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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ---------------TO ---------------.
COMMISSION FILE NUMBER: 000-24647
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TERAYON COMMUNICATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0328533
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2952 BUNKER HILL LANE
SANTA CLARA, CALIFORNIA 95054
(408) 727-4400
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, par value $0.001 per share
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on
March 24, 2000 as reported on the Nasdaq National Market, was approximately
$4,571,171,656. Shares of Common Stock held by each officer and director and by
each person known to the Company who owns 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
As of March 24, 2000, registrant had outstanding 28,972,171 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for the Annual Meeting of Shareholders to
be filed by April 28, 2000.Report on Form 8-K dated December 27, 1999.
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report on Form 10-K contains forward-looking statements of
Terayon Communication Systems, Inc. within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934 which are subject to the "safe harbor" created by those
sections. The forward-looking statements include, but are not limited
to: statements related to industry trends and future growth in the
markets for cable modem systems; our strategies for reducing the cost of
our products; our product development efforts; the effect of GAAP
accounting pronouncements on the our recognition of revenues; our future
research and development; the timing of our introduction of new
products; the timing and extent of deployment of our products by its
customers; and, future profitability. Discussions containing such
forward-looking statements may be found in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." These
forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from those in such
forward-looking statements. We disclaim any obligation to update these
forward-looking statements as a result of subsequent events. The
business risks discussed in Item 7 of this Report on Form 10-K, among
other things, should be considered in evaluating our prospects and
future financial performance.
PART I
ITEM 1. BUSINESS
Overview
Our business is to develop, market and sell broadband access systems
that enable cable operators and other providers of broadband access
services to cost-effectively deploy reliable two-way broadband services
over cable, copper wire and wireless systems. To date, our development
and marketing efforts have focused primarily on cable operators.
However, with some recent acquisitions of complimentary technology and
businesses, we have also turned our attention to providers of broadband
services using existing telephone, copper wire infrastructures and
wireless systems.
For cable operators, our first product was the TeraComm system,
which is based on our patented Synchronous Code Division Multiple Access
or "S-CDMA" technology. The TeraComm system is comprised of the TeraPro
cable modem, the TeraLink 1000 Master Controller, the TeraLink Gateway
and the TeraView Element Management and Provisioning software. Our
patented S-CDMA technology enables reliable two-way broadband
communications over both pure coaxial and hybrid fiber/coax cable
infrastructures and is designed to enable cable operators to maximize
the capacity and reliability of broadband services over any cable plant.
Our technology maximizes the resistance to noise that interferes with
data transmissions over previously unusable frequency spectrums and
thereby allows cable operators to minimize time-consuming and costly
cable plant upgrades, achieve reduced time to market and provide a wide
range of service levels to residential and commercial end users. Cable
operators using the TeraComm system can provide additional revenue-
generating services to end users. This enables cable operators to
compete effectively in the emerging market for broadband access
services.
In recent years, the volume of bandwidth intensive data, voice and
video traffic across the Internet, corporate intranets and other public
networks has increased dramatically. International Data Corporation
("IDC") estimates that the number of Internet users will increase from
approximately 69 million at the end of 1997 to approximately 320 million
by the end of 2002. IDC also estimates that the number of home office
households will increase from approximately 35 million at the end of
1997 to approximately 50 million by the end of 2002. Although various
technologies have emerged to address the need for broadband access, the
existing cable infrastructure currently provides the highest available
two-way transmission speeds and "always-on" availability. In addition,
the existing cable infrastructure currently passes more than 95% of
homes in the U.S. and a large number of small businesses.
We sell our products to cable operators through direct sales forces
in North America, Latin America and Europe. We also distribute our
products via distributors and systems integrators. Companies currently
using or distributing the TeraComm system include Shaw Communications
Inc., Rogers Communications Inc., TCA Cable TV, Inc., Cablevision
Systems, Inc., and Crossbeam Networks Corporation, a wholly owned
subsidiary of Sumitomo Corporation.
The market for broadband access products and services is
characterized by rapid technological change, new product development,
product obsolescence and evolving industry standards. A significant
element of our strategy is to advance industry standards and to extend
our technology leadership and achieve rapid time to market. In November
1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version
of the DOSCIS cable modem specification based in part on our S-CDMA
technology. In September 1999, CableLabs indicated that it intended to
proceed with the advanced PHY work on two parallel tracks: one for the
development of a prototype based on our S-CDMA technology and one for
the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of
the advanced PHY project regarding a separate release that will include
TDMA technologies. In addition, CableLabs reiterated that it is
continuing to work with us on the development of a DOCSIS specification
that could include our S-CDMA technology. To that end, CableLabs has
requested that we submit a prototype of a DOCSIS system that
incorporates an S-CDMA advanced PHY capability for testing. CableLabs
has stated that if the testing of this prototype reveals that the S-CDMA
advanced PHY works as claimed (including proper backwards compatibility
and coexistence with the other aspects of DOCSIS), and if the costs for
adding S-CDMA to DOCSIS products are in line with estimates, then it is
likely, but not certain, that S-CDMA advanced PHY capabilities will be
included in a future version of the DOCSIS specification. The prototype
we submit to CableLabs may fail to demonstrate the level of performance
that CableLabs seeks, even if it does meet performance expectations
there can be no guarantee that CableLabs will incorporate the technology
into a future version of DOCSIS specifications. In addition, if
CableLabs does proceed to include S-CDMA in a future DOCSIS
specification, there can be no guarantee that the DOCSIS S-CDMA
specification will be the same as the specification we incorporated in
the prototype submitted for tests, which may require us to further
develop our prototype.
The rapid evolution of broadband has resulted in cable television
operators, providers of telephone services and other service providers
seeking to provide a bundle of voice, data and video services to their
residential and commercial subscribers over existing and new
infrastructures. Consistent with our objective to be a leading provider
of broadband access, through a series of recent acquisitions,, we are
building a complete portfolio of broadband products to support high
speed delivery of voice, data and video services over cable, copper wire
(DSL) and wireless.
In the fall of 1999, we acquired Imedia Corporation and the
CherryPicker digital video management system. In November 1999, we
completed our acquisition of Radwiz Ltd., a provider of communication
access systems based on high-speed IP routing, integrated with
telephony, and on January 2, 2000 we completed our acquisition of
Telegate Ltd., a developer and manufacturer of telephony and data access
platforms that are deployed by service providers to deliver efficient
carrier-class voice services over cable. In addition, in February 2000,
we entered into definitive agreements to acquire the Access Network
Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary
of Tyco International Ltd., and Combox Ltd. In March 2000 we entered
into an agreement to purchase certain assets of Internet Telecom Ltd.
and an agreement to acquire Ultracom Ltd.
Our company was incorporated in California in January 1993 and
reincorporated in Delaware in July 1998. References in this report to
"Terayon," "we," "our" and "us" refer to Terayon Communication Systems,
Inc. and its subsidiaries.
Recent Events
In October 1999, we entered into Share Purchase Agreements to
acquire Radwiz Ltd. and Telegate Ltd., both Israeli companies. The
acquisition of Radwiz closed in November 1999. Radwiz produces
communication access systems based on high-speed IP routing, integrated
with telephony. Radwiz's systems include both center office Digital
Subscriber Line Access Multiplexers (DSLAMs) and customer premises
equipment for small office, home office (SOHO) business broadband
services. The former shareholders and vested optionholders of Radwiz
received a total of 946,153 shares and options to purchase shares of our
common stock. The total purchase price was approximately $53.6 million.
The acquisition was accounted for as a purchase transaction.
The acquisition of Telegate closed on January 2, 2000. Telegate
produces telephony and data access platforms that are deployed by
service providers to deliver efficient carrier-class voice services over
cable. Telegate also provides in-home networking capability for
telephony and data, based on the Digital Enhanced Cordless Telephony
(DECT) standard. The former shareholders and vested optionholders of
Telegate received a total of 2.2 million shares and options to purchase
shares of our common stock. In addition, the former shareholders are to
receive a cash payment of approximately $3.5 million. The total purchase
price was approximately $145.0 million. We expect to account for the
acquisition as a purchase transaction
In February 2000, we entered into an Asset Purchase Agreement to
acquire certain assets and assume certain liabilities of ANE which
produces DSL (Digital Subscriber Line) systems that provide multiple
phone lines a single pair of copper wires. In general, we will issue
shares and options to purchase shares of our common stock valued at
approximately $85.0 million based on the volume weighted average of the
per share sales price of our common stock as reported on the Nasdaq
National Market for the ten consecutive trading days prior to the
closing date. In addition, we have agreed to establish an employee
retention program for purposes of retaining certain identified employees
of ANE. The retention program provides for up to 3 annual payments to
the identified employees in a total amount of approximately $4.5 million
provided the employees remain employed by us. The retention payments
will be charged to expense in the period incurred. The transaction is
subject to customary closing conditions and is expected to close in the
second quarter of 2000. We expect to account for the acquisition as a
purchase transaction.
In February 2000, we also entered into a Share Purchase Agreement to
acquire Combox Ltd, an Israeli company that manufactures broadband data
systems and satellite communications based on international standards.
Combox's cable data access systems conform to the growing EuroModem
international specification, based on the Digital Video Broadcasting
(DVB) standard. In general, Combox shareholders will receive a total of
775,000 shares and options to purchase shares of our common stock.
Based on the fair market value of our common stock on the days
immediately preceding and following the date the acquisition was
announced, the total purchase price is estimated to be approximately
$92.0 million. The transaction is subject to customary closing
conditions and is expected to close in the second quarter of 2000. We
expect to account for the acquisition as a purchase transaction.
In February 2000, the Company's board of directors approved a two-
for-one split of the Company's outstanding shares of common stock to be
effected in the form of a stock dividend. The stock split is pending
stockholder approval of an increase in the our authorized shares and
therefore the changes in the capital structure resulting from the split
have not been given retroactive effect throughout this Report on Form
10-K.
In March 2000, we entered into an Asset Purchase Agreement
("Internet Telecom Agreement") with our subsidiary Telegate, under which
Telegate agreed to purchase certain assets of Internet Telecom Ltd.
("Internet Telecom"), an Israeli company. Internet Telecom is a
supplier of PacketCable and other standards-based, voice-over-IP
("Internet Protocol") systems and technologies. In general, Telegate
will acquire the assets of Internet Telecom in exchange for shares our
common stock valued at approximately $44.0 million based on the fair
market value of our common stock on the days immediately preceding and
following the date the acquisition was announced and a cash payment
estimated at approximately $2.0 million. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, we entered into a Share Purchase Agreement to acquire
Ultracom Ltd. ("Ultracom"), an Israeli company. Ultracom is a supplier
of broadband systems-on-silicon. In general the Ultracom shareholders
and vested optionholders will receive shares and option of our common
stock valued at approximately $30.0 million based on the closing price
of our common stock as reported by Nasdaq on the fifth business day
immediately preceding the closing and a cash payment estimated at
approximately $2.3 million. We will also assume the unvested Ultracom
options, the value of which will be included in the purchase price. The
transaction is subject to customary closing conditions and is expected
to close in the second quarter. We expect to account for the
transaction as a purchase transaction.
In March 2000, Rogers purchased 1,843,409 shares of our common
stock. The shares were issued on a net issuance basis pursuant to the
exercise of two warrants, each to purchase 1.0 million shares of our
common stock issued in March 1999. Because the warrants were exercised
on a cashless basis the exercise resulted in no proceeds to us.
Business Segments
We operate in one business segment, the sale of broadband access
systems. Our primary products are sold together as part of systems and
we do not report revenue derived from the sale of individual components.
Additional information about our operations by business segment and
geographic region is included in Management's Discussion and Analysis of
Financial Condition and Results of Operations in Item 7 of this report
and Note 13 of Notes to Consolidated Financial Statements included in
Item 8 of this report.
Products
Current Products
The TeraComm System
Our TeraComm system enables cable operators to cost-effectively
deploy reliable two-way broadband access services. The TeraComm system
is comprised of the TeraPro cable modem, the TeraLink 1000 Master
Controller, the TeraLink Gateway and the TeraView Element Management and
Provisioning Software. The price of a TeraComm system is dependent on a
number of variables, including a customer's basic cable system
architecture, the type of routing equipment a customer intends to use,
the level and quality of service that a cable operator desires to
provide and the volume of products purchased by a customer.
TeraPro Cable Modem. The TeraPro cable modem is a data communications
device installed in a subscriber's home or business. The TeraPro cable
modem connects to the subscriber's PC via a standard 10BaseT Ethernet
connector and to the cable network via a standard coaxial cable
connector. The TeraPro cable modem automatically configures itself
without user intervention, thus minimizing modem installation time. In
addition, the configuration software for the TeraPro cable modem is
downloaded remotely, allowing centralized software upgrades directly
from the headend management system. In October 1998, we began volume
shipments of our cable modems in a new single-board design.
The TeraPro cable modem delivers full two-way communication over the
cable network, with data rates of up to 14 Mbps per 5 MHz channel in
both the upstream and the downstream direction. The TeraPro cable modem
operates at full capacity at an SNR as low as 13dB, and gradually
adjusts throughput to provide transmission at an SNR as low as -13dB.
This feature will permit the TeraPro cable modem to operate across any
portion of the 5 to 42 MHz upstream RF spectrum.
TeraLink 1000 Master Controller. The TeraLink 1000 Master Controller
is a data channel controller and multiplexer located at the cable
headend system or distribution hub. The TeraLink 1000 Master Controller
provides control, management and data transport functions for TeraPro
cable modems connected to the cable network. It offers dynamic bandwidth
management, high speed traffic concentration, access control to data
networking resources and data service quality and integrity.
The TeraLink 1000 Master Controller is a single channel, rack-
mountable controller that supports up to 2,000 cable modems per channel.
Additional TeraLink 1000 Master Controllers can be added to scale
service as performance and subscriber needs grow. The TeraLink 1000
Master Controller, with the TeraLink Gateway, provides a 100 BaseT
interface for direct connectivity to a private backbone or any vendor's
router or switch. Alternatively, the TeraLink 1000 Master Controller,
with its built-in ATM OC-3 interface, can be connected via an ATM
switch, or directly to Cisco's 7500 series routers.
TeraLink Gateway. The TeraLink Gateway is a rack-mountable edge
concentrator providing end-user clients with broadband access to a
remote IP backbone (e.g., Internet) as well as efficient communication
between modems. The TeraLink Gateway includes an ATM OC-3 interface for
connectivity to up to two TeraLink 1000 Master Controllers or an ATM
switch. It also provides a 10/100 BaseT Ethernet/Fast Ethernet auto-
sense interface to a headend backbone or any IP router including the
Cisco Universal Broadband Router. The TeraLink Gateway also includes a
separate 10 BaseT interface, which may be connected to a separate
management network or the headend network. The TeraLink Gateway supports
up to 2,000 cable modems per RF channel when connected to a TeraLink
1000 Master Controller. When used with the TeraLink Gateway, the TeraPro
cable modems behave as an extension of the TeraLink Gateway, providing
maximum bandwidth and privacy.
TeraView Element Management and Provisioning Software. The TeraView
Element Management and Provisioning Software is a Windows 95 and Windows
NT standards-based software application installed at the headend system
or the network operations center. The TeraView software allows cable
operators to configure, control, monitor and maintain multiple channels
of the TeraComm system.
CherryPicker Digital Video Management Systems.
CherryPicker Digital Video Management Systems are scalable, open
platforms that enable cable, satellite and terrestrial operators to
deliver customized digital programming. Patented statistical re-
multiplexing technology gives operators ultimate control over
programming and allows them to create a customized output multiplex of
programs by selecting feeds (grooming) from a vast array of sources. The
CherryPicker helps operators maximize their available bandwidth while
enabling them to provide program offerings that target specific local
demographics.
Digital Subscriber Line Systems (xDSL).
We produce communications access systems based on high-speed IP
routing, integrated with telephony. Our innovative systems include both
central office DSLAMs (Digital Subscriber Line Access Multiplexers) and
customer premise equipment for SOHO business broadband services. These
systems deliver high- capacity, symmetric voice and data services to the
business market, with high density port aggregation at the central
office site for maximum cost efficiency.
Multigate Telephony and Data Access Systems
We produce telephony and data access systems for deployment of
efficient carrier-class voice services over cable. Our systems also
provide in-home networking capability for telephony and data, based on
the Digital Enhanced Cordless Telephony ("DECT") standard. Our systems
support voice, high-speed data, and Integrated Service Digital Network
("ISDN") services for the business telecommuting market and the SOHO
market.
Customers
We market our products to providers of broadband access services
that seek to provide broadband access services to both residential and
commercial end users. Our initial target market has consisted of the ten
largest cable companies in each major geographic area. In most markets,
a small number of large cable operators often provides services to a
majority of subscribers in a specific region and thus influences the
purchasing decisions of smaller cable operators. Currently, in the
United States, ten cable operators together own and operate facilities
passing approximately 78% of total homes passed. We commenced volume
shipments of our TeraComm system in the first quarter of 1998. To date,
four of the largest North American cable operators, Cablevision, Rogers,
Shaw and TCA, are offering subscribers reliable broadband access
services using our TeraComm system.
Selected examples of the range of customers and applications for
which the TeraComm system is being commercially deployed are as follows:
Rogers. Rogers is the largest cable operator in Canada and one of the
ten largest North American cable operators, with cable infrastructure
passing approximately 2.8 million homes, primarily located in Toronto,
Ottawa, Vancouver and Southwestern Ontario. Roger's systems are some of
the most advanced two-way cable networks in North America, with over 85%
of its networks currently two-way and capable of supporting high-speed
Internet services.
Shaw. Shaw is the third largest cable operator in Canada, with cable
infrastructure passing approximately 2.0 million homes. Shaw currently
has the largest cable modem deployment in Canada, with over 55,000 cable
modem users. Shaw has selected us to supply cable modem systems for
Shaw's @Home service deployments in various cities throughout Canada.
Sumitomo. We have a distribution agreement with Sumitomo under which
its subsidiary, Crossbeam Networks Corporation ("Crossbeam"), is
distributing the TeraComm system to several of Japan's leading cable
operators, including Jupiter Communications, a joint venture between
Sumitomo and TCI International. The TeraComm system's noise resistant
properties are designed to enable two-way broadband access over pure
coaxial networks, which comprise the majority of Japan's cable
infrastructure.
United Pan-Europe Communications (UPC). UPC is one of the largest
broadband communications companies in Europe, providing cable
television, telephony, Internet and programming services. UPC's systems
have approximately 5.9 million homes in their franchise areas, with 4.9
million homes passed.
TCA. TCA (a subsidiary of Cox Communications, Inc.) is the 16th
largest cable operator in the United States, with cable infrastructure
passing approximately 1.2 million homes, primarily in Texas, Arkansas
and Louisiana. TCA has deployed the TeraComm system in certain
metropolitan areas in Texas.
Cable operators worldwide are also successfully deploying our
CherryPicker Digital Video Management Systems.
Cable operators that have deployed our CherryPicker system include Cox
Communications, Time Warner and Adelphia.
In addition to cable operators, we market our DSL products to leading
providers of telephony services throughout the world. The pending
acquisition of ANE provides Terayon with a strong customer presence in
the U.S. communications market. ANE's customers include all of the
major U.S. ILECs (Incumbent Local Exchange Carriers), including SBC,
Bell Atlantic, Bell South, U.S. West and GTE. The growth of the
Internet has increased the demands on these and other carriers to
provide incremental bandwidth to support a host of voice and data
services. We believe our DSL line of products is positioned to
participate in the growing broadband DSL market.
Four customers accounted for approximately 66% of our revenues in
1999 and three customers accounted for approximately 70% of our revenues
in 1998. We believe that a substantial majority of our revenues will
continue to be derived from sales to a relatively small number of
customers for the foreseeable future. In addition, we believe that sales
to these customers will be focused on a small number of projects.
Research and Development
We believe that our future success will depend on our ability to
enhance our existing products and to develop and introduce new products
that meet a wide range of evolving broadband access service providers
and end user needs. In addition, to address competitive and pricing
pressures, we expect that we will have to reduce the unit cost of
manufacturing our cable modems through design and engineering changes.
For example, in the fourth quarter of 1998, we introduced a single-board
modem, which provides cost savings over our original dual-board modem.
In 1999, we introduced several new versions of the single-board modem,
each of which represented additional cost savings over the previous
version.
We currently are designing and developing a DOCSIS system that
includes S-CDMA advanced PHY capabilities, which will include a cable
modem and an accompanying headend controller. These products are in the
early stages of development and we do not anticipate commercial
availability of these products until late 2000. We also are developing a
common multimedia platform for current and advanced transmission of
data, voice and video over existing broadband infrastructures, including
cable, DSL and wireless. These products also are in the early stages
of development and we do not anticipate commercial availability of these
products until late 2001.
As of December 31, 1999, we had 111 employees engaged in research and
development. Our total research and development expenses were $17.6
million in 1999, $10.7 million in 1998 and $11.3 million in 1997.
Sales and Marketing
We have direct sales forces in North America, Latin America and
Europe. We also distribute our products via distributors and systems
integrators. We have signed a distribution agreement with Sumitomo under
which Crossbeam is distributing the TeraComm system to several of
Japan's leading cable operators. In January 2000, we signed a
distribution agreement with BARCO Communication Systems, for the sale of
Terayon's CherryPicker systems to cable television operators worldwide.
We market our products directly to providers of broadband access
services through our sales force, key distribution and technology
partners, as well as other marketing vehicles such as industry press,
trade shows and the World Wide Web. Through our marketing efforts, we
strive to educate providers on the technological and business benefits
of our system solution, as well as our ability to provide quality
support and service to the customer. We participate in the major trade
shows and industry events for the broadband access industry in the
United States and we are expanding our presence in other markets through
joint participation at local events with our international sales and
marketing partners. Industry referrals and reference accounts are
significant marketing tools we develop and utilize.
Customer Service and Technical Support
We believe that our ability to consistently provide high quality
service and support will be a key factor in attracting and retaining
customers. Our TSS (Technical Services and Support) organization
provides support 24 hours a day, seven days per week. Prior to
deployment of our systems, each customer's needs are assessed and
proactive solutions are implemented, including various levels of
training, periodic management and coordination meetings, and problem
escalation procedures. We place a strong emphasis on technical training
for our customers. Initial training is offered at no cost, both at our
headquarters in Santa Clara and on our customer's premises. At December
31, 1999, the TSS organization consisted of 28 employees located in
North America, Europe, Latin America and Asia.
In addition to our TSS organization, we have developed sophisticated
tools for remote diagnosis and monitoring of the TeraComm systems
deployed by cable operators. These tools allow us to monitor cable
operators' installations of the TeraLink 1000 Master Controller and to
proactively suggest solutions before problems become noticeable to end
users. We are developing a Web-based knowledge system to provide cable
operators with access to the latest technical support information.
Manufacturing
We outsource the materials procurement, printed circuit board
assembly, and product assembly and testing to turnkey contract
manufacturers. Currently, we contract with Solectron, located in
Milpitas, California, and CalComp Electronics, located in Thailand, for
the manufacture of the majority of our products. We have a limited in-
house manufacturing capability at our Santa Clara headquarters. This
facility currently is used for the assembly and final testing of
TeraLink 1000 Master Controllers and TeraLink Gateways. We also use this
facility for pilot production of new product designs, sample testing of
products received from volume manufacturers, developing the
manufacturing process and documentation for new products in preparation
for outsourcing. We also perform repair operations for some of our
products returned from customers with our in-house manufacturing
resources.
Our future success will depend in significant part on our ability to
obtain high volume manufacturing at low costs. As volume increases, we
plan to engage additional contract manufacturers, to procure additional
manufacturing facilities and equipment, to modify existing inventory
procedures, to substantially increase our personnel and to revise our
quality assurance and testing practices. As part of our efforts to
reduce costs, we began volume shipments in fourth quarter of 1998 of our
single-board cable modem, which has higher gross margins than our
original dual-board cable modem. In 1999, we introduced several cost
reduced versions of the single-board modem, as part of our continuing
cost reduction efforts. We anticipate that we will need to reduce
further the cost to manufacture our products and we will continue to
evaluate the use of low cost third-party suppliers and manufacturers.
Subcontractors supply our contract manufacturers with both standard
components and subassemblies manufactured to our specifications. We
depend upon certain key suppliers for a number of the components for our
products. For example, we currently rely on Philips Semiconductor, Inc.
(formerly VLSI Technology, Inc.) for our S-CDMA ASIC, which is used in
our headend and cable modem products. In addition, all of our products
contain one or more components that currently are only available from a
single source.
Competition
The market for broadband access systems is extremely competitive and
is characterized by rapid technological change. Our direct competitors
in the cable modem arena include Cisco, Com21, Matsushita, Motorola,
Nortel, Phasecom, RCA, Samsung, Scientific-Atlanta, Sony, 3Com, Toshiba
and Zenith and there are many other potential market entrants. We also
sell products that compete with existing data access and transmission
systems utilizing the telecommunications networks, such as those of
3Com. Additionally, our controller and headend system products face
intense competition from well-established companies such as Cisco,
Nortel and 3Com. Our direct competitors in the DSL arena include ECI
Telecom, Charles Industries, Pairgain, Copper Mountain, Accelerated
Networks, Integral Access and Vina Technologies.
The principal competitive factors in the broadband access market
include product performance, features and reliability, price, size and
stability of operations, breadth of product line, sales and distribution
capability, technical support and service, relationships with providers
of broadband access services, standards compliance, and general industry
and economic conditions. Some of these factors are outside of our
control. The existing conditions in the broadband access market could
change rapidly and significantly as a result of technological changes,
and the development and market acceptance of alternative technologies
could decrease the demand for our products or render them obsolete. In
addition, these companies and other competitors could introduce
broadband access products that will be less costly or provide superior
performance or achieve greater market acceptance than our products.
Many of our current and potential competitors have significantly
greater financial, technical, marketing, distribution, customer support
and other resources, as well as greater name recognition and access to
customers.
The market for our products may be impacted by the development of
other technologies that enable the provisioning of broadband access
services and the deployment of services over other media. Widespread
acceptance of other technologies or deployment of services over media
not supported by our products could materially limit acceptance of our
broadband access systems. Broadband access services supported by our
products and technology may fail to gain widespread commercial
acceptance by providers of broadband access services and end users.
Regulation
Our business and our customers are subject to varying degrees of
federal, state and local regulation. The jurisdiction of the Federal
Communications Commission extends to the communications industry,
including our broadband access products. The FCC has promulgated
regulations that, among other things, set installation and equipment
standards for communications systems. Although FCC regulations and other
governmental regulations have not materially restricted our operations
to date, future regulations applicable to our business or our customers
could be adopted by the FCC or other regulatory bodies. For example, FCC
regulatory policies affecting the availability of cable services and
other terms on which cable companies conduct their business may impede
our penetration of certain markets. In addition, regulation of cable
television rates may affect the speed at which cable operators upgrade
their cable infrastructures to two-way HFC. In addition, the increasing
demand for communications systems has exerted pressure on regulatory
bodies worldwide to adopt new standards for such products and services.
This process generally involves extensive investigation of and
deliberation over competing technologies. The delays inherent in this
governmental approval process have in the past, and may in the future,
cause the cancellation, postponement or rescheduling of the installation
of communications systems by our customers.
If other countries begin to regulate the cable modem industry more
heavily or introduce standards or specifications with which our products
do not comply, we will be unable to offer products in those countries
until our products comply with those standards or specifications. In
addition, we may have to incur substantial costs to comply with those
standards or specifications. For instance, should the DAVIC standards
for ATM-based digital video be established internationally, we will need
to conform our cable modems to compete. Further, many countries do not
have regulations for installation of cable modem systems or for
upgrading existing cable network systems to accommodate our products.
Whether we currently operate in a country without these regulations or
enter into the market in a country these regulations do not exist, new
regulations could be proposed at any time. The imposition of regulations
like this could place limitations on a country's cable operators'
ability to upgrade to support our products. Cable operators in these
countries may not be able to comply with these regulations, and
compliance with these regulations may require a long, costly process.
For example, we experienced delays in product shipments to a customer in
Brazil due to delays in certain regulatory approvals in Brazil. Similar
delays could occur in other countries in which we market or plan to
market our products. In addition, our customers in certain parts of
Asia, such as Japan, are required to obtain licenses prior to selling
our products, and delays in obtaining required licenses could harm our
ability to sell products to these customers.
In the United States, in addition to complying with FCC regulations,
our products are required to meet certain safety requirements. For
example, we are required to have our products certified by Underwriters
Laboratory in order to meet federal requirements relating to electrical
appliances to be used inside the home. Outside the United States, our
products are subject to the regulatory requirements of each country in
which the products are manufactured or sold. These requirements are
likely to vary widely. We may be unable to obtain on a timely basis or
at all the regulatory approvals that may be required for the
manufacture, marketing and sale of our products. In addition to
regulatory compliance, some cable industry participants may require
certification of compatibility.
Intellectual Property
We rely on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect
proprietary rights in our products. Our pending patent applications may
not be granted. Even if they are granted, the claims covered by the
patents may be reduced from those included in our applications. Any
patent might be subject to challenge in court and, whether or not
challenged, might not be broad enough to prevent third parties from
developing equivalent technologies or products without taking a license
from us. We have entered into confidentiality and invention assignment
agreements with our employees, and we enter into non-disclosure
agreements with some of our suppliers, distributors and appropriate
customers so as to limit access to and disclosure of our proprietary
information. These statutory and contractual arrangements may not prove
sufficient to prevent misappropriation of our technology or to deter
independent third-party development of similar technologies. In
addition, the laws of some foreign countries might not protect our
products or intellectual property rights to the same extent as do the
laws of the United States. Protection of our intellectual property might
not be available in every country in which our products might be
manufactured, marketed or sold.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOSCIS cable modem specification based in part on
our S-CDMA technology. In September 1999, CableLabs indicated that it
intended to proceed with the advanced PHY work on two parallel tracks: one
for the development of a prototype based on our S-CDMA technology and one
for the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of the
advanced PHY project regarding a separate release that will include TDMA
technologies. In addition, CableLabs reiterated that it is continuing to
work with us on the development of a DOCSIS specification that could include
our S-CDMA technology. To that end, we have indicated to CableLabs that we
would contribute some aspects of our S-CDMA technology to the DOCSIS
intellectual property pool if and when a DOCSIS specification is approved
that includes our S-CDMA technology. We would contribute our technology
pursuant to a license agreement with CableLabs that we would execute at that
time, and which contains the terms that CableLabs has established for the
inclusion of any intellectual property from any source in the DOCSIS
specifications. Under the terms of the proposed license agreement, we would
grant to CableLabs a royalty-free license for those aspects of our S-CDMA
technology that are essential for compliance with the DOCSIS cable modem
standard. So-called "implementation know how" is not covered by this
license-only those aspects of the technology that are essential to
implementing a compliant product. CableLabs would have the right to extend
royalty-free sublicenses to companies that wish to build DOCSIS-compatible
products. These sublicenses would allow participating companies to utilize
and incorporate the essential portions of the S-CDMA technology on a
royalty-free basis for the limited use of making and selling products or
systems that comply with the DOCSIS cable modem specification Terayon has
already joined the DOCSIS intellectual property pool and, as a result, we
have a royalty-free sublicense that allows us to ship DOCSIS-compatible
products which contain intellectual property submitted by other companies.
The scope of this license would not extend to the use of the S-CDMA
technology in other areas; only for products that comply with the DOCSIS
specifications. As a result, any of our competitors who join or have
joined the DOCSIS intellectual property pool will have access to some
aspects of our technology without being required to pay us any royalties or
other compensation. If and when we submit S-CDMA to the DOCSIS Intellectual
Property pool, we are in no way restricted from entering into royalty-
bearing license agreements with companies that wish to use the S-CDMA
technology for purposes other than implementing DOCSIS compatible products,
or that do not wish to enter into the DOCSIS intellectual property pool.
Further, some of our competitors have been successful in reverse engineering
the technology of other companies, and the inclusion of S-CDMA in a future
DOCSIS specification would expose some aspects of our technology to those
competitors. DOCSIS specifications are available on an open basis once they
are approved, not only to companies that are members of the DOCSIS IP Pool.
If a competitor is able to duplicate the functionality and capabilities of
our technology, we could lose all or some of the time-to-market advantage we
might otherwise have. Under the terms of the proposed license agreement, if
we sue certain parties to the proposed license agreement on claims of
infringement of any copyright or patent right or misappropriation of any
trade secret, those parties may terminate our license to the patents or
copyrights they contributed to the DOCSIS intellectual property pool. If a
termination like this were to occur, we would continue to have access to
some aspects of the DOCSIS intellectual property pool, but we would not be
able to develop products that fully comply with the DOCSIS cable modem
specification. Also, even if we were to be removed from the IP pool, we
would not be prevented from developing and selling products that fully
comply with the DOCSIS specifications, but we would not be able to do this
with the benefit of a royalty-free license, which would increase the cost of
our products, assuming we were able to obtain a license agreement for the
required technology. Because of these terms, we may find it difficult to
enforce our intellectual property rights against certain companies, even in
areas that are not directly related to DOCSIS specifications and products.
We anticipate that developers of cable modems increasingly will be
subject to infringement claims as the number of products and competitors
in our industry segment grows. We have received letters from two
individuals claiming that our technology infringes patents held by these
individuals. We have reviewed the allegations made by these individuals
and, after consulting with our patent counsel, we do not believe that
our technology infringes any valid claim of these individuals' patents.
If the issues are submitted to a court, the court could find that our
products infringe these patents. In addition, these individuals may
continue to assert infringement. If we are found to have infringed these
individuals' patents, we could be subject to substantial damages and/or
an injunction preventing us from conducting our business. In addition,
other third parties may assert infringement claims against us in the
future. An infringement claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause product shipment
delays or require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms
acceptable to us or at all. Litigation also may be necessary to enforce
our intellectual property rights.
We pursue the registration of our trademarks in the United States and
have applications pending to register several of our trademarks.
However, the laws of certain foreign countries might not protect our
products or intellectual property rights to the same extent as the laws
of the United States. This means that effective trademark, copyright,
trade secret and patent protection might not be available in every
country in which our products might be manufactured, marketed or sold.
Employees
As of December 31, 1999, we had 248 employees, of which 111 were in
the engineering group, 74 were in marketing, sales and customer support,
29 were in operations and 34 were in general and administrative
functions. None of our employees is represented by a union. We believe
that our relations with our employees are good.
Executive Officers of the Registrant
Certain information regarding our executive officers as of March 24,
2000, is set forth below.
Name Age Position
- - ------------------------- ----- ---------------------------------------
Dr. Zaki Rakib(1)......... 41 Chief Executive Officer and Director
Shlomo Rakib.............. 43 Chairman of the Board, President and
Chief Technical Officer
Ray M. Fritz.............. 54 Chief Financial Officer
Dennis J. Picker.......... 52 Chief Operating Officer
Zaki Rakib co-founded Terayon in 1993 and has served as our Chief
Executive Officer since January 1993 and as a director since February
1995. From January 1993 to July 1998, Dr. Rakib also served as our Chief
Financial Officer. Prior to co-founding Terayon, Dr. Rakib served as
Director of Engineering for Cadence Design Systems, an electronic design
automation software company, from 1990 to 1994. Prior to joining
Cadence, Dr. Rakib was Vice President of Engineering at Helios Software,
which was acquired by Cadence in 1990. Dr. Rakib holds B.S., M.S. and
Ph.D. degrees in engineering from Ben-Gurion University in Israel. Dr.
Rakib is the brother of Shlomo Rakib, our Chairman of the Board,
President and Chief Technical Officer.
Shlomo Rakib co-founded Terayon in 1993 and has served as our
Chairman of the Board and President since January 1993 and as Chief
Technical Officer since February 1995. Prior to co-founding Terayon, Mr.
Rakib served as Chief Engineer at Phasecom, Inc., a communications
products company, from 1981 to 1993, where he pioneered the development
of data and telephony applications over cable. Mr. Rakib is the inventor
of several patented technologies in the area of data and telephony
applications over cable. Mr. Rakib holds a B.S.E.E. degree from Technion
University in Israel. Mr. Rakib is the brother of Zaki Rakib, the Chief
Executive Officer and a director of Terayon.
Ray M. Fritz has served as our Chief Financial Officer since July
1998. Prior to joining us, Mr. Fritz was Vice President of Finance and
Operations and Chief Financial Officer of GigaLabs Inc., a provider of
high performance input/output switching solutions, from December 1997 to
July 1998. From August 1994 until August 1997, Mr. Fritz was with
Clarify, Inc., a provider of front office automation systems, as its
Vice President, Finance and Operations and Chief Financial Officer. From
May 1990 to August 1994, he served as Director, Finance of Synopsys,
Inc., an electronic design automation company, and from April 1986 to
May 1990, Mr. Fritz served as Vice President and Controller of LSI Logic
Corporation, a semiconductor company. Prior to that, he held a variety
of finance positions with Xerox Corporation, The Singer Company and
Shell Oil Company. Mr. Fritz holds a B.S. degree in finance/business
administration from Benedictine College, an M.B.A. degree from Atlanta
University and an M.S. degree in tax from Golden Gate University.
Dennis J. Picker has served as our Chief Operating Officer since
February 1998 and served as our Vice President, Standards from October
1997 to February 1998 and our Vice President, Engineering from May 1996
to October 1997. From 1994 to April 1996, Mr. Picker was Director of the
Cable Data Products Business Unit of Motorola, Inc., an electronics
company, and from 1992 to 1994, he was Senior Director of Data
Networking Products at Motorola. Mr. Picker holds a B.S. degree in
electrical engineering from the University of Pennsylvania and an M.S.
degree in electrical engineering from Northwestern University.
ITEM 2. PROPERTIES
Our headquarters are located in an approximately 60,000 square foot
leased facility located in Santa Clara, California. The current lease
for the Santa Clara facility expires in March 2002. We have sales
offices in Atlanta, Georgia; Sao Paulo, Brazil; and Brussels, Belgium.
In addition, we have facilities in Tel Aviv, Israel. Subsequent to
December 31, 1999, we entered into an agreement to lease approximately
82,000 square feet in Tel Aviv for a period of 5 years. It is our
intention to consolidate the operations of our Israeli operations in
this space. We believe that our existing facilities are adequate to meet
our needs for the immediate future and that our future growth can be
accommodated by leasing additional or alternative space near our current
facilities.
ITEM 3. LEGAL PROCEEDINGS
In September 1999, Imedia Corporation, now our subsidiary, was named
as a defendant in a case alleging that Imedia breached its term sheet
agreement with the Plaintiffs by negotiating with us while a no shop
provision was in place and refusing to allowing the Plaintiffs to invest
in Imedia. The Plaintiffs are seeking damages in excess of $12.0
million. As part of the terms of the Imedia Agreement and Plan of
Merger and Reorganization, shares of our common stock to be issued to
the former shareholders of Imedia were placed in escrow to indemnify us
for any damages that are directly or indirectly suffered as a result any
claim brought by any Person who was a prospective investor in Imedia and
was not a securityholder of Imedia on the closing date of the Imedia
acquisition. The value of the escrowed shares was approximately $10.0
million based on the market value of our common stock on the closing
date. The case is in its initial stages, and no trial date has been
established. We have reviewed the allegations made by the Plaintiffs
and we do not believe that the outcome will have a negative impact on
our financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the
fourth quarter of 1999.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market for the Registrant's Stock
Our common stock is traded on the Nasdaq National Market under the
symbol "TERN." Public trading of our common stock commenced on August
18, 1998. Prior to that, there was no public market for our common
stock. The following table sets forth, for the periods indicated, the
high and low per share sale prices of our common stock, as reported by
the Nasdaq National Market.
High Low
---------- ----------
1998:
Third Quarter (from August 18, 1998).............. $15.186 $7.000
Fourth Quarter.................................... $40.500 $9.250
1999:
First Quarter.................................... $50.125 $25.750
Second Quarter................................... $60.500 $26.375
Third Quarter.................................... $57.625 $31.250
Fourth Quarter................................... $75.000 $37.750
2000:
First Quarter (through March 24, 2000)............ $285.250 $54.500
As of March 24, 2000 there were 535 stockholders of record. We
currently intend to retain any earnings for use in our business and do
not anticipate paying any cash dividends in the foreseeable future.
Recent Sales of Unregistered Securities
In November 1999, we issued 1,500,000 shares of Common Stock valued
at $6.50 per share to Shaw Communications Inc. ("Shaw") pursuant to the
exercise of a warrant to purchase 3,000,000 shares of our common stock
issued in 1998. The issuance and sale of these shares was intended to
be exempt from registration under the Securities Act of 1933 as amended
by virtue of Section 4(2) thereof. Shaw represented its intention to
acquire the securities for investment only and not with a view to the
distribution thereof. Appropriate legends are affixed to the stock
certificate. Shaw received adequate information about us.
In March 2000, we issued 1,843,409 shares of our common stock to
Rogers Communications Inc. ("Rogers"). The shares were issued on a net
issuance basis pursuant to the exercise of two warrants, each to
purchase 1,000,000 shares of our common stock, issued in March 1999. The
issuance and sale of these shares was intended to be exempt from
registration under the Securities Act of 1933 as amended by virtue of
Section 4(2) thereof. Rogers represented its intention to acquire the
securities for investment only and not with a view to the distribution
thereof. Appropriate legends are affixed to the stock certificate.
Rogers received adequate information about us.
Use of Proceeds from Sales of Registered Securities
(d) Use of Proceeds from Sales of Registered Securities. We commenced
our initial public offering on August 18, 1998 pursuant to a
Registration Statement on Form S-1 (the "Registration Statement") (File
No. 333-56911). The managing underwriters of the public offering were BT
Alex. Brown (now known as Deutsche Banc Alex. Brown), Hambrecht & Quist,
Lehman Brothers and Salomon Smith Barney. In the offering, we sold an
aggregate of 3,000,000 shares of our common stock for an initial price
of $13.00 per share.
The aggregate proceeds from the offering were $39.0 million. We paid
expenses of approximately $3.9 million, of which approximately $2.7
million represented underwriting discounts and commissions and
approximately $1.2 million represented expenses related to the offering.
Net proceeds from the offering were $35.1 million. Of the net proceeds,
as of December 31, 1999, approximately $15.1 million had been used to
fund operating activities, $1.5 million had been used for payments on
long-term debt and capital lease obligations, $5.7 million had been used
to purchase property and equipment, $2.4 million had been used to
purchase other assets and $1.8 million had been used to fund a pre-
acquisition loan to Imedia. The use of proceeds described in our
Registration Statement. At December 31, 1999, the remainder of the net
proceeds was invested in short-term, interest-bearing, investment grade
securities.
ITEM 6. SELECTED FINANCIAL DATA
Years Ended December 31,
--------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands, except per share data)
Consolidated Statement of
Operations Data:
Revenues....................... $97,009 $31,696 $2,118 $ -- $ --
Cost of goods sold............. 72,044 34,518 6,462 -- 676
--------- --------- --------- --------- ---------
Gross profit (loss)............ 24,965 (2,822) (4,344) -- (676)
--------- --------- --------- --------- ---------
Operating expenses:
Research and development...... 17,579 10,685 11,319 8,020 2,028
Cost of product development assistance
agreement........................ 35,147 -- -- -- --
In-process research and development 14,600 -- -- -- --
Sales and marketing........... 15,727 6,947 4,468 1,141 205
General and administrative.......... 7,476 3,223 2,546 1,789 825
Goodwill amortization.............. 3,524 -- -- -- --
--------- --------- --------- --------- ---------
Total operating expenses...... 94,053 20,855 18,333 10,950 3,058
--------- --------- --------- --------- ---------
Loss from operations........... (69,088) (23,677) (22,677) (10,950) (3,734)
Net interest income........... 5,008 449 128 253 68
--------- --------- --------- --------- ---------
Net loss....................... (64,080) (23,228) (22,549) (10,697) (3,666)
Series F convertible preferred
stock dividend (1)............... -- 23,910 -- -- --
--------- --------- --------- --------- ---------
Net loss applicable to common
stockholders.................. ($64,080) ($47,138) ($22,549) ($10,697) ($3,666)
========= ========= ========= ========= =========
Historical basic and diluted
net loss per share applicable
to common stockholders........ ($3.11) ($5.25) ($5.26) ($2.64) ($1.02)
========= ========= ========= ========= =========
Shares used in computing
historical basic and diluted
net loss per share applicable
to common stockholders (2)........ 20,630 8,986 4,289 4,054 3,589
========= ========= ========= ========= =========
December 31,
--------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands)
Consolidated Balance
Sheet Data:
Cash, cash equivalents and
short-term investments........ $112,992 $28,880 $1,987 $12,864 $8,620
Working capital (deficit)...... 112,374 24,422 (4,847) 9,971 6,934
Total assets................... 301,236 42,146 8,778 15,978 10,202
Long-term debt (less
current portion).............. 37 10 44 1,255 439
Accumulated deficit............ (148,381) (84,301) (37,163) (14,614) (3,917)
Total stockholders' equity
(net capital deficiency)...... $258,655 $28,103 ($1,174) $11,405 $7,955
(1) See Note 10 of Notes to Consolidated Financial Statements for an
explanation of the convertible preferred stock dividend.
(2) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the method employed to determine the number of shares
used to compute per share amounts.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Our line of business is to develop, market and sell broadband access
systems. Our objective is to be the leading provider of broadband
access systems to providers of services to residential and commercial
end users. Since our inception in January 1993, we have focused on the
development of our patented S-CDMA technology, as well as certain other
core technologies, to enable broadband transmission of data over cable
networks. We began the specification and design of our first ASIC in
October 1994 and produced the first version of this ASIC in September
1996. At the same time, we developed an end-to-end broadband access
system, the TeraComm system, around the ASIC. We commenced volume
shipments of our TeraComm system in the first quarter of 1998. However,
with some recent acquisitions of complimentary technology and
businesses, we have also turned our attention to providers of broadband
services using existing telephone, copper wire infrastructures and
wireless systems.
We sell our products both in North America and internationally, and
we market our products primarily to cable operators and distributors.
Our strategy is to supply leading providers of broadband access services
worldwide. Consistent with this strategy, our initial target market
consisted of the ten largest cable companies in each major geographic
area. In most markets, a small number of large cable operators often
provide services to a majority of the subscribers in a specific region
and thus influence the purchase decisions of smaller cable operators.
In North America, three of the largest cable operators, Rogers Cable
Inc. (formerly Rogers Cablesystems Limited), Shaw Communications Inc.,
and TCA Cable TV, Inc. (a subsidiary of Cox Communications, Inc.), are
deploying the TeraComm system. In Japan, through our partner Sumitomo
Corporation, we have established ourselves as the market leader. In
Europe, our TeraComm system is being deployed by UPC, one of Europe's
largest broadband communications companies. As a result of the nature
of the cable industry and our strategic focus, a small number of
customers have accounted for the majority of our revenues to date, and
we expect that the majority of our revenues will continue to be
generated from a small number of customers for the foreseeable future.
In 1999, four customers accounted for approximately 66% of our revenues.
This compares to approximately 70% of our revenues from three customers
in 1998. We anticipate that the timing and maturity of these customers'
deployments of the TeraComm system will result in variations in revenues
generated from these customers.
The market for broadband access products and services is
characterized by rapid technological change, new product development
product obsolescence and evolving industry standards. A significant
element of our strategy is to advance industry standards and to extend
our technology leadership and achieve rapid time to market. In November
1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version
of the DOCSIS cable modem specification based in part on our S-CDMA
technology. In September 1999, CableLabs indicated that it intended to
proceed with the advanced PHY work on two parallel tracks: one for the
development of a prototype based on our S-CDMA technology and one for
the inclusion of Advanced TDMA technology, as proposed by other
companies. In February 2000, CableLabs further clarified the status of
the advanced PHY project regarding a separate release that will include
TDMA technologies. In addition, CableLabs reiterated that it is
continuing to work with us on the development of a DOCSIS specification
that could include our S-CDMA technology. To that end, CableLabs has
requested that we submit a prototype of a DOCSIS system that
incorporates an S-CDMA advanced PHY capability for testing. CableLabs
has stated that if the testing of this prototype reveals that the S-CDMA
advanced PHY works as claimed (including proper backwards compatibility
and coexistence with the other aspects of DOCSIS), and if the costs for
adding S-CDMA to DOCSIS products are in line with estimates, then it is
likely that S-CDMA advanced PHY capabilities will be included in a
future version of the DOCSIS specification. The prototype we submit to
CableLabs may fail to demonstrate the level of performance that
CableLabs seeks, even if it does meet performance expectations there can
be no guarantee that CableLabs will incorporate the technology into a
future version of DOCSIS specifications. In addition, if CableLabs does
proceed to include S-CDMA in a future DOCSIS specification, there can be
no guarantee that the DOCSIS S-CDMA specification will be the same as
the specification we incorporated in the prototype submitted for tests,
which may require us to further develop our prototype. .We intend to
develop future products that are standards compliant and are actively
participating in the development of additional industry standards. As
part of our efforts to offer standards compliant products we introduced
a CableLabs certified DOCSIS 1.0 cable modem to the market in the third
quarter of 1999.
The rapid evolution of broadband has resulted in cable television
operators, providers of telephone service and other service providers
seeking to provide a bundle of voice, data and video services to their
residential and commercial subscribers over existing and new
infrastructures. Consistent with our objective to be a leading provider
of broadband access systems, through a series of recent acquisitions, we
are building a complete portfolio of broadband products to support high-
speed delivery of voice, data and video services over cable, copper wire
(DSL) and wireless. In the fall of 1999, we acquired Imedia Corporation
and the CherryPicker digital video management system. In November 1999,
we completed our acquisition of Radwiz Ltd., a provider of communication
access systems based on high-speed IP routing, integrated with
telephony, and on January 2, 2000 we completed our acquisition of
Telegate Ltd., a developer and manufacturer of telephony and data access
platforms that are deployed by service providers to deliver efficient
carrier-class voice services over cable. In addition, in February 2000,
we entered into definitive agreements to acquire the Access Network
Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary
of Tyco International Ltd., and Combox Ltd. In March 2000 we entered
into an agreement to purchase certain assets of Internet Telecom Ltd.
and an agreement to acquire Ultracom Ltd.
The intensely competitive nature of the market for broadband access
systems has resulted in significant price erosion over time. We have
experienced and expect to continue to experience downward pressure on
our unit ASP or average selling price. We had negative gross margins
from inception until the fourth quarter of 1998 when we achieved a
positive gross margin for the first time as a result of our execution of
cost reduction strategies. A key component of our strategy is to
decrease the cost of manufacturing our products to improve our gross
margins. For example, in the fourth quarter of 1998, we introduced a
cable modem using a single-board design, which has higher gross margins
than our original dual board design. Subsequently, we have successfully
introduced several cost reduced versions of the single-board modem that
have allowed us to continue to improve gross margin performance despite
ongoing ASP declines. We intend to continue to engage in and implement
cost reduction efforts, including the further integration of ASIC
components, other design changes and manufacturing efficiencies.
We sustained net losses applicable to common stockholders of $64.1
million in 1999, $47.1 million in 1998 and $22.5 million in 1997. As a
result, we had an accumulated deficit of $148.4 million as of December
31, 1999. Our operating expenses are based in part on our expectations
of future sales, and we expect that a significant portion of our
expenses will be committed in advance of sales. We expect to continue to
increase our expenditures in technical development and sales and
marketing as we engage in activities related to product enhancement,
cost reduction and increasing market penetration. Additionally, we
expect to increase our capital expenditures and other operating expenses
in order to support and expand our operations. We anticipate that we
will spend approximately $17.0 million on capital expenditures and
approximately $35.0 to $45.0 million on research and development during
the 12 months ended December 31, 2000. Anticipated capital expenditures
consist of purchases of additional test equipment to support higher
levels of production and computer hardware, furniture and leasehold
improvements for expansion of our facilities, implementation of an ERP
system and software and equipment for newly hired employees. As a result
of these anticipated increased operating expenses, we expect to continue
to incur losses for the foreseeable future.
Acquisition of Imedia Corporation and Radwiz Ltd.
In September 1999, we acquired Imedia Corporation. Imedia developed
and manufactured the CherryPicker digital video management system that
enables cable operators to select and customize their program lineup for
viewer preferences, while maximizing video capacity and quality over
standards-based set-top boxes. The former shareholders and vested
optionholders of Imedia received a total of 1.0 million shares and
options to purchase shares of our common stock. The total purchase
price was approximately $109.0 million. The acquisition was accounted
for under the purchase method of accounting.
In November 1999, we acquired Radwiz Ltd., an Israeli company that
produces communication access systems based on high-speed IP routing,
integrated with telephony. Radwiz's systems include both central office
Digital Subscriber Line Access Multiplexers (DSLAMs) and customer
premises equipment for small office, home office (SOHO) business
broadband services. The former shareholders and vested optionholders
of Radwiz received a total of 946,153 shares and options to purchase
shares of our common stock. The total purchase price was approximately
$53.6 million. The Radwiz acquisition was accounted for under the
purchase method of accounting.
This Report on Form 10-K presents our financial results for the year
ended December 31, 1999 combined results with Imedia for the portion of
the period following September 16, 1999 and Radwiz Ltd for the portion
of the period following November 22, 1999. As a result, the information
contained herein may not be comparable to results in previous years.
Recent Events
In October 1999, we entered into a Share Purchase Agreement to
acquire Telegate Ltd, an Israeli company. Telegate produces telephony
and data access platforms that are deployed by service providers to
deliver efficient carrier-class voice services over cable. Telegate also
provides in-home networking capability for telephony and data, based on
the Digital Enhanced Cordless Telephony (DECT) standard. This
transaction closed on January 2, 2000. The former shareholders and
vested optionholders of Telegate received a total of 2,200,000 shares
and options to purchase shares of our common stock. In addition, the
former shareholders are to receive a cash payment of approximately $3.5
million. The total purchase price was approximately $145.0 million. We
expect to account for the acquisition as a purchase transaction.
In February 2000, we entered into an Asset Purchase Agreement to
acquire certain assets and assume certain liabilities of ANE which
produces DSL systems that provide multiple phone lines over the existing
copper telephony a single pair of copper wires. In general, we will
issue shares and options to purchase shares of our common stock valued
at approximately $85.0 million based on the volume weighted average of
the per share sales price of our common stock as reported on the Nasdaq
National Market for the ten consecutive trading days prior to the
closing date.. In addition, we have agreed to establish an employee
retention program for purposes of retaining certain identified employees
of ANE. The retention program provides for up to 3 annual payments to
the identified employees in a total amount of approximately $4.5 million
provided the employees remain employed by us. The retention payments
will be charged to expense in the period incurred. The transaction is
subject to customary closing conditions and is expected to close in the
second quarter of 2000. We expect to account for the acquisition as a
purchase transaction.
In February 2000, we also entered into a Share Purchase Agreement to
acquire Combox Ltd, an Israeli company that manufactures broadband data
systems and satellite communications based on international standards.
Combox's cable data access systems conform to the growing EuroModem
international specification, based on the Digital Video Broadcasting
(DVB) standard. In general, Combox shareholders will receive a total of
775,000 shares and options to purchase shares of our common stock.
Based on the fair market value of our stock on the days immediately
preceding and following the date the acquisition was announced, the
total purchase price is estimated to be approximately $92.0 million. The
transaction is subject to customary closing conditions and is expected
to close in the second quarter of 2000. We expect to account for the
acquisition as a purchase transaction.
In February 2000, our board of directors approved a two-for-one split
of our outstanding shares of common stock to be effected in the form of
a stock dividend. The stock split is pending stockholder approval of an
increase in our authorized shares and therefore the changes in the
capital structure resulting from the split have not been given
retroactive effect throughout this Report on Form 10-K.
In March 2000, we entered into an Asset Purchase Agreement
("Internet Telecom Agreement") with our subsidiary Telegate, under which
Telegate agreed to purchase certain assets of Internet Telecom Ltd.
("Internet Telecom"), an Israeli company. Internet Telecom is a
supplier of PacketCable and other standards-based, voice-over-IP
("Internet Protocol") systems and technologies. In general, Telegate
will acquire the assets of Internet Telecom in exchange for shares our
common stock valued at approximately $44.0 million based on the fair
market value of our common stock on the days immediately preceding and
following the date the acquisition was announced and a cash payment
estimated at approximately $2.0 million. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, we entered into a Share Purchase Agreement to acquire
Ultracom Ltd. ("Ultracom"), an Israeli company. Ultracom is a supplier
of broadband systems-on-silicon. In general the Ultracom shareholders
and vested optionholders will receive shares and option of our common
stock valued at approximately $30.0 million based on the closing price
of our common stock on the fifth business day immediately preceding the
closing and a cash payment estimated at approximately $2.3 million. We
will also assume the unvested Ultracom options, the value of which will
be included in the purchase price. The transaction is subject to
customary closing conditions and is expected to close in the second
quarter. We expect to account for the transaction as a purchase
transaction.
In March 2000, Rogers purchased 1,843,409 shares of our common stock.
The shares were issued on a net issuance basis pursuant to the exercise
of two warrants, each to purchase 1.0 million shares of our common stock
issued in March 1999. Because the warrants were exercised on a cashless
basis the exercise resulted in no proceeds to us.
Results of Operations
Years Ended December 31, 1999 and 1998
Revenues. Our revenues increased to $97.0 million in 1999 from $31.7
million in 1998. Revenues consist primarily of sales of cable modems and
headend equipment to new and existing customers. The increased revenues
in 1999 were primarily attributable to the addition of new customers in
1999 and continuing deployments of our TeraComm system by existing
customers, and, to a lesser extent, the sales of products acquired as a
result of our acquisition of Imedia. The impact on revenues resulting
from the acquisition of Radwiz was not significant for the year ended
December 31, 1999.
We sell our products directly to broadband access service providers,
system resellers and distributors. Revenues related to product sales are
generally recognized when the products are shipped to the customer. A
provision is made for estimated product returns as product shipments are
made. Our existing agreements with our system resellers and distributors
do not contain price protection provisions and do not grant return
rights beyond those provided by the Company's standard warranty.
Cost of Goods Sold. Cost of goods sold consists of direct product
costs as well as the cost of our manufacturing operations group. The
cost of the manufacturing operations group includes assembly, test and
quality assurance for products, warranty costs and associated costs of
personnel and equipment. In 1999, we incurred $72.0 million in cost of
goods sold, which included the cost of our manufacturing operations
group and approximately $1.9 million of amortization of intangibles
assets resulting from the acquisitions of Imedia and Radwiz. In 1998,
we incurred $34.5 million in cost of goods sold, which included the cost
our manufacturing operations group and a charge of $1.3 million relating
to the write-off of obsolete inventory and the transition of
manufacturing operations.
Gross Profit( Loss). Our gross profit was $25.0 million or 26% of
revenue in 1999. This compares to a gross loss of $2.8 million in 1998.
The improvement in our gross profit in 1999 compared to 1998 was due
largely to the introduction of a cable modem using a single-board design
in the fourth quarter of 1998. This modem has a higher gross margin
than our original dual board design. Subsequent to the introduction of
the single-board design, we have successfully introduced cost reduced
versions that have allowed us to continue to improve gross margin. We
intend to continue to engage in and implement cost reduction efforts,
including the further integration of ASIC components, other design
changes and manufacturing efficiencies. We anticipate that continued
decreases in the average sales price of our products will partially, if
not completely, offset the benefits obtained from further cost
reductions, particularly if we are unable to achieve cost reductions
sufficient to offset further average selling price declines.
Our gross profit also is influenced by the sales mix of TeraLink
Master Controllers, TeraLink Gateways and TeraPro cable modems and the
maturity of TeraComm system deployments in any quarter. TeraPro cable
modems have lower margins than the TeraLink Master Controllers and
TeraLink Gateway headend products. New deployments of TeraComm systems
typically include a higher mix of headend equipment and involve smaller
quantities of product sold. Products sold in connection with new
deployments thus generally are sold at higher margins than products
associated with more mature deployments of the TeraComm system, which
generally involve larger quantities of products, primarily cable modems.
We expect that the introduction of new customers and the relationship of
revenues generated from the sale of TeraPro cable modems to our overall
revenue will result in fluctuations in our gross profit in future
periods.
We introduced a CableLabs certified DOSCIS 1.0 cable modem to the
market in third quarter of 1999. We also are currently developing a
DOCSIS system that will include a headend controller. We believe that
the widespread adoption of industry standards will result in further
price pressure. We anticipate that the relationship of revenues
generated from the sale of our proprietary TeraComm system versus a
DOCSIS compliant system will result in fluctuations in our gross profit
in future periods. The impact on our gross margin in 1999 resulting
from the sale of our DOCSIS 1.0 cable modem was not significant.
Our gross margin also is influenced by the level of sales of products
of acquired companies, which produce varying gross margin results. We
expect that our gross margin will fluctuate in future periods as a
result of these and other acquisitions.
Research and Development. Research and development expenses consist
primarily of personnel costs, as well as design expenditures, equipment
and supplies required to develop and to enhance our products. Research
and development expenses increased to $17.6 million in 1999 from $10.7
million in 1998, primarily as a result of increased personnel costs. The
increased personnel costs are a result of expansion in our own employee
base as we continue to focus our efforts on developing new products and
enhancing our current products. The increased personnel costs are also
the result of the acquisitions of Imedia and Radwiz. We intend to
continue to increase investment in research and development as a result
of these and other activities.
Cost of Product Development Assistance Agreement. In March 1999, we
entered into a one-year Product Development Assistance Agreement with
Rogers Communications Inc. Under the terms of the Development Agreement,
Rogers will assist us with the characterization and testing of our
subscriber-end and head-end voice-over-cable equipment. In addition,
Rogers will provide us with technology to assist us with our efforts to
develop high quality, field proven technology solutions that are DOCSIS-
compliant and packet cable-compliant. The Development Agreement has a
term of one year. In consideration of Rogers entering into the
Development Agreement, we issued Rogers two fully vested and non-
forfeitable warrants, each to purchase 1.0 million shares of common
stock on a cashless basis. One warrant has an exercise price of $1.00
per share and one warrant has an exercise price of $37.00 per share.
The warrants may be exercised at any time in full or in part through
March 31, 2000. The fair value of the two warrants was approximately
$45.0 million and will result in a noncash charge included in operations
over the one-year term of the Development Agreement. As a result of
the Development Agreement, our results for 1999 include a noncash charge
of $35.1 million. In March 2000, Rogers purchased 1,843,809 shares of
our common stock on a net exercise basis, resulting in no proceeds to
us.
In-Process Research and Development. We incurred charges of $11.0
million for the year ended December 31, 1999 related to research and
development projects in process at Imedia at the time of the acquisition
and $3.6 million related to research and development project in process
at Radwiz at the time of the acquisition. The projects identified as
in-process will require additional effort in order to establish
technological feasibility. These projects have identifiable
technological risk factors that indicate that even though successful
completion is expected, it is not assured.
In-process technology resulting from the acquisition of Imedia
consists primarily of major additions to Imedia's core technology, which
is related to Imedia's planned development of new features. The
majority of the intended functionality of these new features is not
supported by Imedia's current technology. Intended new features include
offering high quality video service over the Internet and multiplexing
data with video. We expect that in-process technology will be
successfully developed and that initial benefits from these projects
will begin in 2001. However, there remain significant technical
challenges that must be resolved in order to complete the in-process
technology.
In-process technology resulting from the acquisition of Radwiz
consists primarily of major additions to Radwiz's core technology, which
is related to Radwiz's planned development of new features. The
majority of the intended functionality of these new features is not
supported by Radwiz's current technology. Intended new features include
offering: end-to-end carrier quality of service; allowing access via an
ATM network; and, providing ISDN line functionality. We expect that in-
process technology will be successfully developed and that initial
benefits from these projects will begin in mid-year 2000. However,
significant technical challenges must be resolved in order to complete
the in-process technology.
Sales and Marketing. Sales and marketing expenses consist primarily
of salaries and commissions for sales, marketing and support personnel,
and costs related to trade shows, consulting and travel. Sales and
marketing expenses increased to $15.7 million in 1999 from $6.9 million
in 1998, primarily due to increased payroll costs related to additional
sales and support personnel necessary to support the expansion of our
customer base and resulting from the acquisitions of Imedia and Radwiz,
and increased commissions related to higher sales. We expect sales and
marketing expenses to continue to increase as we expand our customer
base.
General and Administrative. General and administrative expenses
primarily consist of salary and benefits for administrative officers and
support personnel, travel expenses, legal, accounting and consulting
fees. General and administrative expenses increased to $7.5 million in
1999 from $3.2 million in 1998. The increase was primarily a result of
costs associated with the increased infrastructure required to support
our expanded activities and due to increased personnel costs associated
with our acquisitions of Imedia and Radwiz. We expect that general and
administrative expenses will continue to increase in the near term as a
result of these factors.
Amortization of Goodwill and Other Intangible Assets. The Imedia
acquisition was completed on September 16, 1999 and was accounted for as
a purchase transaction. The total purchase price, representing the fair
value of our shares issued and transaction and direct acquisition costs,
was approximately $109.0 million. The purchase price was allocated
(based on an independent appraisal) between the net tangible assets of
Imedia on the date of acquisition (approximately $645,000), in-process
research and development (approximately $11.0 million) and intangible
assets acquired (approximately $97.3 million). Intangible assets
consist of developed technology (approximately $27.0 million), assembled
workforce (approximately $2.5 million), trademark (approximately $4.0
million) and goodwill (approximately $63.8 million). The intangible
assets will be amortized straight line over lives ranging from two to
six years. The amortization of developed technology will impact cost of
goods sold in future periods. The amortization of the other intangibles
will principally impact operating expenses in future periods.
The Radwiz acquisition was completed on November 22, 1999 and was
accounted for as a purchase transaction. The total purchase price,
representing the fair value of our shares issued and transaction and
direct acquisition costs, was approximately $53.6 million. The purchase
price was allocated (based on an independent appraisal) between the net
tangible assets of Imedia on the date of acquisition (approximately $3.1
million), in-process research and development (approximately $3.6
million) and net intangible assets acquired (approximately $46.9
million). Intangible assets consist of developed technology
(approximately $29.9 million), assembled workforce (approximately $2.8
million), trademark (approximately $1.1 million) and goodwill
(approximately $24.1 million). Goodwill has been increased and deferred
tax liabilities have been recorded in the amount of approximately $11.0
million to reflect the net tax effect of the book/tax basis differences
in the acquired intangibles, excluding goodwill and in-process research
and development. Deferred tax assets have been realized based on the
projected reversal of taxable temporary differences and have been netted
against deferred tax liabilities for purposes of allocating the purchase
price. The intangible assets will be amortized straight line over lives
ranging from two to six years. The amortization of developed technology
will impact cost of goods sold in future periods. The amortization of
the other intangibles will principally impact operating expenses in
future periods.
We expect amortization of goodwill and other intangibles related to
the acquisitions of Imedia and Radwiz, as well as subsequent
acquisitions, to increase in future periods.
Net Interest Income. Net interest income increased to $5.0 million in
1999 from $449,000 in 1998, primarily as a result of higher average cash
balances subsequent to our public offering in January 1999.
Series F Convertible Preferred Stock Dividend. We recorded a dividend
of $23.9 million in 1998. The dividend represented the fair value of a
warrant to purchase 3,000,000 shares of our common stock (the "Shaw
Warrant"), and was recorded under the provision of EITF No. 96-13,
"Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock." The warrant was issued
in connection with the sale of $5.0 million of convertible preferred
stock to Shaw. Shaw purchased 1,500,000 shares of common stock in March
1999 and 1,500,000 shares of our common stock in November 1999 under the
terms of the Shaw Warrant resulting in net proceeds to us of $19.5
million.
Income Taxes. We have generated operating losses since our inception.
Due to our inability to recognize a benefit from these operating losses
we have no provision for income taxes in 1999 and 1998, We account for
income taxes under Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes ("FAS 109"). Under Statement of Financial
Accounting Standards No. 109, deferred tax assets and liabilities are
determined based on the difference between financial reporting and tax
bases of assets and liabilities, and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected
to reverse. FAS 109 provides for the recognition of deferred tax assets
if realization of such assets is more likely than not. Based upon the
weight of available evidence, which includes the Company's historical
operating performance and the reported cumulative net losses for the
prior three years, the Company has provided a full valuation against its
net deferred tax assets as of December 31, 1999 and 1998. We intend to
evaluate our ability to realize the benefit of the deferred tax assets
on a quarterly basis. See Note 12 to the Consolidated Financial
Statements.
Stock-Based Compensation. As of December 31, 1999, we had recorded
deferred compensation of $2.6 million related to certain stock options
granted in 1998 and 1997. We amortized approximately $631,000 of the
deferred compensation in 1999, $421,000 in 1998 and $12,000 in 1997. The
remainder will be amortized over the related vesting period of the stock
options. See Note 11 of Notes to Consolidated Financial Statements.
Years Ended December 31, 1998 and 1997
Revenues. Our revenues increased to $31.7 million in 1998 from $2.1
million in 1997. Revenues consist primarily of sales of cable modems and
headend equipment to new and existing customers. We did not commence
selling our products until June 1997 and did not commence selling our
products in volume until the first quarter of 1998.
Cost of Goods Sold. In 1998, we incurred $34.5 million in cost of
goods sold, which included the costs our manufacturing operations group
and a charge of $1.3 million relating to the write-off of obsolete
inventory and the transition of manufacturing operations. In 1997, we
incurred $6.5 million in cost of goods sold, which included the cost of
the manufacturing group for the entire period as we readied our products
for commercialization.
Gross Loss. We incurred a gross loss of $2.8 million in 1998. In
1997, we incurred a gross loss of $4.3 million due to costs associated
with our manufacturing operations group. The decrease in gross loss in
1998 compared to 1997 was primarily due to a reduced negative margin on
cable modems, which was partially offset by the $1.3 million write-off
relating to obsolete inventory and the transition of manufacturing
operations to Solectron. We completed the transition to a lower
cost, single-board modem product in the fourth quarter of 1998.
Primarily as a result of this lower cost product, we achieved a positive
gross margin of $425,000 in the fourth quarter of 1998.
Research and Development. Research and development expenses decreased
to $10.7 million in 1998 from $11.3 million in 1997 as a result of the
timing of our development projects.
Sales and Marketing. Sales and marketing expenses increased to $6.9
million in 1998 from $4.5 million in 1997, primarily due to increased
payroll costs related to additional sales and support personnel for
commercial trials and deployment of our products and increased
commissions related to higher sales in 1998.
General and Administrative. General and administrative expenses
increased to $3.2 million in 1998 from $2.5 million in 1997, primarily a
result of the additional reporting requirements imposed on us as a
public company and increased infrastructure to support our expanded
activities.
Net Interest Income. Net interest income increased to $449,000 in
1998 from $128,000 in 1997, primarily as a result of higher average
cash balances subsequent to our initial public offering in August 1998.
Series F Convertible Preferred Stock Dividend. We recorded a dividend
of $23.9 million in 1998. The dividend represents the fair value the
Shaw Warrant. The Shaw Warrant was issued in connection with the sale of
$5.0 million of convertible preferred stock to Shaw (the "Shaw
Financing"). Our accounting conclusion was that the sale of preferred
stock was, in substance, a financing transaction and not the issuance of
equity instruments in exchange for goods or services.
Income Taxes. We have not generated operating losses since inception.
Due to our inability to recognize a benefit from these operating losses
we have no provision for income taxes in 1998 and 1997. We account for
income taxes under Statement of Financial Accounting Standards No. 109.
Realization of deferred tax assets is dependent on future earnings, if
any, the timing and amount of which are uncertain. Accordingly,
valuation allowances in amounts equal to the net deferred tax assets as
of December 31, 1998 and 1997 have been established to reflect these
uncertainties.
Stock-Based Compensation. As of December 31, 1998, we had recorded
deferred compensation of $2.6 million related to certain stock options
granted in 1998 and 1997. We amortized approximately $421,000 of the
deferred compensation in 1998 and $12,000 in 1997. The remainder will be
amortized over the related vesting period of the stock options. See Note
10 of Notes to Consolidated Financial Statements.
Liquidity and Capital Resources
We have met our liquidity needs since inception through December 31,
1999 primarily through private sales of preferred stock, an initial
public offering completed in August 1998 and a public offering completed
in January 1999. The private sales of preferred stock resulted in
aggregate proceeds to us, before deduction of issuance costs, of $52.7
million. The initial public offering of 3,000,000 shares of common stock
at a price of $13.00 per share resulted in net proceeds of $35.1
million. The public offering of 1,750,000 shares of our common stock
and the exercise of the over allotment option of 351,946 shares of new
common stock at a price of $38.00 completed in January 1999 resulted in
net proceeds of $62.5 million.
On January 21, 1999, we completed a public offering of 3,250,000
shares of common stock at a offering price of $38.00 per share. Of the
3,250,000 shares, we sold 1,750,000 shares and certain selling
stockholders sold 1,500,000 shares. We received net proceeds of $62.5
million, after the underwriting discount of approximately $3.3 million
and offering expenses of approximately $700,000. The proceeds from this
offering have been designated for general corporate purposes. On
February 9, 1999, the underwriters exercised their option to purchase
487,500 additional shares of common stock to cover over-allotments, of
which 351,946 shares were purchased from us and 135,554 shares were
purchased from certain selling stockholders. Our net proceeds from the
exercise of the over-allotment option were $12.7 million.
In March 1999, Shaw purchased 1,500,000 shares of our common stock at
$6.50 per share and in November 1999 Shaw purchased an additional
1,500,000 shares of our common stock at $6.50 per share, resulting in
net proceeds to us of $19.5 million. The shares were purchased pursuant
to the exercise of a warrant to purchase 3,000,000 shares of our common
stock issued to Shaw in 1998.
We have used cash in operating activities of $58.7 million since our
inception through December 31, 1999. Cash used in operating activities
was $8.1 million in 1999, $18.1 million in 1998 and $20.8 million in
1997. Cash used in investing activities was $72.2 million in 1999 and
$16.1 million in 1998. Investment activities in 1999 and 1998 consisted
primarily of the purchase of short-term investments. Cash provided by
investing activities, primarily from the sales and maturities of short-
term investments, was $1.5 million in 1997. Cash provided by financing
activities was $98.3 million in 1999, $47.0 million in 1998 and $12.6
million in 1997. Cash provided by financing activities consisted
primarily of proceeds from private sales of preferred stock in 1998,
1997 and 1996, proceeds from our initial public offering of common stock
in 1998 and proceeds from our public offering in January 1999, as well
as proceeds from the exercise of options and warrants in 1999.
At December 31, 1999, we had approximately $32.4 million in cash and
cash equivalents, $80.6 million in short-term investments and had
available a $2.5 million revolving line of credit. There was an unused
standby letter of credit of $150,000 against the line of credit and
approximately $2.35 million was available at December 31, 1999.
Our cash equivalents and short-term investments are subject to market
risk, primarily interest rate and credit risk. Our investments are
managed by outside professional managers within guidelines we establish.
The guidelines, which include security type, credit quality and
maturity, are intended to limit market risk by restricting our
investments to high quality debt instruments with short-term maturities.
Due to the relatively short-term duration of our investments at December
31, 1999, a 1% (100 basis point) increase in short-term interest rates
would not have a significant impact on the market value of our
investments. Our investments in debt securities are classified as
available-for-sale, therefore, we do not recognize gains or losses due
to changes in interest rates unless such securities are sold prior to
maturity. We generally hold securities until maturity and carry the
securities at amortized cost, which approximates market value.
As of December 31, 1999, we had approximately $48.8 million of
unconditional purchase obligations. We anticipate that we will pay these
obligations by March 2000. We intend to make these payments out of
available working capital.
We believe that our current cash balances will be sufficient to
satisfy our cash requirements for at least the next 24 months. We may
require additional financing prior to that time to fund our operations
and we may seek to raise such additional funds through the sale of
public or private equity or debt financing or from other sources. The
sale of additional equity or debt securities may result in additional
dilution to our stockholders. Additional financing may not be available
to us on acceptable terms, or at all, when we require it.
Impact of Year 2000
In prior years, we discussed the nature and progress of our plans to
become Year 2000 ready. In late 1999, we completed the remediation and
testing of our systems. As a result of those planning and
implementation efforts, we experienced no significant disruptions in
mission critical information technology and non-information technology
systems and we believe those systems successfully responded to the Year
2000 date change. We incurred no significant costs in 1999 in
connection with the remediation of our systems. We are not aware of any
material problems resulting from Year 2000 issues, either with our
products, our internal systems, or the products and services of third
parties. We will continue to monitor our mission critical computer
applications and those of our suppliers and vendors throughout the year
2000 to ensure that any latent Year 2000 matters that may arise are
addressed promptly.
Recent Financial Accounting Pronouncement
In September 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. FAS 133 was effective
for fiscal years beginning after September 15, 1999. In July 1999, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and
Hedging Activities -Deferral of the Effective Date of FASB Statement No.
133" (FAS 137). FAS 137 defers for one year the effective date of FAS
133 which will now apply to all fiscal quarters of all fiscal years
beginning after June 15, 2000. We believe that the adoption of FAS 137
will not have a significant impact on our operating results or cash
flows.
In December 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides guidance on the recognition,
presentation and disclosure of revenue in the financial statements of
public companies. The accounting profession is currently exploring
practical means of implementing the guidelines established by SAB 101.
To the extent that SAB 101 is applicable to us, we will be required to
change our revenue recognition policy. Changes in our revenue
recognition polices will be reported as a change in accounting principle
in the second quarter ended June 30, 2000. The change in accounting
principle will not result in any restatement of prior periods but will
result in a cumulative adjustment in the second quarter to reflect the
deferral of revenue previously recognized for shipments that did not
meet the revenue recognition criteria established by SAB 101. Any such
revenue deferred will be subsequently recognized in the period in which
the revenue recognition criteria are met. Revenue for all shipments
occurring after April 1, 2000 will be recognized based on the criteria
established by SAB 101. We currently cannot determine what effect, if
any, that SAB 101 will have on our financial statements. Management
believes that SAB 101 will not affect the underlying strength or
weakness of our business operations as measured by the dollar value of
our product shipments and cash flows.
Certain Business Risks
We Have a Limited Operating History and a History of Losses.
We have a limited operating history, and it is difficult to predict
our future operating results. We were incorporated in January 1993 and
began shipping products commercially in June 1997. We have only been
shipping products in volume since the first quarter of 1998. As of
December 31, 1999, we had an accumulated deficit of $148.4 million. We
believe that we will continue to experience net losses for the
foreseeable future. Most of our expenses are fixed in advance, and we
generally are unable to reduce our expenses significantly in the short
term to compensate for any unexpected delay or decrease in anticipated
revenues. We expect to continue to increase expense for the foreseeable
future to support increased sales and marketing and technical support
costs. Any significant delay in our anticipated revenues or
commercialization of new products would harm our business. The revenue
and profit potential of our business and our industry are unproven. We
had negative gross margins from our inception until the fourth quarter
of 1998, and any future revenue growth may not result in positive gross
margins or operating profits in future periods.
Our Operating Results May Fluctuate.
Our quarterly revenues are likely to fluctuate significantly in the
future due to a number of factors, many of which are outside our
control. Factors that could affect our revenues include the following:
* variations in the timing of orders and shipments of our products;
* variations in the size of the orders by our customers;
* new product introductions by competitors;
* delays in introducing new products;
* delays of orders forecasted by our customers;
* delays by our customers in the completion of upgrades of cable
infrastructure;
* variations in capital spending budgets of broadband access
service providers;
* adoption of industry standards and the inclusion in or
compatibility of our technology with any such standards; and,
* delays in obtaining regulatory approval for commercial deployment
of cable modem systems.
Our expenses generally will vary from quarter to quarter depending
on the level of actual and anticipated business activities. Research and
development expenses will vary as we begin development of new products
and as our development programs move to wafer fabrication, which results
in higher engineering expenses.
We have a limited backlog of orders, and net sales for any future
quarter are difficult to predict. Supply, manufacturing or testing
constraints could result in delays in the delivery of our products. Any
delay in the product deployment schedule of one or more of the providers
of broadband access services that we target would have an adverse effect
on our operating results for a particular period. In addition, due to
the large dollar size of a typical transaction in comparison to our
total revenues, any delay in the closing of a transaction could have a
significant impact on our operating results for a particular period.
A variety of factors affect our gross margin, including the
following:
* the sales mix of our products;
* the volume of products manufactured;
* the type of distribution channel through which we sell our
products;
* the average selling prices or "ASPs" of our products; and
* the effectiveness of our cost reduction measures.
We anticipate that unit ASPs of our products will decline in the
future. This could cause a decrease in the gross margins for these
products. In addition, the maturity of TeraComm system deployments
affects our gross margin. New deployments of the TeraComm system involve
the sale of headend equipment (which has higher margins) and generally
involve smaller quantities of product. New deployments typically are
sold at higher margins than the larger volume sales of product
associated with more mature deployments of the TeraComm system. The
sales mix of TeraLink 1000 Master Controllers, TeraLink Gateways and
TeraPro cable modems also affects our gross margin. The TeraPro cable
modems have significantly lower margins than the TeraLink 1000 Master
Controller and TeraLink Gateway headend products. We expect to achieve
only nominal margins on the TeraPro cable modems for the foreseeable
future. Further, we expect that sales of TeraPro cable modems will
continue to constitute a significant portion of our revenues for the
foreseeable future.
We also anticipate that our operating results will be impacted by
sales, gross profit and operating expenses of acquired companies. The
impact of these factors on our operating results will vary as we acquire
additional companies.
We Are Dependent on a Small Number of Customers.
Four customers accounted for approximately 66% of our revenues for
the year ended December 31, 1999 and three customers accounted for
approximately 70% of our revenues for the year ended December 31, 1998.
We believe that a substantial majority of our revenues will continue to
be derived from sales to a relatively small number of customers for the
foreseeable future. In addition, we believe that sales to these
customers will be focused on a small number of projects.
The cable industry is undergoing significant consolidation in North
America and internationally, and a limited number of cable operators
controls an increasing number of cable systems. As a result, our sales
will be largely dependent upon product acceptance by the leading cable
operators. Currently, ten cable operators in the United States own and
operate facilities passing approximately 86% of total homes passed.
Currently, the timing and size of each customer's order is critical to
our operating results. Our major customers are likely to have
significant negotiating leverage and may attempt to change the terms,
including pricing, upon which we do business with them. These customers
also may require longer payment terms than we anticipate, which could
require us to raise additional capital to meet our working capital
requirements. Our success will depend on our cable modems being widely
deployed and our ability to sell to new customers.
Acquisitions Could Result In Dilution, Operating Difficulties and Other
Harmful Consequences.
We have acquired three companies since September 1999: Imedia
Corporation in September 1999, Radwiz Ltd. in November 1999 and Telegate
Ltd. in January 2000. In addition, in February 2000 we entered into
definitive agreements to acquire the Access Network Electronics division
(ANE) of Tyco Electronics Corporation and Combox Ltd., and in March 2000
we entered into a definitive agreements to acquire certain assets of
Internet Telecom Ltd. and to acquire all of the outstanding shares of
Ultracom Ltd. We expect each of these acquisitions to close in the
second quarter of 2000, subject to certain closing conditions. If
appropriate opportunities present themselves, we intend to acquire
additional businesses, technologies, services or products that we
believe are strategic. The process of integrating any acquired business
into our business and operations is risky and may create unforeseen
operating difficulties and expenditures. The areas in which we may face
difficulties include:
* diversion of management time (both ours and that of the
acquired companies) during the period of negotiation through
closing and after closing from the ongoing development of our
businesses, issues of integration and future products;
* decline in employee morale and retention issues resulting from
changes in compensation, reporting relationships, future
prospects or the direction of the business;
* the need to integrate each company's accounting, management
information, human resource and other administrative systems
to permit effective management, and the lack of control if
this integration is delayed or not implemented; and
* the need to implement controls, procedures and policies
appropriate for a larger public group of companies that prior
to acquisition had been smaller, private companies.
We have very limited experience in managing this integration
process. Moreover, the anticipated benefits of any or all of these
completed or pending acquisitions may not be realized. Future
acquisitions could result in potentially dilutive issuances of equity
securities, the incurrence of debt, contingent liabilities or
amortization expenses related to goodwill and other intangible assets,
any of which could harm our business. Future acquisitions also could
require us to obtain additional equity or debt financing, which may not
be available on favorable terms or at all. Even if available, this
financing may be dilutive.
The Sales Cycle for Our Products Is Lengthy.
The sales cycle associated with our products typically is lengthy,
often lasting six months to a year. Our customers typically conduct
significant technical evaluations of competing technologies prior to the
commitment of capital and other resources. In addition, purchasing
decisions may be delayed because of our customers' internal budget
approval procedures. Sales also generally are subject to customer
trials, which typically last three months. Because of the lengthy sales
cycle and the large size of customers' orders, if orders forecasted for
a specific customer for a particular quarter do not occur in that
quarter, our operating results for that quarter could suffer.
There are Many Risks Associated with Our Participation in the
Establishment of Advanced Physical Layer specifications to be added to
DOCSIS.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOSCIS cable modem specification based in part
on our S-CDMA technology. In September 1999, CableLabs indicated that it
intended to proceed with the advanced PHY work on two parallel tracks:
one for the development of a prototype based on our S-CDMA technology
and