Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2002.
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from____________ to____________.
Commission File Number 000-30928
PATH 1 NETWORK TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3989885
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6215 FERRIS SQUARE, SUITE 140, SAN DIEGO, CALIFORNIA 92121
(858) 450-4220
(Address, including zip code, and telephone number, including area code, of
principal executive offices)
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 ___
As of November 14, 2002, 9,602,216 shares of the registrant's common stock were
outstanding.
PATH 1 NETWORK TECHNOLOGIES INC.
Quarterly Report on Form 10-Q
For the Quarterly Period Ended September 30, 2002
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION.................................................3
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)....................................3
CONDENSED CONSOLIDATED BALANCE SHEETS....................................3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS..........................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS..........................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.....................6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS......................................12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK .............................................................31
ITEM 4. CONTROLS AND PROCEDURES.
PART II - OTHER INFORMATION...................................................31
ITEM 1. LEGAL PROCEEDINGS..................................................31
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS..........................32
ITEM 3. DEFAULTS UPON SENIOR SECURITIES....................................32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................32
ITEM 5. OTHER INFORMATION..................................................32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................33
SIGNATURES ................................................................34
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PATH 1 NETWORK TECHNOLOGIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in US$, thousands except share data)
September 30, December 31,
2002 2001
--------------------------------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 359 $ 1,181
Restricted cash 61 -
Marketable securities, available for sale - 552
Accounts receivable, net 729 322
Inventory 126 78
Other current assets 29 207
--------------------------------------
Total current assets 1,304 2,340
Property and equipment, net 228 365
Assets of discontinued operations - 702
Debt issuance costs, net 509 -
Other assets 158 11
--------------------------------------
Total assets $ 2,199 $ 3,418
======================================
LIABILITIES AND STOCKHOLDERS' (DEFICIT)/EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 790 $ 898
Accrued compensation and benefits 232 469
Liabilities of discontinued operations - 702
Current portion of notes payable 1,341 -
Deferred revenue 67 -
--------------------------------------
Total current liabilities 2,430 2,069
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value; no shares issued or outstanding - -
Common stock, $0.001 par value; 20,000,000 shares authorized, 9 8
9,178,216 and 8,299,126 shares issued outstanding at
September 30, 2002, and December 31, 2001 respectively
Common stock issuable 14 -
Notes receivable from stockholders - (86)
Additional paid-in capital 29,592 26,801
Deferred compensation (87) (276)
Accumulated other comprehensive loss - (616)
--------------------------------------
Accumulated deficit (29,759) (24,482)
--------------------------------------
Total stockholders' equity/(deficit) (231) 1,349
--------------------------------------
Total liabilities and stockholders' equity $ 2,199 $ 3,418
======================================
See accompanying notes to these condensed consolidated financial statements.
PATH 1 NETWORK TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in US$, thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
Revenues:
Product sales $ 537 $ 249 $ 1,222 $ 498
Contract services 105 501 116 801
License revenue 190 190
-------------------------------------------------------------
Total revenues $832 $750 $1,528 $1,299
-------------------------------------------------------------
Cost of revenues:
Cost of product sales 500 75 867 150
Cost of contract services 31 411 33 672
-------------------------------------------------------------
Gross profit 301 264 628 477
Operating expenses:
Engineering research and development 536 435 1,531 1,682
Sales and marketing 161 91 486 273
General and administrative 532 1,083 1,877 2,531
Stock-based compensation (benefit)* 43 (1,883) 216 (3,341)
-------------------------------------------------------------
Total operating (expenses)/benefit (1,272) 274 (4,110) (1,145)
Interest income - 29 - 180
Interest expense (326) - (883) -
Restructuring charge (221) (221)
Loss on sale of securities - (208) (590) (256)
-------------------------------------------------------------
(Loss)/income from continuing operations (1,297) 138 (4,955) (965)
=============================================================
Discontinued operations 0 (373) (317) (1,963)
-------------------------------------------------------------
Net Loss $ (1,297) $ (235) $ (5,272) $ (2,928)
=============================================================
(Loss)/income from continuing operations per common
share - basic $ (0.15) $ 0.02 $ (0.58) $ (0.12)
=============================================================
(Loss)/income from continuing operations per common
share - diluted $ (0.15) $ 0.01 $ (0.58) $ (0.12)
=============================================================
Loss from discontinued operations per common share -
basic $ - $ (0.05) $ (0.04) $ (0.24)
=============================================================
Loss from discontinued operations per common share -
diluted $ - $ (0.04) $ (0.04) $ (0.24)
=============================================================
Loss per common share - basic $ (0.15) $ (0.03) $ (0.61) $ (0.36)
=============================================================
Loss per common share - diluted $ (0.15) $ (0.02) $ (0.61) $ (0.36)
=============================================================
Weighted average common shares outstanding - basic 8,589 8,202 8,589 8,204
=============================================================
Weighted average common shares outstanding - diluted 8,589 9,923 8,589 8,204
=============================================================
(*) The following table shows how the Company's stock-based compensation would
be allocated to the respective department expense line items:
Research and development $ 39 $ (853) $ 158 $ (1,551)
Sales and marketing 1 (317) 46 (572)
General and administrative 3 (713) 12 (1,218)
-------------------------------------------------------------
$ 43 $ (1,883) $ 216 $ (3,341)
=============================================================
See accompanying notes to these condensed consolidated financial statements.
PATH 1 NETWORK TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in US$, thousands)
(unaudited)
Nine Months Ended
September 30,
2002 2001
---------------------------------
Cash flows from operating activities:
Net loss from continuing operations $ (4,955) $ (965)
Adjustments to reconcile net loss to net cash
used in continuing operations
Depreciation and amortization 215 538
Interest expense associated with debt issuance costs 849 -
Notes issued for salary reduction 33 -
Amortization of deferred compensation 212 (3,340)
Loss on investment 596 -
Restructuring charge 221
Warrants issued for recruiting services 138 Changes in assets and
liabilities:
Restricted cash (61) (200)
Other current assets 130 (38)
Other assets (273) (15)
Accounts payable and accrued liabilities 437 (863)
Accounts receivable (407) -
Accrued compensation and benefits (253) 401
Deferred revenue 67 226
---------------------------------
Cash used in operating activities (3,410) (3,897)
Cash flows from investing activities:
Sale of marketable securities 578 2,208
Purchase of Metar ADC assets - (1,000)
Purchases of property and equipment (139) (375)
---------------------------------
Cash provided by investing activities 439 833
Cash flows from financing activities:
Issuance of common stock 995 69
Issue convertible notes 1,308 -
Cash from extinguishment of shareholder notes 86 57
---------------------------------
Cash provided by financing activities 2,389 126
Cash flows from discontinued operations (240) (1,963)
Decrease in cash and cash equivalents (822) (4,901)
Cash and cash equivalents, beginning of period 1,181 7,171
---------------------------------
Cash and cash equivalents, end of period $ 359 $ 2,270
=================================
Supplemental cash flow disclosures:
Unrealized loss in marketable securities $ - $ (1,483)
=================================
Capitalized debt issuance costs in connection with beneficial
conversion charge and warrants $ 1,250 -
=================================
Issuance of common stock in connection with Felber settlement $ 545 -
=================================
See accompanying notes to these condensed consolidated financial statements.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis Of Presentation
The accompanying condensed consolidated balance sheet at September 30, 2002, the
condensed consolidated statements of operations for the three and nine-month
periods ended September 30, 2002 and 2001 and the condensed consolidated
statement of cash flows for the nine-month period ended September 30, 2002 and
2001, have been prepared by Path 1 Network Technologies Inc. (the "Company") and
have not been audited. The condensed consolidated balance sheet at December 31,
2001 has been audited. These consolidated quarterly financial statements, in the
opinion of management, include all adjustments, consisting only of normal and
recurring adjustments, necessary to state fairly the financial information set
forth therein, in accordance with accounting principles generally accepted in
the United States. These consolidated financial statements should be read in
conjunction with the financial statements and notes thereto for the year ended
December 31, 2001 included in the Company's Form 10-K filed April 15, 2002 and
the Company's Form 10-Q filed August 14, 2002. The interim consolidated
financial information contained in this filing is not necessarily indicative of
the results to be expected for any other interim period or for the full year
ending December 31, 2002.
In the period from January 30, 1998 (inception) through September 30, 2002, the
Company incurred losses totaling $29.8 million. The accompanying consolidated
financial statements have been prepared assuming that the Company will continue
as a going concern. This basis of accounting contemplates the recovery of the
Company's assets and the satisfaction of its liabilities in the normal course of
conducting business. Management does not believe that the Company's existing
capital resources will enable the Company to fund operations for the next twelve
months. Management's plans are to reduce costs in all areas of its operating
plan until sufficient capital is raised to support growth and more substantial
orders materialize. The Company has implemented various cost savings plans and
continues to monitor cost savings initiatives. However, even with its cost
reduction plan, the Company needs to raise additional funding to continue as a
going concern. In the event the Company does not receive additional funding, the
Company's plans included, but are not necessarily limited to: 1) further
reducing costs and focusing on selling existing products and services; 2)
selling the Company's assets through a merger or acquisition; or 3) seeking
protection under bankruptcy statutes. Without additional financing, the Company
will be required to further delay, reduce the scope of, or eliminate one or more
of its research and development projects and significantly reduce its
expenditures on product deployment, and may not be able to continue as a going
concern.
Reclassifications
Certain reclassifications have been made to prior periods financial statements
to conform to current year presentation.
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, Business Combinations and No.
142, Goodwill and Other Intangible Assets. Under the new rules, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment. Separable intangible assets that are not deemed to have
an indefinite life will continue to be amortized over their useful lives. The
amortization provisions of SFAS No. 142 apply to goodwill and intangible assets
acquired after June 30, 2001. As the Company did not have any goodwill on its
balance sheet, the adoption of SFAS No. 142 did not have a material impact on
the Company's financial statements.
In October 2001, the FASB issued SFAS No. 144 (FAS 144), Accounting for the
Impairment or Disposal of Long-Lived Assets. FAS 144 establishes a single model
to account for impairment of assets to be held or disposed, incorporating
guidelines for accounting and disclosure of discontinued operations. FAS 144 is
effective for fiscal years beginning after December 15, 2001 and, generally, its
provisions are to be applied prospectively. Management re-evaluated its
investment in acquired technology, namely Sistolic, and recorded an impairment
charge during the year ended December 31, 2001 of $686,000.
In April 2002, the FASB issued SFAS No. 145 ("SFAS 145") Rescission of SFAS No.
4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145
rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt,
SFAS No. 44, Accounting for Intangible Assets of Motor Carriers, and SFAS No.
64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS
requires, among other things, (i) that the modification of a lease that results
in a change of the classification of the lease from capital to operating under
the provisions of SFAS No. 13 be accounted for as a sale-leaseback transaction,
and (ii) the reporting of gains or losses from the early extinguishment of debt
as extraordinary items only if they met the criteria of Accounting Principles
Board Opinion No. 30 ("APB No. 30"), Reporting the Results of Operations. The
amendment of SFAS No. 13 is effective for transactions occurring on or after May
15, 2002. Although the rescission of SFAS No. 4 is effective January 1, 2003,
the FASB has encouraged early application of the provisions of SFAS No. 145. The
Company does not anticipate adoption of this statement will have a material
effect on the Company's financial position or results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standard No. 146
("SFAS No. 146"), Accounting for Costs Associated with Exit or Disposal
Activities (effective January 1, 2003). SFAS No. 146 replaces current accounting
literature and requires the recognition of costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. The Company does not anticipate the
adoption of this statement will have a material effect on the Company's
financial position or results of operations.
Note 2 - Management Estimates And Assumptions
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and reported amounts of expenses during the
reporting period. Actual results could differ from those estimates.
Note 3 - Inventory
The Company records inventory, which consists primarily of raw materials used in
the production of video gateways and related products at the lower of cost or
market. Cost is determined principally on the average cost method. Provisions
for potentially obsolete or slow-moving inventory are made based on analysis of
inventory levels and future sales forecasts.
Note 4 - Revenue Recognition
Product Revenue
Revenue from product sales is recognized when title and risk of loss transfer to
the customer, generally at the time the product is delivered to the customer.
Revenue is deferred when customer acceptance is uncertain or when undelivered
products or services are essential to the functionality of delivered products.
The estimated cost of warranties is accrued at the time revenue is recognized.
Contract Service Revenue
Revenue from support or maintenance contracts, including extended warranty
programs, is recognized ratably over the contractual period. Amounts invoiced to
customers in excess of revenue recognized on support or maintenance contracts
are recorded as deferred revenue until the revenue recognition criteria are met.
Revenue on engineering design contracts, including technology development
agreements, is recognized on a percentage-of-completion method, based on costs
incurred to date compared to total estimated costs, subject to acceptance
criteria. Billings on uncompleted contracts in excess of incurred costs and
accrued profits are classified as deferred revenue.
License Revenue
Revenues from license fees are recognized when persuasive evidence of a sales
arrangement exists, delivery and acceptance have occurred, the price is fixed or
determinable, and collectability is reasonably assured.
Note 5 - Reportable Operating Segments
The Company is a network communications technology company enabling simultaneous
delivery of broadcast quality and interactive video transmissions and other
real-time data streams over Internet Protocol (IP) Ethernet networks. For the
purpose of applying SFAS No. 131, management determined that, subsequent to the
discontinuance of the Silicon Systems business unit ("Sistolic") in April 2002,
it has one operating segment.
The Company currently sells product to a limited amount of customers. For the
period ended September 30, 2002, approximately 74% and 23%, respectively, of
product sales were to the Company's two largest customers in the video
infrastructure market.
Note 6 - Discontinued Operations
In March 2002, a large semiconductor company with whom the Company entered into
a non-exclusive licensing agreement and an engineering services agreement in
December 2001 informed the Company that it was terminating their agreements. The
Company is in a payment dispute with this customer. As a result of this action,
the Company decided to dispose of its Sistolic business unit. On April 3, 2002,
the Company disposed of the assets of this business unit back to Metar SRL, the
Company's former Romanian subsidiary, in exchange for the elimination of the
remaining obligations by the Company to Metar SRL and its affiliates, including
the payable of $686,000, the return of all stock options granted to Michael
Florea and the Romanian employees, and a confirmation that performance criteria
specified in Michael Florea's employment agreement related to a potential $4
million bonus were never met by him. The Company also received a limited use
license to the business unit's intellectual property. Metar SRL also received
35,000 shares of our common stock. Michael Florea resigned on March 27, 2002 as
an officer of the Company in anticipation of this transaction.
The results of operations and the loss on disposal for the three and nine-months
ended September 30, 2002 and 2001 have been included in discontinued operations.
We recorded a loss of $317,000 from discontinued operations for the nine months
ended September 30, 2002. Our loss from discontinued operations for our third
quarter ended September 30, 2001 was $373,000, and a loss of $1,963,000 for the
nine months ended September 30, 2001.
Note 7- Stock Options
The Company accounts for stock-based compensation arrangements in accordance
with the provisions of Accounting Principles Board Opinion ("APB") 25,
Accounting for Stock Issued to Employees, SFAS No. 28, Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans, and SFAS No.
38, Determining the Measurement Date for Stock Option, Purchase, and Award Plans
involving Junior Stock. The Company also complies with the disclosure provisions
of SFAS No. 123, Accounting for Stock-Based Compensation.
The Company accounts for equity instruments issued to non-employees using the
fair value method in accordance with the provisions of SFASI No. 123 and
Emerging Issues Task Issue No. 96-18, Accounting for Equity Instruments that are
Issued to Other than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.
Equity instruments issued to non-employees that are fully vested and
non-forfeitable are measured at fair value at the issuance date and expensed in
the period over which the benefit is expected to be received. Equity instruments
issued to non-employees which are either unvested or forfeitable, for which
counter-party performance is required for the equity instrument to be earned,
are measured initially at the fair value and subsequently adjusted for changes
in fair value until the earlier of: 1) the date at which a commitment for
performance by the counter-party to earn the equity instrument is reached or 2)
the date on which the counter-party's performance is complete.
During the three-month period ended September 30, 2002, the Company recorded a
stock-based compensation expense of $43,000 related to the amortization of
options outstanding to employees and consultants. For the same three-month
period in 2001, the Company recognized a reduction of $1.9 million related to
the amortization of stock based compensation.
Note 8 - Notes Payable
4% Convertible Notes
In April and May 2002, the Company received approximately $1,031,000 from a
private placement of convertible notes to European investors who were existing
Company stockholders. The notes carry a 4% annual coupon, paid quarterly in cash
or stock, at the Company's discretion, and are convertible for a one-year
conversion term at a price of $1.20 per share. As the conversion price was below
the trading market price of the stock on the day the notes were issued, the
Company recorded debt discount of $226,430, and commenced amortizing the debt
discount over the period of the convertible notes' convertibility period
earliest conversion date. Through September 30, 2002, approximately 76% of the
note holders converted their notes into our stock. We recorded interest expense
of $27,144 during the three months ended September 30, 2002 relating to
amortization of debt issuance costs. The unconverted notes representing $258,000
are classified as current portion of notes payable in the accompanying balance
sheet as of September 30, 2002.
In connection with the issuance of the convertible notes in April and May 2002,
the Company issued warrants to purchase 664,871 shares of common stock at $1.60
per share. The warrants are fully vested and expire in June 2007. The Company
recorded deferred interest expense on the warrants of $359,133 based upon a
Black-Scholes valuation, and is amortizing the deferred interest over the life
of the notes. In the third quarter ended September 30, 2002, we recorded
interest expense of $43,051 related to amortization of deferred interest.
May 2002 12% Convertible Note
In May 2002, the Company issued a 12% convertible note in the principal amount
of $1,250,000 to the Laurus Master Fund. The note is convertible at a price of
$1.40 per share and is payable on a monthly basis over 18 months. The price at
which this note converts into our stock generally varies monthly in proportion
to the price of our stock at the time of conversion, and is based generally on a
trailing market price. Principal and interest payments for the first three
months of the loan period were deferred, with principal and interest being
amortized over the remaining 15 months. As the conversion price was below the
trading market price of the stock on the day the note was issued, the Company
recorded a debt discount of $543,515 and is amortizing the debt discount over
the period of the convertible note earliest conversion date using the effective
interest method. Through September 30, 2002 $42,500 of the note had been
converted by the holder. Included in the Company's interest expense is
amortization of deferred interest of $181,172 and debt discount of $40, 387..
The balance of this notes payable as of September 30, 2002 is $1,083,000, and is
classified as a short term liability.
In connection with the issuance of the 12% convertible note in May 2002 the
Company issued warrants to purchase 125,000 shares of common stock at $1.68 per
share. The warrants are fully vested and expire in May 2009.
Note 9 - Subsequent Event
November 2002 12% Convertible Note
On November 7, 2002, the Company issued a 12% convertible note in the principal
amount of $300,000. The note is convertible at a price of $.85 per share and is
payable on a monthly basis over 18 months. The price at which this note converts
into our stock generally varies monthly in proportion to the price of our stock
at the time of conversion, and is based generally on a trailing market price. As
the conversion price was below the trading market price of $.90 per share on the
day the note was issued, the Company will record a debt discount in its fourth
quarter ended December 31, 2002, and will amortize the debt discount over the
period of the convertible note from the earliest conversion date using the
effective interest method. Under the terms of this note, the Company is not
required to file a registration statement until the outstanding principal amount
of the note dated May 2002 (referred to above) has been reduced to $200,000.
In connection with the issuance of the 12% convertible note in November 2002,
the Company issued warrants to purchase 75,000 shares of common stock at $.85
per share. The Company will record deferred interest expense associated with the
warrants in its fourth quarter ended December 31, 2002 under the Black Scholes
valuation method, and will amortize the deferred interest over the life of the
note. The 75,000 warrants issued in connection with the November 7, 2002
convertible note are fully vested and expire in November 2009.
As part of the November 7, 2002 convertible note transaction, the Company also
repriced the conversion price of the May 2002 convertible note and 175,000
warrants (See Note 8) - which had been purchased by the same investor to $.85
per share. The term of the May 2002 note, in turn, was extended to May 7, 2004.
These terms will change the previously reported debt discount amount, deferred
interest expense amount and amortization periods.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward Looking Statements
This document may contain forward-looking statements. These statements relate to
future events or our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as "may," "will,"
"should," "expect," "plan," "anticipate," "believe," "estimate," "predict,"
"potential" or "continue," the negative of such terms or other comparable
terminology. These statements are only predictions. Actual events or results may
differ materially.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of the forward-looking
statements. Except to the extent required by federal law, we disclaim any duty
to update any of the forward-looking statements after the date of this report to
conform such statements to actual results or to changes in our expectations.
You are also urged to carefully review and consider the various disclosures made
by us which attempt to advise interested parties of the factors which affect our
business, including without limitation the disclosures made in this Item 2 or in
the Company's annual report on Form 10-K and other reports and filings made with
the Securities and Exchange Commission.
OVERVIEW
We design and sell products, using proprietary technology that enables the
real-time transmission of audio, video and voice data over a single Internet
Protocol (IP) network with end-to-end high quality of service (QoS). Our
products make it possible for packet-switched IP networks to provide
high-quality, real-time transmissions by coordinating the transport of packets
across these networks in a way that eliminates or minimizes delays and
unreliable delivery. We believe our products can make available the best of both
worlds - the reliability and speed of circuit-switched networks, such as
traditional telephone networks, coupled with the data carrying capability and
low cost of IP networks.
At the core of our suite of products is our patented, patent-pending and
copyrighted technology that is a software and hardware-based solution for
managing network traffic. Our technology is based on our methodology for the
transmission of data on a real-time basis over IP networks, coupled with several
trade secrets and intellectual property in a variety of areas dealing with the
transport and distribution of data, voice and video over packet-based networks.
Our technology addresses the inherent deficiencies of packet switching as
applied to transmission of real-time signals by superimposing a circuit-switched
infrastructure on standard IP networking, while maintaining full compatibility
with existing IP networks. We believe that our technology - combined with our
other proprietary know-how - is capable of supporting the efficient transmission
of all communications over a single network, thus bringing high-level QoS and
real-time audio, video and telephony capabilities to the Internet and to
standard IP networks.
Our customers and prospective customers include telecommunications companies,
cable television operators, satellite operators, entertainment companies,
wireless service providers, new competitive service providers, broadcasters,
government agencies, universities, systems integrators and video server and
equipment providers. We offer long haul video, voice and data products,
video-on-demand transmission products, and design and engineering services to
support these products.
We are focusing intensely on Internet Protocol (IP)-based offerings for
broadcasters and the cable industry, Digital Subscriber Line (DSL) offerings for
the communications industry and integrated solutions for systems integrators
worldwide. Until recently, the resources of our Video Systems business unit were
devoted primarily to research and development. However, we now have products in
production and deployment. In the video transport market, for example, our
Cx1000 IP Video Gateway, which is a video gateway device designed to provide
high quality video transmission capabilities to diversified media companies,
television broadcasters, movie and broadcasting studios, is currently in
production and in the early stages of deployment by a small number of customers.
Our second product in the video transport market, the Cx1400 IP Video
Multiplexer, which is a video-on-demand gateway device designed to provide high
quality video transmission capability to cable television operators, is being
deployed by BarcoNet, N.V., a wholly-owned subsidiary of Scientific-Atlanta,
Inc. BarcoNet is marketing a version of the Cx1400 IP Video Multiplexer in
Europe under the name "iMux".
Liquidity And Capital Resources
From January 30, 1998 (our inception) through September 30, 2002, we incurred
losses totaling $29.8 million. The accompanying financial statements have been
prepared assuming that we will continue as a going concern. This basis of
accounting contemplates the recovery of our assets and the satisfaction of our
liabilities in the normal course of conducting business. We do not believe that
our existing capital resources will enable us to fund operations for the next
twelve months. We had negative working capital of $1,126,000 for our quarter
ended September 30, 2002, and a decrease of $822,000 in cash and cash
equivalents for the nine months ended September 30, 2002.
Our plans are to reduce costs in all areas of our operating plan until
sufficient capital is raised to support our growth and more substantial product
orders materialize; however, even with our cost reduction plans, we need to
raise additional funding to continue as a going concern. In the event we do not
receive additional funding, our plans may include, but are not necessarily
limited to: 1) further reducing costs and focusing on selling existing products
and services; 2) selling the Company's assets through a merger or acquisition;
or 3) seeking protection under bankruptcy statutes. Without additional
financing, we may be required to further delay, reduce the scope of, or
eliminate one or more of our research and development projects and significantly
reduce our expenditures on product deployment, and we may not be able to
continue as a going concern.
Since our inception, we have financed our operations primarily through the sale
of common equity and debt securities to investors and strategic partners. In
April and May 2002, we received approximately $1,031,000 from a private
placement of convertible notes with European investors who were existing Company
stockholders. The notes carry a 4% annual coupon, paid quarterly in cash or
stock, at our discretion, and are convertible for a one-year conversion term at
a price of $1.20 per share. As the conversion price was below the trading market
price of stock on the day the notes were issued, we recorded a debt discount of
$226,430 and amortized the debt discount over the notes' convertibility from the
period of the convertible notes earliest conversion date using the effective
interest method. In connection with the issuance of the convertible notes in
April and May 2002 we issued warrants to purchase 664,781 shares of common stock
at $1.60 per share. The warrants are fully vested and expire in June 2007.
Through September 30, 2002, approximately 76% of the note holders converted
their notes into our stock. We recorded interest expense of $27,144 during the
three months ended September 30, 2002 relating to amortization of debt issuance
costs. In the third quarter ended September 30, 2002, we recorded interest
expense of $43,051 related to amortization of deferred interest.
In May 2002, we issued to Laurus Master Fund a 12% convertible note in the
principal amount of $1,250,000. The note is convertible at a price of $1.40 per
share and is payable on a monthly basis over 18 months. The price at which this
note converts into our stock generally varies monthly in proportion to the price
of our stock at the time of conversion, and is based generally on a trailing
market price. The Company secured a three-month deferral of principal and
interest under the note, with the balance payable over the remaining 15 months.
The Company recorded a debt discount of $543,515 on the date the note was
issued, and commenced amortizing the debt discount over the period of the
convertible note from the earliest conversion date using the effective interest
method.
In connection with the issuance of the 12% convertible note in May 2002 we
issued warrants to purchase 125,000 shares of common stock at $1.68 per share.
The warrants are fully vested and expire on May 2009.
On November 7, 2002, the Company issued a 12% convertible note in the principal
amount of $300,000. The note is convertible at a price of $.85 per share and is
payable on a monthly basis over 18 months. The price at which this note converts
into our stock generally varies monthly in proportion to the price of our stock
at the time of conversion, and is based generally on a trailing market price. As
the conversion price was below the trading market price of the stock of $.90 per
share on the day the note was issued, the Company will record a debt discount in
its fourth quarter ended December 31, 2002, and will amortize the debt discount
over the period of the convertible note from the earliest conversion date using
the effective interest method.
In connection with the issuance of the 12% convertible note in November 2002,
the Company issued warrants to purchase 75,000 shares of common stock at $.85
per share. The Company will record deferred interest expense associated with the
warrants in its fourth quarter ended December 31, 2002 under the Black Scholes
valuation method, and will amortize the deferred interest over the life of the
note.
As part of the November 7, 2002 convertible note transaction, the Company also
repriced the conversion price of the May 2002 convertible note and 175,000
warrants (See Note 8) - which had been purchased by the same investor - to $.85
per share. The term of the May 2002 note was extended to May 7, 2004. These
terms will change the previously reported debt discount amount, deferred
interest expense amount and amortization periods.
The 75,000 warrants issued in connection with the November 7, 2002 convertible
note are fully vested and expire in November 2009.
Cash, cash equivalents, restricted cash and marketable securities totaled
$420,000 at September 30, 2002 compared to $1,181,000 at December 31, 2001. For
the foreseeable future, we expect to incur substantial additional expenditures
associated with research and development in addition to increased costs
associated with staffing for management, manufacturing, sales and marketing and
administration functions. Additional capital is required to implement our
business strategies and fund our plan for future growth and business
development.
At September 30, 2002, we had negative net working capital of $1,126,000
compared to net working capital of $271,000 at December 31, 2001. We are
continuing to seek other sources of additional capital to fund operations until
we are able to fund operations through internal cash flow.
Operating activities used $3,410,000 in cash during the nine month period ended
September 30, 2002 and $3,897,000 for the same period in 2001, primarily due to
the fact that, although our net loss from continuing operations for the nine
month period ended September 30, 2002 was higher, our net loss from operations
in 2001 benefited from a $1.9 million non-cash stock-based compensation
adjustment. Our nine-month results for the period ended September 30, 2002 also
reflect sizable debt issuance costs as well as a favorable change in account
payables.
At September 30, 2002, we have no material commitments other than our operating
leases. Our future capital requirements will depend upon many factors, including
the timing of research and product development efforts, the expansion of our
general and administrative functions, increased sales and marketing efforts, and
the need to finance the manufacturing of commercial products that we may develop
and launch. We expect to continue to expend significant amounts on research and
development staffing, infrastructure and computer equipment to support on-going
research and development activities, as well as our sales and marketing
organization.
As noted above, we will need additional financing in 2002 and 2003. We may
pursue a number of alternatives to raise additional funds, including borrowings;
lease arrangements; collaborative research and development arrangements with
technology companies; the licensing of product rights to third parties; or
additional public and private equity financings. There can be no assurance that
funds from these sources will be available on favorable terms, if at all. If we
raise additional funds through the issuance of equity securities, the percentage
ownership of our stockholders will be reduced or significantly diluted, or such
equity securities may provide for rights, preferences or privileges senior to
those of the holders of our common stock.
Results Of Operations
Three Months Ended September 30, 2002 vs. Three Months Ended September 30, 2001
In our third quarter ended September 30, 2002, net revenue was $832,000 compared
to $750,000 during the three-month period ended September 30, 2001, reflecting
an 11% increase. Our third quarter 2002 revenue came principally from sales of
our products for the video over IP transport market, as well as from license
fees for previously developed technology. In 2001, our third quarter revenue was
primarily generated through an engineering service contract with BarcoNet N.V.,
and sales of an engineering prototype to Leitch Technology Corporation.
We recorded deferred revenue of $60,000 related to a development contract we
have with a strategic partner related to a new product line. We will recognize
revenue under this contract based on the percentage of completion method.
Third quarter cost of goods sold increased to $531,000 from $486,000 in the
quarter ended September 30, 2001. Cost of goods sold for products consists
primarily of raw material costs, warranty costs and labor associated with
manufacturing our products. Cost of goods sold for contract services consists
primarily of engineering payroll costs.
Our gross profit increased 14% to $301,000 from $264,000 in the quarters ending
September 30, 2002 and 2001, respectively. Our increase in gross profit results
primarily from the shift in the mix of our business to selling products,
managing our production and development costs, and license fees.
Engineering research and development expenses for the third quarter ended
September 30, 2002, excluding the effect of stock-based compensation, increased
to $536,000 from $435,000 in the third quarter ended September 30, 2001. The
increase results in part from the sale of our Sistolic business unit in 2001 in
which our R&D costs for the quarter ended September 2001 that were attributable
to Sistolic have been reclassified from R&D to discontinued operations. The
increase is also due to costs to acquire development expertise and tools for our
new products. In comparing the engineering research and development expenses for
the quarters ended September 30, 2002 and 2001, engineering research and
development expenses for the quarter ended September 30, 2001 excludes
approximately $255,000 in expense that has been reclassified to discontinued
operations related to our sale of Sistolic (see Note 6).
Selling, general and administrative expenses for the third quarter ended
September 30, 2002, excluding the effect of stock-based compensation, decreased
41% to $693,000 from $1,174,000 for the third quarter ended September 30, 2001.
The decrease is primarily due to reduced operating expenses in areas such as
such as rent, payroll costs and outside consulting costs resulting from our
continued efforts to reduce and control costs. In comparing the selling, general
and administrative expenses for the quarters ended September 30, 2002 and 2001,
selling, general and administrative expenses for the quarter ended September 30,
2001 excludes approximately $118,000 in expense that has been reclassified to
discontinued operations related to our sale of Sistolic (see Note 6).
Stock-based compensation expense is a non-cash expense item that is recognized
as a result of stock options having exercise prices below estimated fair value.
Stock-based compensation expense is calculated as the difference between
exercise prices and estimated fair market value on the date of grant. If the
options are subject to variable accounting treatment, additional compensation
expense, positive or negative, is recognized each quarter based on the fair
market value of our common stock in accordance with the provisions of variable
stock option accounting. In October 2001, we offered our holders of Class B
common stock options an opportunity to exchange their options for Class A common
stock options. Since all of the option holders of options on Class B common
stock elected to exchange their options for options on Class A common stock, the
Company ceased recording this compensation expense related to employee options
after a final one-time adjustment in October of 2001. We will continue to record
compensation expense related to the outstanding options to consultants and some
employees for the amount of options that vest in that period. In the third
quarter ended September 30, 2002, we recorded a $43,000 non-cash charge for
stock-based compensation, versus a $1.9 million non-cash reduction of
compensation expense in the same quarter ended September 30, 2001.
Interest expense for the third quarter ended September 30, 2002 was $326,000
compared to interest income of $29,000 for the third quarter ended September 30,
2001. The increase in interest expense is due primarily to interest paid on our
European notes and convertible notes, as well as amortization of debt issuance
costs.
Nine Months Ended September 30, 2002 vs. Nine Months Ended September 30, 2001
Revenue increased 18% to $1,528,000 from $1,299,000 for the nine-month period
ended September 30, 2002 and 2001, respectively. Our 2002 revenue results from
the initial shipments of our commercial products for the video over IP transport
market, contract services and license fees. For the nine month period ended
September 30, 2001, our revenues were primarily a result of contract services
performed for BarcoNet N.V.(now owned by Scientific-Atlanta) in the development
of our video multiplexer for the video on demand market (now known as the
Cx1400), and the sale of engineering prototype units to Leitch Technology
Corporation.
In the nine months ended September 30, 2002, we recorded $60,000 in deferred
revenue related to a development contract we have with a strategic partner
related to a new product line. We will recognize revenue under this contract
based on the percentage of completion method.
For the nine months ended September 30, 2002, our cost of goods sold increased
9% to $900,000 from $822,000 for the nine-month period ended September 30, 2001.
Cost of goods sold for products consists principally of raw material costs,
warranty costs and labor associated with building product. Cost of goods sold
for contract services consists primarily of engineering-related costs. The
increase in our cost of goods sold is principally due to the change in the mix
of our business to manufacturing and selling our video gateway products.
Our gross profit increased 32% to $628,000 from $477,000 in the nine months
ending September 30, 2002 and 2001, respectively. Our increase in gross profit
results primarily from the shift in the mix of our business to selling products,
managing our production and development costs, and license fees.
Engineering research and development expenses, excluding the effect of
stock-based compensation, decreased nearly 9% to $1,531,000 from $1,682,000 for
the nine-month period ended September 30, 2002 and 2001, respectively. The
decrease in our engineering research and development expenses is primarily a
result of the sale of our Sistolic business unit and reduced use of outside
consultants. In comparing the engineering research and development expenses for
the nine months ended September 30, 2002 and 2001, engineering research and
development expenses for the nine months ended September 30, 2001 exclude
approximately $830,000 in expense that has been reclassified to discontinued
operations related to our sale of Sistolic (see Note 6).
Selling, general and administrative expenses, excluding the effect of
stock-based compensation, decreased approximately 16% to $2,363,000 from
$2,804,000 for the nine-month period ended September 30, 2002 and 2001,
respectively. The decrease is primarily due to substantial reductions in
selling, general and administrative headcount, outside consultants and other
related expenses stemming from our cost controls. In comparing the selling,
general and administrative expenses for the nine months ended September 30, 2002
and 2001, selling, general and administrative expenses for the nine months ended
September 30, 2001 exclude approximately $1.3 million in expense that has been
reclassified to discontinued operations related to our sale of Sistolic (see
Note 6).
Stock-based compensation expense is a non-cash expense item that is recognized
as a result of stock options having exercise prices below estimated fair value.
Stock-based compensation expense is calculated as the difference between
exercise price and estimated fair market value on the date of grant. If the
options are subject to variable accounting treatment, additional compensation
expense, positive or negative, is recognized each quarter based on the fair
market value of our common stock in accordance with the provisions of variable
stock option accounting. In October 2001, we offered our holders of Class B
common stock options an opportunity to exchange their options for Class A common
stock options. Since all of the option holders of options on Class B common
stock elected to exchange their options for options on Class A common stock, the
Company ceased recording this compensation expense related to employee options
after a final one-time adjustment in October of 2001. We will continue to record
compensation expense related to the outstanding options to consultants and some
employees for the amount of options that vest in that period. In the nine months
ended September 30, 2002, we recorded a $216,000 non-cash charge for stock-based
compensation, versus a $3.3 million non-cash benefit in the same nine-month
period ended September 30, 2001.
Interest expense for the nine months ended September 30, 2002 was $883,000,
compared to interest income of $180,000 for the first nine months ended
September 30, 2001. The increase in interest expense is due to a non-cash
interest charge related to the debt issuance costs (see note 8), together with
interest on our debt obligations through September 30, 2002.
Discontinued Operations
We decided to dispose of our Silicon Systems business unit ("Sistolic")
after a large semiconductor company, with whom we entered into a non-exclusive
licensing agreement and an engineering services agreement related to Sistolic's
technology, informed us that they were terminating their agreements in March
2002. Due to this material and adverse turn of events, we decided that we could
no longer sustain the negative cash flow from Sistolic. Therefore, on April 3,
2002, we disposed of the assets of this business unit back to Metar SRL and Mr.
Michael Florea in exchange for the elimination of our remaining obligations to
Metar SRL and its affiliates, including the payable of $686,000, the return of
all stock options granted to Michael Florea and the Romanian employees, and a
confirmation that performance criteria specified in Michael Florea's employment
agreement with us related to a potential $4 million bonus were never met by him.
We also received a limited use license to the business unit's intellectual
property. In addition, the Romanian facility lease was transferred to Metar SRL
and the Romanian employment contracts were terminated and Metar SRL was
permitted to hire any and all Romanian employees. Metar SRL also received 35,000
shares of our common stock. Michael Florea resigned on March 27, 2002 as an
officer of the Company in anticipation of this transaction. Sistolic's results
of operations for the nine-months ended September 30, 2002 and 2001 have been
included in discontinued operations.
We recorded a loss of $317,000 from discontinued operations for the nine months
ended September 30, 2002. Our loss from discontinued operations for our third
quarter ended September 30, 2001 was $373,000, and a loss of $1,963,000 for the
nine months ended September 30, 2001.
Risk Factors That May Affect Future Results
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND THE OTHER
INFORMATION INCLUDED HEREIN AS WELL AS THE INFORMATION INCLUDED IN OUR FORM 10-K
FILED ON APRIL 15, 2002 AND OTHER REPORTS AND FILINGS MADE WITH THE SECURITIES
AND EXCHANGE COMMISSION. OUR BUSINESS AND RESULTS OF OPERATIONS COULD BE
SERIOUSLY HARMED BY ANY OF THE FOLLOWING RISKS. THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE DUE TO ANY OF THESE RISKS AND STOCKHOLDERS MAY LOSE PART OR
ALL OF THEIR INVESTMENT.
The risks ands uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also impair our operations. Our business and
results of operations could be seriously harmed by the occurrence of any of the
following risk factors. The trading price of our common stock could decline due
to occurrence of any of these risks, and you may lose part or all of your
investment.
We are dependent upon additional funding to meet current commitments, continue
development of our business and limit uncertainty as to our ability to continue
as a going concern; the prospect of obtaining such funding is uncertain.
We need additional funding to meet current commitments and continue development
of our business; if we do not receive additional funding, our ability to
continue as a going concern cannot be assured.
To this end, we implemented a cost reduction program to reduce our negative cash
burn from over $600,000 per month to approximately $250,000 - $350,000 per
month. We have taken steps and are continually reviewing the need to take
additional steps to reduce costs in all areas of our operating plan until
sufficient capital is raised to support growth and more substantial orders
materialize. In the event we do not receive additional funding, our plans may
include, but are not necessarily limited to: 1) further reducing our costs and
focus on selling existing products and services; 2) selling our assets through a
merger or acquisition; or 3) seeking protection under bankruptcy statutes. Even
with our cost reduction efforts, we need to raise additional funding to continue
as a going concern.
Even if we can continue operations, a lack of sufficient funding would
significantly limit our ability to take advantage of potential opportunities,
develop or enhance products or otherwise respond to competitive pressures. We
cannot assure you that additional financing will be available on terms favorable
to us, if at all.
If we raise additional funds through the issuance of equity or equity-linked
securities, the percentage ownership of our stockholders would be reduced or
become diluted. In addition, these securities may have rights, preferences or
privileges senior to the rights of the securities held by our current
stockholders.
We have incurred losses since inception and may never be profitable.
We have incurred operating losses since our inception in January 1998, and we
expect to incur losses and negative cash flow for at least the next few
quarters. As of September 30, 2002, our accumulated deficit was approximately
$29.8 million. We expect to continue to incur significant operating, sales,
marketing, research and development and general and administrative expenses and,
as a result, we will need to generate significant revenues to achieve
profitability. Even if we do achieve profitability, we cannot assure you that we
can sustain or increase profitability on a quarterly or annual basis in the
future.
The market price of our common stock has fluctuated in the past and is likely to
continue to do so, thereby increasing the risk that you may lose all or part of
your investment.
The market price for our common stock is susceptible to a number of internal and
external factors including:
o quarterly variations in operating results and overall financial condition;
o economic and political developments affecting technology spending generally
and adoption of new technologies and products such as ours;
o customer demand or acceptance of our products and solutions;
o short-selling programs;
o changes in IT spending patterns and the rate of consumer acceptance of
video-on-demand;
o product sales progress, both positive and negative;
o the stock market's perception of the telecommunications equipment industry
as a whole;
o technological innovations by others;
o cost or availability of components, sub-assemblies and modules used in our
products;
o the introduction of new products or changes in product pricing policies by
us or our competitors;
o proprietary rights disputes or litigation;
o initiation of or changes in earnings estimates by analysts;
o additions or departures of key personnel; and
o sales of substantial numbers of shares of our common stock or securities
convertible into or exercisable for our common stock.
These and other factors may make it difficult for our stockholders to sell their
shares into the open market if and when eligible to do so. In addition, stock
prices for many technology companies, especially early-stage companies such as
ourselves, fluctuate widely for reasons that may be unrelated to operating
results. These fluctuations, as well as general economic, market and political
conditions such as interest rate increases, recessions or military or political
conflicts, may materially and adversely affect the market price of our common
stock, thereby causing you to lose some or all of your investment.
We recently launched our initial commercial products and services, and these
products and services and our products still in development may not gain
customer acceptance.
We have launched two commercial products for sale into the video transport
market: our Path 1 Cx1000 IP Video Gateway targeted toward the broadcast
transmission infrastructure segment of the video transport market, and our Path
1 Cx1400 IP Video Multiplexer targeted toward the video-on-demand infrastructure
segment of the video transport market. These products are in the early stages of
commercial deployment and are subject to those risks attendant to new product
introductions, including the possible presence of undetected hardware or
software defects in our products, manufacturing and distribution limitations,
unforeseen delays in product installation and customer dissatisfaction. There
can be no assurance that either of these initial products, or our products still
in development, will achieve acceptance by our targeted markets at all or in
time for us to be successful or to meet our funding requirements.
We currently rely on one large customer for the majority of our revenues.
In 2001 and for our nine months ended September 30, 2002, approximately 77% and
74%, respectively, of our revenues were from sales to Scientific-Atlanta and its
subsidiary, BarcoNet N.V. If Scientific-Atlanta or BarcoNet N.V. were to either
reduce their purchases or stop purchasing from us, our revenues and results from
operations would be materially adversely affected.
We expect to encounter sales resistance.
Our Cx1400 video gateway, which provides most of our revenue, is tied to the
video on demand ("VOD") market. If our customers' roll out of VOD is delayed or
unsuccessful, we cannot succeed. So far, VOD has not been widely introduced or
accepted as has been anticipated.
We have only a brief history of sales orders for our products and services, and
our sales have been to a few customers. In our third quarter ended September 30,
2002, over 90% of our revenues were from two customers.
Potential customers may decline to purchase our initial products or services due
to our lack of an established "track record," the level of our products'
technological sophistication, price, our financial condition or other factors.
Further reasons why prospective customers may decline to invest in our products
and services, or may decide to purchase competitors' products and services,
include, but are not limited to:
o reluctance by our customers to commit significant capital to new products
and services at this time;
o general economic conditions affecting rates of adoption of new
technologies, new technology purchases and services associated with such
new technologies;
o introduction of competitive technologies, products and services that may
render our products and services obsolete;
o development or manufacturing delays that prevent the timely introduction of
our products to the market;
o failure by us to establish strong sales, marketing, distribution and
customer service capabilities;
In the event that our products and services are not adopted at the rates we
currently anticipate, or do not receive a significant acceptance from our
primary targeted dominant customer, our operating plan will be negatively
affected and our capital requirements and cash flow shortfalls will be greater
than currently anticipated.
To date, there has been only a limited public market for our common stock and
there is no assurance that an active trading market for our common stock will
ever exist.
To date, there has been only a limited public market for our securities and
there can be no assurance that a broad public market for our securities will
develop in the future, or if such a broad market does develop, that it will
last. Our common stock is presently quoted for trading on the OTC Bulletin
Board, a quotation service that displays real-time quotes and other information
about over-the-counter (OTC) equity securities, and on the Third Segment of the
Frankfurt Stock Exchange. Trading activity in our common stock on the OTC
Bulletin Board is limited and trading activity in our common stock on the
Frankfurt Stock Exchange is dormant. In addition, we may be unable to attract
and maintain good-quality market makers. In the event a liquid market for our
common stock does develop, a supply/demand imbalance may arise that could
adversely affect our stock price. In addition, subsequent issuances of equity or
equity-linked securities may further saturate the market for our common stock.
The resale of substantial amounts of our common stock will have an adverse
effect on the market price of our stock.
We believe our stock has in the past been and may in the future be the subject
of short selling programs. Short sales can severely and negatively affect the
prices of stocks which have little market liquidity.
The rate of market adoption of our technology is uncertain and we could
experience long and unpredictable sales cycles, especially if the slowdown in
the telecommunications industry persists.
Our products are based on new technology, and it is generally extremely
difficult to predict the timing and rate of market adoption of our proposed
products as well as of related new video applications. Our visibility into when
we might begin to realize substantial revenue from product sales is
substantially limited. We are providing new and highly technical products and
services to enable new applications. Thus, the duration of our sales efforts
with prospective customers in all market segments is likely to be lengthy as we
seek to educate them on the uses and benefits of our products. This sales cycle
could be lengthened even further by potential delays related to product
implementation as well as delays over which we have little or no control,
including:
o the length or total dollar amount of our prospective customers' planned
purchasing programs in regard to our products;
o changes in prospective customers' capital equipment budgets or purchasing
priorities;
o prospective customers' internal acceptance reviews; and
o the complexity of prospective customers' technical needs.
These uncertainties, combined with the worldwide slowdown in the
telecommunications business, which began in 2001, and the slowdown in corporate
spending on technology generally as well as new technologies such as ours,
substantially complicate our planning and reduce prospects for sales of our
products. If our prospective customers curtail or eliminate their purchasing
programs, decrease their capital budgets or reduce their purchasing priority,
our results of operations could be adversely affected.
Leitch Technology Corporation is no longer an active, participating partner for
us in the professional broadcast video studio market.
In April 2000, we entered into a strategic marketing relationship with Leitch
Technology Corporation, a Canadian public company and international distributor
of professional video products. Leitch now owns less than 20% of our outstanding
common stock on a fully diluted basis. Leitch no longer is an active partner,
and we do not anticipate doing business with it.
We recently disposed of the assets of our Silicon Systems group.
In October 2000, we agreed to purchase the assets of Metar ADC, an application
specific integrated circuit (ASIC) design and development company based in
Bucharest, Romania, from Metar SRL. We organized these assets into our Silicon
Systems business unit, which we named "Sistolic".
In December 2001, Sistolic entered into a non-exclusive licensing agreement and
an engineering services agreement with a large semiconductor company pursuant to
which Sistolic was to provide front-end design services. We anticipated that the
maximum amount of revenue we could realize from this arrangement was
approximately $5.4 million. In March 2002, after considerable work had been
performed by us under the agreements, the large semiconductor company informed
us that they were summarily terminating these agreements.
Due to this material and adverse turn of events, we concluded that we could no
longer sustain the negative cash flow from the Silicon Systems business unit. On
April 3, 2002, we sold all of the assets of this business unit back to Metar
SRL. Although we retained a limited use license to the business unit's
intellectual property, we have no planned future dealings with Metar SRL.
We may be unable to obtain full patent protection for our core technology and
there is a risk of infringement.
On January 16, 2001, May 8, 2001 and May 31, 2001, we submitted additional
patent applications on topics surrounding our core technologies to supplement
our existing patent portfolio. There can be no assurance that these or other
patents will be issued to us, or, if additional patents are issued, that they or
our three existing patents will be broad enough to prevent significant
competition or that third parties will not infringe upon or design around such
patents to develop competing products. In addition, we have filed or plan to
file patent applications in several foreign countries. There is no assurance
that these or any future patent applications will be granted, or if granted,
that they will not be challenged, invalidated or circumvented.
In addition to seeking patent protection for our products, we intend to rely
upon a combination of trade secret, copyright and trademark laws and contractual
provisions to protect our proprietary rights in our products. There can be no
assurance that these protections will be adequate or that competitors have not
developed or will not independently develop technologies that are substantially
equivalent or superior to ours.
There has been a trend toward litigation regarding patent and other intellectual
property rights in the telecommunications industry. Although there are currently
no lawsuits pending against us regarding possible infringement claims, there can
be no assurance such claims will not be asserted in the future or that such
assertions will not materially adversely affect our business, financial
conditions and results of operations. Any such suit, whether or not it has
merit, would be costly to us in terms of employee time and defense costs and
could materially adversely affect our business.
If an infringement or misappropriation claim is successfully asserted against
us, we may need to obtain a license from the claimant to use the intellectual
property rights. There can be no assurance that such a license will be available
on reasonable terms if at all.
We face competition from established and developing companies, many of which
have significantly greater resources than us, and we expect such competition to
grow.
The markets for our products, future products and services are very competitive.
We face direct and indirect competition from a number of established companies
and development stage companies, and we anticipate that we will face increased
competition in the future as existing competitors seek to enhance their product
offerings and new competitors emerge. Many of our competitors have greater
resources, stronger financial strength, higher name recognition, more
established reputations within the industry and stronger manufacturing,
distribution, sales and customer service capabilities than we do.
The technologies that our competitors and we offer are expensive to design,
develop, manufacture and distribute. Competitive technologies may be owned and
distributed by established companies that possess substantially greater
financial, technical and other resources than we do.
Competitive technologies that offer a similar or superior capacity to converge
and transmit audio, video and telephonic data on a real-time basis over existing
networks may currently exist or may be developed in the future. We cannot assure
you that any technology that we have developed or are currently developing by us
is not being developed by others, or that our technology development efforts
will result in products that are competitive in terms of price and performance.
If our competitors develop products or services that offer significant price or
performance advantages as compared to our current and proposed products and
services, or if we are unable to improve our technology or develop or acquire
more competitive technology, our business could be adversely affected.
We may not be able to profit from growth if we are unable to effectively manage
the growth.
Assuming we receive adequate funding to conduct our business, we anticipate that
we could grow rapidly in the future. This anticipated growth, if it occurs at
all, will place strain on our managerial, financial and personnel resources. The
pace of our anticipated expansion, together with the complexity of the
technology involved in our products and the level of expertise and technological
sophistication incorporated into the provision of our design, engineering,
implementation and support services, demands an unusual amount of focus on the
operational needs of our future customers for quality and reliability, as well
as timely delivery and post-installation and post-consultation field and remote
support. In addition, new customers, especially customers that purchase novel
and technologically sophisticated products such as ours, generally require
significant engineering support. Therefore, adoption of our platforms and
products by customers would increase the strain on our resources. To reach our
goals, we will need to hire rapidly, while at the same time investing in our
infrastructure. We expect that we will also have to expand our facilities. In
addition, we will need to:
o successfully train, motivate and manage new employees;
o expand our sales and support organization;
o integrate new management and employees into our overall operations; and
o establish improved financial and accounting systems.
We may not succeed in anticipating all of the changing demands that growth would
impose on our systems, procedures and structure. If we fail to effectively
manage our expansion, our business may suffer.
We may not be able to hire and retain key employees.
Our future success will depend, in part, on our ability to attract and retain
highly skilled employees, including management, technical and sales personnel.
Significant competition exists for employees in our industry and in our
geographic region. We may be unable to identify and attract highly qualified
employees in the future. In addition, we may not be able to successfully retain
these employees or hire qualified personnel to replace them.
We are dependent on our key employees for our future success.
Our success depends on the efforts and abilities of our senior management and
certain other key personnel. If any of these key employees leaves or is
seriously injured and unable to work and we are unable to find a qualified
replacement, then our business could be harmed.
We rely on several key suppliers of components, sub-assemblies and modules that
we use to manufacture our products, and we are subject to manufacturing and
product supply chain risks.
We purchase components, sub-assemblies and modules from a limited number of
vendors and suppliers that we use to manufacture and test our products. Our
reliance on these vendors and suppliers involves several risks including, but
not limited to, the inability to purchase or obtain delivery of adequate
supplies of such components, sub-assemblies or modules, increases in the prices
of such items, quality, and overall reliability of our vendors and suppliers.
Some of the materials used to produce our products are purchased from foreign
suppliers. Moreover, we do not generally maintain long-term agreements with any
of our vendors or suppliers. Thus we may thus be unable to procure necessary
components, sub-assemblies or modules in time to manufacture and ship our
products, thereby harming our business. We may also be subject to disruptions in
our manufacturing and product testing operations that could have a material
adverse affect on our operating results.
Unanticipated delays or problems in introducing our intended products or
improvements to our intended products may cause customer dissatisfaction or
deprive us of the "first to market" advantage.
Delays in the development of products and the launch of commercial products are
not uncommon in high tech industries such as ours. If we experience problems
related to the introduction or modification of our intended products or the
reliability and quality of such products, which problems delay the introduction
of our intended products or product improvements by even a short time of a few
months, we could experience reduced product sales and adverse publicity which in
turn could have a material adverse impact on our business. We believe the
company first to market with viable products will gain a significant advantage
with customers; delays could prevent us from being the company that gains this
advantage.
The issuance of common stock to DTKA Holdings under our equity line and to
purchasers of units in our 2002 private placement offering would cause
significant dilution to our stockholders, and the resale of such shares by DTKA
and the purchasers in the private placement may depress the price of our common
stock.
In January 2002, we entered into a common stock purchase agreement with DTKA
Holdings Limited, a British Virgin Islands company, for the potential future
issuance and sale of up to $10 million of common stock, which is required to be
registered. Under this arrangement, we, at our sole discretion, may, from time
to time, draw down on this facility (otherwise known as an "equity line"),
requiring DTKA Holdings to purchase shares of our common stock at prices
calculated on the basis of discounts ranging from 6.5% to 8.5% from the daily
volume weighted average price of our common stock on the principal exchange or
trading market on which our common stock is trading on the date of the draw
down. We may not draw down on this facility until we have filed a registration
statement with the Securities and Exchange Commission to register enough shares
of common stock to cover the shares to be issued pursuant to such draw down, and
until this registration statement has been declared effective. As of September
30, 2002 we have not begun the share registration process. The issuance of
shares of common stock to DTKA Holdings pursuant to this equity line could
result in significant dilution to our stockholders. However, we do not currently
intend to draw down on any funds under this facility.
The issuance of common stock to Laurus Funds in connection with our convertible
note to them would cause significant dilution to our stockholders, and the
resale of such shares by Laurus may depress the price of our common stock.
In May 2002, we issued a 12% convertible note in the principal amount of
$1,250,000. The note is convertible at a price of $1.40 per share and is payable
on a monthly basis over 15 months.
On November 7, 2002, the Company issued a 12% convertible note in the principal
amount of $300,000. The note is convertible at a price of $.85 per share and is
payable on a monthly basis over 18 months. As the conversion price was below the
trading market price $.90 per share on the day the note was issued, the Company
will record a debt discount in its fourth quarter ended December 31, 2002, and
will amortize the debt discount over the period of the convertible note from the
earliest conversion date using the effective interest method.
In connection with the issuance of the 12% convertible note in November 2002,
the Company issued warrants to purchase 75,000 shares of common stock at $.85
per share. The Company will record deferred interest expense associated with the
warrants in its fourth quarter ended December 31, 2002 under the Black Scholes
valuation method, and will amortize the deferred interest over the life of the
note.
As part of the November 7, 2002 convertible note transaction, the Company also
repriced the conversion price of the May 2002 convertible note and 175,000
warrants (See Note 8) which had been purchased by the same investor to $.85 per
share. The term of the May 2002 note was extended to May 7, 2004. This will
change the previously reported debt discount amount, deferred interest expense
amount and amortization periods. The 75,000 warrants issued in connection with
the November 7, 2002 convertible note are fully vested and expire in November
2009.
The convertible note financing that we have in place with Laurus Funds may have
a material dilutive impact on our shareholders, as well as a negative impact on
our financial results.
We offer stock options to our employees, non-employee directors, consultants and
advisors, which could result in ongoing dilution to all stockholders. However,
California law currently precludes us from issuing new stock options to
non-executive employees and consultants.
We maintain two equity compensation plans: (i) the 2000 Stock Option/Stock
Issuance Plan (the "2000 Plan"), pursuant to which we may issue options and
common stock to employees, officers, directors, consultants and advisors, and
(ii) the 2001 Employee Stock Purchase Plan (the "Purchase Plan"), approved by
our stockholders in February 2002, pursuant to which our employees are provided
the opportunity to purchase our stock through payroll deductions. As of
September 30, 2002, there were options outstanding to purchase 3,926,898 shares
of common stock under our 2000 Plan; 333,102 shares of common stock remain
available for issuance under the 2000 Plan. A maximum of 250,000 shares of
common stock have been authorized for issuance under the Purchase Plan.
We plan to continue to provide our employees opportunities to participate in the
Purchase Plan. We also wish to issue options, either under the 2000 Plan or
otherwise, to purchase sizable numbers of shares of common stock to new and
existing employees, officers, directors, advisors, consultants or other
individuals as we deem appropriate and in our best interests. These ongoing
purchases of our common stock (as well as future option grants by us and
subsequent exercises of options) could result in substantial dilution to all
stockholders and increased control by management.
The number of shares of common stock subject to currently outstanding options
under the 2000 Plan, as well as shares of common stock subject to options
granted other than under the 2000 Plan, exceeds 30% of the total number of
shares of our currently outstanding common stock. The California Department of
Corporations has issued regulations for companies seeking qualification of stock
option plans, which regulations require that the total number of shares issuable
upon exercise of all options shall not exceed 30% of such companies' outstanding
shares, unless a percentage higher than 30% is approved by at least two-thirds
of the outstanding shares entitled to vote. We unsuccessfully sought to obtain
this two-thirds supermajority vote of the outstanding shares. Therefore the
issuance of further stock options and shares under the 2000 Plan to persons
other than officers, directors and previous optionees requires qualification,
which under current conditions we cannot obtain, of the securities under the
"blue sky" securities provisions of the California Corporations Code. This may
limit our ability to grant options and stock as a means of attracting and
retaining employees.
We are subject to local, state and federal regulation, as well as the rules of
any stock exchanges on which our securities might trade.
Legislation affecting us (or the markets in which we compete) could adversely
impact our ability to implement our business plan on a going-forward basis. The
telecommunications industry is heavily regulated and these regulations are
subject to frequent change. Future changes in local, state, federal or foreign
regulations and legislation pertaining to the telecommunications field may
adversely affect prospective purchasers of telecommunications equipment, which
in turn would adversely affect our business.
Our executive officers, directors and 5% stockholders currently maintain
substantial voting control over us and possess certain rights of first offer and
first refusal in regard to offers and sales of our securities.
As of September 30, 2002, a small number of our executive officers, directors
and 5% stockholders, beneficially own, in the aggregate, approximately 48% of
our outstanding common stock As a result, these stockholders (or subgroups of
them) retain substantial control over matters requiring approval by our
stockholders, such as the election of directors and approval of significant
corporate transactions. Pursuant to the terms of a stockholders' agreement with
Leitch, dated April 10, 2000, Ronald D. Fellman and Douglas A. Palmer, who
together hold approximately 15% of our outstanding common stock, have agreed to
vote all securities of Path 1 held by them in favor of designees of Leitch for
two positions on our seven-person Board of Directors, for as long as Leitch
continues to hold at least 20% of our capital stock (on an as-converted,
as-exercised, fully-diluted basis). As of September 30, 2002, Leitch did not
hold at least 20% of our stock on an as-converted, as-exercised, fully-diluted
basis and thus is not entitled to designate director nominees.
Under this Stockholders' Agreement, Leitch Technology Corporation also has
rights of first refusal to purchase (i) any equity securities offered in a
private sale by Dr. Fellman, Dr. Michael Elliott and Dr. Palmer, and (ii) its
pro rata share of any capital stock, or rights, options, warrants or to purchase
capital stock issued by us, on the same terms and at the same price offered by
us to the third party or parties. These rights of first refusal and the voting
agreement give Leitch the potential to maintain or expand its substantial equity
position in us and exert significant influence over matters of corporate
governance. The right of first refusal with respect to securities offerings by
us could, in certain circumstances, serve as a deterrent to future acquirors,
especially if Leitch does not approve of a proposed merger or acquisition, and
could give Leitch the leverage to condition its consent to offerings of our
securities on our adoption of policies favored by Leitch. In addition, Leitch
maintains demand registration rights pursuant to which it can require us to
register its shares of our common stock with the Securities and Exchange
Commission for resale into the public market. Such registration and resale could
adversely affect the price of our common stock.
Our equity compensation plans give wide latitude to the plan administrator (our
Board of Directors or committee thereof) to make option grants or stock
issuances to our officers and directors and to grant broad auxiliary rights in
connection with such option grants or stock issuances (e.g. full or partial
acceleration of vesting upon change of control or upon attainment of certain
performance milestones). In January 2002, our executive officers and employees
were granted stock options under our 2000 Stock Option/Stock Issuance Plan in
return for their agreement to voluntarily reduce their salaries for a period of
90-days. Our executive officers have continued to receive reduced salaries
through September 30, 2002 in exchange for option grants. Additional option
grants to our officers and directors would serve to increase their equity
ownership of the company and would allow these officers and directors, should
they choose to exercise their options, to exert increased control over us.
Our charter documents contain provisions that could discourage a takeover.
Our Certificate of Incorporation and Bylaws contain provisions that may have the
effect of making more difficult or delaying attempts by others to obtain control
of us, even when these attempts may be in the best interests of the
stockholders. Our Certificate of Incorporation authorizes our Board of
Directors, without further stockholder approval, to issue one or more series of
preferred stock. Any such series of preferred stock could have rights, including
voting rights, superior to that of our common stock, and rights to elect
directors as a class. Grant of such rights could provide the preferred stock
holders with significant control over matters of corporate governance.
In addition, our Bylaws state that special meetings of the stockholders may only
be called by 20% or more of the outstanding stock entitled to vote at such
meeting, and also require that all significant transactions, even those that
would not otherwise require a vote of the Board of Directors, be reviewed and
approved by the Board. These Bylaws provisions may defer the calling of a
meeting at which a change of control might be effected and may serve to deter
potential acquirers.
We do not intend to pay cash dividends.
We have never paid cash dividends on our capital stock and do not anticipate
paying any cash dividends in the foreseeable future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We would be exposed to changes in interest rates primarily from any marketable
securities and investments in certain available-for-sale securities. Under our
current policies, we do not use interest rate derivative instruments to manage
exposure to interest rate changes. At September 30, 2002, we did not have any
marketable securities or investments in available-for-sale securities, nor did
we have any sales denominated in a currency other than the United States dollar.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Our chief executive officer and chief financial officer, after evaluating the
effectiveness of our "disclosure controls and procedures" (as defined in the
Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date
(the "Evaluation Date") within 90 days before the filing date of this quarterly
report, have concluded that as of the Evaluation Date, our disclosure controls
and procedures were effective and designed to ensure that material information
relating to us and our consolidated subsidiaries would be made known to them by
others within those entities.
(b) Changes in internal controls
There were no significant changes in our internal controls or in other factors
that could significantly affect those controls subsequent to the Evaluation
Date.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On March 22, 2002, the Company filed a lawsuit the Superior Court of San Diego
County, California against Mr. Meeuwi J. deKraker, a European national for
$3,500,000 stemming from a material breach of contract of a promissory note in
connection with a subscription agreement for the Company's stock. On October 21,
2002, the Court awarded us a default judgment against the defendant in the sum
of $3,500,000 plus interest and court costs.
The United States presently is not a party to any international convention
governing the recognition and enforcement of judgments by a foreign court, and
whether a judgment from a court in the United States will be recognized and
enforced in a foreign country is generally determined by that foreign country's
domestic laws. We intend to pursue our claim and to enforce this judgment
against the defendant. However, there can be no assurance that the default
judgment awarded the Company will be recognized or enforced by a court of
competent jurisdiction in Belgium (or in any other country where the defendant
might be found or in which a court would have jurisdiction), or if so
recognized, whether we will succeed in collecting the judgment.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 18, 2002 we completed the registration of 2,285,714 shares of common
stock pursuant to a securities purchase agreement between us and Laurus Funds,
Ltd.
On August 7, 2002 we filed Form SB-2 to register 1,767,676 shares of common
stock pursuant to a private placement completed in May 2002.
These were private placements, exempt from the Securities Act registration
requirement by virtue of Securities Act Section 4(2).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
On October 30, 2002, the Company appointed Swenson Advisors LLP as its
independent auditors for 2002.
On October 18, 2002, John R. Zavoli was appointed Chief Financial Officer,
General Counsel and Corporate Secretary.
On September 27, 2002, we announced that Dr. Moshe Nazarathy joined our Board of
Directors, replacing Ronald Fellman (who remains our Chief Technology Officer),
and that Robert Clasen has become our Chief Strategy Officer in addition to
remaining on our Board of Directors.
In May 2002, Dr. Ronald Fellman commenced a qualified selling plan under SEC
10B5-1. The plan runs for sixty trading days starting July 29, 2002 and sells a
maximum of 500 shares per day.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
On July 18, 2002, Form 8-K was filed to report the change in the Company's
principal offices to 6215 Ferris Square, Suite 140, San Diego, California 92121,
as well as various management changes and realignments.
On September 25, 2002, Form 8-K was filed to report the resignation of Ernst &
Young LLP as the Company's independent auditors with effect from September 13,
2002.
Exhibits. The following exhibits are included as part of this report. References
to "us" in this Exhibit List mean Path 1 Network Technologies inc., a Delaware
corporation.
Exhibit
Number Description
10.24 Securities Purchase Agreement dated November 7, 2002 by and between
Path 1 and Laurus Master Fund, Ltd. *
10.25 Allonge to Convertible Note Dated May 16, 2002 dated November 7, 2002
by and between Path 1 and Laurus Master Fund, Ltd. *
10.26 Allonge to Warrant Dated May 16, 2002 dated November 7, 2002 by and
between Path 1 and Laurus Master Fund, Ltd. *
99.1 Certification under Section 906 of the Sarbanes-Oxley Act of 2002. *
* Filed Herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Path 1 Network Technologies Inc.
By: /s/ Frederick A. Cary
- -------------------------
Frederick A. Cary
President and Chief Executive Officer
By: /s/ John R. Zavoli
- ------------------------
John R. Zavoli
(Chief Financial Officer, General Counsel and Corporate Secretary)
Date: November 14, 2002
Exhibits. The following exhibits are included as part of this report. References
to "us" in this Exhibit List mean Path 1 Network Technologies inc., a Delaware
corporation.
Exhibit
Number Description
10.24 Securities Purchase Agreement dated November 7, 2002 by and between
Path 1 and Laurus Master Fund, Ltd. *
10.25 Allonge to Convertible Note Dated May 16, 2002 dated November 7, 2002
by and between Path 1 and Laurus Master Fund, Ltd. *
10.26 Allonge to Warrant Dated May 16, 2002 dated November 7, 2002 by and
between Path 1 and Laurus Master Fund, Ltd. *
99.1 Certification under Section 906 of the Sarbanes-Oxley Act of 2002. *
* Filed Herewith