
billing and collections system for the ISP Channel service. The Company intends
to bill for the Company's services primarily 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, the Company cannot assure you that the Company will be successful in
developing and launching the system in a timely manner or that the Company will
be able to scale the system quickly and efficiently if the number of subscribers
requiring such a billing format increases. Currently, many of the Company's
cable affiliates are responsible for billing and collection for the Company's
Internet access services. As a result, the Company has little or no control over
the accuracy and timeliness of the invoices or over collection efforts.
Given the Company's relatively limited history with billing and collection for
Internet services, the Company cannot predict the extent to which the Company
may experience bad debts or the Company's ability to minimize such bad debts. If
the Company encounters significant problems with the Company's billing and
collections process, the Company's business, financial condition and prospects
could be materially adversely affected.
The Company May Face Potential Liability For Defamatory Or Indecent Content,
Which May Cause The Company To Modify The Way The Company Provides Services
Any imposition of liability on the Company for information carried on the
Internet could have a material adverse effect on the Company's business,
financial condition and prospects. The law relating to liability of Internet
service providers and online service providers for information carried on or
disseminated through their networks is currently unsettled. A number of lawsuits
have sought to impose such liability for defamatory speech and indecent
materials. Congress has attempted to impose such liability, in some
circumstances, for transmission of obscene or indecent materials. In one case, a
court has held that an online service provider 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 the Company's systems, the Company may have to implement measures to
reduce the Company's exposure to such liability. Such measures may require the
expenditure of substantial resources or the discontinuation of certain products
or services.
35
<PAGE>
The Company May Face Potential Liability For Information Retrieved And
Replicated That May Not Be Covered By The Company's Insurance
The Company's liability insurance may not cover potential claims relating to
providing Internet services or may not be adequate to indemnify the Company 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 the
Company's business, financial condition and prospects. Because subscribers
download and redistribute materials that are cached or replicated by the Company
in connection with the Company's Internet services, claims could be made against
the Company or the Company's 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 the Company to determine who the potential rights holders may be
with respect to all materials available through the Company's services. In
addition, a number of third-party owners of patents have claimed to hold patents
that cover various forms of online transactions or online technology. As with
other online service providers, patent claims could be asserted against the
Company based upon the Company's services or technologies.
The Company's Success Depends Upon The Development Of New Products And Services
In The Face Of Rapidly Evolving Technology
The Company's products and services may not be commercially successful
The Company's future development efforts may not result in commercially
successful products and services or the Company's products and services may be
rendered obsolete by changing technology, new industry standards or new product
announcements by competitors.
For example, the Company expects digital set-top boxes capable of supporting
high-speed Internet access services to be commercially available in the next 12
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 the Company's Internet service, the demand for set-top boxes may
never reach the level the Company and industry experts have estimated. Even if
set-top boxes do reach this level of popularity, the Company cannot assure you
that the Company will be able to capitalize on such demand. If this scenario
occurs or if other technologies or standards applicable to the Company's
products or services become obsolete or fail to gain widespread commercial
acceptance, then the Company's business, financial condition and prospects will
be materially adversely affected.
The Company's ability to adapt to changes in technology and industry standards,
and to develop and introduce new and enhanced products and service offerings,
will determine whether the Company can maintain or improve the Company's
competitive position and the Company's prospects for growth. However, the
following factors may hinder the Company's efforts to introduce and sell new
products and services:
o rapid technological changes in the Internet and telecommunications
industries;
o the lengthy product approval and purchase process of the Company's
customers; and
o the Company's reliance on third-party technology for the development of new
products and services.
The Company's suppliers' products may become obsolete, requiring the Company to
purchase additional inventory or replacement equipment
The technology underlying the Company's capital equipment, such as headends and
cable modems, continues to evolve and, accordingly, the Company's equipment
could become out-of-date or obsolete prior to the time the Company originally
intended to replace it or sell it. If this occurs, the Company may need to
purchase substantial amounts of new capital equipment or inventory, which could
have a material adverse effect on the Company's business, financial condition
and prospects.
The Company's competitors' products may make the Company's products less
commercially viable
The introduction by the Company's competitors of products or services embodying,
or purporting to embody, new technology could also render the Company's existing
products and services, as well as products or services under development,
obsolete and unmarketable. Internet, telecommunications and cable technologies
are evolving rapidly. Many large corporations, including large
telecommunications providers, regional Bell operating companies and
telecommunications equipment providers, as well as large cable system operators,
regularly announce new and planned technologies and service offerings that could
impact the market for the Company's services. The announcements can delay
purchasing decisions by the Company's customers and confuse the marketplace
regarding available alternatives. Such announcements could, in the future,
adversely impact the Company's business, financial condition and prospects.
36
<PAGE>
In addition, the Company cannot assure you that the Company 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 the
Company's cable- based consumer and business Internet services. The Company's
services may not achieve widespread acceptance before competitors offer products
and services with speed and performance similar to the Company's current
offerings. In addition, the widespread adoption of new Internet or telecommuting
technologies or standards, cable-based or otherwise, could require substantial
and costly modifications to the Company's equipment, products and services and
could fundamentally alter the character, viability and frequency of
Internet-based advertising, either of which could have a material adverse effect
on the Company's business, financial condition and prospects.
If The Company Is Unable To Successfully Integrate Future Acquisitions Into The
Company's Operations, Then The Company's Results And Financial Condition May Be
Adversely Affected
In addition to the recent acquisition of Intellicom, the Company may acquire
other businesses that the Company believes will complement the Company's
existing businesses. The Company cannot predict if or when any prospective
acquisitions will occur or the likelihood that they will be completed on
favorable terms. Acquiring a business involves many risks, including:
o potential disruption of the Company's ongoing business and diversion of
resources and management time;
o potential dilution to existing stockholders if the Company uses equity
securities to finance acquisitions; o incurrence of unforeseen obligations
or liabilities;
o possible inability of management to maintain uniform standards, controls,
procedures and policies;
o difficulty assimilating the acquired operations and personnel;
o risks of entering markets in which the Company has little or no direct
prior experience; and
o potential impairment of relationships with employees or customers as a
result of changes in management.
The Company cannot assure that the Company will make any acquisitions or that
the Company will be able to obtain additional financing for such acquisitions,
if necessary. If any acquisitions are made, the Company cannot assure that the
Company will be able to successfully integrate the acquired business into the
Company's operations or that the acquired business will perform as expected.
The Company's Equity Investments In Other Companies May Not Yield Any Returns
The Company has made equity investments in several Internet-related companies,
including joint ventures in other countries. In most instances, these
investments are in the form of illiquid securities of private companies. These
companies typically are in an early stage of development and may be expected to
incur substantial losses. The Company's investments in these companies may not
yield any return. Furthermore, if these companies are not successful, the
Company could incur charges related to the write-down or write-off of assets.
The Company also records and continues to record a share of the net losses in
these companies, up to the Company's cost basis, if they are the Company's
affiliates. The Company intends to continue to make significant additional
investments in the future. Losses or charges resulting from these investments
could harm the Company's operating results.
Loss Of Key Personnel May Disrupt The Company's Operations
The loss of key personnel may disrupt the Company's operations. The Company's
success depends, in large part, on the Company's ability to attract and retain
qualified technical, marketing, sales and management personnel. With the
expansion of the ISP Channel, Intellicom and SoftNet Zone's services, the
Company is currently seeking new employees. However, competition for such
personnel is intense in the Company's business, and thus, the Company may be
unsuccessful in its hiring efforts. To launch services on a large-scale basis,
the Company has recently assembled a new management team, many of whom have been
with the Company for less than twelve 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 the Company's business, financial condition and prospects.
37
<PAGE>
Direct And Indirect Government Regulation Can Significantly Impact The Company's
Business
Currently, neither the FCC nor any other federal or state communications
regulatory agency directly regulates Internet access services provided by the
Company's 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 the Company's 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. At least one
federal district court has upheld the local jurisdiction's decision to mandate
open access. The Company cannot predict the ultimate outcome or scope of the
local approval process. Nor can the Company predict the impact, if any, that
future federal, state or local legal or regulatory changes, including open
access conditions, might have on the Company's business.
Regulations affecting the cable industry may discourage cable operators from
upgrading their systems
Regulation of cable television may affect the speed at which the Company's cable
affiliates upgrade their cable infrastructures to two-way cable. Currently, the
Company's cable affiliates have generally elected to classify the distribution
of the Company's services as "additional cable services" under their respective
franchise agreements, and 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 the
Company.
The Company's cable affiliates may be subject to multiple franchise fees for
distributing the Company's services
Another possible risk is that local franchise authorities may subject the cable
affiliates to higher or additional franchise fees or taxes or otherwise require
them to obtain additional franchises in connection with distribution of the
Company's services. There are thousands of franchise authorities in the United
States alone, and thus it will be difficult or impossible for the Company or the
Company's 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, the Company could lose the Company's rights
as the exclusive ISP for some of the Company's cable affiliates and the Company
or the Company's 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, the Company obtains some of the components for the Company's
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 the Company's business, financial condition and
prospects.
38
<PAGE>
The Company Does Not Intend To Pay Dividends
The Company has not historically paid any cash dividends on the Company's common
stock and do not expect to declare any such dividends in the foreseeable future.
Payment of any future dividends will depend upon the Company's earnings and
capital requirements, the Company's debt obligations and other factors the board
of directors deems relevant. The Company currently intends to retain its
earnings, if any, to finance the development and expansion of the ISP Channel
service.
The Company's Stock Price Is Volatile
The volatility of the Company's 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 the Company's common stock has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future. These
factors include:
o announcements of developments related to the Company's business;
o fluctuations in the Company's results of operations;
o sales of substantial amounts of the Company's securities into the
marketplace;
o general conditions in the Company's industries or the worldwide economy;
o an outbreak of war or hostilities;
o a shortfall in revenues or earnings compared to securities analysts'
expectations;
o changes in analysts' recommendations or projections;
o announcements of new products or services by the Company or the Company's
competitors; and
o changes in the Company's relationships with the Company's suppliers or
customers.
The market price of the Company's common stock may fluctuate significantly in
the future, and these fluctuations may be unrelated to the Company's
performance. General market price declines or market volatility in the future
could adversely affect the price of the Company's common stock, and thus, the
current market price may not be indicative of future market prices.
Prospective Anti-Takeover Provisions Could Negatively Impact The Company's
Stockholders
The Company is a Delaware corporation. The Delaware General Corporation Law
contains certain provisions that may discourage, delay or make a change in
control of the Company more difficult or prevent the removal of incumbent
directors. In addition, the Company's certificate of incorporation and bylaws
have certain provisions that have the same effect. These provisions may have a
negative impact on the price of the Company's common stock and may discourage
third-party bidders from making a bid for the Company or may reduce any premiums
paid to stockholders for their common stock.
The Year 2000 Issue Could Harm The Company's Operations
In the past, many computer systems and software products were designed with a
two-digit format in the year portion of the date code field. This posed a
problem for dates after December 31, 1999, due to many computer systems and
software products would turnover to "00" in the year portion of the date code
field, and therefore not distinguish year 2000 from year 1900 (commonly referred
to as the "Year 2000" or "Y2K" issue). In order to distinguish twenty-first
century dates from twentieth century dates, the year portion of the date code
fields require a four-digit format. As a result, computer systems and software
products used by many companies were upgraded or modified to accept the four
digit format the in year portion of the date code field. Prior to December 31,
1999, the Company formulated and implemented a comprehensive Y2K Plan, as
described in the Company's Form 10-K for the fiscal year ended September 30,
1999, to comply with Y2K requirements. To date, and with the January 1, 2000
date rollover, the Company, to its knowledge, has not experienced any material
disruptions associated with the Y2K issue internally or externally through its
cable affiliates, critical suppliers, service providers and contractors.
However, the Company cannot determine if it will be subject to Y2K problems in
the future or if any Y2K problems have arisen that it has failed to detect. The
Company does not separately track the internal costs incurred for the Y2K
project, which costs are principally related to payroll costs for the Company's
information systems staff. The external cost, primarily consultants, is
approximately $350,000 through June 30, 2000. The failure of one or more systems
of the Company or its business partners due to the Y2K issue may have a material
adverse effect on the Company's ability to conduct business, as well as the
Company's financial position and results of operations.
39
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit No. Description of Document
============= ======================================================
3.1 Amended and Restated Certificate of Incorporation of the
Registrant. Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999.
3.2 By-Laws of the Company. Incorporated by reference to the
Company's Registration Statement on Form S-3/A dated April 22,
1999.
27 Financial Data Schedule
(b) Reports on Form 8-K
Current report on Form 8-K filed with the Commission on May 9, 2000.
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOFTNET SYSTEMS, INC.
/s/ Garrett J. Girvan Date: August 14, 2000
------------------------------------------------- ---------------
Garrett J. Girvan
Chief Operating Officer
/s/ Susan Dolce Date: August 14, 2000
------------------------------------------------- ---------------
Susan Dolce
Controller
41