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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended September 30, 1998.
OR
[ ] Transition Report under Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File No.: 1-5270
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
New York 11-1817252
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
520 Logue Avenue, Mountain View, California 94043
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 962-7470
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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Common Stock, par American Stock Exchange
value $.01 per share
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the 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 at December 31, 1998 was approximately $130.3 million.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at December 31, 1998
- -------------------------------------- -----------------------------------
Common stock, $.01 per share par value 8,631,087
Documents Incorporated by Reference:
Proxy Statement for registrant's 1999 Annual Meeting of Shareholders (Part III)
PART I
Item 1. Business
Except for historical information contained herein, the matters discussed
in this Annual Report on Form 10-K contain forward-looking statements that
involve risks and uncertainties that could cause actual results to differ
materially from those anticipated by such forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those risks
discussed under the caption "Risk Factors."
The Company is in the process of implementing a new strategy emphasizing
its Internet services business (the "ISP Channel"). Currently, the Company owns
three businesses: its telecommunications business, its document management
business and its Internet service business. Each business operates through a
wholly owned subsidiary of the Company. As part of its new focus, the Company
has signed separate letters of intent to sell its telecommunications business,
Kansas Communications, Inc. ("KCI") and its document management business,
Micrographic Technology Corporation ("MTC"). The Company is now accounting for
KCI as a discontinued operation. Because the sale of MTC remains subject to
shareholder approval, the Company is accounting for MTC as a continuing business
rather than a discontinued operation. The sale of MTC and KCI is intended to
enable the Company to aggressively expand its ISP Channel. See "Business
- --Micrographic Technology Corporation."
On November 22, 1998, the Company announced its intention to purchase
Intelligent Communications Incorporated ("Intellicom"), the former Xerox Skyway
Network. This acquisition is expected to be completed by June 30, 1999.
Intellicom has a proprietary two-way satellite technology that can be used to
provide Internet access while bypassing the often expensive telephony costs
involved in connecting to the Internet. The Company believes that integrating
this new technology into its existing business plan will allow the Company to
cost effectively provide its ISP Channel service to smaller cable systems in
more remote areas as well as to certain other markets including multiple
dwelling units ("MDU's"), hotels, hospitals, and schools, thereby decreasing the
Company's cost basis and increasing the Company's potential market size. See
"Business -- Intelligent Communications, Inc."
In connection with its increased emphasis on cable-based Internet services,
the Company has built a highly experienced management team to grow its Internet
business, including President and Chief Executive Officer, Dr. Lawrence B.
Brilliant (co-founder of The Well, one of the first on-line communities); Chief
Operating Officer, Garrett J. Girvan (former Chief Operating Officer and Chief
Financial Officer of Viacom Cable); Chief Financial Officer, Douglas S. Sinclair
(formerly Chief Financial Officer of Silicon Valley Networks, Inc.); Director
and President of ISP Channel, Ian B. Aaron (former Director of Marketing, Sales
and Product Development of GTE Business Communications); Vice President and
General Counsel, Steven M. Harris (formerly Vice President, Broadband Services,
Pacific Telesis Group); Chief Marketing Officer, Kevin Gavin (formerly Regional
Vice President of Teligent, Inc.); Director, Edward A. Bennett (former President
of Prodigy Services, President and Chief Executive Officer of VH-1 Networks and
Chief Operating Officer of Viacom Cable); and Director, Sean P. Doherty (former
Chief Operating Officer of At Home Corporation ("@Home")). In addition, the
Company has recruited a number of key employees and consultants with significant
industry experience, including Atam Lalchandani (former Chief Financial Officer
of @Home) and Howard Rheingold (author of Virtual Communities).
The Company's current principal executive office is located at 520 Logue
Avenue, Mountain View, California 94043. To reduce its future rent costs per
square foot, the Company has signed a lease at 650 Townsend Street, San
Francisco, California 94103, and it intends to move its principal executive
offices and ISP Channel to this location in the first calendar quarter of 1999.
ISP Channel
The Company seeks to become the dominant cable-based provider of high-speed
Internet access and other Internet-related services to homes and businesses in
the franchise areas of those cable systems unaffiliated with the six largest
U.S. cable operators and certain other smaller systems. The Company estimates
that its target market comprises over 2,600 systems passing approximately 22
million U.S. homes. As of December 31, 1998, the Company has contracts with
cable operators representing approximately 1.4 million homes passed. In
addition, the Company plans to target certain other markets including MDUs,
hotels, hospitals and schools, which will significantly increase the size of the
Company's market. The Company's Internet service, which is marketed using the
brand name "ISP Channel," provides residential and business subscribers access
to the Internet over the existing cable television infrastructure at speeds up
to 1.5 megabits per second ("Mbps"). This increased speed means that the
required download time for a 10 megabyte file is less than a minute and allows
subscribers to benefit
from sophisticated multimedia applications and programming. The ISP Channel also
offers an intuitive user interface provided through a co-branding agreement with
Excite, Inc. ("Excite"), and local information, news and entertainment
customized for each community served.
Services
High-Speed Internet Access.
The Company's ISP Channel offering utilizes the cable television
infrastructure and the Company's network and content technologies to provide a
rapidly deployable, relatively inexpensive method of access to the Internet for
residential and business subscribers at speeds up to 1.5 Mbps. The ISP Channel
service enables subscribers to experience graphically rich, interactive, and
multimedia applications thereby improving the Internet experience. As of
December 31, 1998, the Company had contracts for its ISP Channel service with 28
cable operators, including Galaxy Telecom L.P. ("Galaxy"), Cable Communications
Co-op of Palo Alto ("Palo Alto Cable Co-op") and Advanced Cable Communications,
Inc. (dba Coral Springs Cable TV, "Coral Springs Cable"), representing 119 cable
systems and approximately 1.4 million homes passed. Nineteen of these systems,
representing over 216,000 homes passed, have been equipped and have begun
offering the Company's services, in most cases during the past three months. In
addition, the Company has non-binding letters of intent with 10 cable operators,
including 39 systems, representing approximately 359,000 homes passed. As of
December 31, 1998, the Company had approximately 1,250 residential and business
subscribers to its ISP Channel service, plus approximately 500 customer orders
in backlog. The Company also provides non-cable based dial-up and dedicated
Internet access to approximately 1,100 residential and business subscribers. For
areas where two-way cable is not yet available, the Company deploys a telephone
return solution, which uses the cable infrastructure for high-speed downstream
transmission and telephone dial-up access for upstream transmission. To use the
ISP Channel via cable modem, residential and business subscribers need a
personal computer with at least a 66 MHz, 486 or equivalent microprocessor and
16 megabytes of main memory. When compatible set-top boxes become widely
available, the Company plans to deliver its high-speed Internet access through
televisions.
Residential. All ISP Channel subscribers are provided an e-mail address,
roaming services, access to unique newsgroups and chat services and personal Web
space as part of their monthly fee. Additionally, the Company provides a
co-branded "cable affiliate/ISP Channel/Excite" default home page that allows
each subscriber to personalize his or her portal to the Internet. Monthly
service charges are currently as low as $39 for flat rate residential service,
with installation charges of approximately $99. The retail price of cable modems
currently ranges from $179 to $349.
Business. The Company's business solutions include Internet and intranet
services over existing cable infrastructure and traditional telephone data lines
when necessary. The Company provides its cable affiliates the ability to offer
local telecommuters, SOHO subscribers and business customers a comprehensive
selection of Internet and corporate local area network ("LAN") access for
employees in the office, and virtual private network ("VPN") and remote local
area network ("RLAN") applications, which extend corporate network access to
remote employees and external organizations, including business partners,
suppliers and customers. The Company's future business services are expected to
include on-line software distribution, secure high-speed data storage
facilities, international roaming services and office-to-office IP telephony.
Prices vary significantly depending on functionality and speed.
On-line Services.
The Company's content and programming services enhance the subscriber's
on-line experience by aggregating local and national content through a national
co-branding agreement with Excite. The Company's network architecture and local
cable headend caching and collaborative server functionality facilitate the
distribution of multimedia applications, including multi-player games, video
conferencing and multicast video applications, as well as local and national
advertising.
National Content Aggregation. The Company has entered into a joint venture
with Excite to provide co-branded ISP Channel/Excite content aggregation,
directory and search services. The co-branded content incorporates a custom
on-line presence for the cable affiliate, including on-line cable schedules,
pay-per-view and, in the future, bill payment options. Personalization also
allows a subscriber to use the co-branded ISP Channel/Excite "push" technology
to create a customized default page incorporating the subscriber's interests,
including local and national news, weather, sports, stock portfolio, horoscope,
local city information and hundreds of other selections. In addition, the
co-branded "cable affiliate/ISP Channel/Excite" user interface provides a
simplified, intuitive navigation tool for the subscriber.
Local On-line Communities. The Company plans to develop and deploy local
on-line communities that target the interests of local residents, including
civic, commercial and education issues. The on-line communities provide a
graphical directory of local services, including shops, restaurants and events
currently not focused on by national, regional or city-wide content aggregation
services. As part of the local content strategy, the Company is developing local
on-line community conferencing forums under the name "LOCALE" to expand local
interests. Local on-line community conferencing forums include an on-line PTA to
foster better communications between parents and teachers and an online town
hall to provide residents a more timely method to communicate with city
officials. The Company also provides subscribers the ability for subscribers to
create their own online conferencing forums.
Video Conferencing and Collaborative Computing. Each of the Company's local
cable affiliate collaborative servers facilitates high-speed desktop video
conferencing (15-30 frames per second) and collaborative computing not feasible
using traditional Internet dial-up access methods. The local collaborative
server allows users to work on documents over the network while engaged in voice
and videoconferences. The Company provides an intuitive user interface that is
integrated into the browser to facilitate "single-click" conferencing to
individuals or groups.
Web Hosting Services. The Company provides a full complement of Web hosting
and server collocation. The Company's Virtual Merchant hosting service allows
businesses to create an online storefront using available software and receive
orders over the Internet in a matter of hours. Cost-effective Web hosting
packages target small business and are deployed in 24 to 48 hours. Commercial
extranet applications allow a business to let their customers or vendors access
their LANs using cable modems or dial-up facilities. Monthly charges for Web
hosting and collocation range from $25 to $1,500 per month depending on
bandwidth usage, number of inquiries (or "hits") per month and scripting and
database requirements.
Local and National Advertising. Through its cable affiliates, the Company
plans to offer the ability to bundle local Internet banner and multimedia
advertising with the existing cable video advertising sales efforts. Through the
Company's network architecture, local and national advertising content will be
stored in the Network Operating Center ("NOC") and replicated at the local cable
affiliate headend to enhance performance. The Company's network architecture
utilizes multicast routing to enable the efficient distribution of
Internet-based advertising, and video and audio content services from content
providers and the NOC to many ISP Channel subscribers simultaneously.
Development of New Services. As the Internet continues to evolve and
encompass additional applications, the Company plans to develop new products and
services targeted to this marketplace for the future. Such products and services
may include set-top box applications, Internet based telephony services
(sometimes called IP telephony), enhancements to the ISP Channel/Excite portal
and improved on-line communities.
Network Architecture
The Company's scalable, distributed network architecture links the
high-bandwidth capacity of the local cable infrastructure with leased nationwide
Internet backbone facilities from major telecommunications carriers, including
MCI, MFS and Sprint. The Company has designed its network to move content closer
to the subscriber (thereby increasing speed of access) and provide end-to-end
network management. The Company's backbone vendors provide it with scalable
Internet backbone capacity, and thereby enable the Company to respond quickly to
increases in demand, avoiding the need to build and maintain a parallel Internet
network.
Network Operations Center. The Company's NOC, which includes a network of
highly redundant servers, network management systems and broadband Internet
access facilities, manages core subscriber services, such as e-mail, newsgroups,
conferencing and chat facilities, and local content replication. The NOC
provides nationwide provisioning for all subscriber services, whether the
customer registers at the local cable affiliate's business office, via a cable
affiliate personalized toll-free telephone number, or through an automated
online provisioning system. The Company is in the process of building a new
state-of-the-art facility to support the activities of a growing number of cable
affiliates and provide the maximum service availability that consumers and
commercial subscribers demand. To date, the Company has deployed one NOC in
Mountain View, California and plans to deploy regional data centers ("RDCs") as
justified by the geographic concentration of cable affiliates in order to reduce
operating and capital expenditures and to provide a level of network redundancy.
Local Content Replication. The Company's network architecture utilizes
content replication technologies to enhance the speed at which content is
delivered to subscribers and makes more efficient use of the cable affiliates'
local headend Internet connectivity by moving the requested information closer
to subscribers. By replicating frequently accessed content in storage servers
located in each cable affiliate's headend, the Company delivers large multimedia
files, including graphically rich Web pages and multimedia content, to numerous
local cable modem subscribers without frequent re-transmission over the
Internet.
Total Network Management. The Company utilizes a network of dedicated
servers to monitor connectivity and performance from the NOC to each online
cable affiliate headend and its respective cable modem subscribers. In addition,
the Company's NOC currently monitors over 250 independent routers and servers on
the Internet, including major backbone providers, major Internet service
providers ("ISPs"), frequently accessed Web sites, and major nationwide peering
and routing facilities across the country. The NOC allows the Company to
automatically reroute Internet traffic to maintain subscriber cable modem
performance despite regional Internet congestion and backbone outages.
Redundant Leased Backbone Facilities. The Company connects cable affiliate
headends to the Internet via facilities leased from MCI, MFS, Sprint and others.
By utilizing multiple providers, the Company can assure maximum network
availability while enhancing the routing efficiency of cable modem subscribers'
Internet requests. National network agreements allow the Company to provide
scalable local connections to its cable affiliates. The Company's network
architecture facilitates high performance, rapid cost-effective deployment
independent of location and software scalability for responsive additions to
network capacities.
Cable Affiliate Headends. Affiliated cable system headends are connected to
the Internet and in turn the NOC through the Company's leased backbone
facilities. Each Internet connection utilizes a high performance router
supporting speeds up to 45 Mbps, which can be upgraded to 155 Mbps as required.
Currently, the Company is deploying headend equipment from 3Com and Com21. In
addition, the Company purchases telephone access lines to support local dial-up
Internet access services or dial-up return for one-way cable systems. The
Company actively monitors its dial-up facilities and purchases additional lines
as necessary to meet subscriber demand. The Company installs servers into the
cable affiliate headend to support local caching, collaborative and IP telephony
functions. Local collaborative servers facilitate desktop video conferencing and
collaborative document sharing. The Company has been evaluating technology from
several IP telephony vendors and plans to deploy IP telephony servers to
facilitate IP telephony services through the Company's network.
Cable Modems and Television Set-Top Boxes. Residential subscribers can
connect to the Internet over the local cable infrastructure using a cable modem
and, in the future will be able to connect via an integrated television set-top
box. In the case of cable modems, the coaxial cable is connected to the cable
modem and the cable modem is connected to an Ethernet card installed in a
subscriber's PC. Internal cable modem PC cards do not require the Ethernet card
installation. In the case of television based high-speed Internet access, the
coaxial cable is attached directly to the set-top box. The Company currently
provides a custom installation CD that allows a cable modem subscriber to choose
either Microsoft Internet Explorer or Netscape Navigator, along with a selection
of popular utility programs. The Company currently uses cable modems
manufactured by 3Com and Com21.
Sales and Marketing
To Cable Operators.
The Company markets its services through the establishment of exclusive
relationships with cable operators whose systems are primarily located in
secondary and tertiary markets and bedroom communities of major DMAs. The
Company uses its seven person sales force with offices in Atlanta, Georgia,
Bethesda, Maryland, Chicago, Illinois, Denver, Colorado and Los Angeles and
Mountain View, California to market the ISP Channel. This sales force targets
the corporate offices of national and regional multiple system operators
("MSOs"). The sales force employs a team-selling approach targeting key
management, marketing and engineering personnel within each cable system. The
Company participates in three national industry trade shows, the Atlantic, NCTA
and Western, in addition to 17 state-sponsored local cable industry trade shows.
The Company began offering telephone-based Internet services in June 1996
and cable-based Internet services in the fourth quarter of fiscal 1997. As of
December 31, 1998, the Company had contracts for its ISP Channel service with 28
cable operators, including Galaxy, Palo Alto Cable Co-op and Coral Springs
Cable, representing 119 cable systems and approximately 1.4 million homes
passed. Nineteen of these systems, representing approximately 216,000 homes
passed, have been equipped and have begun offering the Company's services, in
most cases during the past three months. In addition, the Company has
non-binding letters of intent with ten cable operators, including 39 systems,
representing approximately 359,000 homes passed. As of December 31, 1998, the
Company had approximately 1,250 residential and business subscribers to its ISP
Channel service, plus approximately 500 customer orders in backlog. The Company
also provides non-cable based dial-up and dedicated Internet access to
approximately 1,100 residential and business subscribers.
The Company has a revenue sharing arrangement with its cable affiliates
pursuant to which a cable affiliate generally receives 25% of Internet services
revenue for the first 200 ISP Channel subscribers on a cable system and
approximately 50% of such revenues thereafter. In addition, the Company has
adopted an affiliate incentive program whereby certain cable operators have been
offered either cash or shares of common stock as an incentive to sign an
exclusive contract with the Company for the provision of Internet services to
their cable systems. It is the Company's intention, however, that the affiliate
incentive program will only offer common stock beginning January 1, 1999. The
Company has reserved up to 19.9% of its outstanding common stock as of May 29,
1998 for issuance to cable affiliates under this program. The number of shares
of common stock that may be paid to any individual cable affiliate will depend
on a variety of factors, including the number and size of the cable systems
covered by a contract with an MSO, the number of homes passed and the number of
cable subscribers in a system, the services provided by the Company and the
length of exclusivity of the contract. These incentive payments are expected to
range between $2.00 and $5.00 worth of stock per home passed, based on the fair
market value of the common stock at the time a letter of intent or definitive
agreement is entered into with a cable affiliate, depending upon the various
factors described above. The Company may issue stock or pay cash incentives at
the time a contract is entered into, or it may place the stock or cash incentive
amounts in escrow to be disbursed as cable systems are deployed.
To Internet Subscribers.
Through Cable Affiliates. The Company's agreements with its cable
affiliates provide the Company a conduit to reach potential subscribers. Cable
affiliates provide the Company with television advertising time and the ability
to include material describing the Company's services in bills mailed to cable
subscribers. The Company creates all of the content to be included in such
marketing efforts. The Company has produced an infomercial and is planning to
produce 30 and 60 second commercials to be aired by cable operators.
Direct to the Public. The Company markets directly to homes and businesses
in its cable affiliates' franchise areas through telemarketing, direct mail,
door hangers, and local event marketing. In addition, the Company telemarkets to
existing cable subscribers using the cable affiliate's current subscriber list.
Agreement with Excite
The Company's agreement with Excite creates a strategic relationship
between the companies that will promote the development and national presence of
the Company. Under the agreement, Excite designs, creates and promotes Web pages
for its "Excite Search" and "My Excite Channel" services that display the names
of both the Company and Excite to ISP Channel subscribers. Excite has sole
responsibility for providing and maintaining, at its expense, the resulting Web
portal. The Company is responsible for incorporating the co-branded My Excite
Channel service as a default home page for, or display a link to the co-branded
My Excite Channel service on, the ISP Channel or any personalized service
application.
Excite will sell advertising on the co-branded pages, and will create at
least one promotional space within its service that may be sold by the Company
or its cable affiliates. Excite and the Company will share a portion of the
advertising revenues received from banner advertising that appears on co-branded
pages. Under the terms of the agreement between the Company and its cable
affiliates, the Company may, in turn, share a portion of such revenue with its
cable affiliates.
Customer Care and Billing
As part of the Company's strategy to leverage local cable affiliates' brand
identities, the Company is developing a comprehensive provisioning, billing and
customer care system that allows for its services to be individualized and
co-branded for each cable affiliate system. The Company has entered into
contracts with PeopleSoft, Inc. ("PeopleSoft") (a billing system vendor),
Clarify Inc. ("Clarify") (a customer care system vendor) and Aspect
Telecommunications ("Aspect") (a call center system vendor) to design and
implement an integrated, flexible and scalable solution. The Company's Customer
Care Center ("CCC") is being designed to provide customer service from a central
care center located in Mountain View, California. The CCC will provide
individualized toll-free support for each affiliated cable system for pre-sales
information and through which subscribers can coordinate all services including
provisioning, billing and technical support. Additionally, the Company will
provide cable affiliates with the ability to access individualized Web-based
reporting and call monitoring for all customer care service including
telemarketing, sales and technical support.
Provisioning. The Company today provisions service by means of an
individualized toll-free number with personalized answering for each cable
affiliate system. The Company is in the process of implementing an on-line
provisioning system using the PeopleSoft billing platform that will enable a
subscriber to purchase a cable modem in a retail location or at the cable
affiliate's business office and register and provision the service on-line 24
hours per day. The on-line services will include provisioning, Web-based or
e-mail bill presentation and Web-based service modification.
Billing. The Company currently provides the ability for cable affiliates or
the Company to be responsible for billing and collection. If any cable affiliate
elects to bill ISP Channel subscribers within its franchise area, the Company
maintains a duplicate subscriber record in its system for provisioning and
reconciliation. If the Company provides the billing and collection services, the
Company provides the bill delivery via e-mail and settles accounts
electronically via major credit cards, debit cards or electronic check cashing
services.
Technical Support. The CCC currently utilizes a state of the art digital
private telephone exchange ("PBX") and Automatic Call Distribution ("ACD")
system to provide full-time individualized technical support for each cable
affiliate system. The Company is currently implementing a new Aspect ACD system
accompanied by Clarify's customer care software allowing a subscriber's
information and history to be presented to a technical support representative in
conjunction with each call. The Company's "knowledge base system" facilitates
expedient trouble shooting and historical reporting on an individualized cable
system basis delivered to cable affiliates in real-time through a Web-based
interface or monthly via e-mail.
Vendor Relationships
In addition to the relationships that the Company has with Excite, MCI, MFS
and Sprint, the Company currently depends on a limited number of other suppliers
for certain key technologies used to provide Internet related services. In
particular, the Company depends on 3Com Corporation and Com21, Inc.for headend
and cable modem technology and Cisco Systems, Inc. for network routing and
switching hardware.
Competition
The Company faces competition in two broad areas: (i) competition for
partnerships with cable operators from other cable modem-based providers of
Internet access services, and (ii) competition from other types of providers of
Internet services.
Even if a consumer believes that cable-based Internet access is the best
method of accessing the Internet, the consumer may not be able to obtain this
service from the Company unless the consumer lives in an area serviced by a
cable operator that has partnered with the Company. Thus, an additional and
important class of competition could come from companies which seek to partner
with cable operators and offer to equip these cable systems with Internet access
capability or to manage the cable operator's Internet services or from cable
operators who decide not to choose a partner but rather to build their own
Internet service themselves.
National Cable Modem Service Providers. Competitive cable modem service
providers such as @Home and RoadRunner (and their respective cable partners) are
deploying high-speed Internet access services over HFC cable networks. Where
deployed, these networks provide similar services to those offered by the
Company. These providers and their MSO affiliates have substantially greater
financial and operational resources than the Company and may accordingly be able
to deploy their service more rapidly and aggregate content more effectively than
the Company. In addition, such competitive providers enjoy an inherent advantage
in marketing their services to their MSO affiliates by virtue of such
affiliations.
System Integrators. Companies like Convergence.com, HSAnet, OSS and the
GlobalCenter service of Frontier Communications offer their services to cable
operators to assist these cable operators in upgrading their systems to carry
Internet and Web-based applications. These companies initially charged cable
operators for their technical services, but recently some have adopted a
partnership model similar to the Company's in which the systems integrator will
absorb the cost of the technical upgrading of the system and the integrator and
the cable operator will share revenues.
There are many competing technologies for delivering Internet access to
homes and businesses which compete with the Company's ISP Channel. The number of
such competing technologies is growing and the Company expects that competition
will intensify in the future. The Company's competitors comprise several
categories of providers of Internet services: incumbent local exchange carriers
("ILECs") , interexchange carriers ("IXCs"), competitive local exchange carriers
("CLECs"), ISPs, online service providers (" OSPs"), wireless and satellite data
service providers and digital subscriber line ("DSL") focused CLECs.
Many of these competitors are offering (or may soon offer) technologies and
services that will directly compete with the ISP Channel. Such technologies
include integrated services digital network ("ISDN"), DSL and wireless data.
Certain bases of competition in the Company's markets include transmission
speed, reliability of service, breadth of service availability,
price/performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital availability
and exclusive contracts. The Company believes that it compares unfavorably with
its competitors with regard to, among other things, brand recognition, operating
experience, exclusive contracts, and capital availability. Many of the Company's
competitors and potential competitors have substantially greater resources than
the Company and there can be no assurance that the Company will be able to
compete effectively in its target markets.
Each of these classes of competitors is detailed below:
ILECs. All of the largest ILECs that are present in the Company's target
markets are conducting technical and/or market trials of DSL-based data
services. In addition, at least three regional Bell operating companies
("RBOCs") have sought Federal Communications Commission ("FCC") approval to
provide DSL-based data services across local access and transport area ("LATA")
boundaries prior to the date on which the RBOC is permitted to provide
long-distance voice service across such boundaries. The RBOCs' requests are
being challenged at the FCC by competitors. As they move forward in implementing
DSL-based data services (and secure any additional needed regulatory approvals),
the RBOCs and other ILECs will represent strong competition in all of the
Company's target service areas. The ILECs have an established brand name and
reputation for high quality in their service areas, possess sufficient capital
to deploy DSL equipment rapidly, have their own copper lines and can bundle
digital data services with their existing analog voice services to achieve
economies of scale in serving customers.
National Long Distance Carriers. IXCs, such as AT&T, Sprint and WorldCom
have deployed large-scale Internet access networks, sell connectivity to
businesses and residential customers and have high brand recognition. They also
have interconnection agreements with many of the ILECs, and those agreements may
include collocation spaces from which they could begin to offer DSL services
competitive with the ISP Channel. On June 24, 1998, AT&T and TCI announced their
intention to merge. Such a merger, if consummated, would allow AT&T to provide
Internet services using TCI's cable infrastructure and would give AT&T a
significant economic and voting interest in @Home.
Fiber-Based CLECs ("FCLECs"). FCLECs such as Intermedia Communications
Group, Inc. ("Intermedia") and ICG Communications, Inc. ("ICG") have extensive
fiber networks in many metropolitan areas primarily providing high-speed digital
and voice circuits to large customers. Some FCLECs have announced plans to offer
DSL services competitive with the ISP Channel in many markets targeted by the
Company. These companies could modify their current business focuses to include
residential and small business customers using cable-based access or DSL in
combination with their current fiber networks.
Internet Service Providers. ISPs such as BBN (acquired by GTE Corporation),
UUNET Technologies, Inc. (acquired by WorldCom), Earthlink, Concentric Network
Corporation, MindSpring, Netcom (acquired by ICG) and PSINet, Inc. provide
Internet access to residential and business customers, generally using the
existing public switched telephone network at ISDN speeds or below. Some ISPs
such as HarvardNet Inc. in Massachusetts, InterAccess in Illinois and Vitts
Corporation in New Hampshire have begun offering DSL-based services. Additional
ISPs could become DSL service providers competitive with the Company.
Online Service Providers. OSPs include companies such as America Online
("AOL"), Compuserve (acquired by AOL), MSN (a subsidiary of Microsoft Corp.),
Prodigy, Inc., WorldGate Inc. ("WorldGate") and WebTV (acquired by Microsoft
Corp.) that provide, over the Internet and on proprietary online services,
content and applications ranging from news and sports to consumer video
conferencing. These services are designed for broad consumer access over
telecommunications-based transmission media, which enable the provision of
digital services to the significant number of consumers who have personal
computers with modems. In addition, they provide Internet connectivity, ease of
use and consistency of environment. Many of these OSPs have developed their own
access networks for modem connections. If these OSPs were to extend their access
networks to cable-based access or DSL, they would be competitors of the Company.
Wireless and Satellite Data Service Providers ("WSDSPs"). WSDSPs are
developing wireless and satellite-based Internet connectivity. The Company may
face competition from terrestrial wireless services, including, two Gigahertz
("GHz") and 28 GHz wireless cable systems, multichannel multipoint distribution
service ("MMDS") and local multipoint distribution service ("LMDS"), and 18 GHz
and 39 GHz point-to-point microwave systems. For example, the FCC is currently
considering new rules to permit MMDS licensees to use their systems to offer
two-way services, including high-speed data, rather than solely to provide
one-way video services. The FCC also recently awarded LMDS licenses, which can
be used for high-speed data services as well. In addition, companies such as
Teligent, Inc., Advanced Radio Telecom Corp. and WinStar Communications, Inc.
hold point-to-point microwave licenses to provide fixed wireless services such
as voice, data and videoconferencing.
The Company also may face competition from satellite-based systems.
Motorola Satellite Systems, Inc., Hughes Space and Communications Group (a
subsidiary of General Motors Corporation), Teledesic and others have filed
applications with the FCC for global satellite networks which can be used to
provide broadband voice and data services.
In January 1997, the FCC allocated 300 MHz of spectrum in the 5 GHz band
for unlicensed devices to provide short-range, high-speed wireless digital
communications. These frequencies must be shared with incumbent users without
causing interference. Although the allocation is designed to facilitate the
creation of new wireless LANs, it is too early to predict whether users of these
frequencies could become competitors of the ISP Channel.
DSL-focused CLECs. Certain companies, such as Covad Communications Group
("Covad") and Rhythms NetConnections, Inc. have obtained CLEC certification and
are offering high-speed data services using a strategy of collocating in ILEC
central offices. The 1996 Act specifically grants any and all CLECs the right to
negotiate interconnection agreements with the ILEC providing for such
collocation.
Federal Regulation
Internet Regulation
The Company's Internet services are not currently subject to direct
regulation by the FCC or any other governmental agency. However, it is possible
that new laws and regulations may be adopted that would subject the provision of
the Company's Internet services to government regulation. Certain other
legislative initiatives, including those involving taxation of Internet services
and payment of access charges by ISPs, are also possible. Any new laws regarding
the Internet, particularly those that impose regulatory or financial burdens,
could impact adversely the Company's ability to provide various services and
could have a material adverse effect on the Company's results of operations and
financial condition. The Company cannot predict the impact, if any, that any
future laws or regulatory changes may have on its business.
The introduction of, or changes to, regulations that directly or indirectly
affect the regulatory status of Internet services, affect telecommunications
costs (including the application of reciprocal compensation requirements, access
charges or universal service contribution obligations to Internet services), or
increase the competition from regional telecommunications companies or others,
could have a material adverse effect on the Company's results of operations and
financial condition. For instance, if the FCC determines, through any one of its
ongoing or future proceedings, that the Internet is subject to regulation, the
Company could be required to comply with a number of FCC entry/exit regulations,
reporting, fee, and record-keeping requirements, marketing restrictions, access
charge obligations, and universal service contribution obligations, which could
adversely impact the Company's ability to provide various planned services and
have a material adverse effect on the Company's results of operations and
financial condition. The Company cannot predict the impact, if any, that
regulations or regulatory changes may have on its business. A final
determination by the FCC that providing Internet transport or telephony services
to customers over an IP-based network is subject to regulation also could impact
adversely the Company's ability to provide various planned services and could
have a material adverse effect on the Company's results of operations and
financial condition.
Since Internet services are a relatively recent phenomenon, the legal and
regulatory framework is still in its nascent state of development. The evolving
state of law and regulation is reflected in the FCC's April 10, 1998 Report to
Congress (the "April Report"). In the April Report, the FCC discussed whether
ISPs should be classified as telecommunications carriers, and, on that basis, be
required to contribute to the USF. The April Report concluded that Internet
access service-which the FCC defined as an offering combining computer
processing, information storage, protocol conversion, and routing
transmissions-is an "information service" under the Telecommunications Act of
1996 and thus not subject to regulation. In contrast, the FCC found that the
provision of transmission capabilities to ISPs and other information services
providers do constitute "telecommunications services" under the
Telecommunications Act of 1996. Consequently, parties providing those
telecommunications services are subject to current FCC regulation (and the
corresponding USF obligations).
Another major and unresolved regulatory issue concerns the obligation of
ISPs to pay access charges to ILECs. A proceeding has been pending before the
FCC since December 1996 that raises the issue whether ILECs can assess
interstate access charges on information service providers, including ISPs.
Unlike "basic services," "enhanced services," which are generally analogous to
"information services" and include Internet access services, are exempt from
interstate access charges. The FCC concluded that that exemption for information
services (including Internet access) should remain in place pending the outcome
of the proceeding. On a more general level, the FCC has questioned the
efficiency of the access charge regime and whether access charges- originally
designed in the context of wireline voice services-should be extended to ISPs,
even if it is ultimately concluded that they are telecommunications carriers.
Another major and unresolved regulatory proceeding that could affect the
benefit and cost of the Company's service offerings (to the extent the Company
becomes involved in the exchange of traffic), involves "reciprocal
compensation." Reciprocal compensation relates to the fees paid by one carrier
to terminate traffic on another carrier's network. In July 1997, the FCC was
petitioned to clarify its rules on whether CLECs that serve ISPs are entitled to
reciprocal compensation under the Telecommunications Act of 1996 for calls
originated by customers of an ILEC to an ISP served by a CLEC within the same
local calling area. The ISPs and CLECs believe that such calls are subject to
reciprocal compensation when they originate and terminate within the same local
calling area. In contrast, the ILECs believe that all such calls are interstate
in nature and are not subject to reciprocal compensation. Although the FCC has
not yet resolved the issue, every state that has addressed the issue from an
intrastate perspective (at least fifteen in number) has determined that calls to
ISPs are to be treated as local for purposes of reciprocal compensation.
Resolution of reciprocal compensation issues could increase ISP costs by
increasing telephone charges if the FCC takes a position contrary to the states'
position, and thereby requires states to reverse course.
Another major regulatory issue concerns Internet-based telephony. In the
April Report, the FCC observed that Internet-based telephone service (which the
FCC called "IP telephony") appears to be a telecommunications service rather
than an unregulated information service. The FCC explained that it would
determine on a case-by-case basis whether to regulate the service and thereby
require providers of IP telephony to contribute to the USF. The FCC did not
address the regulatory status of cable system facilities used to provide
Internet access or the USF obligations of cable systems providing such access.
The ultimate resolution of issues concerning cable system provision of Internet
access, as well as IP telephony issues, could affect the regulatory status,
cost, and other aspects of the Company's service offerings. The Company could
also be affected in a material adverse way by federal and state laws and
regulations relating to the liability of on-line services companies and Internet
access providers for information carried on or disseminated through their
networks. Several private lawsuits seeking to impose such liability upon on-line
services companies and Internet access providers are currently pending. In
addition, legislation has been enacted and new legislation has been proposed
that imposes liability for the transmission of or prohibits the transmission of
certain types of information on the Internet, including sexually explicit and
gambling information. The imposition of potential liability on the Company and
other Internet access providers for information carried on or disseminated
through their systems could require the Company to implement measures to reduce
its exposure to such liability, which may require the Company to expend
substantial resources or to discontinue certain service or product offerings.
The increased attention to liability issues as a result of these lawsuits and
legislative actions and proposals could impact the growth of Internet use. While
the Company carries professional liability insurance, it may not be adequate to
compensate claimants or may not cover the Company in the event the Company
becomes liable for information carried on or disseminated through its networks.
Any costs not covered by insurance incurred as a result of such liability or
asserted liability could have a material adverse effect on the Company's results
of operations and financial condition, its ability to meet its obligations under
the Notes and the value of the Warrants and the Warrant Shares.
State Regulation
As use of the Internet has proliferated in the past several years, state
legislators and regulators have increasingly shown interest in regulating
various aspects of the Internet. Much of the legislation that has been proposed
to date may, if enacted, handicap further growth in the use of the Internet. It
is possible that the state legislatures and regulators will attempt to regulate
the Internet in the future, either by regulating transactions or by restricting
the content of the available information and services. Enactment of such
legislation or adoption of such regulations could have a material adverse impact
on the Company.
One area of potential state regulation concerns taxes. A significant number
of bills have been introduced in state legislatures that would tax commercial
transactions on the Internet. For its part, the United States Congress is
currently considering federal legislation to impose a moratorium on state
Internet taxes for a fixed number of years until a coherent policy could be
developed for state Internet taxation, or, in the alternative, to establish
model rules that could govern tax regulation by all states. Future laws or
regulatory changes that lead to state taxation of Internet transactions could
have a material adverse impact on the Company.
Although customer-level use of the Internet to conduct commercial
transactions is still in its infancy, a growing number of corporate entities are
engaging in Internet transactions. This Internet commerce has given rise to a
number of legal and regulatory issues, such as (i) whether and how certain
provisions of the Uniform Commercial Code (adopted by 49 states) apply to
transactions carried out on the Internet and (ii) how to decide which
jurisdiction's laws are to be applied to a particular transaction. It is not
possible to predict how state law will evolve to address new transactional
circumstances created by Internet commerce, or whether the evolution of such
laws will have a material adverse impact on the Company.
State legislators and regulators have also sought to restrict the
transmission or limit access to certain materials on the Internet. For example,
in the past several years, various state legislators have sought to limit or
prohibit: (i) certain communications between adults and minors, (ii) anonymous
and pseudonymous use of the Internet, (iii) on-line gambling, and (iv) the
offering of securities on the Internet. Enforcement of such limitations or
prohibitions in some states could affect transmission in other states. State
laws and regulations that restrict access to certain materials on the Web could
inadvertently block access to other permissible sites. The Company cannot
predict the impact, if any, that any future laws or regulatory changes in this
area may have on its business.
Some states have also sought to impose tort liability or criminal penalties
on various conduct involving the Internet, such as the use of "hate" speech,
invasion of privacy, and fraud. The adoption of such laws could adversely impact
the transmission of non-offensive material on the Internet and, to that extent,
possibly have a material adverse impact on the Company's business.
The Company anticipates that it may in the future seek to offer
telecommunications service as a CLEC. All states in which the Company operates
require a certification or other authorization from the state regulatory
commission to offer intrastate telecommunications services. Many of the states
in which the Company operates are in the process of addressing issues relating
to the regulation of CLECs. Some states may require authorization to provide
enhanced services.
The Telecommunications Act contains provisions that prohibit states and
localities from adopting or imposing any legal requirement that may prohibit, or
have the effect of prohibiting, the ability of any entity to provide any
interstate or intrastate telecommunications service. The FCC is required to
preempt any such state or local requirements to the extent necessary to enforce
the Telecommunications Act's open market entry requirements. States and
localities may, however, continue to regulate the provision of intrastate
telecommunications services and require carriers to obtain certificates or
licenses before providing service.
In states where the Company operates, rulemaking proceedings, arbitration
proceedings and other state regulatory proceedings that may affect the Company's
ability to compete with ILECs are now underway or may be instituted in the
future. These proceedings involve a variety of telecommunications issues,
including but not limited to: pricing and pricing methodologies of local
exchange and intrastate interexchange services; development and approval of
resale agreements between ILECs and CLECs and among CLECs; terms and conditions
governing the provision of telecommunications services; customer service and
unauthorized changes in customer-selected telephone service providers;
complaints regarding anticompetitive practices and transactions between
affiliated telecommunications companies; denial of entry into telecommunications
markets; discount levels for resale of local exchange and toll services;
treatment of and compensation for calls to Internet service providers; charges
for access to ILEC networks; cost sharing and implementation of interim and
permanent number portability; dialing parity; access to and responsibility for
universal service funding; and review and recommendation to the FCC concerning
RBOC authorization to offer in-region long distance service. To the extent the
Company decides in the future to install its own transmission facilities,
rulemaking proceedings, arbitration proceedings and other state regulatory
proceedings may also affect the Company's ability to compete with ILECs. These
proceedings may involve issues including but not limited to: collocation of ILEC
and CLEC facilities; interconnection agreements between ILECs and CLECs; and
access to unbundled and combined network elements of ILECs. In addition, states
in which the Company operates may consider legislation that involves issues
including but not limited to: any of the aforementioned issues in rulemaking
proceedings, arbitration proceedings and other state regulatory proceedings;
alternative forms of regulation; and limitations on the provision of competitive
telecommunications services.
Local Regulation
Although local jurisdictions generally have not sought to regulate the
Internet, it is possible that such jurisdictions will seek to impose regulations
in the future. In particular, local jurisdictions may attempt to tax various
aspects of Internet access or services, such as transactions handled through the
Internet or subscriber access, as a way of generating municipal revenue. The
imposition of local taxes and other regulatory burdens by local jurisdictions
could have a material adverse impact on the Company.
The Company's networks may also be subject to numerous local regulations
such as building codes and licensing. Such regulations vary on a city by city
and county by county basis. To the extent the Company decides in the future to
install its own transmission facilities, it will need to obtain rights-of-way
over private and publicly owned land. There can be no assurance that such
rights-of-way will be available to the Company on economically reasonable or
advantageous terms.
The foregoing discussion of regulatory factors does not describe all laws,
regulations, or restrictions that may apply to the Company. Nor does it review
all laws or regulations under consideration by federal and state governmental
bodies that may affect the Company's operations. It is possible that present and
future laws and regulations not discussed here could have a material adverse
effect on the Company's results of operations and financial condition, its
ability to meet its obligations under the Notes and the value of the Warrants
and the Warrant Shares.
Backlog
As of December 31, 1998, the ISP Channel had 28 signed contracts
representing 119 cable systems and approximately 1.4 million homes passed.
Nineteen of these systems, representing over 216,000 homes passed, have been
equipped and have begun offering the Company's services. One hundred of these
systems, representing approximately 1.2 million homes passed, are in backlog. As
of December 31, 1998, the Company had approximately 1,250 residential and
business subscribers to its ISP Channel service, plus approximately 500 customer
orders in backlog.
Employees
As of December 31, 1998 the Company had eight full-time employees at its
corporate headquarters. The ISP Channel had 86 employees.
Micrographic Technology Corporation
As part of its new focus, the Company has signed a letter of intent to sell
MTC which, because of its size in relation to the Company's overall assets and
because of the concurrent sale of the Company's telecommunications business,
KCI, is subject to approval of the Company's shareholders. The Board of
Directors of the Company intends to submit a proposal to sell MTC together with
its recommendation in favor of such proposal to the Company's shareholders at
its 1999 annual meeting of shareholders and has no reason to believe that such
proposal will not be approved. Because such sale is subject to approval of the
Company's shareholders and the execution of definitive agreements, however, the
sale of MTC is not reflected herein as a discontinued business.
MTC designs, develops, and manufactures sophisticated, automated electronic
document management and film-based imaging solutions for customers with
large-scale, complex, document-intensive requirements. MTC's hardware and
software products are based on an industry standard client-server architecture,
providing flexibility to connect to a wide variety of information systems and
produce output to various storage media, including optical disk, magnetic disk
and tape, CD-ROM, and microfilm and microfiche, spanning the entire document
lifecycle. MTC manufactures a family of Computer Output to Microfilm ("COM")
production systems, from which it has historically derived the majority of its
revenues. MTC's proprietary software captures information from a variety of
sources, then intelligently indexes and directs the data for storage,
distribution and retrieval. MTC expects that its business will increasingly be
focused on the distribution and retrieval of electronically captured information
over a variety of communications media, such as the Internet, LANs and wide area
networks ("WANs"). To this end, MTC is pursuing a strategy of partnering with
providers of features or elements that enhance MTC's electronic data
distribution solutions.
Products and Services
MTC's products consist of a variety of electronic and film-based solutions.
Electronic Solutions
Information Distribution System. The integrated IDS software solution
allows users to automatically collect, organize and transport information to the
print or storage media of choice, enhancing the productivity and cost efficiency
of computer output and storage operations. The following product options
comprise MTC's IDS solution:
Information Distribution System Executive ("IDS EXEC"). The IDS EXEC
software product integrates input, management, execution and reporting
activities under a single point of control, improving efficiency. The IDS
EXEC console manages all data input, job resources, job prioritization and
production, tracks job status and reports audit and job statistics. The IDS
EXEC also intelligently indexes source information for convenient and
timely retrieval irrespective of the storage medium. Additionally, IDS EXEC
makes it possible to reorder images submitted in one sequence to any other
logical ordering sequence specified by the user. Finally, the IDS EXEC
platform contains a variety of Internet-specific applications that offer
its users Internet-based data input and document viewing.
Document Organizer. Document Organizer is a client/server-based
bundling system that analyzes documents and organizes them for production.
Document Organizer arranges large-scale print applications, such as bank
statements or insurance policies, according to the customer's distribution
and retrieval requirements. This allows customers to deliver their
important information according to priority, production process, and
delivery schedule.
Page Handler. Page Handler is a high-speed electronic page-print
interpreter that accepts mainframe print application input which it then
transforms into a variety of output formats, including Internet-compatible
formats, providing the customer with added flexibility as application needs
change.
Computer Output to Laser Disk ("COLD") Integration. MTC is a value-
added reseller of integrated COLD solutions for document management.
Film-Based Solutions
MTC's film-based imaging systems, an alternative to paper and long-term
electronic storage, convert scanned or digital information directly from a
computer or magnetic tape to an analog format for archiving on microfilm or
microfiche. MTC's film-based solutions include:
COM Systems. MTC is a leading manufacturer of automated "cut fiche"
recording and duplicating systems and related software. MTC's COM systems
provide an architectural platform that has universal capability to transfer any
data format to fiche. A key differentiating factor of MTC's COM system is its PC
based client-server architecture. MTC's RAPID 16 millimeter microfilm product
will be released for beta testing in the fourth quarter of fiscal 1998.
Other. MTC offers a complete line of original and duplicate microfilm and
chemicals for use in its COM printer and duplicator systems. MTC acquires a
significant portion of its microfilm and media supplies from Eastman Kodak and
sells them on a drop-ship basis. MTC also supplies spare parts for the worldwide
maintenance of its installed COM user base. Maintenance is subcontracted to
third party organizations, for which MTC receives a monthly royalty.
Customers
MTC markets its products and services principally to high-volume
document-intensive organizations, such as banks, brokerages and other financial
services companies and document-based service providers. Other customers include
businesses primarily in the healthcare industry and government agencies who
desire to use imaging technology to archive large quantities of documents.
Current customers include over 50 service bureaus and organizations such as
Equifax Inc., the Federal Aviation Administration, the Deutsche Bundesbank,
Deutsche Bank AG, Royal Bank of Scotland Group plc, the United States Marine
Corps, and Xerox Corporation.
Competition
The document management industry is highly competitive and rapidly
changing. MTC competes on the basis of breadth of offering, cost, flexibility
and customer service. MTC's strategy of designing its software solutions around
an open architecture has allowed its existing solutions to be more readily
adaptable to changes in the computer industry and more readily acceptable by new
technologies. MTC believes that these intelligent software platforms give its
overall document management solutions a competitive advantage.
MTC has two direct competitors to its hardware products: Agfa, AG in Europe
and Anacomp worldwide. Indirect competitors include IBM, Fuji, Mobius Management
Systems, Inc., Storage Technology and others. In most cases, MTC's competitors
have longer operating histories, greater name recognition, and significantly
greater financial, technical and marketing resources than MTC. While MTC is not
aware of any direct competitors to its software product offerings, the industry
is rapidly evolving and MTC may face significant competition in the future.
Sales and Marketing
MTC markets its document management solutions and services worldwide. In
the United States, MTC employs a six person direct sales force. Internationally,
MTC uses a network of exclusive distributors .
In order to increase its competitive advantage in certain markets, MTC has
developed a comprehensive leasing alternative for its customers. This leasing
alternative, commonly referred to as a price per fiche program ("PPF"), is a
bundled COM service solution that involves a monthly lease payment based upon
the customer's actual monthly microfiche production, a minimum monthly
production provision and lease terms of typically three to five years. In order
to meet the changing needs of its customers' financing requirements, MTC intends
to increase its emphasis on PPF programs. MTC is currently negotiating with its
international distributors, along with several institutions that have a global
financing presence, to develop similar PPF programs for international markets.
MTC's electronic and film-based imaging hardware systems typically range in
price between $200,000 and $1,000,000, and may represent a significant capital
commitment by MTC's customers, leading to a lengthy sales cycle of up to 24
months. Accordingly, MTC's operating results may fluctuate significantly from
period to period.
Suppliers
MTC purchases the raw materials needed for both its manufacturing and spare
part supply operations from various third party vendors. MTC believes that it
can source these purchased parts from a variety of competing vendors and that no
single vendor possesses a critical component that cannot be purchased elsewhere.
MTC currently subcontracts its maintenance services to third party
organizations.
MTC purchases a significant amount of its microfilm and media supplies from
Eastman Kodak. MTC believes it has a strong partnership with Eastman Kodak and
the two parties are currently operating under a signed vendor agreement
extending through December 31, 2000. Alternative suppliers are available to MTC,
however, in the event of an interruption in the vendor relationship.
Research and Development
MTC believes that its future revenue growth and profitability will
principally depend on its success in developing new products, services and
distribution channels. MTC expects to continue to evaluate new product and
service opportunities and engage in extensive research and development
activities. For the year ended September 30, 1997, MTC spent approximately $1.8
million on research and development efforts.
Employees
As of December 31, 1998, MTC had 66 full-time employees
Intelligent Communications, Inc.
Intelligent Communications Incorporated ("Intellicom") provides two-way
satellite Internet access options utilizing very small aperture terminal
("VSAT") technology. Intellicom focuses its sales penetration efforts on rural
markets, particularly ISPs, educational institutions and small businesses. In
addition to providing Internet access options, Intellicom provides
Internet-based applications, consulting services and full Internet services to
the marketplaces it serves. Intellicom's access options include both VSAT
dedicated and dial-up Internet access (including ISDN and direct network
connectivity). Intellicom's other products and services include Web server
hosting and integration services, client software development and maintenance
services, training and network integration and consulting services. Intellicom's
VSAT network infrastructure currently allows network connectivity throughout
North America. Intellicom's VSAT-based point of presence ("POP") locations can
be placed throughout the 48 lower states as well as in southern Canada and south
Alaska. Intellicom may provide its Internet services in the C-band satellite
arena in addition to its Ku-band offering. Many international satellites utilize
the C-band architecture and Intellicom expects to retrofit its equipment for
C-band coverage areas with little difficulty.
Intellicom's objective is to become the leading provider of complete
communications solutions using Internet and VSAT-related technologies to rural,
suburban and urban educational institutions, ISPs and private corporate
Intranets. As a national ISP, Intellicom provides a cost-effective alternative
for Internet services and solutions to rapidly growing Internet customer
networks. Intellicom has worked toward achieving this position by focusing on
building a high performance network infrastructure, integrating and expanding
its suite of value-added products and services, investing in its network
operations and technical support infrastructure, expanding and tailoring its
sales and marketing efforts to reach its targeted customers more effectively,
and building and leveraging relationships with strategic partners.
Products and Services
Intellicom provides its customers with a comprehensive range of Internet
access options, applications and consulting services. Intellicom believes that,
over time, its strategic focus on business applications for the Internet and its
niche network connectivity options will play a larger role in differentiating
Intellicom from its competitors. Intellicom's options and services include a
stable, low-cost VSAT system based on two-way satellite technology, providing
high-speed access to the Internet. Early in 1998, Intellicom introduced the T1
Plus product line as a solution to the marketplace. In addition, Intellicom
developed the Edge Connector server to enhance the VSAT network connectivity
system. This comprehensive package of Internet applications is customized to
work within the VSAT network, specifically for the ISP industry. Cache Plus,
similar to the Edge Connector, was created as Intellicom's answer to Internet
backbone congestion. The objective of Cache Plus is to move a substantial amount
of the Web, FTP and NNTP traffic from the Internet backbone to the `network
edge' via a local proxy server. This proxy server is a `child' to a large
`parent' proxy server at Intellicom's data center in Fremont, California.
Connectivity between the child and parent is accomplished by utilizing
Intellicom's satellite based TCP/IP network and a VSAT antenna at the remote
location. This VSAT connection is accomplished with either a two-way VSAT
solution or a receive-only VSAT antenna. The child proxy server is benefited by
the proxy activity from other users on the satellite carrier. The major benefit
of such technology lies in its ability to cache a majority of the web's most
popular sites.
The proxy server connection is available through three different VSAT
service options and pricing packages. Each solution requires a local proxy
server utilizing the ICP protocol standard. Intellicom makes its Edge Connector
server solution available and delivers it pre-configured to operate as a DNS,
Web, Telnet, FTP, E-Mail and Proxy server. This system is based on the Unix
operating system and is available in numerous configurations.
Network address translation is also a configuration option for this server.
Additionally, Intellicom offers connectivity services based on a range of
VSAT, ISDN and dedicated leased circuit options for customers ranging from
115Kbps to 2Mbps data transfer speeds. The majority of customers use Intellicom
as their primary gateway to the Internet and rely on Intellicom to connect,
secure and maintain their network integrity. Intellicom designs and out-source
manufactures VSAT equipment specifically for its applications.
Intellicom makes a variety of other products and services available,
including Web server hosting and content development services, client software
products and training. All of these products and services are integrated to
provide customers with a total solution to their Internet application needs.
Intellicom enables Internet users to purchase access, applications, products and
services, including network integration services, through a single source.
Intellicom's Network Operations Center continually monitors traffic across
Intellicom's network. In addition to network monitoring, Intellicom also
provides technical support to its customers via a toll-free telephone number 24
hours a day, 7 days a week.
Sales and Marketing
Intellicom coordinates national advertising campaigns using intensified
direct mailings focusing on ISPs, educational institutions and corporate
intranets. The corporate sales and marketing staff will be broken into the
following three divisions: (i) network sales, (ii) reseller network sales and
(iii) content and hosting sales. Intellicom has begun negotiating international
alliances and/or partnering arrangements with other larger telecommunications
companies for international marketing and satellite capacity.
Intellicom is also focusing on building and leveraging relationships with
its strategic partners. This involves expanding market coverage by partnering
into new POP locations and building new relationships with other Internet
products and service providers. This focus will extend the reach of the
Intellicom network to virtually all major cities and locations throughout the
United States. By expanding Intellicom's network coverage, Intellicom is
positioning itself to create marketing relationships with corporations and
membership based organizations (e.g. rural electric associations, credit unions,
etc.). Expanded network coverage will also allow Intellicom to provide private
labeled network connectivity to its partners.
Competition
The market for Internet access services is extremely competitive.
Intellicom believes that its ability to compete successfully depends upon a
number of factors, including: market presence; the capacity, reliability, and
security of its network infrastructure; the pricing policies of its competitors
and suppliers; the timing and release of new products and services by Intellicom
and its competitors; and industry and general economic trends.
The competitors of Intellicom are broken into three groups: (i) other
Internet Access Providers including Netcom On-Line Communications, Inc.,
Performance Systems International, Bolt, Beranek and Newman, Inc. (BBN)
(acquired by GTE), Prodigy and America On-Line, (ii) telecommunications
companies, including MCI, AT&T and Sprint, and (iii) other VSAT based network
connectivity companies, including NSN, CyberSat and Hughes Satellite Service.
Many of these competitors have greater market presence, engineering and
marketing capabilities and financial, technological and personnel resources than
those of Intellicom.
While Intellicom believes that the price and performance characteristics of
its products and services are currently competitive, increased competition may
result in price reductions, reduced gross margin and loss of market share, any
of which could materially affect Intellicom's business, operating results and
financial condition. Many of Intellicom's current and potential competitors have
significantly greater financial, technical, marketing, and other resources than
Intellicom. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale, and support of their products
than Intellicom. The introduction of products embodying new technologies and the
emergence of new industry standards could render Intellicom's existing products
obsolete and unmarketable. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties. Accordingly, it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share. There
can be no assurance that Intellicom will be able to compete successfully against
current or future competitors or that the pressures faced by Intellicom will not
materially adversely affect its business, operating results and financial
condition.
Although most of the established on line services and telecommunications
companies currently offer only limited Internet access, many have announced
plans to offer expanded Internet access capabilities. Intellicom expects that
all of the major on line services and telecommunications companies will compete
fully in the Internet access market and expand the availability of terrestrial
based dedicated circuits, such as ISDN and fiber optics. Intellicom believes
that new competitors, including large networking, software, media, and other
technology and telecommunications companies will enter the wireless based
Internet access markets, resulting in even greater competition for Intellicom.
Certain companies have obtain or expanded their Internet access products and
services as a result of acquisitions which may permit Intellicom's competitors
to devote greater resources to the development and marketing of new competitive
products and services and the marketing of existing products and services. Also,
the ability of some of Intellicom's competitors to bundle other services and
products with Internet access services could place Intellicom at a competitive
disadvantage. Intellicom's competitors are primarily using equipment made by
other third party firms, whereas, Intellicom develops its equipment specifically
for its target markets. The majority of Intellicom competitors are also focused
offshore at the international markets.
Due to increased competition, Intellicom expects to encounter pricing
pressures which could result in significant reductions in the average selling
price of Intellicom's many services. This may include the cost of Internet
access services. There can be no assurance that Intellicom will be able to
offset the effects of price reductions with an increase in its customer base,
its revenues, cost reductions, or otherwise. Also, Intellicom believes that the
industry will see mergers and consolidation in the near future, which could
result in greater price and other competition in the industry. Increase price or
other competition could also result from erosion of Intellicom's market share
and could have a material adverse effect on Intellicom's business, financial
condition, and results of operations. There can be no assurance that Intellicom
will have the financial resources, technical expertise, or marketing and support
capacity to continue to compete successfully.
Employees and Facilities
As of December 31, 1998, Intellicom had 20 employees plus four contract
workers. None of Intellicom's employees is currently subject to any collective
bargaining agreement.
Intellicom operates from thee principal facilities. Corporate headquarters
are located in a 9,000 square foot office space rented in Fremont, California.
Intellicom leases a 6,300 square foot warehouse in Hayward, California and a
1,400 square foot Customer Service Center in Chippewa Falls, Wisconsin.
Intellicom's handles client-side technical support issues and order fulfillment
through its Customer Service Center in Chippewa Falls, Wisconsin.
Legal Proceedings
Intellicom has no material pending litigation.
Factors Affecting the Company's Operating Results
The risks and uncertainties described below are not the only ones facing
us. Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also impair our business operations. If any of the
following risks actually occur, our business, financial condition or results of
operations could be materially adversely affected. In such case, the trading
price of our common stock could decline.
This Annual Report on Form 10-K also contains "forward-looking" statements
that involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including the risks faced by us described below and elsewhere
in this Annual Report on Form 10-K.
We Have Operated Our Internet Services Business Only For a Short Period of Time
We are in the process of selling our non-Internet related subsidiaries to
focus on substantial expansion of our Internet subsidiary (the "ISP Channel").
We acquired the ISP Channel in June 1996. As such, we have very limited
operating history and experience in the Internet services business. The
successful expansion of our ISP Channel will require strategies and business
operations that differ from those historically employed in connection with our
two other businesses. To be successful, we must develop and market products and
services that are widely accepted by consumers and businesses at prices that
provide cash flow sufficient to meet our debt service, capital expenditures and
working capital requirements. Consequently, we cannot assure you that our
ability to develop or maintain strategies and business operations will achieve
positive cash flow and profitability for our ISP Channel.
There is No Proven Commercial Acceptance of the Internet Service Division's
Services
It has become feasible to offer Internet services over existing cable lines
and equipment on a broad scale only recently. There is no proven commercial
acceptance of cable-based Internet services. There are only a few companies
offering such services, and none of these companies are currently profitable.
Because this industry is in its early stages, it is currently very difficult to
predict whether providing cable-modem Internet services will become a viable
business model.
We have launched our ISP Channel service in 19 cable systems in the United
States, but we cannot assure you that it will achieve broad consumer or
commercial acceptance. We currently only have 1,600 subscribers to our ISP
Channel service. The success of our ISP Channel service will depend upon the
willingness of subscribers to pay the monthly fees and installation costs
associated with the service and to purchase or lease the equipment necessary to
access the Internet. Accordingly, we cannot predict whether our pricing model
will prove to be viable, whether demand for our services will materialize at the
prices we expect to charge, or whether current or future pricing levels will be
sustainable. If we do not achieve or sustain such pricing levels or if our
services do not achieve or sustain broad market acceptance, then our business,
financial condition, prospects and ability to repay our debts will be materially
adversely affected.
We Anticipate Having Negative Cash Flow, Net Losses and Accumulated
Stockholders' Deficits for the Foreseeable Future
We have sustained substantial losses over the last five fiscal years. For
the fiscal year ended September 30, 1998, we had net losses of $17.3 million and
for the fiscal year ended September 30, 1997, we had net losses of $2.6 million.
As of September 30, 1998, we had an accumulated stockholders' deficit of $6.2
million. We expect to incur substantial additional losses and experience
substantial negative cash flows as we expand our ISP Channel. The costs of
expansion will include expenses incurred in connection with:
o installing the equipment necessary to enable our cable affiliates to offer
our services;
o research and development of new product and service offerings;
o the continued development of our direct and indirect selling and marketing
efforts; and
o possible charges related to acquisitions, divestitures, business alliances
or changing technologies, including the possible acquisition of Intelligent
Communications, Inc.
Our continued negative cash flow and net losses may result in depressed
market prices for our common stock. We cannot assure you that we will ever
achieve favorable operating results or profitability.
We Will Require Substantial Future Capital
The development of our business will require substantial capital infusions
as a result of (1) our need to enhance and expand product and service offerings
to maintain our competitive position and increase market share and (2) the
substantial investment in equipment and corporate resources required by the
continued national launching of the ISP Channel. In addition, we anticipate that
the majority of cable affiliates with one-way cable systems will eventually
upgrade their cable infrastructure to two-way cable systems, at which time we
will have to upgrade our equipment on any affected cable system to handle
two-way transmissions. We cannot accurately predict whether or when we will
ultimately achieve cash flow levels sufficient to support our operations,
development of new products and services, and expansion of our ISP Channel.
Unless we reach such cash flow levels, we will require additional financing to
provide funding for operations. In this regard, we have announced our intention
to seek up to $150 million in long-term debt financing. In the event we complete
such financing, we will be highly leveraged and such debt securities will have
rights or privileges senior to those of our current shareholders. In the event
that equity securities are issued to raise additional capital, the percentage
ownership of our shareholders will be reduced, shareholders may experience
additional dilution and such securities may have rights, preferences and
privileges senior to those of our common stock. In the event that we cannot
generate sufficient cash flow from operations, or are unable to borrow or
otherwise obtain additional funds on favorable terms to finance operations when
needed, our business, financial condition, prospects and ability to repay our
debts would be materially adversely affected.
Our Quarterly Results May Fluctuate
Our quarterly results have fluctuated and will likely continue to fluctuate
significantly from quarter to quarter. In addition, we are selling MTC and KCI,
our non-Internet subsidiaries, one of which has not been accounted for as a
discontinued operation. As a result, we believe that period-to-period
comparisons of our revenues and results of operations are not necessarily
meaningful and should not be relied upon as indicators of future performance.
Many of the factors that could cause our quarterly operating results to
fluctuate significantly in the future are beyond our control.
Factors attributable to the ISP Channel include, among others:
o the rate at which we enter into agreements with cable operators and the
exclusivity and term of such agreements;
o the rate of subscription to our Internet services and the prices
subscribers pay for such services;
o changes in the revenue sharing arrangements between us and our affiliated
cable operators;
o our ability and that of our cable affiliates to coordinate timely and
effective marketing strategies, in particular, our strategy for marketing
the ISP Channel service to subscribers in such affiliates' local cable
areas;
o the number of subscribers who retain our Internet services;
o the quality of our cable affiliates' cable infrastructure;
o the quality of customer and technical support we are able to provide;
o the rate at which our cable affiliates can complete the installations
required to initiate service for new subscribers;
o the amount and timing of capital expenditures and other costs relating to
the expansion of our ISP Channel;
o the introduction of new Internet services by us or our competitors and
customer acceptance of such services;
o price competition or pricing changes in the Internet or cable industries;
and o changes in law and regulation.
Factors attributable to our MTC business include, among others:
o the size and timing of customer orders and subsequent shipments;
o customer order deferrals in anticipation of new products and services;
o timing of product introductions or enhancements by us or our competitors;
o market acceptance of new products and services;
o technological changes in the industry;
o competitive pricing pressures;
o accuracy of customer forecasts of end-user demand;
o changes in the mix of products sold;
o quality control of products sold; and
o the timing of our ultimate sale of the MTC business.
Additional factors that may affect our quarterly operating results in
general include, among others:
o changes in our operating expenses;
o expenses relating to potential acquisitions
o personnel changes;
o disruption in sources of supply;
o capital spending;
o delays of payments by customers; and
o general economic conditions.
Because of the foregoing factors, we cannot predict with any significant
degree of certainty our quarterly revenue and operating results. It is likely
that in one or more future quarters our results may fall below the expectations
of analysts and investors. In such event, the trading price of our common stock
would likely decrease.
Issuance of Common Stock Pursuant to Existing Obligations Will Result in
Dilution to the Common Stockholders
We have several obligations to issue common stock. The issuance of common
stock as a result of these obligations could result in significant dilution to
the holders of our common stock. We have reserved a total of 8,274,848 shares of
common stock to provide for these obligations, although we could issue
materially less than all of such shares.
We have reserved 2,760,963 shares of common stock for issuance upon the
exercise of options and warrants or conversion of our convertible subordinated
debentures, 1,513,885 shares of common stock for issuance under our cable
affiliate incentive programs, and 4,000,000 shares of common stock for issuance
upon conversion of our outstanding series of preferred stock. In addition, we
currently plan to issue an additional 500,000 shares of common stock to the
shareholders of Intelligent Communications, Inc. as partial consideration for
the purchase of Intelligent Communications, Inc.
The 4,000,000 shares of common stock reserved for issuance upon the
conversion of the preferred stock represent the maximum number of shares
issuable upon such conversion, subject to stock splits and similar events. The
number of shares of common stock that we will issue upon conversion of the
Series B Preferred Stock and Series C Preferred Stock cannot be determined, and
may change as the market price of the common stock changes. Generally, decreases
in the market price of the common stock below the initial conversion prices
would result in more shares of common stock being issued upon conversion of the
Series B Preferred Stock and Series C Preferred Stock.
The maximum conversion price of the Series B Preferred Stock is $13.20, but
may increase to $14.30 on February 28, 1999 if the market price of the common
stock on such date is at or above $14.30. The maximum conversion price of the
Series C Preferred Stock is $9.00, but may increase to $9.75 on May 31, 1999 if
the market price of the common stock on such date is at or above $9.75.
The following table sets forth the number of shares of common stock
issuable upon conversion of the outstanding preferred stock assuming the market
price of the common stock is 25%, 50%, 75% and 100% of the market price of the
common stock on December 31, 1998, which was $17.38 per share.
Percent of Market
Price Series B Preferred Stock (1) Series C Preferred Stock (2)
----- ------------------------- -------------------------
25% 2,000,000 (3) 1,752,963
50% 1,179,696 877,490
75% 786,162 847,265
100% 776,633 847,265
- ----------------
(1) As of December 31, 1998, there were 10,251.56 shares of Series B Preferred
stock outstanding. Each share has a stated value of $1,000. The conversion
prices of the Series B Preferred Stock at 25%, 50%, 75% and 100% of the
market price of $17.38 would be $4.35, $8.69, $13.04 and $13.20,
respectively.
(2) As of December 31, 1998, there were 7,625.39 shares of Series C Preferred
Stock outstanding. Each share has a stated value of $1,000. The conversion
prices of the Series C Preferred Stock at 25%, 50%, 75% and 100% of the
market price of $14.81 would be $4.35, $8.69, $9.00 and $9.00,
respectively.
(3) The Series B Preferred Stock cannot convert into more than 2,000,000
shares of our common stock.
To the extent any of these shares of common stock are issued, the market
price of the common stock may decrease because of the additional shares on the
market. If the actual price of the common stock decreases, the holders of such
preferred stock could convert into greater amounts of common stock, the sales of
which could further depress the stock price. In addition, the significant
downward pressure on the market price of the common stock as the holders of the
preferred stock convert and sell material amounts of common stock could
encourage short sales by such holders or others. Such short sales would place
further downward pressure on the price of the common stock.
The conversion of the preferred stock and issuance of the common stock, may
result in substantial dilution to the interests of other holders of common stock
because each holder of preferred stock may ultimately convert and sell the full
amount issuable upon conversion. The 4.99% ownership limitation contained in the
preferred stock does not prevent the holders from converting into common stock
and then selling such common stock to stay below the limitation, except that
such holders cannot convert into more than 19.99% of our common stock unless we
have received shareholder approval. The Company intends to seek shareholder
approval for conversions in excess of 19.99% at the next Annual Meeting. In any
event, the Series B Preferred Stock and Series C Preferred Stock each cannot
convert into more than 2,000,000 shares of our common stock.
In the event the 2,000,000 share cap for the Series C Preferred Stock is
reached, we must either honor conversion requests over the 2,000,000 share cap
or redeem the remaining Series C Preferred Stock, at its stated value of $1,000
per share plus accrued but unpaid dividends.
Possible Cash Payments to Holders of Preferred Stock.
We are required by our Certificate of Incorporation and the rules of the
American Stock Exchange to obtain shareholder approval prior to issuing more
than 19.99% of our common stock upon conversion of the Series A Preferred Stock,
Series B Preferred Stock and Series C Preferred Stock. If we do not obtain such
shareholder approval, we will be required to make cash payments to holders of
the Series B Preferred Stock, or Series C Preferred Stock who attempt to convert
over the 19.99% limit, unless the Company obtains a waiver from the American
Stock Exchange rule or otherwise ceases to be subject to such rule. The cash
payments would be equal to the number of shares of common stock than would have
been issued absent the 19.99% limit multiplied by the average closing bid price
to the attempted conversion.
In the event the 2,000,000 share cap is reached with respect to the Series
C Preferred Stock, the Company must either honor conversion requests or redeem
the remaining Series C Preferred Stock. The market price of our common stock
would have to fall to $3.75 or below for five days within a thirty day trading
period to reach the 2,000,000 share cap.
The following table sets forth the amount of such cash payment assuming (i)
the market price of such common stock is 25%, 50%, 75%, 100%, 125%, 150% and
175% of the market price of the common stock on December 31, 1998, which was
$17.38 per share; (ii) the floating rate mechanism of the Series B Preferred
Stock and Series C Preferred Stock was in effect; and (iii) the maximum
conversion price of the Series B Preferred Stock and Series C Preferred Stock
was not increased. The actual cash payments may be significantly greater than
those listed in the event the market price of our common stock increases above
$30.42.
Cash Payment for Attempted Conversions
Percentage of
Market Price (1) Series B Preferred Stock (2) Series C Preferred Stock (2) Total Cash Payments
---------------- ---------------------------- ---------------------------- -------------------
25% ($4.35) $ 5,736,206 $ 7,625,390 $ 13,361,596
50% ($8.69) 4,330,786 7,625,390 11,956,176
75% ($13.04) 10,251,560 2,163,775 12,415,335
100% ($17.38) 13,497,887 2,883,927 16,381,814
125% ($21.73) 16,876,242 3,605,738 20,481,980
150% ($26.07) 20,246,831 4,325,890 24,572,721
175% ($30.42) 23,625,186 6,047,702 28,672,888
(1) The conversion prices of the Series B Preferred Stock at 25%, 50%, 75% of
$17.38 would be $4.35, $8.69 and $13.04, respectively. For market prices
greater than $13.20, the conversion price of the Series B Preferred Stock
would be $13.20. The conversion prices for the Series C Preferred Stock at
25% and 50% of $17.38 would be $4.35 and $8.69, respectively. For market
prices greater than $9.00, the conversion price of the Series C Preferred
Stock would be $9.00.
(2) The Series B Preferred Stock cannot convert into more than 2,000,000
shares of common stock. Accordingly, cash payments cease once the Series B
Preferred Stock has converted into, or received cash payments in lieu of
converting into, an aggregate of 2,000,000 shares of common stock. The
Series C Preferred Stock has a similar limitation. However, once the
2,000,000 share limit is reached, whether through cash payments or actual
conversions, the Company must either redeem the remaining Series C
Preferred Stock or continue to honor conversions.
Such cash payments will adversely effect the Company's financial condition
and ability to implement its business plan for ISP Channel, Inc. In addition,
the Company will be required to raise funds elsewhere, which could be difficult
in the event stockholder approval is not obtained. If the Company does not
receive stockholder approval, there can be no assurance that the Company would
be able to obtain adequate sources of additional capital. "Risk Factors -
Possible Cash Payments to Holders of Preferred Stock."
We Rely Substantially on Our Cable Affiliates to Provide Our Internet Services
to Subscribers
The success of our business depends upon our relationship with our cable
affiliates. Therefore, in addition to economic conditions, market conditions and
factors relating to Internet service providers and on-line services
specifically, our success and future business growth will also be subject to
economic and other factors affecting our cable affiliates.
We Do Not Have Direct Contact with Our Subscribers
Because subscribers to the ISP Channel must subscribe through a cable
affiliate, the cable affiliate (and not SoftNet) will substantially control the
customer relationship with the subscriber. For example, under our existing
contracts, cable affiliates are responsible for important functions, such as
billing for and collecting ISP Channel subscription fees and providing the labor
and costs associated with distribution of local marketing materials.
Failure or Delay by Cable Operators to Upgrade Their Systems
Certain ISP Channel services are dependent on the quality of the cable
networks of our cable affiliates. Currently, most cable systems are capable of
providing only information from the Internet to the subscribers, and require a
telephone line to carry information from the subscriber to the Internet. These
systems are called "one-way" cable systems. Cable operators have announced and
begun making major upgrades to their systems to increase the capacity of their
networks and to enable traffic both to and from the Internet over their
networks, so-called "two-way capability." However, cable system operators have
limited experience with implementing such upgrades. These investments have
placed a significant strain on the financial, managerial, operational and other
resources of cable system operators, most of which already maintain a
significant amount of debt.
Further, cable operators must periodically renew their franchises with
city, county or state governments. These governmental bodies may impose
technical and managerial conditions before granting a renewal, and these
conditions may cause the cable operator to delay such upgrades.
In addition, cable operators are primarily concerned with increasing
television programming capacity to compete with other forms of entertainment
delivery systems, such as direct broadcast satellite. Consequently, cable
operators may choose not to upgrade their networks for two-way Internet
capability. Such upgrades have been, and we expect will continue to be, subject
to change, delay or cancellation. Cable operators' failure to complete these
upgrades in a timely and satisfactory manner, or at all, would adversely affect
the market for our products and services in any such operators' franchise area.
In addition, cable operators may roll-out Internet access systems that are
incompatible with our high-speed Internet access services. If repeated on a
broad scale, such failures could have a material adverse effect on our business,
financial condition, prospects and ability to repay our debts.
Unavailability of Two-Way Capability in Certain Markets and Its Uncertain Effect
on Subscription Levels
We provide Internet services to cable systems irrespective of their two-way
capabilities. For "one-way" cable systems, we provide Internet services over
cable systems to homes with a telephone line return path for data from the home.
In those circumstances, our services may not provide the high speed access,
quality of experience and availability of certain applications, such as video
conferencing, necessary to attract and retain subscribers to the ISP Channel
service. Subscribers using a telephone line return path will experience
downstream data transmission speeds to the Internet that are provided by their
analog modems (typically 28.8 Kbps). It is not clear what impact the lack of
two-way capability will have on subscription levels for the ISP Channel.
We Depend on Exclusive Access to Cable Subscribers
The success of our ISP Channel is dependent, in part, on our ability to
gain exclusive access to cable consumers. Our ability to gain exclusive access
to cable customers depends upon our ability to develop exclusive relationships
with cable operators that are dominant within their geographic markets. We
cannot assure that affiliated cable operators will not face competition in the
future or that we will be able to establish and maintain exclusive relationships
with cable operators. Currently, a number of our contracts with cable operators
do not contain exclusivity provisions. Even if we are able to establish and
maintain exclusive relationships with cable operators, we cannot assure the
ability to do so on favorable terms or in sufficient quantities to be
profitable. In addition, we are seeking affiliations with a large number of
cable operators as quickly as possible because we will be excluded from
providing Internet over cable in those areas served by cable operators with
exclusive arrangements with other Internet service providers. Our contracts with
cable affiliates typically range from three to seven years, and we cannot assure
you that such contracts will be renewed on satisfactory terms. If the exclusive
relationship between either us and our cable affiliates or our cable affiliates
and their cable subscribers is impaired, if we do not become affiliated with a
sufficient number of cable operators, or if we are not able to continue our
relationship with a cable affiliate once the initial term of its contract has
expired, our business, financial condition, prospects and ability to repay our
debts could be materially adversely affected.
Impact of Research and Development Activities
We expect to continue extensive research and development activities and to
evaluate new product and service opportunities. These activities will require
our continued investment in research and development and sales and marketing,
which could adversely affect our short-term results of operations. We believe
that future revenue growth and profitability will depend in part on our ability
to develop and successfully market new products and services. Failure to
increase revenues from new products and services, whether due to lack of market
acceptance, competition, technological change or otherwise, would have a
material adverse effect on our business financial condition, prospects and
ability to repay our debts.
Management of Our Expanding Business
To exploit fully the market for our products and services, we must rapidly
execute our sales strategy while managing anticipated growth through the use of
effective planning and operating procedures. To manage our anticipated growth,
we must, among other things:
o continue to develop and improve our operational, financial and management
information systems;
o hire and train additional qualified personnel;
o continue to expand and upgrade core technologies; and
o effectively manage multiple relationships with various customers, suppliers
and other third parties.
Consequently, such expansion could place a significant strain on our
services and support operations, sales and administrative personnel and other
resources. We may, in the future, also experience difficulties meeting demand
for our products and services. Additionally, if we are unable to provide
training and support for our products, it will take longer to install our
products and customer satisfaction may be lower. We cannot assure that our
systems, procedures or controls will be adequate to support our operations or
that management will be able to exploit fully the market for our products and
services. Our failure to manage growth effectively could have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
Non-Exclusivity of Cable Franchises; Risk of Non-Renewal or Termination of
Franchises
Cable television companies operate under non-exclusive franchises granted
by local or state authorities that are subject to renewal and renegotiation from
time to time. A franchise is generally granted for a fixed term ranging from
five to 15 years, but in many cases the franchise may be terminated if the
franchisee fails to comply with the material provisions of the franchise. The
Cable Television Consumer Protection and Competition Act of 1992 prohibits
franchising authorities from granting exclusive cable television franchises and
from unreasonably refusing to award additional competitive franchises. This Act
also permits municipal authorities to operate cable television systems in their
communities without franchises. We cannot assure that cable television companies
having contracts with us will retain or renew their franchises. Non-renewal or
termination of any such franchises would result in the termination of our
contract with the applicable cable operator. If an affiliated cable operator
were to lose its franchise, we would seek to affiliate with the successor to the
franchisee. We cannot, however, assure an affiliation with such successor. In
addition, affiliation with a successor could result in additional costs to us.
If we cannot affiliate with replacement cable operators, our business, financial
condition, prospects and ability to repay our debts could be materially
adversely affected.
We May Lose Cable Affiliates Through Acquisition by Unaffiliated Cable Operators
Under many of our initial contracts, if a cable affiliate is acquired by an
unaffiliated cable operator that already has a relationship with one of our
competitors or chooses not to enter into a contract with us, we may lose our
ability to offer Internet services in the area served by such former cable
affiliate entirely or on an exclusive basis. Such a loss could have a material
adverse effect on our business, financial condition, prospects and ability to
repay our debts.
We Depend on Third-Party Technology
The markets for the products and services we use are characterized by the
following:
o intense competition;
o rapid technological advances;
o evolving industry standards;
o changes in subscriber requirements;
o frequent new product introductions and enhancements; and
o alternative service offerings.
Because of these factors, we must rely upon third parties to develop and
introduce technologies that enhance our current product and service offerings.
Reliance on third parties enables us to develop and introduce our own products
and services on a timely and cost-effective basis to meet changing customer
needs and technological trends in our industries. If our relationship with such
third parties is impaired or terminated, then we would have to find other
developers on a timely basis or develop our own technology. We cannot predict
whether we will be able to obtain the third-party technology necessary for
continued development and introduction of new and enhanced products and
services. In addition, we cannot predict whether we will obtain third-party
technology on commercially reasonable terms or replace third-party technology in
the event such technology becomes unavailable, obsolete or incompatible with
future versions of our products or services. The absence of or any significant
delay in the replacement of third-party technology would have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
We Depend on Third-Party Suppliers
We currently depend on a limited number of suppliers for certain key
products and services. In particular, we depend on Excite, Inc. for national
content aggregation, 3Com Corporation and Com21, Inc. for headend and cable
modem equipment, Cisco Systems, Inc. for specific network routing and switching
equipment, and, among others, MCI Communications Corporation ("MCI") for
national Internet backbone services. Certain of our cable modem and headend
equipment suppliers are in litigation over their patents. We could experience
disruptions in the delivery or increases in the prices of products and services
purchased from vendors as a result of this intellectual property litigation. We
cannot predict when delays in the delivery of key components and other products
may occur due to shortages resulting from the limited number of suppliers, the
financial or other difficulties of such suppliers or the possible limited
availability in the suppliers' underlying raw materials. In addition, we may not
have adequate remedies against such third parties as a result of breaches of
their agreements with us. The inability to obtain sufficient key components or
to develop alternative sources for such components could result in delays or
reductions in our product shipments. If that were to happen, it could have a
material adverse effect on our customer relationships, business, financial
condition, prospects and ability to repay our debts.
We Depend on Third Party Carriers
Our success will depend upon the capacity, reliability and security of the
network used to carry data between our subscribers and the Internet. A
significant portion of such network is owned by third parties, and accordingly
we have no control over its quality and maintenance. We rely on cable operators
to maintain their cable systems. In addition, we rely on other third parties to
provide a connection from the cable system to the Internet. Currently, we have
transit agreements with MCI, WorldCom, Sprint Communications Company, and others
to support the exchange of traffic between our network operations center, cable
system and the Internet. The failure of any other link in the delivery chain
resulting in an interruption of our operations would have a material adverse
effect on our business, financial condition, prospects and ability to repay our
debts.
We Experience Intense Competition in Our Markets
The markets for our products and services are intensely competitive, and we
expect competition to increase in the future. Many of our competitors and
potential competitors have substantially greater financial, technical and
marketing resources, larger subscriber bases, longer operating histories,
greater name recognition and more established relationships with advertisers and
content and application providers than we do. Such competitors may be able to
undertake more extensive marketing campaigns, adopt more