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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ---------------TO ---------------.
COMMISSION FILE NUMBER: 000-24647
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TERAYON COMMUNICATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0328533
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2952 BUNKER HILL LANE
SANTA CLARA, CALIFORNIA 95054
(408) 727-4400
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, par value $0.001 per share
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on
March 24, 2000 as reported on the Nasdaq National Market, was approximately
$4,571,171,656. Shares of Common Stock held by each officer and director and by
each person known to the Company who owns 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
As of March 24, 2000, registrant had outstanding 28,972,171 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for the Annual Meeting of Shareholders to
be filed by April 28, 2000.Report on Form 8-K dated December 27, 1999.
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report on Form 10-K contains forward-looking statements of
Terayon Communication Systems, Inc. within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934 which are subject to the "safe harbor" created by those
sections. The forward-looking statements include, but are not limited
to: statements related to industry trends and future growth in the
markets for cable modem systems; our strategies for reducing the cost of
our products; our product development efforts; the effect of GAAP
accounting pronouncements on the our recognition of revenues; our future
research and development; the timing of our introduction of new
products; the timing and extent of deployment of our products by its
customers; and, future profitability. Discussions containing such
forward-looking statements may be found in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." These
forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from those in such
forward-looking statements. We disclaim any obligation to update these
forward-looking statements as a result of subsequent events. The
business risks discussed in Item 7 of this Report on Form 10-K, among
other things, should be considered in evaluating our prospects and
future financial performance.
PART I
ITEM 1. BUSINESS
Overview
Our business is to develop, market and sell broadband access systems
that enable cable operators and other providers of broadband access
services to cost-effectively deploy reliable two-way broadband services
over cable, copper wire and wireless systems. To date, our development
and marketing efforts have focused primarily on cable operators.
However, with some recent acquisitions of complimentary technology and
businesses, we have also turned our attention to providers of broadband
services using existing telephone, copper wire infrastructures and
wireless systems.
For cable operators, our first product was the TeraComm system,
which is based on our patented Synchronous Code Division Multiple Access
or "S-CDMA" technology. The TeraComm system is comprised of the TeraPro
cable modem, the TeraLink 1000 Master Controller, the TeraLink Gateway
and the TeraView Element Management and Provisioning software. Our
patented S-CDMA technology enables reliable two-way broadband
communications over both pure coaxial and hybrid fiber/coax cable
infrastructures and is designed to enable cable operators to maximize
the capacity and reliability of broadband services over any cable plant.
Our technology maximizes the resistance to noise that interferes with
data transmissions over previously unusable frequency spectrums and
thereby allows cable operators to minimize time-consuming and costly
cable plant upgrades, achieve reduced time to market and provide a wide
range of service levels to residential and commercial end users. Cable
operators using the TeraComm system can provide additional revenue-
generating services to end users. This enables cable operators to
compete effectively in the emerging market for broadband access
services.
In recent years, the volume of bandwidth intensive data, voice and
video traffic across the Internet, corporate intranets and other public
networks has increased dramatically. International Data Corporation
("IDC") estimates that the number of Internet users will increase from
approximately 69 million at the end of 1997 to approximately 320 million
by the end of 2002. IDC also estimates that the number of home office
households will increase from approximately 35 million at the end of
1997 to approximately 50 million by the end of 2002. Although various
technologies have emerged to address the need for broadband access, the
existing cable infrastructure currently provides the highest available
two-way transmission speeds and "always-on" availability. In addition,
the existing cable infrastructure currently passes more than 95% of
homes in the U.S. and a large number of small businesses.
We sell our products to cable operators through direct sales forces
in North America, Latin America and Europe. We also distribute our
products via distributors and systems integrators. Companies currently
using or distributing the TeraComm system include Shaw Communications
Inc., Rogers Communications Inc., TCA Cable TV, Inc., Cablevision
Systems, Inc., and Crossbeam Networks Corporation, a wholly owned
subsidiary of Sumitomo Corporation.
The market for broadband access products and services is
characterized by rapid technological change, new product development,
product obsolescence and evolving industry standards. A significant
element of our strategy is to advance industry standards and to extend
our technology leadership and achieve rapid time to market. In November
1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version
of the DOSCIS cable modem specification based in part on our S-CDMA
technology. In September 1999, CableLabs indicated that it intended to
proceed with the advanced PHY work on two parallel tracks: one for the
development of a prototype based on our S-CDMA technology and one for
the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of
the advanced PHY project regarding a separate release that will include
TDMA technologies. In addition, CableLabs reiterated that it is
continuing to work with us on the development of a DOCSIS specification
that could include our S-CDMA technology. To that end, CableLabs has
requested that we submit a prototype of a DOCSIS system that
incorporates an S-CDMA advanced PHY capability for testing. CableLabs
has stated that if the testing of this prototype reveals that the S-CDMA
advanced PHY works as claimed (including proper backwards compatibility
and coexistence with the other aspects of DOCSIS), and if the costs for
adding S-CDMA to DOCSIS products are in line with estimates, then it is
likely, but not certain, that S-CDMA advanced PHY capabilities will be
included in a future version of the DOCSIS specification. The prototype
we submit to CableLabs may fail to demonstrate the level of performance
that CableLabs seeks, even if it does meet performance expectations
there can be no guarantee that CableLabs will incorporate the technology
into a future version of DOCSIS specifications. In addition, if
CableLabs does proceed to include S-CDMA in a future DOCSIS
specification, there can be no guarantee that the DOCSIS S-CDMA
specification will be the same as the specification we incorporated in
the prototype submitted for tests, which may require us to further
develop our prototype.
The rapid evolution of broadband has resulted in cable television
operators, providers of telephone services and other service providers
seeking to provide a bundle of voice, data and video services to their
residential and commercial subscribers over existing and new
infrastructures. Consistent with our objective to be a leading provider
of broadband access, through a series of recent acquisitions,, we are
building a complete portfolio of broadband products to support high
speed delivery of voice, data and video services over cable, copper wire
(DSL) and wireless.
In the fall of 1999, we acquired Imedia Corporation and the
CherryPicker digital video management system. In November 1999, we
completed our acquisition of Radwiz Ltd., a provider of communication
access systems based on high-speed IP routing, integrated with
telephony, and on January 2, 2000 we completed our acquisition of
Telegate Ltd., a developer and manufacturer of telephony and data access
platforms that are deployed by service providers to deliver efficient
carrier-class voice services over cable. In addition, in February 2000,
we entered into definitive agreements to acquire the Access Network
Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary
of Tyco International Ltd., and Combox Ltd. In March 2000 we entered
into an agreement to purchase certain assets of Internet Telecom Ltd.
and an agreement to acquire Ultracom Ltd.
Our company was incorporated in California in January 1993 and
reincorporated in Delaware in July 1998. References in this report to
"Terayon," "we," "our" and "us" refer to Terayon Communication Systems,
Inc. and its subsidiaries.
Recent Events
In October 1999, we entered into Share Purchase Agreements to
acquire Radwiz Ltd. and Telegate Ltd., both Israeli companies. The
acquisition of Radwiz closed in November 1999. Radwiz produces
communication access systems based on high-speed IP routing, integrated
with telephony. Radwiz's systems include both center office Digital
Subscriber Line Access Multiplexers (DSLAMs) and customer premises
equipment for small office, home office (SOHO) business broadband
services. The former shareholders and vested optionholders of Radwiz
received a total of 946,153 shares and options to purchase shares of our
common stock. The total purchase price was approximately $53.6 million.
The acquisition was accounted for as a purchase transaction.
The acquisition of Telegate closed on January 2, 2000. Telegate
produces telephony and data access platforms that are deployed by
service providers to deliver efficient carrier-class voice services over
cable. Telegate also provides in-home networking capability for
telephony and data, based on the Digital Enhanced Cordless Telephony
(DECT) standard. The former shareholders and vested optionholders of
Telegate received a total of 2.2 million shares and options to purchase
shares of our common stock. In addition, the former shareholders are to
receive a cash payment of approximately $3.5 million. The total purchase
price was approximately $145.0 million. We expect to account for the
acquisition as a purchase transaction
In February 2000, we entered into an Asset Purchase Agreement to
acquire certain assets and assume certain liabilities of ANE which
produces DSL (Digital Subscriber Line) systems that provide multiple
phone lines a single pair of copper wires. In general, we will issue
shares and options to purchase shares of our common stock valued at
approximately $85.0 million based on the volume weighted average of the
per share sales price of our common stock as reported on the Nasdaq
National Market for the ten consecutive trading days prior to the
closing date. In addition, we have agreed to establish an employee
retention program for purposes of retaining certain identified employees
of ANE. The retention program provides for up to 3 annual payments to
the identified employees in a total amount of approximately $4.5 million
provided the employees remain employed by us. The retention payments
will be charged to expense in the period incurred. The transaction is
subject to customary closing conditions and is expected to close in the
second quarter of 2000. We expect to account for the acquisition as a
purchase transaction.
In February 2000, we also entered into a Share Purchase Agreement to
acquire Combox Ltd, an Israeli company that manufactures broadband data
systems and satellite communications based on international standards.
Combox's cable data access systems conform to the growing EuroModem
international specification, based on the Digital Video Broadcasting
(DVB) standard. In general, Combox shareholders will receive a total of
775,000 shares and options to purchase shares of our common stock.
Based on the fair market value of our common stock on the days
immediately preceding and following the date the acquisition was
announced, the total purchase price is estimated to be approximately
$92.0 million. The transaction is subject to customary closing
conditions and is expected to close in the second quarter of 2000. We
expect to account for the acquisition as a purchase transaction.
In February 2000, the Company's board of directors approved a two-
for-one split of the Company's outstanding shares of common stock to be
effected in the form of a stock dividend. The stock split is pending
stockholder approval of an increase in the our authorized shares and
therefore the changes in the capital structure resulting from the split
have not been given retroactive effect throughout this Report on Form
10-K.
In March 2000, we entered into an Asset Purchase Agreement
("Internet Telecom Agreement") with our subsidiary Telegate, under which
Telegate agreed to purchase certain assets of Internet Telecom Ltd.
("Internet Telecom"), an Israeli company. Internet Telecom is a
supplier of PacketCable and other standards-based, voice-over-IP
("Internet Protocol") systems and technologies. In general, Telegate
will acquire the assets of Internet Telecom in exchange for shares our
common stock valued at approximately $44.0 million based on the fair
market value of our common stock on the days immediately preceding and
following the date the acquisition was announced and a cash payment
estimated at approximately $2.0 million. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, we entered into a Share Purchase Agreement to acquire
Ultracom Ltd. ("Ultracom"), an Israeli company. Ultracom is a supplier
of broadband systems-on-silicon. In general the Ultracom shareholders
and vested optionholders will receive shares and option of our common
stock valued at approximately $30.0 million based on the closing price
of our common stock as reported by Nasdaq on the fifth business day
immediately preceding the closing and a cash payment estimated at
approximately $2.3 million. We will also assume the unvested Ultracom
options, the value of which will be included in the purchase price. The
transaction is subject to customary closing conditions and is expected
to close in the second quarter. We expect to account for the
transaction as a purchase transaction.
In March 2000, Rogers purchased 1,843,409 shares of our common
stock. The shares were issued on a net issuance basis pursuant to the
exercise of two warrants, each to purchase 1.0 million shares of our
common stock issued in March 1999. Because the warrants were exercised
on a cashless basis the exercise resulted in no proceeds to us.
Business Segments
We operate in one business segment, the sale of broadband access
systems. Our primary products are sold together as part of systems and
we do not report revenue derived from the sale of individual components.
Additional information about our operations by business segment and
geographic region is included in Management's Discussion and Analysis of
Financial Condition and Results of Operations in Item 7 of this report
and Note 13 of Notes to Consolidated Financial Statements included in
Item 8 of this report.
Products
Current Products
The TeraComm System
Our TeraComm system enables cable operators to cost-effectively
deploy reliable two-way broadband access services. The TeraComm system
is comprised of the TeraPro cable modem, the TeraLink 1000 Master
Controller, the TeraLink Gateway and the TeraView Element Management and
Provisioning Software. The price of a TeraComm system is dependent on a
number of variables, including a customer's basic cable system
architecture, the type of routing equipment a customer intends to use,
the level and quality of service that a cable operator desires to
provide and the volume of products purchased by a customer.
TeraPro Cable Modem. The TeraPro cable modem is a data communications
device installed in a subscriber's home or business. The TeraPro cable
modem connects to the subscriber's PC via a standard 10BaseT Ethernet
connector and to the cable network via a standard coaxial cable
connector. The TeraPro cable modem automatically configures itself
without user intervention, thus minimizing modem installation time. In
addition, the configuration software for the TeraPro cable modem is
downloaded remotely, allowing centralized software upgrades directly
from the headend management system. In October 1998, we began volume
shipments of our cable modems in a new single-board design.
The TeraPro cable modem delivers full two-way communication over the
cable network, with data rates of up to 14 Mbps per 5 MHz channel in
both the upstream and the downstream direction. The TeraPro cable modem
operates at full capacity at an SNR as low as 13dB, and gradually
adjusts throughput to provide transmission at an SNR as low as -13dB.
This feature will permit the TeraPro cable modem to operate across any
portion of the 5 to 42 MHz upstream RF spectrum.
TeraLink 1000 Master Controller. The TeraLink 1000 Master Controller
is a data channel controller and multiplexer located at the cable
headend system or distribution hub. The TeraLink 1000 Master Controller
provides control, management and data transport functions for TeraPro
cable modems connected to the cable network. It offers dynamic bandwidth
management, high speed traffic concentration, access control to data
networking resources and data service quality and integrity.
The TeraLink 1000 Master Controller is a single channel, rack-
mountable controller that supports up to 2,000 cable modems per channel.
Additional TeraLink 1000 Master Controllers can be added to scale
service as performance and subscriber needs grow. The TeraLink 1000
Master Controller, with the TeraLink Gateway, provides a 100 BaseT
interface for direct connectivity to a private backbone or any vendor's
router or switch. Alternatively, the TeraLink 1000 Master Controller,
with its built-in ATM OC-3 interface, can be connected via an ATM
switch, or directly to Cisco's 7500 series routers.
TeraLink Gateway. The TeraLink Gateway is a rack-mountable edge
concentrator providing end-user clients with broadband access to a
remote IP backbone (e.g., Internet) as well as efficient communication
between modems. The TeraLink Gateway includes an ATM OC-3 interface for
connectivity to up to two TeraLink 1000 Master Controllers or an ATM
switch. It also provides a 10/100 BaseT Ethernet/Fast Ethernet auto-
sense interface to a headend backbone or any IP router including the
Cisco Universal Broadband Router. The TeraLink Gateway also includes a
separate 10 BaseT interface, which may be connected to a separate
management network or the headend network. The TeraLink Gateway supports
up to 2,000 cable modems per RF channel when connected to a TeraLink
1000 Master Controller. When used with the TeraLink Gateway, the TeraPro
cable modems behave as an extension of the TeraLink Gateway, providing
maximum bandwidth and privacy.
TeraView Element Management and Provisioning Software. The TeraView
Element Management and Provisioning Software is a Windows 95 and Windows
NT standards-based software application installed at the headend system
or the network operations center. The TeraView software allows cable
operators to configure, control, monitor and maintain multiple channels
of the TeraComm system.
CherryPicker Digital Video Management Systems.
CherryPicker Digital Video Management Systems are scalable, open
platforms that enable cable, satellite and terrestrial operators to
deliver customized digital programming. Patented statistical re-
multiplexing technology gives operators ultimate control over
programming and allows them to create a customized output multiplex of
programs by selecting feeds (grooming) from a vast array of sources. The
CherryPicker helps operators maximize their available bandwidth while
enabling them to provide program offerings that target specific local
demographics.
Digital Subscriber Line Systems (xDSL).
We produce communications access systems based on high-speed IP
routing, integrated with telephony. Our innovative systems include both
central office DSLAMs (Digital Subscriber Line Access Multiplexers) and
customer premise equipment for SOHO business broadband services. These
systems deliver high- capacity, symmetric voice and data services to the
business market, with high density port aggregation at the central
office site for maximum cost efficiency.
Multigate Telephony and Data Access Systems
We produce telephony and data access systems for deployment of
efficient carrier-class voice services over cable. Our systems also
provide in-home networking capability for telephony and data, based on
the Digital Enhanced Cordless Telephony ("DECT") standard. Our systems
support voice, high-speed data, and Integrated Service Digital Network
("ISDN") services for the business telecommuting market and the SOHO
market.
Customers
We market our products to providers of broadband access services
that seek to provide broadband access services to both residential and
commercial end users. Our initial target market has consisted of the ten
largest cable companies in each major geographic area. In most markets,
a small number of large cable operators often provides services to a
majority of subscribers in a specific region and thus influences the
purchasing decisions of smaller cable operators. Currently, in the
United States, ten cable operators together own and operate facilities
passing approximately 78% of total homes passed. We commenced volume
shipments of our TeraComm system in the first quarter of 1998. To date,
four of the largest North American cable operators, Cablevision, Rogers,
Shaw and TCA, are offering subscribers reliable broadband access
services using our TeraComm system.
Selected examples of the range of customers and applications for
which the TeraComm system is being commercially deployed are as follows:
Rogers. Rogers is the largest cable operator in Canada and one of the
ten largest North American cable operators, with cable infrastructure
passing approximately 2.8 million homes, primarily located in Toronto,
Ottawa, Vancouver and Southwestern Ontario. Roger's systems are some of
the most advanced two-way cable networks in North America, with over 85%
of its networks currently two-way and capable of supporting high-speed
Internet services.
Shaw. Shaw is the third largest cable operator in Canada, with cable
infrastructure passing approximately 2.0 million homes. Shaw currently
has the largest cable modem deployment in Canada, with over 55,000 cable
modem users. Shaw has selected us to supply cable modem systems for
Shaw's @Home service deployments in various cities throughout Canada.
Sumitomo. We have a distribution agreement with Sumitomo under which
its subsidiary, Crossbeam Networks Corporation ("Crossbeam"), is
distributing the TeraComm system to several of Japan's leading cable
operators, including Jupiter Communications, a joint venture between
Sumitomo and TCI International. The TeraComm system's noise resistant
properties are designed to enable two-way broadband access over pure
coaxial networks, which comprise the majority of Japan's cable
infrastructure.
United Pan-Europe Communications (UPC). UPC is one of the largest
broadband communications companies in Europe, providing cable
television, telephony, Internet and programming services. UPC's systems
have approximately 5.9 million homes in their franchise areas, with 4.9
million homes passed.
TCA. TCA (a subsidiary of Cox Communications, Inc.) is the 16th
largest cable operator in the United States, with cable infrastructure
passing approximately 1.2 million homes, primarily in Texas, Arkansas
and Louisiana. TCA has deployed the TeraComm system in certain
metropolitan areas in Texas.
Cable operators worldwide are also successfully deploying our
CherryPicker Digital Video Management Systems.
Cable operators that have deployed our CherryPicker system include Cox
Communications, Time Warner and Adelphia.
In addition to cable operators, we market our DSL products to leading
providers of telephony services throughout the world. The pending
acquisition of ANE provides Terayon with a strong customer presence in
the U.S. communications market. ANE's customers include all of the
major U.S. ILECs (Incumbent Local Exchange Carriers), including SBC,
Bell Atlantic, Bell South, U.S. West and GTE. The growth of the
Internet has increased the demands on these and other carriers to
provide incremental bandwidth to support a host of voice and data
services. We believe our DSL line of products is positioned to
participate in the growing broadband DSL market.
Four customers accounted for approximately 66% of our revenues in
1999 and three customers accounted for approximately 70% of our revenues
in 1998. We believe that a substantial majority of our revenues will
continue to be derived from sales to a relatively small number of
customers for the foreseeable future. In addition, we believe that sales
to these customers will be focused on a small number of projects.
Research and Development
We believe that our future success will depend on our ability to
enhance our existing products and to develop and introduce new products
that meet a wide range of evolving broadband access service providers
and end user needs. In addition, to address competitive and pricing
pressures, we expect that we will have to reduce the unit cost of
manufacturing our cable modems through design and engineering changes.
For example, in the fourth quarter of 1998, we introduced a single-board
modem, which provides cost savings over our original dual-board modem.
In 1999, we introduced several new versions of the single-board modem,
each of which represented additional cost savings over the previous
version.
We currently are designing and developing a DOCSIS system that
includes S-CDMA advanced PHY capabilities, which will include a cable
modem and an accompanying headend controller. These products are in the
early stages of development and we do not anticipate commercial
availability of these products until late 2000. We also are developing a
common multimedia platform for current and advanced transmission of
data, voice and video over existing broadband infrastructures, including
cable, DSL and wireless. These products also are in the early stages
of development and we do not anticipate commercial availability of these
products until late 2001.
As of December 31, 1999, we had 111 employees engaged in research and
development. Our total research and development expenses were $17.6
million in 1999, $10.7 million in 1998 and $11.3 million in 1997.
Sales and Marketing
We have direct sales forces in North America, Latin America and
Europe. We also distribute our products via distributors and systems
integrators. We have signed a distribution agreement with Sumitomo under
which Crossbeam is distributing the TeraComm system to several of
Japan's leading cable operators. In January 2000, we signed a
distribution agreement with BARCO Communication Systems, for the sale of
Terayon's CherryPicker systems to cable television operators worldwide.
We market our products directly to providers of broadband access
services through our sales force, key distribution and technology
partners, as well as other marketing vehicles such as industry press,
trade shows and the World Wide Web. Through our marketing efforts, we
strive to educate providers on the technological and business benefits
of our system solution, as well as our ability to provide quality
support and service to the customer. We participate in the major trade
shows and industry events for the broadband access industry in the
United States and we are expanding our presence in other markets through
joint participation at local events with our international sales and
marketing partners. Industry referrals and reference accounts are
significant marketing tools we develop and utilize.
Customer Service and Technical Support
We believe that our ability to consistently provide high quality
service and support will be a key factor in attracting and retaining
customers. Our TSS (Technical Services and Support) organization
provides support 24 hours a day, seven days per week. Prior to
deployment of our systems, each customer's needs are assessed and
proactive solutions are implemented, including various levels of
training, periodic management and coordination meetings, and problem
escalation procedures. We place a strong emphasis on technical training
for our customers. Initial training is offered at no cost, both at our
headquarters in Santa Clara and on our customer's premises. At December
31, 1999, the TSS organization consisted of 28 employees located in
North America, Europe, Latin America and Asia.
In addition to our TSS organization, we have developed sophisticated
tools for remote diagnosis and monitoring of the TeraComm systems
deployed by cable operators. These tools allow us to monitor cable
operators' installations of the TeraLink 1000 Master Controller and to
proactively suggest solutions before problems become noticeable to end
users. We are developing a Web-based knowledge system to provide cable
operators with access to the latest technical support information.
Manufacturing
We outsource the materials procurement, printed circuit board
assembly, and product assembly and testing to turnkey contract
manufacturers. Currently, we contract with Solectron, located in
Milpitas, California, and CalComp Electronics, located in Thailand, for
the manufacture of the majority of our products. We have a limited in-
house manufacturing capability at our Santa Clara headquarters. This
facility currently is used for the assembly and final testing of
TeraLink 1000 Master Controllers and TeraLink Gateways. We also use this
facility for pilot production of new product designs, sample testing of
products received from volume manufacturers, developing the
manufacturing process and documentation for new products in preparation
for outsourcing. We also perform repair operations for some of our
products returned from customers with our in-house manufacturing
resources.
Our future success will depend in significant part on our ability to
obtain high volume manufacturing at low costs. As volume increases, we
plan to engage additional contract manufacturers, to procure additional
manufacturing facilities and equipment, to modify existing inventory
procedures, to substantially increase our personnel and to revise our
quality assurance and testing practices. As part of our efforts to
reduce costs, we began volume shipments in fourth quarter of 1998 of our
single-board cable modem, which has higher gross margins than our
original dual-board cable modem. In 1999, we introduced several cost
reduced versions of the single-board modem, as part of our continuing
cost reduction efforts. We anticipate that we will need to reduce
further the cost to manufacture our products and we will continue to
evaluate the use of low cost third-party suppliers and manufacturers.
Subcontractors supply our contract manufacturers with both standard
components and subassemblies manufactured to our specifications. We
depend upon certain key suppliers for a number of the components for our
products. For example, we currently rely on Philips Semiconductor, Inc.
(formerly VLSI Technology, Inc.) for our S-CDMA ASIC, which is used in
our headend and cable modem products. In addition, all of our products
contain one or more components that currently are only available from a
single source.
Competition
The market for broadband access systems is extremely competitive and
is characterized by rapid technological change. Our direct competitors
in the cable modem arena include Cisco, Com21, Matsushita, Motorola,
Nortel, Phasecom, RCA, Samsung, Scientific-Atlanta, Sony, 3Com, Toshiba
and Zenith and there are many other potential market entrants. We also
sell products that compete with existing data access and transmission
systems utilizing the telecommunications networks, such as those of
3Com. Additionally, our controller and headend system products face
intense competition from well-established companies such as Cisco,
Nortel and 3Com. Our direct competitors in the DSL arena include ECI
Telecom, Charles Industries, Pairgain, Copper Mountain, Accelerated
Networks, Integral Access and Vina Technologies.
The principal competitive factors in the broadband access market
include product performance, features and reliability, price, size and
stability of operations, breadth of product line, sales and distribution
capability, technical support and service, relationships with providers
of broadband access services, standards compliance, and general industry
and economic conditions. Some of these factors are outside of our
control. The existing conditions in the broadband access market could
change rapidly and significantly as a result of technological changes,
and the development and market acceptance of alternative technologies
could decrease the demand for our products or render them obsolete. In
addition, these companies and other competitors could introduce
broadband access products that will be less costly or provide superior
performance or achieve greater market acceptance than our products.
Many of our current and potential competitors have significantly
greater financial, technical, marketing, distribution, customer support
and other resources, as well as greater name recognition and access to
customers.
The market for our products may be impacted by the development of
other technologies that enable the provisioning of broadband access
services and the deployment of services over other media. Widespread
acceptance of other technologies or deployment of services over media
not supported by our products could materially limit acceptance of our
broadband access systems. Broadband access services supported by our
products and technology may fail to gain widespread commercial
acceptance by providers of broadband access services and end users.
Regulation
Our business and our customers are subject to varying degrees of
federal, state and local regulation. The jurisdiction of the Federal
Communications Commission extends to the communications industry,
including our broadband access products. The FCC has promulgated
regulations that, among other things, set installation and equipment
standards for communications systems. Although FCC regulations and other
governmental regulations have not materially restricted our operations
to date, future regulations applicable to our business or our customers
could be adopted by the FCC or other regulatory bodies. For example, FCC
regulatory policies affecting the availability of cable services and
other terms on which cable companies conduct their business may impede
our penetration of certain markets. In addition, regulation of cable
television rates may affect the speed at which cable operators upgrade
their cable infrastructures to two-way HFC. In addition, the increasing
demand for communications systems has exerted pressure on regulatory
bodies worldwide to adopt new standards for such products and services.
This process generally involves extensive investigation of and
deliberation over competing technologies. The delays inherent in this
governmental approval process have in the past, and may in the future,
cause the cancellation, postponement or rescheduling of the installation
of communications systems by our customers.
If other countries begin to regulate the cable modem industry more
heavily or introduce standards or specifications with which our products
do not comply, we will be unable to offer products in those countries
until our products comply with those standards or specifications. In
addition, we may have to incur substantial costs to comply with those
standards or specifications. For instance, should the DAVIC standards
for ATM-based digital video be established internationally, we will need
to conform our cable modems to compete. Further, many countries do not
have regulations for installation of cable modem systems or for
upgrading existing cable network systems to accommodate our products.
Whether we currently operate in a country without these regulations or
enter into the market in a country these regulations do not exist, new
regulations could be proposed at any time. The imposition of regulations
like this could place limitations on a country's cable operators'
ability to upgrade to support our products. Cable operators in these
countries may not be able to comply with these regulations, and
compliance with these regulations may require a long, costly process.
For example, we experienced delays in product shipments to a customer in
Brazil due to delays in certain regulatory approvals in Brazil. Similar
delays could occur in other countries in which we market or plan to
market our products. In addition, our customers in certain parts of
Asia, such as Japan, are required to obtain licenses prior to selling
our products, and delays in obtaining required licenses could harm our
ability to sell products to these customers.
In the United States, in addition to complying with FCC regulations,
our products are required to meet certain safety requirements. For
example, we are required to have our products certified by Underwriters
Laboratory in order to meet federal requirements relating to electrical
appliances to be used inside the home. Outside the United States, our
products are subject to the regulatory requirements of each country in
which the products are manufactured or sold. These requirements are
likely to vary widely. We may be unable to obtain on a timely basis or
at all the regulatory approvals that may be required for the
manufacture, marketing and sale of our products. In addition to
regulatory compliance, some cable industry participants may require
certification of compatibility.
Intellectual Property
We rely on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect
proprietary rights in our products. Our pending patent applications may
not be granted. Even if they are granted, the claims covered by the
patents may be reduced from those included in our applications. Any
patent might be subject to challenge in court and, whether or not
challenged, might not be broad enough to prevent third parties from
developing equivalent technologies or products without taking a license
from us. We have entered into confidentiality and invention assignment
agreements with our employees, and we enter into non-disclosure
agreements with some of our suppliers, distributors and appropriate
customers so as to limit access to and disclosure of our proprietary
information. These statutory and contractual arrangements may not prove
sufficient to prevent misappropriation of our technology or to deter
independent third-party development of similar technologies. In
addition, the laws of some foreign countries might not protect our
products or intellectual property rights to the same extent as do the
laws of the United States. Protection of our intellectual property might
not be available in every country in which our products might be
manufactured, marketed or sold.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOSCIS cable modem specification based in part on
our S-CDMA technology. In September 1999, CableLabs indicated that it
intended to proceed with the advanced PHY work on two parallel tracks: one
for the development of a prototype based on our S-CDMA technology and one
for the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of the
advanced PHY project regarding a separate release that will include TDMA
technologies. In addition, CableLabs reiterated that it is continuing to
work with us on the development of a DOCSIS specification that could include
our S-CDMA technology. To that end, we have indicated to CableLabs that we
would contribute some aspects of our S-CDMA technology to the DOCSIS
intellectual property pool if and when a DOCSIS specification is approved
that includes our S-CDMA technology. We would contribute our technology
pursuant to a license agreement with CableLabs that we would execute at that
time, and which contains the terms that CableLabs has established for the
inclusion of any intellectual property from any source in the DOCSIS
specifications. Under the terms of the proposed license agreement, we would
grant to CableLabs a royalty-free license for those aspects of our S-CDMA
technology that are essential for compliance with the DOCSIS cable modem
standard. So-called "implementation know how" is not covered by this
license-only those aspects of the technology that are essential to
implementing a compliant product. CableLabs would have the right to extend
royalty-free sublicenses to companies that wish to build DOCSIS-compatible
products. These sublicenses would allow participating companies to utilize
and incorporate the essential portions of the S-CDMA technology on a
royalty-free basis for the limited use of making and selling products or
systems that comply with the DOCSIS cable modem specification Terayon has
already joined the DOCSIS intellectual property pool and, as a result, we
have a royalty-free sublicense that allows us to ship DOCSIS-compatible
products which contain intellectual property submitted by other companies.
The scope of this license would not extend to the use of the S-CDMA
technology in other areas; only for products that comply with the DOCSIS
specifications. As a result, any of our competitors who join or have
joined the DOCSIS intellectual property pool will have access to some
aspects of our technology without being required to pay us any royalties or
other compensation. If and when we submit S-CDMA to the DOCSIS Intellectual
Property pool, we are in no way restricted from entering into royalty-
bearing license agreements with companies that wish to use the S-CDMA
technology for purposes other than implementing DOCSIS compatible products,
or that do not wish to enter into the DOCSIS intellectual property pool.
Further, some of our competitors have been successful in reverse engineering
the technology of other companies, and the inclusion of S-CDMA in a future
DOCSIS specification would expose some aspects of our technology to those
competitors. DOCSIS specifications are available on an open basis once they
are approved, not only to companies that are members of the DOCSIS IP Pool.
If a competitor is able to duplicate the functionality and capabilities of
our technology, we could lose all or some of the time-to-market advantage we
might otherwise have. Under the terms of the proposed license agreement, if
we sue certain parties to the proposed license agreement on claims of
infringement of any copyright or patent right or misappropriation of any
trade secret, those parties may terminate our license to the patents or
copyrights they contributed to the DOCSIS intellectual property pool. If a
termination like this were to occur, we would continue to have access to
some aspects of the DOCSIS intellectual property pool, but we would not be
able to develop products that fully comply with the DOCSIS cable modem
specification. Also, even if we were to be removed from the IP pool, we
would not be prevented from developing and selling products that fully
comply with the DOCSIS specifications, but we would not be able to do this
with the benefit of a royalty-free license, which would increase the cost of
our products, assuming we were able to obtain a license agreement for the
required technology. Because of these terms, we may find it difficult to
enforce our intellectual property rights against certain companies, even in
areas that are not directly related to DOCSIS specifications and products.
We anticipate that developers of cable modems increasingly will be
subject to infringement claims as the number of products and competitors
in our industry segment grows. We have received letters from two
individuals claiming that our technology infringes patents held by these
individuals. We have reviewed the allegations made by these individuals
and, after consulting with our patent counsel, we do not believe that
our technology infringes any valid claim of these individuals' patents.
If the issues are submitted to a court, the court could find that our
products infringe these patents. In addition, these individuals may
continue to assert infringement. If we are found to have infringed these
individuals' patents, we could be subject to substantial damages and/or
an injunction preventing us from conducting our business. In addition,
other third parties may assert infringement claims against us in the
future. An infringement claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause product shipment
delays or require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms
acceptable to us or at all. Litigation also may be necessary to enforce
our intellectual property rights.
We pursue the registration of our trademarks in the United States and
have applications pending to register several of our trademarks.
However, the laws of certain foreign countries might not protect our
products or intellectual property rights to the same extent as the laws
of the United States. This means that effective trademark, copyright,
trade secret and patent protection might not be available in every
country in which our products might be manufactured, marketed or sold.
Employees
As of December 31, 1999, we had 248 employees, of which 111 were in
the engineering group, 74 were in marketing, sales and customer support,
29 were in operations and 34 were in general and administrative
functions. None of our employees is represented by a union. We believe
that our relations with our employees are good.
Executive Officers of the Registrant
Certain information regarding our executive officers as of March 24,
2000, is set forth below.
Name Age Position
- - ------------------------- ----- ---------------------------------------
Dr. Zaki Rakib(1)......... 41 Chief Executive Officer and Director
Shlomo Rakib.............. 43 Chairman of the Board, President and
Chief Technical Officer
Ray M. Fritz.............. 54 Chief Financial Officer
Dennis J. Picker.......... 52 Chief Operating Officer
Zaki Rakib co-founded Terayon in 1993 and has served as our Chief
Executive Officer since January 1993 and as a director since February
1995. From January 1993 to July 1998, Dr. Rakib also served as our Chief
Financial Officer. Prior to co-founding Terayon, Dr. Rakib served as
Director of Engineering for Cadence Design Systems, an electronic design
automation software company, from 1990 to 1994. Prior to joining
Cadence, Dr. Rakib was Vice President of Engineering at Helios Software,
which was acquired by Cadence in 1990. Dr. Rakib holds B.S., M.S. and
Ph.D. degrees in engineering from Ben-Gurion University in Israel. Dr.
Rakib is the brother of Shlomo Rakib, our Chairman of the Board,
President and Chief Technical Officer.
Shlomo Rakib co-founded Terayon in 1993 and has served as our
Chairman of the Board and President since January 1993 and as Chief
Technical Officer since February 1995. Prior to co-founding Terayon, Mr.
Rakib served as Chief Engineer at Phasecom, Inc., a communications
products company, from 1981 to 1993, where he pioneered the development
of data and telephony applications over cable. Mr. Rakib is the inventor
of several patented technologies in the area of data and telephony
applications over cable. Mr. Rakib holds a B.S.E.E. degree from Technion
University in Israel. Mr. Rakib is the brother of Zaki Rakib, the Chief
Executive Officer and a director of Terayon.
Ray M. Fritz has served as our Chief Financial Officer since July
1998. Prior to joining us, Mr. Fritz was Vice President of Finance and
Operations and Chief Financial Officer of GigaLabs Inc., a provider of
high performance input/output switching solutions, from December 1997 to
July 1998. From August 1994 until August 1997, Mr. Fritz was with
Clarify, Inc., a provider of front office automation systems, as its
Vice President, Finance and Operations and Chief Financial Officer. From
May 1990 to August 1994, he served as Director, Finance of Synopsys,
Inc., an electronic design automation company, and from April 1986 to
May 1990, Mr. Fritz served as Vice President and Controller of LSI Logic
Corporation, a semiconductor company. Prior to that, he held a variety
of finance positions with Xerox Corporation, The Singer Company and
Shell Oil Company. Mr. Fritz holds a B.S. degree in finance/business
administration from Benedictine College, an M.B.A. degree from Atlanta
University and an M.S. degree in tax from Golden Gate University.
Dennis J. Picker has served as our Chief Operating Officer since
February 1998 and served as our Vice President, Standards from October
1997 to February 1998 and our Vice President, Engineering from May 1996
to October 1997. From 1994 to April 1996, Mr. Picker was Director of the
Cable Data Products Business Unit of Motorola, Inc., an electronics
company, and from 1992 to 1994, he was Senior Director of Data
Networking Products at Motorola. Mr. Picker holds a B.S. degree in
electrical engineering from the University of Pennsylvania and an M.S.
degree in electrical engineering from Northwestern University.
ITEM 2. PROPERTIES
Our headquarters are located in an approximately 60,000 square foot
leased facility located in Santa Clara, California. The current lease
for the Santa Clara facility expires in March 2002. We have sales
offices in Atlanta, Georgia; Sao Paulo, Brazil; and Brussels, Belgium.
In addition, we have facilities in Tel Aviv, Israel. Subsequent to
December 31, 1999, we entered into an agreement to lease approximately
82,000 square feet in Tel Aviv for a period of 5 years. It is our
intention to consolidate the operations of our Israeli operations in
this space. We believe that our existing facilities are adequate to meet
our needs for the immediate future and that our future growth can be
accommodated by leasing additional or alternative space near our current
facilities.
ITEM 3. LEGAL PROCEEDINGS
In September 1999, Imedia Corporation, now our subsidiary, was named
as a defendant in a case alleging that Imedia breached its term sheet
agreement with the Plaintiffs by negotiating with us while a no shop
provision was in place and refusing to allowing the Plaintiffs to invest
in Imedia. The Plaintiffs are seeking damages in excess of $12.0
million. As part of the terms of the Imedia Agreement and Plan of
Merger and Reorganization, shares of our common stock to be issued to
the former shareholders of Imedia were placed in escrow to indemnify us
for any damages that are directly or indirectly suffered as a result any
claim brought by any Person who was a prospective investor in Imedia and
was not a securityholder of Imedia on the closing date of the Imedia
acquisition. The value of the escrowed shares was approximately $10.0
million based on the market value of our common stock on the closing
date. The case is in its initial stages, and no trial date has been
established. We have reviewed the allegations made by the Plaintiffs
and we do not believe that the outcome will have a negative impact on
our financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the
fourth quarter of 1999.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market for the Registrant's Stock
Our common stock is traded on the Nasdaq National Market under the
symbol "TERN." Public trading of our common stock commenced on August
18, 1998. Prior to that, there was no public market for our common
stock. The following table sets forth, for the periods indicated, the
high and low per share sale prices of our common stock, as reported by
the Nasdaq National Market.
High Low
---------- ----------
1998:
Third Quarter (from August 18, 1998).............. $15.186 $7.000
Fourth Quarter.................................... $40.500 $9.250
1999:
First Quarter.................................... $50.125 $25.750
Second Quarter................................... $60.500 $26.375
Third Quarter.................................... $57.625 $31.250
Fourth Quarter................................... $75.000 $37.750
2000:
First Quarter (through March 24, 2000)............ $285.250 $54.500
As of March 24, 2000 there were 535 stockholders of record. We
currently intend to retain any earnings for use in our business and do
not anticipate paying any cash dividends in the foreseeable future.
Recent Sales of Unregistered Securities
In November 1999, we issued 1,500,000 shares of Common Stock valued
at $6.50 per share to Shaw Communications Inc. ("Shaw") pursuant to the
exercise of a warrant to purchase 3,000,000 shares of our common stock
issued in 1998. The issuance and sale of these shares was intended to
be exempt from registration under the Securities Act of 1933 as amended
by virtue of Section 4(2) thereof. Shaw represented its intention to
acquire the securities for investment only and not with a view to the
distribution thereof. Appropriate legends are affixed to the stock
certificate. Shaw received adequate information about us.
In March 2000, we issued 1,843,409 shares of our common stock to
Rogers Communications Inc. ("Rogers"). The shares were issued on a net
issuance basis pursuant to the exercise of two warrants, each to
purchase 1,000,000 shares of our common stock, issued in March 1999. The
issuance and sale of these shares was intended to be exempt from
registration under the Securities Act of 1933 as amended by virtue of
Section 4(2) thereof. Rogers represented its intention to acquire the
securities for investment only and not with a view to the distribution
thereof. Appropriate legends are affixed to the stock certificate.
Rogers received adequate information about us.
Use of Proceeds from Sales of Registered Securities
(d) Use of Proceeds from Sales of Registered Securities. We commenced
our initial public offering on August 18, 1998 pursuant to a
Registration Statement on Form S-1 (the "Registration Statement") (File
No. 333-56911). The managing underwriters of the public offering were BT
Alex. Brown (now known as Deutsche Banc Alex. Brown), Hambrecht & Quist,
Lehman Brothers and Salomon Smith Barney. In the offering, we sold an
aggregate of 3,000,000 shares of our common stock for an initial price
of $13.00 per share.
The aggregate proceeds from the offering were $39.0 million. We paid
expenses of approximately $3.9 million, of which approximately $2.7
million represented underwriting discounts and commissions and
approximately $1.2 million represented expenses related to the offering.
Net proceeds from the offering were $35.1 million. Of the net proceeds,
as of December 31, 1999, approximately $15.1 million had been used to
fund operating activities, $1.5 million had been used for payments on
long-term debt and capital lease obligations, $5.7 million had been used
to purchase property and equipment, $2.4 million had been used to
purchase other assets and $1.8 million had been used to fund a pre-
acquisition loan to Imedia. The use of proceeds described in our
Registration Statement. At December 31, 1999, the remainder of the net
proceeds was invested in short-term, interest-bearing, investment grade
securities.
ITEM 6. SELECTED FINANCIAL DATA
Years Ended December 31,
--------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands, except per share data)
Consolidated Statement of
Operations Data:
Revenues....................... $97,009 $31,696 $2,118 $ -- $ --
Cost of goods sold............. 72,044 34,518 6,462 -- 676
--------- --------- --------- --------- ---------
Gross profit (loss)............ 24,965 (2,822) (4,344) -- (676)
--------- --------- --------- --------- ---------
Operating expenses:
Research and development...... 17,579 10,685 11,319 8,020 2,028
Cost of product development assistance
agreement........................ 35,147 -- -- -- --
In-process research and development 14,600 -- -- -- --
Sales and marketing........... 15,727 6,947 4,468 1,141 205
General and administrative.......... 7,476 3,223 2,546 1,789 825
Goodwill amortization.............. 3,524 -- -- -- --
--------- --------- --------- --------- ---------
Total operating expenses...... 94,053 20,855 18,333 10,950 3,058
--------- --------- --------- --------- ---------
Loss from operations........... (69,088) (23,677) (22,677) (10,950) (3,734)
Net interest income........... 5,008 449 128 253 68
--------- --------- --------- --------- ---------
Net loss....................... (64,080) (23,228) (22,549) (10,697) (3,666)
Series F convertible preferred
stock dividend (1)............... -- 23,910 -- -- --
--------- --------- --------- --------- ---------
Net loss applicable to common
stockholders.................. ($64,080) ($47,138) ($22,549) ($10,697) ($3,666)
========= ========= ========= ========= =========
Historical basic and diluted
net loss per share applicable
to common stockholders........ ($3.11) ($5.25) ($5.26) ($2.64) ($1.02)
========= ========= ========= ========= =========
Shares used in computing
historical basic and diluted
net loss per share applicable
to common stockholders (2)........ 20,630 8,986 4,289 4,054 3,589
========= ========= ========= ========= =========
December 31,
--------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands)
Consolidated Balance
Sheet Data:
Cash, cash equivalents and
short-term investments........ $112,992 $28,880 $1,987 $12,864 $8,620
Working capital (deficit)...... 112,374 24,422 (4,847) 9,971 6,934
Total assets................... 301,236 42,146 8,778 15,978 10,202
Long-term debt (less
current portion).............. 37 10 44 1,255 439
Accumulated deficit............ (148,381) (84,301) (37,163) (14,614) (3,917)
Total stockholders' equity
(net capital deficiency)...... $258,655 $28,103 ($1,174) $11,405 $7,955
(1) See Note 10 of Notes to Consolidated Financial Statements for an
explanation of the convertible preferred stock dividend.
(2) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the method employed to determine the number of shares
used to compute per share amounts.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Our line of business is to develop, market and sell broadband access
systems. Our objective is to be the leading provider of broadband
access systems to providers of services to residential and commercial
end users. Since our inception in January 1993, we have focused on the
development of our patented S-CDMA technology, as well as certain other
core technologies, to enable broadband transmission of data over cable
networks. We began the specification and design of our first ASIC in
October 1994 and produced the first version of this ASIC in September
1996. At the same time, we developed an end-to-end broadband access
system, the TeraComm system, around the ASIC. We commenced volume
shipments of our TeraComm system in the first quarter of 1998. However,
with some recent acquisitions of complimentary technology and
businesses, we have also turned our attention to providers of broadband
services using existing telephone, copper wire infrastructures and
wireless systems.
We sell our products both in North America and internationally, and
we market our products primarily to cable operators and distributors.
Our strategy is to supply leading providers of broadband access services
worldwide. Consistent with this strategy, our initial target market
consisted of the ten largest cable companies in each major geographic
area. In most markets, a small number of large cable operators often
provide services to a majority of the subscribers in a specific region
and thus influence the purchase decisions of smaller cable operators.
In North America, three of the largest cable operators, Rogers Cable
Inc. (formerly Rogers Cablesystems Limited), Shaw Communications Inc.,
and TCA Cable TV, Inc. (a subsidiary of Cox Communications, Inc.), are
deploying the TeraComm system. In Japan, through our partner Sumitomo
Corporation, we have established ourselves as the market leader. In
Europe, our TeraComm system is being deployed by UPC, one of Europe's
largest broadband communications companies. As a result of the nature
of the cable industry and our strategic focus, a small number of
customers have accounted for the majority of our revenues to date, and
we expect that the majority of our revenues will continue to be
generated from a small number of customers for the foreseeable future.
In 1999, four customers accounted for approximately 66% of our revenues.
This compares to approximately 70% of our revenues from three customers
in 1998. We anticipate that the timing and maturity of these customers'
deployments of the TeraComm system will result in variations in revenues
generated from these customers.
The market for broadband access products and services is
characterized by rapid technological change, new product development
product obsolescence and evolving industry standards. A significant
element of our strategy is to advance industry standards and to extend
our technology leadership and achieve rapid time to market. In November
1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version
of the DOCSIS cable modem specification based in part on our S-CDMA
technology. In September 1999, CableLabs indicated that it intended to
proceed with the advanced PHY work on two parallel tracks: one for the
development of a prototype based on our S-CDMA technology and one for
the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of
the advanced PHY project regarding a separate release that will include
TDMA technologies. In addition, CableLabs reiterated that it is
continuing to work with us on the development of a DOCSIS specification
that could include our S-CDMA technology. To that end, CableLabs has
requested that we submit a prototype of a DOCSIS system that
incorporates an S-CDMA advanced PHY capability for testing. CableLabs
has stated that if the testing of this prototype reveals that the S-CDMA
advanced PHY works as claimed (including proper backwards compatibility
and coexistence with the other aspects of DOCSIS), and if the costs for
adding S-CDMA to DOCSIS products are in line with estimates, then it is
likely that S-CDMA advanced PHY capabilities will be included in a
future version of the DOCSIS specification. The prototype we submit to
CableLabs may fail to demonstrate the level of performance that
CableLabs seeks, even if it does meet performance expectations there can
be no guarantee that CableLabs will incorporate the technology into a
future version of DOCSIS specifications. In addition, if CableLabs does
proceed to include S-CDMA in a future DOCSIS specification, there can be
no guarantee that the DOCSIS S-CDMA specification will be the same as
the specification we incorporated in the prototype submitted for tests,
which may require us to further develop our prototype. .We intend to
develop future products that are standards compliant and are actively
participating in the development of additional industry standards. As
part of our efforts to offer standards compliant products we introduced
a CableLabs certified DOCSIS 1.0 cable modem to the market in the third
quarter of 1999.
The rapid evolution of broadband has resulted in cable television
operators, providers of telephone service and other service providers
seeking to provide a bundle of voice, data and video services to their
residential and commercial subscribers over existing and new
infrastructures. Consistent with our objective to be a leading provider
of broadband access systems, through a series of recent acquisitions, we
are building a complete portfolio of broadband products to support high-
speed delivery of voice, data and video services over cable, copper wire
(DSL) and wireless. In the fall of 1999, we acquired Imedia Corporation
and the CherryPicker digital video management system. In November 1999,
we completed our acquisition of Radwiz Ltd., a provider of communication
access systems based on high-speed IP routing, integrated with
telephony, and on January 2, 2000 we completed our acquisition of
Telegate Ltd., a developer and manufacturer of telephony and data access
platforms that are deployed by service providers to deliver efficient
carrier-class voice services over cable. In addition, in February 2000,
we entered into definitive agreements to acquire the Access Network
Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary
of Tyco International Ltd., and Combox Ltd. In March 2000 we entered
into an agreement to purchase certain assets of Internet Telecom Ltd.
and an agreement to acquire Ultracom Ltd.
The intensely competitive nature of the market for broadband access
systems has resulted in significant price erosion over time. We have
experienced and expect to continue to experience downward pressure on
our unit ASP or average selling price. We had negative gross margins
from inception until the fourth quarter of 1998 when we achieved a
positive gross margin for the first time as a result of our execution of
cost reduction strategies. A key component of our strategy is to
decrease the cost of manufacturing our products to improve our gross
margins. For example, in the fourth quarter of 1998, we introduced a
cable modem using a single-board design, which has higher gross margins
than our original dual board design. Subsequently, we have successfully
introduced several cost reduced versions of the single-board modem that
have allowed us to continue to improve gross margin performance despite
ongoing ASP declines. We intend to continue to engage in and implement
cost reduction efforts, including the further integration of ASIC
components, other design changes and manufacturing efficiencies.
We sustained net losses applicable to common stockholders of $64.1
million in 1999, $47.1 million in 1998 and $22.5 million in 1997. As a
result, we had an accumulated deficit of $148.4 million as of December
31, 1999. Our operating expenses are based in part on our expectations
of future sales, and we expect that a significant portion of our
expenses will be committed in advance of sales. We expect to continue to
increase our expenditures in technical development and sales and
marketing as we engage in activities related to product enhancement,
cost reduction and increasing market penetration. Additionally, we
expect to increase our capital expenditures and other operating expenses
in order to support and expand our operations. We anticipate that we
will spend approximately $17.0 million on capital expenditures and
approximately $35.0 to $45.0 million on research and development during
the 12 months ended December 31, 2000. Anticipated capital expenditures
consist of purchases of additional test equipment to support higher
levels of production and computer hardware, furniture and leasehold
improvements for expansion of our facilities, implementation of an ERP
system and software and equipment for newly hired employees. As a result
of these anticipated increased operating expenses, we expect to continue
to incur losses for the foreseeable future.
Acquisition of Imedia Corporation and Radwiz Ltd.
In September 1999, we acquired Imedia Corporation. Imedia developed
and manufactured the CherryPicker digital video management system that
enables cable operators to select and customize their program lineup for
viewer preferences, while maximizing video capacity and quality over
standards-based set-top boxes. The former shareholders and vested
optionholders of Imedia received a total of 1.0 million shares and
options to purchase shares of our common stock. The total purchase
price was approximately $109.0 million. The acquisition was accounted
for under the purchase method of accounting.
In November 1999, we acquired Radwiz Ltd., an Israeli company that
produces communication access systems based on high-speed IP routing,
integrated with telephony. Radwiz's systems include both central office
Digital Subscriber Line Access Multiplexers (DSLAMs) and customer
premises equipment for small office, home office (SOHO) business
broadband services. The former shareholders and vested optionholders
of Radwiz received a total of 946,153 shares and options to purchase
shares of our common stock. The total purchase price was approximately
$53.6 million. The Radwiz acquisition was accounted for under the
purchase method of accounting.
This Report on Form 10-K presents our financial results for the year
ended December 31, 1999 combined results with Imedia for the portion of
the period following September 16, 1999 and Radwiz Ltd for the portion
of the period following November 22, 1999. As a result, the information
contained herein may not be comparable to results in previous years.
Recent Events
In October 1999, we entered into a Share Purchase Agreement to
acquire Telegate Ltd, an Israeli company. Telegate produces telephony
and data access platforms that are deployed by service providers to
deliver efficient carrier-class voice services over cable. Telegate also
provides in-home networking capability for telephony and data, based on
the Digital Enhanced Cordless Telephony (DECT) standard. This
transaction closed on January 2, 2000. The former shareholders and
vested optionholders of Telegate received a total of 2,200,000 shares
and options to purchase shares of our common stock. In addition, the
former shareholders are to receive a cash payment of approximately $3.5
million. The total purchase price was approximately $145.0 million. We
expect to account for the acquisition as a purchase transaction.
In February 2000, we entered into an Asset Purchase Agreement to
acquire certain assets and assume certain liabilities of ANE which
produces DSL systems that provide multiple phone lines over the existing
copper telephony a single pair of copper wires. In general, we will
issue shares and options to purchase shares of our common stock valued
at approximately $85.0 million based on the volume weighted average of
the per share sales price of our common stock as reported on the Nasdaq
National Market for the ten consecutive trading days prior to the
closing date.. In addition, we have agreed to establish an employee
retention program for purposes of retaining certain identified employees
of ANE. The retention program provides for up to 3 annual payments to
the identified employees in a total amount of approximately $4.5 million
provided the employees remain employed by us. The retention payments
will be charged to expense in the period incurred. The transaction is
subject to customary closing conditions and is expected to close in the
second quarter of 2000. We expect to account for the acquisition as a
purchase transaction.
In February 2000, we also entered into a Share Purchase Agreement to
acquire Combox Ltd, an Israeli company that manufactures broadband data
systems and satellite communications based on international standards.
Combox's cable data access systems conform to the growing EuroModem
international specification, based on the Digital Video Broadcasting
(DVB) standard. In general, Combox shareholders will receive a total of
775,000 shares and options to purchase shares of our common stock.
Based on the fair market value of our stock on the days immediately
preceding and following the date the acquisition was announced, the
total purchase price is estimated to be approximately $92.0 million. The
transaction is subject to customary closing conditions and is expected
to close in the second quarter of 2000. We expect to account for the
acquisition as a purchase transaction.
In February 2000, our board of directors approved a two-for-one split
of our outstanding shares of common stock to be effected in the form of
a stock dividend. The stock split is pending stockholder approval of an
increase in our authorized shares and therefore the changes in the
capital structure resulting from the split have not been given
retroactive effect throughout this Report on Form 10-K.
In March 2000, we entered into an Asset Purchase Agreement
("Internet Telecom Agreement") with our subsidiary Telegate, under which
Telegate agreed to purchase certain assets of Internet Telecom Ltd.
("Internet Telecom"), an Israeli company. Internet Telecom is a
supplier of PacketCable and other standards-based, voice-over-IP
("Internet Protocol") systems and technologies. In general, Telegate
will acquire the assets of Internet Telecom in exchange for shares our
common stock valued at approximately $44.0 million based on the fair
market value of our common stock on the days immediately preceding and
following the date the acquisition was announced and a cash payment
estimated at approximately $2.0 million. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, we entered into a Share Purchase Agreement to acquire
Ultracom Ltd. ("Ultracom"), an Israeli company. Ultracom is a supplier
of broadband systems-on-silicon. In general the Ultracom shareholders
and vested optionholders will receive shares and option of our common
stock valued at approximately $30.0 million based on the closing price
of our common stock on the fifth business day immediately preceding the
closing and a cash payment estimated at approximately $2.3 million. We
will also assume the unvested Ultracom options, the value of which will
be included in the purchase price. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, Rogers purchased 1,843,409 shares of our common stock.
The shares were issued on a net issuance basis pursuant to the exercise
of two warrants, each to purchase 1.0 million shares of our common stock
issued in March 1999. Because the warrants were exercised on a cashless
basis the exercise resulted in no proceeds to us.
Results of Operations
Years Ended December 31, 1999 and 1998
Revenues. Our revenues increased to $97.0 million in 1999 from $31.7
million in 1998. Revenues consist primarily of sales of cable modems and
headend equipment to new and existing customers. The increased revenues
in 1999 were primarily attributable to the addition of new customers in
1999 and continuing deployments of our TeraComm system by existing
customers, and, to a lesser extent, the sales of products acquired as a
result of our acquisition of Imedia. The impact on revenues resulting
from the acquisition of Radwiz was not significant for the year ended
December 31, 1999.
We sell our products directly to broadband access service providers,
system resellers and distributors. Revenues related to product sales are
generally recognized when the products are shipped to the customer. A
provision is made for estimated product returns as product shipments are
made. Our existing agreements with our system resellers and distributors
do not contain price protection provisions and do not grant return
rights beyond those provided by the Company's standard warranty.
Cost of Goods Sold. Cost of goods sold consists of direct product
costs as well as the cost of our manufacturing operations group. The
cost of the manufacturing operations group includes assembly, test and
quality assurance for products, warranty costs and associated costs of
personnel and equipment. In 1999, we incurred $72.0 million in cost of
goods sold, which included the cost of our manufacturing operations
group and approximately $1.9 million of amortization of intangibles
assets resulting from the acquisitions of Imedia and Radwiz. In 1998,
we incurred $34.5 million in cost of goods sold, which included the cost
our manufacturing operations group and a charge of $1.3 million relating
to the write-off of obsolete inventory and the transition of
manufacturing operations.
Gross Profit( Loss). Our gross profit was $25.0 million or 26% of
revenue in 1999. This compares to a gross loss of $2.8 million in 1998.
The improvement in our gross profit in 1999 compared to 1998 was due
largely to the introduction of a cable modem using a single-board design
in the fourth quarter of 1998. This modem has a higher gross margin
than our original dual board design. Subsequent to the introduction of
the single-board design, we have successfully introduced cost reduced
versions that have allowed us to continue to improve gross margin. We
intend to continue to engage in and implement cost reduction efforts,
including the further integration of ASIC components, other design
changes and manufacturing efficiencies. We anticipate that continued
decreases in the average sales price of our products will partially, if
not completely, offset the benefits obtained from further cost
reductions, particularly if we are unable to achieve cost reductions
sufficient to offset further average selling price declines.
Our gross profit also is influenced by the sales mix of TeraLink
Master Controllers, TeraLink Gateways and TeraPro cable modems and the
maturity of TeraComm system deployments in any quarter. TeraPro cable
modems have lower margins than the TeraLink Master Controllers and
TeraLink Gateway headend products. New deployments of TeraComm systems
typically include a higher mix of headend equipment and involve smaller
quantities of product sold. Products sold in connection with new
deployments thus generally are sold at higher margins than products
associated with more mature deployments of the TeraComm system, which
generally involve larger quantities of products, primarily cable modems.
We expect that the introduction of new customers and the relationship of
revenues generated from the sale of TeraPro cable modems to our overall
revenue will result in fluctuations in our gross profit in future
periods.
We introduced a CableLabs certified DOSCIS 1.0 cable modem to the
market in third quarter of 1999. We also are currently developing a
DOCSIS system that will include a headend controller. We believe that
the widespread adoption of industry standards will result in further
price pressure. We anticipate that the relationship of revenues
generated from the sale of our proprietary TeraComm system versus a
DOCSIS compliant system will result in fluctuations in our gross profit
in future periods. The impact on our gross margin in 1999 resulting
from the sale of our DOCSIS 1.0 cable modem was not significant.
Our gross margin also is influenced by the level of sales of products
of acquired companies, which produce varying gross margin results. We
expect that our gross margin will fluctuate in future periods as a
result of these and other acquisitions.
Research and Development. Research and development expenses consist
primarily of personnel costs, as well as design expenditures, equipment
and supplies required to develop and to enhance our products. Research
and development expenses increased to $17.6 million in 1999 from $10.7
million in 1998, primarily as a result of increased personnel costs. The
increased personnel costs are a result of expansion in our own employee
base as we continue to focus our efforts on developing new products and
enhancing our current products. The increased personnel costs are also
the result of the acquisitions of Imedia and Radwiz. We intend to
continue to increase investment in research and development as a result
of these and other activities.
Cost of Product Development Assistance Agreement. In March 1999, we
entered into a one-year Product Development Assistance Agreement with
Rogers Communications Inc. Under the terms of the Development Agreement,
Rogers will assist us with the characterization and testing of our
subscriber-end and head-end voice-over-cable equipment. In addition,
Rogers will provide us with technology to assist us with our efforts to
develop high quality, field proven technology solutions that are DOCSIS-
compliant and packet cable-compliant. The Development Agreement has a
term of one year. In consideration of Rogers entering into the
Development Agreement, we issued Rogers two fully vested and non-
forfeitable warrants, each to purchase 1.0 million shares of common
stock on a cashless basis. One warrant has an exercise price of $1.00
per share and one warrant has an exercise price of $37.00 per share.
The warrants may be exercised at any time in full or in part through
March 31, 2000. The fair value of the two warrants was approximately
$45.0 million and will result in a noncash charge included in operations
over the one-year term of the Development Agreement. As a result of
the Development Agreement, our results for 1999 include a noncash charge
of $35.1 million. In March 2000, Rogers purchased 1,843,809 shares of
our common stock on a net exercise basis, resulting in no proceeds to
us.
In-Process Research and Development. We incurred charges of $11.0
million for the year ended December 31, 1999 related to research and
development projects in process at Imedia at the time of the acquisition
and $3.6 million related to research and development project in process
at Radwiz at the time of the acquisition. The projects identified as
in-process will require additional effort in order to establish
technological feasibility. These projects have identifiable
technological risk factors that indicate that even though successful
completion is expected, it is not assured.
In-process technology resulting from the acquisition of Imedia
consists primarily of major additions to Imedia's core technology, which
is related to Imedia's planned development of new features. The
majority of the intended functionality of these new features is not
supported by Imedia's current technology. Intended new features include
offering high quality video service over the Internet and multiplexing
data with video. We expect that in-process technology will be
successfully developed and that initial benefits from these projects
will begin in 2001. However, there remain significant technical
challenges that must be resolved in order to complete the in-process
technology.
In-process technology resulting from the acquisition of Radwiz
consists primarily of major additions to Radwiz's core technology, which
is related to Radwiz's planned development of new features. The
majority of the intended functionality of these new features is not
supported by Radwiz's current technology. Intended new features include
offering: end-to-end carrier quality of service; allowing access via an
ATM network; and, providing ISDN line functionality. We expect that in-
process technology will be successfully developed and that initial
benefits from these projects will begin in mid-year 2000. However,
significant technical challenges must be resolved in order to complete
the in-process technology.
Sales and Marketing. Sales and marketing expenses consist primarily
of salaries and commissions for sales, marketing and support personnel,
and costs related to trade shows, consulting and travel. Sales and
marketing expenses increased to $15.7 million in 1999 from $6.9 million
in 1998, primarily due to increased payroll costs related to additional
sales and support personnel necessary to support the expansion of our
customer base and resulting from the acquisitions of Imedia and Radwiz,
and increased commissions related to higher sales. We expect sales and
marketing expenses to continue to increase as we expand our customer
base.
General and Administrative. General and administrative expenses
primarily consist of salary and benefits for administrative officers and
support personnel, travel expenses, legal, accounting and consulting
fees. General and administrative expenses increased to $7.5 million in
1999 from $3.2 million in 1998. The increase was primarily a result of
costs associated with the increased infrastructure required to support
our expanded activities and due to increased personnel costs associated
with our acquisitions of Imedia and Radwiz. We expect that general and
administrative expenses will continue to increase in the near term as a
result of these factors.
Amortization of Goodwill and Other Intangible Assets. The Imedia
acquisition was completed on September 16, 1999 and was accounted for as
a purchase transaction. The total purchase price, representing the fair
value of our shares issued and transaction and direct acquisition costs,
was approximately $109.0 million. The purchase price was allocated
(based on an independent appraisal) between the net tangible assets of
Imedia on the date of acquisition (approximately $645,000), in-process
research and development (approximately $11.0 million) and intangible
assets acquired (approximately $97.3 million). Intangible assets
consist of developed technology (approximately $27.0 million), assembled
workforce (approximately $2.5 million), trademark (approximately $4.0
million) and goodwill (approximately $63.8 million). The intangible
assets will be amortized straight line over lives ranging from two to
six years. The amortization of developed technology will impact cost of
goods sold in future periods. The amortization of the other intangibles
will principally impact operating expenses in future periods.
The Radwiz acquisition was completed on November 22, 1999 and was
accounted for as a purchase transaction. The total purchase price,
representing the fair value of our shares issued and transaction and
direct acquisition costs, was approximately $53.6 million. The purchase
price was allocated (based on an independent appraisal) between the net
tangible assets of Imedia on the date of acquisition (approximately $3.1
million), in-process research and development (approximately $3.6
million) and net intangible assets acquired (approximately $46.9
million). Intangible assets consist of developed technology
(approximately $29.9 million), assembled workforce (approximately $2.8
million), trademark (approximately $1.1 million) and goodwill
(approximately $24.1 million). Goodwill has been increased and deferred
tax liabilities have been recorded in the amount of approximately $11.0
million to reflect the net tax effect of the book/tax basis differences
in the acquired intangibles, excluding goodwill and in-process research
and development. Deferred tax assets have been realized based on the
projected reversal of taxable temporary differences and have been netted
against deferred tax liabilities for purposes of allocating the purchase
price. The intangible assets will be amortized straight line over lives
ranging from two to six years. The amortization of developed technology
will impact cost of goods sold in future periods. The amortization of
the other intangibles will principally impact operating expenses in
future periods.
We expect amortization of goodwill and other intangibles related to
the acquisitions of Imedia and Radwiz, as well as subsequent
acquisitions, to increase in future periods.
Net Interest Income. Net interest income increased to $5.0 million in
1999 from $449,000 in 1998, primarily as a result of higher average cash
balances subsequent to our public offering in January 1999.
Series F Convertible Preferred Stock Dividend. We recorded a dividend
of $23.9 million in 1998. The dividend represented the fair value of a
warrant to purchase 3,000,000 shares of our common stock (the "Shaw
Warrant"), and was recorded under the provision of EITF No. 96-13,
"Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock." The warrant was issued
in connection with the sale of $5.0 million of convertible preferred
stock to Shaw. Shaw purchased 1,500,000 shares of common stock in March
1999 and 1,500,000 shares of our common stock in November 1999 under the
terms of the Shaw Warrant resulting in net proceeds to us of $19.5
million.
Income Taxes. We have generated operating losses since our inception.
Due to our inability to recognize a benefit from these operating losses
we have no provision for income taxes in 1999 and 1998, We account for
income taxes under Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes ("FAS 109"). Under Statement of Financial
Accounting Standards No. 109, deferred tax assets and liabilities are
determined based on the difference between financial reporting and tax
bases of assets and liabilities, and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected
to reverse. FAS 109 provides for the recognition of deferred tax assets
if realization of such assets is more likely than not. Based upon the
weight of available evidence, which includes the Company's historical
operating performance and the reported cumulative net losses for the
prior three years, the Company has provided a full valuation against its
net deferred tax assets as of December 31, 1999 and 1998. We intend to
evaluate our ability to realize the benefit of the deferred tax assets
on a quarterly basis. See Note 12 to the Consolidated Financial
Statements.
Stock-Based Compensation. As of December 31, 1999, we had recorded
deferred compensation of $2.6 million related to certain stock options
granted in 1998 and 1997. We amortized approximately $631,000 of the
deferred compensation in 1999, $421,000 in 1998 and $12,000 in 1997. The
remainder will be amortized over the related vesting period of the stock
options. See Note 11 of Notes to Consolidated Financial Statements.
Years Ended December 31, 1998 and 1997
Revenues. Our revenues increased to $31.7 million in 1998 from $2.1
million in 1997. Revenues consist primarily of sales of cable modems and
headend equipment to new and existing customers. We did not commence
selling our products until June 1997 and did not commence selling our
products in volume until the first quarter of 1998.
Cost of Goods Sold. In 1998, we incurred $34.5 million in cost of
goods sold, which included the costs our manufacturing operations group
and a charge of $1.3 million relating to the write-off of obsolete
inventory and the transition of manufacturing operations. In 1997, we
incurred $6.5 million in cost of goods sold, which included the cost of
the manufacturing group for the entire period as we readied our products
for commercialization.
Gross Loss. We incurred a gross loss of $2.8 million in 1998. In
1997, we incurred a gross loss of $4.3 million due to costs associated
with our manufacturing operations group. The decrease in gross loss in
1998 compared to 1997 was primarily due to a reduced negative margin on
cable modems, which was partially offset by the $1.3 million write-off
relating to obsolete inventory and the transition of manufacturing
operations to Solectron. We completed the transition to a lower
cost, single-board modem product in the fourth quarter of 1998.
Primarily as a result of this lower cost product, we achieved a positive
gross margin of $425,000 in the fourth quarter of 1998.
Research and Development. Research and development expenses decreased
to $10.7 million in 1998 from $11.3 million in 1997 as a result of the
timing of our development projects.
Sales and Marketing. Sales and marketing expenses increased to $6.9
million in 1998 from $4.5 million in 1997, primarily due to increased
payroll costs related to additional sales and support personnel for
commercial trials and deployment of our products and increased
commissions related to higher sales in 1998.
General and Administrative. General and administrative expenses
increased to $3.2 million in 1998 from $2.5 million in 1997, primarily a
result of the additional reporting requirements imposed on us as a
public company and increased infrastructure to support our expanded
activities.
Net Interest Income. Net interest income increased to $449,000 in
1998 from $128,000 in 1997, primarily as a result of higher average
cash balances subsequent to our initial public offering in August 1998.
Series F Convertible Preferred Stock Dividend. We recorded a dividend
of $23.9 million in 1998. The dividend represents the fair value the
Shaw Warrant. The Shaw Warrant was issued in connection with the sale of
$5.0 million of convertible preferred stock to Shaw (the "Shaw
Financing"). Our accounting conclusion was that the sale of preferred
stock was, in substance, a financing transaction and not the issuance of
equity instruments in exchange for goods or services.
Income Taxes. We have not generated operating losses since inception.
Due to our inability to recognize a benefit from these operating losses
we have no provision for income taxes in 1998 and 1997. We account for
income taxes under Statement of Financial Accounting Standards No. 109.
Realization of deferred tax assets is dependent on future earnings, if
any, the timing and amount of which are uncertain. Accordingly,
valuation allowances in amounts equal to the net deferred tax assets as
of December 31, 1998 and 1997 have been established to reflect these
uncertainties.
Stock-Based Compensation. As of December 31, 1998, we had recorded
deferred compensation of $2.6 million related to certain stock options
granted in 1998 and 1997. We amortized approximately $421,000 of the
deferred compensation in 1998 and $12,000 in 1997. The remainder will be
amortized over the related vesting period of the stock options. See Note
10 of Notes to Consolidated Financial Statements.
Liquidity and Capital Resources
We have met our liquidity needs since inception through December 31,
1999 primarily through private sales of preferred stock, an initial
public offering completed in August 1998 and a public offering completed
in January 1999. The private sales of preferred stock resulted in
aggregate proceeds to us, before deduction of issuance costs, of $52.7
million. The initial public offering of 3,000,000 shares of common stock
at a price of $13.00 per share resulted in net proceeds of $35.1
million. The public offering of 1,750,000 shares of our common stock
and the exercise of the over allotment option of 351,946 shares of new
common stock at a price of $38.00 completed in January 1999 resulted in
net proceeds of $62.5 million.
On January 21, 1999, we completed a public offering of 3,250,000
shares of common stock at a offering price of $38.00 per share. Of the
3,250,000 shares, we sold 1,750,000 shares and certain selling
stockholders sold 1,500,000 shares. We received net proceeds of $62.5
million, after the underwriting discount of approximately $3.3 million
and offering expenses of approximately $700,000. The proceeds from this
offering have been designated for general corporate purposes. On
February 9, 1999, the underwriters exercised their option to purchase
487,500 additional shares of common stock to cover over-allotments, of
which 351,946 shares were purchased from us and 135,554 shares were
purchased from certain selling stockholders. Our net proceeds from the
exercise of the over-allotment option were $12.7 million.
In March 1999, Shaw purchased 1,500,000 shares of our common stock at
$6.50 per share and in November 1999 Shaw purchased an additional
1,500,000 shares of our common stock at $6.50 per share, resulting in
net proceeds to us of $19.5 million. The shares were purchased pursuant
to the exercise of a warrant to purchase 3,000,000 shares of our common
stock issued to Shaw in 1998.
We have used cash in operating activities of $58.7 million since our
inception through December 31, 1999. Cash used in operating activities
was $8.1 million in 1999, $18.1 million in 1998 and $20.8 million in
1997. Cash used in investing activities was $72.2 million in 1999 and
$16.1 million in 1998. Investment activities in 1999 and 1998 consisted
primarily of the purchase of short-term investments. Cash provided by
investing activities, primarily from the sales and maturities of short-
term investments, was $1.5 million in 1997. Cash provided by financing
activities was $98.3 million in 1999, $47.0 million in 1998 and $12.6
million in 1997. Cash provided by financing activities consisted
primarily of proceeds from private sales of preferred stock in 1998,
1997 and 1996, proceeds from our initial public offering of common stock
in 1998 and proceeds from our public offering in January 1999, as well
as proceeds from the exercise of options and warrants in 1999.
At December 31, 1999, we had approximately $32.4 million in cash and
cash equivalents, $80.6 million in short-term investments and had
available a $2.5 million revolving line of credit. There was an unused
standby letter of credit of $150,000 against the line of credit and
approximately $2.35 million was available at December 31, 1999.
Our cash equivalents and short-term investments are subject to market
risk, primarily interest rate and credit risk. Our investments are
managed by outside professional managers within guidelines we establish.
The guidelines, which include security type, credit quality and
maturity, are intended to limit market risk by restricting our
investments to high quality debt instruments with short-term maturities.
Due to the relatively short-term duration of our investments at December
31, 1999, a 1% (100 basis point) increase in short-term interest rates
would not have a significant impact on the market value of our
investments. Our investments in debt securities are classified as
available-for-sale, therefore, we do not recognize gains or losses due
to changes in interest rates unless such securities are sold prior to
maturity. We generally hold securities until maturity and carry the
securities at amortized cost, which approximates market value.
As of December 31, 1999, we had approximately $48.8 million of
unconditional purchase obligations. We anticipate that we will pay these
obligations by March 2000. We intend to make these payments out of
available working capital.
We believe that our current cash balances will be sufficient to
satisfy our cash requirements for at least the next 24 months. We may
require additional financing prior to that time to fund our operations
and we may seek to raise such additional funds through the sale of
public or private equity or debt financing or from other sources. The
sale of additional equity or debt securities may result in additional
dilution to our stockholders. Additional financing may not be available
to us on acceptable terms, or at all, when we require it.
Impact of Year 2000
In prior years, we discussed the nature and progress of our plans to
become Year 2000 ready. In late 1999, we completed the remediation and
testing of our systems. As a result of those planning and
implementation efforts, we experienced no significant disruptions in
mission critical information technology and non-information technology
systems and we believe those systems successfully responded to the Year
2000 date change. We incurred no significant costs in 1999 in
connection with the remediation of our systems. We are not aware of any
material problems resulting from Year 2000 issues, either with our
products, our internal systems, or the products and services of third
parties. We will continue to monitor our mission critical computer
applications and those of our suppliers and vendors throughout the year
2000 to ensure that any latent Year 2000 matters that may arise are
addressed promptly.
Recent Financial Accounting Pronouncement
In September 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. FAS 133 was effective
for fiscal years beginning after September 15, 1999. In July 1999, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and
Hedging Activities -Deferral of the Effective Date of FASB Statement No.
133" (FAS 137). FAS 137 defers for one year the effective date of FAS
133 which will now apply to all fiscal quarters of all fiscal years
beginning after June 15, 2000. We believe that the adoption of FAS 137
will not have a significant impact on our operating results or cash
flows.
In December 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides guidance on the recognition,
presentation and disclosure of revenue in the financial statements of
public companies. The accounting profession is currently exploring
practical means of implementing the guidelines established by SAB 101.
To the extent that SAB 101 is applicable to us, we will be required to
change our revenue recognition policy. Changes in our revenue
recognition polices will be reported as a change in accounting principle
in the second quarter ended June 30, 2000. The change in accounting
principle will not result in any restatement of prior periods but will
result in a cumulative adjustment in the second quarter to reflect the
deferral of revenue previously recognized for shipments that did not
meet the revenue recognition criteria established by SAB 101. Any such
revenue deferred will be subsequently recognized in the period in which
the revenue recognition criteria are met. Revenue for all shipments
occurring after April 1, 2000 will be recognized based on the criteria
established by SAB 101. We currently cannot determine what effect, if
any, that SAB 101 will have on our financial statements. Management
believes that SAB 101 will not affect the underlying strength or
weakness of our business operations as measured by the dollar value of
our product shipments and cash flows.
Certain Business Risks
We Have a Limited Operating History and a History of Losses.
We have a limited operating history, and it is difficult to predict
our future operating results. We were incorporated in January 1993 and
began shipping products commercially in June 1997. We have only been
shipping products in volume since the first quarter of 1998. As of
December 31, 1999, we had an accumulated deficit of $148.4 million. We
believe that we will continue to experience net losses for the
foreseeable future. Most of our expenses are fixed in advance, and we
generally are unable to reduce our expenses significantly in the short
term to compensate for any unexpected delay or decrease in anticipated
revenues. We expect to continue to increase expense for the foreseeable
future to support increased sales and marketing and technical support
costs. Any significant delay in our anticipated revenues or
commercialization of new products would harm our business. The revenue
and profit potential of our business and our industry are unproven. We
had negative gross margins from our inception until the fourth quarter
of 1998, and any future revenue growth may not result in positive gross
margins or operating profits in future periods.
Our Operating Results May Fluctuate.
Our quarterly revenues are likely to fluctuate significantly in the
future due to a number of factors, many of which are outside our
control. Factors that could affect our revenues include the following:
* variations in the timing of orders and shipments of our products;
* variations in the size of the orders by our customers;
* new product introductions by competitors;
* delays in introducing new products;
* delays of orders forecasted by our customers;
* delays by our customers in the completion of upgrades of cable
infrastructure;
* variations in capital spending budgets of broadband access
service providers;
* adoption of industry standards and the inclusion in or
compatibility of our technology with any such standards; and,
* delays in obtaining regulatory approval for commercial deployment
of cable modem systems.
Our expenses generally will vary from quarter to quarter depending
on the level of actual and anticipated business activities. Research and
development expenses will vary as we begin development of new products
and as our development programs move to wafer fabrication, which results
in higher engineering expenses.
We have a limited backlog of orders, and net sales for any future
quarter are difficult to predict. Supply, manufacturing or testing
constraints could result in delays in the delivery of our products. Any
delay in the product deployment schedule of one or more of the providers
of broadband access services that we target would have an adverse effect
on our operating results for a particular period. In addition, due to
the large dollar size of a typical transaction in comparison to our
total revenues, any delay in the closing of a transaction could have a
significant impact on our operating results for a particular period.
A variety of factors affect our gross margin, including the
following:
* the sales mix of our products;
* the volume of products manufactured;
* the type of distribution channel through which we sell our
products;
* the average selling prices or "ASPs" of our products; and
* the effectiveness of our cost reduction measures.
We anticipate that unit ASPs of our products will decline in the
future. This could cause a decrease in the gross margins for these
products. In addition, the maturity of TeraComm system deployments
affects our gross margin. New deployments of the TeraComm system involve
the sale of headend equipment (which has higher margins) and generally
involve smaller quantities of product. New deployments typically are
sold at higher margins than the larger volume sales of product
associated with more mature deployments of the TeraComm system. The
sales mix of TeraLink 1000 Master Controllers, TeraLink Gateways and
TeraPro cable modems also affects our gross margin. The TeraPro cable
modems have significantly lower margins than the TeraLink 1000 Master
Controller and TeraLink Gateway headend products. We expect to achieve
only nominal margins on the TeraPro cable modems for the foreseeable
future. Further, we expect that sales of TeraPro cable modems will
continue to constitute a significant portion of our revenues for the
foreseeable future.
We also anticipate that our operating results will be impacted by
sales, gross profit and operating expenses of acquired companies. The
impact of these factors on our operating results will vary as we acquire
additional companies.
We Are Dependent on a Small Number of Customers.
Four customers accounted for approximately 66% of our revenues for
the year ended December 31, 1999 and three customers accounted for
approximately 70% of our revenues for the year ended December 31, 1998.
We believe that a substantial majority of our revenues will continue to
be derived from sales to a relatively small number of customers for the
foreseeable future. In addition, we believe that sales to these
customers will be focused on a small number of projects.
The cable industry is undergoing significant consolidation in North
America and internationally, and a limited number of cable operators
controls an increasing number of cable systems. As a result, our sales
will be largely dependent upon product acceptance by the leading cable
operators. Currently, ten cable operators in the United States own and
operate facilities passing approximately 86% of total homes passed.
Currently, the timing and size of each customer's order is critical to
our operating results. Our major customers are likely to have
significant negotiating leverage and may attempt to change the terms,
including pricing, upon which we do business with them. These customers
also may require longer payment terms than we anticipate, which could
require us to raise additional capital to meet our working capital
requirements. Our success will depend on our cable modems being widely
deployed and our ability to sell to new customers.
Acquisitions Could Result In Dilution, Operating Difficulties and Other
Harmful Consequences.
We have acquired three companies since September 1999: Imedia
Corporation in September 1999, Radwiz Ltd. in November 1999 and Telegate
Ltd. in January 2000. In addition, in February 2000 we entered into
definitive agreements to acquire the Access Network Electronics division
(ANE) of Tyco Electronics Corporation and Combox Ltd., and in March 2000
we entered into a definitive agreements to acquire certain assets of
Internet Telecom Ltd. and to acquire all of the outstanding shares of
Ultracom Ltd. We expect each of these acquisitions to close in the
second quarter of 2000, subject to certain closing conditions. If
appropriate opportunities present themselves, we intend to acquire
additional businesses, technologies, services or products that we
believe are strategic. The process of integrating any acquired business
into our business and operations is risky and may create unforeseen
operating difficulties and expenditures. The areas in which we may face
difficulties include:
* diversion of management time (both ours and that of the
acquired companies) during the period of negotiation through
closing and after closing from the ongoing development of our
businesses, issues of integration and future products;
* decline in employee morale and retention issues resulting from
changes in compensation, reporting relationships, future
prospects or the direction of the business;
* the need to integrate each company's accounting, management
information, human resource and other administrative systems
to permit effective management, and the lack of control if
this integration is delayed or not implemented; and
* the need to implement controls, procedures and policies
appropriate for a larger public group of companies that prior
to acquisition had been smaller, private companies.
We have very limited experience in managing this integration
process. Moreover, the anticipated benefits of any or all of these
completed or pending acquisitions may not be realized. Future
acquisitions could result in potentially dilutive issuances of equity
securities, the incurrence of debt, contingent liabilities or
amortization expenses related to goodwill and other intangible assets,
any of which could harm our business. Future acquisitions also could
require us to obtain additional equity or debt financing, which may not
be available on favorable terms or at all. Even if available, this
financing may be dilutive.
The Sales Cycle for Our Products Is Lengthy.
The sales cycle associated with our products typically is lengthy,
often lasting six months to a year. Our customers typically conduct
significant technical evaluations of competing technologies prior to the
commitment of capital and other resources. In addition, purchasing
decisions may be delayed because of our customers' internal budget
approval procedures. Sales also generally are subject to customer
trials, which typically last three months. Because of the lengthy sales
cycle and the large size of customers' orders, if orders forecasted for
a specific customer for a particular quarter do not occur in that
quarter, our operating results for that quarter could suffer.
There are Many Risks Associated with Our Participation in the
Establishment of Advanced Physical Layer specifications to be added to
DOCSIS.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOSCIS cable modem specification based in part
on our S-CDMA technology. In September 1999, CableLabs indicated that it
intended to proceed with the advanced PHY work on two parallel tracks:
one for the development of a prototype based on our S-CDMA technology
and one for the inclusion of Advanced TDMA technology, as proposed by
other companies. In February 2000, CableLabs further clarified the
status of the advanced PHY project regarding a separate release that
will include TDMA technologies. In addition, CableLabs reiterated that
it is continuing to work with us on the development of a DOCSIS
specification that could include our S-CDMA technology. To that end,
CableLabs has requested that we submit a prototype of a DOCSIS system
that incorporates an S-CDMA advanced PHY capability for testing.
CableLabs has stated that if the testing of this prototype reveals that
the S-CDMA advanced PHY works as claimed (including proper backwards
compatibility and coexistence with the other aspects of DOCSIS), and if
the costs for adding S-CDMA to DOCSIS products are in line with
estimates, then it is likely, but not certain, that S-CDMA advanced PHY
capabilities will be included in a future version of the DOCSIS
specification. The prototype we submit to CableLabs may fail to
demonstrate the level of performance that CableLabs seeks, even if it
does meet performance expectations there can be no guarantee that
CableLabs will incorporate the technology into a future version of
DOCSIS specifications. In addition, if CableLabs does proceed to
include S-CDMA in a future DOCSIS specification, there can be no
guarantee that the DOCSIS S-CDMA specification will be the same as the
specification we incorporated in the prototype submitted for tests,
which may require us to further develop our prototype.
Our future revenues and operating results are likely to suffer if S-
CMDA is not included in a future release of DOCSIS. We also may incur
substantial additional research and development expenditures to adapt
our specifications to the version adopted by CableLabs.
CableLabs has not established a schedule for adding the S-CDMA
capabilities to the DOCSIS specifications. Delays in the establishment
of a final specification for S-CDMA in DOCSIS could harm our plans to
sell DOCSIS compatible modems and headend equipment. In particular, if
the final DOCSIS S- CMDA specification is not approved prior to the time
when we ready to ship DOCSIS products with S-CDMA features included,
then we may be required to delay the introduction of those products
until the DOCSIS S-CDMA specification is released or to introduce the S-
CDMA features as proprietary enhancements to a standard DOCSIS product.
Either one of these events could harm revenues and operating results.
We have already given CableLabs assurances that we will contribute
some aspects of our proprietary S-CDMA technology to a royalty-free
intellectual property pool, if S-CDMA is included in a future version of
DOCSIS specifications. This royalty-free pool has been established by
CableLabs to facilitate the participation of as many vendors as possible
in providing equipment that is compatible with the DOCSIS
specifications. As a result, any of our competitors who join the DOCSIS
intellectual property pool would have access to some aspects of our
technology and would not be required to pay us any royalties or other
compensation. If a competitor is able to duplicate the functionality and
capabilities of our technology, we could lose some or all of the time-
to-market advantage we might otherwise have, which could harm our future
revenues and operating results.
We believe the addition of advanced upstream PHY capabilities to
DOCSIS will increase the overall market for DOCSIS-compatible products,
and as such will result in increased competition in the cable modem
market. This competition could come from existing competitors or from
new competitors who enter the market as a result of the enhancements to
the specifications. This increased competition is likely to result in
lower ASPs of cable modem systems and could harm revenues and gross
margins. Because our competitors will be able to incorporate some
aspects of our technology into their products, our current customers may
choose alternate suppliers or choose to purchase DOCSIS- compliant cable
modems with advanced PHY capabilities from multiple suppliers. We may be
unable to produce DOCSIS compliant cable modems with advanced PHY
capabilities more quickly or at lower cost than our competitors. The
inclusion of our S-CDMA technology in future DOCSIS specification could
result in increased competition for the services of our existing
employees who have experience with S-CDMA. The loss of these employees
to one or more competitors could harm our business.
DOCSIS standards have not yet been accepted in Europe and Asia. An
alternate standard for cable modem systems, called the EuroModem
standard, or DAVIC/DVB, has been formalized, and some European cable
system operators have embraced it. We intend to develop and sell
products that comply with the EuroModem standard and to pursue having
portions of our S-CDMA technology included in a future version of the
EuroModem standard. We may be unsuccessful in these efforts.
We Need to Develop New Products.
Our future success will depend in part on our ability to develop,
introduce and market new products in a timely manner. We also must
respond to competitive pressures, evolving industry standards and
technological advances. Our current S-CDMA products are not DOCSIS-
compliant. We are currently developing a prototype of a DOCSIS system
that incorporates an S-CDMA advanced PHY capability for testing and
eventual inclusion in the DOCSIS standard. There is no guarantee that
we will be successful in developing the prototype or that the prototype,
if successfully developed, will be included in a future release of the
DOCSIS standard. We anticipate that during 2000, existing or potential
customers may delay purchases of our current cable modem system in order
to purchase systems that comply with the DOCSIS standard. In addition,
potential new customers could decide to purchase DOCSIS compliant
products from one or more of our competitors rather than from us. As a
result, our product sales in the second half of 2000 may be lower than
we anticipate. In order to promote sales of our currents products we
may be required to reduce our prices for sales to existing customers.
This would harm our operating results and gross margin.
As a result of the inclusion of TDMA technology in the new DOCSIS
version announced by CableLabs in February 2000, we will have to
incorporate advanced TDMA technology into our DOCSIS-compliant products.
If we are unable to do this effectively, or in a timely manner, we will
lose some or all of the time-to-market advantage we might otherwise have
had.
Our future success will also depend on our ability to develop and
market DSL products for broadband applications. The market for DSL
broadband applications is also subject to evolving standards, such as
NEBS compliance in the North American market, and technological
advances. There is no guarantee that we will be successful in
developing products that are compliant with these standards or that we
will be successful in keeping pace with future technological advances in
this arena.
Average Selling Prices of Cable Equipment Typically Decrease.
The cable equipment systems industry has been characterized by
erosion of average selling prices. We expect this to continue. This
erosion is due to a number of factors, including competition, rapid
technological change and price performance enhancements. The average
selling prices for our products may be lower than expected as a result
of competitive pricing pressures, our promotional programs and customers
who negotiate price reductions in exchange for longer term purchase
commitments. We anticipate that ASPs and gross margins for our products
will decrease over product life cycles. In addition, we believe that the
widespread adoption of industry standards is likely to further erode
ASPs, particularly for cable modems. It is likely that the widespread
adoption of industry standards will result in increased retail
distribution of cable modems, which could put further price pressure on
our modems. Decreasing ASPs could result in decreased revenue even if
the number of units sold increases. As a result, we may experience
substantial period-to-period fluctuations in future operating results
due to ASP erosion. Therefore, we must continue to develop and introduce
on a timely basis next-generation products with enhanced functionalities
that can be sold at higher gross margins. Our failure to do this could
cause our revenues and gross margin to decline.
We Must Achieve Cost Reductions.
Certain of our competitors currently offer cable modems at prices
lower than ours. Market acceptance of our products will depend in part
on reductions in the unit cost of our products. We expect that as
headend equipment becomes more widely deployed, the price of cable
modems and other products will decline. In particular, we believe that
the widespread adoption of industry standards such as DOCSIS will cause
increased price competition for cable modems. However, we may be unable
to reduce the cost of our modems sufficiently to enable us to compete
with other cable modem suppliers. Our cost reduction efforts may not
allow us to keep pace with competitive pricing pressures or lead to
gross margin improvement.
Some of our competitors are larger and manufacture products in
significantly greater quantities than we intend to for the foreseeable
future. Consequently, these competitors have more leverage in obtaining
favorable pricing from suppliers and manufacturers. In order to remain
competitive, we must significantly reduce the cost of manufacturing our
cable modems through design and engineering changes. We may not be
successful in redesigning our products. Even if we are successful, our
redesign may be delayed or may contain significant errors and product
defects. In addition, any redesign may not result in sufficient cost
reductions to allow us to significantly reduce the list price of our
products or improve our gross margin. Reductions in our manufacturing
costs will require us to use more highly integrated components in future
products and may require us to enter into high volume or long-term
purchase or manufacturing agreements. Volume purchase or manufacturing
agreements may not be available on acceptable terms. We could incur
expenses without related revenues if we enter into a high volume or
long-term purchase or manufacturing agreement and then decide that we
cannot use the products or services offered by such agreement.
We Must Keep Pace with Rapid Technological Change to Remain Competitive.
The markets for our products are characterized by rapid
technological change, evolving industry standards, changes in end-user
requirements and frequent new product introductions and enhancements.
Our future success will depend upon our ability to enhance our existing
products and to develop and introduce new products that achieve market
acceptance. Providers of broadband access services may adopt alternative
technologies or they may deploy alternative services that are
incompatible with our products.
The demand for broadband access services has resulted in the
development of several competing modulation technologies. Our products
utilize a modulation technology known as Synchronous Code Division
Multiple Access or "S-CDMA," while several of our competitors utilize
modulation technologies known as Time Division Multiple Access or "TDMA"
and Frequency Division Multiple Access or "FDMA." Our headend equipment
and cable modem products currently are not interoperable with the
headend equipment and modems of other suppliers of broadband access
products. As a result, potential customers who wish to purchase
broadband access products from multiple suppliers may be reluctant to
purchase our products. Although our technology may be incorporated into
a future version of a DOCSIS specification or another industry standard,
we cannot be certain that major cable operators will adopt these
standards. Major cable operators may not adopt products or technologies
based on our current proprietary S-CDMA technology or on any future
industry standard S-CDMA technology. Further, major cable operators may
adopt products or standards technologies based on competing modulation
technologies. If competitors using other modulation technologies can
incorporate functionality and capabilities currently found in S-CDMA,
the value of our S-CDMA technology would be diminished.
Broadband Access Services Have Not Achieved Widespread Market Acceptance
and Many Competing Technologies Exist.
Our success will depend upon the widespread commercial acceptance of
broadband access services by service providers and end users of
broadband access services. The market for these services is not fully
developed. We cannot accurately predict the future growth rate or the
ultimate size of the market for broadband access services. Potential
users of our products may have concerns regarding the security,
reliability, cost, ease of installation and use and capability of cable
modems in general.
The market for our products may be impacted by the development of
other technologies that enable the provisioning of broadband access
services and the deployment of services over other media. Widespread
acceptance of other technologies or deployment of services over media
not supported our products could materially limit acceptance of our
broadband access systems. Broadband access services based on our
products and technology may fail to gain widespread commercial
acceptance by providers of broadband access services and end users. In
addition, we only recently began to offer products based on alternate
technologies such as DSL. We may not be successful in marketing and
selling these products.
We Need to Develop Additional Distribution Channels.
We presently market our TeraComm system to cable operators and
systems integrators. We believe that much of the North American cable
modem market may shift to a retail distribution model. Accordingly, we
may need to redirect our future marketing efforts to sell our cable
modems directly to retail distributors and end users. This shift would
require us to establish new distribution channels for our products. We
may be unable to establish these additional distribution channels. If we
do establish them, we may be unable to hire the additional personnel
necessary to foster and enhance such distribution channels. In addition,
if the cable modem market shifts to a retail distribution model, we may
not successfully establish a retail distribution presence. To the extent
that large consumer electronics companies enter the cable modem market,
their well-established retail distribution capabilities would provide
them with a significant competitive advantage.
We May Be Unable to Market Effectively to Broadband Access Service
Providers.
Our growth and future success will be substantially dependent upon
our ability to convince providers of broadband access services to adopt
our technologies, purchase our products and effectively market our
products to end users. Our potential customers are likely to prefer
purchasing products from established manufacturing companies that can
demonstrate the capability to supply large volumes of products on short
notice. In addition, many of our potential customers may be reluctant to
adopt technologies that have not gained acceptance among other providers
of similar services. This reluctance could result in lengthy product
testing and acceptance cycles for our products. Consequently, the
impediments to our initial sales may be even greater than those to later
sales.
No established distribution network in the cable modem industry
exists that would provide us with easy access to smaller or
geographically diverse cable operators. Therefore, our initial sales to
larger, more established cable operators are critical to our business.
Although we intend to establish strategic relationships with leading
distributors worldwide, we may not succeed in establishing these
relationships. Even if we do establish these relationships, the
distributors may not succeed in marketing our products to cable
operators. Some of our competitors have already established
relationships with certain cable operators, such as Motorola Inc.'s
relationships with Tele-Communications, Inc. or "TCI," Time Warner
Cable, Comcast Corporation and Cox Communications, Inc. These
established relationships may further limit our ability to sell products
to those cable operators. We do not have long, well-established
relationships with those cable operators. If we were to sell our
products to those cable operators, it would likely not be based on long-
term contracts and those customers would be able to terminate their
relationships with us at any time. In addition, one or more of our
current customers could cancel its relationship with us at any time.
We have recently begun marketing and selling our products to
providers of DSL broadband services and thus we have very limited
experience. We do not have long, well-established relationships with
these telephony providers and we may not be successful in establishing
these relationships.
We Are Dependent on Cable Operators and Other Service Providers.
We depend on cable operators to purchase our cable modem systems and
to provide our cable modems to end users. Cable operators have a limited
amount of available bandwidth over which they can offer robust data
services, and they may not choose to provide these data services to
their customers. If cable operators choose to provide these services, we
also will depend upon them to market these services to cable customers,
to install our equipment and to provide support to end users. In
addition, we will be highly dependent on cable operators to continue to
maintain their cable infrastructure in a manner that allows us to
provide consistently high performance and reliable services. Our success
also will depend upon the acceptance of our products by other providers
of services to the cable industry, such as Excite@ Home's @Home Network
and Road Runner, a joint venture between MediaOne Group, Inc. and Time
Warner Cable.
We Are Dependent on the Cable Industry to Upgrade to Two-Way Cable
Infrastructure.
Demand for our products will depend to a significant degree upon the
magnitude and timing of capital spending by cable operators for
implementation of access systems for data transmission over cable
networks. This involves the enabling of two-way transmission over
existing coaxial cable networks and the eventual upgrade to HFC in areas
of higher penetration of data services. If cable operators fail to
complete these upgrades of their cable infrastructures in a timely and
satisfactory manner, the market for our products could be limited. In
addition, few businesses in the United States currently have cable
access. Cable operators may not choose to upgrade existing residential
cable systems or to install new cable systems to serve business
locations.
The success and future growth of our business will be subject to
economic and other factors affecting the cable television industry
generally, particularly its ability to finance substantial capital
expenditures. Capital spending levels in the cable industry in the
United States have fluctuated significantly in the past, and we believe
that such fluctuations will occur in the future. The capital spending
patterns of cable operators are dependent on a variety of factors,
including the following:
* the availability of financing;
* cable operators' annual budget cycles, as well as the typical
reduction in upgrade projects during the winter months;
* the status of federal, local and foreign government regulation
and deregulation of the telecommunications industry;
* overall demand for cable services;
* competitive pressures (including the availability of
alternative data transmission and access technologies);
* discretionary consumer spending patterns; and
* general economic conditions.
In recent periods, the United States cable market has been
characterized by the acquisition of smaller and independent cable
operators by large cable operators. We cannot predict the effect, if
any, that consolidation in the United States cable industry will have on
overall capital spending patterns by cable operators. The effect on our
business of further industry consolidation also is uncertain.
We Are Dependent on Contract Manufacturers.
We depend heavily upon the manufacturing capabilities of our
contract manufacturers. The emerging nature of the cable modem market
makes it difficult for us to accurately forecast demand for our
products. Our inability to accurately forecast the actual demand for our
products could result in supply, manufacturing or testing capacity
constraints. These constraints could result in delays in the delivery of
our products or the loss of existing or potential customers, either of
which could negatively impact our business, operating results or
financial condition. In addition, we had unconditional purchase
obligations of approximately $48.8 million as of December 31, 1999
primarily to purchase minimum quantities of materials and components
used to manufacture our products. We must fulfill these obligations even
if demand for our products is lower than we anticipate.
We Are Dependent on Key Suppliers.
We manufacture all of our products using components or subassemblies
procured from third-party suppliers. Some of these components are
available from a single source and others are available from limited
sources. All of our sales are from products containing one or more
components that are available only from single supply sources. In
addition, some of the components are custom parts produced to our
specifications. For example, we currently rely on Philips
Semiconductors, Inc. to supply a custom ASIC that is used in our
products. Other components, such as the radio frequency tuner and some
surface acoustic wave filters, are procured from sole source suppliers.
Any interruption in the operations of vendors of sole source parts could
adversely affect our ability to meet our scheduled product deliveries to
customers. Delays in key component or product deliveries may occur due
to shortages resulting from a limited number of suppliers, the financial
or other difficulties of such suppliers or a limitation in component
product availability. We are dependent on semiconductor manufacturers
and are affected by worldwide conditions in the semiconductor market. If
we are unable to obtain a sufficient supply of components from our
current sources, we could experience difficulties in obtaining
alternative sources or in altering product designs to use alternative
components. Resulting delays or reductions in product shipments could
damage customer relationships. Further, a significant increase in the
price of one or more of these components could harm our gross margin or
operating results.
Due to increasing demand for electronic and communications
equipment, the worldwide market for component parts is currently
constrained. Due to the current market conditions, we may be unable to
obtain a sufficient supply of component parts necessary to manufacture
products to meet the current or future demand of our customers. If we
are unable to satisfy our customers demand, our relationships with our
customers may be damaged and our customers could decide to purchase
product from our competitors. Inability to meet demand or a decision by
one or more of our customers to purchase from our competitors could harm
our operating results.
We Must Transition to New Semiconductor Process Technologies.
Our future success will depend in part upon our ability to develop
products that utilize new semiconductor process technologies. These
technologies change rapidly and require us to spend significant amounts
on research and development. We continuously evaluate the benefits of
redesigning our integrated circuits using smaller geometry process
technologies to improve performance and reduce costs. The transition of
our products to integrated circuits with increasingly smaller geometries
will be important to our competitive position. Other companies have
experienced difficulty in migrating to new semiconductor processes and,
consequently, have suffered reduced yields, delays in product deliveries
and increased expense levels. Moreover, we depend on our relationship
with our third-party manufacturers to migrate to smaller geometry
processes successfully. We may be unable to migrate to new semiconductor
process technologies successfully or on a timely basis.
We Are Dependent on Contract Manufacturers to Assemble and Test Our
Products.
Most of our products are assembled and tested by contract
manufacturers using testing equipment that we provide. As a result of
our dependence on these contract manufacturers for assembly and testing
of our products, we do not directly control product delivery schedules
or product quality. Any product shortages or quality assurance problems
could increase the costs of manufacture, assembly or testing of our
products. In addition, as manufacturing volume increases, we will need
to procure and assemble additional testing equipment and provide it to
our contract manufacturers. The production and assembly of testing
equipment typically requires significant time. We could experience
significant delays in the shipment of our products if we are unable to
provide this testing equipment to our contract manufacturers in a timely
manner.
There Are Many Risks Associated with International Operations.
Sales to customers outside of the United States accounted for
approximately 84% of our revenues in 1999 and approximately 74% of our
revenues in 1998. We expect sales to customers outside of the United
States to continue to represent a significant percentage of our revenues
for the foreseeable future. International sales are subject to a number
of risks, including the following:
* changes in foreign government regulations and communications
standards;
* export license requirements, tariffs and taxes;
* other trade barriers;
* difficulty in collecting accounts receivable;
* difficulty in managing foreign operations; and
* political and economic instability.
If our customers are impacted by currency devaluations or general
economic crises, such as the recent economic crisis affecting many Asian
and Latin American economies, their ability to purchase our products
could be significantly reduced. Payment cycles for international
customers typically are longer than those for customers in the United
States. Foreign markets for our products may develop more slowly than
currently anticipated. Foreign countries may decide not to construct
cable infrastructure or may prohibit, terminate or delay the
construction of new cable plants for a variety of reasons. These reasons
include environmental issues, economic downturns, the availability of
favorable pricing for other communications services or the availability
and cost of related equipment. Any action like this by foreign countries
would reduce the market for our products.
We anticipate that our foreign sales generally will be invoiced in
U.S. dollars, and we currently do not plan to engage in foreign currency
hedging transactions. However, as we commence and expand our
international operations, we may be paid in foreign currencies and
exposure to losses in foreign currency transactions may increase. We may
choose to limit our exposure by the purchase of forward foreign exchange
contracts or through similar hedging strategies. No currency hedging
strategy can fully protect against exchange-related losses. In addition,
if the relative value of the U.S. dollar in comparison to the currency
of our foreign customers should increase, the resulting effective price
increase of our products to those foreign customers could result in
decreased sales.
We May Be Unable to Provide Adequate Customer Support.
Our ability to achieve our planned sales growth and retain current
and future customers will depend in part upon the quality of our
customer support operations. Our customers generally require significant
support and training with respect to the our broadband access systems,
particularly in the initial deployment and implementation stage. To date
our sales have been concentrated in a small number of customers. We have
limited experience with widespread deployment of our products to a
diverse customer base. We may not have adequate personnel to provide the
levels of support that our customers may require during initial product
deployment or on an ongoing basis. Our inability to provide sufficient
support to our customers could delay or prevent the successful
deployment of our products. In addition, our failure to provide adequate
support could harm our reputation and relationship with our customers
and could prevent us from gaining new customers.
Our Industry is Highly Competitive with Many Established Competitors.
The market for broadband access systems is extremely competitive and
is characterized by rapid technological change. Our direct competitors
in the cable access systems arena include Cisco Systems, Com21, General
Instrument, Matsushita Electric Industrial (which markets products
under the brand name "Panasonic"), Motorola, Nortel Networks, Phasecom,
Thomson Consumer Electronics(which markets products under the brand name
"RCA"), Samsung , Scientific-Atlanta, Sony, 3Com, Toshiba and Zenith
Electronics. We also compete with companies that develop integrated
circuits for broadband access products, such as Broadcom. We also sell
products that compete with existing data access and transmission systems
utilizing the telecommunications networks, such as those of 3Com.
Additionally, our controller and headend system products face intense
competition from well-established companies such as Cisco, Nortel and
3Com. In addition, we compete with companies in the DSL arena such as
ECI, Charles Industries, Pairgain, Copper Mountain, Accelerated
Networks, Integral Access and Vina Technologies. As standards, such as
DOCSIS, are developed for broadband access systems, other companies may
enter the broadband access systems market. The principal competitive
factors in our market include the following:
* product performance, features and reliability;
* price;
* size and stability of operations;
* breadth of product line;
* sales and distribution capability;
* technical support and service;
* relationships with providers of broadband access services; and
* compliance with industry standards.
Some of these factors are outside of our control. The existing
conditions in the broadband access market could change rapidly and
significantly as a result of technological changes. The development and
market acceptance of alternative technologies could decrease the demand
for our products or render them obsolete. Our competitors may introduce
broadband access products that are less costly, provide superior
performance or achieve greater market acceptance than our products.
Many of our current and potential competitors have significantly
greater financial, technical, marketing, distribution, customer support
and other resources, as well as greater name recognition and access to
customers than we do. The anticipated widespread adoption of DOCSIS is
likely to cause increased price competition in the North American
market. The adoption of DOCSIS also could result in lower sales of our
headend products in the North American market. Any increased price
competition or reduction in sales of our headend products would result
in downward pressure on our gross margin. We cannot accurately predict
how the competitive pressures that we face will affect our business.
Our Business Is Dependent on the Internet and the Development of the
Internet Infrastructure.
Our success will depend in large part on increased use of the
Internet to increase the need for high speed broadband access networks.
Critical issues concerning the commercial use of the Internet remain
largely unresolved and are likely to affect the development of the
market for our products. These issues include security, reliability,
cost, ease of access and quality of service. Our success also will
depend on the growth of the use of the Internet by businesses,
particularly for applications that utilize multimedia content and thus
require high bandwidth. The recent growth in the use of the Internet has
caused frequent periods of performance degradation. This has required
the upgrade of routers, telecommunications links and other components
forming the infrastructure of the Internet by Internet service providers
and other organizations with links to the Internet. Any perceived
degradation in the performance of the Internet as a whole could
undermine the benefits of our products. Potentially increased
performance provided by our products and the products of others
ultimately is limited by and reliant upon the speed and reliability of
the Internet backbone itself. Consequently, the emergence and growth of
the market for our products will depend on improvements being made to
the entire Internet infrastructure to alleviate overloading and
congestion.
Our Failure to Manage Growth Could Adversely Affect Us.
The growth of our business has placed, and is expected to continue
to place, a significant strain on our limited personnel, management and
other resources. Our management, personnel, systems, procedures and
controls may be inadequate to support our existing and future
operations. To manage any future growth effectively, we will need to
attract, train, motivate, manage and retain employees successfully, to
integrate new employees into our overall operations and to continue to
improve our operational, financial and management systems.
We Are Dependent on Key Personnel.
Due to the specialized nature of our business, we are highly
dependent on the continued service of, and on the ability to attract and
retain qualified engineering, sales, marketing and senior management
personnel. The competition for this personnel is intense. The loss of
any of these persons, particularly our Chairman, President and Chief
Technical Officer, Shlomo Rakib, and our Chief Executive Officer, Zaki
Rakib, would harm our business. In addition, if we are unable to hire
additional qualified personnel as needed, we may be unable to adequately
manage and complete our existing sales commitments and to bid for and
execute additional sales. Further, we must train and manage our growing
employee base, which is likely to require increased levels of
responsibility for both existing and new management personnel. Our
current management personnel and systems may be inadequate, and we may
fail to assimilate new employees successfully.
Highly skilled employees with the education and training that we
require, especially employees with significant experience and expertise
in both data networking and radio frequency design, are in high demand.
We may not be able to continue to attract and retain the qualified
personnel necessary for the development of our business. We do not have
"key person" insurance coverage for the loss of any of our employees.
Any officer or employee of our company can terminate his or her
relationship with us at any time. Our employees generally are not bound
by non-competition agreements with us.
Our Business Is Subject to the Risks of Product Returns, Product
Liability and Product Defects.
Products as complex as ours frequently contain undetected errors or
failures, especially when first introduced or when new versions are
released. Despite testing, errors may occur. The occurrence of errors
could result in product returns and other losses to our company or our
customers. This occurrence also could result in the loss of or delay in
market acceptance of our products. Due to the recent introduction of our
products, we have limited experience with the problems that could arise
with this generation of products. Our purchase agreements with our
customers typically contain provisions designed to limit our exposure to
potential product liability claims. However, the limitation of liability
provision contained in our purchase agreements may not be effective as a
result of federal, state or local laws or ordinances or unfavorable
judicial decisions in the United States or other countries. We have not
experienced any product liability claims to date, but the sale and
support of our products entails the risk of such claims. In addition,
any failure by our products to properly perform could result in claims
against us by our customers. We maintain insurance to protect against
certain claims associated with the use of our products, but our
insurance coverage may not adequately cover any claim asserted against
us. In addition, even claims that ultimately are unsuccessful could
result in our expenditure of funds in litigation and management time and
resources.
We May Be Unable to Adequately Protect or Enforce Our Intellectual
Property Rights.
We rely on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect
proprietary rights in our products. Our pending patent applications may
not be granted. Even if they are granted, the claims covered by the
patents may be reduced from those included in our applications. Any
patent might be subject to challenge in court and, whether or not
challenged, might not be broad enough to prevent third parties from
developing equivalent technologies or products without taking a license
from us. We have entered into confidentiality and invention assignment
agreements with our employees, and we enter into non-disclosure
agreements with some of our suppliers, distributors and appropriate
customers so as to limit access to and disclosure of our proprietary
information. These statutory and contractual arrangements may not prove
sufficient to prevent misappropriation of our technology or to deter
independent third-party development of similar technologies. In
addition, the laws of some foreign countries might not protect our
products or intellectual property rights to the same extent as do the
laws of the United States. Protection of our intellectual property might
not be available in every country in which our products might be
manufactured, marketed or sold.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOSCIS cable modem specification based in part
on our S-CDMA technology. In September 1999, CableLabs indicated that it
intended to proceed with the advanced PHY work on two parallel tracks:
one for the development of a prototype based on our S-CDMA technology
and one for the inclusion of Advanced TDMA technology, as proposed by
other companies. In February 2000, CableLabs further clarified the
status of the advanced PHY project regarding a separate release that
will include TDMA technologies. In addition, CableLabs reiterated that
it is continuing to work with us on the development of a DOCSIS
specification that could include our S-CDMA technology. To that end, we
have indicated to CableLabs that we would contribute some aspects of our
S-CDMA technology to the DOCSIS intellectual property pool if and when a
DOCSIS specification is approved that includes our S-CDMA technology. We
would contribute our technology pursuant to a license agreement with
CableLabs that we would execute at that time, and which contains the
terms that CableLabs has established for the inclusion of any
intellectual property from any source in the DOCSIS specifications.
Under the terms of the proposed license agreement, we would grant to
CableLabs a royalty-free license for those aspects of our S-CDMA
technology that are essential for compliance with the DOCSIS cable modem
standard. So-called "implementation know how" is not covered by this
license-only those aspects of the technology that are essential to
implementing a compliant product. CableLabs would have the right to
extend royalty-free sublicenses to companies that wish to build DOCSIS-
compatible products. These sublicenses would allow participating
companies to utilize and incorporate the essential portions of the S-
CDMA technology on a royalty-free basis for the limited use of making
and selling products or systems that comply with the DOCSIS cable modem
specification Terayon has already joined the DOCSIS intellectual
property pool and, as a result, we have a royalty-free sublicense that
allows us to ship DOCSIS-compatible products which contain intellectual
property submitted by other companies. The scope of this license would
not extend to the use of the S-CDMA technology in other areas; only for
products that comply with the DOCSIS specifications. As a result, any
of our competitors who join or have joined the DOCSIS intellectual
property pool will have access to some aspects of our technology without
being required to pay us any royalties or other compensation. If and
when we submit S-CDMA to the DOCSIS Intellectual Property pool, we are
in no way restricted from entering into royalty-bearing license
agreements with companies that wish to use the S-CDMA technology for
purposes other than implementing DOCSIS compatible products, or that do
not wish to enter into the DOCSIS intellectual property pool. Further,
some of our competitors have been successful in reverse engineering the
technology of other companies, and the inclusion of S-CDMA in a future
DOCSIS specification would expose some aspects of our technology to
those competitors. DOCSIS specifications are available on an open basis
once they are approved, not only to companies that are members of the
DOCSIS IP Pool. If a competitor is able to duplicate the functionality
and capabilities of our technology, we could lose all or some of the
time-to-market advantage we might otherwise have. Under the terms of the
proposed license agreement, if we sue certain parties to the proposed
license agreement on claims of infringement of any copyright or patent
right or misappropriation of any trade secret, those parties may
terminate our license to the patents or copyrights they contributed to
the DOCSIS intellectual property pool. If a termination like this were
to occur, we would continue to have access to some aspects of the DOCSIS
intellectual property pool, but we would not be able to develop products
that fully comply with the DOCSIS cable modem specification. Also, even
if we were to be removed from the IP pool, we would not be prevented
from developing and selling products that fully comply with the DOCSIS
specifications, but we would not be able to do this with the benefit of
a royalty-free license, which would increase the cost of our products,
assuming we were able to obtain a license agreement for the required
technology. Because of these terms, we may find it difficult to enforce
our intellectual property rights against certain companies, even in
areas that are not directly related to DOCSIS specifications and
products..
We anticipate that developers of cable modems increasingly will be
subject to infringement claims as the number of products and competitors
in our industry segment grows. We have received letters from two
individuals claiming that our technology infringes patents held by these
individuals. We have reviewed the allegations made by these individuals
and, after consulting with our patent counsel, we do not believe that
our technology infringes any valid claim of these individuals' patents.
If the issues are submitted to a court, the court could find that our
products infringe these patents. In addition, these individuals may
continue to assert infringement. If we are found to have infringed these
individuals' patents, we could be subject to substantial damages and/or
an injunction preventing us from conducting our business. In addition,
other third parties may assert infringement claims against us in the
future. An infringement claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause product shipment
delays or require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms
acceptable to us or at all. Litigation also may be necessary to enforce
our intellectual property rights.
We pursue the registration of our trademarks in the United States and
have applications pending to register several of our trademarks.
However, the laws of certain foreign countries might not protect our
products or intellectual property rights to the same extent as the laws
of the United States. This means that effective trademark, copyright,
trade secret and patent protection might not be available in every
country in which our products might be manufactured, marketed or sold.
Our Business Is Subject to Communications Industry Regulations.
Our business and our customers are subject to varying degrees of
federal, state and local regulation. The jurisdiction of the Federal
Communications Commission extends to the communications industry,
including our broadband access products. The FCC has promulgated
regulations that, among other things, set installation and equipment
standards for communications systems. Although FCC regulations and other
governmental regulations have not materially restricted our operations
to date, future regulations applicable to our business or our customers
could be adopted by the FCC or other regulatory bodies. For example, FCC
regulatory policies affecting the availability of cable services and
other terms on which cable companies conduct their business may impede
our penetration of certain markets. In addition, regulation of cable
television rates may affect the speed at which cable operators upgrade
their cable infrastructures to two-way HFC. In addition, the increasing
demand for communications systems has exerted pressure on regulatory
bodies worldwide to adopt new standards for such products and services.
This process generally involves extensive investigation of and
deliberation over competing technologies. The delays inherent in this
governmental approval process have in the past, and may in the future,
cause the cancellation, postponement or rescheduling of the installation
of communications systems by our customers.
If other countries begin to regulate the cable modem industry more
heavily or introduce standards or specifications with which our products
do not comply, we will be unable to offer products in those countries
until our products comply with those standards or specifications. In
addition, we may have to incur substantial costs to comply with those
standards or specifications. For instance, should the DAVIC standards
for ATM-based digital video be established internationally, we will need
to conform our cable modems to compete. Further, many countries do not
have regulations for installation of cable modem systems or for
upgrading existing cable network systems to accommodate our products.
Whether we currently operate in a country without these regulations or
enter into the market in a country these regulations do not exist, new
regulations could be proposed at any time. The imposition of regulations
like this could place limitations on a country's cable operators'
ability to upgrade to support our products. Cable operators in these
countries may not be able to comply with these regulations, and
compliance with these regulations may require a long, costly process.
For example, we experienced delays in product shipments to a customer in
Brazil due to delays in certain regulatory approvals in Brazil. Similar
delays could occur in other countries in which we market or plan to
market our products. In addition, our customers in certain parts of
Asia, such as Japan, are required to obtain licenses prior to selling
our products, and delays in obtaining required licenses could harm our
ability to sell products to these customers.
Our Business Is Subject to Other Regulatory Approvals and
Certifications.
In the United States, in addition to complying with FCC regulations,
our products are required to meet certain safety requirements. For
example, we are required to have our products certified by Underwriters
Laboratory in order to meet federal requirements relating to electrical
appliances to be used inside the home. Outside the United States, our
products are subject to the regulatory requirements of each country in
which the products are manufactured or sold. These requirements are
likely to vary widely. We may be unable to obtain on a timely basis or
at all the regulatory approvals that may be required for the
manufacture, marketing and sale of our products. In addition to
regulatory compliance, some cable industry participants may require
certification of compatibility.
Risk of Earthquakes and or Other Natural Disasters
The facility housing our corporate headquarters, the majority of our
research and development activities and our in-house manufacturing
operations are located in an area of California known for seismic
activities. In addition, the operations of some of our key suppliers
are also located in this area and in other areas know for seismic
activity, such as Taiwan. An earthquake, or other significant natural
disaster, could result in an interruption in our business or that of one
or more of our key suppliers. Such an interruption could harm our
operating results.
Our Stock Price Has Been and Is Likely to Continue to Be Volatile.
The trading price of our common stock has been and is likely to be
highly volatile. Our stock price could be subject to wide fluctuations
in response to a variety of factors, including the following:
* Actual or anticipated variations in quarterly operating results;
* Announcements of technological innovations;
* New products or services offered by us or our competitors;
* Changes in financial estimates by securities analysts;
* Conditions or trends in the broadband access services industry;
* Changes in the economic performance and/or market valuations of
Internet, online service or broadband access service industries;
* Changes in the economic performance and/or market valuations of
other Internet, online service or broadband access service
companies;
* Our announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
* Adoption of industry standards and the inclusion of or
compatibility of our technology with such standards;
* Adverse or unfavorable publicity regarding us or our products;
* Additions or departures of key personnel;
* Sales of common stock; and
* Other events or factors that may be beyond our control.
In addition, the stock markets in general, and the Nasdaq National
Market and the market for broadband access services and technology
companies in particular, have experienced extreme price and volume
fluctuations recently. These fluctuations often have been unrelated or
disproportionate to the operating performance of these companies. The
trading prices of many technology companies' stocks are at or near
historical highs and these trading prices and multiples are
substantially above historical levels. These trading prices and
multiples may not be sustained. These broad market and industry factors
may materially adversely affect the market price of our common stock,
regardless of our actual operating performance. In the past, following
periods of volatility in the market price of a company's securities,
securities class action litigation often has been instituted against
that company. Litigation like this, if instituted, could result in
substantial costs and a diversion of management's attention and
resources.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TERAYON COMMUNICATION SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors...................
Consolidated Balance Sheets........................................
Consolidated Statements of Operations...............................
Consolidated Statements of Stockholders' Equity (Net Capital Deficiency)
Consolidated Statements of Cash Flows.................................
Notes to Consolidated Financial Statements...........................
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Terayon Communication Systems, Inc.
We have audited the accompanying consolidated balance sheets of
Terayon Communication Systems, Inc. as of December 31, 1999 and 1998,
and the related consolidated statements of operations, stockholders'
equity (net capital deficiency), and cash flows for each of the three
years in the period ended December 31, 1999. These financial statements
are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on our
audits.
We conducted our audits 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 consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of Terayon Communication Systems, Inc. at December
31, 1999 and 1998, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December
31, 1999, in conformity with accounting principles generally accepted in
the United States.
/s/ Ernst & Young LLP
San Jose, California
January 17, 2000
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
---------- ----------
1999 1998
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents............................. $32,398 $14,342
Short-term investments................................ 80,594 14,538
Accounts receivable, less allowance for doubtful
accounts of $1461 in 1999 and $594 in 1998........... 14,015 2,090
Accounts receivable from related parties.............. 7,281 1,549
Inventory............................................. 4,991 3,950
Other current assets.................................. 4,161 1,856
---------- ----------
Total current assets.................................... 143,440 38,325
Property and equipment, net............................. 6,157 3,593
Officer note receivable................................. -- 100
Intangibles and other assets............................ 151,639 128
---------- ----------
Total assets............................................ $301,236 $42,146
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $13,217 $8,600
Accrued payroll and related expenses.................. 5,938 2,475
Deferred revenues..................................... 4,541 --
Warranty reserves..................................... 2,685 1,064
Other accrued liabilities............................. 4,668 1,735
Current portion of long-term debt..................... 12 --
Current portion of capital lease obligations.......... 5 29
---------- ----------
Total current liabilities........................... 31,066 13,903
Long-term debt.......................................... 31 --
Long-term portion of capital lease obligations.......... 6 10
Other long-term obligations............................. 480 130
Deferred tax liability.................................. 10,998 --
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares--5,000,000
Issued and outstanding shares--none................... -- --
Common stock, $.001 par value:
Authorized shares--45,000,000
Issued and outstanding shares--24,479,379 in 1999 and
16,458,121 in 1998................................... 24 16
Additional paid in capital............................ 408,854 114,594
Accumulated deficit................................... (148,381) (84,301)
Deferred compensation................................. (1,553) (2,184)
Stockholders' notes receivable........................ (6) (22)
Accumulated other comprehensive income................. (283) --
---------- ----------
Total stockholders' equity.......................... 258,655 28,103
---------- ----------
Total liabilities and stockholders' equity.......... $301,236 $42,146
========== ==========
See accompanying notes.
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years Ended December 31,
--------------------------------
1999 1998 1997
---------- ---------- ----------
Revenues:
Product revenues....................... $57,345 $19,150 $1,021
Related party product revenues......... 39,664 12,546 617
Contract consulting and technology
development revenues.................. -- -- 480
---------- ---------- ----------
Total revenues....................... 97,009 31,696 2,118
Cost of goods sold:
Cost of product revenues............... 46,215 22,296 3,904
Cost of related party product revenues. 25,829 12,222 2,558
---------- ---------- ----------
Total cost of goods sold............. 72,044 34,518 6,462
---------- ---------- ----------
Gross profit (loss)...................... 24,965 (2,822) (4,344)
Operating expenses:
Research and development............... 17,579 10,685 11,319
Cost of product development assistance
agreement........................... 35,147 -- --
In-process research and development... 14,600 -- --
Sales and marketing.................... 15,727 6,947 4,468
General and administrative............. 7,476 3,223 2,546
Goodwill amortization.................. 3,524 -- --
---------- ---------- ----------
Total operating expenses............. 94,053 20,855 18,333
---------- ---------- ----------
Loss from operations..................... (69,088) (23,677) (22,677)
Interest income.......................... 5,101 808 396
Interest expense......................... (93) (359) (268)
---------- ---------- ----------
Net loss................................. (64,080) (23,228) (22,549)
Series F convertible preferred
stock dividend.......................... -- 23,910 --
---------- ---------- ----------
Net loss applicable to common
stockholders............................ ($64,080) ($47,138) ($22,549)
========== ========== ==========
Historical basic and diluted net loss
per share applicable to common
stockholders............................ ($3.11) ($5.25) ($5.26)
========== ========== ==========
Shares used in computing historical
basic and diluted net loss per share
applicable to common stockholders....... 20,630 8,986 4,289
========== ========== ==========
Pro forma basic and diluted net loss
per share applicable to common
stockholders............................ ($3.41) ($2.07)
========== ==========
Shares used in computing pro forma
basic and diluted net loss per share
applicable to common stockholders....... 13,804 10,873
========== ==========
See accompanying notes.
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(in thousands, except share amounts)
Total
Convertible Addi- Stock- Accumulated Stockholders'
Preferred Stock Common Stock tional Deferred holders' Other Equity
---------------------------------------- Paid-In Accumulate Compen- Notes Comprehensive(Net Capital
Shares Amount Shares Amount Capital Deficit sation Receivable Income Deficiency)
-----------------------------------------------------------------------------------------------------------
Balance at December 31,
1996.................. 6,322,174 25,989 4,138,799 90 -- (14,614) -- (60) 11,405
Exercise of options
for cash to purchase
common stock.......... -- -- 481,648 140 -- -- -- -- -- 140
Net cash proceeds from
issuance of Series D
preferred stock....... 808,987 9,818 -- -- -- -- -- -- -- 9,818
Unearned compensation
related to stock
options............... -- -- -- 228 -- -- (228) -- -- --
Amortization of
unearned compensation. -- -- -- -- -- -- 12 -- -- 12
Net loss applicable to
common stockholders
and comprehensive net
loss applicable to
common stockholders... -- -- -- -- -- (22,549) -- -- -- (22,549)
-----------------------------------------------------------------------------------------------------------
Balance at December 31,
1997.................. 7,131,161 35,807 4,620,447 458 -- (37,163) (216) (60) -- (1,174)
Net cash proceeds from
issuance of Series D
preferred stock ...... 114,089 1,454 -- -- -- -- -- -- -- 1,454
Conversion of advance
from related party to
Series D preferred
stock ................ 153,846 2,000 -- -- -- -- -- -- -- 2,000
Net cash proceeds from
issuance of preferred stock
and a warrant ....... 384,615 844 -- 4,089 -- -- -- -- -- 4,933
Dividends on Series F
convertible preferred
stock ................ -- -- -- 23,910 -- -- -- -- -- 23,910
Value of preferred stock
warrant issued to
Series D preferred
stockholder .......... -- 19 -- -- -- -- -- -- -- 19
Exercise of options for
cash to purchase common
stock ................ -- -- 205,276 56 -- -- -- -- -- 56
Exercise of option for
note receivable to
purchase common stock
...................... -- -- 24,375 9 -- -- -- (9) -- --
Value of common stock
warrant .............. -- -- -- 35 -- -- -- -- -- 35
Cash proceeds from
payment on a
stockholder note
receivable ........... -- -- -- -- -- -- -- 47 -- 47
Unearned compensation
related to stock
options .............. -- -- -- 1,849 -- -- (1,849) -- -- --
Transfer to additional
paid in capital
as a result of
reincorporation....... -- (40,116) -- (30,401) 70,517 -- -- -- -- --
Conversion of preferred
stock into common
stock upon the initial
public offering ...... (7,783,711) (8) 7,783,711 8 -- -- -- -- -- --
Issuance of common
stock in connection
with the initial
public offering, net
of issuance costs..... -- -- 3,000,000 3 35,133 -- -- -- -- 35,136
Conversion of
redeemable preferred
stock to common stock
upon the initial
public offering ...... -- -- 576,924 -- 7,500 -- -- -- -- 7,500
Conversion of
redeemable common
stock upon the initial
public offering ...... -- -- 10,000 -- 13 -- -- -- -- 13
Exercise of common
stock warrant for cash -- -- 50,000 -- 500 -- -- -- -- 500
Issuance of common stock
in legal settlement to
an employee .......... -- -- 13,000 -- 169 -- -- -- -- 169
Exercise of options
for cash to purchase
common stock.......... -- -- 174,388 -- 222 -- -- -- -- 222
Unearned compensation
related to stock
options............... -- -- -- -- 540 -- (540) -- -- --
Amortization of
unearned compensation
related to stock
options............... -- -- -- -- -- -- 421 -- -- 421
Net loss applicable to
common stockholders
and comprehensive net
loss applicable to
common stockholders... -- -- -- -- -- (47,138) -- -- -- (47,138)
-----------------------------------------------------------------------------------------------------------
Balance at December
31, 1998.............. -- $ -- 16,458,121 $16 $114,594 ($84,301) ($2,184) ($22) -- $28,103
Issuance of common
stock , net of issuance
costs................. -- - 2,101,946 2 75,123 -- -- -- -- 75,125
Exercise of options
for cash to purchase
common stock.......... -- - 963,993 1 2,486 -- -- -- -- 2,487
Exercise of common
stock warrant for cash -- - 3,000,000 3 19,497 -- -- -- -- 19,500
Cash proceeds from
payment on a
stockholder note
receivable ........... -- - -- - -- -- -- 16 -- 16
Amortization of
unearned compensation
related to stock...... -- - -- - -- -- 631 -- -- 631
Issuance of warrant to
purchase common stock -- - -- - 35,587 -- -- -- -- 35,587
Issuance of common stock
for Employee Stock
Purchase Plan........ -- - 101,163 - 1,170 -- -- -- -- 1,170
Compensation expense related
to option acceleration for
terminated employees. -- - -- - 856 -- -- -- -- 856
Compensation expense for
common stock issued in
exchange for services -- - -- - 61 -- -- -- -- 61
Compensation expense for
common stock issued in lieu
of bonus............. -- - 596 - 25 -- -- -- -- 25
Acquisition of Imedia
Corporation........... -- - 857,407 1 106,737 -- -- -- -- 106,738
Acquisition of Radwiz
Limited.............. -- - 996,153 1 52,718 -- -- -- -- 52,719
Comprehensive income:
Increase in unrealized gain
on short-term
investments......... -- - -- - -- -- -- -- (283) (283)
Net loss applicable to
common stockholders. -- - -- - -- (64,080) -- -- -- (64,080)
-------------
Comprehensive income... (64,363)
-----------------------------------------------------------------------------------------------------------
Balance at December
31, 1999.............. -- - 24,479,379 $24 $408,854 ($148,381) ($1,553) ($6) ($283) $258,655
===========================================================================================================
See accompanying notes.
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
-----------------------------
1999 1998 1997
--------- --------- ---------
Operating activities:
Net loss applicable to common stockholders...... ($64,080) ($47,138) ($22,549)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................. 2,121 1,992 1,563
Amortization of intangible assets............. 6,089 -- --
In-process research and development.......... 14,600 -- --
Amortization of unearned compensation related
to stock options............................. 631 421 12
Loss on disposal of fixed assets.............. 33 -- --
Compensation expense for common stock issued
in exchange for consuting services.......... 61 -- --
Value of common and preferred stock warrants
issued....................................... 35,587 54 --
Series F convertible preferred stock
dividend..................................... -- 23,910 --
Issuance of common stock to an employee....... 25 -- --
Option acceleration related to a
terminated employee......................... 856 -- --
Changes in operating assets and liabilities:
Accounts receivable.......................... (11,925) (1,516) (574)
Accounts receivable from related parties..... (5,732) (1,187) (362)
Inventory.................................... (1,041) (2,628) (1,322)
Other current assets......................... (2,305) (1,166) (391)
Accounts payable............................. 4,617 6,368 1,550
Accrued payroll and related expenses......... 3,463 1,423 482
Deferred revenues............................ 4,541 -- --
Warranty reserves............................ 1,621 528 536
Other accrued liabilities.................... 2,933 914 540
Deferred revenue............................. -- (95) (330)
Deferred rent................................ 5 4 24
Other noncurrent liabilities................. -- -- (24)
--------- --------- ---------
Net cash used in operating activities........... (7,900) (18,116) (20,845)
--------- --------- ---------
Investing activities:
Purchases of short-term investments............. (217,323) (32,959) (10,995)
Proceeds from sales and maturities of
short-term investments......................... 150,984 18,839 15,085
Purchases of property and equipment............. (4,718) (1,970) (2,606)
Officer note receivable......................... 100 -- --
Purchase of developed technology................ (1,850) -- --
Purchase of other assets........................ (508) -- 15
Cash received from Imedia acquisiton............ 202 -- --
Cash received from Radwiz acquisition........... 2,457 -- --
Cash paid for acquisition of Radwiz............. (250)
Pre-acquisition loan to Imedia.................. (1,800) -- --
--------- --------- ---------
Net cash provided by (used in) investing
activities..................................... (72,706) (16,090) 1,499
--------- --------- ---------
Financing activities:
Principal payments on capital leases............ (28) (70) (144)
Principal payments on long-term debt............ -- (2,812) (909)
Proceeds from long-term debt.................... 43 -- 1,654
Increase in other noncurrent liabilities....... 355 -- 0
Exercise of options and warrant to purchase
common stock................................... 21,983 778 140
Advance from related party...................... -- -- 2,000
Proceeds from issuance of preferred stock....... -- 6,387 9,818
Proceeds from issuance of redeemable preferred
stock.......................................... -- 7,500 --
Principal payments on redeemable common
stockholder and common stockholder notes
receivable..................................... 16 60 --
Proceeds from issuance of common stock.......... 76,293 35,136 --
--------- --------- ---------
Net cash provided by financing activities.... 98,662 46,979 12,559
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................................... 18,056 12,773 (6,787)
Cash and cash equivalents at beginning of year.. 14,342 1,569 8,356
--------- --------- ---------
Cash and cash equivalents at end of year........ $32,398 $14,342 $1,569
========= ========= =========
Supplemental disclosures of cash flow
information:
Cash paid for interest.......................... $0 $359 $268
Supplemental noncash investing and financing
activities:
Exercise of option for note receivable to
purchase redeemable common stock............... $ -- $ -- $13
Exercise of option for note receivable to
purchase common stock.......................... $ -- $9 $ --
Conversion of advance from related party to
Series D preferred stock....................... $ -- $2,000 $ --
Issuance of common stock in legal settlement to
an employee.................................... $ -- $169 $ --
Conversion of preferred stock to common stock... $ -- $8 $ --
Conversion of redeemable preferred stock to
common stock .................................. $ -- $7,500 $ --
Conversion of redeemable common stock to common
stock ......................................... $ -- $13 $ --
Acquisition of Imedia Corporation............... $106,737 $ -- $0
Acquisition of Radwiz Ltd....................... $52,468 $ -- $0
See accompanying notes.
1. Organization and Summary of Significant Accounting Policies
Description of Business
Terayon Communication Systems, Inc. (the Company) was incorporated
under the laws of the state of California on January 20, 1993 for the
purpose of developing, producing, and marketing broadband access system
products. In October 1997, the Company changed its legal name from
Terayon Corporation. In July 1998, the Company reincorporated in the
State of Delaware.
Basis of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries Imedia Corporation ("Imedia")
and Radwiz, Ltd. ("Radwiz"), and its majority owned subsidiaries,
Terayon Communication Systems Europe and Terayon do Brasil. The minority
interests in net losses of Terayon Communication Systems Europe and
Terayon do Brasil were insignificant for all periods presented. All
material intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
Reclassifications
Certain amounts in the 1998 and 1997 financial statements have been
reclassified to conform with the 1999 presentation.
Advertising Expenses
The Company accounts for advertising costs as expense in the period
in which they are incurred. Advertising expense for the years ended
December 31, 1999, 1998 and 1997 was not significant.
Research and Development Costs
Research and development costs are charged to expense as incurred.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased
with an original maturity of three months or less to be cash
equivalents. Investments with an original maturity at the time of
purchase of over three months are classified as short-term investments
regardless of maturity date as all investments are classified as
available-for-sale and can be readily liquidated to meet current
operational needs. The Company accounts for investments in accordance
with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities". Management
determines the appropriate classification of debt securities at the time
of purchase and reevaluates such designation as of each balance sheet
date. The Company's short-term investments, which consist primarily of
commercial paper, U.S. government and U.S. government agency obligations
and fixed income corporate securities, are classified as available-for-
sale and are carried at amortized cost which approximates fair market
value. The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts to
maturity. Such amortization, as well as any interest on the securities,
is included in interest income. Realized gains and losses and declines
in value judged to be other-than-temporary on available-for-sale
securities are included in interest income. The cost of securities sold
is based on the specific identification method. The Company had no
investments in equity securities at either December 31, 1999 or December
31, 1998.
Concentrations of Credit Risk, Customer, Supplier, and Product
The Company operates in one business segment, the development and
sale of broadband access systems, which it sells primarily to customers
within the cable and communications industries, including related
parties (see Note 15). The Company performs ongoing credit evaluations
of its customers and generally requires no collateral. A relatively
small number of customers and resellers account for a significant
percentage of the Company's revenues. The Company expects that the sale
of its products to a limited number of customers and resellers may
continue to account for a high percentage of revenues for the
foreseeable future.
Currently, the Company relies on single source suppliers of materials
and labor for the significant majority of its product inventory but is
actively pursuing additional supplier alternatives. As a result, should
the Company's current suppliers not produce and deliver inventory for
the Company to sell on a timely basis, operating results may be
adversely impacted.
Substantially all of the Company's revenues have been attributable to
sales of the TeraLink and the TeraPro. These products are expected to
account for a significant part of the Company's revenues for the
foreseeable future. As a result, a decline in demand for or failure to
achieve broad market acceptance of the TeraLink or the TeraPro would
adversely affect operating results.
In addition, market acceptance of the Company's products may be
affected by the emergence and evolution of industry standards. While the
Company expects its products to become compliant with industry
standards, its inability to do so may adversely affect operating
results.
The Company invests its excess cash in debt instruments of
governmental agencies, and corporations with credit ratings of AA/AA- or
better or A1/P1 or better, respectively. The Company has established
guidelines relative to diversification and maturities that attempt to
maintain safety and liquidity. The Company has not experienced any
significant losses on its cash equivalents or short-term investments.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or
market. The components of inventory are as follows (in thousands):
December 31,
---------------------
1999 1998
---------- ----------
Finished goods.................... $3,201 $3,355
Work-in-process................... 583 170
Raw materials..................... 1,207 425
---------- ----------
$4,991 $3,950
========== ==========
During the year ended December 31, 1998 the Company was required to
purchase inventory components from its previous contract manufacturer
that were subsequently sold to its current contract manufacturer. As a
result of the transition to the Company's current contract manufacturer,
the Company recorded a charge of approximately $1,300,000. A portion of
the charge consisted of approximately $750,000 of raw material
components that were deemed obsolete due to a design change in the
Company's bill of materials. The charge also consisted of a write down
of approximately $550,000 for parts repurchased from the Company's
previous contract manufacturer and then resold to the Company's current
contract manufacturer, as the Company's current contract manufacturer
could purchase the related parts at a lower cost than the Company had
valued the inventory. Therefore, the Company wrote down the inventory to
the lower of cost or market as part of selling the inventory to its
current contract manufacturer.
Property and Equipment
Property and equipment are carried at cost less accumulated
depreciation and amortization. Property and equipment are depreciated
for financial reporting purposes using the straight-line method over the
estimated useful lives of three to five years. Leasehold improvements
are amortized using the straight-line method over the shorter of the
useful lives of the assets or the terms of the leases. The
recoverability of the carrying amount of property and equipment is
assessed based on estimated future undiscounted cash flows and if an
impairment exists the charge to operations is measured as the excess of
the carrying amount over the fair value of the assets. Based upon this
method of assessing recoverability, no asset impairment occurred in any
of the years presented.
Property and equipment are as follows (in thousands):
December 31,
---------------------
1999 1998
---------- ----------
Software and computers............ $7,729 $4,411
Furniture and equipment........... 7,410 3,567
Leasehold improvements............ 459 197
Automobiles....................... 165 --
---------- ----------
15,763 8,175
Accumulated depreciation and
amortization..................... (9,606) (4,582)
---------- ----------
Property and equipment, net....... $6,157 $3,593
========== ==========
Intangibles and Other Assets
Intangibles and other assets consisted of the following at December
31, 1999 (in thousands):
Developed technology, gross..................... $56,850
Goodwill, gross................................. 87,942
Other intangibles, gross........................ 10,450
-----------
155,242
Accumulated amortization of intangible assets... (6,089)
-----------
Intangibles, net................................ 149,153
Other Assets................................... 2,486
-----------
Total intangibles and other assets........ $151,639
===========
Revenue Recognition
The Company sells it products directly to broadband access service
providers, system resellers and distributors. Revenues related to
product sales are generally recognized when the products are shipped to
the customer. A provision is made for estimated product returns as
product shipments are made. The Company's existing agreements with its
system resellers and distributors do not contain price protection
provisions and do not grant return rights beyond those provided by the
Company's standard warranty. The Company has also performed some
research and product development work under best efforts technology
development agreements. Due to technological risk factors, the costs of
these agreements were expensed as incurred and were included in cost of
goods sold in prior years. Revenues under technology development
agreements are recognized when applicable customer milestones have been
met, including deliverables and, in any case, not in excess of the
amount that would be recognized using the percentage-of-completion
method. The Company met milestones under an agreement in the fourth
quarter of the year ended December 31, 1997 and recognized the related
revenue (see Note 4).
Warranty Reserves
The Company's products generally carry a one-year warranty that
includes factory and on-site repair services as needed for replacement
of parts. Estimated expenses for warranty obligations are accrued as
revenue is recognized. Reserve estimates are adjusted periodically to
reflect actual experience.
Stock-Based Compensation
As described in Note 10, the Company has elected to account for its
employee stock plans in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion
No. 25), and to adopt the disclosure-only provisions as required under
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (FAS 123).
Comprehensive Income
The Company has adopted Statement of Accounting Standards No. 130,
"Reporting Comprehensive Income" (FAS 130). FAS 130 requires that all
items required to be recognized under accounting standards as components
of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
Accumulated other comprehensive income presented in the accompanying
consolidated balance sheets consists of net unrealized gain on short-
term investments for the year ended December 31, 1999. The Company's
comprehensive net loss was the same as its net loss for the years ended
December 31, 1998 and 1997.
Segments of an Enterprise
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 superseded
Statement of Financial Accounting Standards No. 14, "Financial Reporting
for Segments of a Business Enterprise". FAS 131 establishes standards
for the way that public business enterprises report information about
operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments
in interim financial reports. FAS 131 also establishes standards for
related disclosures about products and services, geographic areas, and
major customers. The adoption of FAS 131 did not affect the Company's
results of operations or financial position, and did not affect the
disclosure of segment information (see Note 12).
Net Loss Per Share Applicable to Common Stockholders
Historical basic and diluted net loss per share applicable to common
stockholders was computed using the weighted average number of common
shares outstanding. Options, warrants, restricted stock and preferred
stock were not included in the computation of historical diluted net
loss per share applicable to common stockholders because the effect
would be antidilutive.
Pro forma net loss per share applicable to common stockholders was
computed as described above and also gives effect, even if antidilutive,
to common equivalent shares from preferred stock that automatically
converted upon the closing of the Company's initial public offering
(using the as-if-converted method).
A reconciliation of shares used in the calculation of historical and
pro forma basic and diluted net loss per share applicable to common
stockholders follows (in thousands, except per share data):
A reconciliation of shares used in the calculation of historical and pro
forma basic and diluted net loss per share follows (in thousands, except per
share data):
Years Ended December 31,
--------------------------------
1999 1998 1997
---------- ---------- ----------
Net loss.................................. ($64,080) ($23,228) ($22,549)
Series F convertible preferred stock
dividend (note 10)....................... -- 23,910 --
---------- ---------- ----------
Net loss applicable to common
stockholders............................. ($64,080) ($47,138) ($22,549)
========== ========== ==========
Shares used in computing historical
basic and diluted net loss per share
applicable to common stockholders........ 20,630 8,986 4,289
Historical basic and diluted net loss
per share applicable to common
stockholders............................. ($3.11) ($5.25) ($5.26)
========== ========== ==========
Shares used in computing historical
basic and diluted net loss per share
applicable to common stockholders........ 8,986 4,289
Adjustment to reflect the effect of the
assumed conversion of weighted average
shares of convertible preferred stock
outstanding applicable to common
stockholders............................. 4,818 6,584
---------- ----------
Shares used in computing pro forma
basic and diluted net loss per share
applicable to common stockholders........ 13,804 10,873
========== ==========
Pro forma basic and diluted net loss
per share applicable to common
stockholders............................ ($3.41) ($2.07)
========== ==========
Options to purchase 4,442,269 and 2,691,234 shares of common stock
were outstanding at December 31, 1999 and 1998, respectively, and
warrants to purchase 2,036,159 and 3,019,191 shares of common stock were
outstanding at December 31, 1999 and 1998, respectively, but were not
included in the computation of diluted net loss per share, since the
effect would be antidilutive.
Impact of Recently Issued Accounting Standard
In September 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133). FAS 133
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. FAS 133 was
effective for fiscal years beginning after September 15, 1999. In July
1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities -Deferral of the Effective Date of
FASB Statement No. 133" (FAS 137). FAS 137 defers for one year the
effective date of FAS 133 which will now apply to all fiscal quarters of
all fiscal years beginning after June 15, 2000. The Company believes
that the adoption of FAS 137 will not have a significant impact on the
Company's operating results or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on the recognition, presentation
and disclosure of revenue in the financial statements of public
companies. Changes in the Company's revenue recognition policy
resulting from SAB 101 would be reported as a change in accounting
principle and would result in a cumulative adjustment in the second
quarter to reflect the deferral of revenue for shipments previously
recognized as revenue that did not meet the revenue recognition criteria
established by SAB 101. The Company currently cannot determine the
effect, if any, that SAB 101 will have on the Company's financial
statements. Management believes that SAB 101, to the extent it is
applicable to the Company, will not effect the underlying strength or
weakness of the Company's business operations as measured by the dollar
value of the Company's shipments and cash flows.
2. Fair Value of Financial Instruments
The following estimated fair value amounts have been determined using
available market information and appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data
to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts that the
Company could realize in a current market exchange.
December 31, 1999
-------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Short-term investments Cost Gains Losses Value
- - ------------------------------------ ---------- ---------- ---------- ----------
(in thousands)
Commercial paper.................... $30,027 $ -- $ -- $30,027
Government agency obligations....... 41,780 -- (255) 41,525
Fixed income corporate securities.. 9,070 -- (28) 9,042
---------- ---------- ---------- ----------
Total............................. $80,877 $ -- ($283) $80,594
========== ========== ========== ==========
December 31, 1998
-------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Short-term investments Cost Gains Losses Value
- - ------------------------------------ ---------- ---------- ---------- ----------
(in thousands)
Commercial paper.................... $8,426 $ -- $ -- $8,426
Government agency obligations....... 6,112 -- -- 6,112
---------- ---------- ---------- ----------
Total............................. $14,538 $ -- $ -- $14,538
========== ========== ========== ==========
Realized gains and losses were insignificant for each of the three
years in the period ended December 31, 1999.
3. Officer Note Receivable
In March 1996, the Company loaned an officer $100,000 pursuant to a
promissory note. The note was paid in full in 1999.
4. Technology Development Agreement
On January 4, 1995, the Company entered into a Development and
Production Agreement with a telecommunications systems manufacturer (the
Manufacturer), whereby the Company agreed to develop an enabling
technology for use with certain manufacturer technology (the Product).
Pursuant to the agreement, the Manufacturer is obligated to purchase
certain minimum quantities of the Product, and the Company has agreed to
provide the Product to the Manufacturer on favorable pricing terms for a
period of four years following completion of the Product. In addition,
the Company has agreed that for the first three months following the
completion of the Product, the Company will not sell the Product to any
third party for use in the carrying of voice-over coaxial cables.
In accordance with the agreement, the Company will receive funding
from the Manufacturer totaling $1,000,000. These payments were
originally received upon the completion of certain milestones set forth
in the agreement. As of December 31, 1997, approximately $480,000 of
cash advances had been received under the agreement. In the fourth
quarter of the year ended December 31, 1997, the Company delivered the
Product under the agreement and recognized the $480,000 as revenue. In
March 1998, the agreement was amended, and the Company is to receive the
remaining payments (in addition to normal Product billings) over a
certain number of future unit shipments to the Manufacturer.
5. Commitments
The Company leases its facilities and certain equipment under
operating leases. The operating lease for the Company's facilities
expire in 2002 and 2003. Rental expense was approximately $1,013,000,
$853,000, and $850,000 for the years ended December 31, 1999, 1998, and
1997, respectively. In October 1999, the Company subleased the
facilities formerly occupied by Imedia Corporation to a third party
through 2003. Sublease rental income was approximately $57,400 for the
period from September 16, 1999 (acquisition date) to December 31, 1999.
The Company leases certain equipment under noncancelable lease
agreements that are accounted for as capital leases. Equipment under
capital lease arrangements and included in property and equipment
aggregated approximately $34,600 and $452,000 at December 31, 1999 and
1998, respectively. Related accumulated amortization was approximately
$29,300 and $375,000 at December 31, 1999 and 1998, respectively.
Amortization expense related to assets under capital leases is included
in depreciation expense. In addition, the capital leases are secured by
the related equipment and the Company is required to maintain liability
and property damage insurance.
Future minimum lease payments under noncancelable operating leases
and capital leases are as follows (in thousands):
Future minimum lease payments under noncancelable operating leases and
capital leases are as follows (in thousands):
December 31, 1999
---------------------
Operating Capital
Leases Leases
---------- ----------
2000...................................... $1,972 $6
2001...................................... 2,015 7
2002...................................... 957
2003...................................... 99 --
---------- ----------
Total minimum payments.................... $5,043 13
==========
Less amount representing interest......... 2
----------
11
Less current portion...................... 5
----------
$6
==========
Future minimum sublease payments to be received under noncancelable
subleases are approximately $878,000.
Unconditional Purchase Obligations
The Company has unconditional purchase obligations to a few of its
suppliers that support the Company's ability to manufacture its
products. The obligations require the Company to purchase minimum
quantities of the suppliers' products at a specified price. At December
31, 1999, the Company had approximately $48,829,000 of unconditional
purchase obligations ($10,281,000 at December 31, 1998).
Royalties
The Company has purchased, through its acquisition of Radwiz Ltd.,
certain technology that was developed by Radwiz and a former sister
company utilizing funding provided by the Israeli Chief Scientist of the
Ministry of Industry and Trade ("OCS"). The purchase of the technology
was approved by the OCS. As a condition for this approval, the Company
has committed to pay royalties to the Government of Israel on proceeds
from sales of products based on this technology. Royalty rates are 3% -
5%. Royalties are payable from the commencement of sales of products
based on the technology until the cumulative amount of the royalties
paid and accrued by the Company equals 100% of the dollar amount
received. The Company's total obligation for royalties, based on
royalty-bearing Government participations received or accrued, net of
royalties paid or accrued, totaled approximately $5,900,000 at December
31, 1999.
6. Debt Obligations
The Company has a credit agreement with a bank to provide a line of
credit in an amount of $2,500,000. At December 31, 1999, the Company
had an unused standby letter of credit of $150,000 outstanding against
the line of credit and $2,350,000 was available under the line of
credit.
The credit agreement provides for interest at a rate equal to prime
(8.5% at December 31, 1999) and matures one year from the date of the
agreement. At December 31, 1999, there were no outstanding borrowings
under this credit agreement and approximately $2,500,000 was available.
Outstanding borrowings under the credit agreement are secured by
certain Company assets. The credit agreement contains affirmative and
negative covenants and requires, among other things, that the Company
maintain its primary banking relationship with the bank. The credit
agreement also limits, among other things, the Company's ability to
incur additional debt, to pay cash dividends, or to purchase or sell
certain assets. Finally, the agreement restricts the Company to a
minimum tangible net worth and prohibits certain acquisitions, mergers,
consolidations, or similar transactions without the prior consent of the
bank.
In 1999, Radwiz borrowed approximately $43,000 from an Israeli bank.
The borrowing bore interest at LIBOR plus 1.25% and was paid in full
subsequent to December 31, 1999.
The Company incurred interest expense related to the debt
obligations of approximately $22,000, $256,000, and $205,000 for the
years ended December 31, 1999, 1998, and 1997, respectively.
7. Accrued Severance Pay
Radwiz is subject to Israeli law and labor agreements, under which
Radwiz is required to make severance payments to dismissed employees and
employees leaving its employment in certain other circumstances.
Radwiz's severance pay liability to its employees, which is calculated
on the basis of the salary of each employee for the last month of the
reported year multiplied by the years of such employee's employment is
included in the Company's consolidated balance sheet on the accrual
basis, and is partially funded by a purchase of insurance policies in
Radwiz's name. At December 31, 1999, approximately $329,000 for accrued
severance pay was included in other long-term obligations.
Approximately $165,000 relating to the amounts funded by the purchase of
insurance policies was included in other assets at December 31, 1999.
8. Contingencies
The Company received letters from two individuals claiming that the
Company's technology infringes patents held by these individuals. The
Company has reviewed the allegations made by these individuals and,
after consulting with its patent counsel, the Company does not believe
that its technology infringes any valid claim of these individuals'
patents. If the issues are submitted to a court, the court could find
that the Company's products infringe these patents. In addition, these
individuals may continue to assert infringement. If the Company is found
to have infringed these individuals' patents, it could be subject to
substantial damages and/or an injunction preventing it from conducting
its business. In addition, other third parties may assert infringement
claims against the Company in the future. An infringement claim, whether
meritorious or not, could be time-consuming, result in costly
litigation, cause product shipment delays or require the Company to
enter into royalty or licensing agreements. These royalty or licensing
agreements may not be available on terms acceptable to the Company or at
all. The Company has reviewed the allegations made by these individuals
and management does not believe that the outcome will have a material
adverse effect on the Company's financial position, results of
operations, or cash flows.
In September 1999, Imedia Corporation, now a subsidiary of the
Company, was named as a defendant in a case alleging that Imedia
breached its term sheet agreement with the Plaintiffs by negotiating
with the Company while a no shop provision was in place and refusing to
allow the Plaintiffs to invest in Imedia. The Plaintiffs are seeking
damages in excess of $12.0 million. As part of the terms of the Imedia
Agreement and Plan of Merger and Reorganization, shares of the Company's
common stock to be issued to the former shareholders of Imedia were
placed in escrow to indemnify the Company for any damages that are
directly or indirectly suffered as a result any claim brought by any
Person who was a prospective investor in Imedia and was not a
securityholder of Imedia on the closing date of the Imedia acquisition.
The value of the escrowed shares was approximately $10.0 million based
on the market value of the Company's common stock on the closing date.
The case is in its initial stages, and no trial date has been
established. The Company has reviewed the allegations made by the
Plaintiffs and management does not believe that the outcome will have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
In the normal course of business, the Company from time to time
receives inquiries with regard to various legal proceedings. In the
opinion of management, any liability resulting from these inquiries has
been accrued and will not have a material adverse effect on the
Company's financial position or results of operations.
9. Public Offerings
In August 1998, the Company completed its initial public offering and
issued 3,000,000 shares of its common stock to the public at a price of
$13.00 per share. The Company received net proceeds of approximately
$35,136,000 in cash. Upon the closing of the offering, all of the
outstanding shares of convertible preferred stock, redeemable
convertible preferred stock, and redeemable common stock outstanding
were converted into an aggregate of 8,360,635 shares of common stock.
In January 1999, the Company completed a public offering of 3,250,000
shares of common stock, of which 1,750,000 shares were offered by the
Company and 1,500,000 shares were offered by existing stockholders. The
public offering resulted in proceeds to the Company of approximately
$62,500,000, net of underwriting discounts, commissions, and other
offering costs. In February 1999, the underwriters purchased an
additional 487,500 shares of common stock as a result of the exercise of
the over-allotment option, of which 351,946 and 135,554 shares of common
stock were purchased from the Company and certain existing stockholders,
respectively. This additional sale of common stock resulted in
additional proceeds of approximately $12,700,000 to the Company.
10. Redeemable Stock
In 1998, the Company issued 384,616 shares of Series D redeemable
convertible preferred stock resulting in proceeds of approximately
$5,000,000 and also issued 192,308 shares of Series F redeemable
convertible preferred stock resulting in proceeds of approximately
$2,500,000. The Series D and F redeemable preferred stockholders had
options ("Put Rights") to sell the Company some or all of the Series D
and F redeemable convertible preferred stock at $13.00 per share. The
Put Rights expired upon the completion of the Company's initial public
offering in August 1998.
In conjunction with the Series D redeemable convertible preferred
stock agreement, the Company issued a warrant to purchase 38,462 shares
of Series D convertible preferred stock. The Company recorded expense of
$19,000 to reflect the value of the warrant. In August 1998, the Company
completed its initial public offering (see Note 9) which caused the
termination of the unexercised warrant.
In September 1997, the Company issued redeemable common stock to an
employee in return for a full recourse note receivable for $13,000. The
note bore an interest rate of 5.81% per annum and was due in September
1998. The note was paid in full in January 1998. Pursuant to the stock
purchase agreement, the employee had the option to sell some or all of
his shares to the Company on or after September 22, 1998 at a purchase
price of $13.00 per share (the "Put Price"). Such option expired upon
the earlier of (a) September 22, 2003 or (b) the completion of the
Company's initial public offering of shares of its common stock. In
August 1998, the Company completed its initial public offering (see Note
9) which caused the termination of the option and the conversion of the
redeemable common stock into the Company's common stock. The Company
expensed approximately $88,000 and $29,000 for the years ended December
31, 1998 and 1997, respectively, representing the difference between the
common stock's per share price and the Put Price over the option's
vesting period.
11. Stockholders' Equity
Common Stock
In 1998, the Company's stockholders approved an increase in the
authorized number of common shares from 20,000,000 shares to 30,000,000
shares.
In 1999, the Company's stockholders approved an increase in the
authorized number of common shares from 30,000,000 to 45,000,000.
Preferred Stock
In 1998, the Company's Certificate of Incorporation was amended to
authorize 5,000,000 shares of preferred stock which the Board of
Directors has the authority to fix or alter the designation, powers,
preferences and rights of the shares of each such series and
qualifications, limitations or restrictions to any unissued series of
preferred stock.
Delaware Reincorporation
In July 1998, the Company's stockholders approved the Company's
reincorporation in Delaware. The par value of the preferred and common
stock is $.001 per share. The Company's reincorporation has been
reflected in the consolidated financial statements. The change resulted
in the transfer of $40,116,000 from convertible preferred stock and
$30,401,000 from common stock to additional paid-in capital.
Common Stock Warrants
In conjunction with a Series F convertible preferred stock financing
in April 1998, the Company issued a warrant to purchase 3,000,000 shares
of the Company's common stock at an exercise price of $6.50 per share to
Shaw Communications, Inc. (the "Shaw Warrant"). The Shaw Warrant is
exercisable at any time prior to December 31, 2003. In addition, the
Company issued a warrant (the "Anti-Dilution Warrant") to purchase an
indeterminate number of shares of common stock. The Anti-Dilution
Warrant is exercisable at the option of Shaw Communications, Inc.
("Shaw") during the period that Shaw owns equity securities of the
Company (purchased in April 1998) and in the event the Company issues
new equity securities at below the current market price as defined in
the Anti-Dilution Warrant. The aggregate exercise price is $1.00. In
June 1998, the Company issued certain equity securities that, as of
December 31, 1998, require the Company to issue an additional 19,191
shares of common stock pursuant to the Anti-Dilution Warrant. In 1999,
the Company issued certain equity securities that, as of December 31,
1999, require the Company to issue an additional 16,968 shares of common
stock pursuant to the Anti-Dilution Warrant. The Company recorded
expenses of approximately $439,000 for the year ended December 31, 1999
relating to shares issuable pursuant to the Anti-Dilution Warrant.
The Company recorded a dividend of $23,910,000 in the quarter ended
June 30, 1998, representing the fair value of the Shaw Warrant under
EITF No. 96-13, "Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock." The Company's
accounting conclusion with respect to the Shaw Warrant issued in
connection with the sale of the convertible preferred stock (the "Shaw
Financing") is based on management's conclusion that the sale of
convertible preferred stock was, in substance, a financing transaction
and not the issuance of equity instruments in exchange for goods or
services.
In March 1999, Shaw purchased 1,500,000 shares of the Company's
common stock at $6.50 per share and in November 1999 Shaw purchased an
additional 1,500,000 shares of the Company's common stock at $6.50 per
share, resulting in net proceeds to the Company of $19.5 million. The
shares were purchased pursuant to the exercise of a warrant to purchase
3,000,000 shares of the Company's common stock issued to Shaw in 1998.
In June 1998, the Company issued a warrant to purchase 50,000 shares
of the Company's common stock at $10.00 per share. The Company recorded
an expense of $35,000 to reflect the value of the warrant in the year
ended December 31, 1998. The warrant was exercised in August 1998.
On March 18, 1999, the Company entered into a one-year Product
Development Assistance Agreement ("Development Agreement") with Rogers
Communications Inc. Under the terms of the Development Agreement, Rogers
will provide the Company assistance with the characterization and
testing of the Company's subscriber-end and head-end voice over cable
equipment. In addition, Rogers will provide the Company technology to
assist the Company in connection with its efforts to develop high
quality, field proven technology solutions that are DOCSIS (1.0, 1.1 and
1.2)-compliant and packet cable-compliant. In consideration of Rogers
entering into the Development Agreement, the Company issued Rogers two
fully vested and non-forfeitable warrants, each to purchase 1,000,000
shares of common stock. One warrant has an exercise price of $1.00 per
share and one warrant has an exercise price of $37.00 per share. The
warrants may be exercised in full or in part through March 31, 2000.
The fair value of the two warrants was approximately $45,000,000 and
will be a noncash charge included in operations over the term of the
Product Development Assistance Agreement. As a result of the
Development Agreement, the Company's results for 1999 include a noncash
charge of $35.1 million. Subsequent to December 31, 1999, Rogers
exercised the warrants on a cashless basis resulting in the issuance of
1,843,809 shares of the Company's common stock and no proceeds to the
Company.
Common Stock Reserved
Common stock reserved for issuance is as follows:
December 31,
1999
-----------
Common stock options............... 6,803,514
Common stock warrants.............. 2,033,879
Employee stock purchase plan....... 598,837
-----------
9,436,230
===========
Stock-Based Compensation
In March 1995 and February 1997, the Board of Directors approved a
stock option plan and an equity incentive plan, respectively, that
authorized the grant of options to purchase shares of the Company's
common stock. In June 1998, the Company's Board of Directors authorized
the adoption of the amended 1997 Equity Incentive Plan, increasing the
aggregate number of shares authorized for issuance under the 1997 Plan
to 3,300,000 shares (2,250,000 additional shares). However, each year on
January 1, starting with January 1, 1999, the aggregate number of shares
that are available for issuance under the 1997 Plan will automatically
be increased to a number equal to 5% of the Company's outstanding shares
of common stock on such date. In addition, in June 1998, the Company's
Board of Directors authorized the adoption of the 1998 Non-Employee
Directors' Stock Option Plan, pursuant to which 200,000 shares of the
Company's common stock have been reserved for future issuance to non-
employee directors of the Company. In October 1999, the Company's Board
of Directors authorized the adoption of the 1999 Non-Officers Equity
Incentive Plan, pursuant to which 3,000,000 shares of the Company's
common stock have been reserved for future issuance to non-officer
employees of the Company. At December 31, 1999, the total authorized
number of shares under the 1995, 1997, 1998 and 1999 plans was
2,114,747, 3,300,000, 200,000 and 3,000,000 respectively. The plans are
administered by the Board of Directors and provide for incentive stock
options or nonqualified stock options to be issued to employees,
directors, and consultants of the Company. Prices for incentive stock
options may not be less than the fair value of the common stock at the
date of grant. Prices for nonqualified stock options may not be less
than 85% of the fair value of the common stock at the date of grant.
Options are immediately exercisable and vest over a period not to exceed
five years from the date of grant. Any unvested stock issued is subject
to repurchase by the Company at the original issuance price upon
termination of the option holder's employment. Unexercised options
expire ten years after the date of grant.
In March and July 1997, the Board of Directors authorized grants of
common stock options outside the Company's stock option plans. The
options are for 70,000 shares of common stock and generally vest over a
three-year period in six equal installments occurring every six months.
In May and June 1998, the Board of Directors authorized additional
grants of 70,000 shares of common stock outside the Company's stock
option plans.
During the years ended December 31, 1998 and 1997, the Company
recorded aggregate deferred compensation of approximately $2,389,000 and
$228,000, respectively, representing the difference between the grant
price and the deemed fair value of the Company's common stock options
granted during these periods. The amortization of deferred compensation
is being charged to operations and is being amortized over the vesting
period of the options, which is typically five years. For the years
ended December 31, 1999,1998 and 1997, the amortized expense was
approximately $631,000,$421,000 and 12,000, respectively.
The following is a summary of additional information with respect to
the 1995 Stock Option Plan, the 1997 Equity Incentive Plan, the 1998
Non-Employee Directors' Stock Option Plan, the 1999 Non-Officer Equity
Incentive Plan and option grants made outside the plans:
Options
Outstanding
and Exercisable
-----------------------
Weighted-
Options Number Average
Available of Exercise
for Grant Shares Price
----------- ----------- -----------
Balance at December 31, 1996........ 121,578 1,886,950 $0.31
Options authorized................ 1,120,000 -- $ --
Options granted................... (1,304,050) 1,304,050 $1.71
Options exercised................. -- (481,648) $0.30
Options canceled.................. 372,168 (372,168) $0.56
----------- -----------
Balance at December 31, 1997........ 309,696 2,337,184 $1.05
Options authorized................ 2,520,000 -- $ --
Options granted................... (1,185,081) 1,185,081 $9.45
Options exercised................. -- (404,039) $0.69
Options canceled.................. 426,992 (426,992) $2.79
----------- -----------
Balance at December 31, 1998........ 2,071,607 2,691,234 $4.54
Options authorized................ 3,000,000 -- --
Options granted................... (3,184,384) 3,184,384 $39.97
Options exercised................. (963,993) $3.46
Options canceled.................. 469,356 (469,356) $11.67
Options Repurchased............... 4,666 $0.50
----------- -----------
Balance at December 31, 1999........ 2,361,245 4,442,269 $28.68
=========== ===========
In addition, the following table summarizes information about stock options
that were outstanding and exercisable at December 31, 1999:
Options Outstanding and Exercisable
-----------------------------------
Weighted-
Average
Weighted- Remaining
Number Average Contractual
of Exercise Life
Range of Exercise Prices Shares Price (in Years)
- - ------------------------------------- ----------- ----------- -----------
$ 0.10 -- $ 0.50........... 311,076 $0.39 6.25
$ 0.51 -- $ 1.25........... 199,941 $1.25 7.35
$ 1.26 -- $ 3.00........... 62,962 $2.49 7.72
$ 3.01 -- $6.83........... 474,255 $6.31 8.35
$6.84 -- $13.00........... 461,739 $10.70 9.04
$13.01 -- $32.75........... 721,693 $29.04 9.32
$32.76 -- $66.88........... 2,210,603 $44.83 9.68
-----------
Total.................... 4,442,269
===========
At December 31, 1999, approximately 109,000 shares of common stock
outstanding were subject to repurchase by the Company. Common stock
subject to repurchase represents any unvested shares of common stock
held by an optionholder which, upon termination of the optionholder's
employment, may be repurchased by the Company. Such shares are subject
to repurchase at their original issuance price.
In June 1998, the Board of Directors approved, and the Company
adopted, the 1998 Employee Stock Purchase Plan (the "ESPP"), which is
designed to allow eligible employees of the Company to purchase shares
of common stock at semiannual intervals through periodic payroll
deductions. An aggregate of 700,000 shares of common stock has been
reserved for the ESPP, and 101,163 shares have been issued through
December 31, 1999. The Purchase Plan is implemented in a series of
successive offering periods, each with a maximum duration of 24 months.
Eligible employees can have up to 15% of their base salary deducted that
is to be used to purchase shares of the common stock on specific dates
determined by the Board of Directors (up to a maximum of $25,000 per
year based upon the fair market value of the shares at the beginning
date of the offering). The price of common stock purchased under the
Purchase Plan will be equal to 85% of the lower of the fair market value
of the common stock on the commencement date of each offering period or
the specified purchase date.
The Company has elected to follow APB Opinion No. 25 and related
interpretations in accounting for its employee stock plans because, as
discussed below, the alternative fair value accounting provided for
under FAS 123 requires the use of valuation models that were not
developed for use in valuing employee stock instruments. Under APB
Opinion No. 25, when the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
Pro forma information regarding net loss is required under FAS 123
and is calculated as if the Company had accounted for its employee stock
options granted during the years ended December 31, 1999, 1998 and 1997
and for its ESPP shares to be issued under the fair value method of FAS
123. The fair value for employee stock options granted was estimated at
the date of grant based on the Black-Sholes model using the following
weighted average assumptions: risk-free interest rates 6.70%, 5.39%, and
5.75% for 1999, 1998, and 1997, respectively; no dividend yield, a
volatility factor of .80 (no volatility factor of the expected market
price of the Company's common stock for options granted prior to the
Company's initial public offering in August 1998 as the minimum value
method was used); and a weighted average expected life of the option of
five years. The fair value for employee stock purchase plan shares to be
issued was estimated using the following weighted average assumptions:
risk-free interest rate of 6.71 and 5.19% for 1999 and 1998,
respectively, no dividend yield, a volatility factor of .80, and a
weighted average expected life of the shares of six months.
As discussed above, the valuation models used under FAS 123 were
developed for use in estimating the fair value of traded options that
have no vesting restrictions and are fully transferable. In addition,
valuation models require the input of highly subjective assumptions,
including the expected life of the option. Because the Company's
employee stock options have characteristics significantly different from
those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock
instruments.
For purposes of pro forma disclosures, the estimated fair value of
the options granted and ESPP shares to be issued is amortized to expense
over their respective vesting periods. Had compensation cost for the
Company's stock-based compensation plans been determined based on the
fair value at the grant dates for awards under those plans consistent
with the method of FAS 123, the Company's net loss applicable to common
stockholders and net loss per share applicable to common stockholders
would have been increased to the pro forma amounts indicated below (in
thousands, except per share data):
Years Ended December 31,
--------------------------------
1999 1998 1997
---------- ---------- ----------
Pro forma net loss applicable to
common stockholders............... ($75,321) ($47,997) ($22,627)
========== ========== ==========
Pro forma basic and diluted net
loss per share applicable to
common stockholders............... ($3.65) ($5.34) ($5.28)
========== ========== ==========
The pro forma impact of options granted and ESPP shares to be issued
on the net loss applicable to common stockholders for the years ended
December 31, 1998 and 1997 is not representative of the effects on net
income (loss) for future years, as future years will include the effects
of options vesting as well as the impact of multiple years of stock
option grants.
The options' weighted average grant date fair value, which is the
value assigned to the options under FAS 123, was $28.31, $3.20, and
$0.41,for options granted during 1999, 1998, and 1997,respectively. The
weighted average grant date fair value of ESPP shares to be issued was
$8.40 and $7.70 for the year ended December 31, 1999 and 1998.
Stockholders' Notes Receivable
In February 1993, the Company issued common stock to a founder in
return for a full recourse note receivable for $12,500. The note bore
interest rate of 7.04% per annum and was paid in 1999.
During June and December 1995, two officers of the Company were
provided cash advances totaling approximately $81,000 for the purpose of
purchasing the Company's Series A preferred stock. The final payment of
the full recourse notes was paid in 1998.
In January 1998, the Company issued common stock to an employee in
exchange for a full recourse note receivable for $9,000. The note bears
interest at 5.7% and is payable in three equal annual payments
commencing in January 1999.
12. Income Taxes
Due to operating losses and the inability to recognize the benefits
therefrom, there is no provision for income taxes for the fiscal years
ended December 31, 1999, 1998, and 1997.
The reconciliation of income tax expense (benefit) attributable to net
loss applicable to common stockholders computed at the U.S. federal
statutory rates to income tax expense (benefit) for the fiscal years
ended December 31, 1999, 1998, and 1997 is as follows (in thousands):
Years Ended December 31,
--------------------------------
1999 1998 1997
---------- ---------- ----------
Tax provision (benefit) at U.S.
statutory rate...................... ($21,788) ($16,027) ($7,667)
Goodwill amortization................. $1,198 -- --
In-process research and development... $4,964 -- --
Loss for which no tax benefit is
currently recognizable.............. 15,626 7,898 7,667
Nondeductible preferred stock dividend -- 8,129 --
---------- ---------- ----------
$ -- $ -- $ --
========== ========== ==========
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax assets as
of December 31, 1999 and 1998 are as follows (in thousands):
Year Ended December 31,
---------------------
1999 1998
---------- ----------
Deferred Tax Assets:
Net operating loss carryforwards............ $18,700 $18,448
Tax credit carryforwards.................... 2,200 1,956
Capitalized research and development........ 1,020 1,776
Deferred warrant expense................... 13,970 --
Deferred revenue......................... 1,800 --
Other, net.................................. 4,780 2,364
---------- ----------
Total deferred tax assets................. 42,470 24,544
Deferred Tax Liabilities
Acquired intangibles........................ (10,998) --
Valuation allowance.......................... (31,472) (24,544)
---------- ----------
Net deferred tax assets $ -- $ --
========== ==========
Realization of deferred tax assets is dependent on future earnings,
if any, the timing and the amount of which are uncertain. Accordingly, a
valuation allowance, in an amount equal to the net deferred tax asset as
of December 31, 1999 and 1998, has been established to reflect these
uncertainties. The change in the valuation allowance was a net increase
of approximately $6,928,000, $8,159,000, $10,329,000 and for the years
ended December 31, 1999, 1998, and 1997, respectively.
As of December 31, 1999, the Company had federal and California net
operating loss carryforwards of approximately $52,200,000 and
$22,500,000, respectively. The Company also had federal and California
research and development tax credit carryforwards of approximately
$1,325,000 and $1,056,000, respectively. The net operating loss and
credit carryforwards will expire at various dates beginning in the years
2000 through 2019, if not utilized.
Utilization of net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended,
and similar state provisions. The annual limitation may result in the
expiration of net operating loss and tax credit carryforwards before
full utilization.
13. Segments of an Enterprise and Related Information
The Company operates in one business segment, the sale of broadband
access systems, which it sells primarily to customers within the cable
and communications industries. The TeraPro and TeraLink are sold
together as part of an entire system, and the Company accordingly does
not report revenue derived from these components.
The Chief Executive Officer has been identified as the Chief
Operating Decision Maker (CODM) because he has final authority over
resource allocation decisions and performance assessment. The CODM does
not receive discrete financial information about the individual
components.
Four of the Company's customers, Shaw Communications, Inc., Rogers
Cable Inc., United Pan-Europe Communications and Sumitomo Corporation,
accounted for 40%, 30%, 14% and 11%, respectively, of total revenues for
the year ended December 31, 1999. Three of the Company's customers, Shaw
Communications, Inc., Cablevision Systems Corporation and Sumitomo
Corporation accounted for 40%, 16% and 14%, respectively, of total
revenues for the year ended December 31, 1998. No other customer
accounted for more than 10% of revenues during these years.
Total net export revenues to regions outside of the United States
were approximately $81,411,000 and $23,383,000 for the years ended
December 31, 1999 and 1998, respectively. Revenues by geographic region
were as follows (in thousands):
Years Ended December 31,
---------------------
1999 1998
---------- ----------
Revenues:
United States................................. $15,598 $8,313
Canada........................................ 41,008 13,032
Europe and Israel............................. 24,746 4,387
Asia.......................................... 12,755 4,614
South America................................. 2,902 1,350
---------- ----------
Total revenues.............................. $97,009 $31,696
========== ==========
14. 401(k) Profit Sharing Plan and Trust
During 1995, the Company adopted a 401(k) Profit Sharing Plan and
Trust that allows eligible employees to make contributions subject to
certain limitations. The Company may make discretionary contributions
based on profitability as determined by the Board of Directors. No
amount was contributed by the Company to the plan during the years ended
December 31, 1999, 1998, and 1997.
15. Related Party Transactions
During the year ended December 31, 1997, the Company recognized
revenue of approximately $617,000 in connection with product shipments
made to Sumitomo Corporation, a significant stockholder in the Company
as of December 31, 1997. During the year ended December 31, 1998,
Sumitomo Corporation's ownership interest was diluted as a result of
subsequent Company financings, including the Company's initial public
offering, and Sumitomo is no longer considered a related party. Accounts
receivable from Sumitomo Corporation totaled approximately $362,000 at
December 31, 1997.
During the year ended December 31, 1998, the Company recognized
revenue of $12,546,000 in connection with product shipments made to Shaw
Communications, Inc., a significant stockholder (see Note 11) with a
position on the Company's Board of Directors as of December 31, 1998.
Accounts receivable from Shaw Communications, Inc. totaled approximately
$1,549,000 at December 31, 1998.
On March 18, 1999, the Company entered into a Supply Agreement with
Rogers Cablevision Limited ("Rogers Cablevision"), a subsidiary of
Rogers Communications. Under the Supply Agreement, the Company agreed
to make available to Rogers Cablevision its current TeraLink Gateway and
TeraLink 1000 Master Controller, and TeraPro Cable Modems and specified
software. The Company also committed to certain product pricing and
specifications. Under the terms of the Supply Agreement, Rogers retains
the right to return to the Company all product purchased until certain
conditions are met by the Company. Accordingly, the Company does not
recognize revenue on shipments to Rogers until the milestones have been
achieved or Rogers has waived the right to return the product. For the
year ended December 31, 1999, Rogers waived their right to return
certain product purchased and the Company recognized approximately
$17,100,000 in revenues from sales to Rogers. The Company also had
deferred revenues from Rogers of approximately $4,500,000 at December
31, 1999. Subsequent to year end Rogers waived all remaining rights of
return under the Supply Agreement; accordingly, the only rights of
return available to Rogers are those provided under Terayon's standard
warranty policy.
The Supply Agreement and the Development Agreement (see Note 11) do
not constitute a commitment by either Rogers Cablevision or Rogers
Communications to purchase or deploy any particular volume or quantity
of the Company's product. No such commitment will be made unless Rogers
Cablevision or Rogers Communications issues a purchase order to the
Company.
During the year ended December 31, 1999, the Company recognized
revenue of $39,664,000 in connection with product shipments made to Shaw
and Rogers, significant shareholders (see Note 11) with positions on the
Company's Board of Directors as of December 31, 1999. Accounts
receivable from these parties totaled approximately $7,281,000 at
December 31, 1999.
During the year ended December 31, 1999, the Company incurred
approximately $200,000 of expense related to consulting services
performed by a member of the Company's Board of Directors.
16. Business Combinations
Imedia Corporation
In July 1999, the Company entered into an Agreement and Plan of
Reorganization (the "Agreement") to acquire Imedia Corporation
("Imedia"), a California corporation. Imedia produces routing and re-
multiplexing systems for digital video that enable cable operators to
select and customize their program lineup for viewer preferences, while
maximizing video capacity and quality over standards-based set-top
boxes. The Imedia acquisition was completed on September 16, 1999 (the
"Closing Date").
In accordance with the Agreement, the shareholders, vested
optionholders and warrantholders are entitled to receive shares of the
Company's common stock in varying amounts in a series of up to three
stock payments, the last of which will occur on or before the 18-month
anniversary of the Closing Date. The aggregate number of shares of the
Company's common stock issued under the Agreement will depend, among
other things, on the performance of the Company's common stock over the
period during which the payments are to be made. In no event, shall the
number of shares issued exceed 3,000,000 shares, adjusted for any
splits, combinations, stock dividends and the like. The Agreement also
provides for the payment by the Company of certain Additional
Consideration in the form of cash or additional shares of the Company's
common stock in the event that certain pricing conditions are not
satisfied. The total value of the consideration that will ultimately
be paid, as measured by certain valuation formulae and based upon an
average of the price of the Company's common stock as reported on the
Nasdaq National Market, is not to exceed $99,000,000 nor be less than
$69,000,000. The holders of unvested Imedia options also will receive
options to purchase the Company's common stock, the fair value of which
will be included in the purchase price. The Company issued 827,407
shares of common stock and 172,477 options and warrants to purchase
common stock to the vested optionholders and warrantholders of Imedia on
the Closing Date. In addition, the unvested optionholders of Imedia
options also received options to purchase the Company's common stock,
the fair value of which was included in the purchase price. Subsequent
to year end, the valuation formulae specified in the Agreement were
satisfied, and, accordingly, the Company's obligation to issue
additional common stock or options and warrants to purchase common stock
beyond those issued at the Closing Date was eliminated. As a result, no
additional consideration will be issued in the future to the former
stockholders, optionholders and warrantholders of Imedia.
The acquisition was accounted for under the purchase method of
accounting. The purchase price was allocated to the assets acquired and
liabilities assumed based on a determination from an independent
appraisal of their respective fair values. The approximate purchase
based upon the valuation formulae was determined as $99,000,000. The
consolidation of the assets and liabilities significantly affected the
Company's balance sheet at December 31, 1999, as depicted in the
following tables:
Approximate purchase price (in thousands):
Approximate purchase price (in thousands):
Purchase price........................................ $106,347
Estimated transaction and other direct costs.......... 2,631
--------------
$108,978
==============
Purchase price allocation:
Purchase price allocation:
Historical net tangible assets of
Imedia at September 16, 1999..... ($355)
Forgiveness of Imedia note payable.. 1,000
----------
$645
Amortization
Life of Intangibles
-----------------------
Intangible assets acquired:
Developed technology................ 27,000 6 years 4,500
Assembled workforce................. 2,500 2 1,250
Trademark........................... 4,000 6 667
In-process research and development. 11,000 --
Goodwill............................ 63,833 6 10,639
----------
$108,978
==========
Tangible assets of Imedia principally include cash, accounts
receivable and property and equipment. Liabilities principally include
accounts payable and accrued liabilities. At the Closing Date, the
Company forgave Imedia's note payable obligation of $1,000,000.
To determine the value of the developed technology, the expected
future cash flow attributed to all existing technology was discounted,
taking into account risks related to the characteristics and application
of the technology, existing and future markets and assessments of the
life cycle stage of the technology. The analysis resulted in a
valuation of approximately $27,000,000 for developed technology that had
reached technological feasibility and therefore was capitalizable. The
developed technology is being amortized on a straight-line basis over a
six year period.
The value of the assembled workforce was derived by estimating the
costs to replace the existing employees, including recruiting and hiring
costs and training costs for each category of employee. The analysis
yielded a valuation of approximately $2,500,000 for the assembled
workforce. The asset is being amortized on a straight line basis over a
two year period. The goodwill allocation is approximately $63,833,000.
The value of the in-process research and development was determined
based on the expected cash flow attributed to the in-process projects,
taking into account revenue that is attributable to previously developed
technology, the level of effort to date in the in-process research and
development, the percentage of completion of the project and the level
of risk associated with the in-process technology. The projects
identified as in-process are those that were underway at Imedia at the
time of the acquisition and will, after the Closing Date, require
additional effort in order to establish technological feasibility.
These projects have identifiable technological risk factors that
indicate that even though successful completion is expected, it is not
assured. The value of the in-process research and development was
determined as approximately $11,000,000.
In-process technology acquired consists primarily of major additions
to Imedia's core technology, which is related to Imedia's planned
development of new features. The majority of the intended functionality
of these new features is not supported by Imedia's current technology.
Intended new features include offering high quality video service over
the Internet and multiplexing data with video. The Company expects that
in-process technology will be successfully developed and that initial
benefits from these projects will begin in calendar 2001.
Notwithstanding the Company's expectations, there remain significant
technical challenges that must be resolved in order to complete the in-
process technology.
Radwiz Ltd.
In October 1999, the Company entered into a Share Purchase Agreement
to acquire Radwiz Ltd., an Israeli company. Radwiz produces
communication access systems based on high-speed IP routing, integrated
with telephony. Radwiz's systems include both central office Digital
Subscriber Line Access Multiplexers (DSLAMs) and customer premises
equipment for small office, home office (SOHO) business broadband
services. The Radwiz acquisition was completed on November 22, 1999.
In accordance with the Agreement, the shareholders and vested
optionholders received cash and shares of the Company's common stock and
options to purchase shares of the Company's common stock. The aggregate
number of shares of the Company's common stock to be issued under the
Radwiz Agreement will depend, among other things, on the performance of
the Company's common stock over the period between the closing of the
merger and the twelve month anniversary. The Company paid $250,000 in
cash and issued 873,582 shares of Terayon common stock to the former
shareholders of Radwiz and issued options to purchase 72,571 shares of
Terayon common stock to the vested optionholders of Radwiz on the
Closing Date. In addition, the unvested optionholders of Radwiz options
also received options to purchase the Company's common stock, the fair
value of which was included in the purchase price.
The purchase price was allocated to the assets acquired and
liabilities assumed based on a determination from an independent
appraisal of their respective values. The approximate purchase price was
determined to be $52,700,000. This represents the minimum purchase
price, as specified in the Agreement, to be issued to the shareholders
and vested optionholders of Radwiz ($50,000,000,) plus the value of the
options issued to unvested optionholders of Radwiz ($2,700,000) based on
the market value of the Company's common stock on the date the
acquisition was announced. Proceeds to be received from the Radwiz
optionholders upon exercise of their options are not significant. The
consolidation of the assets and liabilities significantly affected the
Company's balance sheet at December 31, 1999, as depicted in the
following tables.
Approximate purchase price (in thousands):
Approximate purchase price (in thousands):
Purchase price........................................ $52,667
Estimated transaction and other direct costs.......... 902
--------------
$53,569
==============
Purchase price allocation:
Purchase price allocation:
Historical net tangible assets of
Radwiz at November 22, 1999....... $3,058
Amortization
Life of Intangibles
-----------------------
Intangible assets acquired:
Developed technology................ 29,850 6 years 4,975
Assembled workforce................. 2,800 2 1,400
Trademark........................... 1,150 6 192
In-process research and development. 3,600 --
Goodwill............................ 24,109 6 4,018
Deferred tax liability.............. (10,998)
----------
$53,569
==========
Tangible assets of Radwiz principally include cash, accounts
receivable, inventory and property and equipment. Liabilities
principally include accounts payable and accrued liabilities.
To determine the value of the developed technology, the expected
future cash flow attributed to all existing technology was discounted,
taking into account risks related to the characteristics and
applications of the technology, existing and future markets, and
assessments of the life cycle stage of technology. The analysis resulted
in a valuation of approximately $29,850,000 for developed technology
that had reached technological feasibility and therefore was
capitalizable. The developed technology is being amortized on a straight
line basis over a six year period.
The value of the assembled workforce was derived by estimating the
costs to replace the existing employees, including recruiting and hiring
costs and training costs for each category of employee. The analysis
yielded a valuation of approximately $2,800,000 for the assembled
workforce. The asset is being amortized on a straight-line basis over a
two year period.
The goodwill allocation is approximately $24,100,000.
The value of the in-process research and development was determined
based on the expected cash flow attributed to the in-process projects,
taking into account revenue that is attributable to previously developed
technology, the level of effort to date in the in-process research and
development, the percentage of completion of the project and the level
of risk associated with the in-process technology. The projects
identified as in process at Radwiz are those that will be underway at
the time of the acquisition of Radwiz and would, after consummation of
the acquisition, require additional effort to establish technological
feasibility. These projects have identifiable technological risk factors
that indicate that even though successful completion is expected, it is
not assured. The value of the in-process research and development was
determined as approximately $3,600,000. In-process technology acquired
in the transaction consists primarily of additions to Radwiz's core
technology, which is related to Radwiz's planned development of new
features. The majority of the intended functionality of these new
features is not supported by Radwiz's current technology. Intended new
features include offering: end-to-end carrier quality of service;
allowing access via an ATM network; and, providing ISDN line
functionality.
The Company expects that the in-process technology will be
successfully developed, and that initial benefits from these projects
will begin in calendar 2000. Notwithstanding the Company's expectation
that the in-process technology will be successfully developed, there
remain significant technical challenges that must be resolved in order
to complete the in- process technology.
The following selected unaudited pro forma combined results of
operations of the Company, Imedia and Radwiz for the year ended December
31, 1999 and 1998 have been prepared assuming that the acquisitions
occurred at the beginning of the period presented. The following
selected unaudited pro forma financial information is not necessarily
indicative of the results that would have occurred had the acquisition
been completed at the beginning of the period indicated nor is it
indicative of future operating results (in thousands, except per share
data):
Year Ended December 31,
-----------------------
1999 1998
-----------------------
Revenues.....................................$102,280 $34,754
Net loss applicable to common stockholders...($75,422) ($59,796)
Net loss per share applicable to common
stockholders............................... ($2.92) ($5.60)
Shares used in calculation of net loss per
share applicable to common stockholders.... 25,832 10,687
The net loss applicable to common stockholders and net loss per share
applicable to common stockholders in 1999 does not include the in-
process research and development charges of approximately $11,000,000
and $3,600,000 for Imedia and Radwiz, respectively.
17. Subsequent Events (Unaudited)
In October 1999, the Company entered into a Share Purchase Agreement
(the "Telegate Agreement") to acquire Telegate Ltd, an Israeli company.
Telegate produces telephony and data access platforms that are deployed
by service providers to deliver efficient carrier-class voice services
over cable. Telegate also provides in-home networking capability for
telephony and data, based on the Digital Enhanced Cordless Telephony
(DECT) standard. In general, the Telegate shareholders and vested
optionholders will receive a total of 2,200,000 shares and options to
purchase shares of the Company's common stock and a cash payment equal
to Telegate's net cash balance at closing minus $2,000,000. The total
purchase price is estimated to be approximately $144,950,000. The
transaction was completed on January 2, 2000. We expect to account for
the acquisition as a purchase transaction.
The following selected unaudited pro forma combined results of
operations of the Company, Imedia, Radwiz and Telegate for the year
ended December 31, 1999 and 1998 have been prepared assuming that the
acquisitions occurred at the beginning of the period presented. The
following selected unaudited pro forma financial information is not
necessarily indicative of the results that would have occurred had the
acquisition been completed at the beginning of the period indicated nor
is it indicative of future operating results (in thousands, except per
share data):
Year Ended December 31,
-----------------------
1999 1998
-----------------------
Revenues.....................................$111,424 $38,323
Net loss applicable to common stockholders...($84,696) ($65,806)
Net loss per share applicable to common
stockholders............................... ($3.02) ($5.11)
Shares used in calculation of net loss per
share applicable to common stockholders.... 28,032 12,887
The net loss applicable to common stockholders and net loss per share
applicable to common stockholders in 1999 does not include the in-
process research and development charges of approximately $11,000,000
and $3,600,000 for Imedia and Radwiz, respectfully.
In February 2000, the Company entered into an Asset Purchase
Agreement (the "ANE Agreement") to acquire certain assets and assume
certain liabilities of the Access Network Electronics Division (ANE) of
Tyco Electronics Corporation, a subsidiary of Tyco International Ltd.
ANE produces DSL (Digital Subscriber Line) systems that provide multiple
phone lines over the existing copper telephony network. In general, we
will issue shares of our common stock at closing valued at approximately
$85,000,000 based on the volume weighted average of the per share sales
price of the Company's common stock as reported on the Nasdaq National
Market for the ten consecutive trading days prior to the closing date.
In addition, the Company has agreed to establish an employee retention
program for purposes of retaining the certain identified employees of
ANE. The retention program provides for up to 3 annual payments to the
identified employees in a total amount of approximately $4,500,000
provided the employees remain employed by the Company. The retention
payments will be charged to expense over the employees' respective
periods of service. The transaction is subject to customary closing
conditions and is expected to close in the second quarter of 2000. We
expect to account for the acquisition as a purchase transaction.
In February 2000, the Company also entered into a Share Purchase
Agreement (the "Combox Agreement") to acquire Combox Ltd ("Combox"), an
Israeli company. Combox is a manufacturer of broadband data systems and
satellite communications based on international standards. Combox's
cable data access systems conform to the growing EuroModem international
specification, based on the Digital Video Broadcasting (DVB) standard.
In general, the Combox shareholders will receive a total of 775,000
shares of the Company's common stock. The total purchase price is
estimated to be approximately $92,000,000 based on the fair market value
of the Company's common stock on the days immediately preceding and
following the date the acquisition was announced. In addition, the
Company will issue options to purchase common stock of the Company to
the vested and unvested optionholders of Combox options. The
transaction is subject to customary closing conditions and is expected
to close in the second quarter of 2000. We expect to account for the
acquisition as a purchase transaction.
In February 2000, the Company's board of directors approved a two-
for-one split of the Company's outstanding shares of common stock to be
effected in the form of a stock dividend. The stock split is pending
stockholder approval of an increase in the Company's authorized shares
and therefore the changes in the capital structure resulting from the
split have not been given retroactive effect in the Company's
consolidated financial statements as of December 31, 1999.
In March 2000, the Company and Telegate, now a subsidiary of the
Company, entered into an Asset Purchase Agreement ("Internet Telecom
Agreement") under which Telegate agreed to purchase certain assets of
Internet Telecom Ltd. ("Internet Telecom"), an Israeli company.
Internet Telecom is a supplier of PacketCable and other standards-based,
voice-over-IP ("Internet Protocol") systems and technologies. In
general, Telegate will acquire the assets of Internet Telecom in
exchange for shares of the Company sock valued at approximately $44.0
million based on the fair market value of the Company's stock on the
days immediately preceding and following the announcement of the
acquisition and a cash payment estimated at approximately $2,000,000.
The transaction is subject to customary closing conditions and is
expected to close in the second quarter. We expect to account for the
transaction as a purchase transaction.
In March 2000, Rogers Communications purchased 1,843,109 shares of
the Company's common stock. The stock was purchased pursuant to two
warrants to purchase common stock issued to Rogers Communications in
connection with the Product Development Assistance Agreement (note 10).
The shares were purchased on a net exercise basis and resulted in no
proceeds to the Company.
In March 2000, the Company entered into a Share Purchase Agreement
to acquire Ultracom Ltd. ("Ultracom"), an Israeli company. Ultracom is a
supplier of broadband systems-on-silicon. In general the Ultracom
shareholders and vested optionholders will receive shares and option of
the Company's tock valued at approximately $30,000,000 based on the
closing price of the Company's common stock as reported by Nasdaq on the
fifth business day prior to the Closing and a cash payment estimated at
approximately $2,300,000. The Company will also assume the unvested
Ultracom options, the value of which will be included in the purchase
price. The transaction is subject to customary closing conditions and
is expected to close in the second quarter. We expect to account for
the transaction as a purchase transaction.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
Not applicable.
PART III
ITEM 10. Directors and Officers of the Registrant
The information required by this item for the Company's directors is
incorporated by reference to the 2000 Proxy Statement, under the caption
"Election of Directors", and for the executive officers of the Company,
the information is included in Part I hereof under the caption
"Executive Officers of the Registrant."
ITEM 11. Executive Compensation
Incorporated by reference to the 2000 Proxy Statement, the section
title "Executive Compensation."
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference to the 2000 Proxy Statement, the section
titled "Record Date and Voting Securities" and the section titled
"Security Ownership."
ITEM 13. Certain Relationship and Related Transactions
Incorporated by reference to the 2000 Proxy Statement, under the
section titled "Certain Transactions."
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-
K
(a) The following documents are filed as part of this report on Form 10-
K:
1. Consolidated Financial Statements. The following consolidated
financial statements of Terayon Communication Systems, Inc. and
related Independent Auditors' Report are filed as part of this
report of Form 10-K:
* Independent Auditors' Report.
* Consolidated Balance Sheets, as of December 31, 1999
and 1998.
* Consolidated Statements of Operations, Consolidated
Statements of Stockholders' Equity (Net Capital
Deficiency), Consolidated Statements of Cash Flows
and Notes to Consolidated Financial Statements for
the years ended December 31, 1999, 1998 and 1997.
2. Consolidated Financial Statement Schedules. The following
consolidated financial statement schedules of Terayon
Communication Systems, Inc. are filed as part of this report on
Form 10-K and should be read in conjunction with the Consolidated
Financial statements of Terayon Communication Systems, Inc:
* Schedule II of Valuation and Qualifying Accounts
for the years ended December 31, 1999, 1998 and
1997.
Schedules not listed above are omitted because they are not required,
they are not applicable or the information is already included in the
consolidated financial statements or notes thereto.
3. Exhibits. The exhibits listed on the accompanying Index to
Exhibits are filed or incorporated by reference as part of this
report on Form 10-K.
(b) Reports on Form 8-K.
On December 13, 1999, Terayon filed a Report of Form 8-K dated
November 22, 1999 reporting Terayon's acquisition of Radwiz Ltd. and
Terayon's planned acquisition of Telegate Ltd. The current report was
amended on December 27, 1999 to include the financial statements of
Radwiz and Telegate and pro forma financial information reflecting the
purchase combination of Terayon and Radwiz and Telegate.
(c) Exhibits.
EXHIBIT INDEX
Exhibit
Number Exhibit Description
- - ---------- --------------------------------------------------------------
2.1 Agreement and Plan of Merger, dated as fo July 15, 1999, among
Terayon Communication Systems, Inc., Cherry Acquisition Corporation
and Imedia Corporation. (6)
2.1 Share Purchase Agreement, dated October 12, 1999, by and among
Terayon Communication Systems, Inc. and the shareholders of
Radwiz Ltd. and Radwiz Ltd. (7)
2.2 Share Purchase Agreement, dated October 14, 1999, by and among
Terayon Communication Systems, Inc. and the shareholders of
Telegate Ltd. and Telegate Ltd. (7)
3.1 Amended and Restated Certificate of Incorporation of the
Registrant.
3.2 Bylaws of the Registrant. (2)
4.1 Reference is made to Exhibits 3.1 through 3.2.
4.2 Specimen Common Stock Certificate. (2)
4.3 Amended and Restated Information and Registration Rights Agreement
dated April 6, 1998. (2)
10.1 Form of Indemnity Agreement between the Registrant and each of its
directors and officers. (2)
10.2 1995 Stock Option Plan, as amended on March 26, 1996. (2)
10.3 1997 Equity Incentive Plan, as amended on June 9, 1998. (2)
10.4 1998 Employee Stock Purchase Plan. (2)
10.5 1998 Non-Employee Directors Stock Option Plan. (2)
10.6** Supply Agreement between the Registrant and ECI Telecom Ltd. dated
March 3, 1998. (2)
10.7 Lease Agreement dated January 23, 1996 between the Registrant and
Arrillaga Family Trust and Richard T. Peery Separate Property
Trust. (2)
10.8 Employment Agreement between the Registrant and Zaki Rakib dated
February 1993. (2)
10.9 Employment Agreement between the Registrant and Selim Rakib dated
February 1993. (2)
10.10 Loan and Security Agreement dated August 10, 1998 between the
Company and Silicon Valley Bank and Schedule to Loan and Security
Agreement dated August 10, 1998 between the Company and Silicon
Valley Bank (3)
10.11 Streamline Facility Agreement dated October 30, 1998 between the
Company and Silicon Valley Bank.(1)
10.12 Product Development Agreement between the Registrant and Cisco
Systems, Inc. dated July 22, 1996. (2)
10.13 Promissory Note and Stock Pledge Agreement between the Registrant
and Shlomo Rakib dated March 6, 1996. (2)
10.14 Stock Repurchase Agreement between the Registrant and Zaki Rakib
dated March 16, 1995. (2)
10.15 Stock Repurchase Agreement between the Registrant and Shlomo Rakib
dated March 16, 1995. (2)
10.16 Series A Preferred Stock Purchase Agreement between the Registrant
and Lewis Solomon dated June 16, 1995. (2)
10.17 Promissory Note between the Registrant and Lewis Solomon dated June
16, 1997. (2)
10.18 Stock Pledge Agreement between the Registrant and Lewis Solomon
dated June 16, 1997. (2)
10.19 Anti-Dilution Warrant to Purchase Shares of Common Stock dated
April 6, 1998 issued ("Anti-Dilution Warrant") to Shaw
Communications Inc. (2)
10.20 Waiver to Anti-Dilution Warrant dated January 19, 1999. (1)
Statement No. 333-69699).
10.21 Amendment No. 1 to Lease dated April 8, 1999 between the Company and
John Arrillaga Survivor's Trust and Richard T. Peery Separate
Property Trust (4).
10.22 Lease Agreement dated April 8, 1999 between the Company and John
Arrillage Survivor's Trust and Richard T. Peery Separate Property
Trust (4).
10.23 Lease Agreement dated April 20, 1998 between Imedia Corporation and
Martin CL Associate, L.P. (5)
10.24 Sublease Agreement dated November 15, 1999 between Imedia Corporation
and ISP Channel, Inc. (5)
10.25 1999 Non-Officer Equity Incentive Plan. (8)
10.26 Form of Non-Statutory Stock Option Agreement Used in Connection
with the 1999 Non-Officer Equity Incentive Plan. (8)
21.1 List of Subsidiaries. (Incorporated by reference to Exhibit 21.1 of
Registration Statement No. 333-56911).
23.1 Consent of Independent Auditors
24.1 Power of Attorney (see Signature page).
27.1 Financial Data Schedule.
- - ---------
(1)Incoporated by reference to exhibits to the Company's Registration Statement
on Form S-1 filed on December 24, 1998 (File No. 333-69699).
(2)Incorporated by reference to exhibits to the Company's Registration Statement
on Form S-1 filed on June 16, 1998 (File No. 333-56911).
(3)Incorporated by reference to the Company's Report on Form 10-Q filed on
November 12, 1998 (File No. 000-24647).
(4)Incorporated by reference to the Company's Report on Form 10-Q filed on
August 13, 1999.
(5)Incorporated by reference to the Company's Report on Form 10-Q filed on
November 15, 1999.
(6)Incorporated by reference to the Company's Report on Form 8-K filed on
October 1, 1999.
(7)Incorporated by reference to the Company's Report on Form 8-K filed on
December 13, 1999.
(8)Incorporated by reference to the Company's Registration Statement on
Form S-8 filed on December 29, 1999.
** Confidential treatment has been granted for portions of this document. The
information omitted pursuant to such confidential treatment order has been
filed separately with the Securities and Exchange Commission.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed
on its behalf by the undersigned, thereunto due authorized, in County of
Santa Clara, State of California, on the 30th day of March, 2000.
TERAYON COMMUNICATION SYSTEMS, INC.
/s/ Ray M. Fritz
By___________________________________
Ray M. Friz
Chief Financial Officer
Each person whose signature appears below constitutes Dr. Zaki Rakib,
Shlomo Rakib and Ray M. Fritz his true and lawful attorney-in-fact and agent,
each acting alone, with full power of substitution and resubstitution, for
him and in his name, place and stead, in any and all capacities, to sign
any or all amendments to this Annual Report on Form 10-K, and to file the
same, with all exhibits thereto, and all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said attorney-in-
fact and agent,full power and authority to do and perform each and every act
and thing requisite and necessary to be done in and about the premises, as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, each
acting alone, or his or her substitutes, may lawfully do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
Signature Title Date
- - --------------------------- ---------------------------------- --------------
/s/ Zaki Rakib Chief Executive Officer and March 30, 2000
- - --------------------------- Director (Principal Executive
Dr. Zaki Rakib Officer)
/s/ Ray M. Fritz Chief Financial Officer (Principal March 30, 2000
- - --------------------------- Financial and Accounting Officer)
Ray M. Fritz
/s/ Shlomo Rakib Chairman of the March 30, 2000
- - --------------------------- Board of Directors
Shlomo Rakib
/s/ Michael D'Avella Director March 30, 2000
- - ---------------------------
Michael D'Avella
/s/ Christopher J. Schaepe Director March 30, 2000
- - ---------------------------
Christopher J. Schaepe
/s/ Lewis Solomon Director March 30, 2000
- - ---------------------------
Lewis Solomon
/s/ Mark Stevens Director March 30, 2000
- - ---------------------------
Mark Stevens
/s/ Alek Krstajic Director March 30, 2000
- - ---------------------------
Alek Krstajic
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Balance Additions Balance
at Charged to at
Beginning Costs and Write- End of
of Period Expenses offs Period
----------- ----------- ---------- ----------
(in thousands)
Year ended December 31, 1999....
Allowance for doubtful accounts $594 $867 $ -- $1,461
Warranty reserve............... $1,064 $2,951 $1,330 $2,685
Year ended December 31, 1998....
Allowance for doubtful accounts $20 $574 $ -- $594
Warranty reserve............... $536 $1,658 $1,130 $1,064
Year ended December 31, 1997....
Allowance for doubtful accounts $ -- $20 $ -- $20
Warranty reserve............... $ -- $536 $ -- $536