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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT
TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED MAY 31, 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 NUMBER 000-26565
LIBERATE TECHNOLOGIES
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 94-3245315
(State or Other Jurisdiction of (I.R.S. Employer Incorporation or
Incorporation) Organization
Identification No.)
2 CIRCLE STAR WAY, SAN CARLOS, CALIFORNIA 94070-6200
(Address of Principal Executive Offices) (Zip Code)
(650) 701-4000
Registrant's Telephone Number, Including Area Code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Company (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 Company
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
Company was approximately $2,354,751,000 based on the last reported sale price
of the Company's common stock on the Nasdaq National Market System on July 31,
2000. There were 102,659,427 shares of common stock outstanding as of July 31,
2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on October 24, 2000 are incorporated by reference in
Items 10, 11, 12 and 13 of Part III of this Report.
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LIBERATE TECHNOLOGIES
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MAY 31, 2000
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 19
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 20
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 21
Item 6. Selected Financial Data..................................... 22
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 24
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 37
Item 8. Financial Statements and Supplementary Data................. 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure........................................ 38
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 39
Item 11. Executive Compensation...................................... 40
Item 12. Stock Ownership of Certain Beneficial Owners and
Management.................................................. 40
Item 13. Certain Relationships and Related Transactions.............. 40
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 41
Signatures............................................................... 45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS............................... F-1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in the Annual Report on Form 10-K, constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our or our industry's actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. These
factors include those listed under Part I "Business--Risk Factors."
Forward-looking statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of such terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. In evaluating these
statements, you should specifically consider various factors, including the
risks outlined under Part I "Business--Risk Factors." These factors may cause
our actual results to differ materially from any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of such statements. We
are under no duty to update any of the forward-looking statements after the date
of this Annual Report on Form 10-K to conform such statements to actual results.
2
PART I
ITEM 1. BUSINESS
OVERVIEW
Liberate, incorporated in Delaware in April 1996, is a leading provider of a
comprehensive software platform for delivering content, services and
applications to a broad range of information appliances. Information appliances,
which include television set-top boxes, game consoles and personal digital
assistants, are devices that are enhanced by Internet capability. Network
operators, such as telecommunications companies, cable and satellite television
operators and Internet service providers, or ISPs, can use our server software
to deliver Internet-enhanced services to numerous information appliances and
millions of consumers. Information appliance manufacturers can use our client
software to Internet-enable their products. Our open platform also provides a
uniform environment for developers to enhance existing content and create new
Internet applications and services for delivery on multiple platforms. Our
software platform is designed to enable network operators to provide consumers
with universal access to these Internet-enhanced applications and services. To
extend the functionality of our software platform, we have also developed
strategic alliances with leading technology vendors such as Cisco Systems,
Inktomi, Netscape, Oracle, Sun Microsystems, Scientific-Atlanta and General
Instrument (recently acquired by Motorola). We also have established commercial
relationships with numerous large network operators, such as America Online,
Cable & Wireless Communications (portions of which were recently acquired by
NTL), Comcast, Cox Communications, Insight Communications, NTL, Shaw
Communications and US WEST.
PRODUCTS AND TECHNOLOGY
Our information appliance software platform includes a full range of client
and server products, tools and applications. We offer network operators a suite
of server solutions tailored to the cable, satellite, telecommunications and ISP
markets. We deliver client products targeted for the needs of information
appliance manufacturers with a current focus on television-related devices. Our
tools and pre-configured applications allow network operators and information
appliance manufacturers to offer a fully customizable client and server
platform.
Our client and server software platform incorporates proprietary technology
that we have developed to address the needs of network operators and information
appliance manufacturers, including the following technologies:
- EXPERTISE IN DIGITAL TELEVISION AND INTERNET TECHNOLOGY. We have spent
over three years developing fundamental expertise in working with Internet
browser and server software. This enables us to easily modify and enhance
our client software with critical third-party technologies such as Java
and Real Audio while maintaining compatibility with Internet standards. We
have also developed a wealth of expertise in the deployment of interactive
applications and services over various digital television network
architectures. We are also pioneering the development of key industry
standards in the Americas and in Europe.
- OPTIMIZED CLIENT TECHNOLOGY. In just 700Kb of memory, we offer one of the
smallest, most efficient client engines available with HTML and JavaScript
capabilities, which allows it to be used in a wide variety of information
appliances. Additionally, we offer client engines as small as 300Kb that
utilize Internet-based server engines to support low-end set-top boxes
such as the Motorola DCT-2000. In addition, we have developed a
proprietary display technology called IQView, which optimizes Internet
content for delivery on virtually any display device without specialized
graphics hardware.
- PORTABLE CLIENT ARCHITECTURE. We have developed our client software with
the flexibility to operate on a wide variety of information appliances.
Our client software currently supports processors
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from, among others, STMicrotechnology, Motorola, ARM, Hitachi, IBM, Intel,
National Semiconductor, MIPS and Sun Microsystems, and runs on multiple
operating systems, including Microsoft Windows CE, PowerTV, VxWorks and
Linux.
- RELIABLE SERVER ARCHITECTURE. We have based our server software on open
Internet standards and subsequently enjoy a scalable, secure and
expandable platform. In addition, we have pre-integrated our server
technology with industry leading server solutions to make integration with
our network operator customers faster and easier.
The following table provides a list of our principal products and a brief
description of the features and benefits to our customers of each.
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE SERVER PRODUCTS
LIBERATE CONNECT-TM- Subscriber and application management Network operators can control
subscriber access to applications and
services and can access subscriber data
for efficient customer support
Internet standard security Network operators can offer subscribers
and external e-commerce providers
highly secure transactions
Open standards integration interfaces Network operators can seamlessly
integrate our servers with existing
subscriber management, database and
billing systems
Device management tools Network operators can distribute
software updates automatically and
efficiently to all network devices and
restore services rapidly in case of
client or network failure
Highly scalable architecture Network operators can scale networks to
support millions of subscribers by
simply installing more servers on the
system
LIBERATE MEDIACAST-TM- Content and application broadcasting Network operators can utilize existing
network infrastructure to broadcast
Internet content and interactive
applications
Multiple transport stream capability Network operators can more fully
utilize infrastructure assets by
transmitting data over different
networks
LIBERATE TRANSCODER-TM- Reduced processing and memory load Network operators can deliver rich
Internet content and applications to a
broad range of information appliances
Internet content error checking Network operators can ensure accurate
rendering of HTML, image and audio
content
LIBERATE DATAPOINT-TM- Storage of consumer and set-top box Network operators can store their
related information users' service and applications
preferences on the headend, as well as
key technical data on their users'
set-top boxes
Reliance on proven, scalable database Liberate Datapoint is ported on the
Oracle 8i database, ensuring
scalability and reliability of the
architecture in volume deployments
LIBERATE COMMAND-TM- Server and applications management Network operators can manage and
through Internet browser-based monitor all our server systems and
interface applications throughout their network
from any Internet connected workstation
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE APPLICATIONS
LIBERATE TV INFO-TM- XML-based architecture receives, Network operators can combine and
integrates and exports multiple TV deliver TV program data and Internet
and Internet data sources to multiple data to various applications, including
clients and applications interactive program guides, channel
bars and pay-per-view applications
LIBERATE TV MAIL-TM- TV-based e-mail application Network operators can offer customized
e-mail services using existing
infrastructure
Picture and video e-mail Network operators are able to offer
rich multimedia content which enhances
the e-mail experience
LIBERATE TV CHAT-TM- Online discussion application Network operators can promote
integrated with TV programming subscriber communities by supplementing
existing TV programming with
interactive online discussion
capabilities
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LIBERATE CLIENT PRODUCTS
LIBERATE TV Small memory requirement, 700Kb Information appliance manufacturers can
NAVIGATOR-TM--CABLE, STANDARD reduce costs by reducing memory and
PROFILE processing component costs, and
software runs on memory-constrained
devices, including digital set-top
boxes
Integrated video and data path Network operators can use existing high
bandwidth video delivery systems to
deliver Internet-based interactive
television content and applications,
such as TV-based browsers and e-mail
HTML and JavaScript support Network operators can deliver Internet
standards-based applications, content
and services to their customer base
Highly portable Information appliance manufacturers can
easily add our software platform to a
variety of existing and next-generation
information appliances
Customizable user interface Network operators and information
appliance manufacturers can brand and
control the user interface associated
with the service and of applications
offered
LIBERATE TV Small memory requirements, starting Network operators can deliver
NAVIGATOR-TM--CABLE, COMPACT at 300Kb, capability to run with less interactive services to set-top boxes
PROFILE than 10 MIPS of CPU performance that have memory and processor
constraints
Support of MPEG I-Frames Network operators can maximize
bandwidth to the box with existing
network infrastructure
Headend based HTML to MPEG I-Frames Information appliance manufacturers and
transcoding network operators can use existing
content development tools to build
interactive applications
LIBERATE TV Support of more client focused Network operators can deliver services
NAVIGATOR-TM--TELCO, STANDARD architectures where the network through telecommunications networks
PROFILE bandwidth is limited, such as using phone lines as a two-way path
narrowband fixed line ISP services
Support of Input Method Engine and Network operators can deliver services
double byte characters to a number of international markets
including the Japanese and Chinese
markets
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE TOOLS
LIBERATE TV PRODUCER-TM- Tools and tutorials for creating Developers can rapidly create Internet
applications content and applications targeted to a
television audience
LIBERATE TV EMULATOR-TM- Real-time client emulator running on Developers can inexpensively design and
the Windows platform test their application without a full
broadcast enabled environment
Suite of integrated debugging tools Developers can debug JavaScript and
HTML-based code in an easy to use
development environment
LIBERATE TV CUSTOMIZER-TM- Tool for modifying the look and feel Developers can create a customized look
of the user interface and and brand for a network operator
applications service which is consistent across the
entire service
LIBERATE TV PORTER-TM- A tool set for porting the Liberate Semiconductor companies and hardware
TV Navigator client to new or manufacturers can develop and deliver
existing set-top boxes drivers compliant with the Liberate
Porting API
Sample drivers developed in the Second source porting programs benefit
course of a porting project network operators by enabling a wide
choice of our enabled set-top boxes
that result in lower hardware costs and
accelerate volume deployments
LIBERATE TV EXTENDER-TM- A set of extension APIs for Liberate Along with our partners, network
TV Navigator to add functionality operators and technology partners, we
beyond the core platform can plug in specific software modules
to address applications such as Video
On Demand and Conditional Access
interfaces
Generic extension interfaces make our
solution open, maximizing network
operators' freedom to choose their
technology vendors
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SERVICES
We provide a comprehensive set of consulting, engineering, training and
maintenance services to our customers. The deployment by network operators of
Internet standards-based services and the development by information appliance
manufacturers of new products require a high level of customer service and
support. We believe that our consulting and engineering services organizations
are critical to the successful sale and deployment of our products. We typically
charge customers on a time and materials basis for our services.
CONSULTING AND ENGINEERING SERVICES. As of May 31, 2000, our consulting and
engineering services groups consisted of 65 full-time employees. These
organizations provide project management support, which includes service
implementation guidance, product customization and product configuration
support. These organizations also provide project management and engineering
assistance to information appliance manufacturers, as well as assistance with
custom application development. To help ensure seamless product deployments,
these organizations may work closely, often onsite, with network operators to
integrate and install our software.
MAINTENANCE AND TRAINING. As of May 31, 2000, our customer service, support
and training organizations consisted of 25 full-time employees that provide
worldwide support and services. Outside of the United States, we have worked
with Oracle to augment our service capability. We run a technical training
program for our worldwide customers and developers. Curriculum and training
classes are available for most of our products.
SALES AND MARKETING
We sell products primarily through our direct sales force. Indirect
resellers are utilized in certain developing markets such as Latin America and
Australia. We intend to increase the number of indirect distribution partners.
Our sales force, which consisted of 33 individuals as of May 31, 2000, is
organized into teams consisting of sales representatives and systems engineers.
As of May 31, 2000, direct sales professionals were located in North America,
Europe and Asia/Pacific. We use our direct sales force to target the customers
that we believe provide the highest potential for service deployment and
revenues.
More specifically, we sell our server products either directly to network
operators or to system integrators who then resell to network operators. We sell
our client products to both information appliance manufacturers and network
operators. Information appliances containing our software platform are
distributed by the manufacturer to the end user either through a retail channel
or through network operators.
To complement the direct sales and distribution efforts, we utilize an
integrated marketing approach focused on identifying customer needs, defining
products and stimulating demand. We participate in tradeshows worldwide, arrange
speaking engagements for key personnel, sponsor conferences and run a program
for developers. An internal creative production group supports the marketing
effort by helping to define the next generation of interfaces for our products.
Actual consumer and usage feedback based on our current deployments is used to
provide feedback for the development of future products or enhancement of
current products.
During fiscal year 2000, we launched our PopTV-TM- Program, which is a
developer and technology partner program designed to help bring complete
interactive TV offerings to market sooner by providing end-to-end solutions.
CUSTOMERS
As of May 31, 2000, we have achieved over 30 network operator design wins,
and information appliance manufacturers have shipped over 500,000 units,
including units from previous product lines, that incorporate our software. Our
software, depending on the version, is either localized or in the
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process of being localized for a number of international markets and languages,
including Chinese and Japanese.
COMPETITION
Competition in the information appliance software market is intense. Our
principal competitors on the client software side include Microsoft, OpenTV
(which recently acquired another former competitor, Spyglass), Canal+
Technologies and PowerTV. On the server side, our primary competitor is
Microsoft. We also expect additional competition from other established and
emerging companies. We expect competition to persist and intensify as the
information appliance market develops and competitors focus on additional
product and service offerings. We believe that the principal competitive factors
in our industry are the quality and breadth of product and service offerings,
the ease and speed with which a product can be integrated into network
operators' existing internal systems and deployed to network operators'
customers, the efficiency with which our software platform operates with
numerous information appliances, the adequacy of financial resources, the
competitiveness of product pricing, the length of time-to-market and the
effectiveness of sales and marketing efforts. We believe that we presently
compete favorably with our competitors in these areas. However, the market for
information appliances is evolving, and we cannot be certain that we will
compete successfully in the future. See "Risk Factors--Competition From Bigger,
Better Capitalized Competitors Could Result In Price Reductions, Reduced Gross
Margins And Loss Of Market Share."
PROPRIETARY RIGHTS
We seek to protect our proprietary rights and our other intellectual
property through a combination of copyrights, trademarks, patents and trade
secret protection, as well as through contractual protections such as
proprietary information agreements and nondisclosure agreements. However, we
cannot guarantee that the steps we have taken to protect our proprietary rights
will be adequate to deter misappropriation of our proprietary information, and
we may not be able to detect unauthorized use and take appropriate steps to
enforce our intellectual property rights. See "Risk Factors--Our Limited Ability
To Protect Our Intellectual Property And Proprietary Rights May Harm Our
Competitiveness."
EMPLOYEES
As of May 31, 2000, we had 414 employees, including 225 in engineering, 61
in sales and marketing, 90 in services and 38 in administration. None of our
employees is represented by a collective bargaining agreement. We have never
experienced a work stoppage, and we consider our relations with our employees to
be good.
Our future operating results depend in significant part on the continued
service of our key technical, sales and senior management personnel, none of
whom, except Mitchell E. Kertzman, Coleman Sisson and Philip A. Vachon, are
party to an employment agreement. Our future success also depends on our
continuing ability to attract and retain highly qualified technical, sales and
senior management personnel. Competition for these personnel is intense, and we
may not be able to retain the key members of our technical, sales and senior
management staff or attract these personnel in the future. We have experienced
difficulty in recruiting qualified technical, sales and senior management
personnel, and we expect to experience these difficulties in the future. If we
are unable to hire and retain qualified personnel in the future, our business
could be seriously harmed.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN THIS FORM 10-K, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING OUR COMPANY AND OUR
BUSINESS BECAUSE SUCH FACTORS CURRENTLY MAY HAVE A
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SIGNIFICANT IMPACT ON OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION.
AS A RESULT OF THE RISK FACTORS SET FORTH BELOW AND ELSEWHERE IN THIS
FORM 10-K, AND THE RISKS DISCUSSED IN OUR OTHER SECURITIES AND EXCHANGE
COMMISSION FILINGS, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED
IN ANY FORWARD-LOOKING STATEMENTS.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS
DIFFICULT
We were incorporated in April 1996 and began shipping our initial products
to customers in the last quarter of fiscal 1997. Our limited operating history
makes evaluation of our business and prospects difficult. Companies in an early
stage of development frequently encounter heightened risks and unexpected
expenses and difficulties. For us, these risks include:
- The limited number of network operators who have deployed products and
services incorporating our technology
- The limited number of information appliance manufacturers who have
incorporated our technology into their products
- Delays in deployment of high speed networks and Internet-enhanced services
and applications by our network operator customers
- Our unproven long-term business model, which depends on generating the
majority of our revenues from royalty fees paid by network operators and
information appliance manufacturers
These risks, expenses and difficulties apply particularly to us because our
market, the information appliance software market, is new and rapidly evolving.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE
We incurred net losses of approximately $3.3 million in fiscal 1996,
$19.0 million in fiscal 1997, $94.4 million in fiscal 1998, $33.1 million in
fiscal 1999 and $80.8 million in fiscal 2000. Our net losses of $94.4 million in
fiscal 1998 included a $58.1 million charge for the Navio acquisition related to
acquired in-process research and development. Our net losses of $80.8 million in
fiscal 2000 included a $1.9 million charge for the SourceSuite acquisition
related to acquired in-process research and development, amortization of
purchased intangibles of $22.1 million and warrant amortization of
$10.8 million. As of May 31, 2000, we had an accumulated deficit of
approximately $230.5 million. In addition, subsequent to our fiscal year end, we
completed the MoreCom acquisition resulting in a charge of $22.4 million related
to acquired in-process research and development and capitalization of up to
$520.2 million of purchased intangibles, which will be amortized over three
years.
Since our inception, we have not had a profitable quarter and may never
achieve or sustain profitability. Although our revenues increased for each of
the last three fiscal years, we may not be able to sustain our historical
revenue growth rates. We also expect to continue to incur increasing cost of
revenues, research and development, sales and marketing and general and
administrative expenses. If we are to achieve profitability given our planned
expenditure levels, we will need to generate and sustain substantially increased
license and royalty revenues; however, we are unlikely to be able to do so for
the foreseeable future. As a result, we expect to incur significant and
increasing losses and negative cash flows for the foreseeable future. In
addition, from the beginning of fiscal 1997 through May 31, 2000, approximately
64% of our revenues have been derived from services provided by us and not from
license and royalty fees paid by network operators and information appliance
manufacturers in conjunction with the deployment of products and services
incorporating our software products. If we are unable to derive a greater
proportion of our revenues from these license and royalty fees, our losses will
likely continue indefinitely.
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OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR
STOCK PRICE TO FLUCTUATE
Our quarterly operating results have varied in the past and are likely to
vary significantly from quarter to quarter. As a result, we believe that period
to period comparisons of our operating results are not a good indication of our
future performance. Moreover, we expect to derive substantially all of our
revenues for the near term from license fees and related consulting and support
services. Over the longer term, to the extent deployments increase, we expect to
derive an increasing portion of our revenues from royalties paid by network
operators and information appliance manufacturers. If deployments do not
increase or this transition otherwise does not occur, we are unlikely to be able
to generate or sustain substantially increased revenue, and our operating
results will be seriously harmed.
In the short term, we expect our quarterly revenues to be significantly
dependent on a small number of relatively large orders for our products and
services, which generally have a long sales cycle. As a result, our quarterly
operating results may fluctuate significantly if we are unable to complete one
or more substantial sales in any given quarter. In some cases, we recognize
revenues from services on a percentage of completion basis. Our ability to
recognize these revenues may be delayed if we are unable to meet service
milestones on a timely basis. Moreover, because our expenses are relatively
fixed in the near term, any shortfall from anticipated revenues could result in
losses for the quarter.
Although we have limited historical financial data, in the past we have
experienced seasonality in our quarter ending August 31. These seasonal trends
may continue to affect our quarter to quarter revenues.
THE MARKET FOR INFORMATION APPLIANCES IS NEW AND MAY NOT DEVELOP AS WE
ANTICIPATE
Because the information appliance market is emerging, the potential size of
this new market opportunity and the timing of its development are uncertain. As
a result, our profit potential is unproven. We are dependent upon the
commercialization and broad acceptance by consumers and businesses of a wide
variety of information appliances including, among others, television set-top
boxes, game consoles, smart phones and personal digital assistants. Initial
commercialization efforts in this industry have been primarily focused on
television set-top boxes. Broad acceptance of all information appliances,
particularly television set-top boxes, will depend on many factors. These
factors include:
- The willingness of large numbers of consumers to use devices other than
personal computers to access the Internet
- The development of content and applications for information appliances
- The emergence of industry standards that facilitate the distribution of
content over the Internet to these devices
If the market for information appliances does not develop or develops more
slowly than we anticipate, our revenues will not grow as fast as anticipated, if
at all.
OUR SUCCESS DEPENDS ON NETWORK OPERATORS INTRODUCING, MARKETING AND PROMOTING
PRODUCTS AND SERVICES FOR INFORMATION APPLIANCES BASED ON OUR TECHNOLOGY
Our success depends on large network operators introducing, marketing and
promoting products and services based on our technology. There are, however,
only a limited number of large network operators worldwide. Moreover, only a
limited number of network operators have introduced or are in the process of
deploying products and services incorporating our technology and services for
information appliances. In addition, none of our network operator customers is
contractually obligated to introduce, market or promote products and services
incorporating our technology, nor are any of our network operator customers
contractually required to achieve any specific introduction schedule.
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Accordingly, even if a network operator initiates a customer trial of products
incorporating our technology, that operator is under no obligation to continue
its relationship with us or to launch a full-scale deployment of these products.
Further, our agreements with network operators are not exclusive, so network
operators with whom we have agreements may enter into similar license agreements
with one or more of our competitors.
Moreover, because the large scale deployment of products and services
incorporating our technology by network operators is complex, time consuming and
expensive, each deployment of these products and services requires our expertise
to tailor our technology to the customer's particular product offering. This
process requires a lengthy and significant commitment of resources by our
customers and us. This commitment of resources may slow deployment, which could,
in turn, delay market acceptance of these products and services. Unless network
operators introduce, market and promote products and services incorporating our
technology in a successful and timely manner, our software platform will not
achieve widespread acceptance, information appliance manufacturers will not use
our software in their products and our revenues will not grow as fast as
anticipated, if at all.
IF INFORMATION APPLIANCE MANUFACTURERS DO NOT MANUFACTURE PRODUCTS THAT
INCORPORATE OR OPERATE WITH OUR TECHNOLOGY, OR IF THESE PRODUCTS DO NOT ACHIEVE
ACCEPTANCE, WE MAY NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
We do not manufacture hardware components that incorporate our technology.
Rather, we license software technology to information appliance manufacturers or
work with them to ensure that our products operate together. Accordingly, our
success will depend, in part, upon our ability to convince a number of
information appliance manufacturers to manufacture products that incorporate or
operate with our technology and the successful introduction and commercial
acceptance of these products. Our efforts also significantly depend on network
operators deploying services using our server software.
While we have entered into a number of agreements with information appliance
manufacturers, none of these manufacturers is contractually obligated to
introduce or market information appliances incorporating our technology, nor is
any of them contractually required to achieve any specific production schedule.
Moreover, our agreements with information appliance manufacturers are not
exclusive, so information appliance manufacturers with whom we have agreements
may enter into similar license agreements with one or more of our competitors.
Our failure to convince information appliance manufacturers to incorporate our
software platform into their products or modify their products to operate with
our software, or the failure of these products to achieve broad acceptance with
consumers and businesses, will result in revenues that do not grow as fast as
expected, if at all.
COMPETITION FROM BIGGER, BETTER CAPITALIZED COMPETITORS COULD RESULT IN PRICE
REDUCTIONS, REDUCED GROSS MARGINS AND LOSS OF MARKET SHARE
Competition in the information appliance software market is intense. Our
principal competitors on the client software side include Microsoft, OpenTV
(which recently acquired another former competitor, Spyglass), Canal+
Technologies and PowerTV. On the server side, our primary competitor is
Microsoft. We expect additional competition from other established and emerging
companies. We expect competition to persist and intensify as the information
appliance market develops and competitors focus on additional product and
service offerings. Increased competition could result in price reductions, fewer
customer orders, reduced gross margins, longer sales cycles, reduced revenues
and loss of market share.
Many of our existing and potential competitors, particularly Microsoft, have
longer operating histories, a larger customer base, greater name recognition and
significantly greater financial, technical, sales and marketing and other
resources than we do. This may place us at a disadvantage in responding to our
competitors' pricing strategies, technological advances, advertising campaigns,
strategic
11
partnerships and other initiatives. In addition, many of our competitors have
well-established relationships with our current and potential customers.
Moreover, some of our competitors, particularly Microsoft, have significant
financial resources, which have enabled them in the past and may enable them in
the future to make large strategic investments in our current and potential
customers. Such investments may enable competitors to strengthen existing
relationships or quickly establish new relationships with our current or
potential customers. For example, as a result of an investment in AT&T,
Microsoft obtained a nonexclusive licensing agreement under which AT&T will
purchase at least 7.5 million licenses of Microsoft software for television
set-top boxes. Investments such as this may discourage our potential or current
customers who receive these investments from deploying our information appliance
software, regardless of their views of the relative merits of our products and
services.
ORACLE'S OWNERSHIP OF OUR STOCK COULD LIMIT THE ABILITY OF OTHER STOCKHOLDERS TO
INFLUENCE THE OUTCOME OF DIRECTOR ELECTIONS AND OTHER TRANSACTIONS SUBMITTED FOR
A VOTE OF OUR STOCKHOLDERS
Based on 102,659,427 shares outstanding on July 31, 2000, Oracle
beneficially owned 35,374,843 shares, or approximately 34% of our outstanding
common stock. In addition, Comcast, Cox and MediaOne--each a network operator
and an investor in us--and Oracle have agreed to vote the shares of our common
stock held by them to elect one representative designated by such network
operators and one representative designated by Oracle to our Board of Directors.
As of May 31, 2000, there were no designees of Oracle on our Board of Directors.
Oracle, through its ownership of our capital stock, may exert significant
influence over us, including; influence over matters that require stockholder
approval, the election of directors, significant corporate transactions, such as
acquisitions, and efforts to block an unsolicited tender offer. This
concentration of ownership could also have the effect of delaying or preventing
a third party from acquiring control over us at a premium above the then current
market price of our common stock.
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF CUSTOMERS
FOR A SIGNIFICANT PORTION OF OUR REVENUES
We currently derive, and we expect to continue to derive, a significant
portion of our revenues from a limited number of customers. In fiscal 2000, our
five largest customers accounted for approximately 51% of our revenues, with
Cable & Wireless Communications accounting for 18% of our total revenues and
Wind River Systems accounting for 15% of our total revenues. For fiscal 1999,
our five largest customers accounted for approximately 54% of our total
revenues, with Wind River Systems accounting for 23% of our total revenues and
Cable & Wireless Communications accounting for 10% of our total revenues. We
expect that we will continue to be dependent upon a limited number of customers
for a significant portion of our revenues in future periods, although the
customers may vary from period to period. As a result, if we fail to
successfully sell our products and services to one or more customers in any
particular period, or if a large customer purchases fewer of our products or
services, defers or cancels orders, or terminates its relationship with us, our
revenues could decline significantly.
OUR LENGTHY SALES CYCLE MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS, WHICH
COULD CAUSE OUR STOCK PRICE TO DECLINE
We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a customer. In many
cases, the decision for our customers to use our products and services requires
them to change their established business practices and conduct their business
in new ways. As a result, we may need to educate our potential customers on the
use and benefits of our products and services. In addition, our customers
generally must consider a wide range of other issues before committing to
purchase and incorporate our technology into their offerings. As a
12
result of these and other factors, including the approval at a number of levels
of management within a customer's organization, our sales cycle averages from
six to twelve months and may sometimes be significantly longer. Because of the
length of our sales cycle, we have a limited ability to forecast the timing and
amount of specific sales.
In addition, we base our quarterly revenue projections, in part, upon our
expectation that specific sales will occur in a particular quarter. In the past,
our sales have occurred in quarters other than those anticipated by us. If our
expectations, and thus our revenue projections, are not accurate for a
particular quarter, our actual operating results for that quarter could fall
below the expectations of financial analysts and investors.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE SIGNIFICANTLY IF OUR SOFTWARE
CANNOT SUPPORT AND MANAGE A SUBSTANTIAL NUMBER OF USERS
Despite frequent testing of our software's scalability in a laboratory
environment, the ability of our software platform to support and manage a
substantial number of users in an actual deployment is uncertain. If our
software platform does not efficiently scale to support and manage a substantial
number of users while maintaining a high level of performance, demand for our
products and services and our ability to sell additional products to our
existing customers will be significantly reduced.
INTERNATIONAL REVENUES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES;
ACCORDINGLY, IF WE ARE UNABLE TO EXPAND OUR INTERNATIONAL OPERATIONS IN A TIMELY
MANNER, OUR GROWTH IN INTERNATIONAL REVENUES WILL BE LIMITED
International revenues accounted for approximately 53% of our total revenues
for fiscal 2000, and approximately 51% for fiscal 1999. We anticipate that a
significant portion of our revenues for the foreseeable future will be derived
from sources outside the United States, especially as we increase our sales and
marketing activities with respect to international licensing of our technology.
Accordingly, our success will depend, in part, upon international economic
conditions and upon our ability to manage international sales and marketing
operations. To successfully expand international sales, we must establish
additional foreign operations, hire additional personnel and increase our
foreign direct and indirect sales forces. This expansion will require
significant management attention and resources, which could divert attention
from other aspects of our business. To the extent we are unable to expand our
international operations in a timely manner, our growth in international sales,
if any, will be limited.
Moreover, substantially all of our revenues and costs to date have been
denominated in U.S. dollars. However, expanded international operations may
result in increased foreign currency payables. Although we may from time to time
undertake foreign exchange hedging transactions to cover a portion of our
foreign currency transaction exposure, we do not currently attempt to cover
potential foreign currency exposure. Accordingly, any fluctuation in the value
of foreign currency could seriously harm our ability to increase international
revenues.
WE MAY HAVE TO CEASE OR DELAY PRODUCT SHIPMENTS IF WE ARE UNABLE TO OBTAIN KEY
TECHNOLOGY FROM THIRD PARTIES
We rely on technology licensed from third parties, including applications
that are integrated with internally developed software and used in our products.
Most notably, we license certain Java and Jini technologies from Sun
Microsystems, VxWorks real-time operating system from Wind River Systems, font
technology from BitStream, multimedia architecture from RealNetworks and
security from RSA. These third party technology licenses may not continue to be
available to us on commercially reasonable terms, or at all, and we may not be
able to obtain licenses for other existing or future technologies that we desire
to integrate into our products. If we cannot maintain existing third party
technology licenses or enter into licenses for other existing or future
technologies needed for our
13
products we would be required to cease or delay product shipments while we seek
to develop alternative technologies.
WE DO NOT CURRENTLY HAVE LIABILITY INSURANCE TO PROTECT AGAINST THIRD PARTY
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT COULD BE EXPENSIVE TO DEFEND
We expect that, like other software product developers, we will increasingly
be subject to infringement claims as the number of products and competitors
developing information appliance software grows and the functionality of
products in different industry segments overlaps. From time to time, we hire or
retain employees or external consultants who have worked for independent
software vendors or other companies developing products similar to those offered
by us. These prior employers may claim that our products are based on their
products and that we have misappropriated their intellectual property. We cannot
guarantee that:
- An infringement claim will not be asserted against us in the future
- The assertion of such a claim will not result in litigation
- We would prevail in such litigation
- We would be able to obtain a license for the use of any infringed
intellectual property from a third party on commercially reasonable terms,
or at all
We currently do not have liability insurance to protect against the risk
that licensed third party technology infringes the intellectual property of
others. Any claims relating to our intellectual property, regardless of their
merit, could seriously harm our ability to develop and market our products and
manage our day to day operations because they could:
- Be time consuming and costly to defend
- Divert management's attention and resources
- Cause product shipment delays
- Require us to redesign our products
- Require us to enter into royalty or licensing agreements
WE COULD SUFFER LOSSES AND NEGATIVE PUBLICITY IF OUR TECHNOLOGY CAUSES A FAILURE
OF OUR NETWORK OPERATOR CUSTOMERS' SYSTEMS
Our technology is integrated into the products and services of our network
operator customers. Accordingly, a defect, error or performance problem with our
technology could cause our customers' telecommunication, cable or satellite
television or Internet service systems to fail for a period of time. Any such
failure will cause severe customer service and public relations problems for our
customers. As a result, any failure of our network operator customers' systems
caused by our technology could result in:
- Delayed or lost revenue due to adverse customer reaction
- Negative publicity regarding us and our products and services
- Claims for substantial damages against us, regardless of our
responsibility for such failure
Any claim could be expensive and require the expenditure of a significant amount
of resources regardless of whether we prevail. We currently do not have
liability insurance to protect against this risk.
14
OUR SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH THE LATEST TECHNOLOGICAL
CHANGES BUT WE HAVE EXPERIENCED AND MAY IN THE FUTURE EXPERIENCE DELAYS IN
COMPLETING DEVELOPMENT AND INTRODUCTION OF NEW SOFTWARE PRODUCTS
The market for information appliance software is characterized by evolving
industry standards, rapid technological change and frequent new product
introductions and enhancements. Our technology enables network operators to
deliver content and applications to information appliances over the Internet.
Accordingly, our success will depend in large part upon our ability to adhere to
and adapt our products to evolving Internet protocols and standards. Therefore,
we will need to develop and introduce new products that meet changing customer
requirements and emerging industry standards on a timely basis. In the past, we
have experienced delays in completing the development and introduction of new
software products. We may encounter such delays in the development and
introduction of future products as well. In addition, we may:
- Fail to design our current or future products to meet customer
requirements
- Fail to develop and market products and services that respond to
technological changes or evolving industry standards in a timely or cost
effective manner
- Encounter products, capabilities or technologies developed by others that
render our products and services obsolete or noncompetitive or that
shorten the life cycles of our existing products and services
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
MAY HARM OUR COMPETITIVENESS
Our ability to compete and continue to provide technological innovation is
substantially dependent upon internally developed technology. We rely primarily
on a combination of patents, trademark laws, copyright laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
technology. While we have numerous patent applications pending, patents may not
issue from these or any future applications. In addition, our existing and
future patents may not survive a legal challenge to their validity or provide
significant protection for us.
The steps we have taken to protect our proprietary rights may not be
adequate to prevent misappropriation of our proprietary information. Further, we
may not be able to detect unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Our competitors may also
independently develop similar technology. In addition, the laws of many
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States. Any failure by us to meaningfully protect our
intellectual property could result in competitors offering products that
incorporate our most technologically advanced features, which could seriously
reduce demand for our products and services.
FAILURE TO MANAGE OUR GROWTH MAY SERIOUSLY HARM OUR ABILITY TO DELIVER PRODUCTS
IN A TIMELY MANNER, FULFILL EXISTING CUSTOMER COMMITMENTS AND ATTRACT AND RETAIN
NEW CUSTOMERS
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources,
especially as more network operators and information appliance manufacturers
incorporate our software into their products and services. This potential for
rapid growth is particularly significant in light of the large customer bases of
network operators and information appliance manufacturers and the frequent need
to tailor our products and services to our customers' unique needs. To the
extent we add several customers simultaneously or add customers whose product
needs require extensive customization, we may need to significantly expand our
operations. Moreover, we expect to significantly expand our domestic and
international operations by,
15
among other things, expanding the number of employees in professional services,
research and development and sales and marketing.
This additional growth will place a significant strain on our limited
personnel, financial and other resources. Our future success will depend, in
part, upon the ability of our senior management to manage growth effectively.
This will require us to implement additional management information systems, to
further develop our operating, administrative, financial and accounting systems
and controls, to hire additional personnel, to develop additional levels of
management within the corporation, to locate additional office space in the
United States and internationally and to maintain close coordination among our
research and development, sales and marketing, services and support and
administrative organizations. Failure to accomplish any of these requirements
would seriously harm our ability to deliver products in a timely fashion,
fulfill existing customer commitments and attract and retain new customers.
THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD HARM OUR COMPETITIVENESS
We believe that our success will depend on the continued employment of our
senior management team and key technical personnel, none of whom, except
Mitchell E. Kertzman, our President and Chief Executive Officer, Coleman Sisson,
our Chief Operating Officer, and Philip A. Vachon, our Senior Vice President of
Worldwide Sales, has an employment agreement with us. If one or more members of
our senior management team or key technical personnel were unable or unwilling
to continue in their present positions, these individuals would be very
difficult to replace and our ability to manage day to day operations, develop
and deliver new technologies, attract and retain customers, attract and retain
other employees and generate revenues, would be seriously harmed.
OUR PLANNED EXPANSION OF OUR INDIRECT DISTRIBUTION CHANNELS WILL BE EXPENSIVE
AND MAY NOT SUCCEED
To date, we have sold our products and services principally through our
direct sales force. In the future, we intend to expand the number and reach of
our indirect channel partners, primarily overseas, through distribution
agreements. The development of these indirect channels will require the
investment of significant company resources, which could seriously harm our
business if our efforts do not generate significant revenues. Moreover, we may
not be able to attract indirect channel partners that will be able to
effectively market our products and services. The failure to recruit indirect
channel partners that are able to successfully market our products and services
could seriously hinder the growth of our business.
WE MAY NEED TO MAKE ACQUISITIONS IN ORDER TO REMAIN COMPETITIVE IN OUR MARKET
AND ACQUISITIONS COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS AND
DILUTE STOCKHOLDER VALUE
We may acquire other businesses in the future in order to remain competitive
or to acquire new technologies. As a result of future acquisitions, we may need
to integrate product lines, technologies, widely dispersed operations and
distinct corporate cultures. In addition, the product lines or technologies of
future acquisitions may need to be altered or redesigned in order to be made
compatible with our software products or the software architecture of our
customers. These integration efforts may not succeed or may distract our
management from operating our existing business. Our failure to successfully
manage future acquisitions could seriously harm our operating results. In
addition, our stockholders would be diluted if we finance acquisitions by
incurring convertible debt or issuing equity securities.
16
WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE ACQUISITIONS INTO OUR BUSINESS OR
ACHIEVE THE EXPECTED BENEFITS OF THE ACQUISITIONS
Our acquisitions of SourceSuite and MoreCom will require integrating our
business with their businesses, including integrating product lines,
technologies, widely-dispersed operations and distinct corporate cultures. We
may not be able to successfully assimilate the personnel, operations and
customers of these acquired companies into our business. Additionally, we may
fail to achieve the anticipated synergies from these acquisitions, including
product development and other operational synergies. The integration process may
further strain our existing financial and managerial controls and reporting
systems and procedures. This may result in the diversion of management and
financial resources from our core business objectives. In addition, we are not
experienced in managing significant facilities or operations in geographically
distant areas. We may not be able to retain various individuals who provide
services to these acquired companies that we intend to hire in connection with
these acquisitions. Our failure to successfully manage these acquisitions could
seriously harm our operating results.
WE MAY INCUR NET LOSSES OR INCREASED NET LOSSES WHEN WE ARE REQUIRED TO RECORD A
SIGNIFICANT ACCOUNTING EXPENSE RELATED TO THE ISSUANCE OF WARRANTS
In fiscal year 1999, we entered into letter agreements with several network
operators whereby we agreed to issue warrants to purchase up to an aggregate of
4,599,992 shares of common stock which are exercisable if those network
operators satisfy certain milestones. The value of the warrants is estimated
using the Black-Scholes model as of the earlier of the grant date or the date
that it becomes probable that the warrants will be earned. Pursuant to the
requirements of Emerging Issues Task Force No. 96-18, the warrants will continue
to be revalued in situations where they are granted prior to the establishment
of a performance commitment. The value of the warrants is recorded primarily as
a noncurrent asset on the accompanying consolidated balance sheets and will be
amortized over the estimated economic life of the arrangements with the network
operators.
As of May 31, 2000, warrants to purchase up to 2,336,660 shares of our
common stock were earned by these network operators. The fair market value of
these warrants at the time they were earned was $117.2 million. As of May 31,
2000, accumulated amortization for the warrants was $10.8 million.
If the remaining warrants are earned, we will be required to record
significant non-cash accounting expenses related to these warrants. As a result,
we could incur net losses or increased net losses for a given period and this
could seriously harm our operating results and stock price.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL NOT INCREASE IF THE INTERNET DOES NOT
CONTINUE TO GROW AND IMPROVE
Acceptance of our software platform depends substantially upon the
widespread adoption of the Internet for commerce, communications and
entertainment. As is typical in the case of an emerging industry characterized
by rapidly changing technology, evolving industry standards and frequent new
product and service introductions, demand for and acceptance of recently
introduced Internet products and services are subject to a high level of
uncertainty. In addition, critical issues concerning the commercial use of the
Internet remain unresolved and may affect the growth of Internet use, especially
in the consumer markets we target. The adoption of the Internet for commerce,
communications and access to content and applications, particularly by those
that have historically relied upon alternative means of commerce, communications
and access to content and applications, generally requires understanding and
acceptance of a new way of conducting business and exchanging information.
Moreover, widespread application of the Internet outside of the United States
will require reductions in the cost of Internet access to prices affordable to
the average consumer.
17
To the extent that the Internet continues to experience an increase in
users, an increase in frequency of use or an increase in the amount of data
transmitted by users, we cannot guarantee that the Internet infrastructure will
be able to support the demands placed upon it. In addition, the Internet could
lose its viability as a commercial medium due to delays in development or
adoption of new standards or protocols required to handle increased levels of
Internet activity, or due to increased government regulation. Changes in, or
insufficient availability of, telecommunications or similar services to support
the Internet could also result in slower response times and could adversely
impact use of the Internet generally. If use of the Internet does not continue
to grow or grows more slowly than expected, or if the Internet infrastructure,
standards, protocols or complementary products, services or facilities do not
effectively support any growth that may occur, demand for our products and
services will decline significantly.
INCREASING GOVERNMENT REGULATION COULD CAUSE DEMAND FOR OUR PRODUCTS AND
SERVICES TO DECLINE SIGNIFICANTLY
We are subject not only to regulations applicable to businesses generally,
but also laws and regulations directly applicable to the Internet. Although
there are currently few such laws and regulations, state, federal and foreign
governments may adopt a number of these laws and regulations governing any of
the following issues:
- User privacy
- Copyrights
- Consumer protection
- Taxation of e-commerce
- The online distribution of specific material or content
- The characteristics and quality of online products and services
We do not engage in e-commerce, nor do we distribute content over the
Internet. However, one or more states or the federal government could enact
regulations aimed at companies, like us, which provide software that facilitates
e-commerce and the distribution of content over the Internet. The likelihood of
such regulation being enacted will increase as the Internet becomes more
pervasive and extends to more people's daily lives. Any such legislation or
regulation could dampen the growth of the Internet and decrease its acceptance
as a communications and commercial medium. If such a reduction in growth occurs,
demand for our products and services will decline significantly.
WE EXPECT OUR OPERATIONS TO CONTINUE TO PRODUCE NEGATIVE CASH FLOW;
CONSEQUENTLY, IF WE CANNOT RAISE ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO FUND
OUR CONTINUED OPERATIONS
Since our inception, cash used in our operations has substantially exceeded
cash received from our operations, and we expect this trend to continue for the
foreseeable future. We believe that our existing cash balances will be
sufficient to meet our working capital and capital expenditure needs for at
least the next 12 months. After that, we may need to raise additional funds, and
we cannot be certain that we will be able to obtain additional financing on
favorable terms, or at all. If we need additional capital and cannot raise it on
acceptable terms, we may not be able to, among other things:
- Develop or enhance our products and services
- Acquire complementary technologies, products or businesses
- Open new offices, in the United States or internationally
- Hire, train and retain employees
- Respond to competitive pressures or unanticipated requirements
18
PROVISIONS OF OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DETER TAKEOVERS AND
PREVENT YOU FROM RECEIVING A PREMIUM FOR YOUR SHARES
Certain provisions of our certificate of incorporation and bylaws may
discourage, delay or prevent a change in control of our company that a
stockholder may consider favorable. These provisions include:
- Authorizing the issuance of "blank check" preferred stock that could be
issued by our Board of Directors to increase the number of outstanding
shares and thwart a takeover attempt
- Requiring super-majority voting to effect certain amendments to our
certificate of incorporation and bylaws
- Limitations on who may call special meetings of stockholders
- Prohibiting stockholder action by written consent, which requires all
actions to be taken at a meeting of the stockholders
- Establishing advance notice requirements for nominations of candidates for
election to the Board of Directors or for proposing matters that can be
acted upon by stockholders at stockholder meetings
In addition, Section 203 of the Delaware General Corporation Law and
provisions in our stock incentive plans may discourage, delay or prevent a
change in control of our company.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. This risk is especially acute for us because technology companies
have experienced greater than average stock price volatility in recent years
and, as a result, have been subject to, on average, a greater number of
securities class action claims than companies in other industries. Due to the
potential volatility of our stock price, we may in the future be the target of
similar litigation. Securities litigation could result in substantial costs and
divert management's attention and resources.
OUR STOCK PRICE COULD DECLINE BY SHARES BECOMING AVAILABLE FOR SALE IN THE
FUTURE
Shares of our common stock that are restricted, either by law or otherwise,
will become available for resale in the future. This includes the eligibility
for sale of 3,963,780 shares on July 19, 2001, pursuant to Rule 144, upon the
satisfaction of the Rule 144 holding period. These resales could adversely
affect the market price of our common stock and could impair our ability to
raise capital through the sale of additional equity securities.
ITEM 2. PROPERTIES
We lease approximately 181,000 square feet of office space for our
headquarters in San Carlos, California, approximately 17,000 square feet of
office space in London, Ontario, Canada, and approximately 5,000 square feet of
office space in Salt Lake City, Utah. In addition, we lease approximately 1,100
square feet in London, United Kingdom and office suites in both Bellevue,
Washington and Tokyo, Japan, primarily for sales offices. The acquisition of
MoreCom on June 22, 2000 added approximately 16,000 square feet of additional
leased office space in Horsham, Pennsylvania.
We sublease approximately 79,000 square feet of our headquarters office
space to third parties, approximately 26,000 square feet of which was subleased
subsequent to our fiscal year end. In addition,
19
we lease approximately 45,000 square feet in Sunnyvale, California, which is
subleased from us by a third party.
Subsequent to our fiscal year end, we committed to a lease in London, United
Kingdom, for approximately 17,000 square feet. The lease is expected to be
effective October 2000 and is coincident with termination of our current London,
United Kingdom facility lease. We also entered into an additional facility lease
for approximately 10,000 square feet in Salt Lake City, Utah. Upon commencement
of this lease in October 2000, we intend to sublease our current 5,000 square
foot facility.
ITEM 3. LEGAL PROCEEDINGS
In December 1998, a former employee of ours filed an action in the
California Superior Court for the County of San Mateo against us for, among
other things, unpaid commissions of approximately $1.5 million, constructive
employment termination, intentional misrepresentation and negligent
misrepresentation. In October 1999, the plaintiff amended his complaint against
us, adding claims for damages for failure to pay wages under the California
Labor Code and common law retaliation, and sought to impose a constructive trust
on the allegedly withheld commissions and any enhancement in value of that
money. In December 1999, we filed a motion for summary judgment/summary
adjudication to dismiss all of the claims brought by the plaintiff. In
January 2000, the Court dismissed eight of the ten claims brought against us
leaving only the claims of intentional and negligent misrepresentation for
trial. In February 2000, we settled this matter, obtaining the complete
dismissal of all claims against us in exchange for the payment of a nominal
amount of cash and the issuance of a nominal number of shares of our common
stock.
As part of our acquisition of the Virtual Modem software product and related
assets and technology of SourceSuite described in Notes 4 and 6 to Consolidated
Financial Statements, we acquired certain patents that were the subject of a
patent infringement lawsuit. This lawsuit was initially brought by Interactive
Channel Technologies and SMI Holdings, affiliated companies of SourceSuite,
against Worldgate Communications in May 1998. The patent infringement claims
have been assigned to us as a result of the merger with SourceSuite. In
June 1998, Worldgate filed a counterclaim against the plaintiffs and Source
Media, a shareholder of SourceSuite, alleging among others, violations of the
Lanham Act and Delaware's Uniform Deceptive Trade Practices Act, common law
unfair competition, tortious interference with existing and prospective business
relationships and misappropriation of confidential information and trade
secrets. The case is still in the discovery stage. Briefing on the patent claim
construction issues has commenced, and a hearing on such claims has been
scheduled for September 25, 2000. We believe that the patent infringement claims
against Worldgate are valid and intend to continue to vigorously prosecute this
action. In addition, we have agreed to defend Interactive Channel, SMI Holdings
and Source Media against the cross-complaint brought by Worldgate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock has been quoted on the Nasdaq National Market System
("Nasdaq") under the symbol LBRT since our initial public offering on July 28,
1999. The following table sets forth, for the periods indicated, the high and
low closing sale prices per share of our common stock as reported on the Nasdaq
(as adjusted for our two-for-one stock split effected on January 14, 2000):
FISCAL YEAR 2000 HIGH LOW
- ---------------- -------- --------
First Quarter (beginning July 28, 1999).................... $ 13.50 $ 7.69
Second Quarter............................................. $ 84.19 $13.63
Third Quarter.............................................. $128.53 $69.06
Fourth Quarter............................................. $114.50 $21.87
On July 31, 2000, the last reported sales price of our common stock was
$22.94, and there were 330 holders of record of our common stock. This does not
include the number of persons whose stock is in nominee or "street name"
accounts through brokers.
RECENT SALE OF UNREGISTERED SECURITIES
During our fiscal year ended May 31, 2000, we have issued and sold the
following unregistered securities, all of which reflect the one-for-six reverse
stock split effected in July 1999 and the two-for-one stock split effected in
January 2000:
1. On August 2, 1999, we issued and sold 1,627,604 shares of our common
stock to Lucent Technologies for $7.68 per share or an aggregate of
$12,499,998.
2. On March 3, 2000, we issued 886,000 shares of common stock each to
Source Media and Insight Interactive or an aggregate of 1,772,000 shares
of common stock in connection with the acquisition of the Virtual Modem
assets and technologies via merger with SourceSuite, a joint venture
owned by Source Media and Insight Interactive.
The issuances of the securities described in Item 1, was deemed to be exempt
from registration under the Securities Act of 1933, as amended (the "Act"), in
reliance on Section 4(2) of the Act as transactions by an issuer not involving
any public offering. In addition, the recipient of securities in that
transaction represented its intention to acquire the securities for investment
only and not with a view to or for sale in connection with any distribution
thereof and appropriate legends were affixed to the share certificates issued in
that transaction. The recipient had adequate access, through its relationship
with our company, to information about our company.
The issuances of the securities described in Item 2, was deemed to be exempt
from registration in reliance on Section 3(a)(10) of the Act, where the terms
and conditions of the issuance and exchange of the securities in that
transaction were approved, after a hearing on the fairness of such terms and
conditions at which all persons receiving securities issued in such transaction
had the right to appear, by the California Commissioner of Corporations.
DIVIDEND POLICY
We have not paid any cash dividends since our inceptions and do not intend
to pay any cash dividends in the foreseeable future.
21
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial data included elsewhere in this 10-K filing. The
consolidated statement of operations data for the years ended May 31, 1998, 1999
and 2000 and the consolidated balance sheet data at May 31, 1999 and 2000, are
derived from audited consolidated financial statements included elsewhere in
this 10-K filing. The consolidated statement of operations data for the period
from our inception on December 1, 1995 to May 31, 1996 and year ended May 31,
1997, and the consolidated balance sheet data at May 31, 1996, 1997 and 1998,
are derived from audited consolidated financial statements not included in this
10-K filing. The historical results are not necessarily indicative of results to
be expected in any future period.
PERIOD FROM
INCEPTION
(DECEMBER 1, YEARS ENDED MAY 31,
1995 TO --------------------------------------------
MAY 31, 1996 1997 1998 1999 2000
------------ --------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenues:
License and royalty................................... $ -- $ 231 $ 4,162 $ 5,281 $ 10,233
Service............................................... -- 44 6,110 12,032 17,784
-------- --------- --------- -------- ---------
Total revenues...................................... -- 275 10,272 17,313 28,017
-------- --------- --------- -------- ---------
Cost of revenues:
License and royalty................................... -- -- 3,779 2,279 2,006
Service............................................... -- -- 2,230 8,247 21,738
-------- --------- --------- -------- ---------
Total cost of revenues.............................. -- -- 6,009 10,526 23,744
-------- --------- --------- -------- ---------
Gross margin............................................ -- 275 4,263 6,787 4,273
-------- --------- --------- -------- ---------
Operating expenses:
Research and development.............................. 5,479 21,721 19,981 18,171 32,271
Sales and marketing................................... -- 7,805 14,407 11,730 18,740
General and administrative............................ -- 1,023 2,453 3,975 7,837
Amortization of purchased intangibles................. -- -- 4,563 6,084 22,081
Amortization of warrants.............................. -- -- -- 18 10,776
Amortization of deferred stock compensation........... -- -- -- 507 2,053
Acquired in-process research and development.......... -- -- 58,100 -- 1,936
Restructuring charges................................. -- -- 1,175 -- --
-------- --------- --------- -------- ---------
Total operating expenses............................ 5,479 30,549 100,679 40,485 95,694
-------- --------- --------- -------- ---------
Loss from operations.................................... (5,479) (30,274) (96,416) (33,698) (91,421)
Interest and other income (expense), net................ -- (465) 10 59 10,787
-------- --------- --------- -------- ---------
Loss before income tax provision (benefit).............. (5,479) (30,739) (96,406) (33,639) (80,634)
Income tax provision (benefit).......................... (2,200) (11,750) (2,015) (586) 137
-------- --------- --------- -------- ---------
Net loss................................................ $ (3,279) $ (18,989) $ (94,391) $(33,053) $ (80,771)
======== ========= ========= ======== =========
Basic and diluted net loss per share.................... $ -- $ -- $ (890.48) $ (56.60) $ (1.14)
Shares used in computing basic and diluted net loss per
share................................................. -- -- 106 584 70,988
CONSOLIDATED BALANCE SHEET DATA
Cash and cash equivalents............................... $ -- $ 245 $ 12,138 $ 33,657 $ 132,962
Working capital (deficit)............................... (412) (23,180) (18,275) 5,446 232,579
Total assets............................................ 487 4,441 32,311 70,185 746,187
Deferred revenues....................................... -- 45 25,367 40,790 69,132
Total long-term liabilities............................. -- -- 4,115 4,315 1,929
Accumulated deficit..................................... (3,279) (22,268) (116,659) (149,712) (230,483)
Total stockholders' equity (deficit).................... 75 (19,256) (6,136) 12,226 658,167
22
The following table represents the respective balances as a percentage of total
revenues:
YEARS ENDED MAY 31,
------------------------------------
1998 1999 2000
-------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenues:
License and royalty....................................... 41% 31% 37%
Service................................................... 59 69 63
---- ---- ----
Total revenues.......................................... 100 100 100
---- ---- ----
Cost of revenues:
License and royalty....................................... 37 13 7
Service................................................... 22 48 78
---- ---- ----
Total cost of revenues.................................. 59 61 85
---- ---- ----
Gross margin................................................ 41 39 15
---- ---- ----
Operating expenses:
Research and development.................................. 195 105 115
Sales and marketing....................................... 140 68 67
General and administrative................................ 24 23 28
Amortization of purchased intangibles..................... 44 35 79
Amortization of warrants.................................. -- -- 38
Amortization of deferred stock compensation............... -- 3 7
Acquired in-process research and development.............. 566 -- 7
Restructuring charges..................................... 11 -- --
---- ---- ----
Total operating expenses................................ 980 234 341
---- ---- ----
Loss from operations........................................ (939) (195) (326)
Interest and other income, net.............................. -- -- 39
---- ---- ----
Loss before income tax provision (benefit).................. (939) (195) (287)
Income tax provision........................................ (20) (3) --
---- ---- ----
Net loss.................................................... (919)% (192)% (287)%
==== ==== ====
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF OUR COMPANY SHOULD BE READ IN CONJUNCTION WITH "SELECTED
FINANCIAL DATA" AND OUR FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS 10-K FILING. THIS DISCUSSION AND ANALYSIS OF OUR FINANCIAL
RESULTS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS, UNCERTAINTIES
AND ASSUMPTIONS. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING,
BUT NOT LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS
10-K FILING.
OVERVIEW
We are a leading provider of a comprehensive software platform for
delivering content, services and applications to a broad range of information
appliances. We began operations in December 1995 as a division of Oracle to
develop server and client software for the consumer, corporate and educational
markets and began shipping our initial products and generating revenues in the
last quarter of fiscal 1997. In April 1996, we were incorporated as a Delaware
corporation.
We generate revenues by licensing our server and client products and
providing related services to network operators and information appliance
manufacturers. In addition, service revenues are generated from consulting,
training and maintenance provided in connection with client and server licenses.
License revenues consist principally of fees earned from the licensing of
our software, as well as royalty fees earned upon the shipment or activation of
products which incorporate our software. Revenues from up-front software license
fees are typically recognized upon final delivery of the licensed product, when
collection is probable and when the fair market value and the fee for each
element of the transaction is fixed and determinable. In addition to up-front
license fees, network operators typically pay per subscriber server royalty
fees. We recognize revenue on these server subscriber fees when a network
operator reports to us that a user of an information appliance has activated the
operators' service. We also license our client software to either network
operators or information appliance manufacturers. They typically pay us client
royalties on a per unit basis. We typically recognize revenue when they report
to us that an information appliance owner has activated the operators' service,
or in the case of an information appliance manufacturer, we generally recognize
these fees upon shipment of the device by the manufacturer.
Service revenues consist of consulting, engineering, training and
maintenance services. Maintenance services include both updates and technical
support. Consulting, engineering and training revenues are generally recognized
as services are performed. Maintenance revenue is recognized ratably over the
term of the agreement and typically ranges from 17% to 25% of annual license
fees and activation royalties. In instances where software license agreements
include a combination of consulting services, training, and maintenance, these
separate elements are unbundled from the arrangement based on each element's
relative fair value. For fiscal 2000, total service revenues were
$17.8 million, representing 63.5% of our total revenues. We expect service
revenues to continue to account for a significant portion of total revenues
until customers begin deploying services and information appliances
incorporating our software on a large scale.
A significant event in our history was the acquisition of Navio
Communications in August 1997. Navio was a development stage company involved in
designing Internet application and server software for the consumer market. In
connection with the acquisition, we changed our strategic direction and
restructured our operations. Prior to the acquisition, we focused on selling
software to original equipment manufacturers of network computer products for
corporate customers. Following the acquisition, we focused our development and
marketing efforts on fewer products targeted primarily at the consumer
information appliance market and aggressively pursued sales to a limited number
of large network operators and information appliance manufacturers. As a result
of this strategic shift, we
24
significantly reduced our sales and engineering operations for corporate
products and increased investment in the development of client and server
software for the consumer market.
To more closely align our product offerings with this strategic shift in
direction, we entered into an agreement with Sun Microsystems in May 1999 to
transfer our NC Navigator and NC Administration Server technology to Sun while
retaining the right to ship, support and maintain these products for existing
customers using this technology. In addition, we have agreed not to compete in
the corporate network computer market and, specifically, network computers
intended to displace personal computers or terminals, until May 2002. However,
outside of this market, we intend to continue developing new products based on
network computer technology. In each of fiscal 1999 and fiscal 2000, sales of NC
Navigator and NC Desktop products and related services accounted for
$2.5 million of our total revenues.
We have also agreed with Sun to co-develop television set-top box
technology. We will distribute the co-developed technology pursuant to a
nonexclusive license with Sun. In addition, under this license, we have agreed
to incorporate Sun's Personal Java technology, television interface software and
Jini technology in our software products and to pay Sun a royalty. Sun has also
agreed to promote us as one of its preferred channel partners within the TV
devices market. We believe this relationship will result in co-marketing and
co-selling efforts with Sun of the jointly-developed technology on a worldwide
basis.
To date, we have completed three acquisitions. For further detail on all
three transactions, see Notes 4 and 14 to Consolidated Financial Statements. The
first acquisition, as mentioned above, was Navio Communications in August 1997.
The acquisition was accounted for as a purchase. In connection with the
acquisition, we wrote off approximately $58.1 million of acquired in-process
research and development in fiscal 1998. Purchased intangibles of approximately
$18.3 million were recorded in connection with the acquisition and are being
amortized on a straight-line basis over an estimated useful life of three years.
In March 2000, we acquired the Virtual Modem assets of SourceSuite in
exchange for 1,772,000 shares of our common stock or approximately
$190.5 million based on a common stock price of $107.53 per share. The
acquisition was accounted for as a purchase. In connection with the acquisition,
we hired various individuals who provided services to SourceSuite. We expensed
approximately $1.9 million of acquired in-process research and development,
which in the opinion of our management, had not reached technological
feasibility and had no alternative future use. We also recorded goodwill and
other intangibles of approximately $192.0 million, which is being amortized over
an estimated useful life of three years.
In March 2000, we entered into a Merger Agreement and Plan of Reorganization
to acquire MoreCom. The acquisition was completed in June 2000 for 8,030,059
shares of our common stock, or approximately $504.2 million based on a common
stock price of $69.86 per share. The acquisition will be accounted for as a
purchase. In connection with the acquisition, we expect to expense up to
$22.4 million of acquired in-process research and development, which in the
opinion of our management, has not reached technological feasibility and has no
alternative future use. We also expect to record goodwill and other intangibles
of up to $520.2 million to be amortized over an estimated useful life of three
years.
In addition, in January 2000, we terminated negotiations involving our
proposed acquisition of another company. Costs related to this terminated
acquisition totaled approximately $624,000 and were expensed in fiscal 2000.
We have also made several equity investments:
- In February 2000, we made a strategic investment in ICE Interactive of
Sydney, Australia, a venture formed to bring wide-scale deployment of
interactive TV services to Australia and New
25
Zealand. Along with our company, Oracle and Burdekin Pacific are also
investors in the new company.
- In May 2000, we made a strategic investment of approximately $4.0 million
in DIVA Systems in exchange for 444,445 shares of Series E preferred
stock.
- In August 2000, we made a strategic investment of approximately
$3.0 million in Everypath in exchange for 179,425 shares of Series C
preferred stock.
In July 2000, Cisco Systems agreed to purchase 3,963,780 shares of our
common stock at approximately $25.23 per share, resulting in aggregate cash
proceeds to us of $100.0 million.
In fiscal 1998, Wind River Systems accounted for 16% of our total revenues
and Thomson Multimedia accounted for 10% of our total revenues. In fiscal 1999,
Wind River Systems accounted for 23% of our total revenues and Cable & Wireless
Communications accounted for 10% of our total revenues. In fiscal 2000, Cable &
Wireless Communications accounted for 18% of our total revenues and Wind River
Systems accounted for 15% of our total revenues. Revenues attributable to Wind
River Systems relate to a source code license we granted Wind River Systems in
December 1997. Wind River Systems paid us a license fee of $10.0 million for
this license which was recorded as deferred revenues and is being amortized over
a 30-month period as license, royalty and service revenues. Revenues
attributable to Cable & Wireless Communications in fiscal 1999 and in fiscal
2000 relate to license, royalty and service revenues. Revenues from Thomson
Multimedia related to a one-time paid-up software license. We expect that we
will continue to be dependent upon a limited number of customers for a
significant portion of our revenues in future periods, although the customers
may vary from period to period.
Deferred revenues consist primarily of payments received from customers for
prepaid license and royalty fees and prepaid services for undelivered product
and services. Deferred revenues increased from $40.8 million at May 31, 1999 to
$69.1 million at May 31, 2000. This increase resulted largely from prepayments
from network operators. Deferred revenues can fluctuate significantly. These
fluctuations are the result of:
- when we record deferred revenues, which depends on the timing of large
prepaid license and royalty fees and service contracts
- when we recognize deferred revenues, which depends on when services are
performed and when network operators and information appliance
manufacturers deploy products and services based on our technology
International revenues accounted for approximately 50% of our total revenues
in fiscal 1998, 51% of our total revenues in fiscal 1999 and 53% of our total
revenues in fiscal 2000. We anticipate international revenues to continue to
represent a significant portion of total revenues for the foreseeable future.
In fiscal year 1999, we entered into letter agreements with several network
operators whereby we agreed to issue warrants to purchase up to an aggregate of
4,599,992 shares of common stock which are exercisable if those network
operators satisfy certain milestones. The value of the warrants is estimated
using the Black-Scholes model as of the earlier of the grant date or the date
that it becomes probable that the warrants will be earned. Pursuant to the
requirements of Emerging Issues Task Force No. 96-18, the warrants will continue
to be revalued in situations where they are granted prior to the establishment
of a performance commitment. The value of the warrants is recorded primarily as
a noncurrent asset on the accompanying consolidated balance sheet and will be
amortized over the estimated economic life of the arrangements with the network
operators.
As of May 31, 2000, warrants to purchase up to 2,336,660 shares of our
common stock were earned by these network operators. The fair market value of
these warrants at the time they were earned was $117.2 million. As of May 31,
2000, accumulated amortization for the warrants was $10.8 million.
26
If the remaining warrants are earned, we will be required to record
significant non-cash accounting expenses related to these warrants. As a result,
we could incur net losses or increased net losses for a given period and this
could seriously harm our operating results and stock price.
Since inception, we have incurred net losses of $230.5 million. These losses
include write-offs totaling $60.0 million of acquired in-process research and
development related to our acquisitions, $97.6 million of research and
development expenditures, $32.7 million of amortization of purchased intangibles
and $10.8 million of amortization of warrants. We anticipate incurring
significant operating losses for the foreseeable future as we:
- continue to invest in research and development and professional and
engineering services to support new devices for our software platform and
large-scale deployments by our network operator customers
- record non-cash expenses related to the acquired in-process research and
development and amortization of purchased intangibles associated with our
acquisitions and amortization of warrant expense associated with the
issuance of performance warrants to various network operators
YEAR ENDED MAY 31, 1999 AND YEAR ENDED MAY 31, 2000
REVENUES
Total revenues increased 62% from $17.3 million for fiscal 1999 to
$28.0 million for fiscal 2000.
LICENSE AND ROYALTY. License and royalty revenues increased 94% from
$5.3 million for fiscal 1999 to $10.2 million for fiscal 2000. This increase was
due primarily to increased royalty revenues resulting from increased
deployments, primarily from existing customers, and the expiration of
prepayments associated with previous product lines.
SERVICE. Service revenues increased 48% from $12.0 million for fiscal 1999
to $17.8 million for fiscal 2000. This increase was due primarily to the
continued expansion of our professional services organization, created in the
beginning of fiscal 1999. To a lesser extent, the increase was due to the
overall increase in maintenance revenues.
COST OF REVENUES
Total cost of revenues increased 126% from $10.5 million for fiscal 1999 to
$23.7 million for fiscal 2000. We anticipate that total cost of revenues will
increase in dollar amounts in future periods as we provide continued services to
support customer implementations and as we experience higher third party license
costs as deployments increase.
LICENSE AND ROYALTY. Cost of license and royalty revenues decreased 12%
from $2.3 million for fiscal 1999 to $2.0 million for fiscal 2000. These amounts
represented 43% and 20% of license and royalty revenues over the respective
periods. The decrease in cost of license and royalty revenues in dollar amounts
was due primarily to a one-time credit received from a third party vendor
related to maintenance and support and lower costs related to final amortization
of certain prepaid in-bound licenses. We expect the cost of license and royalty
revenues, as a percentage of license and royalty revenues, to fluctuate in
future periods. Amortization of certain third party costs will have the effect
of decreasing license and royalty costs as a percentage of related revenues.
However, introduction of new third party technology may offset the effect of the
amortized costs or increase license and royalty cost as a percentage of related
revenues.
SERVICE. Cost of service revenues increased 164% from $8.2 million for
fiscal 1999 to $21.7 million for fiscal 2000. These amounts represented 69% and
122% of service revenues over the respective periods. The increase in dollar
amounts and as a percentage of service revenues was due primarily to our
continued investment in our professional services organization, necessary to
meet the growth in
27
customer installation, training and deployment of our products, as well as an
increase in the level of billable custom development projects. We expect cost of
service revenues to increase in dollar amounts to the extent existing and new
customers install and deploy our products. We also expect the cost of service
revenues, as a percentage of service revenues, to fluctuate in future periods.
These costs may increase in the near term due to continued expansion of services
as existing and new customers install and deploy our products and we continue to
provide and support limited trial installations of our products at discounted
prices to network operators in order to continue to increase our market share.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of salary and other related costs for personnel and external
contractors as well as costs related to outsourced development projects to
support product development. Research and development expenses increased 78%
from $18.2 million for fiscal 1999 to $32.3 million for fiscal 2000. These
amounts represented 105% and 115% of total revenues over the respective periods.
The increase in dollar amounts and as a percentage of total revenues was due
primarily to higher personnel and related expenses resulting from increased
staffing, increased use of external contractors and an increase in outsourced
development projects, in particular a project with General Instrument (recently
acquired by Motorola). The classification of costs between research and
development and cost of service revenues may fluctuate between categories
depending on the level of projects that are billable at any point in time. We
believe that continued investment in research and development is critical to
attaining our strategic objectives. Consequently, we expect research and
development expenses to increase significantly in dollar amounts in future
periods. However, if revenues increase, we expect research and development
expenses to decline as a percentage of total revenues in the long term.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and other related costs for sales and marketing personnel, sales
commissions, travel, facilities for regional offices, public relations,
marketing materials and tradeshows. Sales and marketing expenses increased 60%
from $11.7 million for fiscal 1999 to $18.7 million for fiscal 2000. These
amounts represented 68% and 67% of total revenues over the respective periods.
The increase in dollar amounts was due primarily to increased employee related
expenses including higher headcount, commission costs and travel related
expenses. In addition, the increase in marketing activities, including our PopTV
program and our increased tradeshow presence, also contributed to this increase.
We believe these expenses will increase in dollar amounts in future periods as
we expand our direct sales and marketing efforts domestically and abroad.
However, if revenues increase, we expect these costs to decrease as a percentage
of total revenues in the long term.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other employee related costs for corporate
development, finance, human resources and legal, as well as outside legal and
other professional fees. General and administrative expenses increased 97% from
$4.0 million for fiscal 1999 to $7.8 million for fiscal 2000. These amounts
represented 23% and 28% of total revenues over the respective periods. The
increase in dollar amounts and as a percentage of total revenues was due
primarily to increased staffing, including the formation of our corporate
development organization, the establishment of the infrastructure necessary to
support our obligations as a public company and merger termination costs of
approximately $624,000. In addition, we incurred costs related to our expansion
into international markets. We believe these expenses will increase in dollar
amounts as we continue to add personnel. However if revenues increase, we expect
these costs to decrease as a percentage of total revenues in the long term.
28
AMORTIZATION OF PURCHASED INTANGIBLES. Purchased intangibles represent the
purchase price of Navio and SourceSuite in excess of identified tangible assets
and are amortized over three years. In August 1997, we recorded approximately
$18.3 million of purchased intangibles related to the Navio acquisition. In
March 2000, we recorded approximately $192.2 million of purchased intangibles
related to the SourceSuite acquisition. We recorded approximately $6.1 million
of amortization expense for fiscal 1999 and approximately $22.1 million of
amortization expense for fiscal 2000. We believe these expenses will increase in
dollar amounts as we continue to amortize these balances. In addition, the
acquisition of MoreCom in June 2000 will increase these expenses.
AMORTIZATION OF WARRANTS. As of May 31, 2000, warrants to purchase up to
2,336,660 shares of our common stock were earned by network operators. The fair
market value of these warrants at the time they were earned was $117.2 million.
We recorded warrant amortization expense of $18,000 and $10.8 million in fiscal
1999 and fiscal 2000, respectively. We expect warrant amortization to continue
to increase as additional warrants are earned.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Deferred stock compensation
represents the difference between the estimated fair value of our common stock
for accounting purposes and the option exercise price of such options at the
grant date. In fiscal 1999, we began recording deferred stock compensation for
stock options granted to employees and others. These amounts are amortized on a
straight-line basis over the 48-month vesting period of such options.
Amortization of deferred stock compensation was approximately $507,000 for
fiscal 1999 compared to $2.1 million for fiscal 2000. The majority of the stock
option grants being amortized were granted in the latter half of fiscal 1999. We
anticipate that deferred stock compensation expense will remain relatively
stable from year to year, with decreases resulting from the effect of employee
terminations.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the
SourceSuite acquisition in March 2000, we expensed approximately $1.9 million of
acquired in-process research and development which, in the opinion of
management, had not reached technological feasibility and had no alternative
future use. See Note 4 to Consolidated Financial Statements.
INTEREST AND OTHER INCOME (EXPENSE), NET
Net interest and other income includes interest income on our cash, cash
equivalents, short-term and long-term investments partially offset by interest
expense on capital leases, bank charges and losses on disposals of fixed assets.
Net interest and other income increased from approximately $59,000 for fiscal
1999 to $10.8 million for fiscal 2000. The increase is primarily due to interest
income on proceeds from our private placement offering in May 1999, our initial
public offering of common stock in August 1999 and our secondary offering in
February 2000. This was partially offset by losses on disposal of fixed assets.
INCOME TAX PROVISION (BENEFIT)
Income tax provision (benefit) includes income tax benefit and foreign
withholding tax expense. Income tax provision of approximately $137,000 for
fiscal 2000, consisted primarily of foreign withholding tax expense for royalty
revenue. Income tax benefit of approximately $586,000 for fiscal 1999 was
comprised of the benefits received under a tax-sharing agreement with Oracle
that provides for our consolidation into Oracle's tax group for certain state
income tax payment purposes. Since the effective date of our initial public
offering, upon which Oracle's ownership percentage was reduced to less than 50%,
our results are no longer included in any of Oracle's consolidated state tax
returns and we will no longer receive a tax benefit from Oracle. See Note 10 to
Consolidated Financial Statements.
As of May 31, 2000, we had federal net operating loss carryforwards of
approximately $22.3 million and tax credits totaling $2.5 million. The federal
net operating loss carryforwards expire at various dates between 2013 and 2020.
The Tax Reform Act of 1986 imposes substantial restrictions on the utilization
of net operating losses and tax credits in the event of an "ownership change" of
a
29
corporation. Our ability to utilize net operating loss carryforwards on an
annual basis will be limited as a result of a prior "ownership change" in
connection with private sales of equity securities. We have provided a full
valuation allowance on the deferred tax asset because of the uncertainty
regarding its realization. Our accounting for deferred taxes under Statement of
Financial Accounting Standards No. 109 involves the evaluation of a number of
factors concerning the realizability of our deferred tax assets. In concluding
that a full valuation allowance was required, management primarily considered
factors such as our history of operating losses and expected future losses and
the nature of our deferred tax assets.
YEAR ENDED MAY 31, 1998 AND YEAR ENDED MAY 31, 1999
REVENUES
Total revenues increased 69% from $10.3 million in fiscal 1998 to
$17.3 million in fiscal 1999.
LICENSE AND ROYALTY. License and royalty revenues increased 27% from
$4.2 million in fiscal 1998 to $5.3 million in fiscal 1999. This increase was
due primarily to revenues related to our source code license agreement with Wind
River Systems increasing by $1.4 million in fiscal 1999 compared to fiscal 1998.
To a lesser extent, this increase was due to a larger number of information
appliances shipped by our licensees, which increased revenues by $1.2 million in
fiscal 1999. This license and royalty increase was partially offset by decreased
license revenues from other sources.
SERVICE. Service revenues increased 97% from $6.1 million in fiscal 1998 to
$12.0 million in fiscal 1999. Approximately $4.9 million of this increase was
due to the creation of our professional services organization and an increase in
engineering services provided to new and existing customers. To a lesser extent,
the increase was due to higher maintenance revenues as a result of a larger
number of server and client licensees.
COST OF REVENUES
Total cost of revenues increased 75% from $6.0 million in fiscal 1998 to
$10.5 million in fiscal 1999.
LICENSE AND ROYALTY. Cost of license and royalty revenues decreased 40%
from $3.8 million in fiscal 1998 to $2.3 million in fiscal 1999. These amounts
represented 91% of license and royalty revenues in fiscal 1998 and 43% of
license and royalty revenues in fiscal 1999. The decrease in cost of license and
royalty revenues in dollar amounts was due primarily to isolated costs of
approximately $980,000 incurred in fiscal 1998 relating to payments made to
support third-party sales of television set-top boxes and smart cards. In
addition, several prepaid licenses were fully amortized during fiscal 1998.
SERVICE. Cost of service revenues increased 270% from $2.2 million in
fiscal 1998 to $8.2 million in fiscal 1999. These amounts represented 36% and
69% of service revenues over the respective periods. The increase in dollar
amounts and as a percentage of cost of service revenues was due primarily to
expenses of $3.6 million associated with the establishment and expansion of our
professional services organization. To a lesser extent, the increase was due to
increased expenses related to engineering services provided to new and existing
customers and expenses associated with the establishment and expansion of our
customer support organization.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses decreased 9%
from $20.0 million in fiscal 1998 to $18.2 million in fiscal 1999. Our efforts
following the Navio acquisition to focus on the development of fewer products
resulted in lower average headcount which led to a decrease in expenses. To a
lesser extent, research and development expenses decreased because we outsourced
fewer development projects. Nevertheless, during this period, we also incurred
expenses associated with
30
the development of our core products. In May 1999, we entered into an agreement
with General Instrument (recently acquired by Motorola) where we committed to
pay up to $10.0 million over a three-year period for development services to be
performed by General Instrument.
SALES AND MARKETING. Sales and marketing expenses decreased 19% from
$14.4 million in fiscal 1998 to $11.7 million in fiscal 1999. In connection with
the refocusing of our product line as discussed above, we also realigned our
sales efforts which resulted in a significant reduction in the number of sales
and marketing personnel which reduced expenses.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
62% from $2.5 million in fiscal 1998 to $4.0 million in fiscal 1999. The
increase was primarily due to increased staffing which resulted in higher
expenses. To a lesser extent, the increase was due to higher legal and
professional fees.
RESTRUCTURING CHARGE. In the third quarter of fiscal 1998, we recognized a
restructuring charge of $1.2 million resulting primarily from a reduction in
workforce. This charge consisted primarily of severance payments and the
accelerated vesting of options. At May 31, 1999, we had $266,000 remaining in
accrued restructuring, related to severance payments that have not been paid
out.
AMORTIZATION OF WARRANTS. As of May 31, 1999, we issued or committed to
issue warrants to purchase up to 416,666 shares of common stock to two network
operators for satisfying commercial milestones. The fair value of the warrants
was $1,522,000, of which $18,000 was charged to operations. The remaining
balance of $1,504,000 was recorded as an asset in the consolidated balance sheet
and is being amortized over the estimated economic life of the arrangements with
the network operators.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Deferred stock compensation
represents the difference between the estimated fair value of the common stock
for accounting purposes and the option exercise price of such options at the
date of grant. In fiscal 1999, we recorded total deferred stock compensation of
$7.1 million, net of terminations, in connection with stock options granted to
employees and others. These amounts are amortized on a straight-line basis over
the 48-month vesting period of such options. Approximately $507,000 of
amortization expense was recorded during fiscal 1999. In June 1999, we recorded
approximately $1.6 million of deferred stock compensation. No deferred stock
compensation expense was recorded in fiscal 1998.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the Navio
acquisition in August 1997, we expensed $58.1 million of acquired in-process
research and development which, in the opinion of management, had not reached
technological feasibility and had no alternative future use. See Note 4 to
Consolidated Financial Statements.
INTEREST AND OTHER INCOME (EXPENSE), NET
Net interest income increased from $10,000 in fiscal 1998 to $59,000 in
fiscal 1999. Net interest income increased as a result of higher average cash
balances.
INCOME TAX PROVISION (BENEFIT)
Our income tax benefit was $2.0 million in fiscal 1998 and $586,000 in
fiscal 1999. The benefit for fiscal 1999 was comprised of the benefits received
under a tax-sharing agreement with Oracle that provides for our consolidation
into Oracle's tax group for certain state income tax payment purposes. Since the
effective date of our initial public offering, upon which Oracle's ownership
percentage was reduced to less than 50%, our results are no longer included in
any of Oracle's consolidated state tax returns and we will no longer receive a
tax benefit from Oracle. See Note 10 to Consolidated Financial Statements.
31
The benefit for fiscal 1998 consists of the estimated cash benefit pursuant
to the above agreement plus the estimated assumed federal and state tax benefit
Oracle received for the period from June 1, 1997 through August 11, 1997.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth unaudited consolidated quarterly financial
data from the periods indicated. We derived this from consolidated financial
statements, and, in the opinion of our management, they include all adjustments,
which consist only of normal recurring adjustments, necessary to present fairly
the financial results for the periods. Results of operations for any previous
fiscal quarter do not necessarily indicate what results may be for any future
period.
QUARTERS ENDED
-------------------------------------------------------------------------------------
AUG. 31, NOV. 30, FEB. 28, MAY 31, AUG. 31, NOV. 30, FEB. 29, MAY 31,
1998 1998 1999 1999 1999 1999 2000 2000
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues:
License and royalty.................... $ 1,139 $ 1,398 $ 1,525 $ 1,219 $ 1,482 $ 2,000 $ 3,043 $ 3,708
Service................................ 2,169 3,003 2,956 3,904 3,806 4,074 4,488 5,416
------- ------- ------- -------- -------- -------- -------- --------
Total revenues....................... 3,308 4,401 4,481 5,123 5,288 6,074 7,531 9,124
------- ------- ------- -------- -------- -------- -------- --------
Cost of revenues:
License and royalty.................... 600 716 638 325 522 586 510 388
Service................................ 1,199 1,672 1,827 3,549 5,562 5,131 4,576 6,469
------- ------- ------- -------- -------- -------- -------- --------
Total cost of revenues............... 1,799 2,388 2,465 3,874 6,084 5,717 5,086 6,857
------- ------- ------- -------- -------- -------- -------- --------
Gross margin............................. 1,509 2,013 2,016 1,249 (796) 357 2,445 2,267
------- ------- ------- -------- -------- -------- -------- --------
Operating expenses:
Research and development............... 4,041 4,014 4,834 5,282 5,342 6,300 9,633 10,996
Sales and marketing.................... 2,145 3,258 2,673 3,654 3,216 3,702 5,200 6,622
General and administrative............. 814 794 952 1,415 1,424 1,756 2,370 2,287
Amortization of purchased
intangibles.......................... 1,521 1,521 1,521 1,521 1,521 1,521 1,521 17,518
Amortization of warrants............... -- -- -- 18 359 710 4,023 5,684
Amortization of deferred stock
compensation......................... 7 104 282 114 504 525 518 506
Acquired in-process research and
development.......................... -- -- -- -- -- -- -- 1,936
------- ------- ------- -------- -------- -------- -------- --------
Total operating expenses............. 8,528 9,691 10,262 12,004 12,366 14,514 23,265 45,549
------- ------- ------- -------- -------- -------- -------- --------
Loss from operations..................... (7,019) (7,678) (8,246) (10,755) (13,162) (14,157) (20,820) (43,282)
Interest and other income (expense),
net.................................... 81 68 (10) (80) 697 1,641 2,095 6,354
------- ------- ------- -------- -------- -------- -------- --------
Loss before income tax provision
(benefit).............................. (6,938) (7,610) (8,256) (10,835) (12,465) (12,516) (18,725) (36,928)
Income tax provision (benefit)........... (271) (287) (329) 301 41 8 12 76
------- ------- ------- -------- -------- -------- -------- --------
Net loss................................. $(6,667) $(7,323) $(7,927) $(11,136) $(12,506) $(12,524) $(18,737) $(37,004)
======= ======= ======= ======== ======== ======== ======== ========
LIQUIDITY AND CAPITAL RESOURCES
Prior to May 31, 2000, we funded our operations as follows:
- Prior to the Navio acquisition, Oracle funded our operations primarily
through intercompany advances, capital contributions and the purchase of
equity securities
- In May 1999, we completed a private round of financing
- In July 1999, we completed our initial public offering of shares of our
common stock, and immediately following this offering, we completed a
private placement
- In February 2000, we completed a secondary offering of shares of our
common stock
Cash used in operating activities was approximately $16.8 million for fiscal
2000. This increase was primarily due to a higher net loss related primarily to
increased staffing, partially offset by an increase
32
in deferred revenues of $28.3 million and depreciation and amortization expense,
including warrants and deferred compensation, of $37.1 million. Cash used in
operating activities was approximately $6.5 million for fiscal 1999 and was
primarily due to a net loss of $33.1 million, offset in part by $7.4 million in
amortization and depreciation expenses and an increase of $15.4 million in
deferred revenues. In fiscal 1998, cash used in operating activities was
approximately $2.2 million and was primarily attributable to a net loss of
$94.4 million, offset in part by an increase of $22.3 million in deferred
revenues and $6.1 million in amortization and depreciation expenses and a
$58.1 million write-off of in-process research and development related to our
acquisition of Navio.
Net cash used in investing activities was approximately $297.6 million for
fiscal 2000. This increase was primarily due to the purchase of investments of
$383.2 million, the purchase of property and equipment of $11.0 million for our
new facilities and an increase in restricted cash of $8.8 million, partially
offset by maturities of our investments of $105.3 million. We used
$21.4 million of cash in investing activities during fiscal 1999. This cash was
used primarily to fund capital expenditures and purchase short-term investments.
Cash provided by investing activities of $1.2 million in fiscal 1998 consisted
primarily of cash acquired in the acquisition of Navio, offset in part by
purchases of property and equipment.
Net cash provided by financing activities was approximately $413.6 million
for fiscal 2000. The secondary offering, initial public offering and the private
stock placement contributed $407.5 million of the increase in cash generated by
financing activities since May 31, 1999. Net cash provided by financing
activities was $49.4 million for fiscal 1999 and related primarily to the
Series E preferred stock financing which occurred in May 1999. For fiscal 1998,
net cash provided by financing activities was $12.8 million and related
primarily to proceeds from capital contributions from Oracle and from issuances
of preferred stock and convertible notes payable.
At May 31, 2000, we had $133.0 million in cash and cash equivalents and did
not have any material commitments for capital expenditures, other than a capital
lease. See Note 6 to Consolidated Financial Statements. At May 31, 2000, we also
had $176.1 million in short-term investments, $117.6 million in long-term
investments and $8.8 million in restricted cash.
Under a development agreement entered into with General Instrument (recently
acquired by Motorola) in April 1999, we are committed to pay $10.0 million in
development fees for certain services to be performed by General Instrument.
These fees are being paid out in quarterly installments over a three year
period, of which approximately $3.6 million was expensed in fiscal 2000.
During the first quarter of fiscal 2000, we signed an amendment to the
Technology License and Distribution Agreement with Sun Microsystems. This
amendment called for us to pay certain minimum royalties and support fees in
exchange for the right to certain Sun technology and to maintain the status as a
preferred vendor of Sun. Minimum guaranteed royalties and support fees of
approximately $3.8 million are to be paid to Sun through the period ended
December 31, 2004. Approximately $583,000 of royalty and support expenses
related to this agreement were recorded for fiscal 2000.
In July 2000, Cisco Systems agreed to purchase $100.0 million worth of
shares of our common stock.
We believe that the net proceeds from our various offerings, together with
cash and cash equivalents generated from operations, will be sufficient to meet
our working capital requirements for at least the next 12 months. If our cash
balances and cash generated from operations is insufficient to satisfy our
liquidity requirements, we may seek to raise such additional funds through
public or private equity or debt financings. If additional funds are raised
through the issuance of debt securities, these securities could have certain
rights, preferences, and privileges senior to holders of common stock, and the
terms of such debt could impose restrictions on our operations. The sale of
additional equity or debt securities could result in additional dilution to our
stockholders. Additional financing may not be available at all and, if
available, such financing may not be obtainable on terms favorable to us. If we
33
are unable to obtain this additional financing, we may be required to reduce the
scope of our planned product development and marketing efforts, which could
seriously harm our business.
VALUATION OF IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with our acquisitions of Navio and SourceSuite, we had outside
appraisal firms perform valuations of the acquired companies which were used as
aids in determining the fair value of the identifiable assets and in allocating
the purchase price among the acquired assets, including the portion of the
purchase price attributed to in-process research and development. Assets
identified generally included in-process research and development, developed
technology, assembled workforce, installed customer base and goodwill.
NAVIO ACQUISITION
The valuation technique employed in the Navio appraisal was designed to
properly reflect all intellectual property rights in the intangible assets,
including core technology. The value of the developed technology was derived
from direct sales of existing products including their contribution to
in-process research and development. In this way, value was properly attributed
to the engineering know-how embedded in the existing product that will be used
in developmental products. The appraisal also considered the fact that the
existing know-how diminishes in value over time as new technologies are
developed and changes in market conditions render current products and
methodologies obsolete.
Assets were identified through on-site interviews with management and a
review of data provided by Navio's and our management concerning the acquired
assets, technologies in development, costs necessary to complete the in-process
research and development, market potential, historical financial performance,
estimates of future performance and the assumptions underlying these estimates.
Purchased incomplete research and development projects were identified
through extensive interviews and detailed analysis of development plans provided
by management concerning the following:
- Uniqueness of development work and the costs incurred
- Critical tasks required to complete the project
- Opportunities which were expected to arise from the project
- Degree of leverage of the new technology on legacy technology
- Risks associated with project completion
- Assessment of types of efforts involved, for example software development
- Length of time project was expected to be useful
- Timing related to completion of projects and resources allocated to
completion, including associated expenses
None of the in-process research and development value was associated with
routine on-going efforts to enhance or otherwise improve on the qualities of the
existing products. Navio's engineers were developing advanced, next generation
technologies that involved creating product designs and disparate technologies
to form superior products. The in-process research and development value was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from such projects and discounting the net cash flows back to their
present value. The discount rate of 37.5% considers the uncertainty surrounding
the successful development of the purchased in-process technology, the useful
life of such technology, the profitability levels of such technology and the
uncertainty of technological advances that were indeterminable at that time.
34
NATURE AND DESCRIPTION. The purchased in-process research and development
consisted of three projects: NC Navigator, TV Navigator and DTV Navigator. The
fair value assigned to each of these projects is as follows:
NC Navigator................................................ $13,700,000
TV Navigator................................................ $32,600,000
DTV Navigator............................................... $11,800,000
The NC Navigator project was aimed at the development of Internet client
software for network computers targeted at the corporate marketplace. NC
Navigator was intended to allow network computers to access the Internet with
the same look and feel of a Netscape web browser for personal computers. TV
Navigator was focused on the development of a software product that was to
enable the integration of the Internet with devices such as television set-top
boxes, satellite systems and game consoles. DTV Navigator was intended to
develop a software server that would allow television networks to provide
Internet software and applications to consumers. This system also would enable
television networks to broadcast Internet content. Each of these research and
development projects was dependent on the development of unproven Internet
technologies.
STAGE OF COMPLETION. The appraisal included the valuation of each specific
research and development project underway at the acquisition date. In the months
leading up to the purchase, Navio had made significant progress in their
research and development programs. However, due to the substantial time and
effort necessary to produce these products in accordance with functional
specifications, technological feasibility of the research and development
projects had not yet been achieved. The acquired projects included Navio's
Internet browser software. The efforts required to develop the purchased
in-process technology of Navio into commercially viable products principally
related to the completion of planning, designing, prototyping, verification and
testing activities that were necessary to establish that the software could be
produced to meet its design specifications, including functions, features and
technical performance requirements. Anticipated completion dates for the
projects in-process was approximately three to 36 months, at which time Navio
expected to begin selling the developed software products. The primary risks of
the research and development projects involved functionality, scalability and
compatibility with software standards. The costs to complete NC Navigator, TV
Navigator and DTV Navigator were estimated at $8 million, $19 million and
$7 million, respectively.
The resulting net cash flows from such projects were based on management's
estimates of product revenues, operating expenses, research and development
costs and income taxes from such projects. The revenue projections used to value
the in-process research and development were based on estimates of relevant
market sizes and growth factors, expected trends in technology and the nature
and expected timing of new product introductions by us and our competitors. Our
projections may ultimately prove to be incomplete or inaccurate, and
unanticipated events and circumstances are likely to occur. As a result, the
underlying assumptions used to forecast revenues and costs and develop such
projects may not transpire as estimated.
Navio's development team had made significant technological and creative
strides in the development of its experimental Internet technologies as of
August 1997. Since its inception in February 1996, Navio incurred research and
development costs of $2 million for NC Navigator, $5 million for TV Navigator
and $2 million for DTV Navigator. As of the acquisition date, Navio was a
development stage company with minimal product revenues and large net losses.
Navio was entering the testing phase for two of its developmental products, NC
Navigator 3.0 and TV Navigator 1.1. Historical revenues represented services and
limited sales of a Netscape product sold as a test network computer browser on
an experimental basis. This product was superseded by NC Navigator 3.0.
ALTERNATIVE FUTURE USE. Before we made the decision not to capitalize the
value ascribed to in-process research and development, the projects were
evaluated individually to determine if
35
technological feasibility had been achieved and if there were any alternative
future uses. Such evaluation consisted of a specific review of the efforts,
including the overall objectives of the project, progress toward the objectives
and uniqueness of the development efforts.
Navio's technical activities were concentrated on the development of new
product knowledge having specific commercial objectives, and efforts were
focused on translating those applied research findings and other scientific
know-how into commercially viable software products. The acquired research and
development was related to developing experimental Internet technologies for
which no market existed at the time of the acquisition. Due to its specialized
nature, the in-process research and development project had no alternative
future use, either for re-employment elsewhere in the business or in
liquidation, in the event the project failed.
SOURCESUITE ACQUISITION
The valuation technique employed in the appraisal for the SourceSuite
acquisition was designed to properly allocate the purchase price of the acquired
assets. Assets were identified through interviews with senior management of the
acquired company. In addition, data for comparable companies was reviewed, as
well as the financial plans for the acquired company for the next several years.
The assets that were identified consisted primarily of existing technology,
assembled workforce, in-process research and development, trademarks and
goodwill.
The value of SourceSuite's in-process technology, existing technology and
trademarks were developed primarily on the basis of the income approach. This
approach measures the present worth and anticipated future benefits of the
intangible asset. Revenue is allocated to existing and future technology.
Appropriate expenses are deducted and economic rents are charged for the use of
other assets. A present value of after-tax cash flows attributable to the
technology is then calculated. In the case of in-process technology, the cost to
complete the technology is not deducted and the cash flows are multiplied by the
percentage of completion of each project. Revenue was allocated to the
technology by estimating the number of man-years invested in both the existing
and in-process technology, net of replacement or obsolescence of any technology.
The percentage of completion of each project was determined by dividing the
number of man-years invested as of the valuation date by the estimated total
number of man-years upon completion. A weighted average cost of capital was
calculated by applying the Capital Asset Pricing Model to comparable public
companies. A discount rate of 25% was selected to value the existing technology.
A discount rate of 30% was selected to value the in-process technology to take
into account the additional risk associated with the technology that had not yet
been completed.
The in-process workforce was valued using the cost approach. This approach
considers the concept of replacement as an indicator of value. Therefore, the
in-place workforce was valued by estimating the cost to recruit and train a
comparable workforce.
If we do not successfully deploy commercially-accepted technology or
products based on the acquired in-process research and development, our
operating results could be adversely affected in future periods.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
requires us to value derivative financial instruments, including those used for
hedging foreign currency exposures, at current market value with the impact of
any change in market value being charged against earnings in each period. SFAS
No. 133 will be effective for and adopted by us in the first quarter of the
fiscal year ending May 31, 2002. To date, we have not entered into any
derivative financial instrument contracts. Thus, we believe that SFAS No. 133
will not have a material impact on our financial position or results of
operations.
36
In December 1999, the Securities Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition." This bulletin summarizes views
of the Staff on applying generally accepted accounting principles to revenue
recognition in financial statements. We will be required to adopt SAB No. 101 in
the fourth quarter of fiscal 2001. We believe that our current revenue
recognition policy complies with the guidelines in SAB No. 101 and, therefore,
do not believe the adoption of SAB No. 101 will have a material impact on our
financial position or results of operations.
In March 2000, the FASB issued Financial Interpretation No. 44, "Accounting
for Certain Transactions involving Stock Compensation an interpretation of APB
Opinion 25." Interpretation No. 44 is effective July 1, 2000. Interpretation
No. 44 clarifies the application of APB Opinion 25 for various matters,
specifically: the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to the
terms of a previously fixed stock option or award; and the accounting for an
exchange of stock compensation awards in a business combination. We do not
believe that the adoption of Interpretation No. 44 will have a material impact
on our financial position or results of operations.
In March 2000, the FASB's Emerging Issue Task Force ("EITF") reached a
consensus on EITF 00-2, "Accounting for Web Site Development Costs." EITF 00-2
discusses how an entity should account for costs incurred to develop a web site.
The EITF is effective in the first quarter of fiscal 2001. We do not believe
that the adoption of EITF 00-2 will have a material impact on our financial
position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. As of May 31, 2000, our investment portfolio includes
$294 million of U.S. government obligations, commercial paper and other
corporate securities which are subject to no interest rate risk when held to
maturity but may increase or decrease in value if interest rates change prior to
maturity. We do not use derivative financial instruments in our investment
portfolio. We place our investments with high credit quality issuers and, by
policy, limit the amount of credit exposure to any one issuer. As stated in our
policy, we are averse to principal loss and seek to preserve our invested funds
by limiting the fault risk, market risk and reinvestment risk. We currently
maintain sufficient cash and cash equivalent balances to typically hold our
investments to maturity. An immediate 10% change in interest rates would be
immaterial to our financial condition or results of operations.
FOREIGN CURRENCY. We transact business in various foreign currencies and,
accordingly, we are subject to exposure from adverse movements in foreign
currency exchange rates. To date, the effect of changes in foreign currency
exchange rates on revenues and operating expenses have not been material.
Substantially all of our revenues are earned in U.S. dollars. Operating expenses
incurred by our foreign subsidiaries are denominated primarily in European
currencies. We currently do not use financial instruments to hedge these
operating expenses. We intend to assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis.
37
The following is a summary of investments:
AS OF MAY 31, 2000
-----------------------------------
GROSS
AMORTIZED UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
--------- ---------- ----------
(IN THOUSANDS)
Money market.................................. $ 32,509 $ -- $ 32,509
Commercial paper.............................. 122,464 (48) 122,416
Government notes and bonds.................... 111,462 (364) 111,098
Corporate notes and bonds..................... 128,575 (502) 128,073
Certificates of deposit....................... 11,000 -- 11,000
Market auction preferreds-taxable............. 6,000 -- 6,000
Equity securities............................. 4,000 -- 4,000
-------- ----- --------
$416,010 $(914) $415,096
======== ===== ========
Included in cash and cash equivalents......... $118,350 $ (8) $118,342
Included in short-term investments............ 176,053 (371) 175,682
Included in long-term investments............. 121,607 (535) 121,072
-------- ----- --------
$416,010 $(914) $415,096
======== ===== ========
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of our company, including our
consolidated balance sheets as of May 31, 1999 and 2000, and consolidated
statements of operations, consolidated statements of stockholders' equity, and
consolidated statements of cash flows for the years ended May 31, 1998, 1999 and
2000 and notes to the consolidated financial statements, together with a report
thereon of Arthur Andersen LLP, dated June 23, 2000 appear on pages F-1 through
F-29.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
38
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors and other key employees of Liberate,
and their ages as of May 31, 2000, are as follows:
NAME AGE POSITION
- ---- -------- --------
Mitchell E. Kertzman...................... 51 President, Chief Executive Officer and Director
Nancy J. Hilker........................... 42 Vice President and Chief Financial Officer
David A. Limp............................. 34 Senior Vice President, Corporate Development
Coleman Sisson............................ 42 Chief Operating Officer
Charles G. Tritschler..................... 35 Vice President, Marketing
Philip A. Vachon.......................... 43 Senior Vice President, Worldwide Sales
Steven Weinstein.......................... 45 Senior Vice President and Chief Technology
Officer
Gordon T. Yamate.......................... 45 Vice President, General Counsel and Secretary
David J. Roux............................. 43 Chairman of the Board of Directors
James L. Barksdale........................ 57 Director
Charles N. Corfield....................... 41 Director
Bradley P. Dusto.......................... 47 Director
Dr. David C. Nagel........................ 55 Director
Barry M. Schuler.......................... 46 Director
EXECUTIVE OFFICERS
MITCHELL E. KERTZMAN has been President, Chief Executive Officer and a
director of Liberate since November 1998. Prior to joining Liberate,
Mr. Kertzman was a member of the board of directors of Sybase, a database
company, from February 1995 until he joined Liberate. He served as Chairman of
Sybase's board of directors since July 1997. Between February 1998 and
August 1998, he also served as Co-Chief Executive Officer of Sybase. From
July 1996 until February 1997, Mr. Kertzman served as Chief Executive Officer of
Sybase, and from July 1996 until July 1997 he also served as President of
Sybase. Between February 1995 and July 1996, he served as an Executive Vice
President of Sybase. In February 1995, Sybase merged with Powersoft Corporation,
a provider of application development tools. Mr. Kertzman had served as Chief
Executive Officer and a director of Powersoft since he founded it in 1974. He
also served as President of Powersoft from April 1974 to June 1992.
Mr. Kertzman also serves as a director of Chordiant Software, CNET, Extensity
and Handspring.
NANCY J. HILKER has been Vice President and Chief Financial Officer of
Liberate since its merger with Navio in August 1997. Prior to the merger, she
had served as Vice President and Secretary of Navio since July 1996. Prior to
joining Navio, Ms. Hilker served in various capacities at IntelliCorp, a
software company, from June 1991 to July 1996, most recently as Chief Financial
Officer and Secretary. From October 1979 to June 1991, Ms. Hilker held various
positions at Deloitte & Touche, an accounting firm, as a manufacturing and high
technology specialist in the emerging business services group. Ms. Hilker is a
Certified Public Accountant.
DAVID A. LIMP has been Senior Vice President of Corporate Development since
January 1999. Mr. Limp was our Vice President of Marketing from August 1997 to
January 1999. From December 1996 to August 1997, Mr. Limp was Vice President of
Marketing of Navio. Prior to joining Navio, Mr. Limp served in various
capacities at Apple Computer from July 1987 to November 1996, most recently as
director of its North and South American PowerBook division.
COLEMAN SISSON has been our Chief Operating Officer since November 1999.
Prior to joining Liberate, Mr. Sisson was President and Chief Operating Officer
of CyberSafe, a network security
39
company, from July 1997 to November 1999. From August 1995 to July 1997,
Mr. Sisson served as Senior Vice President and General Manager, Education
Services Group, at Vanstar, a technology product and services company. From
June 1992 to August 1995, Mr. Sisson served as Vice President, Worldwide
Customer Services, at Powersoft, a provider of application development tools.
CHARLES G. TRITSCHLER has been Vice President of Marketing since
January 1999. Mr. Tritschler was our Director of Product Marketing from
August 1997 to January 1999. From April 1997 to August 1997, Mr. Tritschler was
Director of Product Marketing of Navio. Prior to joining Navio, Mr. Tritschler
served in various capacities at Apple Computer from July 1988 to April 1997,
most recently as Product Line Manager.
PHILIP A. VACHON has been Senior Vice President of Worldwide Sales since
January 1999. Before that he served as our Senior Vice President of Americas
Sales from June 1997 to January 1999. Prior to joining Liberate, Mr. Vachon
served in various capacities at Oracle, from March 1987 to June 1997, most
recently as Vice President of Alliances. Prior to joining Oracle, Mr. Vachon
worked at Applied Data Research, a database software company, from
February 1984 to December 1986 in various sales and technical positions.
Mr. Vachon also serves as a director of Boca Research.
STEVEN WEINSTEIN has been Senior Vice President and Chief Technology Officer
since March 2000. Before that he served as our Senior Vice President of
Strategic Initiatives from November 1999 to March 2000. From March 1999 to
November 1999, Mr. Weinstein was our Senior Vice President of Product
Development. From August 1997 to March 1999, Mr. Weinstein was our Vice
President of Product Development. From September 1996 to August 1997,
Mr. Weinstein was Vice President of Product Development of Navio. Prior to
joining Navio, Mr. Weinstein was the General Manager and Vice President of
Production at Spectrum HoloByte/MicroProse, a computer game manufacturer, from
July 1992 to September 1996. Prior to that, Mr. Weinstein served as Vice
President of Software Engineering at Electronics for Imaging, a hardware and
software company, from August 1991 to August 1992.
GORDON T. YAMATE has been Vice President and General Counsel since
March 1999 and has been Secretary since May 1999. Prior to joining Liberate,
Mr. Yamate was associated with the law firm of McCutchen, Doyle, Brown &
Enersen, LLP since September 1983, and had been a partner since June 1988.
BOARD OF DIRECTORS
The information concerning our directors required by this Item is
incorporated by reference to the Proxy Statement for the 2000 Annual Meeting of
Stockholders under the heading "Election of Directors."
ITEM 11. EXECUTIVE COMPENSATION
The response to this Item will be contained in the Proxy Statement for the
2000 Annual Meeting under the heading "Executive Compensation and Related
Information" and is incorporated herein by reference.
ITEM 12. STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this Item will be contained in the Proxy Statement for the
2000 Annual Meeting under the heading "Stock Ownership of Certain Beneficial
Owners and Management" and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this Item will be contained in the Proxy Statement for the
2000 Annual Meeting under the heading "Certain Relationships and Related
Transactions" and is incorporated herein by reference.
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Agreement and Plan of Merger, dated May 16, 1997, between
Liberate and Navio. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
2.2 Merger Agreement and Plan of Reorganization with SourceSuite
LLC, dated January 12, 2000. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-95139).)
2.3 Plan and Agreement of Reorganization with MoreCom, Inc.,
dated March 27, 2000. (Incorporated by reference to
similarly numbered exhibit to the Form 8-K filed by the
Registrant on July 7, 2000).
2.4 Amendment No. 1 to Plan and Agreement of Reorganization with
MoreCom, Inc. (Incorporated by reference to similarly
numbered exhibit to the Form 8-K filed by the Registrant
on July 7, 2000).
3.1 Amended and Restated Bylaws of Liberate. (Incorporated by
reference to Exhibit 3.4 to the Registration Statement on
Form S-1 filed by the Registrant (Reg. No. 333-78781).)
3.2 Sixth Amended and Restated Certificate of Incorporation of
Liberate. (Incorporated by reference to Exhibit 3.5 to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
4.1 Specimen Certificate of Liberate's common stock.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
9.1 Voting Agreement, dated May 12, 1999, among Liberate,
Oracle, Comcast Technology, Cox Communications and
MediaOne Interactive Services. (Incorporated by reference
to similarly numbered exhibit to the Registration
Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)
10.1 Form of Indemnification Agreement entered into between
Liberate and its directors and executive officers.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.2 Network Computer, Inc. 1996 Stock Option Plan, and form of
Option Agreement. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.3 Navio Communications, Inc. 1996 Stock Option Plan and form
of Option Agreement. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.4 Navio Communcations, Inc. Non-Qualified Option Plan, and
form of Option Agreement. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.5 1999 Equity Incentive Plan. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.6 1999 Employee Stock Purchase Plan. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
41
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.7 Employment Agreement between Liberate and Mitchell E.
Kertzman, dated October 12, 1998, as amended, and
January 5, 2000. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on
Form S-1 filed by the Registrant (Reg. No. 333-95139).)
10.8 Employment Agreement, dated October 17, 1997, with Wei Yen,
as amended. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.9 Settlement Agreement and Release of Claims, dated October 8,
1998, with Wei Yen. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.10 Settlement Agreement and General Release of All Claims,
dated March 16, 1998, between Jerry Baker, Oracle and
Liberate. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.11 Employment letter between Liberate and Gordon Yamate, dated
March 12, 1999. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.12 Employment letter between Liberate and Jim Peterson, dated
April 6, 1999. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.13 OEM License Agreement, dated December 31, 1997, between
Liberate and Wind River Systems, as amended. (Incorporated
by reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.14 Technology License Agreement, dated September 8, 1998,
between Liberate and Oracle. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.15 Letter Agreement, dated May 16, 1997, among Liberate, Oracle
and Navio. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.16 Source Code License Agreement, dated July 9, 1996, between
Netscape and TVSoft, as amended. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.17 OEM License Agreement, dated October 17, 1996, between
Oracle and Netscape, as amended. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.18 Cooperation Agreement, dated July 1, 1999, between Liberate
and Intel, as amended. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.19 Convertible Promissory Note, dated November 12, 1997, issued
to Middlefield Ventures. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.20 Convertible Promissory Note Purchase Agreement, dated
November 12, 1997, entered between Liberate and
Middlefield Ventures. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.21 Stockholders Agreement, dated August 11, 1997, among
Liberate and the investors named therein. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
42
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.22 Admission Agreement, dated November 12, 1997, among Liberate
and the investors named therein. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.23 Sublease Agreement for Redwood Shores office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.24 Maintenance Agreement for Redwood Shores office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.25 Furniture and Equipment Lease for Redwood Shores office
space, dated September 17, 1997, between Liberate and
Oracle. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.26 Sublease Agreement for Salt Lake City office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.27 Letter Agreement for London office space, dated December
1998, between Liberate and Oracle. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.28 Lease Agreement for Sunnyvale office space, dated November
4, 1996, between Navio and Netscape. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.29 Circle Star Lease Agreement for San Carlos office space,
dated April 27, 1999. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.30 Guaranty of Lease for San Carlos office space, dated April
27, 1999, between Circle Star Center Associates and
Oracle. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.31 Tax Allocation and Indemnity Agreement, dated August 17,
1997, between Liberate and Oracle. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.32 Network Computer, Inc. Stock Option Agreement, dated October
15, 1998, with David Roux. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.33 Network Computer, Inc. Stock Option Agreement, dated October
15, 1998, with Mitchell Kertzman. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.34 Series E Preferred Stock Purchase Agreement, dated May 12,
1999, among Liberate and the investors names therein.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.35 Stock Purchase Agreement, dated June 30, 1999, among
Liberate and Lucent Technologies Inc. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.36 Lease Agreement for Salt Lake City, Utah office space, dated
April 1, 1999 between Robert D. Kaufman and Dale E.
Kaufman and Liberate. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.37 Master Lease Agreement, dated August 2, 1999, with Steelcase
Financial Services, Inc. (Incorporated by reference to
similarly numbered exhibit to the Form 10-Q filed by the
Registrant on October 13, 1999).
43
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.38 Irrevocable Letter of Credit dated September 3, 1999 and
Standby Letter of Credit Agreement. (Incorporated by
reference to similarly numbered exhibit to the Form 10-Q
filed by the Registrant on October 13, 1999).
10.39 Employment letter between Liberate and Coleman Sisson, dated
November 5, 1999. (Incorporated by reference to Exhibit
10.39 to the Form 10-Q filed by the Registrant on January
14, 2000).
10.40 Sublease Agreement for One Circle Star Way office space,
dated December 22, 1999 between Liberate and ThirdVoice,
Inc. (Incorporated by reference to similarly numbered
exhibit to the Form 10-Q filed by the Registrant on April
13, 2000).
10.41 Sublease Agreement for One Circle Star Way office space,
dated February 17, 2000 between Liberate and
Charitableway.com. (Incorporated by reference to similarly
numbered exhibit to the Form 10-Q filed by the Registrant
on April 13, 2000).
10.42 Amendment to Employment Agreement between Liberate and
Coleman Sisson, dated February 28, 2000. (Incorporated by
reference to similarly numbered exhibit to the Form 10-Q
filed by the Registrant on April 13, 2000).
10.43 Stock Purchase Agreement dated July 16, 2000, between Cisco
Systems, Inc. and Liberate. (Incorporated by reference to
similarly numbered exhibit to the Form 8-K filed by the
Registrant on July 28, 2000).
10.44 Employment letter between Liberate and Philip A. Vachon,
dated June 30, 2000.
21.1 Subsidiaries of Liberate, as amended.
23.1 Consent of Independent Public Accountants, Arthur Andersen
LLP.
27.1 Financial Data Schedule.
Schedules not listed above have been omitted because the information required to
be set forth therein is not applicable or is shown in the financial statements
or notes thereto.
44
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, on the 25th day of
August, 2000:
LIBERATE TECHNOLOGIES
By: /s/ MITCHELL E. KERTZMAN
-----------------------------------------
Mitchell E. Kertzman
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the 25th day of August, 2000:
NAME TITLE
---- -----
/s/ MITCHELL E. KERTZMAN President, Chief Executive Officer
- --------------------------------- and Director (Principal Executive
Mitchell E. Kertzman Officer)
/s/ DAVID J. ROUX
- --------------------------------- Chairman of the Board of Directors
David J. Roux
/s/ NANCY J. HILKER Vice President and Chief Financial
- --------------------------------- Officer (Principal Financial and
Nancy J. Hilker Accounting Officer)
/s/ JAMES L. BARKSDALE
- --------------------------------- Director
James L. Barksdale
/s/ CHARLES N. CORFIELD
- --------------------------------- Director
Charles N. Corfield
/s/ BRADLEY P. DUSTO
- --------------------------------- Director
Bradley P. Dusto
/s/ DR. DAVID C. NAGEL
- --------------------------------- Director
Dr. David C. Nagel
- --------------------------------- Director
Barry M. Schuler
45
LIBERATE TECHNOLOGIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations and Comprehensive
Loss...................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Liberate Technologies:
We have audited the accompanying consolidated balance sheets of Liberate
Technologies (a Delaware corporation) and subsidiaries as of May 31, 1999 and
2000, and the related consolidated statements of operations and comprehensive
loss, stockholders' equity (deficit) and cash flows for each of the three years
in the period ended May 31, 2000. These financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Liberate Technologies and
subsidiaries as of May 31, 1999 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended May 31,
2000 in conformity with accounting principles generally accepted in the United
States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements as a whole.
/s/ ARTHUR ANDERSEN LLP
San Jose, California
June 23, 2000 (except with
respect to the matters
discussed in Note 14, as to
which the date is July 16, 2000)
F-2
LIBERATE TECHNOLOGIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
MAY 31,
-------------------
1999 2000
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 33,657 $132,962
Short-term investments.................................... 19,751 176,053
Accounts receivable, net of allowance for doubtful
accounts of $247 in 1999 and $436 in 2000............... 2,647 3,058
Receivable from affiliate................................. 482 543
Prepaid expenses and other current assets................. 2,553 6,054
-------- --------
Total current assets.................................. 59,090 318,670
PROPERTY AND EQUIPMENT, net................................. 2,269 12,759
OTHER ASSETS:
Restricted cash........................................... -- 8,788
Long-term investments..................................... -- 121,607
Warrants.................................................. 862 106,127
Purchased intangibles, net................................ 7,606 177,482
Other..................................................... 358 754
-------- --------
Total assets.......................................... $ 70,185 $746,187
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 1,643 $ 1,759
Accrued liabilities....................................... 8,911 10,290
Accrued payroll and related expenses...................... 2,248 4,303
Deferred revenues......................................... 40,790 69,132
Current portion of capital leases......................... -- 607
Note payable to affiliate................................. 52 --
-------- --------
Total current liabilities............................. 53,644 86,091
LONG-TERM LIABILITIES:
Capital lease obligations, net of current portion......... -- 1,019
Other long-term liabilities............................... -- 910
Long-term debt............................................ 4,315 --
-------- --------
Total liabilities..................................... 57,959 88,020
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $0.01 par value
Authorized--259,749,900 shares and 20,000,000 shares at
May 31, 1999 and 2000, respectively
Outstanding--65,955,398 shares and no shares at May 31,
1999 and 2000, respectively............................ 660 --
Common stock, $0.01 par value
Authorized--407,500,000 shares and 200,000,000 shares at
May 31, 1999 and 2000, respectively
Outstanding--1,234,344 shares and 90,927,732 shares at
May 31, 1999 and 2000, respectively.................... 12 909
Contributed and paid-in-capital........................... 166,643 803,400
Warrants.................................................. 1,522 89,770
Deferred stock compensation............................... (6,579) (5,583)
Stockholder notes receivable.............................. (348) (8)
Accumulated other comprehensive income.................... 28 162
Accumulated deficit....................................... (149,712) (230,483)
-------- --------
Total stockholders' equity............................ 12,226 658,167
-------- --------
Total liabilities and stockholders' equity............ $ 70,185 $746,187
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
LIBERATE TECHNOLOGIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(in thousands, except per share data)
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
REVENUES:
License and royalty....................................... $ 4,162 $ 5,281 $ 10,233
Service................................................... 6,110 12,032 17,784
-------- -------- --------
Total revenues........................................ 10,272 17,313 28,017
-------- -------- --------
COST OF REVENUES:
License and royalty....................................... 3,779 2,279 2,006
Service................................................... 2,230 8,247 21,738
-------- -------- --------
Total cost of revenues................................ 6,009 10,526 23,744
-------- -------- --------
Gross margin.......................................... 4,263 6,787 4,273
-------- -------- --------
OPERATING EXPENSES:
Research and development.................................. 19,981 18,171 32,271
Sales and marketing....................................... 14,407 11,730 18,740
General and administrative................................ 2,453 3,975 7,837
Amortization of purchased intangibles..................... 4,563 6,084 22,081
Amortization of warrants.................................. -- 18 10,776
Amortization of deferred stock compensation............... -- 507 2,053
Acquired in-process research and development.............. 58,100 -- 1,936
Restructuring charge...................................... 1,175 -- --
-------- -------- --------
Total operating expenses.............................. 100,679 40,485 95,694
-------- -------- --------
Loss from operations.................................. (96,416) (33,698) (91,421)
INTEREST INCOME, net........................................ 114 80 11,634
OTHER EXPENSE, net.......................................... (104) (21) (847)
-------- -------- --------
Loss before income tax provision (benefit)................ (96,406) (33,639) (80,634)
INCOME TAX PROVISION (BENEFIT).............................. (2,015) (586) 137
-------- -------- --------
Net loss.................................................. (94,391) (33,053) (80,771)
FOREIGN CURRENCY TRANSLATION ADJUSTMENT..................... 19 13 134
-------- -------- --------
Comprehensive loss........................................ $(94,372) $(33,040) $(80,637)
======== ======== ========
BASIC AND DILUTED NET LOSS PER SHARE........................ $(890.48) $ (56.60) $ (1.14)
======== ======== ========
SHARES USED IN COMPUTING BASIC AND DILUTED NET LOSS PER
SHARE..................................................... 106 584 70,988
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
LIBERATE TECHNOLOGIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
CONVERTIBLE
PREFERRED STOCK COMMON STOCK CONTRIBUTED DEFERRED
---------------------- --------------------- AND PAID-IN STOCK
SHARES AMOUNT SHARES AMOUNT CAPITAL WARRANTS COMPENSATION
----------- -------- ---------- -------- ----------- --------- -------------
BALANCE, MAY 31, 1997............. 28,333,300 $284 32 $ -- $ 2,732 $ -- $ --
Value of options assumed in
acquisition..................... -- -- -- -- 18,234 -- --
Issuance of convertible preferred
stock........................... 24,411,020 244 -- -- 81,491 -- --
Contribution of capital from
affiliate....................... -- -- -- -- 8,080 -- --
Stock options exercised........... 1,253,326 12 426,624 4 590 -- --
Acceleration of option vesting.... -- -- -- -- 365 -- --
Stockholder note repayment........ -- -- -- -- -- -- --
Translation gain.................. -- -- -- -- -- -- --
Refund of contributed capital..... -- -- -- -- (1,502) -- --
Net loss.......................... -- -- -- -- -- -- --
----------- ---- ---------- ---- -------- ------- -------
BALANCE, MAY 31, 1998............. 53,997,646 540 426,656 4 109,990 -- --
Stock options exercised........... 1,541,100 16 807,688 8 2,181 -- --
Issuance of convertible preferred
stock, net...................... 10,416,652 104 -- -- 47,386 -- --
Deferred stock compensation....... -- -- -- -- 7,086 -- (7,086)
Amortization of deferred stock
compensation.................... -- -- -- -- -- -- 507
Issuance of warrants.............. -- -- -- -- -- 1,522 --
Translation gain.................. -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- --
----------- ---- ---------- ---- -------- ------- -------
BALANCE, MAY 31, 1999............. 65,955,398 660 1,234,344 12 166,643 1,522 (6,579)
Issuance of stock related to stock
option exercises and ESPP....... 233,810 2 2,748,374 28 5,995 -- --
Conversion of preferred stock to
common stock.................... (66,189,208) (662) 66,189,208 662 -- -- --
Issuance of common stock in
connection with the initial
public offering, net............ -- -- 13,402,100 134 97,703 -- --
Issuance of common stock related
to conversion of debt........... -- -- 843,880 8 4,335 -- --
Issuance of common stock related
to private placement, net....... -- -- 1,627,604 16 12,484 -- --
Issuance of common stock related
to secondary offering, net...... -- -- 2,890,000 29 297,181 -- --
Issuance of common stock related
to the SourceSuite
acquisition..................... -- -- 1,772,000 18 190,528 -- --
Deferred stock compensation....... -- -- -- -- 1,057 -- (1,057)
Amortization of deferred stock
compensation.................... -- -- -- -- -- -- 2,053
Issuance of warrants.............. -- -- -- -- -- 115,724 --
Issuance of common stock related
to warrant exercises............ -- -- 220,222 2 27,474 (27,476) --
Translation gain.................. -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- --
----------- ---- ---------- ---- -------- ------- -------
BALANCE, MAY 31, 2000............. -- $ -- 90,927,732 $909 $803,400 $89,770 $(5,583)
=========== ==== ========== ==== ======== ======= =======
ACCUMULATED TOTAL
STOCKHOLDER OTHER STOCKHOLDERS'
NOTES COMPREHENSIVE ACCUMULATED EQUITY
RECEIVABLE INCOME (LOSS) DEFICIT (DEFICIT)
----------- -------------- ------------ -------------
BALANCE, MAY 31, 1997............. $ -- $ (4) $ (22,268) $ (19,256)
Value of options assumed in
acquisition..................... -- -- -- 18,234
Issuance of convertible preferred
stock........................... (34) -- -- 81,701
Contribution of capital from
affiliate....................... -- -- -- 8,080
Stock options exercised........... (2) -- -- 604
Acceleration of option vesting.... -- -- -- 365
Stockholder note repayment........ 10 -- -- 10
Translation gain.................. -- 19 -- 19
Refund of contributed capital..... -- -- -- (1,502)
Net loss.......................... -- -- (94,391) (94,391)
---- ---- --------- ---------
BALANCE, MAY 31, 1998............. (26) 15 (116,659) (6,136)
Stock options exercised........... (322) -- -- 1,883
Issuance of convertible preferred
stock, net...................... -- -- -- 47,490
Deferred stock compensation....... -- -- -- --
Amortization of deferred stock
compensation.................... -- -- -- 507
Issuance of warrants.............. -- -- -- 1,522
Translation gain.................. -- 13 -- 13
Net loss.......................... -- -- (33,053) (33,053)
---- ---- --------- ---------
BALANCE, MAY 31, 1999............. (348) 28 (149,712) 12,226
Issuance of stock related to stock
option exercises and ESPP....... 340 -- -- 6,365
Conversion of preferred stock to
common stock.................... -- -- -- --
Issuance of common stock in
connection with the initial
public offering, net............ -- -- -- 97,837
Issuance of common stock related
to conversion of debt........... -- -- -- 4,343
Issuance of common stock related
to private placement, net....... -- -- -- 12,500
Issuance of common stock related
to secondary offering, net...... -- -- -- 297,210
Issuance of common stock related
to the SourceSuite
acquisition..................... -- -- -- 190,546
Deferred stock compensation....... -- -- -- --
Amortization of deferred stock
compensation.................... -- -- -- 2,053
Issuance of warrants.............. -- -- -- 115,724
Issuance of common stock related
to warrant exercises............ -- -- -- --
Translation gain.................. -- 134 -- 134
Net loss.......................... -- -- (80,771) (80,771)
---- ---- --------- ---------
BALANCE, MAY 31, 2000............. $ (8) $162 $(230,483) $ 658,167
==== ==== ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
LIBERATE TECHNOLOGIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(94,391) $(33,053) $(80,771)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 6,070 7,367 24,260
Amortization of warrants................................ -- 18 10,776
Non-cash compensation expense........................... 365 507 2,053
Write-off of acquired in-process research and
development............................................ 58,100 -- 1,936
Loss on disposal of fixed assets........................ 71 -- 604
Provision for doubtful accounts......................... 277 (31) 189
Non-cash tax benefit.................................... (1,502) -- --
Changes in operating assets and liabilities, net of
acquisition:
Increase in accounts receivable....................... (1,438) (297) (550)
Increase in prepaid expenses and other current
assets............................................... (957) (311) (3,701)
(Increase) decrease in other assets................... 1,601 290 (396)
Increase in accounts payable.......................... 141 188 116
Increase (decrease) in accounts payable to
affiliate............................................ 5,529 (1,734) (61)
Increase (decrease) in accrued liabilities............ 961 4,500 (2,542)
Increase in accrued payroll and related expenses...... 586 453 2,055
Increase in deferred revenues......................... 22,285 15,422 28,342
Increase in interest payable.......................... 115 200 --
Increase in other long-term liabilities............... -- -- 910
-------- -------- --------
Net cash used in operating activities............... (2,187) (6,481) (16,780)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investments................... -- -- 105,340
Purchase of investments................................... -- (19,751) (383,249)
Purchases of property and equipment....................... (923) (1,635) (10,936)
Increase in restricted cash............................... -- -- (8,788)
Proceeds from sale of fixed assets........................ 170 -- --
Cash acquired in Navio acquisition........................ 1,970 -- --
-------- -------- --------
Net cash provided by (used in) investing
activities.......................................... 1,217 (21,386) (297,633)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from secondary public offering, net.............. -- -- 297,210
Proceeds from initial public offering, net................ -- -- 97,837
Proceeds from private placement, net...................... -- -- 12,500
Proceeds from issuance of common stock, net............... 161 1,535 6,395
Principal payments on capital lease obligations........... -- -- (306)
Repayment of notes payable................................ -- (5,000) (52)
Proceeds from issuance of convertible preferred stock,
net..................................................... 603 47,838 --
Contribution of capital................................... 8,080 -- --
Proceeds from notes payable............................... 4,000 5,000 --
-------- -------- --------
Net cash provided by financing activities........... 12,844 49,373 413,584
-------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... 19 13 134
-------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 11,893 21,519 99,305
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 245 12,138 33,657
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 12,138 $ 33,657 $132,962
======== ======== ========
SUPPLEMENTAL NON-CASH ACTIVITIES:
Conversion of intercompany payable to convertible preferred
stock..................................................... $ 23,000 $ -- $ --
======== ======== ========
Conversion of debt and accrued interest to equity........... -- -- 4,343
======== ======== ========
Deferred stock compensation................................. -- 7,086 1,260
======== ======== ========
Equipment acquired under capital lease...................... -- -- 1,224
======== ======== ========
Issuance of stockholder notes receivable.................... 36 322 23
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest...................................... 117 290 90
======== ======== ========
Cash paid for income taxes.................................. 275 196 49
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Liberate Technologies (the "Company"), formerly known as Network
Computer, Inc., was incorporated in Delaware in April 1996, and is a leading
provider of a comprehensive software platform for delivering content, services
and applications to a broad range of information appliances. Information
appliances, which include television set-top boxes, game consoles and personal
digital assistants, are devices that are enhanced by Internet capability. In
December 1995, the Company began operations as a division of Oracle Corporation
("Oracle") developing technology for use in the network computer. As of May 31,
2000, Oracle owned 38.9% of the outstanding shares of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All intercompany accounts and transactions have been
eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications, none of which affected net income, have been made
to prior year amounts to conform to the current year presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS, INVESTMENTS AND RESTRICTED CASH
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. As of May 31, 1999 and
2000, cash equivalents consisted of money market funds and commercial paper in
the amount of $27.3 million and $118.4 million, respectively.
The Company's investments are classified as "held-to-maturity" given the
Company's positive intent and ability to hold the investments to maturity.
Held-to-maturity securities are stated at amortized cost, including adjustments
for amortization of premiums and accretion of discounts. As of May 31, 1999 and
2000, short-term investments consisted primarily of commercial paper maturing at
various dates.
In September 1999, the Company entered into a new facilities operating lease
agreement. As part of the agreement, the Company is required to hold a
certificate of deposit to secure an Irrevocable Letter of Credit for its
security deposit. As of May 31, 2000, the certificate of deposit amounted to
approximately $8.8 million and is included in restricted cash in the
accompanying consolidated balance sheet.
F-7
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a summary of investments:
AS OF MAY 31, 2000
-----------------------------------
GROSS
AMORTIZED UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
--------- ---------- ----------
(in thousands)
Money market.................................. $ 32,509 $ -- $ 32,509
Commercial paper.............................. 122,464 (48) 122,416
Government notes and bonds.................... 111,462 (364) 111,098
Corporate notes and bonds..................... 128,575 (502) 128,073
Certificates of deposit....................... 11,000 -- 11,000
Market auction preferreds-taxable............. 6,000 -- 6,000
Equity securities............................. 4,000 -- 4,000
-------- ----- --------
$416,010 $(914) $415,096
======== ===== ========
Included in cash and cash equivalents......... $118,350 $ (8) $118,342
Included in short-term investments............ 176,053 (371) 175,682
Included in long-term investments............. 121,607 (535) 121,072
-------- ----- --------
$416,010 $(914) $415,096
======== ===== ========
AS OF MAY 31, 1999
-----------------------------------
GROSS
AMORTIZED UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
--------- ---------- ----------
(in thousands)
Money market.................................. $ 27,278 $ -- $ 27,278
Commercial paper.............................. 19,751 (14) 19,737
-------- ----- --------
$ 47,029 $ (14) $ 47,015
======== ===== ========
Included in cash and cash equivalents......... $ 27,278 $ -- $ 27,278
Included in short-term investments............ 19,751 (14) 19,737
-------- ----- --------
$ 47,029 $ (14) $ 47,015
======== ===== ========
ICE INTERACTIVE. In January 2000, the Company invested in ICE Interactive,
a joint venture formed with several parties, including Oracle Corporation
Australia Pty Limited and Burdekin Pacific Ltd. to facilitate deployment of
interactive TV services in Australia and New Zealand. The Company received a
9.9% equity interest in ICE in exchange for certain software products of the
Company. In addition, ICE signed an agreement to obtain licenses from the
Company. The investment is valued at zero given the nonmonetary nature of the
Company's initial investment and is accounted for using the cost method.
DIVA SYSTEMS. In May 2000, Liberate made a strategic investment of
approximately $4.0 million in DIVA Systems in exchange for 444,445 shares of
Series E preferred stock. The investment is included in long-term investments
and is accounted for using the cost method.
F-8
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to a
concentration of credit risk consist principally of accounts receivable. As of
May 31, 1999 and 2000, approximately 80% and 66% of accounts receivable were
concentrated with two and three customers, respectively. The Company performs
ongoing credit evaluations of its customers' financial condition, and the risk
of loss with respect to its accounts receivable is further mitigated by the fact
that the Company's customer base is comprised of well established companies. The
Company provides reserves for credit losses which, to date, have been
insignificant.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets of three
to five years. Leasehold improvements are amortized over the shorter of the
remaining lease term or the estimated useful lives of the improvements using the
straight-line method.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's subsidiaries is the local currency.
Accordingly, all assets and liabilities are translated into U.S. dollars at the
current exchange rate as of the applicable balance sheet date. Revenues and
expenses are translated at the average exchange rate prevailing during the
period. Gains and losses resulting from the translation of the financial
statements are reported as a separate component of stockholders' equity.
Foreign currency transaction gains and losses are included in other income
(expense) and have not been material.
SOFTWARE DEVELOPMENT COSTS
Under the criteria set forth in Statement of Financial Accounting Standards
("SFAS") No. 86, "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed," capitalization of software development costs
begins upon the establishment of technological feasibility of the product, which
the Company has defined as the completion of beta testing of a working product.
The establishment of technological feasibility and the ongoing assessment of the
recoverability of these costs require considerable judgment by management with
respect to certain external factors, including, but not limited to, anticipated
future gross product revenues, estimated economic life and changes in software
and hardware technology. Amounts that could have been capitalized under this
statement after consideration of the above factors were immaterial and,
therefore, no software development costs have been capitalized by the Company to
date.
REVENUE RECOGNITION
License revenues consist principally of license fees earned from the
licensing of the Company's software, as well as royalty fees earned upon the
shipment or activation of products which incorporate the Company's software.
Revenues from software license fees are typically recognized when delivery has
occurred, collection of the receivable is probable, the fee is fixed or
determinable and vendor-specific objective evidence exists to allocate the total
fee to all delivered and undelivered elements of the arrangement. Revenue is
deferred in cases where the license arrangement calls for the future delivery of
products or services for which the Company does not have vendor-specific
objective evidence to
F-9
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
allocate a portion of the total fee to the undelivered element. In such cases,
revenue is recognized when the undelivered elements are delivered or
vendor-specific objective evidence of the undelivered elements becomes
available. If license arrangements include the rights to unspecified future
products, revenue is recognized over the contractual or estimated economic term
of the arrangement. Royalty revenues are recognized when reported to the
Company, which occurs after shipment or activation of the related products.
Prepaid royalties are deferred and recognized when reported.
Service revenues consist of consulting, engineering, training and
maintenance services. Maintenance services include both updates and technical
support. Consulting, engineering and training revenues are generally recognized
as services are performed. Maintenance revenue is recognized ratably over the
term of the agreement. In instances where software license agreements include a
combination of consulting services, training, and maintenance, these separate
elements are unbundled from the arrangement based on each element's relative
fair value.
DEFERRED REVENUES
Deferred revenues consist principally of payments received from customers
for future services, prepaid royalties and license fees for undelivered product.
The conversion of these deferred revenue balances into income is largely
dependent on two main factors:
- when the Company performs the services for the network operators and
information appliance manufacturers
- when the network operators and information appliance manufacturers choose
to deploy products and services based on the Company's technology
Both of these timing factors are largely dependent on the Company's customers.
Because of this, it is difficult to accurately predict when these deferred
revenues will be converted into income. Although the Company has classified all
of the deferred revenue balances as current liabilities, a significant portion
may be deferred or may not be recognized until subsequent fiscal years.
COMPREHENSIVE INCOME
Comprehensive income includes foreign currency translation gains and losses
and unrealized gains and losses on equity securities that have been previously
excluded from net income and reflected instead in equity. The Company has
reported the components of comprehensive income on its statement of operations.
COMPUTATION OF NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number of
shares of common stock outstanding. Diluted loss per share information is the
same as basic net loss per share since potential common shares from conversion
of preferred stock, stock options, and warrants are antidilutive. As of May 31,
2000, an additional 15,401,376 potential shares were not included in the
calculation as they would have been antidilutive.
RESTRUCTURING CHARGE
A restructuring charge of $1.2 million was recorded in the fiscal year ended
May 31, 1998. Approximately $1.0 million of this charge related to severance
payments associated with the termination of two executive officers. The
remaining charge of approximately $200,000 was for
F-10
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
severance payments and the acceleration of stock option vesting related to the
termination of 20 employees, primarily in the sales group. All terminations and
termination benefits were communicated to the affected employees prior to
May 31, 1998. At May 31, 2000, this restructuring charge has been paid out and
actual payments approximated the original estimates.
LONG-LIVED ASSETS
Liberate reviews long-lived assets, certain identifiable intangibles and
goodwill related to these assets for impairment in accordance with SFAS
No. 121, "Accounting for the Impairment of Long-lived Assets and For Long-lived
Assets to be Disposed Of."
For assets to be held and used, including acquired intangibles, Liberate
initiates its review whenever events or changes in circumstances indicate that
the carrying amount of a long-lived asset may not be recoverable. Recoverability
of an asset is measured by comparison of its carrying amount to the future
undiscounted cash flows that the asset is expected to generate. Any impairment
to be recognized is measured by the amount by which the carrying amount of the
asset exceeds its fair market value.
Assets to be disposed of and for which management has committed to a plan to
dispose of the assets, whether through sale or abandonment, are reported at the
lower of carrying amount or fair value less cost to sell.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
requires the Company to value derivative financial instruments, including those
used for hedging foreign currency exposures, at current market value with the
impact of any change in market value being charged against earnings in each
period. SFAS No. 133 will be effective for and adopted by the Company in the
first quarter of the fiscal year ending May 31, 2002. To date, the Company has
not entered into any derivative financial instrument contracts. Thus, the
Company believes that SFAS No. 133 will not have a material impact on its
financial position or results of operations.
In December 1999, the Securities Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition." This bulletin summarizes views
of the Staff on applying generally accepted accounting principles to revenue
recognition in financial statements. The Company will be required to adopt SAB
No. 101 in the fourth quarter of fiscal 2001. The Company believes that its
current revenue recognition policy complies with the guidelines in SAB No. 101
and, therefore, does not believe the adoption of SAB No. 101 will have a
material impact on its financial position or results of operations.
In March 2000, the FASB issued Financial Interpretation No. 44, "Accounting
for Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion 25." Interpretation No. 44 is effective July 1, 2000. Interpretation
No. 44 clarifies the application of APB Opinion 25 for various matters,
specifically: the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to the
terms of a previously fixed stock option or award; and the accounting for an
exchange of stock compensation awards in a business combination. The Company
does not believe that the adoption of Interpretation No. 44 will have a material
impact on its financial position or results of operations.
F-11
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 2000, the FASB's Emerging Issue Task Force ("EITF") reached a
consensus on EITF 00-2, "Accounting for Web Site Development Costs." EITF 00-2
discusses how an entity should account for costs incurred to develop a web site.
The EITF is effective in the first quarter of fiscal 2001. The Company does not
believe that the adoption of EITF 00-2 will have a material effect on its
financial position or results of operations.
3. SEGMENT REPORTING
Liberate operates solely in one segment, the development, manufacturing and
sale of information appliance software for consumer, corporate and educational
marketplaces. As of May 31, 1998, 1999 and 2000, the Company's long-term assets
are located primarily in the United States. The Company's revenues by geographic
area are as follows:
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
(IN THOUSANDS)
United States.................................... $ 5,137 $ 8,542 $13,168
England.......................................... 682 2,517 7,140
Japan............................................ 3,280 3,763 3,686
Canada........................................... 346 587 1,541
Other............................................ 827 1,904 2,482
------- ------- -------
Consolidated..................................... $10,272 $17,313 $28,017
======= ======= =======
International revenues consist of sales to customers in foreign countries.
During the years ended May 31, 1998, 1999 and 2000, international revenues were
50%, 51% and 53% of total revenues, respectively.
The percentage of sales to significant customers is as follows:
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
Customer A............................................... 16% 23% 15%
Customer B............................................... * 10% 18%
Customer C............................................... 10% * *
- ------------------------
* Less than 10%
4. ACQUISITIONS
NAVIO COMMUNICATIONS, INC.
Effective August 11, 1997, the Company acquired Navio Communications, Inc.
("Navio"). In connection with the acquisition, the Company issued 17,441,322
shares of Series B and C convertible preferred stock and stock options to
acquire 6,315,780 shares of Series C convertible preferred stock in exchange for
all of the outstanding common stock, preferred stock and options to purchase
shares of Navio common stock. The acquisition was accounted for as a purchase
and, accordingly, the results of operations of Navio have been included in the
consolidated financial statements commencing on the
F-12
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS (CONTINUED)
date of acquisition. The fair market value of the equity securities issued in
the acquisition was approximately $77.1 million and the total purchase price was
$77.7 million.
The Company wrote off approximately $58.1 million of acquired in-process
research and development which, in the opinion of management, had not reached
technological feasibility and had no alternative future use. Purchased
intangibles, representing purchase price in excess of identified tangible
assets, of approximately $18.3 million were recorded and are being amortized on
a straight-line basis over an estimated useful life of three years. Amortization
expense related to this transaction was approximately $4.6 million,
$6.1 million and $6.1 million for the years ended May 31, 1998, 1999 and 2000,
respectively.
The value assigned to acquired in-process research and development was
determined by identifying research projects in areas for which technological
feasibility has not been established. The value was determined by estimating the
costs to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present values. The discount rate
included a factor that took into account the uncertainty surrounding the
successful development of the acquired in-process technology.
In connection with the acquisition, net assets acquired were as follows:
(in thousands)
Purchased intangibles, including in-process technology...... $ 76,354
Property, plant and equipment and other noncurrent assets... 1,752
Cash, receivables and other current assets.................. 3,715
Current liabilities assumed................................. (4,133)
--------
Net assets acquired......................................... $ 77,688
========
In connection with the acquisition, for up to 60 days after the closing
date, certain former common stockholders of Navio had the right to put to Oracle
up to 50% of the preferred shares they received, and shares issuable under stock
options assumed by the Company in the acquisition, for a price of $3.35 per
share. A total of 3,818,496 shares of Series C convertible preferred stock for
approximately $12.8 million in proceeds were put to Oracle under this
arrangement.
Additionally, a call option was held by Oracle to purchase all of the
Series B and Series C convertible preferred stock at a to-be-determined buy-out
price. The buy-out price was to be determined as follows: (1) if exercised prior
to December 31, 1999, the price would be 120% of the per share price determined
by an independent third party valuation of the Company's shares, or (2) if
exercised after December 31, 1999, the per share price determined by an
independent third party valuation of the Company's shares. The call option
terminated upon the Company's initial public offering.
The following table presents the unaudited pro forma results assuming that
the Company had merged with Navio at the beginning of fiscal year 1998. Net
income has been adjusted to exclude the write-off of acquired in-process
research and development of $58.1 million and includes amortization of
F-13
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS (CONTINUED)
purchased intangibles of approximately $6.1 million. This information may not
necessarily be indicative of the future combined results of operations of the
Company.
YEAR ENDED
MAY 31, 1998
------------
(in thousands,
except per
share data)
Revenues.................................................... $ 11,065
Net loss.................................................... $(42,227)
Basic net loss per share.................................... $(398.37)
SOURCESUITE LLC
On March 3, 2000, the Company acquired the Virtual Modem assets of
SourceSuite LLC ("SourceSuite") in exchange for 1,772,000 shares of the
Company's common stock. The acquisition was accounted for as a purchase and,
accordingly, the results of operations of SourceSuite have been included in the
consolidated financial statements commencing on the date of acquisition. The
fair market value of the equity securities issued in the acquisition was
approximately $190.5 million.
The Company wrote off approximately $1.9 million of acquired in-process
research and development which, in the opinion of management, had not reached
technological feasibility and had no alternative future use. Purchased
intangibles, representing purchase price in excess of identified tangible
assets, of approximately $192.0 million were recorded and are being amortized on
a straight-line basis over an estimated useful life of three years. Accumulated
amortization was approximately $13.3 million at May 31, 2000.
The value assigned to acquired in-process research and development was
determined by identifying research projects in areas for which technological
feasibility has not been established. The value was determined by estimating the
costs to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present values. The discount rate
includes a factor that takes into account the uncertainty surrounding the
successful development of the acquired in-process technology. If these projects
are not successfully developed, future revenue and profitability of the Company
may be adversely affected. Additionally, the value of the other purchased
intangible assets may be impaired.
In connection with the acquisition, net assets acquired were as follows:
(in thousands)
Purchased intangibles, including in-process technology...... $193,893
Property, plant and equipment and other noncurrent assets... 421
Cash, receivables and other current assets.................. 167
Current liabilities assumed................................. (149)
--------
Net assets acquired......................................... $194,332
========
The following table presents the unaudited pro forma results assuming that
the Company had merged with SourceSuite at the beginning of fiscal year 1999.
Net income has been adjusted to exclude the write-off of acquired in-process
research and development of $1.9 million and includes amortization of purchased
intangibles of approximately $64.0 million for each of the years ended May 31,
1999 and
F-14
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS (CONTINUED)
2000. This information may not necessarily be indicative of the future combined
results of operations of the Company.
YEARS ENDED MAY 31,
-------------------------
1999 2000
----------- -----------
(in thousands, except per
share data)
Revenues.............................................. $ 17,313 $ 28,017
Net loss.............................................. $(101,944) $(129,607)
Basic net loss per share.............................. $ (43.27) $ (1.83)
5. PROPERTY AND EQUIPMENT
At May 31, 1999 and 2000, property and equipment consisted of the following:
YEARS ENDED MAY 31,
-------------------
1999 2000
-------- --------
(in thousands)
Computer equipment...................................... $4,060 $ 6,216
Software................................................ 816 1,446
Furniture and equipment................................. 225 3,526
Leasehold improvements.................................. 465 6,074
------ -------
5,566 17,262
Less: Accumulated depreciation and amortization......... (3,297) (4,503)
------ -------
$2,269 $12,759
====== =======
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company has various operating leases that expire at various dates
through fiscal year 2010. Future minimum lease payments relating to these
agreements as of May 31, 2000, are as follows:
Year ending May 31,
- ------------------- (in thousands)
2001........................................................ $ 6,816
2002........................................................ 6,529
2003........................................................ 6,183
2004........................................................ 6,322
2005........................................................ 6,508
Thereafter.................................................. 33,695
-------
$66,053
=======
Rent expense, without the effect of sublease income, under the Company's
operating leases for the years ended May 31, 1998, 1999 and 2000 was
approximately $1.8 million, $2.3 million and $4.7 million, respectively. The
Company currently has commitments by various sublessees of approximately
$5.4 million. The related sublease agreements expire on various dates through
August 30, 2002. The
F-15
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
payments received from the sublessees have been offset against rent expense in
the consolidated statements of operations.
In September 1999, the Company entered into a new facilities operating lease
agreement. As part of the agreement, the Company is required to hold a
certificate of deposit to secure an Irrevocable Letter of Credit for its
security deposit. As of May 31, 2000, the certificate of deposit amounted to
approximately $8.8 million and is included in restricted cash in the
accompanying consolidated balance sheet.
CAPITAL LEASE
On August 2, 1999, the Company entered into a Master Equipment Lease to
finance office furniture and equipment. The Company has executed six lease
schedules under this capital lease, each with a 36-month payment period. Total
assets acquired under these schedules are approximately $1.9 million.
Accumulated depreciation was approximately $290,000 at May 31, 2000.
The following is a schedule by years of future minimum lease payments under
capital leases together with the present value of the net minimum lease payments
as of May 31, 2000 are as follows:
Year ending May 31,
(in thousands)
2001.................................................... $ 748
2002.................................................... 748
2003.................................................... 351
------
Total minimum lease payments................................ 1,847
Less: Amount representing interest.......................... (221)
------
Present value of net minimum lease payments................. 1,626
Less: current portion....................................... (607)
------
Long-term portion........................................... $1,019
======
GENERAL INSTRUMENT CORPORATION
In April 1999, the Company entered into a Manufacturer's Representative
Agreement and a Development Agreement with General Instrument Corporation
("GI"), who was recently acquired by Motorola. Under the developer's agreement,
the Company committed to pay GI $10.0 million in development fees for certain
services to be performed by GI. These fees will be paid out in quarterly
installments over a three-year period. Approximately $556,000 and $3.6 million
was expensed in fiscal 1999 and fiscal 2000, respectively. Under the
manufacturer's agreement, the Company agreed to pay to GI a "commission" on all
GI terminals deployed by network operators with the Company's products on them.
However, the commissions only become effective after specific sales thresholds
are met. Prior to attaining those thresholds, no commissions are due to GI on
these sales. In connection with this commission, GI has committed to the Company
that certain volumes of GI terminals will be sold. After the three year period
is over, GI may be required to pay the Company for any shortfall of terminal
sales below committed volume levels.
F-16
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
SUN MICROSYSTEMS
In May 1999, the Company entered into an agreement with Sun Microsystems
("Sun") to transfer their NC Navigator and NC Administration Server software to
Sun while retaining the right to ship, support and maintain these products for
existing customers using this technology. Although the Company does not intend
to actively pursue new sales opportunities in the corporate network computer
market, outside of this market they intend to continue developing new products
based on this technology. In each of fiscal 1999 and fiscal 2000, sales of these
products and related services accounted for $2.5 million of total revenues. Sun
has also agreed to co-develop television set-top box technology with the
Company, which will be distributed pursuant to a non-exclusive license with Sun.
During the first quarter of fiscal 2000, the Company signed an amendment to
the Technology License and Distribution Agreement with Sun. This amendment
called for us to pay certain minimum royalties and support fees in exchange for
the right to certain Sun technology and to maintain the status as a preferred
vendor of Sun. Minimum guaranteed royalties and support fees of approximately
$3.8 million are to be paid to Sun through the period ended December 31, 2004.
Approximately $583,000 of royalty and support expenses related to this agreement
were recorded in fiscal 2000.
LEGAL MATTERS
In December 1998, a former employee of the Company filed an action in the
California Superior Court for the County of San Mateo against the Company for,
among other things, unpaid commissions of approximately $1.5 million,
constructive employment termination, intentional misrepresentation and negligent
misrepresentation. In October 1999, the plaintiff amended his complaint against
the Company, adding claims for damages for failure to pay wages under the
California Labor Code and common law retaliation, and sought to impose a
constructive trust on the allegedly withheld commissions and any enhancement in
value of that money. In December 1999, the Company filed a motion for summary
judgment/summary adjudication to dismiss all of the claims brought by the
plaintiff. In January 2000, the Court dismissed eight of the ten claims brought
against Liberate leaving only the claims of intentional and negligent
misrepresentation for trial. In February 2000, Liberate settled this matter,
obtaining the complete dismissal of all claims against the Company in exchange
for the payment of a nominal amount of cash and the issuance of a nominal number
of shares of Liberate's common stock.
As part of the Company's acquisition of the Virtual Modem software product
and related assets and technology of SourceSuite described in Note 4, the
Company acquired certain patents that were the subject of a patent infringement
lawsuit. This lawsuit was initially brought by Interactive Channel
Technologies, Inc. and SMI Holdings, Inc., affiliated companies of SourceSuite,
against Worldgate Communications, Inc. in May 1998. The patent infringement
claims have been assigned to the Company as a result of the merger with
SourceSuite. In June 1998, Worldgate filed a counterclaim against the plaintiffs
and Source Media, Inc., a shareholder of SourceSuite, alleging among others,
violations of the Lanham Act and Delaware's Uniform Deceptive Trade Practices
Act, common law unfair competition, tortious interference with existing and
prospective business relationships and misappropriation of confidential
information and trade secrets. The case is still in the discovery stage.
Briefing on the patent claim construction issues has commenced, and a hearing on
such claims has been scheduled for September 25, 2000. The Company believes that
the patent infringement claims against Worldgate are valid and intends to
continue to vigorously prosecute this action. In addition, the
F-17
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company has agreed to defend Interactive Channel, SMI Holdings and Source Media
against the cross-complaint brought by Worldgate.
7. CONVERTIBLE PREFERRED STOCK
Since inception, Liberate has issued 66,178,670 shares of preferred stock.
All outstanding shares of preferred stock were converted into shares of common
stock upon the closing of the Company's initial public offering (IPO) in
August 1999. Additionally, all outstanding warrants to purchase preferred stock
were converted to warrants to purchase common stock. Upon closing of the IPO,
Liberate authorized 20,000,000 shares of undesignated preferred stock for future
issuance.
The Company had the following number of shares of each series of convertible
preferred stock:
AS OF MAY 31, 1999
-------------------------
SHARES AMOUNT
---------- ------------
Series A preferred stock........................... 28,333,300 $ 11,412,000
Series A-1 preferred stock......................... 6,969,694 23,000,000
Series B preferred stock........................... 4,641,516 15,663,000
Series C/C-1 preferred stock....................... 15,594,236 44,156,000
Series D preferred stock........................... -- --
Series E preferred stock........................... 10,416,652 47,490,000
---------- ------------
65,955,398 $141,721,000
========== ============
8. COMMON STOCK
The Company has authorized 200,000,000 shares of common stock. At May 31,
2000, the Company has reserved the following shares of authorized, but unissued
shares of common stock for future issuance:
Employee stock purchase plan................................ 1,377,432
Warrants.................................................... 4,366,660
Stock options............................................... 14,057,801
----------
19,801,893
==========
WARRANT AGREEMENTS
In fiscal year 1999, the Company entered into letter agreements with several
network operators whereby it agreed to issue warrants to purchase up to an
aggregate of 4,599,992 shares of common stock which are exercisable if those
network operators satisfy certain milestones. The value of the warrants is
estimated using the Black-Scholes model as of the earlier of the grant date or
the date that it becomes probable that the warrants will be earned. Pursuant to
the requirements of Emerging Issues Task Force No. 96-18, the warrants will
continue to be revalued in situations where they are granted prior to the
establishment of a performance commitment. The value of the warrants is recorded
primarily as a noncurrent asset on the accompanying consolidated balance sheet
and will be amortized over the estimated economic life of the arrangements with
the network operators.
F-18
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMON STOCK (CONTINUED)
As of May 31, 2000, warrants to purchase up to 2,336,660 shares of our
common stock were earned by these network operators. The fair market value of
these warrants at the time they were earned was $117.2 million. As of May 31,
2000, accumulated amortization for the warrants was $10.8 million. If the
remaining warrants are earned, we will be required to record significant
non-cash accounting expenses related to these warrants. As a result, we could
incur net losses or increased net losses for a given period and this could
seriously harm our operating results and stock price.
STOCK SPLITS
In May 1999, the Company's Board of Directors approved a one-for-six reverse
stock split of the Company's outstanding shares of common and preferred stock
which was declared effective on July 26, 1999. All share and per share
information included in the accompanying consolidated financial statements and
notes have been adjusted retroactively to reflect this reverse stock split.
On December 21, 1999 the Company announced a two-for-one stock split in the
form of a stock dividend which was declared effective January 14, 2000. At the
effective date of the stock split, the number of shares of Liberate's common
stock outstanding increased to approximately 83,600,000 shares. All share and
per share information included in the accompanying consolidated financial
statements and notes have been adjusted retroactively to reflect this split.
INITIAL PUBLIC OFFERING
On August 2, 1999, Liberate completed its initial public offering in which
it sold 12,500,000 shares of common stock at $8 per share. Liberate sold an
additional 902,100 shares of common stock at $8 per share related to the
exercise of the underwriters' overallotment. The total aggregate proceeds from
these transactions were $107.2 million. Underwriters' discounts and other
related costs were $9.4 million, resulting in net proceeds of $97.8 million.
PRIVATE PLACEMENT WITH LUCENT TECHNOLOGIES
In June 1999, the Company entered into a stock purchase agreement with
Lucent Technologies ("Lucent") under which, contingent upon and immediately
following consummation of the sale of shares in the IPO, Lucent agreed to invest
$12.5 million in a private placement of shares of the Company's common stock at
a price per share equal to 96% of the IPO price.
SECONDARY OFFERING
On February 24, 2000, Liberate completed a secondary public offering in
which it sold 2,890,000 shares of common stock at $108 per share. Proceeds from
this transaction were $312.1 million. Underwriters' discounts and other related
costs were $14.9 million, resulting in net proceeds of $297.2 million.
9. STOCK PLANS
OPTION ASSUMED FOR NAVIO
In connection with the Company's acquisition of Navio, each outstanding
option to purchase shares of Navio common stock was automatically converted into
an option to purchase convertible preferred stock of the Company based upon the
conversion ratio.
F-19
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK PLANS (CONTINUED)
Options assumed are immediately exercisable and the shares of stock issued
upon exercise that are unvested are subject to repurchase, at the original
purchase price, by the Company upon the termination of the optionholders'
service to the Company. The Company's repurchase right expires generally at the
rate of 25% of the original grant, commencing 12 months after the date of grant
or employment, and in monthly increments over the following 36 months.
At May 31, 2000, the Navio plan had 850,842 options outstanding at a
weighted average exercise price of $0.64 per share, of which 296,759 options
were vested. Also at May 31, 2000, an additional 4,544 options were outstanding,
specifically for Navio vendors, at a weighted average exercise price of $0.18
per share, of which 4,033 options were vested.
1996 STOCK OPTION PLAN
On October 1, 1996, the Company adopted the 1996 Stock Option Plan (the
"1996 Plan"). The 1996 Plan, as amended, provides for the grant of both
incentive and non-qualified stock options to employees, consultants and
directors for the purchase of up to 11,666,666 shares of Series A common stock.
Incentive stock options may only be granted to employees.
The exercise price of incentive stock options cannot be less than the fair
market value of the common stock on the grant date, as determined by the board
of directors. The 1996 Plan also provides for holders of non-qualified options
to purchase shares at not less than 85% of the fair market value on the grant
date. The term of the incentive and non-qualified stock options is generally ten
years from the date of grant or a shorter term as provided in the option
agreement. Options generally vest over four years.
1999 EQUITY INCENTIVE PLAN
In May 1999, the Board of Directors adopted, and the stockholders approved,
the Company's 1999 Equity Incentive Plan (the "1999 Plan"). The types of awards
that may be made under the 1999 Plan are options to purchase shares of common
stock, stock appreciation rights, restricted shares and stock units. Any shares
not yet issued under the Company's 1996 Stock Option Plan as of the date of the
Company's initial public offering were available for grant under the 1999 Plan
(approximately 3,051,498 shares), plus, commencing on June 1, 2000, annual
increases equal to the lesser of 6,000,000 shares or 5% of the outstanding
common shares on such date. The exercise price for all incentive stock options
and nonstatutory stock options may not be less than 100% or 85%, respectively,
of the fair market value of the Company's common stock on the date of grant. The
options vest over four years and have a term of ten years.
The Company accounts for outstanding stock options under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"). In accordance with APB No. 25, no compensation expense has been
recognized related to options granted to employees except as discussed below in
"Deferred Stock Compensation," as all employee options were granted with an
exercise price equal to the fair market value of the underlying stock. If
compensation cost had been
F-20
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK PLANS (CONTINUED)
determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's pro forma net loss would have been as follows:
YEARS ENDED MAY 31,
-------------------------------
1998 1999 2000
-------- -------- ---------
(in thousands)
Net loss--as reported......................... $(94,391) $(33,053) $ (80,771)
======== ======== =========
Net loss--pro forma........................... $(94,415) $(36,446) $(112,632)
======== ======== =========
Pursuant to the provisions of SFAS No. 123, the fair value of options
granted was estimated on the grant date using the Black-Scholes option pricing
model and the following assumptions:
YEARS ENDED MAY 31,
--------------------------------------
1998 1999 2000
---------- ---------- ------------
Risk-free interest rate.................. 5.56% 4.75% 6.09%
Average expected life of option.......... 2.83 years 3.97 years 4.62 years
Dividend yield........................... 0% 0% 0%
Volatility of common stock............... 0% 70% 146%
Weighted average fair value of options
granted................................ $ 0.08 $ 4.32 $ 35.36
Stock option activity under the 1996 Plan and the 1999 Plan is summarized
below:
WEIGHTED
OPTIONS AVERAGE
AVAILABLE OPTIONS EXERCISE
FOR GRANT OUTSTANDING PRICE
---------- ----------- --------
Balance at May 31, 1997...................... 2,733,398 2,266,602 $ 0.30
Granted.................................... (2,631,924) 2,631,924 $ 1.69
Exercised.................................. -- (426,624) $ 0.38
Cancelled.................................. 1,610,492 (1,610,492) $ 0.60
---------- ---------- ------
Balance at May 31, 1998...................... 1,711,966 2,861,410 $ 1.40
Authorized................................. 6,666,666 -- --
Granted.................................... (4,303,458) 4,303,458 $ 3.21
Exercised.................................. -- (356,300) $ 1.08
Cancelled.................................. 655,612 (655,612) $ 1.70
---------- ---------- ------
Balance at May 31, 1999...................... 4,730,786 6,152,956 $ 2.65
Granted.................................... (4,043,785) 4,043,785 $37.76
Exercised.................................. -- (1,226,194) $ 1.95
Cancelled--1996 Plan....................... 60,752 (738,108) $ 3.29
Cancelled--1999 Plan....................... 12,000 (12,000) $77.29
---------- ---------- ------
Balance at May 31, 2000...................... 759,753 8,220,439 $19.86
========== ========== ======
Additionally, on October 15, 1998, the Company issued non-qualified stock
options outside of the Plan to an executive officer and to an outside director
for the purchase of 4,999,998 shares of the
F-21
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK PLANS (CONTINUED)
Company's common stock at a price of $2.55 per share. As of May 31, 2000,
options to purchase 4,222,223 shares were still outstanding, of which 1,409,722
shares were vested. The options vest over four years and have a term of ten
years.
A summary of all outstanding options, including those assumed in connection
with the Navio acquisition, to purchase common stock and preferred stock at
May 31, 2000 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AS REMAINING AVERAGE EXERCISABLE AS AVERAGE
RANGE OF EXERCISE OF MAY 31, CONTRACTUAL EXERCISE OF MAY 31, EXERCISE
PRICE 2000 LIFE PRICE 2000 PRICE
- ------------------------- -------------- ----------- -------- -------------- --------
$ 0.18 -- $ 1.95 1,893,351 7.10 $ 1.12 1,234,356 $ 0.83
$ 2.25 -- $ 2.85 5,514,847 8.37 $ 2.53 1,756,669 $ 2.54
$ 3.75 -- $ 6.00 3,564,382 8.94 $ 4.32 507,557 $ 3.82
$ 7.50 -- $ 44.00 1,017,123 9.52 $31.08 1,000 $21.88
$49.19 -- $123.00 1,308,345 9.72 $85.23 6,250 $96.38
---------- ---- ------ --------- ------
13,298,048 8.56 $13.13 3,505,832 $ 2.29
========== ==== ====== ========= ======
DEFERRED STOCK COMPENSATION
In connection with the grant of certain stock options to employees in fiscal
1999 and fiscal 2000, the Company recorded deferred compensation of
$7.1 million and $1.6 million, respectively, representing the difference between
the estimated fair value of the common stock for accounting purposes and the
option exercise price of such options at the date of grant. Such amount is
presented as a reduction of stockholders' equity. Approximately $507,000 and
$2.1 million was expensed during the years ended May 31, 1999 and 2000,
respectively, and the balance will be expensed ratably over the period the
options vest (generally four years). Compensation expense is decreased in the
period of forfeiture for any accrued but unvested compensation arising from the
early termination of an optionholder's services.
1999 EMPLOYEE STOCK PURCHASE PLAN
In May 1999, the Board of Directors adopted, and the stockholders approved,
the Company's 1999 Employee Stock Purchase (the "1999 Purchase Plan"). A total
of 1,666,666 shares of common stock has been reserved for issuance under the
1999 Purchase Plan, plus, commencing on June 1, 2000, annual increases equal to
the lesser of 1,666,666 shares, 2% of the outstanding common shares on such date
or a lesser amount determined by the Board of Directors. The 1999 Purchase Plan
permits eligible employees to acquire shares of the Company's common stock
through periodic payroll deductions of up to 15% of base cash compensation. Each
participant may purchase up to 1,500 shares on any purchase date. Each offering
period will have a maximum duration of 6 months. However, the first offering
period commenced on the effective date of the initial public offering and ended
on March 31, 2000. The price at which the common stock may be purchased is 85%
of the lower of the fair market value of the Company's common stock on the date
immediately before the first day of the applicable offering period or on the
last day of the respective purchase period. In the case of the first offering,
the price at which the common stock may be purchased is 85% of the lower of $8
per share, the price to the public in the initial public offering, or the fair
market value on the purchase date. As of May 31, 2000, an
F-22
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK PLANS (CONTINUED)
aggregate of 1,666,666 shares of common stock had been reserved under the Plan,
of which 1,377,432 shares remained available for issuance. Employees purchased
289,234 shares in fiscal year 2000.
10. INCOME TAXES
The Company and Oracle have entered into a tax sharing agreement effective
August 12, 1997. Under the terms of the agreement, the Company is responsible
for its share of Oracle's consolidated tax liability, computed as if the Company
had filed a separate return. Further, if the Company would have no tax due on a
separate return basis and the inclusion of the Company's tax operating losses
reduces Oracle's consolidated tax liability, Oracle will pay to the Company the
tax savings generated by including the Company in its consolidated tax return.
Oracle is not required to reimburse the Company for the tax savings obtained by
Oracle prior to August 12, 1997. Oracle realized a tax savings of approximately
$1.4 million for the period from June 1, 1997 to August 11, 1997. This amount is
reflected as a tax benefit in the accompanying statement of operations and a
corresponding refund of contributed capital to Oracle in the accompanying
consolidated statement of stockholders' equity. Subsequent to the acquisition of
Navio on August 12, 1997, the Company is no longer included in Oracle's
consolidated Federal Tax Returns. For the period from August 12, 1997 to
May 31, 1998, and for the fiscal year ended May 31, 1999, Oracle realized state
and local tax savings of approximately $788,000 and $781,000, respectively.
These amounts are reflected as a benefit in the accompanying statement of
operations and a corresponding receivable from affiliate in the accompanying
consolidated balance sheets. On July 28, 1999, as a result of the initial public
offering, the Company is no longer included in Oracle's combined state filings.
Income taxes have been calculated on a separate company basis pursuant to
the provisions of SFAS No. 109, "Accounting for Income Taxes". The components of
the provision (benefit) for income taxes are as follows:
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
(in thousands)
Current:
Federal............................................ $(1,303) $ -- $ --
State.............................................. (987) (781) --
Foreign............................................ 275 195 137
------- ----- ----
Total provision (benefit)........................ $(2,015) $(586) $137
======= ===== ====
F-23
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The provision (benefit) for income taxes differs from the amounts which
would result by applying the applicable statutory Federal income tax rate to
income before taxes, as follows:
YEARS ENDED MAY 31,
------------------------------
1998 1999 2000
-------- -------- --------
(in thousands)
Benefit at Federal statutory rate.............. $(33,755) $(11,774) $(28,222)
State income taxes, net of Federal benefit..... (5,500) (1,917) (4,596)
Change in valuation allowance.................. 15,162 10,926 22,537
Tax credits.................................... -- -- (580)
Nondeductible write-off of in-process research
and development.............................. 20,335 -- 788
Nondeductible goodwill amortization............ 1,610 2,129 8,987
Stock compensation............................. -- -- 835
Other.......................................... 133 50 388
-------- -------- --------
Total provision (benefit).................. $ (2,015) $ (586) $ 137
======== ======== ========
Components of the net deferred tax asset are as follows:
YEARS ENDED MAY 31,
-------------------
1999 2000
-------- --------
(in thousands)
Net operating losses..................................... $ 4,678 $ 7,788
Temporary differences.................................... 16,306 34,676
Tax credits.............................................. 1,434 2,491
-------- -------
Total deferred tax asset................................. 22,418 44,955
Valuation allowance...................................... (22,418) (44,955)
-------- -------
Total net deferred tax asset......................... $ -- $ --
======== =======
A valuation allowance has been recorded for the entire deferred tax asset as
a result of uncertainties regarding realization of the asset including limited
operating history of the Company, the lack of profitability to date and the
uncertainty over future operating profitability.
At May 31, 2000, the Company had federal net operating loss carryforwards of
approximately $22.3 million and tax credits totaling $2.5 million. The federal
net operating loss carryforwards expire at various dates between 2013 and 2020.
Under current tax law, net operating loss carryforwards available to offset
future operating income in any given year may be limited upon the occurrence of
certain events, including significant changes in ownership interests.
11. RELATED PARTY TRANSACTIONS
TRANSACTIONS WITH ORACLE
In December 1995, the Company began operations as a division of Oracle. As
of May 31, 2000, Oracle owned approximately 38.9% of the outstanding common
stock of the Company.
Prior to September 1997, Oracle performed certain services and incurred
certain costs for the benefit of the Company. Services provided included tax,
treasury, risk management, employee benefits,
F-24
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED)
legal, accounting and other general corporate services. The costs of the
services provided by Oracle were allocated to the Company based upon the
relative headcount of the Company to the total consolidated headcount of Oracle.
The charge for these services totaled approximately $250,000 for the year ended
May 31, 1998. In the opinion of management, the method of allocating the costs
is reasonable and the cost of the services allocated to the Company is not
significantly different from the costs that would have been incurred had the
Company performed these functions. Commencing in September 1997, the Company
ceased obtaining these services from Oracle.
From inception until August 1997, Oracle funded the Company's operations
through an intercompany payable account. In connection with the Company's
acquisition of Navio in August 1997, Oracle converted approximately $18 million
of outstanding intercompany payables into 5,454,544 shares of the Company's
Series A-1 preferred stock. The shares of preferred stock converted into an
equal number of shares of common stock upon the closing of the Company's initial
public offering. From inception until June 1, 1998, from time to time in the
ordinary course of business, the Company and Oracle entered into intercompany
transactions. Additionally, in fiscal 1998, Oracle contributed capital of
approximately $8.1 million to the Company.
In July 1997, the Company entered into a convertible note purchase agreement
with Oracle. Under this agreement, Oracle agreed to provide up to $10.0 million
for general working capital purposes, as needed, in the form of convertible
notes and up to $19.2 million to fund the Company's obligations under the
put/call and voting agreement, as discussed below. The convertible notes bear
annual interest at 8% and are convertible, at Oracle's option, into shares of
the Company's preferred stock. As of May 31, 1999, the Company had borrowed
approximately $10.0 million under this arrangement, and Oracle had converted
$5.0 million of the indebtedness into 1,515,150 shares of the Company's
Series A-1 preferred stock. The shares of preferred stock converted into an
equal number of shares of common stock upon the closing of the Company's initial
public offering. In May 1999, the Company repaid the outstanding portion of the
indebtedness, totaling approximately $5.0 million. The Company does not intend
to borrow additional funds under this arrangement.
In August 1997, in connection with the acquisition of Navio, the Company
entered into a put/call and voting agreement with Oracle and former Navio
stockholders, including Netscape. Among other things, this agreement granted the
former Navio stockholders the right, for a period of 60 days following the
closing of the acquisition, to compel Oracle to purchase up to 50% of the shares
received by them in the acquisition or 50% of the shares issuable under stock
options assumed by the Company in the acquisition. As a result of the exercise
of these put rights, Oracle purchased a total of 3,818,496 shares of the
Company's Series C preferred stock. Oracle subsequently converted these shares
into shares of the Series C-1 preferred stock. The shares of preferred stock
converted into an equal number of shares of common stock upon the closing of the
Company's initial public offering.
The Company previously leased office space in Redwood Shores, California
from Oracle under a lease that provided for monthly payments of approximately
$124,000. The Company terminated the lease in September 1999. The Company also
previously leased furniture and equipment for the Redwood Shores office from
Oracle under a lease entered into in September 1997, as amended, that obligated
the Company to make monthly payments to Oracle of approximately $57,000. In
addition, the Company previously contracted for Oracle to perform maintenance
and repair services at the Redwood Shores office. The furniture and equipment
lease and the maintenance and repair services agreement were terminated
simultaneously with the office lease.
F-25
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED)
The Company previously leased office space in Salt Lake City, Utah from
Oracle under a lease that provided for monthly payments of approximately $4,000.
The lease terminated in February 2000. The Company also leased furniture and
equipment for the Salt Lake City office from Oracle under a furniture lease
signed with Oracle in March 1999, that provides for monthly payments of
approximately $750.
The Company leases office space in London, England from Oracle under a lease
that provides for monthly payments of approximately $4,200. The lease terminates
in October 2000.
During the fourth quarter of fiscal 1999, the Company entered into a lease
for the office space in San Carlos, California. In connection with entering into
this lease, Oracle provided a $10.0 million guaranty to the landlord. The
guaranty was terminated after the closing of the Company's initial public
offering on July 27, 1999.
On November 19, 1997, the Company's Board of Directors waived the Company's
right of first offer with respect to 663,074 shares of Series B preferred stock
offered for sale by Sony Corporation. Subsequently, such shares were acquired by
Oracle.
The Company has entered into a Services Agreement dated March 5, 1998 with
Oracle. Pursuant to the Services Agreement, Oracle provides professional
services to certain of the Company's customers.
The Company has entered into a Technology License Agreement with Oracle in
fiscal 1998. Pursuant to the Technology License Agreement, Oracle may promote,
market and distribute sublicenses of the Company's products through its
worldwide distribution channels for a period of three years.
During fiscal 1999 and fiscal 2000, the Company paid approximately $243,000
and $107,000, respectively, to Oracle Japan for commissions related to the
license of software.
In August 1997, the Company entered into a tax allocation and indemnity
agreement with Oracle. This agreement provides for the Company's consolidation
into Oracle's tax group for income tax payment purposes. Under the agreement,
the Company's tax liability is computed as if the Company had filed a separate
return for amounts due in certain state and local jurisdictions. As a member of
Oracle's tax group, the Company is allocated a share of the aggregate tax
liability of the group. The agreement provides that Oracle will indemnify the
Company for penalties or other damages attributed to the failure of Oracle to
make timely filings or to make timely or full payments, provided that the
Company pay the allocated share and provide necessary information on a timely
basis. Under the agreement, Oracle owes the Company, as of May 31, 2000,
approximately, $923,000 for use of tax losses. Since the effective date of the
Company's initial public offering, upon which Oracle's ownership percentage was
reduced to less than 50%, the Company's results are no longer included in any of
Oracle's consolidated state tax returns, and the Company will no longer receive
a tax benefit from Oracle.
TRANSACTIONS WITH NETSCAPE AND AMERICA ONLINE
As a result of the acquisition of Navio in August 1997, Netscape became a
stockholder of the Company. In March 1999, Netscape became a wholly-owned
subsidiary of America Online ("AOL"), one of the Company's customers. As of
May 31, 2000, AOL owned approximately 7.48% of the outstanding common stock of
the Company.
F-26
LIBERATE TECHNOLOGIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED)
Navio entered into a Source Code License Agreement with Netscape ("Netscape
Source Code License") dated July 9, 1996, as amended on April 6, 1998 and
September 28, 1998. In connection with the Company's acquisition of Navio and
pursuant to a letter agreement dated May 16, 1997, Netscape consented to the
assignment of the Netscape Source Code License from Navio to the Company.
Pursuant to such letter agreement, Netscape and Oracle also agreed that the
Company's products would be distributed pursuant to an OEM License Agreement by
and between Netscape and Oracle dated October 17, 1996. Pursuant to this
agreement, the Company has the right to use approximately $1.0 million in
prepaid royalties with Netscape. As of May 31, 2000, the Company has used
approximately $40,000 of these royalties. In addition, the Company has paid AOL
approximately $575,000 in support fees under this agreement.
Under a letter agreement executed in December 1997 in connection with the
source code license agreement with Netscape and the April 1998 amendment to the
source code license agreement, as of May 31, 2000, the Company has paid Netscape
approximately $200,000 for the purchase of rights and licenses.
The Company and Netscape are also co-sublessors of real property located in
Sunnyvale, California. Netscape and Navio originally leased the property in
November 1996, and Navio's rights and duties under the lease were assigned to
the Company in connection with the Company's acquisition of Navio. Subsequently,
the property was subleased to a third party. The lease terminates in
November 2001.
As a result of all of the agreements with Netscape described above, the
Company has recognized expenses totaling approximately $401,000, $687,000 and
$430,000 in each of the fiscal years ended May 31, 1998, 1999 and 2000,
respectively.
The Company entered into a trial license and support agreement with AOL in
July 1998, which terminated upon the execution of a technology license and
support agreement entered into in August 1998. The Company also entered into a
source code access agreement in August 1998, which also terminated upon the
execution of the technology license and support agreement. In addition, the
Company entered into a consulting services agreement in February 1999 with AOL,
under which new product features are being developed. As of May 31, 2000, the
Company has received payments from AOL under all these agreements aggregating
approximately $6.7 million.
The Company recognized 1%, 10% and 9%, or approximately $139,000,
$1.7 million and $2.6 million of total revenues from revenue transactions with
related parties during the fiscal years ended May 31, 1998, 1999 and 2000,
respectively.
12. THIRD PARTY FINANCING AGREEMENTS
On November 12, 1997, the Company entered into a Convertible Promissory Note
(the "Notes") Purchase and Cooperation Agreement (the "Agreement") with a third
party investor (the "Investor").
The Agreement was for the sale of up to three $4.0 million Notes that are
convertible into Series D convertible preferred stock. During the year ended
May 31, 1998, the Company sold the first Note of $4.0 million. The Note bears
interest at the lesser of 5% or the maximum interest rate permitted under
applicable Federal and state laws. The Note automatically converted on the
consummation of the Company's initial public offering.
In the Agreement, the investor agreed to fund $3.0 million of the Company's
non-recurring engineering ("NRE") efforts through December 31, 1999. The Company
recognizes the NRE revenue
F-27
12. THIRD PARTY FINANCING AGREEMENTS (CONTINUED)
as services are performed and recognized approximately $72,000, $871,000 and
$1.3 million of revenue during the years ended May 31, 1998, 1999 and 2000,
respectively. In consideration of the funding, the Company agreed to pay the
investor a royalty for each license of the Company's software incorporating that
technology, up to a maximum of $3.9 million. The obligation to pay the royalty
terminates four years after the first commercial shipment of hardware
implementing the Company's software.
13. RETIREMENT PLAN
The Company has a retirement plan under Section 401(k) of the Internal
Revenue Code. Under the retirement plan, participating employees may defer a
portion of their pretax earnings up to the Internal Revenue Service annual
contribution limit. The Company may make contributions to the plan at the
discretion of the Board of Directors. To date, no such contributions have been
made by the Company.
14. SUBSEQUENT EVENTS
ACQUISITION OF MORECOM
In June 2000, the Company acquired MoreCom. In connection with the
acquisition, the Company issued and/or reserved for issuance an aggregate of
8,030,059 shares of common stock in exchange for all of the outstanding stock
and options of MoreCom. The acquisition was accounted for as a purchase. The
fair market value of the equity securities issued in the acquisition was
approximately $504.2 million.
Also in connection with the acquisition, the Company expects to expense up
to $22.4 million of acquired in-process research and development, which in the
opinion of the Company's management, has not reached technological feasibility
and has no alternative future use. The Company also expects to record goodwill
and other intangibles of up to $520.2 million to be amortized over an estimated
economic life of three years.
ISSUANCE OF COMMON STOCK
On July 16, 2000, Cisco Systems agreed to purchase 3,963,780 shares of
Liberate common stock at approximately $25.23 per share, resulting in aggregate
cash proceeds to Liberate of $100.0 million.
F-28
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
DEDUCTIONS,
BALANCE AT ADDITIONS- BALANCE
BEGINNING RETURNS AND AT END OF
DESCRIPTION OF YEAR PROVISIONS WRITE-OFFS YEAR
- ----------- ---------- ----------- ---------- ---------
Allowance for doubtful accounts
Year ending May 31, 2000.......................... $247 $226 $ 37 $436
Year ending May 31, 1999.......................... 278 220 251 247
Year ending May 31, 1998.......................... 1 329 52 278
F-29
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Agreement and Plan of Merger, dated May 16, 1997, between
Liberate and Navio. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
2.2 Merger Agreement and Plan of Reorganization with SourceSuite
LLC, dated January 12, 2000. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-95139).)
2.3 Plan and Agreement of Reorganization with MoreCom, Inc.,
dated March 27, 2000. (Incorporated by reference to
similarly numbered exhibit to the Form 8-K filed by the
Registrant on July 7, 2000).
2.4 Amendment No. 1 to Plan and Agreement of Reorganization with
MoreCom, Inc. (Incorporated by reference to similarly
numbered exhibit to the Form 8-K filed by the Registrant
on July 7, 2000).
3.1 Amended and Restated Bylaws of Liberate. (Incorporated by
reference to Exhibit 3.4 to the Registration Statement on
Form S-1 filed by the Registrant (Reg. No. 333-78781).)
3.2 Sixth Amended and Restated Certificate of Incorporation of
Liberate. (Incorporated by reference to Exhibit 3.5 to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
4.1 Specimen Certificate of Liberate's common stock.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
9.1 Voting Agreement, dated May 12, 1999, among Liberate,
Oracle, Comcast Technology, Cox Communications and
MediaOne Interactive Services. (Incorporated by reference
to similarly numbered exhibit to the Registration
Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)
10.1 Form of Indemnification Agreement entered into between
Liberate and its directors and executive officers.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.2 Network Computer, Inc. 1996 Stock Option Plan, and form of
Option Agreement. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.3 Navio Communications, Inc. 1996 Stock Option Plan and form
of Option Agreement. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.4 Navio Communcations, Inc. Non-Qualified Option Plan, and
form of Option Agreement. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.5 1999 Equity Incentive Plan. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.6 1999 Employee Stock Purchase Plan. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.7 Employment Agreement between Liberate and Mitchell E.
Kertzman, dated October 12, 1998, as amended, and
January 5, 2000. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on
Form S-1 filed by the Registrant (Reg. No. 333-95139).)
10.8 Employment Agreement, dated October 17, 1997, with Wei Yen,
as amended. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.9 Settlement Agreement and Release of Claims, dated October 8,
1998, with Wei Yen. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.10 Settlement Agreement and General Release of All Claims,
dated March 16, 1998, between Jerry Baker, Oracle and
Liberate. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.11 Employment letter between Liberate and Gordon Yamate, dated
March 12, 1999. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.12 Employment letter between Liberate and Jim Peterson, dated
April 6, 1999. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.13 OEM License Agreement, dated December 31, 1997, between
Liberate and Wind River Systems, as amended. (Incorporated
by reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.14 Technology License Agreement, dated September 8, 1998,
between Liberate and Oracle. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.15 Letter Agreement, dated May 16, 1997, among Liberate, Oracle
and Navio. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-78781).)
10.16 Source Code License Agreement, dated July 9, 1996, between
Netscape and TVSoft, as amended. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.17 OEM License Agreement, dated October 17, 1996, between
Oracle and Netscape, as amended. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.18 Cooperation Agreement, dated July 1, 1999, between Liberate
and Intel, as amended. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.19 Convertible Promissory Note, dated November 12, 1997, issued
to Middlefield Ventures. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.20 Convertible Promissory Note Purchase Agreement, dated
November 12, 1997, entered between Liberate and
Middlefield Ventures. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.21 Stockholders Agreement, dated August 11, 1997, among
Liberate and the investors named therein. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.22 Admission Agreement, dated November 12, 1997, among Liberate
and the investors named therein. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.23 Sublease Agreement for Redwood Shores office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.24 Maintenance Agreement for Redwood Shores office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.25 Furniture and Equipment Lease for Redwood Shores office
space, dated September 17, 1997, between Liberate and
Oracle. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.26 Sublease Agreement for Salt Lake City office space, dated
September 17, 1997, between Liberate and Oracle.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.27 Letter Agreement for London office space, dated December
1998, between Liberate and Oracle. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.28 Lease Agreement for Sunnyvale office space, dated November
4, 1996, between Navio and Netscape. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.29 Circle Star Lease Agreement for San Carlos office space,
dated April 27, 1999. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.30 Guaranty of Lease for San Carlos office space, dated April
27, 1999, between Circle Star Center Associates and
Oracle. (Incorporated by reference to similarly numbered
exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
10.31 Tax Allocation and Indemnity Agreement, dated August 17,
1997, between Liberate and Oracle. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.32 Network Computer, Inc. Stock Option Agreement, dated October
15, 1998, with David Roux. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.33 Network Computer, Inc. Stock Option Agreement, dated October
15, 1998, with Mitchell Kertzman. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.34 Series E Preferred Stock Purchase Agreement, dated May 12,
1999, among Liberate and the investors names therein.
(Incorporated by reference to similarly numbered exhibit
to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)
10.35 Stock Purchase Agreement, dated June 30, 1999, among
Liberate and Lucent Technologies Inc. (Incorporated by
reference to similarly numbered exhibit to the
Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)
10.36 Lease Agreement for Salt Lake City, Utah office space, dated
April 1, 1999 between Robert D. Kaufman and Dale E.
Kaufman and Liberate. (Incorporated by reference to
similarly numbered exhibit to the Registration Statement
on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
10.37 Master Lease Agreement, dated August 2, 1999, with Steelcase
Financial Services, Inc. (Incorporated by reference to
similarly numbered exhibit to the Form 10-Q filed by the
Registrant on October 13, 1999).
10.38 Irrevocable Letter of Credit dated September 3, 1999 and
Standby Letter of Credit Agreement. (Incorporated by
reference to similarly numbered exhibit to the Form 10-Q
filed by the Registrant on October 13, 1999).
10.39 Employment letter between Liberate and Coleman Sisson, dated
November 5, 1999. (Incorporated by reference to Exhibit
10.39 to the Form 10-Q filed by the Registrant on January
14, 2000).
10.40 Sublease Agreement for One Circle Star Way office space,
dated December 22, 1999 between Liberate and ThirdVoice,
Inc. (Incorporated by reference to similarly numbered
exhibit to the Form 10-Q filed by the Registrant on April
13, 2000).
10.41 Sublease Agreement for One Circle Star Way office space,
dated February 17, 2000 between Liberate and
Charitableway.com. (Incorporated by reference to similarly
numbered exhibit to the Form 10-Q filed by the Registrant
on April 13, 2000).
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.42 Amendment to Employment Agreement between Liberate and
Coleman Sisson, dated February 28, 2000. (Incorporated by
reference to similarly numbered exhibit to the Form 10-Q
filed by the Registrant on April 13, 2000).
10.43 Stock Purchase Agreement dated July 16, 2000, between Cisco
Systems, Inc. and Liberate. (Incorporated by reference to
similarly numbered exhibit to the Form 8-K filed by the
Registrant on July 28, 2000).
10.44 Employment letter between Liberate and Philip A. Vachon,
dated June 30, 2000.
21.1 Subsidiaries of Liberate, as amended.
23.1 Consent of Independent Public Accountants, Arthur Andersen
LLP.
27.1 Financial Data Schedule.
Schedules not listed above have been omitted because the information required to
be set forth therein is not applicable or is shown in the financial statements
or notes thereto.