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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER: 000-25755
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WORLDGATE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2866697
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3190 TREMONT AVENUE
TREVOSE, PENNSYLVANIA 19053
(Address of principal executive (Zip Code)
offices)
(215) 354-5100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the common stock held by non-affiliates of the
registrant was approximately $92.9 million as of March 19, 2001, based on the
closing sale price per share of common stock, as quoted on the Nasdaq National
Market.
The number of shares of the registrant's common stock outstanding as of
March 19, 2001 was 23,445,765.
DOCUMENTS INCORPORATED BY REFERENCE
[NONE]
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WORLDGATE COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder 14
Matters.....................................................
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition 17
and Results of Operations...................................
Item 7A. Quantitative and Qualitative Disclosures About Market 30
Risk........................................................
Item 8. Financial Statements and Supplementary Data................. F-1
Item 9. Changes in and Disagreements with Accountants on Accounting 31
and Financial Disclosure....................................
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 31
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and 41
Management..................................................
Item 13. Certain Relationships and Related Transactions.............. 42
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 43
8-K.........................................................
WORLDGATE COMMUNICATIONS, INC.
This report contains forward-looking statements that involve risks and
uncertainties. These forward-looking statements are based on management's
current expectations and are subject to a number of uncertainties and risks that
could cause actual results to differ significantly from those anticipated in
these forward-looking statements. Factors that may cause such a difference
include, but are not limited to, those set forth in the "Management's Discussion
and Analysis of Financial Condition and Results of Operations" as well as those
discussed elsewhere in this report.
PART I
ITEM 1: BUSINESS
WorldGate Communications, Inc., or sometimes WorldGate or the Company, was
incorporated in Delaware in 1996 to succeed to the business of our predecessor,
WorldGate Communications, L.L.C., which commenced operations in March 1995. In
April 1999, we completed our initial public offering of 5,000,000 shares of our
common stock. Our common stock is listed on the NASDAQ National Market and is
traded under the symbol "WGAT". Our executive offices are located at 3190
Tremont Avenue, Suite 100, Trevose, Pennsylvania 19053.
OVERVIEW
We are a leader in providing interactive television products and services to
the cable television industry. Interactive television, or ITV, is a rapidly
growing sector of the cable television industry, with its focus on deploying
services or applications to allow television viewers to interact with programs,
advertisements and other content on their television sets. Viewers input
information via wireless keyboards or other remote control devices. We offer our
customers, the cable operators who want to offer ITV applications to their
subscribers, a wide array of ITV applications and related services and products.
We believe that we are unique in that we can offer cable operators a wide
variety of ITV solutions tailored to their needs. Our business strategy, as more
fully described below, is designed to take advantage of our unique position. ITV
has several components. First, cable operators must create the infrastructure to
deploy ITV applications. We design, assemble, install and maintain the equipment
and computer software, or systems, necessary to provide these ITV applications.
Second, cable operators must have the flexibility to concurrently provide
multiple ITV applications, including applications such as interactive program
guides, or IPGs, Internet over television services, video on demand and enhanced
television, or eTV, products. We provide a platform, called middleware, that
works in combination with the set-top boxes currently used by cable operators
for television programming to provide these ITV applications. Our middleware is
designed as an "open standards" platform, which means it will work with a wide
variety of applications, including many of the third party applications that are
in existence today. Finally, in addition to our systems and middleware products,
we license a variety of our own ITV applications to our cable operator
customers.
Once our cable operator customers have the necessary systems, middleware and
applications installed and deployed, we may receive revenue from advertising and
television commerce, or t-commerce, in addition to any licensing fees we receive
for the use of our technologies. For example, our Internet over television
service, the WorldGate(SM) Service, contains advertisements for which we receive
revenues. Our products and services also provides cable subscribers with
opportunities to execute transactions via their television sets, for which we
also receive revenues. We partner with, and share these revenues with, our
content providers and cable operator customers, which ensures that our
subscribers have a wide variety of viewer-friendly content when using our
service. In addition, we provide training and customer support for our cable
operator customers. Some of this training, support and maintenance provides
additional revenues for us. Finally, we provide a full range of aggregating
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and reporting functions to help our cable operator customers and content
providers manage their interactive offerings.
Furthermore, we are a partial owner and manager of TVGateway, LLC, a joint
venture between us and four of the largest six multiple system operators, or
MSOs, in the U.S. This joint venture was formed during 2000 to provide cable
operators with interactive applications for their digital products, including
an IPG. We receive licensing fees from TVGateway for the use of our proprietary
technology, and we receive management fees for managing the joint venture.
PRODUCTS AND SERVICES
We have tailored our business strategy around the diverse variety of
services and products described above. Specifically, the core products and
services that we have developed and/or are deploying include:
- WORLDGATE APPLICATION LAUNCHER INTERFACE, OR WALI. WALI is a middleware
product that allows multiple ITV applications to run simultaneously on a
television set-top box. WALI is based upon our patented "Ultra-Thin
Client(SM)" technology, which uses existing cable television architecture
to deploy a centralized interactive system. "Ultra-Thin Client" enables us
to install, maintain and upgrade our hardware at the cable operator's
plant, also called a headend. Because most of our technology is located at
the headend, cable subscribers need only use the currently deployed
generation of low cost set-top boxes with limited memory and processing
resources to offer ITV applications. This significantly reduces the cost
of deploying ITV applications. In addition, our Ultra-Thin Client
architecture permits upgrades to be made either at the headend or through
software downloads to the set-top boxes. This minimizes the need to repair
or upgrade these boxes.
- CABLEWARE 2000(SM). We introduced CableWare 2000 in September of 2000 as
the next generation of our field-proven middleware. This product provides
an "open standards" middleware platform that enables broad deployment of
several ITV applications that can interact with each other in a
multitasking environment. In addition, CableWare 2000 provides the
opportunity to use our recently introduced Flash-driven interactive
overlay technology, which allows networks and cable operators to provide
interactive information along with, or over, their broadcasts, so viewers
can watch programming and interact with additional content simultaneously.
- WORLDGATE(SM) SERVICE. Developed as our flagship product and now flanked
by a full range of other offerings, the WorldGate Service is still a vital
part of our business strategy. The WorldGate Service provides a variety of
compelling ITV applications to our cable operator customers. The WorldGate
Service operates on both already existing cable set-top boxes, and on more
advanced, next-generation set-top boxes. The WorldGate Service works in
conjunction with WALI or CableWare 2000, and works seamlessly with the
TVGateway IPG. The WorldGate Service includes enhanced television, or eTV,
applications such as access to the Internet over television, e-mail, chat
as well as interfaces with video on demand applications, or VOD, and a
variety of IPGs and other eTV features, including t-commerce.
- CHANNEL HYPERLINKING(SM). Channel HyperLinking is our patented technology
that allows cable subscribers to link directly from television programming
and advertising to related content through the press of a single button.
This powerful feature supplements the WorldGate Service and/or the
TVGateway Service, and has a variety of revenue producing uses for cable
operators, broadcasters and advertisers and provides a valuable tool for
viewers, who can flip back and forth almost instantly between watching
television and the Internet.
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DEPLOYMENTS
As of December 31, 2000, approximately 104,000 subscribers on 35 cable
systems in 14 countries around the world subscribe to our products and services.
We have installed our technology in over 500 cable system sites. Among our cable
operator customers are five of the six largest MSOs in the U.S., including AT&T
Broadband, Comcast Cable Communications, Charter Communications, Inc., Cox
Communications, Inc. and Adelphia Communications Corp. We believe that we are
currently the only provider in the ITV industry that can deploy our services and
products over both analog and digital cable platforms.
In 2000, three cable operators, Charter, Comcast and AT&T, accounted for
approximately 49% of our revenues relating to the deployment of our services, or
33%, 8% and 8%, respectively. Domestically, we added significant cable operators
to our list of customers in 2000, including AT&T and Blue Ridge Communications.
Internationally, our business strategy continues to include a commitment to
deploying our services to cable operators around the world. To that end, in 2000
and early 2001 we have added deployments, or have obtained commitments to
deploy, with:
- Telefonica, Peru
- Cablevision S.A., Mexico
- Asianet Satellite Systems Ltd, India
- TeleCable Nacional C por A, Dominican Republic
- CableVision Monterrey, Mexico
MATERIAL DEVELOPMENTS FOR WORLDGATE IN 2000
The following is a summary of material developments for us that have
occurred since December 31, 1999:
- ISSUANCE OF NEW PATENTS. On April 11, 2000, the U.S. Patent and Trademark
Office issued a third patent to us covering aspects of our Channel
HyperLinking(SM) technology and our Ultra-Thin Client(SM) architecture.
- ACQUISITION OF DIGITAL VIDEO ART, INC. On April 28, 2000, we acquired
Digital Video Art, Inc., a Campbell, California based engineering services
company providing out-sourced product development, with expertise in
digital television and 3D graphics. We believe the acquisition expanded
our leadership role in the technical development of interactive
television. The newly acquired engineering team, has extensive experience
with General Instrument's DCT5000 advanced digital platform and
Microsoft's Windows CE. The development and design professionals have
joined WorldGate's engineering team, which has been recognized
internationally for the creation of its patented Ultra-Thin Client(SM) and
Channel HyperLinking(SM) applications that enable WorldGate to deliver its
services using the cable television infrastructure.
- INVESTMENT AND COMMITMENT BY TOP CABLE OPERATORS. On July 24, 2000, we
entered into multi-year agreements with Adelphia Communications
Corporation, Comcast Cable Communications Inc. and Cox
Communications, Inc. and agreed to an extension of an existing agreement
with Charter Communications, Inc. for the digital deployment of the
WorldGate Service. Along with the deployment agreements, these cable
operators, purchased $24.5 million of our common stock, and we issued each
of them warrants to purchase additional shares of our common stock. These
warrants vest based upon the distribution of the WorldGate Service.
- FORMATION OF TVGATEWAY JOINT VENTURE. Also on July 24, 2000, we entered
into a joint venture with the above referenced four cable operators called
TVGateway, LLC. TVGateway(SM) has
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licensed WorldGate's patented Channel HyperLinking(SM) and Ultra-Thin
Client(SM)technology from us, which can provide the back office
infrastructure support necessary to implement interactive advertising and
programming for the partners' digital set-top boxes. The TVGateway joint
venture has also licensed the WorldGate Application Launcher Interface, or
WALI, middleware through which multiple applications can be easily
interchanged in the digital set-top box. We also receive management fees
for operating the TVGateway joint venture and provide equipment to the
venture.
- INTRODUCTION OF SIGNIFICANT NEW MIDDLEWARE PRODUCT. On September 13, 2000,
we announced CableWare 2000(SM), an open-standards middleware platform
designed to address the need to deploy enhanced and interactive TV
applications, such as video-on-demand, Internet access, IPGs, and other
enhanced TV products, in a multitasking environment on the approximately
eight million digital set-top boxes in the market today. Developers of
enhanced TV content and advertising that have been targeting
next-generation advanced set-top boxes, will now be able to port the
majority of those applications to the CableWare 2000 environment on the
current generation of digital converters and maintain an integration path
to the next generation boxes when they are deployed.
- CONTRACT WITH AT&T BROADBAND. On November 6, 2000, WorldGate and AT&T
Broadband, the nation's largest cable operator, announced that they will
deploy WorldGate's interactive services to digital cable set-top boxes.
The service will be available to AT&T Digital Cable customers in Cedar
Falls and Waterloo, Iowa and Tacoma, Washington using Motorola DCT-2000
set top boxes, remote controls and optional wireless keyboards.
- INTEGRATION WITH MAJOR VOD PROVIDERS. In 2000, we successfully integrated
the WorldGate Service with several of the premiere VOD providers,
including SeaChange, DIVA, nCube, and Concurrent. This integration allows
us to offer our MSO customers and their subscribers a wide variety of the
top video on demand resources.
- INTRODUCTION OF CONTENT DEVELOPERS PROGRAM. Also in 2000, in recognition
of the need to provide subscribers with the best possible interactive
experience, we formed our Certified Developer Program, known as the CDP.
The CDP gives our content providers access to an array of talented
developers trained to design interactive content specifically for the
television, and the WorldGate platform. WorldGate's current CDP members
are listed below:
ARTiFACT ExtendMedia Proteus
Beyond Z Interactive Media Filter Media Pushy-Broad
Blue Zone Flying Colors Interactive [+]ITV
CenterSeat Intellocity USA RANDOM/ORDER
Commerce.TV MassHysteria Respond TV
CYLO MetaTV Spiderdance
Enlighten Steeplechase
Mixed Signals Technologies Media
WORLDGATE SOLUTION
Our solution is to provide our cable operator customers with an array of
useful, compatible and effective products that allow these customers to deploy a
cost effective ITV service to their subscribers. We believe that we are the only
company that can provide a complete solution for our customers interested in
deploying ITV, backed up with proprietary technology and our commitment to
service and support. Our services utilize the proprietary ULTRA-THIN CLIENT
network architecture to allow for easy deployment and set-up, central system
management and centrally administered upgrades. In the subscriber home, users
need only employ a television, a remote control or WorldGate wireless keyboard,
and a WorldGate capable digital or advanced analog box--both of which are
currently being
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deployed by cable operators for business reasons largely unrelated to
interactive television. We enable subscribers to browse the Web, send and
receive e-mail, participate in chat sessions and shop online. We enable cable
operators to provide revenue generating t-commerce products and deploy "open
standards" IPGs and middleware products that allow them to use competitive
products. With features such as our CHANNEL HYPERLINKING technology, the
WorldGate Service can integrate the interactivity of the Internet with the
television viewing experience. By enabling such enhanced TV applications,
including low cost Internet access, integrated Internet/television advertising
and t-commerce, we believe that we are pioneering a new mass market.
All of these interactive applications and solutions are part of the offering
we bring to our cable operator partners. To provide enhanced value to our
customers, we developed data monitoring and reporting systems, which we collect
and aggregate at our Network Operations Center (NOC). Data collected and
aggregated covers:
- Household demographic data;
- Session start and end time;
- Web click-stream with time stamps;
- Channel number and time; and
- Browser and session logs.
This set of data can assist advertisers and programmers in creating and
adjusting their interactive strategies based on subscriber activities, giving
them a powerful tool to help deliver compelling experiences. System monitoring
also helps to ensure that the sites most visited by our subscribers are operable
on the Service. By using our unique reporting capabilities to give users a
superior interactive experience, content providers, as well as cable operators,
reap the benefits of added revenue streams and satisfied customers.
We have conducted some of the first market studies for ITV using these
reporting capabilities and other research methods. These studies are invaluable
for providing cable operators with the information they need to deliver
compelling interactive services to their subscribers and for allowing us to
improve our products according to user value and demand.
WORLDGATE BUSINESS MODEL
We derive revenues from cable operators and e-commerce merchants and
advertisers. We expect to enhance these revenue opportunities by implementing
the strategies described below.
REVENUE DERIVED FROM CABLE OPERATORS. In most instances, we sell our
headend server equipment and wireless keyboards to cable operators and license
the software for our various ITV products, including CableWare 2000 and the
WorldGate Service, to cable operators for a monthly subscriber fee. We believe
that cable operators will either offer our services to their subscribers as a
premium service, requiring subscribers to pay a separate monthly fee for the
service, or as a part of a package of services in which the subscriber pays a
monthly fee for the entire package. Generally, we receive monthly fees from the
cable operators based on the total number of subscribers to our services.
REVENUE DERIVED FROM E-COMMERCE AND T-COMMERCE MERCHANTS. We have
negotiated agreements with companies in the business of selling products and
services online and via ITV through which these companies pay for the
opportunity to promote their business through portals by sharing a portion of
the revenues they are paid or by paying a fixed fee per transaction. Although
such revenues are currently not significant we intend to make access to online
shopping opportunities both simple and convenient for our subscribers so that we
can participate in the rapid growth forecasted for e-commerce and t-commerce.
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REVENUE DERIVED FROM ADVERTISERS. We have space on our various menu pages
that is available for banner advertising and other promotions. When subscribers
click on these banners, they can be linked quickly to another Web page that
gives more detailed information about the subject of the banner ad. Advertisers
typically pay fees based on the number of times that their ad is displayed on a
page viewed by a subscriber, so as the number of WorldGate subscribers grows, we
expect our advertising revenues to grow. We believe we provide advertisers with
a particularly attractive opportunity since information derived from the
cooperating cable system will permit us to know the general geographic area in
which each of our subscribers lives, and in many cases the zip codes and perhaps
more extensive demographic information regarding our subscribers if they wish to
share that information with us. In order to protect the confidentiality of this
information we have designed our system to maintain only encrypted subscriber
information and then only on separate computers which are independent of the
servers for the WorldGate Service. Having location and other data regarding our
subscribers is expected to be valuable because advertisers typically are willing
to pay higher advertising fees if they can target their ads based on such
information. We expect to share the revenues derived from Internet advertising
with cable operators. No meaningful revenue was derived from advertising in
2000.
Our CHANNEL HYPERLINKING technology will provide one button linking from
television and advertising content to a related fully interactive Internet web
site. This sort of advertising is "self targeted" because subscribers themselves
decide whether they want to get more information. This is in sharp contrast to
traditional television advertising that typically includes sending messages to
large numbers of viewers on an unsolicited basis. In addition to the value
achieved by self-targeting, the value of our CHANNEL HYPERLINKING technology is
enhanced by both the availability of demographic information and interactivity.
By delivering an interactive experience, we are able to give the subscribers the
opportunity to follow a variety of paths to gain extensive information about the
subject of interest. The interactivity also allows the subscribers in many cases
to purchase a product or service online. With the average cable household being
exposed to tens of thousands of television advertisements annually, we believe
that there are many opportunities for use of our CHANNEL HYPERLINKING
technology.
Our CHANNEL HYPERLINKING technology business model is based on a revenue
split with our cable operator customers and the television networks. We expect
revenue to come from advertisers seeking to engage the WorldGate Service
subscribers in some form of interactivity while using our CHANNEL HYPERLINKING
technology. This business model assumes that interactions will be on a
pay-for-performance basis such that advertisers and others will pay us based on
the number of "clicks" that occur. No meaningful revenue was derived from this
service in 2000.
REVENUE DERIVED FROM TVGATEWAY JOINT VENTURE. We are the provider of
headend equipment for the TVGateway joint venture and receive management fee
revenue for managing the venture on behalf of its MSO partners. In 2000, 28% of
our revenues were attributable to consulting fees from TVGateway.
BUSINESS STRATEGY
We offer technology in the form of hardware sales and software licensing;
service and support of our business partners; and share revenue streams from
interactive advertising and commerce via our technology and services on the
television. The principal elements of our business strategy include the
following:
PROVIDE COMPELLING VALUE FOR END-USERS. Unlike other companies who can
offer just one of the many pieces that make up interactive television, we enable
our subscribers to access an array of ITV applications. Consumers no longer have
to subscribe to several different complicated services in order to get the
features they want, with WorldGate they can get it in one simple package. The
Company's products and services were designed to operate on the widely available
existing cable television systems,
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as well as future set-top technologies, and were developed to provide consumers
with an easy to use, cost-effective product. For example, to access the
WorldGate SERVICE, a consumer needs only their existing television, a WorldGate
enabled digital or advanced analog cable set-top box and a wireless remote or
keyboard, with all but the television typically supplied by the cable operator.
In addition, WorldGate's CHANNEL HYPERLINKING AND CABLEWARE ETV technology have
been designed to offer consumers easy, fast and interactive access to content
which is associated with a television program or advertisement they are viewing.
PROVIDE COMPELLING VALUE FOR CABLE OPERATORS. We believe that cable
operators assess the viability of an investment in a new service by considering
the cost of initial investment in equipment, service reliability, overall
operating and maintenance expenses and the incremental revenue that can be
generated by such service. The WorldGate Service can be offered to cable
subscribers through the cable operators' existing two-way infrastructure, or its
one-way infrastructure using a telephone line. Furthermore, the WorldGate
Service has been designed to be deployed with low capital costs for headend
equipment as low as $12 per WorldGate subscriber. These systems are also
designed to be efficiently upgraded as the cable operator's infrastructure is
improved through the deployment of new generation cable boxes or the deployment
of cable modem ready plant, i.e. a cable plant that has been upgraded to improve
the original transmission quality to permit the use of cable modems, and easily
expanded as the number of subscribers grows. There is, however, no need for any
costly upgrades to make the plant cable modem ready as a requirement for the
WorldGate Service. Accordingly, the WorldGate Service can provide cable
operators with the low investment opportunity for immediate incremental revenue
streams from subscriber fees and sharing of advertising and online transaction
fees.
PROVIDE COMPELLING VALUE FOR PROGRAMMERS, ADVERTISERS, ADVERTISING AGENCIES
AND E-COMMERCE MERCHANTS. Through WorldGate's CHANNEL HYPERLINKING AND CABLEWARE
ETV technology, programmers and advertisers may enhance their television content
with related Web-based materials by providing their viewers with the ability to
interact on a real-time basis with their television programming or advertising.
As observed in our deployments with AT&T and Massillon Cable, we are
facilitating a market of active subscribers for interactive advertising. Giving
consumers the ability to link immediately to an advertiser's Internet site to
find more information about the product or to place an order is a valuable user
feature and an effective way for advertisers to reach their customers using a
new method. We believe this ability increases the value of the program or
advertising to the television networks or advertisers, and that as a result,
programmers and advertisers will be able to increase their revenues, brand
extension and loyalty.
COMPETITION
The iTV industry is highly competitive in the general categories of
applications and middleware. We are likely to encounter significant competition
with respect to each of these areas.
APPLICATIONS
ITV applications fall into two general categories: enhanced television (eTV)
and Internet-based applications. eTV services generally allow the television
viewer to access additonal content related to programming or advertising, obtain
additional product information and purchase products while watching television.
Our primary competition in this area includes Wink Communications, ACTV Inc.,
and ICTV Inc.
Internet-based applications include email, chat, online games and web
browsing. Various companies are attempting to provide Internet access to cable
television consumers through a set-top appliance connected to a television. In
some instances this appliance may be a dedicated unit, such as is currently
utilized by ICTV and the Interactive Channel, or a cable converter box, such as
that utilized by the
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WorldGate Service. The use of a dedicated unit adds incremental costs which are
not present when the service is offered directly over a cable box. Generally,
these solutions are cable-based and do not use the telephone infrastructure,
thus mitigating bandwidth constraints. To our knowledge, none of WorldGate's
competitors have been successful at commercially deploying Internet applications
through the cable infrastructure. However, several companies are attempting to
develop these applications, and accordingly we believe that our major
competitors in the Internet over television category will be ICTV, Microsoft,
Liberate and OpenTV.
MIDDLEWARE
Several companies are attempting to leverage the use of their platforms to
obtain greater distribution for their ITV applications. For example, our
competitors, Liberate Technologies, Microsoft Corporation and OpenTV are
developing middleware products that compete with our CableWare 2000 middleware.
We believe that middleware vendors are pursuing a business strategy based on the
premise that once a cable operator adopts their middleware platform, that cable
company would be more likely to use their applications as well. Therefore, if
our competition is more successful than we are in marketing and deploying our
middleware on a large scale, and their business strategy is validated, we may
find it more difficult to deploy our applications on a large scale.
OTHER
We will also experience competition from providers of other eTV
applications. Two examples are the providers of video-on-demand, or VOD, and
personal video recording, or PVR. VOD allows television viewer to order movies
or television programs when they want them and PVR lets viewers pause, rewind,
and replay broadcasts of television programming, as well as record programs.
While these personalized television services do not compete directly with the
WorldGate's products, they may compete for "space" within the cable set-top box.
WorldGate has attempted to mitigate this form of competition by integrating its
software with the software provided by four of the leading providers of VOD
technology, including Concurrent Computer Corporation, Diva, nCube, and
SeaChange. Additional forms of consumer interactivity include the following
methods of accessing Internet content:
- telephone access through a personal computer,
- telephone access through a television,
- cable access through a personal computer, and
- cable access through a television.
While these various methods of Internet access and types of services offered
may be construed as competitive, they may also be complementary. Household
members may prefer to use different methods of Internet service/access based on
availability and their intended business or leisure use. Currently, the majority
of Internet users utilize a personal computer and a modem to access the Internet
over a telephone line through a connection to an Internet service provider, such
as America Online and Mindspring. We believe that this mode of Internet access
may be limited by the technological complexity and obsolescence issues usually
associated with a personal computer, bandwidth constraints which may result in
significant dial-up connection times and delays, and the expense, including the
investment in a personal computer, ISP monthly fees, and possible telephone
access charges. Recent advancements within telephone systems may mitigate some
of the delays associated with bandwidth constraints. Recently, Integrated
Services Digital Network, or ISDN, and Digital Subscriber Line, or DSL,
technologies enable high-speed data transmission speeds over specially
conditioned telephone lines. The regional bell operating companies, some in
conjunction with AOL, and many of the competitive local exchange carriers offer
high-speed telephone access through a personal computer.
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Set-top appliances, such as those provided by Microsoft's Ultimate TV, have
been introduced to provide Internet access through telephone lines to a
television without requiring a personal computer. WorldGate believes that this
mode of Internet access may be limited by the need to purchase a dedicated or
"single-purpose" set-top appliance, which adds expense and carries obsolescence
risk, telephone bandwidth constraints and monthly subscription fees.
Leveraging the broadband infrastructure of cable television systems, several
services have been launched to provide high-speed Internet access to cable
subscribers with personal computers. Companies in this segment include
Excite-At-Home and Road-Runner. WorldGate believes that subscribers to these
services require a separate high-speed cable modem with an installation cost of
approximately $40-$100 and that additional costs are also incurred for monthly
subscription fees in the range of $30-$50.
TECHNOLOGY
Our technology can be classified under three major product lines:
- CableWare 2000 Middleware
- Ultra-Thin Client Internet web browser
- Enhanced TV
CABLEWARE 2000(SM) MIDDLEWARE
Middleware has become an important new category of product offering for
cable operators. Middleware consists of a software layer that allows easier
integration of new applications and content services. Ideal middleware would
enable application developers to write highly sophisticated applications for the
set-top box that seamlessly communicate and interact with other applications.
This middleware would also include a presentation engine that would allow
content developers to easily offer simple applications, such as stock tickers,
without having the cost and schedule burden of engaging professional computer
programmers. All of this needs to be implemented in a manner efficient enough to
run on low-end set-top boxes, but also needs to include the sophisticated
facilities necessary to get the most from advanced set-tops.
Our CableWare 2000 middleware is being designed to meet these disparate
goals. CableWare includes a sophisticated software interface layer that enables
coexistence and communication of multiple native set-top applications. It also
includes an advanced presentation engine that allows artists and content
developers to create compelling content for the platform. Additionally,
CableWare 2000 provides a Java facility.
ULTRA-THIN CLIENT INTERNET WEB BROWSER
WorldGate's patented ULTRA-THIN CLIENT(SM) platform allows substantially all
client-related processing to be performed at the cable headend. This platform is
comprised of three primary components:
- Servers are located at the cable headend;
- A WorldGate enabled digital or advanced analog cable box; and
- A remote control and/or optional wireless infrared keyboard
There are typically two servers located at the cable headend. One server
manages all information traveling to and from this server to the Internet. This
server also manages individual Internet sessions, processes data for
presentation on the television screen, and manages the Web browsing client. The
second server manages real-time communications from the cable headend to a
subscriber's cable box. This server acts as a bi-directional router for data on
a cable network. These servers:
- Are based on a multi-processor architecture
10
- Can be accessed remotely by WorldGate for performance monitoring and
software upgrades
- Are configured such that typical full screen refresh times are:
- Five seconds or less on an analog platform
- One thirtieth ( 1/30( th)) of a second on a digital platform
General Web surfing is provided by our browser technology using high
performance server headend systems. The WorldGate Service browser currently
supports HTML Version 3.2, HTTP Version 1.0 and 1.1, HTML Frames, Image formats
such as GIF Animations, JPEG, and XBM formats. We believe we are the only
company that supports a full Java implementation offering on a set-top platform.
Java is used for such applications as chat and instant messaging. The WorldGate
platform supports JavaScript that is compatible with the Netscape browser.
ENHANCED TV
ETV services generally allow the television viewer to obtain more
information or request products while watching television. One feature of our
eTV services is our patented CHANNEL HYPERLINKING technology. This technology
interactivity links a television viewer with enhanced information or other
content related to the advertisement and/or programming being viewed. When a
cable television subscriber makes a CHANNEL HYPERLINKING request, the
subscriber's cable box sends a signal to the cable headend indicating the
channel and program information of the program the subscriber is viewing. This
information is then matched with the corresponding Web address for the program,
which has been stored at a cable headend database. The subscriber is then linked
to the corresponding Web site for full Internet interactivity. This entire
process occurs within seconds.
INTELLECTUAL PROPERTY
WorldGate regards its technology as proprietary, and relies on a combination
of patents, copyrights, trademarks, trade secret laws, contractual restrictions,
restrictions on disclosure and other methods to establish and protect our
technology and proprietary rights and information. WorldGate has filed patent
applications in the United States and internationally covering aspects of its
real-time, two-way interactive systems, including its ULTRA-THIN CLIENT
architecture, centralized data processing, communications schemes, CHANNEL
HYPERLINKING technology and other aspects of its interactive television
products.
We have devoted significant attention to our research and development
efforts that have already been recognized by the issuance of six patents
worldwide containing over 300 claims collectively. In addition, we currently
have over 50 applications pending containing over 1,700 claims collectively. Our
intellectual property covers numerous facets of interactive television, enhanced
television and interactive advertising applications, including systems and
techniques for the transmission, retrieval, display and means of navigating
through interactive information. In particular, we have received significant
intellectual property coverage for our pioneering work in developing ultra-thin
client solutions for the cable industry. Given the breadth and pioneering nature
of our efforts, we continue to enhance our position as the worldwide leader in
the interactive television marketplace. In addition, we have built upon these
achievements and our industry leading ability to manage transmission bandwidth
and client resources in the home to develop efficient and effective, standards
based middleware solutions that are capable of operating within the low resource
current generation set-tops while being migratable to the more powerful set-tops
being introduced.
11
BACKLOG
The Company typically delivers ordered equipment to customers within a few
days of receiving such orders. We do not generally maintain a material amount of
orders in backlog.
RESEARCH AND DEVELOPMENT
To date, engineering and development has been, and continues to be, a
significant focus of WorldGate. Development of the WorldGate Service has
required combining technical experience and knowledge from two historically
separate industries, the Internet and cable. The principal elements of
WorldGate's engineering and development activities during 2000 were enhancing
our existing Ultra-Thin Client(SM) technology and developing the CableWare
2000(SM) middleware technology. Our engineering and development expenditures
were approximately $9,684,000; 12,440,000; and $17,560,000 for the years ended
December 31, 1998, 1999, and 2000, respectively. The expenditures in 2000
excludes $4,174,000 of compensation expense related to the acquisition of
Digital Video Art, Inc. See Note 11 to our financial statements for the year
ended December 31, 2000 for a further discussion of our acquisition of Digital
Video Art, Inc.
FINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
1998 1999 2000
-------- -------- --------
United States
Sales to Domestic Customers.................. $ 845 $ 3,744 $ 17,466
Operating Loss............................... (27,444) (37,720) (51,837)
Identifiable Assets.......................... 5,621 89,170 74,841
Export Sales*................................ 177 1,850 1,775
- ------------------------
* Contracts and orders are denominated in U.S. dollars
EMPLOYEES
As of December 31, 2000, on a consolidated basis, we had approximately 300
full-time employees. All of our employees are located in Trevose, Pennsylvania,
except for seventeen employees located at our offices in Campbell, California
and an aggregate of seven sales people located in Colorado, Florida and New
York. None of our employees are represented by a labor union, and we have no
collective bargaining agreement. We consider our employee relations to be good.
ITEM 2. PROPERTIES.
Our corporate headquarters is located in Trevose, Pennsylvania in a leased
facility consisting of approximately 72,000 square feet. The lease for this
space will expire in June 2009, with an option to extend for an additional
10 years.
ITEM 3. LEGAL PROCEEDINGS.
On May 11, 1998, Interactive Channel Technologies, Inc. and SMI
Holdings, Inc., subsidiaries of Source Media, Inc. ("Source"), filed a complaint
against us in the U.S. District Court for the District of Delaware, alleging
that the WorldGate Service infringes patents issued to Source. The complaint
sought injunctive relief, as well as monetary damages and attorney fees. In our
answer filed on June 22, 1998, we denied these allegations and further asserted
that the patents in suit were invalid. In addition we filed multiple
counterclaims against Source asserting that Source misappropriated our
confidential information and trade secrets, and intentionally and tortiously
interfered with our existing and prospective business relationships, which
counterclaims Source moved to dismiss. Source's motion was
12
denied. On or about March, 6, 2000, Liberate Technologies, LLC, acquired rights
in the alleged infringed-upon patents from Source, and Liberate was substituted
as plaintiff. In January 2001, a settlement agreement was executed resolving all
claims in the litigation. On March 1, 2001, we filed with the court a motion to
enforce the terms of the settlement agreement. On March 19, 2001, the court
granted our motion and enforced the settlement agreement, which will result in
the dismissal of all claims with prejudice. We have previously stated our belief
that the ultimate resolution of this matter would not have a material effect on
our consolidated financial position, operations or cash flow of the Company, and
the settlement agreement enforced by the court is consistent with that position.
On October 6, 1998, Advanced Interactive, Inc. ("AII") filed a complaint in
the U.S. District Court for the Northern District of Illinois, Eastern Division,
against Matsushita Electric Corporation, Matsushita Electric Industrial
Co. Ltd., Sharp Electronics Corp., Sharp Corp., Interactive Channel
Technologies, Thomson Consumer Electronics, Toshiba Consumer Products, Inc.,
Toshiba America, Inc., Toshiba Corporation, General Instrument Corporation,
Scientific-Atlanta, Inc., ATI Technologies, Inc., ADS Technologies, Inc.,
Gateway 2000, Inc., STB Systems, Inc., Hauppauge Computer Works, Inc., WebTV
Networks, Inc., and us, alleging that each of the above companies infringed a
patent issued to AII. The complaint seeks monetary damages and attorney fees. In
our answer filed on December 2, 1998, we denied these allegations and further
asserted that the patent in suit was invalid. Subsequently, the defendants have
filed a joint motion for partial summary adjudication of claim construction
issues. On February 27, 2000 the Court agreed with the claim construction
proposed by the defendants and granted defendant's joint motion for partial
summary judgement, and entered judgement accordingly. AII filed an appeal, and
the appeal is pending. In the opinion of management, the ultimate resolution of
this matter will not have a material effect on the consolidated financial
position, operations or cash flow of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
WorldGate held its Annual Meeting of Shareholders on October 5, 2000. At
this meeting, the shareholders voted in favor of the following items listed in
the Proxy Statement dated October 5, 2000:
(1) Election of Directors
NOMINEE FOR WITHHELD
- ------- ---------- ---------
Thomas G. Baxter..................................... 19,792,048 34,475
Alan Gerry........................................... 19,791,970 34,553
Marcia J. Hooper*.................................... 19,793,108 33,415
Clarence L. Irving, Jr............................... 19,789,098 37,425
Hal M. Krisbergh..................................... 19,142,846 683,677
David E. Wachob...................................... 19,800,926 25,597
Ronald A. Walter..................................... 19,789,898 36,625
- ------------------------
* Ms. Hooper resigned in November 2000.
(2) Proposal to Approve an Amendment to Our 1996 Stock Option Plan to
increase the number of shares of common stock authorized to be issued under the
Plan:
FOR AGAINST ABSTAIN
- ---------- --------- --------
11,542,257 1,430,150 33,678
(3) Ratification of the selection of PricewaterhouseCoopers LLP as our
Independent Auditors for the year ending December 31, 2000:
FOR AGAINST ABSTAIN
- ---------- --------- --------
19,797,155 13,744 13,625
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock, $0.01 par value, has been traded on the Nasdaq National
Market under the symbol "WGAT" since our initial public offering in April 15,
1999. The following table shows the high and low closing sales price as reported
by the Nasdaq National Market for each quarter since we have been public.
HIGH LOW
-------- --------
YEAR ENDED DECEMBER 31, 1999
Second Quarter (from the date of our initial public
offering, April 15, 1999)............................... $51.25 $23.75
Third Quarter............................................. 51.31 21.25
Fourth Quarter............................................ 48.00 19.88
YEAR ENDED DECEMBER 31, 2000
First Quarter............................................. 45.00 25.50
Second Quarter............................................ 27.88 13.63
Third Quarter............................................. 29.44 17.38
Fourth Quarter............................................ 25.00 3.69
YEAR ENDED DECEMBER 31, 2001
First Quarter (through March 19, 2001).................... 10.00 4.00
On March 19, 2001, the last reported sale price of our common stock as
reported on the Nasdaq National Market was $5.75 per share.
As of March 19, 2001, we had 355 holders of record of our common stock.
DIVIDENDS
We have never paid or declared any cash dividends on our common stock. We do
not anticipate paying any cash dividends in the foreseeable future. We currently
expect to retain future earnings, if any, to finance the growth and development
of our business.
SALE OF UNREGISTERED SECURITIES
(1) From September 2, 1998 through February 8, 1999, WorldGate sold an aggregate
of 1,529,714 shares of series C preferred stock at a purchase price of
$11.00 per share to various accredited investors. These sales were exempt
from registration pursuant to Section 4(2) of the Securities Act and
Rule 506 of Regulation D thereunder.
(2) On March 2, 1999 WorldGate issued its senior secured promissory notes in the
aggregate principal amount of $6 million and issued warrants to purchase up
to 331,490 shares of common stock. These sales were exempt from registration
pursuant to Section 4(2) of the Securities Act.
(3) On August 15, 2000, we completed a private placement of an aggregate of
1,531,211 shares of our common stock (the "MSO Shares") to four cable
operators who are accredited investors (each a "MSO"). The shares were sold
for $16.02 per share, resulting in proceeds from the offering of
$24.5 million. The MSOs were also issued warrants (the "MSO Warrants") to
purchase in the aggregate up to 1,500,000 additional shares of common stock
at a per share exercise price of $24.78 and up to 500,000 additional shares
of common stock at a per share exercise price of $12.39. The MSO Warrants
are subject to vesting at varying rates based on the deployment of the
Company's Internet TV service on the MSOs' digital cable system.
14
The MSO Shares and the MSO Warrants were issued in reliance upon the
exemption from the registration requirements of the Securities Act of 1933
afforded to transactions not involving a public offering by Section 4(2) of
that Act and Rule 506 thereunder. The MSO Shares issued in the offering have
been registered for resale by the MSOs. In addition, the MSO Warrants grant
to the MSOs certain "piggyback" and "demand" registration rights. Generally,
a "piggyback" registration right allows holders to include their shares of
common stock in registration statements we or other stockholders initiate
and a "demand" registration right allows holders to require us to file a
registration statement to register their shares of common stock.
(4) In November 2000, we entered into a deployment agreement with AT&T Broadband
to deploy our interactive services to AT&T digital customers in Cedar Falls
and Waterloo, Iowa and Tacoma, Washington. As part of this agreement, we
issued warrants to AT&T to purchase up to 1,000,000 shares of our common
stock at a per share exercise price of $16.02. The warrants are subject to
vesting at varying rates based on the deployment of our Internet TV service
on AT&T's digital cable systems.
The AT&T warrants were issued in reliance upon the exemption from the
registration requirements of the Securities Act of 1933 afforded to
transactions not involving a public offering by Section 4(2) of that Act and
Rule 506 thereunder. The warrants grant to AT&T certain demand registration
rights.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
On April 15, 1999, our Registration Statement on Form S-1 (Commission file
number 333-71997) covering the initial public offering of 5,000,000 shares of
our common stock at twenty one dollars ($21.00) per share was declared
effective.
The net proceeds of the offering to the Company (after deducting the
foregoing expenses associated with such offering) was $111,192,000. From the
effective date of the Registration Statement to December 31, 2000, the net
proceeds have been used for the following purposes:
Purchase and installation of machinery and equipment........ $ 3,565,000
Acquisition of other business (including transaction
costs).................................................... 145,000
Repayment of indebtedness................................... 6,927,000
Working capital............................................. 54,538,000
Temporary investments, including cash and cash
equivalents............................................... 20,415,000
Other purposes (for which at least $100 has been used)
including: investments, including debt instruments of the
United States Government and its agencies and in high
quality corporate issuers................................. 25,602,000
------------
$111,192,000
============
Except for compensation expenses, all of the foregoing payments were direct
or indirect payments to persons other than (i) directors, officers or their
associates; (ii) persons owning ten percent (10%) or more of the Company's
common stock; or (iii) affiliates of the Company
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial information for each of the years ended
December 31, 2000, December 31, 1999, December 31, 1998, December 31, 1997 and
December 31, 1996 are derived from our audited financial statements. You should
read the following information in conjunction with our
15
financial statements and notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
report.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1996 1997 1998 1999 2000
---------- ---------- ---------- ----------- -----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Statement of operations data:
Revenues
Product revenues............... $ -- $ 141 $ 1,022 $ 5,594 $ 13,428
Consulting revenues............ -- -- -- -- 5,813
Total Costs and expenses..... -- 141 1,022 5,594 19,241
Costs and expenses:
Cost of product revenues....... -- 1,530 9,919 15,593 20,314
Cost of consulting revenues.... -- -- -- -- 4,849
Engineering and development.... 1,408 6,981 9,684 12,440 21,734
Sales and marketing............ 428 3,623 5,157 8,719 12,779
General and administrative..... 1,093 2,432 3,587 6,270 10,507
Depreciation and
amortization................. 22 119 292 895
---------- ---------- ---------- ----------- -----------
Total costs and expenses..... 2,929 14,588 28,466 43,314 71,078
Loss from operations............. (2,929) (14,447) (27,444) (37,720) (51,837)
Other income, net................ 8 423 423 3,319 3,562
Interest expense................. (2) (17) (101) (230) (72)
Loss from unconsolidated
entity......................... -- -- -- -- 1,250
Loss before extraordinary item... (2,923) (14,041) (27,122) (34,631) (49,597)
Extraordinary
item--extinguishment of debt... -- -- (1,019) --
Net loss......................... (2,923) (14,041) (27,122) (35,650) (49,597)
Accretion on preferred stock..... (75) (2,436) (6,145) (2,475) --
Net loss available to common
Stockholders................... $ (2,998) $ (16,477) $ (33,267) $ (38,125) $ (49,597)
========== ========== ========== =========== ===========
Basic and diluted net loss per
common share:(1)
Loss before extraordinary
item......................... $ (0.33) $ (1.81) $ (3.66) $ (2.07) $ (2.23)
Extraordinary item............. -- -- (.06) --
Net loss..................... $ (0.33) $ (1.81) $ (3.66) $ (2.13) $ (2.23)
========== ========== ========== =========== ===========
Weighted average common stock
Outstanding--basic and
diluted........................ 9,100,801 9,100,801 9,100,801 17,869,827 22,246,143
========== ========== ========== =========== ===========
Balance sheet data:
Cash and cash equivalents,
restricted cash And short term
equivalents.................... $ 7,574 $ 17,318 $ 368 $ 75,670 $ 46,505
Total assets..................... 7,583 18,412 5,621 89,170 74,841
Long-term obligations, including
current Portion................ 591 1,128 1,185 421
Total mandatory redeemable
preferred stock................ 8,571 34,366 49,276 -- --
Warrant for mandatory redeemable
preferred Stock................ 881 881 -- --
Total stockholders' equity
(deficit)...................... (1,451) (19,177) (52,240) 82,657 55,781
Other data:
Common shares outstanding........ 9,100,801 9,100,801 9,100,801 21,488,456 23,308,196
- ------------------------
(1) For purposes of computing the net loss per common share before extraordinary
item, loss before extraordinary item has been reduced by the accretion on
preferred stock.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
We may from time to time make written or oral forward-looking statements,
including those contained in the following Management's Discussion and Analysis
of Financial Condition and Results of Operations. In order to take advantage of
the "safe harbor" provisions of the private Securities Litigation Reform Act of
1995, we are hereby identifying certain important factors which could cause our
actual results, performance or achievement to differ materially from those that
may be contained in or implied by any forward-looking statement made by or on
behalf of WorldGate. The factors, individually or in the aggregate, that could
cause such forward-looking statements not to be realized include, without
limitation, the following: (1) difficulty in developing and implementing
marketing and business plans, (2) continued losses, (3) industry competition
factors and other uncertainty that a market for the WorldGate(SM) Service will
develop, (4) challenges associated with cable operators (including, uncertainty
that they will offer the WorldGate Service, inability to predict the manner in
which they will market and price the WorldGate Service and existence of
potential conflicts of interests and contractual limitations impeding their
ability to offer the WorldGate Service), (5) challenges associated with cable
box manufacturers (including uncertainty that they will support our technology
in their cable boxes), (6) challenges with advertisers and television
programmers (including uncertainties that they will support our CHANNEL
HYPERLINKING technology), (7) loss of any one of our largest customers,
(8) departure of one or more key persons, (9) rapid technological change could
render our services obsolete, (10) Company liability associated with information
retrieved and replicated on the Internet and e-commerce transaction,
(11) uncertainty in obtaining necessary additional capital to fund future
operations, (12) pending intellectual property claims against us could be costly
and result in the loss of significant rights, (13) other risks identified in
filings with the Securities and Exchange Commission. We caution you that the
foregoing list of important factors is not intended to be, and is not,
exhaustive. We do not undertake to update any forward-looking statement that may
be made from time to time by or on behalf of WorldGate.
RESULTS OF OPERATIONS:
2000 VERSUS 1999
REVENUES.
Revenues increased from $5,594,000 for the year ended December 31, 1999 to
$19,241,000 for the year ended December 31, 2000. Seventy percent of all
revenues were attributable to the commercial deployments of WorldGate's
interactive television products and services and cable subscribers subscribing
to these services as of December 31, 2000. At December 31, 1999 there were 14
commercial deployments and 15,000 participating subscribers. At December 31,
2000 there were 35 commercial deployments and 10 trials expected to result in
deployments, with approximately 104,000 cable customers subscribing to our
interactive TV products. Thirty percent of all revenues in 2000 were
attributable to consulting fees with TVGateway, an unconsolidated entity. See
Note 10 to our financial statements for the year ended December 31, 2000 for
further discussion of our relationship with TVGateway.
Costs and Expenses.
COST OF REVENUES. Cost of revenues consists primarily of product costs,
related to initial trials, commercial deployments and WorldGate modules to be
incorporated into set-top boxes, and consulting revenue costs, related primarily
to TVGateway revenues for engineering and administration services we incurred.
Product costs of revenues for the years ended December 31, 2000 and 1999 were
$20,314,000 and $15,593,000, respectively, or approximately 151% and 279%,
respectively, of product revenues. Consulting cost of revenues for the year
ended December 31, 2000 were $4,849,000 or approximately
17
83% of consulting revenues. There were no consulting revenues or cost of
revenues in 1999. This reduction in the product cost of revenues as a percent of
revenues is primarily attributable to our reduction of unit costs and the
reduced requirement for the WorldGate modules to be incorporated into set-top
box deliveries.
ENGINEERING AND DEVELOPMENT. Engineering and development expenses primarily
consist of compensation of employees, cost of design and programming, testing,
documentation and support of our hardware, software and services. Engineering
and development costs were $21,734,000 and $12,440,000, respectively, for the
years ended December 31, 2000 and 1999. Staff increases accounted for
approximately $2,400,000 of this increase along with $7,300,000 of costs
incurred in 2000 relating to our acquisition of Digital Video Art, Inc. on
April 28, 2000 and its operation from that date. Digital Video Art, Inc. is an
engineering development firm in Campbell, California.
SALES AND MARKETING. Sales and marketing costs consist primarily of
compensation, attendance at conferences and trade shows, travel costs necessary
to support our domestic and international customer market base, promotions and
other marketing programs substantially related to initial trial installations
and commercial deployments. For the years ended December 31, 2000 and 1999,
sales and marketing expenses were $12,779,000 and $8,719,000. The increase of
approximately 47% was primarily the result of additional trade show costs of
approximately $500,000 and increases in staff, travel and marketing and
promotional expenditures of approximately $3,300,000 for our growth in system
deployments.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of expenditures for administration, office and facility operations,
finance and general management activities, including legal, accounting and other
professional fees. General and administrative expenses were $10,507,000 and
$6,270,000, respectively, for the years ended December 31, 2000 and 1999. This
increase of approximately 68% was primarily due to $396,000 of additional
deferred compensation expense related to options previously granted, and
$2,300,000 of additional legal, consulting, travel, facility and insurance costs
incurred during the year ended December 31, 2000. Additionally, we recorded an
increase in our reserve for doubtful accounts receivable of $1,300,000 for the
year ended December 31, 2000.
In response to the general economic slow-down in the United States,
management will continue to monitor business growth and development and to
adjust expenses as appropriate.
INTEREST AND OTHER INCOME AND INTEREST EXPENSE. Interest and other income
and interest expense consist of interest earned on cash and cash equivalents and
short-term investments, and interest expense on equipment financing and
short-term debt. Interest and other income increased from $3,319,000 for the
year ended December 31, 1999, to $3,562,000 for the year ended December 31,
2000. During 1999 we earned interest on an average cash balance of approximately
$54,000,000, primarily as a result of the net proceeds received of $111,192,000
from our initial public offering ("IPO") in April 1999, and incurred interest
expense related to our $6,000,000 financing and $1,100,000 equipment financing
facility. In comparison, during the year ended December 31, 2000, we earned
interest on an average cash balance of $57,755,000, primarily from the net
proceeds received from our IPO and the proceeds of $24,530,000 from the sale of
our common stock in July 2000.
INCOME TAXES. We have incurred net operating losses since inception and
accordingly had no income taxes due and have not recorded any income tax benefit
for those losses.
1999 VERSUS 1998
REVENUES.
Revenues increased from $1,022,000 for the year ended December 31, 1998 to
$5,594,000 for the year ended December 31, 1999. Substantially all our revenues
continue to be attributable to the
18
increase in commercial deployments of the WorldGate Service and cable
subscribers subscribing to the WorldGate Service as of December 31, 1999. At
December 31, 1998 there were three commercial deployments and 1,200
participating subscribers. At December 31, 1999 there were 14 commercial
deployments, with approximately 15,000 cable customers subscribing to the
WorldGate Service. For the year ended December 31, 1999, revenues consisted
primarily of sales of headends, keyboards and related products.
COSTS AND EXPENSES
COST OF REVENUES. Cost of revenues consists primarily of product costs
related to initial trials, commercial deployments and WorldGate modules to be
incorporated into set-top boxes. Costs of Revenues for the years ended
December 31, 1999 and 1998 were $15,593,000 and $9,919,000, respectively, or
approximately 279% and 971%, respectively, of revenues. This reduction in the
costs of revenues as a percent of revenues is primarily attributable to the
Company's reduction of unit costs and the reduced requirement for the WorldGate
modules to be incorporated into set-top box deliveries.
ENGINEERING AND DEVELOPMENT. Engineering and development expenses primarily
consist of compensation of employees, cost of design and programming, testing,
documentation and support of our hardware, software and services. Engineering
and development costs were $12,440,000 and $9,684,000, respectively, for the
years ended December 31, 1999 and 1998.
SALES AND MARKETING. Sales and marketing costs consist primarily of
compensation, attendance at conferences and trade shows, travel costs necessary
to cover a domestic and international customer market base, promotions and other
marketing programs substantially related to initial trial installations and
commercial deployments. For the years ended December 31, 1999 and 1998, sales
and marketing expenses were $8,719,000 and $5,157,000, respectively. The
increase of approximately 69% was primarily the result of additional trade show
costs of approximately $1,200,000 and increases in marketing and promotional
expenditures.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of expenditures for administration, office and facility operations,
finance and general management activities, including legal, accounting and other
professional fees. General and administrative expenses were $6,270,000 and
$3,587,000, respectively, for the years ended December 31, 1999 and 1998. This
increase of approximately 75% was primarily due to a $273,000 placement fee for
financing obtained in March 1999, $277,000 of additional deferred compensation
expense related to options previously granted, moving costs of $269,000
associated with our relocation to larger facilities in June 1999 and $1,300,000
of additional legal, consulting, facility and insurance costs incurred during
the year ended December 31, 1999. Additionally, the Company recorded a reserve
for doubtful accounts receivable of $150,000 at December 31, 1999.
INTEREST AND OTHER INCOME AND INTEREST EXPENSE. Interest and other income
and interest expense consist of interest earned on cash and cash equivalents and
short-term investments, and interest expense on equipment financing and
short-term debt. Interest and other income increased from $423,000 for the year
ended December 31, 1998, to $3,319,000 for the year ended December 31, 1999.
During 1998 we earned interest on the proceeds of a $19,935,000 private
placement with multiple closings from November 1997 through January 1998, and on
proceeds received of $7,952,000 that was part of a $16,827,000 private placement
with multiple closings from September 1998 through February 1999. In comparison,
during the year ended December 31, 1999, we earned interest on an average cash
balance of approximately $54,000,000, primarily as a result of the net proceeds
received of $111,192,000 from our "IPO" and incurred interest expense related to
our $6,000,000 financing and $1,100,000 equipment financing facility.
19
EXTRAORDINARY LOSS. As a result of the early extinguishment in April 1999
of notes we issued in March 1999, we recognized a loss of $1,019,000 during the
second quarter of 1999, primarily related to the remaining unamortized debt
discount balance.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, our primary source of liquidity consisted of cash
and cash equivalents and short-term investments that are highly liquid, are of
high quality investment grade and predominantly have maturities of less than one
year.
At December 31, 2000, we had cash and cash equivalents of $20,415,000 (in
addition to $26,090,000 in short-term investments) as compared to $9,256,000 of
cash and cash equivalents and $66,414,000 in short-term investments at
December 31, 1999. Net cash used in operations was $49,749,000 for the year
ended December 31, 2000, as compared to $42,160,000 used in 1999. The increase
in net cash used in operations was primarily attributable to our increased
expenditures in 2000, increase in inventory, and higher accounts receivable
balances that resulted primarily from shipments late in the fourth quarter.
Cash provided by investing activities during 2000 totaled $36,813,000 versus
$67,637,000 in cash used during 1999. The proceeds from the IPO in 1999 and the
issuance of common stock in 2000 were used to purchase short-term investments.
During 2000, we utilized the net proceeds from our maturing short-term
investments in contrast to 1999, where it was a net investor. Capital
expenditures were approximately $2,324,000 and $1,463,000 during 2000 and 1999,
respectively. During 2000, we also invested $1,250,000 in TVGateway, an
unconsolidated entity. See Note 9 to our financial statements for a further
discussion of our investment in TVGateway.
Net cash provided by financing activities was $24,095,000 and $118,925,000,
respectively, for the years ended December 31, 2000 and 1999. The net cash
provided in 1999 primarily resulted from our IPO in April 1999, with net
proceeds of $111,192,000. The reported net cash provided in 2000 was primarily
due to the proceeds received from the issuance of our common stock in a private
placement.
In July 2000, we entered into agreements with four cable operators regarding
the digital deployment of our WorldGate Service. In connection with such
agreements, on August 15, 2000, the cable operators purchased an aggregate of
1,531,211 shares of our common stock yielding proceeds of $24,530,000. In
addition, we issued warrants to the cable operators to purchase additional
shares of our common stock which will vest at varying rates based on the
deployment of our WorldGate Service on each MSO's digital cable system.
Assuming that there is no significant change in our business, we believe
that our current cash and short-term investment balances, in addition to cash
provided by operations, will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures for at least the next twelve
months. After the twelve-month period, we may require additional funds to
support our working capital requirements or for other purposes and may seek to
raise additional funds through public or private equity financing, bank debt
financing, or from other sources. There can be no assurance that this capital
will be available on terms acceptable to us, if at all. We implemented
significant expense reductions during the fourth quarter of 2000 and we continue
to evaluate various financing options and may move to secure additional funding
during 2001 if acceptable terms can be obtained.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting
and reporting standards for derivative financial instruments and hedging
activities and requires the Company to recognize all derivatives as either
assets or liabilities on
20
the balance sheet and measure them at fair value. Gains and losses resulting
from changes in fair value would be accounted for depending on the use of the
derivative and whether it is designated and qualifies for hedge accounting. In
June 1999, the FASB issued SFAS 137, which defers the implementation of
SFAS 133. The Company will be required to implement SFAS 133 in 2001. Management
has determined that SFAS 133 will not have any material impact on the Company's
financial statements.
On April 3, 2000 the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) 44, "Accounting for Certain Transactions Involving Stock
Compensation--an Interpretation of APB 25." FIN 44 specifically answers
twenty-nine questions on the implementation of APB 25 that were derived from a
survey of members of the Emerging Issues Task Force (EITF) and the task force on
stock compensation. FIN 44 became effective July 1, 2000, but certain
conclusions in FIN 44 cover specific events that occur after December 15, 1998.
To the extent that FIN 44 covers events that occurred after December 15, 1998,
but before the effective date of July 1, 2000, the effects of applying FIN 44
are recognized on a prospective basis from July 1, 2000. The adoption of FIN 44
has not had a material effect on our financial position and results of
operations.
On June 26, 2000 the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101B which extended the implementation date of SAB
101, "Revenue Recognition" to the three month period ending December 31, 2000.
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. The adoption of SAB 101 has not had a material
impact on our financial position or results of operations.
OPERATIONS AND LIQUIDITY
To date, the Company has funded operations primarily through private sales
of equity securities and through an initial public offering of common stock in
April 1999. As of December 31, 2000 the Company had cash, cash equivalents, and
short-term investments of $46,505,000. The quarterly operating cash usage for
the fourth quarter of 2000 was $7.4 million. Based on estimates of the Company
and considering its past operating cash usage, the Company feels it has
sufficient cash reserves to fund the business for the foreseeable future. If the
Company's operating cash usage exceeds its internal estimates over this period,
then additional financing or a reduction in operating expenses would be
required. Additional financing, should it be required, would be subject to the
risk of availability, may be dilutive to the Company's shareholders, or could
provide restrictions on operating activities.
21
FACTORS AFFECTING OUR BUSINESS CONDITION
IN ADDITION TO OTHER INFORMATION IN THIS FORM 10-K, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING OUR COMPANY AND OUR
BUSINESS. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK, AND YOU
SHOULD BE ABLE TO BEAR THE COMPLETE LOSS OF YOUR INVESTMENT. WE ALSO CAUTION YOU
THAT THIS FORM 10-K INCLUDES FORWARD-LOOKING STATEMENTS THAT ARE BASED ON
MANAGEMENT'S BELIEFS AND ASSUMPTIONS AND ON INFORMATION CURRENTLY AVAILABLE TO
MANAGEMENT. FUTURE EVENTS AND CIRCUMSTANCES AND OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE PROJECTED IN ANY FORWARD-LOOKING STATEMENTS. YOU SHOULD
CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, THE OTHER INFORMATION IN THIS
FORM 10-K, THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN AND THE RISK FACTORS
DISCUSSED IN OUR OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION WHEN
EVALUATING OUR COMPANY AND OUR BUSINESS. THE RISKS AND UNCERTAINTIES DESCRIBED
BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT
PRESENTLY KNOW BY US OR THAT WE CURRENTLY DEEM IMMATERIAL ALSO MAY IMPAIR OUR
BUSINESS OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS
COULD BE HARMED. IN SUCH CASE, THE TRADING PRICE OF OUR COMMON STOCK WOULD
DECLINE.
WE MAY BE UNABLE TO OBTAIN NECESSARY ADDITIONAL CAPITAL TO FUND OPERATIONS IN
THE FUTURE.
To date, we have funded operations primarily through private sales of equity
securities and through our initial public offering of common stock in
April 1999. If we are unable to obtain additional financing on terms acceptable
to us as needed, our business, operating results and financial condition will be
materially adversely affected. As of December 31, 2000, we had cash, cash
equivalents, and short-term investments of $46.5 million. Our quarterly
operating cash usage was $7.4 million for the fourth quarter of 2000. If this
operating cash usage stays the same, we could fund our cash requirements from
cash-on-hand for approximately six quarters from December 31, 2000. If, however,
our operating cash usage increases during one or more quarters, we may not have
cash-on-hand necessary to fund our cash requirements for six quarters without
obtaining additional financing.
If we need additional capital and cannot raise it on acceptable terms, we
may not be able to, among other things:
- continue to operate our business as a going concern,
- develop or enhance our products and services,
- hire, train and retain employees, and
- respond to competitive pressures or unanticipated requirements.
In addition, we cannot predict with certainty the timing or amount of our
capital requirements. Our capital requirements depend on numerous factors,
including:
- the rate of acceptance of our products by cable operators, cable
subscribers, advertisers, television programmers, e-commerce companies and
Internet content providers,
- our ability to maintain and increase the number of subscribers, and
- the rate of commercialization of our products, including the WorldGate
Service, and the acquisition of related businesses or technology, if any.
Any additional equity financing, if available, may be dilutive to our
stockholders, and debt financing, if available, may involve significant
restrictions on our financing and operating activities.
WE MAY EXPERIENCE DIFFICULTIES DEVELOPING AND IMPLEMENTING OUR MARKETING AND
BUSINESS PLANS.
We began operations in March 1995 and our service was first made
commercially available in the third quarter of 1998. As a result, our operating,
sales and marketing and other strategies are still being
22
developed, and we do not have a history which may give us or you an indication
of how we may respond to situations presented to us. If we are not successful in
implementing our marketing and business plans on a timely basis or otherwise
effectively managing our development, our business, operating results and
financial condition will be materially adversely affected.
IF WE CONTINUE TO INCUR LOSSES, WE MAY NOT BE ABLE TO FINANCE THE COMMERCIAL
DEPLOYMENT OF OUR PRODUCTS.
We have experienced losses and have had negative cash flow in each quarter
and year since inception, and we expect to continue to operate at a loss for the
foreseeable future. Although our revenues increased for each of the last three
fiscal years, we may be unable to sustain our historical revenue growth rates or
achieve any growth at all. To make a profit, we must increase our revenues and
gross profit margin. If we are not able to do so, our losses may extend beyond
the foreseeable future and we may not be able to continue financing the
commercial deployment, development and enhancement of our products.
Our aggregate revenues from inception to December 31, 2000 were
approximately $26.0 million, and our aggregate accumulated deficit at
December 31, 2000 was approximately $138.7 million. In addition, we currently
intend to increase our operating expenses and capital expenditures in order to
continue the commercial deployment of our products and the TVGateway Service. As
a result, we expect to experience substantial additional operating losses and
negative cash flow for the foreseeable future.
BECAUSE TELEVISION-BASED INTERNET ACCESS IS NEW, WE CANNOT BE CERTAIN THAT A
MARKET OR SUSTAINABLE DEMAND FOR OUR PRODUCTS WILL DEVELOP.
The market for television-based Internet access is new and evolving, and no
single technology or approach to providing this access has been widely adopted
by consumers or cable operators. As a result, we cannot guarantee that a market
for television-based Internet access in general, or for our interactive TV
products in particular, will develop or that demand for our interactive TV
products will be sustainable. If the market does not develop, develops more
slowly than expected or becomes saturated with competitors or competing
technology becomes more widely accepted, our business, operating results, and
financial condition will be materially adversely affected.
THE COMPETITIVE MARKET FOR INTERNET ACCESS MAY LIMIT DEMAND OR PRICING FOR THE
WORLDGATE SERVICE.
We experience intense competition. Many companies provide and others may in
the future provide products and services with functionality similar to those
comprising our interactive TV products. As a result of this and future
competition, demand for our interactive TV products may suffer, we may be
restricted in the pricing we can charge for our products and our business,
financial condition and results of operations may be adversely affected.
Competitors provide their services through a variety of technologies, which are
in various stages of implementation and adoption. Many of our competitors have
significantly greater financial, technical, marketing, distribution, customer
support, name recognition, compelling content, access to consumers and other
resources, and more established relationships with cable operators, advertisers
and content and application providers than we have.
WE MAY NOT SUCCEED IF CABLE OPERATORS DO NOT OFFER THE WORLDGATE SERVICE TO
THEIR SUBSCRIBERS.
Because our interactive TV products are made available to cable subscribers
through a cable operator's system, our growth and future success depends
substantially on cable operators offering our interactive TV products to their
subscribers at satisfactory rates. We have entered into a limited number of
agreements with cable operators providing for the commercial launch of our
interactive TV products in some of the markets served by these cable operators.
If cable operators determine that our
23
service is not viable as a business proposition or if they determine that the
service does not meet their business or operational expectations or strategies,
they will not offer our interactive TV products to their subscribers.
Furthermore, because there are a limited number of cable operators, as well as
consolidation in the industry, the failure to reach agreements with one or more
major cable operators which service a significant number of cable subscribers
could materially adversely affect the market for our interactive TV products.
OUR REVENUES WILL DEPEND ON THE MANNER IN WHICH CABLE OPERATORS MARKET AND PRICE
OUR INTERACTIVE TV PRODUCTS.
We depend on cable operators to provide our interactive TV products to their
subscribers and therefore have limited or no control over a number of important
factors, including:
- the cable operators' advertising or marketing strategy, if any, regarding
their offering of our interactive TV products to their subscribers,
- the monthly fees cable operators charge to their subscribers for our
interactive TV products, and
- the extent to which cable operators purchase additional WorldGate
equipment to avoid reduction in performance if subscriber demand grows.
Our revenues may not meet our expectations if the cable operators'
marketing, pricing and operating strategies are inconsistent with our business
model.
THE MARKET FOR OUR INTERACTIVE TV PRODUCTS WILL BE ADVERSELY AFFECTED IF CABLE
OPERATORS DO NOT CONTINUE TO UPGRADE THEIR SYSTEM INFRASTRUCTURES TO SUPPORT
TWO-WAY DATA TRANSMISSIONS.
The adoption of our interactive TV products is dependent upon continued
investment by cable operators to upgrade their infrastructures to support
two-way data transmissions. It is uncertain whether cable operators will upgrade
their infrastructures and the failure of cable operators to complete these
upgrades in a timely and satisfactory manner would adversely affect the market
for our interactive TV products.
Although our interactive TV products can operate over one-way cable plant
that is only capable of transmitting programming to subscribers, it can do so
only in conjunction with a telephone line. As such, it is less convenient and
efficient for a subscriber to use our interactive TV products over one-way cable
plant and, to date, the majority of cable operators who are deploying our
interactive TV products have done so over two-way cable plants that are capable
of transmitting information from the cable operator's facility to the
subscribers and vice versa. We cannot assure you that cable operators will
upgrade their cable plant to two-way plant or that they will do so in a timely
and satisfactory manner. In the event that they do not do so, our business,
financial condition and results of operations could be materially adversely
affected.
CABLE OPERATORS MAY BE CONTRACTUALLY LIMITED IN THEIR ABILITY TO OFFER OUR
INTERACTIVE TV PRODUCTS.
We are aware that some cable operators, such as Cablevision, Comcast
Corporation, Cox Communications, Inc. and AT&T Broadband, whose cable systems
serve more than 26 million U.S. homes, or at least 26% of all U.S. homes, have
entered into distribution agreements with At Home Corporation. These agreements
contain exclusivity provisions that purport to prohibit these cable operators
from conducting or participating in any business in the United States that
involves the provision of residential Internet services over their cable plants
at data transmission speeds greater than 128 Kbps. These agreements could be
interpreted to preclude or hinder these cable operators from offering our
interactive TV products to their subscribers at speeds in excess of 128 Kbps. If
cable operators are unwilling or unable to offer our interactive TV products to
subscribers in these cable
24
systems, our business, financial condition and results of operations would be
materially adversely affected.
CABLE OPERATORS AND CABLE BOX MANUFACTURERS MAY NOT OFFER OUR INTERACTIVE TV
PRODUCTS BECAUSE THEY MAY HAVE POTENTIAL CONFLICTS OF INTEREST OR FOR OTHER
REASONS.
Some cable operators and cable box manufacturers are stockholders of other
companies that provide Internet services. To the extent that these cable
operators elect not to offer the WorldGate Service because of these affiliations
or other reasons, our business, financial condition and results of operations
could be materially adversely affected. For example, AT&T Broadband, Comcast,
Cox and Cablevision are stockholders of At Home; and AT&T Broadband and AOL/Time
Warner have established their own cable-based Internet service, called Road
Runner, with proprietary content featuring various AOL/Time Warner publications
and services. Also, some companies that provide Internet services, such as
Microsoft Corporation, are stockholders of cable operators or cable box
manufacturers. We cannot assure you that there will not be other investments
among providers of Internet services, cable operators and/or cable box
manufacturers. As a result or for other reasons, these cable operators and cable
box manufacturers may be reluctant to provide any service, including the
WorldGate Service, or to otherwise work with any entity that provides other
Internet services in competition with their affiliates.
ONLY CABLE TELEVISION SUBSCRIBERS WHO UTILIZE A CABLE SET-TOP BOX CAN RECEIVE
OUR INTERACTIVE TV PRODUCTS.
For cable television subscribers to receive our interactive TV products,
they must have a cable set-top box that can be WorldGate enabled. Currently,
many cable television subscribers receive their cable television service through
the cable line directly into their televisions, without a set-top box. We cannot
assure you that cable operators serving these subscribers will elect to provide
them with set-top boxes for the purpose of offering our interactive TV products,
or that these customers will choose to utilize a set-top box in order to receive
our interactive TV products.
WE ARE SUBJECT TO CAPACITY CONSTRAINTS AND SYSTEM FAILURES.
Due to the limited deployment of our interactive TV products, the ability of
our service to accommodate a substantial number of users is not yet known. We
cannot assure you that we will be able to provide high quality performance and
high transaction speeds as the number of subscribers grows or their usage
increases. In addition, as subscriber penetration grows it may be necessary for
cable operators to purchase additional equipment, and we cannot assure you that
they will do so.
The performance of our interactive TV products is also subject to reduction
in performance and interruption from human errors, telecommunication failures,
computer viruses and similar events. Any of these problems in our systems or
those of cable operators could result in reduced subscriber demand. We have
experienced performance reduction and service interruptions from time to time in
the past and we expect that these problems will continue from time to time. Our
failure to provide uninterrupted service at a level of performance acceptable to
subscribers would have a material adverse effect on our business, financial
condition and results of operations.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND RESULT IN THE LOSS
OF SIGNIFICANT RIGHTS.
Our success depends, in part, on our ability to maintain and continue to
develop a strong patent position for our products and technologies both in the
United States and other countries. As with most technology companies, our patent
position involves complex legal and factual questions. Without our patent and
other intellectual property protections, other companies could offer
substantially identical products for sale without incurring the sizeable
development and testing costs that we have incurred.
25
Our ability to recoup these expenditures and realize profits upon the licensing
of our products and services could be diminished.
The process of obtaining patents is time consuming and expensive. Even if we
spend the necessary time and money, a patent may not issue or it may
insufficiently protect the technology it was intended to protect. We can never
be certain that we were the first to develop the technology or that we were the
first to file a patent application for the particular technology because U.S.
patent applications are maintained in secrecy until a patent issues and
publications in the scientific or patent literature lag behind actual
discoveries. Even after the U.S. Patent and Trademark Office issues patent
rights to us, our competitors may develop similar or duplicate technologies or
design around the patented aspects of our technology, which may decrease sales
of our prospective products, therefore causing a negative impact on our profit.
Competitors and others may also challenge our patent rights in court by
alleging patent infringement. If we lose a patent infringement suit, third
parties may claim significant damages, require us to license the disputed
technology or require us to cease using the disputed technology. We cannot
assure you that licenses to the technology owned by any third parties would be
available to us on commercially reasonable terms, if at all. Irrespective of the
validity or the successful assertion of any patent claims, any litigation could
result in significant costs and diversion of management time and resources.
THE SUCCESS OF OUR CHANNEL HYPERLINKING TECHNOLOGY WILL BE ADVERSELY AFFECTED IF
ADVERTISERS AND TELEVISION PROGRAMMERS DO NOT PROVIDE US WITH NECESSARY CONTENT.
Our future growth and long-term success depends substantially on our ability
to convince advertisers and television programmers to use our CHANNEL
HYPERLINKING technology with their advertisements and television programs. We
believe that the adoption of the CHANNEL HYPERLINKING technology is
substantially dependent on:
- our service meeting advertisers' and programmers' business or operational
expectations or strategies,
- subscribers accepting and using our service as part of their television
experience, and
- us achieving a significant number of subscribers to the our interactive TV
products.
We cannot assure you that we will achieve either of the above goals. If we
fail to incorporate our CHANNEL HYPERLINKING technology in a substantial number
of advertisements and programs, our business, operating results and financial
condition could be materially adversely affected.
RAPID TECHNOLOGICAL CHANGE COULD RENDER OUR SERVICES OBSOLETE.
The market for consumer Internet access services and online content is
characterized by rapid technological developments, frequent new product
introductions and evolving industry standards. The nature of the market for
these products and services and their rapid evolution requires that we
continually improve the performance, features and reliability of our interactive
TV products, particularly in response to competitive offerings. We may not be
successful in responding quickly, cost-effectively and adequately to these
developments. There may be a time-limited market opportunity for our interactive
TV products, and we may not be successful in achieving widespread acceptance of
our interactive TV products before competitors offer products and services with
speed and performance similar to, or better than, our current offerings.
26
THE LOSS OF ANY ONE OF OUR LARGEST CUSTOMERS COULD ADVERSELY AFFECT OUR REVENUES
AND FUTURE PROSPECTS.
We have in the past derived, and expect in the future to derive, a
significant portion of our revenues from a limited number of customers. In the
event that any of these customers cease to offer our interactive TV products,
our business, operating results and financial condition could be materially
adversely affected. In 2000, three cable operators, Charter, Comcast and AT&T,
accounted for approximately 49% of our revenues. In addition, revenues from
consulting fees from our TVGateway joint venture accounted for 28% of our
revenues. We cannot assure you that any of these customers will continue to
offer our interactive TV products to their cable subscribers, or continue to use
our consulting services.
OUR INTERNATIONAL OPERATIONS ARE SUBJECT TO MANY UNCERTAINTIES.
A key component of our strategy is the expansion of the our sales of
interactive TV products into international markets. International revenues
accounted for approximately 9.2% of our total revenues for fiscal 2000. We
anticipate that a portion of our revenues will continue to be derived from
sources outside the United States. Accordingly, our success will depend, in
part, upon international economic conditions and our ability to manage
international sales and marketing operations. We have limited experience in
developing localized versions of our service and in developing relationships
with international cable system operators. We may not be successful in expanding
our service offerings into foreign markets. In addition to the uncertainty
regarding our ability to generate revenues from foreign operations and expand
our international presence, there are certain risks inherent in doing business
on an international level, such as:
- difficulties in collecting accounts receivable and longer collection
periods,
- regulatory requirements, including the regulation of Internet access,
- export and import restrictions, including tariffs and other trade
barriers,
- difficulties in staffing and managing foreign operations,
- political instability, and
- fluctuations in currency exchange rates.
In addition, although substantially all of our revenues and costs to date
have been denominated in U.S. dollars, we may enter into agreements resulting in
foreign currency payables. Although we may from time to time undertake foreign
exchange hedging transactions to cover a portion of our foreign currency
exposure, we do not currently attempt to cover potential foreign currency
exposure. Accordingly, any fluctuation in the value of foreign currency could
seriously harm our ability to increase international revenues.
Any of the above factors could materially adversely affect the success of
our current and future domestic and international operations.
WE MAY HAVE LIABILITY FOR INFORMATION RETRIEVED OR REPLICATED ON THE INTERNET.
Claims for negligence, copyright or trademark infringement or other legal
theories could be made against us because information can be downloaded and
redistributed by users of our interactive TV products. Copyright and trademark
laws are evolving both domestically and internationally and we are uncertain how
they apply to our interactive TV products. The imposition of liability for
information carried by us would have a material adverse effect on our business,
operating results and financial condition.
27
WE MAY HAVE LIABILITY FOR E-COMMERCE TRANSACTIONS.
As part of our business, we are seeking to enter into agreements with
content providers, advertisers and e-commerce merchants under which we will
receive a share of revenue from the purchase of goods and services by users of
our interactive TV products. These arrangements may expose us to additional
legal risks and uncertainties, including potential liabilities to consumers of
these products and services. Our insurance may not cover potential claims of
this type or may not be adequate to indemnify us for all liability that may be
imposed.
WE COULD BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION WHICH AFFECTS OUR
ABILITY TO OFFER OUR SERVICE OR WHICH AFFECTS DEMAND FOR OUR SERVICE.
We are subject to varying degrees of federal, state, local and foreign
regulations as well as laws enacted by the U.S. Congress and other governments.
The Federal Communications Commission has established regulations that, among
other things, set licensing, access, installation and equipment standards for
communications systems. We are uncertain how these regulations may be applied to
Internet services offered over cable television systems.
We also anticipate that due to its increasing popularity and use, the
Internet will be subject to increased attention and regulation. These laws and
regulations may regulate issues such as:
- user privacy,
- defamation,
- network access,
- pricing,
- taxation,
- content,
- quality of products and services, and
- intellectual property ownership and infringement.
These laws and regulations could expose us to liability, materially increase
our cost of providing our service, and decrease the growth and acceptance of the
Internet in general and access to the Internet over cable systems.
OUR BUSINESS WOULD SUFFER IF WE WERE TO LOSE THE SERVICES OF HAL M. KRISBERGH OR
OTHER KEY PERSONNEL.
Our success depends in significant part upon the continued service of our
key technical, sales and senior management personnel, particularly
Mr. Krisbergh, who has significant relevant experience in the cable television
industry. No officer or employee of WorldGate is bound by an employment
agreement, and any officer or employee of WorldGate could terminate his or her
relationship with us at any time. Our future success will also depend on our
ability to attract, train, retain and motivate highly qualified senior
management, technical, marketing and sales personnel. Because competition for
these personnel is intense, we cannot assure you that we will be able to do so.
THE ABILITY TO INFLUENCE THE OUTCOME OF STOCKHOLDER VOTES MAY BE LIMITED BY THE
SIGNIFICANT OWNERSHIP INTEREST OF OUR CHAIRMAN AND CHIEF EXECUTIVE OFFICER.
Hal M. Krisbergh beneficially owns approximately 25% of our outstanding
common stock as of March 19, 2001. Mr. Krisbergh has the voting power to
exercise substantial control over the election of our entire board of directors
and all votes on matters requiring stockholder approval. This
28
concentration of ownership may also have the effect of delaying or preventing a
change in control of WorldGate.
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS COULD DISCOURAGE UNWANTED
TAKEOVER ATTEMPTS AND COULD REDUCE THE OPPORTUNITY FOR STOCKHOLDERS TO GET A
PREMIUM FOR THEIR SHARES.
We are subject to Delaware laws and to provisions of our certificate of
incorporation and by-laws that could have the effect of delaying, deterring or
preventing a change in control of WorldGate. As a result, our management could
attempt to utilize these laws and provisions to discourage or reject unsolicited
bids to acquire us, including bids that would have paid stockholders a premium
over the then current market price of their shares.
OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.
The market price of our common stock has been and will likely continue to be
highly volatile, as is the stock market in general, and the market for
Internet-related and technology companies in particular. Investors may not be
able to resell their shares of our common stock following periods of volatility
because of the market's adverse reaction to such volatility. Factors that could
cause such volatility may include, among other things:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations;
- new products or services;
- changes in financial estimates by securities analysts;
- conditions or trends in the Internet or cable industry;
- changes in the market valuations of other Internet or cable companies;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships or joint ventures;
- capital commitments;
- additions or departures of key personnel; and
- sales of common stock.
Many of these factors are beyond our control. These factors may materially
adversely affect the market price of our common stock, regardless of our
operating performance.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY.
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. This risk is especially acute for us because technology companies
have experienced greater than average stock price volatility in recent years
and, as a result, have been subject to, on average, a greater number of
securities class action claims than companies in other industries. Due to the
potential volatility of our stock price, we may in the future be the target of
similar litigation. Securities litigation could result in substantial costs and
divert management's attention and resources.
SUBSTANTIAL SALES OF OUR COMMON STOCK COULD LOWER OUR STOCK PRICE.
The market price for our common stock could drop as a result of sales of a
large number of our presently outstanding shares, including shares issued upon
the exercise of outstanding options and
29
warrants, or the perception that these sales could occur. These factors also
could make it more difficult for us to raise funds through future offerings of
our common stock. Certain holders of our common stock have demand and piggy-back
registration rights. The exercise of such rights could adversely affect the
market price of our common stock. We have filed:
- on May 20, 1999 a registration statement (Registration No. 333-78943) to
register 1,600,000 shares of common stock under our stock option plan;
- on October 8, 1999, a shelf registration statement (Registration
No. 333-87029) under the Securities Act for 331,490 shares of common stock
issuable upon exercise of outstanding warrants and 373,83 shares of common
stock;
- on July 28, 2000, a registration statement (Registration No. 333-42526)
under the Securities Act for resale of 1,531,211 shares of common stock
that we issued to four cable operators;
- on November 9, 2000, a registration statement (Registration
No. 333-49612) to register an additional 1,600,000 shares of common stock
under our stock option plan; and
- on November 29, 2000, a registration statement (Registration
No. 333-35936) under the Securities Act for resale of 250,000 shares of
common stock that we issued to shareholders of Digital Video Art, a
California corporation we acquired in April 2000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk. Our exposure to market risk related to changes in
interest rates relates primarily to our investment portfolio. We invest in
instruments that meet high credit quality standards, and we limit the amount of
credit exposure to any one issue, issuer and type of investment.
As of December 31, 2000, our cash and cash equivalents and investments
consisted of $46,505,000, most of which were cash equivalents having a maturity
of less than one year. Due to the average maturity and conservative nature of
our investment portfolio, a sudden change in interest rates would not have a
material effect on the value of the portfolio. Management estimates that had the
average yield of our investments decreased by 100 basis points, our interest
income for the year ended December 31, 2000 would have decreased by less than
$508,000. This estimate assumes that the decrease occurred on the first day of
2000 and reduced the yield of each investment instrument by 100 basis points.
The impact on our future interest income of future changes in investment yields
will depend largely on the gross amount of our investments.
Foreign Currency Exchange Risk. Although we transact business in various
foreign countries, the principal portion of our business is in the United States
and substantially all of our revenues and costs to date have been denominated in
U.S. dollars. As a result, adverse movements in foreign currency exchange rates
would not have a material adverse effect on us.
30
ITEM 8.
WORLDGATE COMMUNICATIONS, INC.
INDEX TO FINANCIAL STATEMENTS
PAGE
--------
Report of PricewaterhouseCoopers LLP........................ F-2
Consolidated Balance Sheets as of December 31, 1999 and
2000...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1999 and 2000.......................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)
and Redeemable Preferred Stock for the years ended
December 31, 1998, 1999 and 2000.......................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1999 and 2000.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
WorldGate Communications, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and
redeemable preferred stock and cash flows present fairly, in all material
respects, the financial position of WorldGate Communications, Inc. and its
subsidiaries at December 31, 2000 and December 31, 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management: our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 16, 2001
F-2
WORLDGATE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
----------------------
1999 2000
--------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 9,256 $ 20,415
Short-term investments.................................... 66,414 26,090
Accounts receivable less allowance for doubtful accounts
of $150 in 1999 and $1,450 in 2000...................... 3,248 7,004
Inventory................................................. 5,600 11,264