e10vk
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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(Mark One)
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þ
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2006
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OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE TRANSITION PERIOD
FROM TO
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COMMISSION
FILE NUMBER:
000-24647
TERAYON COMMUNICATION SYSTEMS, INC.
(Exact Name of Registrant as
Specified in Its Charter)
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Delaware
(State or Other
Jurisdiction of
Incorporation or Organization)
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77-0328533
(IRS Employer
Identification No.)
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2450
WALSH AVENUE
SANTA CLARA, CALIFORNIA 95051
(408) 235-5500
(Address,
Including Zip Code, and Telephone Number,
Including Area Code, of the Registrants Principal
Executive Offices)
SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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Title of Each Class:
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Name of Each Exchange on Which Registered:
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None
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None
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SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, par value $0.001 per share
(Title
of Class)
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 requirement for the past
90 days. Yes þ No o
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 registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one).
Large Accelerated
Filer o Accelerated
Filer þ Non-Accelerated
Filer o
Indicate by check mark whether the registrant is a shell company
(as defined in Exchange Act
Rule 12b-2). Yes o No þ
The aggregate market value of the voting and non-voting stock
held by non-affiliates of the registrant was approximately
$83,479,370 on June 30, 2006. For purposes of this
calculation only, the registrant has excluded stock beneficially
owned by directors and officers and owners of more than ten
percent of its common stock. By doing so, the registrant does
not admit that such persons are affiliates within the meaning of
Rule 405 under the Securities Act of 1933 or for any other
purpose.
Indicate the number of shares outstanding of each of the
registrants classes of common stock, as of the latest
practicable date: Common Stock, $0.001 par value,
77,637,177 shares outstanding as of March 9, 2007.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the registrants definitive proxy statement for
the 2007 annual stockholders meeting are incorporated herein by
reference in Part III of this Annual Report on
Form 10-K
to the extent stated herein.
INDEX
TERAYON COMMUNICATION SYSTEMS, INC.
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PART I
Overview
We currently develop, market and sell digital video equipment to
network operators and content aggregators who offer video
services. Our primary products include the Network
CherryPicker®
line of digital video processing systems and the CP 7600 line of
digital-to-analog
decoders. Our products are used for multiple digital video
applications, including the rate shaping of video content to
maximize the bandwidth for standard definition (SD) and high
definition (HD) programming, grooming customized channel
line-ups,
carrying local ads for local and national advertisers and
branding by inserting corporate logos into programming. Our
products are sold primarily to cable operators, telecom carriers
and satellite providers in the United States, Europe (including
the Middle East) and Asia.
This Report on
Form 10-K
includes trademarks and registered trademarks of Terayon
Communication Systems, Inc. and its consolidated subsidiaries.
As used in this report, the terms Terayon, the
Company, we, us or
our refer to Terayon Communication Systems, Inc. and
its consolidated subsidiaries. Products or service names of
other companies mentioned in this Report on
Form 10-K
may be trademarks or registered trademarks of their respective
owners.
We were incorporated in California and reincorporated in
Delaware in 1998. Our principal executive headquarters are
located at 2450 Walsh Avenue, Santa Clara, California 95051. Our
telephone number is
(408) 235-5500.
History
of the Company
We were founded in 1993 to provide cable operators with a cable
data system enabling them to offer high-speed, broadband
Internet access to their subscribers. By 1999, we were primarily
selling this cable data system composed of cable
modems and cable modem termination systems (CMTS)
which utilized our proprietary Synchronous Code
Division Multiple Access (S-CDMA) technology. Also in 1999,
we initiated an acquisition strategy that ultimately included
the acquisition of ten companies to expand our product offerings
within the cable industry and outside of the cable industry to
the telecom and satellite industries. With the market downturn
in 2000, we refocused our business to target the cable industry
and began selling data and voice products based on industry
standard specifications, particularly the Data Over Cable System
Interface Specification (DOCSIS), thereby beginning our
transition from proprietary-based products to standards-based
products. Also at this time, we focused our business on
providing digital video products to cable operators and
satellite providers. Since 2000, we have terminated our
data-over-satellite
business and all of our acquired telecom-focused businesses and
incurred restructuring charges in connection with these actions.
In 2004, we refocused the Company to make digital video
solutions (DVS) the core of our business. In particular, we
began expanding our focus beyond cable operators to more
aggressively pursue opportunities for our digital video products
with television broadcasters, telecom carriers and satellite
television providers. As part of this strategic refocus, we
elected to continue selling our home access solutions (HAS)
product, including cable modems, embedded multimedia terminal
adapters (eMTA) and home networking devices, but ceased future
investment in our CMTS product line. This decision was based on
weak sales of the CMTS products and the anticipated extensive
research and development investment required to support the
product line in the future. As part of our decision to cease
investment in the CMTS product line, we incurred severance,
restructuring and asset impairment charges and were subject to
litigation from Adelphia Communications Corporation (Adelphia),
one of the principal purchasers of our CMTS product. In March
2005, we sold certain cable modem semiconductor assets to ATI
Technologies, Inc. and terminated our internal semiconductor
division.
In January 2006, we announced that the Company would focus
solely on digital video product lines, and as a result, we
discontinued our HAS product line. We determined that there were
no short or long-term synergies between our HAS product line and
digital video product lines which made the HAS products
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increasingly irrelevant given our core business of digital
video. Though we continued to sell our remaining inventory of
HAS products and CMTS products in 2006, the profit margins for
our cable modems and eMTAs have continued to decrease due to
competitive pricing pressures and the ongoing commoditization of
the products.
Industry
Dynamics
We participate in the worldwide market for equipment sold
primarily to network operators, including cable operators,
television broadcasters, telecom carriers and satellite
providers. Our business is influenced by the following
significant trends in our industry:
Migration
of cable operators to all-digital networks
During the next several years, we believe that most North
American and many foreign cable operators will continue to
migrate their networks to all-digital operations in order to
deliver new services and substantially improve network
efficiency. Current efforts in this migration include digital
simulcasting, which is a transition step to an all-digital
network infrastructure. Digital simulcasting has been adopted by
all major U.S. cable operators, as well as many second-tier
cable operators in the United States. We further expect it to be
adopted by additional second and third-tier operators in the
U.S. and by major operators worldwide.
Ability
to leverage network infrastructures to offer multiple products
and services
Within the last few years, several cable operators and telecom
carriers have begun offering a triple play bundle of
services that includes video, voice and high-speed data over a
single network. Their key objectives are to capture higher
average revenues per subscriber, secure market share and reduce
the churn of subscribers. The delivery of
triple play services has led to increased
competition between the cable operators and telecom carriers.
This competition has led network operators to upgrade their
infrastructure by purchasing equipment that allows them to
provide the triple play of services.
Delivering digital video services is a key area of growing
competition between cable operators and telecom carriers.
Verizon and AT&T, the two largest telecom carriers in the
U.S., are currently rolling out digital video services in select
cities nationwide. We believe that as telecom carriers expand
their digital video service rollouts, they will increasingly
require products that have technology like our Network
CherryPicker®
products to generate advertising revenues. Additionally, we are
currently working with Alcatel, Motorola, Inc. (Motorola), and
other leading telecom equipment vendors which have been selected
by several large telecom carriers to serve as systems
integrators responsible for the carriers deployment of
digital video services.
Network
operators and content aggregators must combat ad skipping
technologies
Consumers increasing use of digital video recorders (DVRs)
capable of skipping over commercial advertisements is a growing
threat to network operators and content aggregators, which face
the possibility of lower advertising revenues from advertisers
who pay in large part based on the number of viewers watching a
program. To overcome the reduction of advertising viewers
because of ad skipping DVRs, network operators and content
aggregators are increasingly seeking solutions based on digital
overlay techniques to directly insert ads into the program being
aired. These overlaid ads typically appear in a
lower corner of the television picture and cannot be skipped by
DVRs since they appear within the TV program itself. This
approach has already been proven by programmers such as SpikeTV
and MTV, and we believe that network operators and content
aggregators will increasingly rely on overlay techniques to
maintain or even increase their advertising revenues.
Continued
network investment to support new product requirements in
competitive and emerging markets
The cable, digital broadcast satellite and telecom companies
will continue their investments in equipment to provide advanced
services in a cost-effective manner to increase average revenues
per unit from their subscribers. According to Kagan Research,
LLC, in 2006 U.S. cable operators spent $11.1 billion
on infrastructure, compared to $10.6 billion in 2005, an
increase of 5%. In addition, we believe that telecom
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carriers (in particular Verizon and AT&T) will become an
increasing source of competition to traditional video service
providers as they continue to upgrade their networks to offer
video services, including high definition digital television
(HDTV) services. While in the early stages, the development of a
mobile video network is underway, and we expect that digital
program insertion capabilities will play an important part in
the growth of this emerging market.
Consolidation
of the cable industry
In the late 1990s, U.S. cable operators began an
unprecedented wave of consolidation, with several of the larger
operators initiating aggressive growth strategies primarily
through the acquisition of small, medium and large cable
operators. Comcast Corporation (Comcast) the largest
U.S. operator today with more than 24 million
subscribers took the top spot in 2002 when it
acquired AT&T Broadband, which had become the nations
largest operator after acquiring TCI and MediaOne in 1999. In
August 2006, Adelphia, formerly the fifth largest operator with
approximately 4.8 million subscribers, was purchased by
Comcast and Time Warner Cable (TWC). According to Kagan
Research, LLC, as of September 2006, 58.6 million of the
estimated 65.6 million cable subscribers in the
U.S. are served by the top ten U.S. cable operators,
representing more than 89% of the market. With
fewer but much larger cable
operators to sell to, cable equipment vendors must continue
adding new products and services to win business.
This has led to a consolidation of cable equipment vendors
seeking to expand their product lines and to strengthen
relationships with key operators. For example, General
Instrument Corporation and Scientific-Atlanta, Inc.
(Scientific-Atlanta) were acquired by Motorola and Cisco
Systems, Inc. (Cisco), respectively. Consolidation amongst
smaller vendors has also taken place, including the acquisition
of BroadBus Technologies, Inc. by Motorola; Arroyo Video
Solutions, Inc. by Cisco; Entone, Inc.s video networking
software business by Harmonic, Inc. (Harmonic); nCUBE
Corporation by C-COR Incorporated (C-Cor); Tandberg Television
ASA by Ericsson; and BigBand Networks purchase of ADC
Telecommunications, Inc.s CMTS business.
The move
towards localized and personalized content
The major U.S. cable operators are increasingly delivering
more targeted, locally-relevant content to their subscribers as
part of their long-term effort to deliver truly personalized
content to individual subscribers. The current efforts include
Video on Demand (VOD) in which programming is selected by the
individual subscriber and transmitted whenever the subscriber
requests it. Cable operators are also increasingly using digital
advertising insertion to deliver locally relevant advertisements
to their viewers.
The use of VOD services is growing amongst U.S. cable
subscribers, with 54% of digital subscribers using the service
during 2006, up from 49% in 2005 and 35% in 2004, according to
the Cable & Telecommunications Association for
Marketing. As the number of subscribers using VOD grows it will
become increasingly important for cable operators to manage the
bandwidth required to deliver these individual programs. Cable
operators are also generating increasing revenues from
delivering local advertising to their subscribers. In 2006,
U.S. cable operators earned more than $5.0 billion
carrying local advertising, an increase of 9% over the
$4.6 billion billed in 2005, according to Kagan Research,
LLC.
Business
We currently develop, market and sell digital video equipment,
including our Network
CherryPicker®
digital video processing systems and our CP 7600 line of
digital-to-analog
decoders. Our products are sold to and used by cable, telecom,
broadcast and satellite operators for multiple digital video
applications, including the rate shaping of video content to
maximize the bandwidth for SD and HD programming, grooming
customized channel
line-ups,
carrying local ads for local and national advertisers, and
branding themselves by inserting their corporate logos into
their programming. In 2006, we continued to sell our remaining
inventory of CMTS and HAS products, including cable modems and
eMTAs, that we discontinued in January 2006. We expect to sell
off our remaining inventory of CMTS and HAS products in 2007.
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The design of digital video processing equipment requires
expertise in Motion Picture Experts Group (MPEG) digital video
formats and Internet Protocol (IP). Our expertise in MPEG and
IP, coupled with our experience in designing, developing and
manufacturing complex equipment, has helped us secure a
leadership position in statistical remultiplexing (rate shaping)
which provides the cable and satellite operators with bandwidth
management capabilities for their SD and HD digital video
services and to support increased VOD usage. We believe we are
well positioned to capitalize on the growing demand for network
operators to provide advanced bandwidth intensive video services
such as adding additional HDTV channels.
Our DVS products are designed to enable localization
on-demand, or the delivery of on-demand, real-time video
constructed to meet the advertising needs of local and regional
markets. Further, we believe our digital video products enable
network operators and content aggregators to more
cost-effectively overlay advertisements directly into their
programming. Our capabilities include advanced graphical overlay
and SqueezeBack: cable operators can localize advertisements by
overlaying graphics with locally relevant information (e.g.,
local store locations) or squeeze back the
television image so that blank space appears on the bottom
and/or sides
of the screen into which similar relevant information can be
inserted. This approach is more efficient compared to the
traditional approach which requires the advertisements and the
program to first be converted from digital to analog video, the
insertion of the overlaid advertisements, and the subsequent
re-encoding of the program and the advertisements back to
digital. Since our method works entirely in the compressed
digital domain, there is no need for decoders to convert the
digital video to analog or for separate re-encoders to then
convert the analog video back to digital. To complement our
cable and satellite product offerings, we developed new software
during 2006 for the DM 6400 model of our Network
CherryPicker®
line to support the new MPEG-4/AVC digital video format that
most telecom carriers have chosen for their video services.
Today, we continue to develop additional software applications
for the Network
CherryPicker®
platform that enables our customers in cable, satellite and
telecom to create advanced service solutions.
Business
Strategy
Our goal is to be the leading provider of digital video products
that enable network operators and content aggregators to more
efficiently deliver digital video services to meet the needs of
local and regional markets, thereby reducing costs and
generating new revenues. To achieve this goal, we are pursuing
the following strategies:
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capitalize on the increasing demand for advanced digital video
services, including HDTV and video on demand, by leveraging our
strengths in bandwidth management, ad insertion, grooming
applications and products;
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continue to develop video applications with enhanced
capabilities that meet the localization on-demand and
personalized advertising needs of network operators, and to
address emerging markets, such as mobile video;
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increase the distribution opportunities for our digital video
products through reseller channels by developing new
relationships and expanding existing system integration
partnerships with partners such as Harmonic, Alcatel-Lucent and
Motorola; and
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improve margins through focused product cost-reduction efforts
and by streamlining operational activities across our product
lines.
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The ongoing migration of network operators to all-digital
IP-based
networks represents a significant opportunity for us with
products and technologies that enable these operators to
maximize their bandwidth and to manipulate their digital video
content completely within the digital domain, which maximizes
flexibility and reduces costs. We believe we are well positioned
to capitalize on this expanding market in large part because of
the success that our digital video products have had with the
major U.S. cable operators and satellite providers.
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Products
Historically, we had multiple product lines that we sold to
cable operators, satellite providers and telecom carriers. Our
cable data product line consisted initially of a proprietary
system composed of a CMTS and cable modems. We later expanded
our cable data product line with standards-based offerings,
including CMTS, cable modems and eMTA products meeting the
DOCSIS and EuroDOCSIS specifications. We discontinued sales of
our CMTS products in 2004 and our modems and eMTAs in 2006. Our
cable data products were complemented by our Multigate
voice-over-cable
solution, which we inherited through our acquisition of Telegate
Ltd. We discontinued the Multigate product line in 2004. Our
telecom product line consisted of our Internet Protocol in the
Loop or IPTL digital subscriber line access multiplexer,
MainSail multi-service access platform and MiniPlex digitally
added main line products, all of which we acquired through our
acquisitions of Radwiz, MainSail Systems and the Access Network
Electronics division of Tyco International. We discontinued
these telecom products in 2003. Our
Internet-over-satellite
product line consisted of the SatStream system we inherited via
our acquisition of ComBox. We discontinued our satellite product
in 2002.
We continue to sell our digital video product lines, which
currently consist of the Network
CherryPicker®
products and our CP 7600
digital-to-analog
decoder. Our Network
CherryPicker®
line of digital video processing systems give cable, telecom and
satellite operators flexibility in managing their digital video
content, including the rate shaping of video content to maximize
the bandwidth for SD and HD programming, grooming customized
channel
line-ups,
carrying ads for local advertisers and branding themselves by
inserting their corporate logos into their programming. To date,
cable, satellite, television broadcasters and telecommunications
providers have deployed more than 7,800 of our Terayon
CherryPicker®
and related digital video systems components.
Our Network
CherryPicker®
DM line is currently composed of two models, the DM 6400
and the DM 3200. Our DM 6400 helps cable operators
seamlessly insert commercials for local advertisers into their
digital programming. According to Kagan Research, LLC, in 2006,
U.S. cable operators billed more than $5.0 billion
running local advertisements, a 9% increase over the
$4.6 billion billed in 2005. We believe this market will
continue to grow and that we are well positioned in this space
based on our current success in digital ad insertion and the
relationships we have with the major advertising server
companies, particularly SeaChange International, Inc. and C-Cor.
Additionally, in February 2007 we added new graphic overlay and
SqueezeBack capabilities to the DM 6400, enabling cable
operators to further localize advertisements. The DM 6400
is also ideal for telecom carriers since it specifically
supports the new MPEG-4/AVC digital video format most telecom
carriers have chosen for their video services. Our DM 3200
provides statistical remultiplexing functionality and advanced
stream processing capabilities for applications not requiring ad
insertion.
Our CP 7600
digital-to-analog
video decoder is used by cable operators to implement a
digital simulcast architecture to improve the
bandwidth efficiency of their networks. All major
U.S. cable operators have adopted digital simulcasting and
both second and third-tier operators are in the process of
deploying the architecture. Prior to digital simulcasting,
operators had to send all of their programming in both digital
and analog formats to support both groups of subscribers. This
traditional approach consumes enormous amounts of bandwidth
within their networks. With simulcasting, operators now deliver
just one set of programming digitally and use the CP 7600 at the
edge of their networks (just before reaching the
Hybrid Fiber Coaxial or HFC distribution network) to decode the
programming to analog for their analog subscribers, and to pass
the digital programming on to their digital subscribers
untouched. This more bandwidth-efficient approach is an
evolutionary step towards an architecture that is completely
digital and
IP-based and
that will support the delivery of a new generation of services.
We are currently developing a next-generation platform to run
our advanced digital video networking applications. This new
platform will complement our existing Network
CherryPicker®
line, and will have considerably greater video stream processing
power to support video service providers as they increase the
amount of personalized and localized content they deliver to
viewers.
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Product
research and development
We maintain ongoing research and development activities for our
digital video product line. Our research and development efforts
are focused on developing new software applications and improved
hardware platforms to address customer requirements across
multiple industries while maintaining technological leadership.
Another key goal is to improve the gross margins of our existing
products by reducing their component and manufacturing costs.
Our research and development expense was $17.4 million for
the year ended December 31, 2006 compared with
$17.7 million and $33.2 million for the years ended
December 31, 2005 and 2004, respectively. We currently
anticipate that overall research and development spending in
2007 will remain constant compared to 2006, and will focus
almost entirely on developing new hardware platforms and
software applications for digital video solutions. Developing
new and innovative solutions is important for us to remain
competitive with larger companies that devote considerably more
resources to product development.
Customers
We market and sell our digital video products to multiple
vertical target markets consisting of the largest cable,
satellite and telecom operators in North America.
Some of our principal customers and resellers include the
following:
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Comcast;
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Cox Communications Inc. (Cox);
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TWC;
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EchoStar Communications Corporation; and
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Harmonic.
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We believe that a substantial majority of our revenues will
continue to be derived from sales to a relatively small number
of customers located in the United States for the foreseeable
future. Comcast and Harmonic accounted for approximately 20% and
15%, respectively, of our total revenue for the year ended
December 31, 2006. Harmonic, Thomson Broadcast and Comcast
accounted for approximately 12%, 11% and 10%, respectively, of
our total revenue for the year ended December 31, 2005. For
the year ended December 31, 2004, two customers, Adelphia
and Comcast accounted for approximately 20% and 13%,
respectively, of our total revenue. With the discontinuation of
our data products, our sales have become increasingly
concentrated in the United States and our presence outside the
United States has decreased. A small percentage of our total
digital video revenue has historically been derived from
customers located outside the United States. We expect that
trend will continue. The loss of any of our significant
customers generally could have a material adverse effect on our
business and results of operations.
Market
Competition
The market for broadband equipment vendors is extremely
competitive and is characterized by rapid technological change
and, more recently, market consolidation. With our digital video
products, we believe that we are currently the market leader in
ad insertion, grooming and remultiplexing with our Network
CherryPicker®
line of digital video processing systems. However, several
companies have entered this market, including Cisco through its
acquisition of Scientific-Atlanta, Scopus Video Networks Ltd.,
BigBand Networks, RGB Networks, Inc. (RGB), SeaChange
International, Inc., and Ericsson through its acquisition of
Tandberg Television ASA. We believe that this increase in
competition may lead to additional pricing pressures and
declining gross margins.
The principal competitive factors in our market include the
following:
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quality of product performance, features and reliability;
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customer technical support and service;
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price;
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size and financial stability of operations;
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breadth of product line;
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sales and distribution capabilities;
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relationships with network operators and content
aggregators; and
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meeting current or prospective industry or customer standards
applicable to our products.
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Many of our competitors and potential competitors are
substantially larger and have significant advantages over us,
including, without limitation:
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larger and more established selling and marketing capabilities;
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greater economies of scale;
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significantly greater financial, technical, engineering,
marketing, distribution, customer support and other resources;
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greater name recognition and a larger installed base of
customers; and
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well-established relationships with our existing and potential
customers.
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Some of the above competitive factors are outside of our
control. Conditions in the market could change rapidly and
significantly as a result of technological advancements.
Additionally, there may be pressure to develop new or
alternative industry standards and specifications for video
products and applications. The broader adoption of any such
standards and specifications would necessitate greater spending
on developing new products. The development and market
acceptance of new or alternative technologies could decrease the
demand for our products or render them obsolete, and could
impact the pricing and gross margin of our digital video
products. Our competitors, many of which have greater resources
than we do, may introduce products that are less costly, provide
superior performance or achieve greater market acceptance than
our products. These competitive pressures have impacted and are
likely to continue to adversely impact our business.
Given these competitive and other market factors, we continually
look for opportunities to compete effectively and create value
for our stockholders. We may, at any time and from time to time,
be in the process of identifying or evaluating product
development initiatives, partnerships, strategic alliances or
transactions and other alternatives in order to maintain market
position and maximize shareholder value. Market and other
competitive factors may cause us to change our strategic
direction, and we may not realize the benefits of any such
initiatives, partnerships, alliances or transactions. We cannot
assure that any such initiatives, partnerships, alliances or
transactions that we identify and pursue would actually result
in our competing effectively, maintaining market position or
increasing stockholder value. Our failure to realize any
expected benefits from such initiatives, partnerships, alliances
or transactions could negatively impact our financial position,
results of operations, cash flows and stock price.
Sales and
Marketing
We market and sell our products directly to network operators
and content aggregators through our direct sales forces in North
America and our limited sales forces in EMEA and Asia. We also
market and sell our products through distributors, system
integrators and resellers throughout the world and rely on this
network to sell the majority of our products sold outside the
United States.
We support our sales activities through marketing communication
vehicles, such as industry press, trade shows, advertising and
the Internet. Through our marketing efforts, we strive to
educate network operators and content aggregators on the
technological and business benefits of our products, as well as
our ability to provide quality support and service. We
participate in the major trade shows and industry events in the
United States and limited events outside the United States.
Industry referrals and reference accounts are significant
marketing tools we develop and utilize.
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We also make our products available for customers to test, which
is very often a prerequisite for making a sale of our more
complex products. These tests can be comprehensive and lengthy,
and can dramatically increase the sales cycle for these
products. Participating in these tests often requires us to
devote considerable time and resources from our engineering and
customer support organizations.
International
Sales
We have international sales offices in Brussels, Belgium and Tel
Aviv, Israel. In the years ended December 31, 2006, 2005
and 2004, approximately 29%, 42% and 47%, respectively, of our
net revenues were derived from customers outside of the United
States. In January 2006, we announced that the Company would
focus solely on digital video product lines. Digital video
revenues outside the United States have been nominal, and we
expect such revenues to increase slightly in 2007, but they will
continue to constitute a small percentage of overall revenues.
As a result, we expect the portion of our overall revenue
generated from outside the United States to continue to decrease
in 2007 as we will have limited sales of the existing inventory
of our CMTS and HAS products, which historically made up a large
portion of our international sales.
The majority of our international sales are currently invoiced
in U.S. dollars. However, we do enter into certain
transactions in Euros and other currencies. Invoicing in other
currencies subjects us to risks associated with foreign exchange
rate fluctuations. Although we do not currently have any foreign
currency hedging arrangements in place, we will consider the
need for hedging or other strategies to minimize these risks if
the amount of invoicing in non-dollar denominated transactions
materially increases.
Our international operations are subject to certain risks common
to foreign operations in general, such as governmental
regulations and import restrictions. In addition, there are
social, political, labor and economic conditions in specific
countries or regions, difficulties in staffing and managing
foreign operations and potential adverse foreign tax
consequences, among other factors, that could also have an
adverse impact on our business and results of operations outside
of the United States.
Customer
Service and Technical Support
We believe that our ability to provide consistently high quality
service and support will continue to be a key factor in
attracting and retaining customers. Our technical services and
support organization, with personnel in North America, Europe,
Israel and Asia, offers support 24 hours a day, seven days
per week. Prior to the deployment of our products, each
customers needs are assessed and proactive solutions are
implemented, including various levels of training, periodic
management and coordination meetings and problem escalation
procedures.
Backlog
We typically ship product and invoice customers shortly upon
receipt of a purchase order as our customers typically request
the immediate delivery of product. Assuming product
availability, our practice is to ship our products promptly upon
the receipt of purchase orders from our customers. We only have
backlog if the product is not available to ship to the customer.
Therefore, we have limited backlog and believe that backlog
information is not material to an understanding of our business.
Manufacturing
Our digital video products are single sourced from a
manufacturer in San Jose, California. Our HAS products,
which were discontinued in January 2006, were single sourced
from a manufacturer in China.
Our manufacturing operations employ semiconductors,
electromechanical components and assemblies as well as raw
materials such as plastic resins and sheet metal. Although we
believe the materials and supplies necessary for our
manufacturing operations are currently available in the
quantities we require, we sometimes experience a shortage in the
supply of certain component parts as a result of strong demand
in the industry for those parts.
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Our subcontractors purchase materials, supplies and product
subassemblies from a substantial number of vendors. For many of
our products, there are existing alternate sources of supply.
However, we sole source certain components contained in our
products, such as the semiconductors used in our products. While
this has not resulted in material disruptions in the past,
should any change in these relationships or disruptions to our
vendors operations occur, our business and results of
operations could be adversely affected.
In an effort to prevent shortages of supplies used in the
manufacturing process by our subcontractor, we source and
inventory various raw products and components as part of our
supply chain program. In doing so we may put ourselves at risk
of carrying inventory that may become excessive based on our
future sales failing to meet current sales forecasts or become
obsolete before utilization by those manufacturers. We have
recorded costs as a result of vendor cancellation charges.
Intellectual
Property
We rely on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and
protect proprietary rights in our products. Even though we seek
to establish and protect proprietary rights in our products,
there are associated risks. Our pending patent applications may
not be granted. Even if they are granted, the claims covered by
the patent may be reduced from those included in our
applications. Any patent might be subject to challenge in court
and, whether or not challenged, might not be broad enough to
prevent third parties from developing equivalent technologies or
products without a license from us.
We have entered into confidentiality and invention assignment
agreements with our employees and consultants, and we enter into
non-disclosure agreements with many of our suppliers,
distributors and customers so as to limit access to and
disclosure of our proprietary information. These contractual
arrangements, as well as statutory protections, may not prove to
be sufficient to prevent misappropriation of our technology or
deter independent third-party development of similar
technologies. In addition, the laws of some foreign countries
may not protect our intellectual property rights to the same
extent as do the laws of the United States. Litigation may be
necessary to enforce our intellectual property rights.
The development of standards or specifications is common in our
industry, as is the contribution of intellectual property to
associated intellectual property pools. For example, for our HAS
products to be competitive, we were required to be compliant
with the DOCSIS and the PacketCable standards. We entered into
an agreement with Cable Television Laboratories, Inc.
(CableLabs) whereby we licensed to CableLabs on a royalty-free
basis all of our intellectual property rights to the extent that
such rights may be asserted against a party desiring to design,
manufacture or sell DOCSIS based products, including DOCSIS 2.0
based products. There may be pressure to develop new industry
standards and specifications for video products and
applications. Vendors like us may have to build products that
meet these standards in order to sell to network operators.
The contractual arrangements, as well as statutory protections,
we employ may not prove to be sufficient to prevent
misappropriation of our technology or deter independent
third-party development of similar technologies. We have in the
past received and may in the future receive letters claiming
that our technology infringes the intellectual property rights
of others. We have consulted with our patent counsel for all
such letters received and have or are in the process of
reviewing the allegations made by such third parties. If these
allegations were submitted to a court, the court could find that
our products infringe third party intellectual property rights.
If we are found to have infringed third party rights, we could
be subject to substantial damages
and/or an
injunction preventing us from conducting our business. In
addition, other third parties may assert infringement claims
against us in the future. A claim of infringement, whether
meritorious or not, could be time-consuming, result in costly
litigation, divert our managements resources, cause
product shipment delays or require us to enter into royalty or
licensing arrangements. These royalty or licensing arrangements
may not be available on terms acceptable to us, if at all.
We pursue the registration of our trademarks in the United
States and have applications pending to register several of our
trademarks throughout the world. However, the laws of certain
foreign countries might not protect our products or intellectual
property rights to the same extent as the laws of the United
States.
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Effective trademark, copyright, trade secret and patent
protection may not be available in every country in which our
products may be manufactured, marketed or sold.
Employees
As of December 31, 2006, we had 114 employees, of which 99
were located in the United States, and 15 were located outside
the United States in Israel, Canada, Europe and Asia. We had 49
employees in research and development, 33 in marketing, sales
and customer support, 16 in operations and 16 in general and
administrative functions. None of our employees are represented
by collective bargaining agreements. We believe that our
relations with our employees are good.
Access to
Our Reports
Our Internet Web site address is www.terayon.com. Our Annual
Reports on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended (Exchange Act) are available free of charge
through our Web site as soon as reasonably practicable after
they are electronically filed with, or furnished to, the
Securities and Exchange Commission (Commission). We will also
provide those reports in electronic or paper form free of charge
upon a request made to Mark A. Richman, Chief Financial Officer,
c/o Terayon Communication Systems, Inc., 2450 Walsh Avenue,
Santa Clara, CA 95051. Furthermore, all reports we file
with the Commission are available free of charge via EDGAR
through the Commissions Web site at www.sec.gov. In
addition, the public may read and copy materials filed by us at
the Commissions public reference room located at 100 F.
Street, N.E., Washington, D.C., 20549 or by calling
1-800-SEC-0330.
The following is a summary description of some of the many
risks we face in our business. You should carefully review the
risks described below before making an investment decision. 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 also may impair
our business operations. If any of the following risks actually
occur, our business could be harmed. In such case, the trading
price of our common stock could decline, and you may lose all or
part of your investment. You should also consider the other
information described in this report.
Risks
Related to the Restatement
The
restatement of our consolidated financial statements has had a
material adverse impact on us, including increased costs, the
delisting of our common stock from The NASDAQ Stock Market, the
increased possibility of legal or administrative proceedings,
and a default under our subordinated note
agreement.
We determined that our consolidated financial statements for the
years ended December 31, 2000, 2002, 2003 and 2004, and as
of and for the quarters of 2004 and for the first two quarters
of 2005, as described in more detail in our Annual Report on
Form 10-K
for the year ended December 31, 2005 filed on
December 29, 2006 (2005
Form 10-K),
should be restated. As a result of these events, we have become
subject to a number of additional risks and uncertainties,
including the following:
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We have incurred substantial unanticipated costs for accounting
and legal fees in 2005 and 2006 in connection with the
restatement. Although the restatement is complete, we expect to
incur additional costs as indicated below.
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We face an increased risk of being subject to legal or
administrative proceedings. In December 2005, the Securities and
Exchange Commission (Commission) issued a formal order of
investigation in connection with our accounting review of
certain customer transactions. This investigation has diverted
and will continue to divert more of our managements time
and attention and continue to cause us to
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incur substantial costs. Such investigations can also lead to
fines or injunctions or orders with respect to future
activities, as well as further substantial costs and diversion
of managements time and attention.
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On June 23, 2006, a securities litigation lawsuit based on
the events concerning the restatement was filed against us and
certain of our current and former executive officers. On
November 8, 2006, a new lead plaintiff was appointed in the
case, and on January 8, 2007, the new lead plaintiff filed
an amended complaint. On March 9, 2007, Terayon and the
individual defendants filed a motion to dismiss the amended
complaint. That motion is scheduled to be heard on June 5,
2007. The amended complaint was purportedly filed on behalf of
all persons who purchased our common stock between June 28,
2001 and March 1, 2006, and it added several current and
former officers and directors and our former accounting firm to
the defendants named in the original complaint. The amended
complaint incorporates the prior allegations and includes new
allegations relating to the restatement of our consolidated
historical financial statements as reported in our 2005
Form 10-K.
In connection with this litigation and any further litigation
that is pursued or other relief sought by persons asserting
claims for damages allegedly resulting from or based on the
restatement or events related thereto, we will incur defense
costs that may include the amount of our deductible and defense
costs exceeding our insurance coverage regardless of the
outcome. Additionally, we may incur costs if the insurers of our
directors and our liability insurers deny coverage for the costs
and expenses related to any litigation.
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Likewise, such events may divert our managements time and
attention away from the operation of the business. If we do not
prevail in any such actions, we could be required to pay
substantial damages or settlement costs.
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We were de-listed from The NASDAQ Stock Market because we were
unable to file our periodic reports with the Commission on a
timely basis. This failure was attributable to our inability to
complete the restatement of our consolidated financial
statements for prior periods. As previously disclosed on our
Current Reports on
Form 8-K
filed on November 22, 2005 and January 20, 2006,
NASDAQ notified us of its intention to de-list our common stock
based on our failure to timely file our Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2005, and our failure
to solicit proxies and hold an annual shareholders meeting
during 2005. On March 31, 2006, The NASDAQ Listing and
Qualifications Panel determined to de-list our securities from
The NASDAQ Stock Market effective as of the opening of business
on April 4, 2006, and our common stock currently trades on
the Pink Sheets. See our risk factor entitled Our common
stock has been de-listed from The NASDAQ Stock Market and trades
on the Pink Sheets. We may be unable to relist on The
NASDAQ Stock Market or any other exchange because we may not be
able to meet the applicable initial listing requirements.
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Because we were unable to timely file our Quarterly Report on
Form 10-Q
for September 30, 2005, we defaulted on our
$500 million of 5% convertible subordinated notes (Notes)
due August 2007. On March 21, 2006, we paid off the entire
principal amount of outstanding Notes, including all accrued and
unpaid interest and related fees, for a total of
$65.6 million. As a result, our repayment of the Notes
reduced our unrestricted cash, decreased our liquidity and could
materially impair our ability to operate our business especially
if we are unable to generate positive cash flow from operations.
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The restatement may also result in other negative ramifications,
including the potential loss of confidence by suppliers,
customers, employees, investors, and security analysts, the loss
of institutional investor interest, fewer business development
opportunities and delays in future earnings announcements,
regulatory filings with the Commission and listing with a
securities exchange.
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Material
weaknesses or deficiencies in our internal control over
financial reporting could harm stockholder and business
confidence in our financial reporting, our ability to obtain
financing and other aspects of our business.
Maintaining an effective system of internal control over
financial reporting is necessary for us to provide reliable
financial reports. As described in Item 9A
Controls and Procedures of this
Form 10-K,
management, under the supervision of the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), conducted an evaluation
of disclosure controls and procedures. Based on that evaluation,
the CEO and CFO
13
concluded that our disclosure controls and procedures were not
effective at a reasonable assurance level as of
December 31, 2006 and as of the filing date of this
Form 10-K
due to the material weaknesses discussed below. Because the
material weaknesses described below have not been remediated as
of the filing date of this
Form 10-K,
the CEO and CFO continue to conclude that our disclosure
controls and procedures are not effective as of the filing date
of this
Form 10-K.
A material weakness in internal control over financial reporting
is defined by the Public Company Accounting Oversight
Boards Audit Standard No. 2 as being a significant
deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material
misstatement of the financial statements would not be prevented
or detected. A significant deficiency is a control deficiency,
or combination of control deficiencies, that adversely affects
our ability to initiate, authorize, record, process, or report
external financial data reliably in accordance with generally
accepted accounting principles (GAAP) such that there is more
than a remote likelihood that a misstatement of the annual or
interim financial statements that is more than inconsequential
will not be prevented or detected.
We were not able to fully execute the remediation plans that
were established to address material weaknesses previously
identified. As a result, the following material weaknesses were
not fully remediated and remain ongoing as of December 31,
2006 and as of the date of this filing.
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insufficient controls related to the identification, capture and
timely communication of financially significant information
between certain parts of the organization and the accounting and
finance department to enable these departments to account for
transactions in a complete and timely manner;
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lack of sufficient personnel with technical accounting
experience in the accounting and finance department and
inadequate review and approval procedures to prepare external
financial statements in accordance with GAAP;
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the use of estimates, including monitoring and adjusting
balances related to certain accruals, reserves, and fixed assets;
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ineffective controls over the documentation, authorization and
review of manual journal entries and ineffective controls to
ensure the accuracy and completeness of certain general ledger
account analysis and reconciliations conducted in connection
with period end financial reporting.
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For further information about these material weaknesses, please
see Item 9A Controls and Procedures
Managements Report on Internal Control over Financial
Reporting included in this
Form 10-K.
Because of these material weaknesses, management concluded that,
as of December 31, 2006, our internal control over
financial reporting was not effective.
Because we have concluded that our internal control over
financial reporting is not effective and our independent
registered public accountants issued an adverse opinion on the
effectiveness of our internal controls, and to the extent we
identify future weaknesses or deficiencies, there could be
material misstatements in our consolidated financial statements
and we could fail to meet our financial reporting obligations.
While we are in the process of implementing the remediation
efforts described in Item 9A Controls and
Procedures Remediation Steps to Address Material
Weaknesses, we may continue to experience difficulties or delays
in implementing measures to remediate the material weaknesses.
Additionally, if the remedial measures are insufficient to
address the identified material weaknesses or if additional
material weaknesses or significant deficiencies in our internal
controls are discovered in the future, we may fail to meet our
future reporting obligations on a timely basis, our financial
statements may contain material misstatements, our operating
results may be harmed, and we may be subject to litigation.
Any failure to address the identified material weaknesses or any
additional material weaknesses or significant deficiencies in
our internal controls could also adversely affect the results of
future management evaluations and auditor attestation reports
regarding the effectiveness of our internal control over
financial reporting that are required under Section 404 of
the Sarbanes-Oxley Act of 2002.
Any material weakness or unsuccessful remediation could affect
investor confidence in the accuracy and completeness of our
financial statements. As a result, our ability to obtain any
additional financing, or
14
additional financing on favorable terms, could be materially and
adversely affected, which, in turn, could materially and
adversely affect our business, our strategic alternatives, our
financial condition and the market value of our securities. In
addition, perceptions of us among customers, lenders, investors,
securities analysts and others could also be adversely affected.
Current material weaknesses or any weaknesses or deficiencies
identified in the future could also hurt confidence in our
business and the accuracy and completeness of our financial
statements, and adversely affect our ability to do business with
these groups.
We can give no assurances that the measures we have taken to
date, or any future measures we may take, will remediate the
material weaknesses identified or that any additional material
weaknesses will not arise in the future due to our failure to
implement and maintain adequate internal controls over financial
reporting. In addition, even if we are successful in
strengthening our controls and procedures, those controls and
procedures may not be adequate to prevent or identify
irregularities or ensure the fair presentation of our financial
statements included in our periodic reports filed with the
Commission.
Our
revenue recognition policy on digital video products has been
corrected.
As more fully described in our 2005
Form 10-K,
we now recognize revenue from our digital video products under
Staff Accounting Bulletin (SAB) No. 101, Revenue
Recognition, as amended by SAB No. 104 and
SOP 97-2,
Software Revenue Recognition. Our new revenue
recognition policy under these accounting standards is complex.
We rely upon key accounting personnel to maintain and implement
the controls surrounding such policy. If the policy is not
applied on a consistent basis or if we lose any of our key
accounting personnel, the accuracy of our consolidated financial
statements could be materially affected. This could cause future
delays in our earnings announcements, regulatory filings with
the Commission and potential delays in listing with a securities
exchange.
Our
common stock has been de-listed from The NASDAQ Stock Market and
trades on the Pink Sheets.
Effective April 4, 2006, our common stock was delisted from
The NASDAQ Stock Market and was subsequently quoted by the
National Quotation Service Bureau (Pink Sheets). The trading of
our common stock on the Pink Sheets may reduce the price of our
common stock and the levels of liquidity available to our
stockholders. In addition, the trading of our common stock on
the Pink Sheets may materially and adversely affect our access
to the capital markets, and the limited liquidity and reduced
price of our common stock could materially and adversely affect
our ability to raise capital through alternative financing
sources on terms acceptable to us or at all. Stocks that trade
on the Pink Sheets are no longer eligible for margin loans, and
a company trading on the Pink Sheets cannot avail itself of
federal preemption of state securities or blue sky
laws, which adds substantial compliance costs to securities
issuances, including pursuant to employee option plans, stock
purchase plans and private or public offerings of securities.
Our delisting from The NASDAQ Stock Market and quotation of our
common stock on the Pink Sheets may also result in other
negative ramifications, including the potential loss of
confidence by suppliers, customers, employees, investors, and
security analysts, the loss of institutional investor interest
and fewer business development opportunities.
If we
are not able to remain current with our filings with the
Commission, we will face several adverse
consequences.
If we are unable to remain current with our filings with the
Commission and comply with the Commissions reporting
requirements, we will face several restrictions. We will not be
able to have a registration statement under the Securities Act
of 1933, covering a public offering of securities, declared
effective by the Commission, or make offerings pursuant to
existing registration statements; we will not be able to make an
offering to any purchasers not qualifying as accredited
investors under certain private placement
rules of the Commission under Regulation D; we will not be
eligible to use a short form registration statement
on
Form S-3
for a period of at least 12 months after the time we become
current in our periodic and current reports under the Securities
Exchange Act of 1934, as amended (Exchange Act); we will not be
able to deliver the requisite annual report and proxy statement
to our stockholders to hold our annual stockholders meeting; our
employees cannot be granted stock options, nor are they able to
exercise stock options registered on
Form S-8,
as
Form S-8
is currently not available to us; and our common stock may not
15
be eligible for re-listing on The NASDAQ Stock Market or
alternative exchanges. These restrictions may impair our ability
to raise funds in the public markets, should we desire to do so,
and to attract and retain employees.
Risks
Related to Our Business
We
have a history of losses, may continue to incur losses in the
future and may never achieve or maintain
profitability.
We have incurred losses in each year since our inception. We
began shipping products commercially in June 1997, and we have
been shipping products in volume since the quarter ended
March 31, 1998. As of December 31, 2006, we had an
accumulated deficit of approximately $1.1 billion. We
continue to be, and in future periods may remain, unable to
generate sufficient cash flow from operations to fund our
expenses. We believe that we will continue to experience
challenges in selling our products at a profit and may continue
to operate with net losses for the foreseeable future.
As a result of our losses, we have had to use available cash and
cash equivalents to supplement the operation of our business.
Additionally, we generally have been unable to significantly
reduce our short-term expenses in order to compensate for
unexpected decreases in anticipated revenues or delays in
generating anticipated revenues. For example, we have fixed
commitments with some of our suppliers that require us to
purchase minimum quantities of their products at a specified
price irrespective of whether we can subsequently use such
quantities in our products. In addition, we have significant
operating lease commitments for facilities and equipment that
generally cannot be cancelled in the short-term without
substantial penalties, if at all.
We
depend on capital spending from the cable, satellite and
telecommunications industries for our revenues, and any decrease
or delay in capital spending in these industries would
negatively impact our revenues, financial condition and cash
flows.
Historically, a significant portion of our revenues have been
derived from sales to cable television operators. Future demand
for our products will depend on the magnitude and timing of
capital spending by cable television operators, satellite
operators, telecom companies and broadcasters for constructing
and upgrading their systems. Customers view the purchase of our
products as a significant and strategic decision. Digital video,
movie and broadcast products are relatively complex and their
purchase generally involves a significant commitment of capital.
Our customers capital spending patterns are dependent on a
variety of factors, including:
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Cable and satellite operators and telecom providers access
to financing;
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Annual budget cycles, and the typical reduction in upgrade
projects during the winter months;
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Discretionary customer spending patterns;
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Impact of industry consolidation and financial restructuring;
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Federal, local and foreign government regulation of
telecommunications and television broadcasting, and regulatory
approvals that our customers need to obtain;
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Overall demand for communication services and acceptance of new
video, voice and data services;
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Evolving industry standards and network architecture;
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Delays associated with the evaluation of new services, new
standards, and system architectures by cable and satellite
operators and telecom providers;
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An emphasis on generating revenue from existing customers by
operators instead of new construction or network upgrades;
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The strategic focus of our customers and potential customers;
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Competitive pressures, including pricing pressures; and
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General economic conditions.
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Financial and budgetary pressures on our existing and potential
customers in the cable, satellite and telecom industries will
adversely impact purchasing decisions and may cause delays in
the purchase of our products. Any one of the above factors could
impact spending by cable operators on digital video equipment
and thus could impact our business and result in excess
inventory, decreased sales and revenue or other adverse effects.
Due to
the lengthy, complex and unpredictable sale cycle involved in
the sale of our products, revenues forecasted for a particular
period may not be realized, our financial results may vary and
past results should not be relied on as an indication of future
performance.
Our products have a lengthy, complex and unpredictable sales
cycle that contributes to the uncertainty of our operating
results. Factors that contribute to the lengthiness, complexity
and unpredictability of the sales cycle for our products include:
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A significant commitment of capital and other resources by
service providers;
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Delays frequently associated with large capital expenditures and
implementation procedures within an organization;
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Substantial time required to engineer the deployment of new
technologies or new video, voice and data services;
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Significant technical evaluations, including customer trials, of
our products as well as competing products prior to making a
purchasing decision; and
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Significant test marketing of new services to subscribers.
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Moreover, the purchase of our digital video products typically
requires coordination and agreement among a potential
customers corporate headquarters and regional and local
operations. Even if corporate headquarters agrees to purchase
our products, local operations may retain a significant amount
of autonomy and may not elect to purchase our products.
Additionally, a portion of our expenses related to anticipated
orders is fixed and is difficult to reduce or change, which may
further impact our revenues and operating results for a
particular period.
We expect that there will be fluctuations in the number and
value of orders received. Because of the lengthy sales cycle and
the size of customer orders, if orders forecasted for a specific
customer for a particular period do not occur in that period,
our revenues and operating results for that particular period
could suffer. As a result,
period-to-period
comparisons of our results of operations are not necessarily
meaningful, and these comparisons should not be relied upon as
indications of future performance.
Our
operating results are likely to fluctuate significantly and may
fail to meet or exceed the expectations of securities analysts
or investors or our guidance, causing our stock price to
decline.
Our operating results have fluctuated and are likely to continue
to fluctuate significantly in the future due to a number of
factors, many of which we cannot control. For example, in the
fourth quarter of 2006, DVS product revenues were higher than
expected due to the accelerated purchasing by some of our
telecom and cable customers that was originally expected to
occur in the first quarter of 2007. As a result, our DVS product
revenues in the first quarter of 2007 may be lower than expected
as these customers deploy and integrate product purchased.
Period-to-period
comparisons of our operating results are not necessarily
meaningful, and these comparisons should not be relied upon as
indications of the future. Because these factors are difficult
for us to forecast, our business, financial condition and
results of operations from one period or a series of periods may
be adversely affected and may be below the expectations of
analysts and investors, resulting in a decrease in the market
price of our common stock. Our business and product mix has
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also changed in the past several years based on our business
restructuring, making historical comparisons more unreliable as
indicators of future performance.
Factors that affect our revenues include, among others, the
following:
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The sales cycle and timing of significant customer orders, which
are dependent on the capital spending budgets of cable and
satellite operators, telecom providers and other customers;
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Variations in the size of the orders by our customers and
pricing concessions on volume sales;
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Competitive market conditions, including pricing actions by our
competitors;
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New product introductions or the introduction of added features
or functionality to products by competitors or by us;
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Delays in our introduction of new products, in our introduction
of added features or functionality to our products, or our
commercialization of products that are competitive in the
marketplace;
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International conflicts, including the continuing conflict in
Iraq, and acts of terrorism, and the impact of adverse economic,
market and political conditions worldwide;
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The ability of our products to be qualified or certified as
meeting industry standards
and/or
customer standards;
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Changes in market demand;
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Economic and financial conditions specific to the cable,
satellite and telecom industries, and general economic
conditions;
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Timing of revenue recognition on sales arrangements, which may
include multiple deliverables;
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The amount and timing of sales to telecom companies, which are
particularly difficult to predict;
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Changes in domestic and international regulatory environments;
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Market acceptance of new and existing products;
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The mix of our customer base, sales channels and our products
sold;
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The level of international sales; and
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Delays in our receipt of, or cancellation of, orders forecasted
by customers.
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Our financial results are affected by the gross margin we
achieve for the year relative to our gross revenues. A variety
of factors influence our gross margin for a particular period,
including, among others, the following:
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The sales mix of our products, the volume of products
manufactured, and the average selling prices (ASPs) of our
products;
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The costs of manufacturing our products;
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Delays in reducing the cost of our products and the
effectiveness of our cost reduction measures;
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The type of distribution channel through which we sell our
products; and
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Our ability to manage excess and obsolete inventory.
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In addition, the nature of our customers budget cycle
causes fluctuations in our quarterly operating results and could
result in additional losses to investors. Recently, our
operating results have been affected by our customers use
of remaining budget at the end of their fiscal year to purchase
equipment and accelerate build-out projects. We can provide no
assurances that fluctuations in our quarterly operating results
will diminish in the future.
18
Our
expenses for any given quarter are based on expected sales and
if sales are below expectations, our operating results may be
adversely impacted by our inability to adjust spending to
compensate for the shortfall in revenue.
We often recognize a substantial portion of our revenues in the
last month of the quarter. We establish our expenditure levels
for product development and other operating expenses based on
projected sales levels, and expenses are relatively fixed,
particularly in the short term. For example, a significant
percentage of these operating expenses are fixed due to
operating leases for our facilities and equipment. Also, we have
fixed commitments with some of our suppliers that require us to
purchase minimum quantities of their products at a specified
price. Because we have in the past been unable to use all of the
products that we purchased from our suppliers, we have taken
vendor cancellation charges as a result of these fixed
commitments, and we may have to take additional charges in the
future if we are unable to use all of the products that we
purchase from our suppliers. As of December 31, 2006,
$6.4 million of purchase obligations were outstanding. The
obligations are generally expected to become payable at various
times throughout 2007. Our expenses for any given quarter are
typically based on expected sales and if sales are below
expectations, our operating results may be adversely impacted by
our inability to adjust spending to compensate for the shortfall.
Because
our customer base is highly concentrated among a limited number
of large customers, the loss of or reduced demand from these
customers could have a material adverse effect on our business,
financial condition and results of operations.
Our customers in the cable industry have undergone and continue
to undergo significant consolidation in both North America and
internationally, as a limited number of cable operators control
an increasing number of systems. We expect this consolidation to
continue in the foreseeable future. As of September 2006, the
top ten U.S. Multiple System Operators (MSOs) (based on total
subscribers) collectively served 58.6 million cable
subscribers, which is approximately 89% of the total
65.6 million cable subscribers in the U.S., according to
Kagan Research, LLC. The top 10 MSOs are Comcast Cable
Communications; Time Warner Cable; Charter Communications, Inc.;
Cox Communications, Inc.; Cablevision System Corporation;
Bright House Networks LLC; Mediacom LLC; Suddenlink
Communications; Insight Communications Company, Inc.; and
CableOne. As a result of the consolidation among cable
operators, our revenues from digital video products have been,
and we expect that they will continue to be, highly concentrated
among a limited number of large customers primarily located in
the United States. Further business combinations may occur in
our customer base that results in increased purchasing leverage
by these customers over us. This may reduce the selling prices
of our products and services and as a result may harm our
business, financial condition and results of operations.
Typically, our sales are made on a purchase order or system
contract basis, and none of our customers has entered into a
long-term agreement requiring it to purchase our products.
Moreover, we do not typically require our customers to purchase
a minimum quantity of our products, and our customers can
generally cancel or significantly reduce their orders on short
notice without significant penalties. Our sales to these
customers tend to vary significantly from year to year depending
on the customers budget for capital expenditures and our
new product introductions and improvements. A significant amount
of our revenues will continue to be derived from a limited
number of large customers. The loss of or reduced demand for
products from any of our major customers could have a material
adverse effect on our business, financial condition and results
of operations. Also, we may not succeed in attracting new
customers as many of our potential customers have pre-existing
relationships with our current or potential competitors and the
continued consolidation of the cable industry may also reduce
the number of potential customers. To attract new customers and
retain existing customers, we may be faced with price
competition, which may adversely affect our gross margins and
revenues.
A portion of our sales are made to a small number of resellers,
who often incorporate our products and applications in systems
that are sold to an end-user customer, which is typically a
cable operator, satellite provider or broadcast operator. If one
or more of these resellers develop their own products or elect
to purchase similar products from another vendor, our ability to
generate revenue and our results of operations may suffer.
19
Our
continued growth will depend on our ability to diversify our
customer base and deliver products that help enable telecom
companies to provide video services. If the projected growth in
demand for video services from telecom companies does not
materialize or if these service providers find alternative
methods of delivering video services, future sales of our
digital video products will be adversely impacted.
We are attempting to diversify our customer base beyond cable
and satellite customers, principally into the telecom market, as
well as the broadcast market. Major telecom companies have begun
to implement plans to rebuild or upgrade their networks to offer
bundled video, voice and data services. Although we have
recently begun selling digital video products to telecoms in the
fourth quarter of 2006, we will need to devote considerable
resources to obtain orders, qualify our products and hire
knowledgeable personnel to address telecom customers. If
technological advancements allow these companies to provide
video services without upgrading their current system
infrastructure or provide more cost-effective methods of
delivering video services than our products, sales of our
digital video products will suffer. Even if these providers
choose our products, they may not be successful in marketing
video services to their customers, in which case additional
sales of our products would likely be reduced. If we fail to
penetrate the telecom market successfully, our growth in
revenues and operating results would be correspondingly limited.
In order to be successful in this market, we may need to build
alliances with integrators that sell telecom equipment to the
telecom operators, adapt our products for telecom applications,
adopt pricing specific to the telecom industry and the
integrators that sell to the telecom operators, and build
internal expertise to handle particular contractual and
technical demands of the telecom industry. As a result of these
and other factors, we cannot give any assurances that we will be
able to increase our revenues from the telecom market, or that
we can do so profitably, and any failure to generate revenues
and profits from telecom customers could adversely affect our
business, financial condition and results of operations.
The
reductions in workforce associated with any restructuring
efforts could disrupt the operation of our business, distract
our management from focusing on revenue-generating efforts,
result in the erosion of employee morale, and impair our ability
to respond rapidly to growth opportunities in the
future.
We have implemented a number of restructuring plans since 2001.
The employee reductions and changes in connection with our
restructuring activities, as well as any future changes in
senior management and key personnel, could result in an erosion
of morale, and affect the focus and productivity of our
remaining employees, including those directly responsible for
revenue generation and the management and administration of our
accounting and finance department, which in turn may adversely
affect our future revenues or cause other administrative
deficiencies. Additionally, employees directly affected by the
reductions may seek future employment with our business
partners, customers or competitors. Although all employees are
required to sign a proprietary information agreement with us at
the time of hire, there can be no assurances that the
confidential nature of our proprietary information will be
maintained in the course of such future employment.
Additionally, we may face wrongful termination, discrimination,
or other claims from employees affected by the reductions
related to their employment and termination. We could incur
substantial costs in defending ourselves or our employees
against such claims, regardless of the merits of such actions.
Furthermore, such matters could divert the attention of our
employees, including management, away from our operations, harm
productivity, harm our reputation and increase our expenses. We
cannot assure you that our restructuring efforts will be
successful, and we may need to take additional restructuring
efforts, including additional personnel reductions, in the
future.
We are
dependent on key personnel and we may face challenges in hiring
and retaining qualified personnel due to the
restatement.
Due to the specialized nature of our business, we are highly
dependent on the continued service of and on our ability to
attract and retain qualified senior management, accounting and
finance, engineering, sales and marketing personnel and
employees with significant experience and expertise in video,
data networking and radio frequency design. The competition for
some of these personnel is intense, particularly for engineers
with Motion Picture Experts Group (MPEG), Internet Protocol (IP)
and real time processing experience. Given the lengthy
restatement process, it has become more difficult to attract and
retain key personnel, and we may incur
20
additional expenses in attempting to do so. We have experienced
turnover in our accounting and finance organization and have
augmented internal resources to address staffing deficiencies
primarily through the engagement of external contractors. We
previously used an outside accounting consulting firm to assist
with the preparation of our financial statements, and we may not
be able to prepare future financial statements without such
outside accounting assistance.
There can be no assurances that the additional expenses we may
incur, or our efforts to recruit and retain such individuals,
will be successful. The loss of the services of any of our key
employees, the inability to attract or retain qualified
personnel in the future, or delays in hiring required personnel,
could delay the development and introduction of, and negatively
affect our ability to sell, our products. Additionally, we do
not have key person insurance coverage for the loss of any of
our employees. Any officer or employee can terminate his or her
relationship with us at any time. Our employees generally are
not bound by non-competition agreements. The loss of the
services of any key personnel, or our inability to attract or
retain qualified personnel could have a material adverse effect
on our business, financial condition and results of operations.
Our
future growth depends on developments in the digital video
industry, on the adoption of new technologies and on several
other industry trends.
Future demand for our products will depend significantly on the
growing market acceptance of several emerging services,
including digital video, high definition television (HDTV),
video on demand,
voice-over-IP,
IP-based TV,
ad insertion, and logo overlays. The effective delivery of these
services will depend, in part, on a variety of new network
architectures and standards, such as: FTTP and DSL networks
designed to facilitate the delivery of video services by telecom
operators; new video compression standards such as MPEG-4/H.264
and VC-1 for
both standard and high definition services; the greater use of
protocols such as IP; and the introduction of new consumer
devices, such as advanced set-top boxes and DVRs. If adoption of
these emerging services
and/or
technologies is not as widespread or as rapid as we expect, or
if we are unable to develop new products based on these
technologies on a timely basis, our net sales growth will be
materially and adversely affected.
Furthermore, other technological, industry and regulatory trends
will affect the growth of our business. These trends include the
following:
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Convergence, or the desire of certain network operators to
deliver a package of video, voice and data services to
consumers, also known as the triple play;
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The use of digital video applications by businesses, governments
and educators;
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The entry of telecom providers into the video business to allow
them to offer the triple play purchase of services;
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Efforts by regulators and governments in the United States and
abroad to encourage the adoption of broadband and digital
technologies; and
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The extent and nature of regulatory attitudes towards such
issues as competition between operators, access by third parties
to networks of other operators, and local franchising
requirements for telecom companies to offer video.
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If, for instance, operators do not pursue the triple
play or new video products and technology aggressively or
in the timeline we expect, our ability to sell our digital video
products and grow our revenues will be materially and adversely
affected.
The
markets in which we operate are characterized by rapidly
changing technology, and we need to develop and introduce new
and enhanced products in a timely manner to remain
competitive.
The markets in which we operate are characterized by rapidly
changing technologies, evolving industry standards, frequent new
product introductions and relatively short product life. To
compete successfully in these markets, we must design, develop,
manufacture and sell new or enhanced products that provide
21
increasingly higher levels of performance and reliability.
Digital video markets are relatively immature, making it
difficult to accurately predict the markets future growth
rates, sizes or technological directions. In view of the
evolving nature of these markets, network operators and content
aggregators may decide to adopt alternative architectures,
industry standards or technologies that are incompatible with
our current or future video products and applications. The
development and greater market acceptance of new architectures,
industry standards or technologies could decrease the demand for
our products or render them obsolete, and could negatively
impact the pricing and gross margin of our digital video
products. Our competitors, many of which have greater resources
than we do, may introduce products that are less costly, provide
superior performance or achieve greater market acceptance than
our products. If we are unable to design, develop, manufacture
and sell products that incorporate or are compatible with these
new architectures, industry standards or technologies, our
business and financial results will be materially and adversely
impacted. Our ability to realize revenue growth depends on our
ability to:
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Develop, in a timely manner, new products and applications that
keep pace with developments in technology;
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Develop products that are cost effective;
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Meet evolving customer requirements;
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Enhance our current product and applications offerings; and
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Achieve market acceptance.
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The pursuit of necessary technological advances and the
development of new products and functionality require
substantial time and expense. We may not be able to successfully
develop or introduce new or enhanced products if they are not
cost effective, are not brought to the market in a timely
manner, are not in accordance with evolving industry standards
and architecture, fail to achieve market acceptance, or are
ahead of the market. If the technologies we are currently
developing or intend to develop do not achieve feasibility or
widespread market acceptance, our business will be materially
and adversely impacted. In addition, in order to successfully
develop and market certain of our current or future digital
video products, we may be required to enter into technology
development or licensing agreements with third parties. Failure
to enter into development or licensing agreements, when
necessary, could limit our ability to develop and market new
products and could cause our operating results to suffer. The
entry into such development or licensing agreements may not be
on terms favorable to us and could negatively impact our gross
margins.
Additionally, because of the lengthy sales cycle combined with a
lengthy product development cycle, our customers may elect not
to purchase our products or new features or functionality
because they have elected to select alternate technologies or
vendors. We may be unable to forecast the new products, features
or functionality desired by our customers. We may spend
considerable research and development dollars without having our
products, features or functionality be accepted in the market.
Because we are now focused solely on the development of digital
video products, our inability to develop products, features and
functionality that our customers might purchase would have an
adverse impact on us, and would negatively affect our sales,
revenue, margins and available cash for future development
efforts.
Average
selling prices of our digital video products may decline, which
would materially and adversely affect our financial
performance.
The ASPs for our digital video products may decline due to the
introduction of new products, the adoption of new industry
standards, the entry into licensing agreements, an increase in
the number of competitors, competitive pricing pressures,
promotional programs and customers possessing strong negotiating
positions which require price reductions as a condition of
purchase. The adoption of industry standards and specifications
may erode ASPs on our digital video products if the adoption of
such standards leads to the commoditization of products similar
to ours. The entry into technology development or licensing
agreements, as necessitated by industry developments and
business needs, could also reduce our ASPs. Decreasing ASPs may
also require us to sell our products at much lower gross margins
than in the past, and could result in decreased revenues even if
the number of units that we sell increases. We may experience
substantial
22
period-to-period
fluctuations in future revenue, gross margin and operating
results due to ASP erosion in our digital video products.
Therefore, we must continue to develop and introduce on a timely
basis and a cost-effective manner new products or
next-generation products with enhanced functionalities that can
be sold at higher gross margins. If we fail to do so, our
revenues and gross margins may decline further.
We
must achieve cost reductions or increase revenues to attain
profitability.
In order to achieve profitability, we must significantly
increase our revenues, continue to reduce the cost of our
products, and reduce and control our operating expenses. In
prior years, we experienced revenue declines which were, in
large part, due to declining product ASPs resulting from our
transition from a proprietary platform to the Data Over Cable
System Interface Specification (DOCSIS) standards platform.
Although we have implemented expense reduction and restructuring
plans in the past that have focused on cost reductions and
operating efficiencies, we continue to operate at a loss. A
large portion of our expenses, including rent and operating
lease expenditures, is fixed and difficult to reduce or change.
Accordingly, if our revenue does not meet our expectations, we
may not be able to adjust our expenses quickly enough to
compensate for the shortfall in revenue which, in turn, could
materially and adversely impact our business, financial
condition and results of operations.
While we continue to work to reduce the cost of our products
through design and engineering changes, we may not be successful
in redesigning our products, and, even if we are successful, our
efforts may be delayed or our redesigned products may contain
significant errors and product defects. In addition, any
redesign may not result in sufficient cost reductions to allow
us to reduce significantly the prices of our products or improve
our gross margins. Reduction in our product costs may require us
to use lower-priced components that are highly integrated in
future products and may require us to enter into high volume or
long-term purchase or manufacturing agreements. Volume purchase
or manufacturing agreements may not be available on acceptable
terms, if at all, and we could incur significant expenses
without related revenues if we cannot use the products or
services offered by such agreements. We have incurred
significant vendor cancellation charges related to volume
purchases and manufacturing agreements in the past and may incur
such charges in the future.
Our
repayment of our Notes could adversely affect our financial
condition, and we may not be able to raise additional funds to
continue operating our business.
Our main source of liquidity continues to be our unrestricted
cash and cash equivalents on hand. As a result of our history of
operating losses, we expect to continue to use our unrestricted
cash to fund operating losses in the future. Our unrestricted
cash, cash equivalents and short-term investments totaled
$20.3 million and $101.3 million as of
December 31, 2006 and 2005, respectively. On March 21,
2006, we paid off the entire principal amount of the outstanding
Notes due August 2007, including all accrued and unpaid interest
thereon and related fees, for an aggregate amount of
$65.6 million. Our repayment in full of the Notes reduced
our unrestricted cash, decreased our liquidity and could
materially impair our ability to operate our business,
especially if we are unable to generate positive cash flow from
operations.
If our operating losses are more severe than expected or
continue longer than expected, we may find it necessary to seek
other sources of financing to support our operations and to
provide available funds for working capital. We may need to
raise additional funds in order to support more rapid expansion,
develop new or enhanced services, respond to competitive
pressures, acquire complementary businesses or technologies or
respond to unanticipated requirements. We may seek to raise
additional funds through private or public sales of securities,
strategic relationships, bank debt, and financing under leasing
arrangements or otherwise. Based on our delay in filing our
periodic reports due to the restatement, we are currently not
eligible to use a short-form registration statement
on
Form S-3.
If additional funds are raised through the issuance of equity
securities, the percentage ownership of our current stockholders
will be reduced, stockholders may experience additional dilution
or such equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock.
No assurances can be given that additional financing will be
available on acceptable terms, if at all. If adequate funds are
not available or are not available on acceptable terms, we may
be unable to continue operations, develop our products, take
advantage of future opportunities or respond to
23
competitive pressures or unanticipated requirements, which could
have a material adverse effect on our business, financial
condition, operating results and liquidity.
Substantially
all of our future revenue will be derived from the sale of our
digital video products, and our operating results, financial
conditions and cash flows will depend upon our ability to
generate sufficient revenue from the sale of our digital video
products.
In January 2006 we announced that we will focus solely on our
digital video products and applications. We expect to sell off
all remaining inventories from our discontinued HAS and CMTS
product lines during 2007. Accordingly, we are susceptible to
adverse trends affecting the digital video market segment,
including technological obsolescence and the entry of new
competition. We expect that this market may continue to account
for substantially all of our revenue in the near future. As a
result, our future success depends on our ability to continue to
sell our digital video products and applications, the gross
margin of such sales, our ability to maintain and increase our
market share by providing other value-added services to the
market, and our ability to successfully adapt our technology and
services to other related markets. Markets for our existing
services and products may not continue to expand and we may not
be successful in our efforts to penetrate new markets.
We may
be unable to provide adequate customer support.
Our ability to achieve our planned sales growth and retain
current and future customers will depend in part upon the
quality of our customer support operations. Our customers
generally require significant support and training with respect
to our products, particularly in the initial deployment and
implementation stages. Spikes in demand of our support services
may cause us to be unable to serve our customers adequately. We
may not have sufficient personnel to provide the levels of
support that our customers may require during initial product
deployment or on an ongoing basis especially during peak
periods. Our inability to provide sufficient support to our
customers could delay or prevent the successful deployment of
our products. In addition, our failure to provide adequate
support could harm our reputation and relationships with our
customers and could prevent us from selling products to existing
customers or gaining new customers.
Furthermore, we may experience transitional issues relating to
customer support in connection with our decision to dispose of
or discontinue various investments and product lines. We may
incur liability associated with customers dissatisfaction
with the level of customer support maintained for discontinued
product lines.
The
deployment process for our equipment may be lengthy and may
delay the receipt of new orders and cause fluctuations in our
revenues.
The timing of deployment of our equipment can be subject to a
number of other risks, including the availability of skilled
engineering and technical personnel, the availability of other
equipment such as fiber optic cable, and the need for local
zoning and licensing approvals. The systems of our customers are
both diverse and complex, and our ability to configure, test and
integrate our systems with other elements of our customers
networks is dependent upon technologies provided to our
customers by third parties. The deployment and integration
process can delay and impact the timing of our revenues. We
believe that changes in our customers deployment plans
have delayed, and may in the future delay, the receipt of new
orders. Since the majority of our sales have been to relatively
few customers, a delay in equipment deployment with any one
customer could have a material adverse effect on our sales for a
particular period.
We may
have financial exposure to litigation.
We and/or
our directors and officers are defendants in a number of
lawsuits, including securities litigation lawsuits and patent
litigation. See Item 3 Legal Proceedings for
more information regarding our litigation. As a result, we may
have financial exposure to litigation as a defendant and because
we are obligated to indemnify our officers and members of our
Board of Directors for certain actions taken by our officers and
directors on our behalf.
24
In order to limit financial exposure arising from litigation
and/or our
obligation to indemnify our officers and directors, we have
historically purchased directors and officers
insurance (D&O Insurance). There can be no assurance that
D&O Insurance will be available to us in the future or, if
D&O Insurance is available, that it will not be
prohibitively expensive.
If there is no insurance coverage for the litigation or, even if
there is insurance coverage, if a carrier is subsequently
liquidated or placed into liquidation, we will be responsible
for the attorney fees and costs resulting from the litigation.
The incurrence of significant fees and expenses in connection
with the litigation could have a material adverse effect on our
results of operations.
The
loss of existing reseller and system integrator relationships or
the failure to establish new relationships or strategic
partnerships could have a material adverse effect on our
business, financial conditions and results of
operations.
Our products have been traditionally sold to large cable
operators and satellite operators with recent, limited sales to
television broadcasters and telecom companies. A portion of our
sales are made to a small number of resellers and system
integrators, who often incorporate our products and applications
in systems that are sold to an end-user customer, which is
typically a cable operator, satellite provider or broadcast
operator. The resale relationships provide an opportunity to
sell our products to our resellers customer bases. We rely
upon these resellers for recommendations of our products during
the evaluation stage of the purchasing process, as well as for
implementation and customer support services. A number of our
competitors also have strong relationships with the resellers.
Although we intend to establish new strategic relationships with
leading resellers worldwide to gain access to new customers,
including telecom providers, we may not succeed in establishing
these relationships. Even if we do establish and maintain these
relationships, our resellers or strategic partners may not
succeed in marketing our products to their customers. Some of
our competitors have established long-standing relationships
with cable, satellite and telecom operators that may limit our
and our resellers ability to sell our products to those
customers. Even if we were to sell our products to those
customers, it would likely not be based on long-term
commitments, and those customers would be able to terminate
their relationships with us at any time without significant
penalties. Our resellers or strategic partners may also
terminate their relationship with us upon short notice without
significant penalties.
Based on our sole focus on our digital video products, the
reduction of our sales force, and our increasing focus on the
telecom market, we are increasingly reliant on resellers and
system integrators. In order to successfully market to telecom
companies, we believe we will need to build alliances with
system integrators that sell telecom equipment to the telecom
operators. We may be unsuccessful in maintaining our current
reseller and system integrator relationships as well as
attracting system integrators that sell to telecom companies.
Some of our resellers and system integrators have sold in the
past, and may sell in the future, products that compete with our
products. The loss of existing reseller and system integrator
relationships or the failure to establish new relationships or
strategic partnerships could have a material adverse effect on
our business, financial condition and results of operations.
We may
fail to accurately forecast customer demand for our products,
which could have a negative impact on our customer relationships
and our revenues.
The nature of the broadband industry makes it difficult for us
to accurately forecast demand for our products. Our inability to
forecast accurately the actual demand for our products may
result in too much or too little supply of products or an
over/under capacity of manufacturing or testing resources at any
given point in time. The existence of any one or more of these
situations could have a negative impact on our business,
operating results or financial condition. We have incurred
significant vendor cancellation charges related to volume
purchase and manufacturing agreements in the past and may incur
such charges in the future. We had purchase obligations of
approximately $6.4 million as of December 31, 2006,
primarily to purchase minimum quantities of materials and
components used to manufacture our products. We may be obligated
to fulfill these purchase obligations even if demand for our
products is lower than we anticipate.
25
Forecasting to meet our customers demand is particularly
difficult for our products. Our ability to meet customer demand
will depend significantly on the availability of our single
contract manufacturer. In recent years, in response to lower
sales and falling ASPs, we significantly reduced our headcount
and other expenses. As a result, we may be unable to respond to
customer demand that increases more quickly than we expect. If
we fail to meet customers supply expectations, our sales
would be adversely affected and we may lose key customer
relationships.
We may
not be able to manage expenses and inventory risks associated
with meeting the demand of our customers.
From time to time, we receive indications from our customers as
to their future plans and requirements to ensure that we will be
prepared to meet their demand for our products. If actual orders
differ materially from these indications, our ability to manage
inventory and expenses may be affected. If we enter into
purchase commitments to acquire materials, or expend resources
to manufacture products and such products are not purchased by
our customers, our business and operating results could suffer.
Although we generally do not have long term supply agreements
with our customers and have limited backlog of orders for our
products, we must maintain or have available sufficient
inventory levels to satisfy anticipated demand on a timely
basis. Maintaining sufficient inventory levels to ensure prompt
delivery of our products increases the risk of inventory
obsolescence and associated write-offs, which could harm our
business, financial conditions and results of operations.
We are
dependent on a key third-party manufacturer and any failure of
our manufacturer could materially adversely affect our financial
condition and operating results.
Our products are single sourced from a manufacturer in
San Jose, California. Any interruption in the operations of
our manufacturer could adversely affect our ability to meet our
scheduled product deliveries to customers. If we experience
delays or quality control problems or any failure from our
current manufacturer, we may be unable to supply products in a
timely manner to our customers. While we believe that there are
alternative manufacturers available, we believe that the
procurement from alternative suppliers could take several
months. In addition, these alternative suppliers may not be able
to supply us products that are functionally equivalent, or make
our products available to us on a timely basis or on similar
terms. Resulting delays, quality control problems or reductions
in product shipments could materially and adversely affect on
our financial performance, damage customer relationships, and
expose us to potential damages that may arise from our inability
to supply our customers with products. Further, a significant
increase in the price of underlying components, such as our
semiconductor components, could harm our gross margins or
operating results. There may not be manufacturers that are able
to meet our future volume or quality requirements at a price
that is favorable to us. Any financial, operational, production
or quality assurance difficulties experienced by our single
manufacturer could harm our business and financial results.
Additionally, we attempt to limit this risk by maintaining
safety stocks of these components, subassemblies and modules. As
a result of this investment in inventories, we have in the past
been and in the future may be subject to risk of excess and
obsolete inventories, which could harm our business. In this
regard, our gross margins and operating results could be
adversely affected by excess and obsolete inventory.
Our products are assembled and tested by our single manufacturer
using testing equipment that we provide. As a result of our
dependence on the contract manufacturer for the assembly and
testing of our products, we do not directly control product
delivery schedules or product quality. Any product shortages or
quality assurance problems could increase the costs of
manufacturing, assembling or testing our products. In addition,
as manufacturing volume increases, we will need to procure and
assemble additional testing equipment and provide it to our
contract manufacturer. The production and assembly of testing
equipment typically require significant lead times. We could
experience significant delays in the shipment of our products if
we are unable to provide this testing equipment to our contract
manufacturers in a timely manner.
26
We are
dependent upon international sales and there are many risks
associated with international operations, any of which could
harm our financial condition and results of
operations.
We are dependent upon international sales, even though we expect
sales to customers outside of the United States to represent a
significantly smaller percentage of our revenues for the
foreseeable future compared to our historical revenues. For the
years ended December 31, 2006, 2005 and 2004, approximately
29%, 42% and 47%, respectively, of our net revenues were from
customers outside of the United States. We may be unable to
maintain or increase international sales of our products.
International sales are subject to a number of risks, including
the following:
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Changes in foreign government regulations and communications
standards;
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Import and export license requirements, tariffs and taxes, trade
barriers and trade disputes;
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The uncertainty of laws and enforcement in certain countries
relating to the protection of intellectual property;
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Difficulty in complying with environmental laws;
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Difficulty in collecting accounts receivable and longer payment
cycles for international customers than those for customers in
North America;
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Currency and exchange rate fluctuations;
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The burden of complying with a wide variety of foreign laws,
treaties and technical standards;
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Difficulty in staffing and managing foreign operations;
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Specific social, political, labor and economic conditions, and
political and economic changes in international markets; and
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Multiple and possibly overlapping tax structures and potentially
adverse tax consequences.
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One or more of these factors may have a material adverse effect
on our future operations and consequently, on our business,
financial conditions and operating results.
While we generally invoice our foreign sales in
U.S. dollars, we invoice some of our sales in Europe in
Euros and local currency in other countries. Since we have also
elected to take payment from our customers in local currencies
and may elect to take payment in other foreign currencies in the
future, we are exposed to losses as the result of foreign
currency fluctuations. We currently do not engage in foreign
currency hedging transactions. We may in the future choose to
limit our exposure by the purchase of forward foreign exchange
contracts or through similar hedging strategies. No currency
hedging strategy can fully protect against exchange-related
losses. In addition, if the relative value of the
U.S. dollar in comparison to the currency of our foreign
customers should increase, the resulting effective price
increase of our products to our foreign customers could result
in decreased sales. If our customers are affected by currency
devaluations or general economic downturns, their ability to
purchase our products could be reduced significantly.
We are
subject to regulation by U.S. and foreign governments and
qualification requirements by non-governmental agencies. If we
are unable to obtain and maintain regulatory qualifications for
our existing and future products, our financial results may be
adversely affected.
The cable, satellite and telecom industries are subject to
extensive regulation in the United States and in foreign
countries, which may affect the sale of our products and the
growth of our business domestically and internationally. The
growth of our business and our financial performance depend in
part on regulations in these industries. Our products are also
subject to qualification, clearance, and approval in certain
countries, and we cannot make any assurances that we will be
able to maintain these qualifications, clearances or approvals
in all the countries in which we operate. If we do not comply
with the applicable regulatory requirements in each of the
jurisdictions where our products are sold, we may be subject to
regulatory enforcement actions which could require us to, among
other things, cease selling our products.
27
We are subject to the Foreign Corrupt Practices Act (FCPA) and
other laws which prohibit improper payments or offers of
payments to foreign governments and their officials and
political parties by U.S. and other business entities for the
purpose of obtaining or retaining business. We make sales in
countries known to experience corruption. Our sales activities
in such countries create the risk of unauthorized payments or
offers of payments by one of our employees, consultants, sales
agents or distributors which could be in violation of various
laws including the FCPA, even though such parties are not always
subject to our control. We have attempted to implement
safeguards to prevent losses from such practices and to
discourage such practices by our employees, consultants, sales
agents and distributors. However, our safeguards may prove to be
less than effective and our employees, consultants, sales agents
or distributors may engage in conduct for which we might be held
responsible. Violations of the FCPA may result in severe
criminal or civil sanctions, and we may be subject to other
liabilities, which could adversely affect our business,
financial condition and results of operations.
Furthermore, foreign countries may decide to prohibit, terminate
or delay the construction of new infrastructure or the adoption
of new technology for a variety of reasons. These reasons
include environmental issues, economic downturns, availability
of favorable pricing for other communications services and the
availability and cost of related equipment. Regulations dealing
with access by competitors to the networks of incumbent
operators could slow or stop additional construction or
expansion of these operators. Increased regulation of our
customers pricing or service offerings could limit their
investments and consequently the sale of our products. Changes
in regulations could have an adverse impact on our business and
financial results.
The
markets in which we operate are intensely competitive and many
of our competitors are larger and more
established.
The markets for digital video products and applications are
extremely competitive and have been characterized by rapid
technological changes. Competitors vary in size and in the scope
and breadth of the products and services they offer. Our current
competitors include Scopus Video Networks Ltd.; RGB Networks,
Inc.; BigBand Networks; Cisco Systems, Inc. through its
acquisition of Scientific-Atlanta, Inc.; SeaChange
International, Inc.; and Ericsson through its acquisition of
Tandberg Television ASA. Competitors who could enter into the
digital video applications and products market include larger
and more established players such as Motorola, Inc. and
Alcatel-Lucent. Companies that have historically not had a large
presence in digital video applications and products market have
recently begun to expand their market share through mergers and
acquisitions. Further, our competitors may bundle their products
or incorporate functionality into existing products in a manner
that discourages users from purchasing our products or which may
require us to lower our selling prices resulting in lower gross
margins. Consolidation in the industry also may result in larger
competitors that may have significant combined resources with
which to compete against us. We also face competition from early
stage companies with access to significant financial backing
that seek to improve existing technologies or develop new
technologies. Increased competition could result in reductions
in price and revenues, lower profit margins, loss of customers
and loss of market share. Any one of these factors could
materially and adversely affect our business, financial
condition and operating results.
The principal competitive factors in our market include the
following:
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Product performance, features and reliability;
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Price;
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Size and stability of operations;
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Breadth of product line;
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Sales and distribution capabilities;
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Technical support and service;
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Relationships with network operators and content
aggregators; and
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Compliance with industry standards.
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Many of our competitors and potential competitors are
substantially larger and have significant advantages over us,
including, without limitation:
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Larger and more established selling and marketing capabilities;
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Greater economies of scale;
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Significantly greater financial, technical, engineering,
marketing, distribution, customer support and other resources;
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Greater name recognition and a larger installed base of
customers; and
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Well-established relationships with our existing and potential
customers.
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Our competitors and potential competitors may be in a better
position to withstand any significant reduction in capital
spending by customers in these markets or to reduce selling
prices for competitive reasons. They often have broader product
lines and market focus and may not be as susceptible to
downturns in a particular market. Many of our competitors and
potential competitors have been in operation longer than we have
and therefore have more long-standing and established
relationships with domestic and foreign customers. In addition,
many of our competitors manufacture their products in countries
where the cost of production is significantly lower than in
California, where we produce most of our products, thus enabling
them to offer competitively lower prices for their products.
If any of our competitors products or technologies were to
become the industry standard, our business could be seriously
harmed. If our competitors are successful in bringing these
products to market earlier, or if these products are more
technologically capable than ours, then our sales could be
materially and adversely affected. Our competitors may be in a
stronger position to respond quickly to new or emerging
technologies and changes in customer requirements. Our
competitors may also be able to devote greater resources to the
development, promotion and sale of their products and services
than we can. Accordingly, we may not be able to maintain or
expand our revenues if competition increases and we are unable
to respond effectively.
Given these competitive and other market factors, we continually
look for opportunities to compete effectively and create value
for our stockholders. We may, at any time and from time to time,
be in the process of identifying or evaluating product
development initiatives, partnerships, strategic alliances or
transactions and other alternatives in order to maintain market
position and maximize shareholder value. Market and other
competitive factors may cause us to change our strategic
direction, and we may not realize the benefits of any such
initiatives, partnerships, alliances or transactions. We cannot
assure you that any such initiatives, partnerships, alliances or
transactions that we identify and pursue would actually result
in our competing effectively, maintaining market position or
increasing stockholder value. Our failure to realize any
expected benefits from such initiatives, partnerships, alliances
or transactions could negatively impact our financial position,
results of operations, cash flows and stock price.
Our
business is subject to the risks of warranty returns, product
liability and product defects.
Products like ours are very complex and can frequently contain
undetected errors or failures, especially when first introduced
or when new versions are released. Despite testing, errors may
occur. Product errors could affect the performance or
interoperability of our products, delay the development or
release of new products or new versions or upgrades of products,
and adversely affect our reputation, our customers
willingness to buy products from us, and market acceptance and
perception of our products. Any such errors or delays in
releasing new products or new versions or upgrades of products
or allegations of unsatisfactory performance could cause us to
lose revenue or market share, increase our service costs, cause
us to incur substantial costs in redesigning the products,
subject us to liability for damages and divert our resources
from other tasks, any one of which could materially and
adversely affect our business, results of operations and
financial condition. Although we have limitation of liability
provisions in our standard terms and conditions of sale, they
may not be effective as a result of federal, state or local laws
or ordinances or unfavorable judicial decisions in the United
States or other countries. The sale and support of our products
also entails the risk of
29
product liability claims. We maintain insurance to protect
against certain claims associated with the use of our products,
but our insurance coverage may not adequately cover any claim
asserted against us. In addition, even claims that ultimately
are unsuccessful could result in our expenditure of funds in
litigation and divert managements time and other resources.
We may
be unable to adequately protect or enforce our intellectual
property rights.
We rely on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and
protect proprietary rights in our products. Even though we seek
to establish and protect proprietary rights in our products,
there are risks. There are no assurances that any patent,
trademark, copyright or other intellectual property rights owned
by us will not be invalidated, circumvented or challenged, that
such intellectual property rights will provide competitive
advantages to us or that any of our pending or future patent
applications will be issued with the scope of the claims sought
by us, if at all. There are no assurances that others will not
develop technologies that are similar or superior to our
technology, duplicate our technology, or design around the
patents that we own. In addition, effective patent, copyright
and trade secret protection may be unavailable or limited in
certain foreign countries in which we do business or may do
business in the future.
Our pending patent applications may not be granted. Even if they
are granted, the claims covered by any patent may be reduced
from those included in our applications. Any patent might be
subject to challenge in court and, whether or not challenged,
might not be broad enough to prevent third parties from
developing equivalent technologies or products without a license
from us.
We believe that the future success of our business will depend
on our ability to translate the technological expertise and
innovation of our employees into new and enhanced products. We
have entered into confidentiality and invention assignment
agreements with our employees, and we enter into non-disclosure
agreements with many of our suppliers, distributors and
appropriate customers so as to limit access to and disclosure of
our proprietary information. These contractual arrangements, as
well as statutory protections, may not prove sufficient or
effective to prevent misappropriation of our technology, trade
secrets or other proprietary information or deter independent
third-party development of similar technologies. In addition,
the laws of some foreign countries may not protect our
intellectual property rights to the same extent as do the laws
of the United States. We may, in the future, take legal action
to enforce our patents and other intellectual property rights,
to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could
negatively affect our business, operating results, financial
position and liquidity.
We pursue the registration of our trademarks in the United
States and have applications pending to register several of our
trademarks throughout the world. However, the laws of certain
foreign countries might not protect our products or intellectual
property rights to the same extent as the laws of the United
States. Effective trademark, copyright, trade secret and patent
protection may not be available in every country in which our
products may be manufactured, marketed or sold.
Our
use of open source and third-party software could impose
limitations on our ability to commercialize our
products.
We incorporate open source software into our products, including
certain open source code which is governed by the GNU General
Public License, Lesser GNU General Public License and Common
Development and Distribution License. The terms of many open
source licenses have not been interpreted by U.S. courts,
and there is a risk that these licenses could be construed in a
manner that could impose unanticipated conditions or
restrictions on our ability to commercialize our products. In
such event, we could be required to seek licenses from third
parties in order to continue offering our products, make
generally available, in source code form, proprietary code that
links to certain open source modules, re-engineer our products,
discontinue the sale of our products if re-engineering could not
be accomplished on a cost-effective
30
and timely basis, or become subject to other consequences, any
of which could adversely affect our business, operating results
and financial condition.
We may also find that we need to incorporate certain proprietary
third-party technologies, including software programs, into our
products in the future. However, licenses to relevant
third-party technology may not be available to us on
commercially reasonable terms, if at all. Therefore, we could
face delays in product releases until alternative technology can
be identified, licensed or developed, and integrated into our
current products. These delays, if they occur, could materially
adversely affect our business, operating results and financial
condition.
Third
party claims of infringement or other claims against us could
adversely affect our ability to market our products, require us
to redesign our products or seek licenses from third parties,
and seriously harm our operating results and disrupt our
business.
The industry in which we operate is characterized by vigorous
protection of intellectual property rights, which on occasion
have resulted in significant and often protracted litigation. As
is typical in our industry, we have been and may from time to
time be notified of claims asserting that we are infringing
intellectual property rights owned by third parties. We also
have in the past agreed to, and may from time to time in the
future agree to, indemnify customers of our technology or
products for claims against such customers by a third party
based on claims that our technology or products infringe patents
of that third party. Currently, in the cable industry, there is
industry-wide patent litigation involving the DOCSIS standard
and certain video technologies. Our customers have been sued for
using certain DOCSIS complaint products and video products,
including our products. Our customers have requested indemnity
pursuant to the terms and conditions of our sales to them, and
we are contributing to the legal fees and costs of these
litigations. Additionally, we may have further liability under
indemnity obligations if there is a settlement or judgment.
Please see Item 3 Legal Proceedings for
additional information.
We further believe that companies may be increasingly subject to
infringement claims as distressed companies and individuals
attempt to generate cash by enforcing their patent portfolio
against a wide range of products. These types of claims,
meritorious or not, may result in costly and time-consuming
litigation; divert managements attention and other
resources; require us to enter into royalty arrangements;
subject us to significant damages or injunctions restricting the
sale of our products; require us to indemnify our customers for
the use of the allegedly infringing products; require us to
refund payment of allegedly infringing products to our customers
or to forgo future payments; require us to redesign certain of
our products; invalidate our proprietary rights; or damage our
reputation. Although we carry general liability insurance, our
insurance may not cover potential claims of this type and may
not be adequate to indemnify us for all liability that may be
imposed. Our failure to obtain a license for key intellectual
property rights from a third party for technology used by us
could cause us to incur substantial liabilities and prevent us
from manufacturing and selling products utilizing the
technology. Alternatively, we could be required to expend
significant resources to develop non-infringing technology with
no assurances that we would be successful in such endeavors. The
occurrence of any of the above events could materially and
adversely affect our business, results of operations and
financial condition.
We are
exposed to the credit risk of our customers and to credit
exposures in weakened markets, which could result in material
losses.
Most of our sales are on an open credit basis. Payment terms in
the United States are typically 30 to 60 days, and because
of local customs or conditions, longer in some markets outside
the United States. Beyond our open credit arrangements, we have
also experienced a request for customer financing and
facilitation of leasing arrangements, which we have not provided
to date and do not expect to provide in the future. We expect
demand for enhanced open credit terms, for example, longer
payment terms, customer financing and leasing arrangements, to
continue and believe that such arrangements are a competitive
factor in obtaining business. Our decision not to provide these
types of financing arrangements may adversely affect our ability
to sell products, and therefore, our revenue, operations and
business.
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Because of current conditions in the global economy, our
exposure to credit risks relating to sales on an open credit
basis has increased. Although we monitor and attempt to mitigate
the associated risk, there can be no assurance that our efforts
will be effective in reducing credit risk. Additionally, there
have been significant insolvencies and bankruptcies among our
customers, which have caused and may continue to cause us to
incur economic and financial losses. There can be no assurance
that additional losses would not be incurred and that such
losses would not be material. Although these losses have
generally not been material to date, future losses, if incurred,
could harm our business and have a material adverse effect on
our operating results and financial condition.
We
have and we may seek to expand our business through acquisitions
which could disrupt our business operations and harm our
operating results.
In order to expand our business, we may make strategic
acquisitions of other companies or certain assets. We plan to
continue to evaluate opportunities for strategic acquisitions
from time to time, and may make an acquisition at some future
point. However, the current volatility in the stock market and
the current price of our common stock may adversely affect our
ability to make such acquisitions. Any acquisition that we make
involves substantial risks, including the following:
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Difficulties in integrating the operations, technologies,
products and personnel of an acquired company;
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Diversion of managements attention from normal daily
operations of the business;
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Potential difficulties in completing projects associated with
in-process research and development;
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Difficulties in entering markets in which we have no or limited
direct prior experience and where competitors in such markets
have stronger market positions;
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Initial dependence on unfamiliar supply chains or relatively
small supply partners;
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Insufficient revenues to offset increased expenses associated
with acquisitions; and
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The potential loss of key employees of the acquired companies.
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Acquisitions may also cause us to:
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Issue common stock that would dilute our current
stockholders percentage ownership;
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Assume liabilities;
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Record goodwill and
non-amortizable
intangible assets that will be subject to impairment testing and
potential periodic impairment charges;
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Incur amortization expenses related to certain intangible assets;
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Incur large and immediate write-offs; or
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Become subject to litigation.
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For example, we made ten acquisitions during the period between
1999 and 2000. Due to various economic conditions, none of the
products from our acquired businesses, other than the digital
video products, have achieved the level of market acceptance
that was forecasted at the time of their acquisitions.
Additionally, certain product groups have not achieved the level
of technological development needed to be marketable or to
expand the market. Mergers and acquisitions of high-technology
companies are inherently risky, and no assurance can be given
that our future acquisitions will be successful and will not
materially adversely affect our business, operating results or
financial condition. Failure to manage and successfully
integrate acquisitions we make could materially harm our
business and operating results. Even when an acquired company
has already developed and marketed products, there can be no
assurance that product enhancements will be made in a timely
fashion or that all pre-acquisition due diligence will have
identified all possible issues that might arise with respect to
such products.
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Our
products are subject to safety approvals and
certifications.
In the United States, our products are required to meet certain
safety requirements. For example, we are required to have our
video products certified by Underwriters Laboratory in order to
meet federal requirements. Outside the United States, our
products are subject to the regulatory requirements of each
country in which the products are manufactured or sold. These
requirements are likely to vary widely. We may be unable to
obtain on a timely basis, or at all, the regulatory approvals
that may be required for the manufacture, marketing and sale of
our products.
Compliance
with current and future environmental regulations may be costly
which could impact our future earnings.
We may be subject to environmental and other regulations due to
our production and marketing of products in certain states and
countries. In addition, we could face significant costs and
liabilities in connection with product take-back legislation,
which enables customers to return a product at the end of its
useful life and charges us with financial and other
responsibility for environmentally safe collection, recycling,
treatment and disposal. We also face increasing complexity in
our product design and procurement operations as we adjust to
new and upcoming requirements relating to the materials
composition of our products, including the restrictions on lead
and certain other substances in electronics that apply to
specified electronics products put on the market in the European
Union as of July 1, 2006 (Restriction of Hazardous
Substances in Electrical and Electronic Equipment Directive
(EU RoHS). The European Union has also finalized the Waste
Electrical and Electronic Equipment Directive (WEEE), which
makes producers of electrical goods financially responsible for
specified collection, recycling, treatment and disposal of past
and future covered products. The deadline for enacting and
implementing this directive by individual European Union
governments was August 13, 2004 (WEEE Legislation),
although extensions were granted in some countries. Producers
became financially responsible under the WEEE Legislation
beginning in August 2005. Other countries, such as the United
States, China and Japan, have enacted or may enact laws or
regulations similar to the EU RoHS or WEEE Legislation. Other
environmental regulations may require us to reengineer our
products to utilize components which are more environmentally
compatible. Such reengineering and component substitution may
result in additional costs to us. Although we currently do not
anticipate any material adverse effects based on the nature of
our operations and the effect of such laws, there is no
assurance that such existing laws or future laws will not have a
material adverse effect on us.
We are
subject to import/export controls, and various import/export
licensing requirements could materially and adversely affect our
business or require us to significantly modify our current
business practices.
Our products are subject to U.S. export controls and may be
exported outside the United States only with the required level
of export license or through an export license exception, in
most cases because we incorporate encryption technology into our
products. In addition, various countries regulate the import of
certain encryption technology and have enacted laws that could
limit our ability to distribute our products or could limit our
customers ability to implement our products in those
countries. We may have to make certain filings with the U.S. and
foreign governments in order to obtain permission to export
certain of our products. In the past, we may have inadvertently
failed to file certain import/export applications and notices,
and we may have to make certain filings and request permission
to continue exportation of any affected products without
interruption while these applications are pending. If we do have
to make such filings, there are no assurances that we will
obtain permission to continue exporting the affected products or
that we will obtain any required import/export approvals now or
in the future. If we do not receive the required import/export
approvals, we may be unable to ship those products to certain
customers located outside of the United States. In addition, we
may be subject to fines or other penalties due to the failure to
file certain import/export applications and notices.
Changes in our products or changes in export and import
regulations may create delays in the introduction of our
products in international markets, prevent our customers with
international operations from deploying our products throughout
their global systems or, in some cases, prevent the export or
import of our products to certain countries altogether. Any
change in export or import regulations or related legislation,
shift in approach
33
to the enforcement or scope of existing regulations, or change
in the countries, persons or technologies targeted by such
regulations, could result in decreased use of our products by,
or in our decreased ability to export or sell our products to,
existing or potential customers internationally.
In addition, we may be subject to customs duties and export
quotas, which could have a significant impact on our revenue and
profitability. While we have not encountered significant
difficulties in connection with the sales of our products in
international markets, the future imposition of significant
increases in the level of customs duties or export quotas could
have a material adverse effect on our business.
Changes
in telecommunications legislation and regulations could harm our
prospects and future sales.
Changes in telecommunications legislation and regulations in the
United States and other countries could affect the sales of our
products. In particular, regulations dealing with access by
competitors to the networks of incumbent operators could slow or
stop additional construction or expansion by these operators.
Local franchising and licensing requirements may slow the entry
of telecom companies into the digital video business. Increased
regulation of our customers pricing or service offerings
could limit their investments and consequently the sales of our
products. Changes in regulations could have a material adverse
effect on our business, operating results, and financial
condition.
Compliance
with changing laws and regulations relating to corporate
governance and public disclosure has resulted, and will continue
to result, in the incurrence of additional
expenses.
New and changing laws and regulations, including the
Sarbanes-Oxley Act of 2002, new Commission regulations and
NASDAQ Stock Market Rules, impose stricter corporate governance
requirements, greater disclosure obligations, and greater focus
on disclosure and internal controls. These new laws and
regulations have had the effect of increasing the complexity and
cost of our Companys corporate governance compliance,
diverting the time and attention of our management from
revenue-generating activities to compliance activities, and
increasing the risk of personal liability for our board members
and executive officers involved in our Companys corporate
governance process. Our efforts to comply with evolving laws and
regulations have resulted, and will continue to result, in
increased general and administrative expenses, and increased
professional and independent auditor fees. In addition, it has
become more difficult and expensive for us to obtain director
and officer liability insurance.
In order to meet the new corporate governance and financial
disclosure obligations, we have been taking, and will continue
to take, steps to improve our controls and procedures, including
disclosure and internal controls, and related corporate
governance policies and procedures to address compliance issues
and correct any deficiencies that we may discover. Our efforts
to correct the deficiencies in our disclosure and internal
controls have required, and will continue to require, the
commitment of significant financial and managerial resources. In
addition, the costs associated with the continued testing and
remediation of our internal controls have been significant and
material in the year ended December 31, 2006, and we
anticipate that such costs may continue to be material in future
years as these controls are maintained and continually evaluated
and tested.
Furthermore, changes in our operations and the growth of our
business may require us to modify and expand our disclosure
controls and procedures, internal controls and related corporate
governance policies. In addition, the new and changed laws and
regulations are subject to varying interpretations in many cases
due to their lack of specificity, and as a result, their
application in practice may evolve over time as new guidance is
provided by regulatory and governing bodies. If our efforts to
comply with new or changed laws and regulations differ from the
conduct intended by regulatory or governing bodies due to
ambiguities or varying interpretations of the law, we could be
subject to regulatory sanctions, our reputation may be harmed
and our stock price may be adversely affected.
34
Recent
and proposed regulations related to equity compensation could
adversely affect earnings, our ability to raise capital and
affect our ability to attract and retain key
personnel.
Since our inception, we have used stock options as a fundamental
component of our employee compensation packages. We believe that
our stock option plans are an essential tool to link the
long-term interests of stockholders and employees, especially
executive management, and serve to motivate management to make
decisions that will, in the long run, give the best returns to
stockholders. The Financial Accounting Standards Board announced
changes to GAAP that required us to record a charge to earnings
for employee stock option grants and employee stock purchase
plan rights for all future periods beginning on January 1,
2006. In the event that the assumptions used to compute the fair
value of our stock-based awards are later determined to be
inaccurate or if we change our assumptions significantly in
future periods, our stock-based compensation expense and results
of operations could be materially affected which could impede
any capital raising efforts. Additionally, to the extent that
new accounting standards make it more difficult or expensive to
grant options to employees, we may incur increased compensation
costs, change our equity compensation strategy or find it
difficult to attract, retain and motivate employees, each of
which could materially and adversely affect our business.
New
privacy laws and regulations or changing interpretations of
existing laws and regulations could harm our
business.
Governments in the United States and other countries have
adopted laws and regulations regarding privacy and advertising
that could impact important aspects of our business. In
particular, governments are considering new limitations or
requirements with respect to our customers collection,
use, storage and disclosure of personal information for
marketing purposes. Any legislation enacted or regulation issued
could dampen the growth and acceptance of addressable
advertising which is enabled by our products. If the use of our
products to increase advertising revenue is limited or becomes
unlawful, our business, results of operations and financial
condition would be harmed.
Our
stock price has been and is likely to continue to be highly
volatile.
The market price of our common stock has fluctuated
significantly in the past and is likely to fluctuate in the
future. Investors may be unable to resell our common stock at or
above their purchase price. In the past, companies that have
experienced volatility in the market price of their stock have
been subject to securities class action litigation.
Our stock price could be subject to extreme fluctuations in
response to a variety of factors, including the following:
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Actual or anticipated variations in quarterly operating results;
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Announcements of technological innovations;
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New products or services offered by us or our competitors;
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Changes in financial estimates by securities analysts;
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Conditions or trends in the broadband services and technologies
industry;
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Changes in the economic performance
and/or
market valuations of technology, Internet, online service or
broadband service industries;
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Announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments, by us or
our current or potential competitors;
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Adoption of industry standards and the inclusion or
compatibility of our technology with such standards;
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Adverse or unfavorable publicity regarding us or our products;
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Additions or departures of key personnel;
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Sales of common stock; and
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Other events or factors that may be beyond our control.
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In addition, the stock markets in general, including the Pink
Sheets and The NASDAQ Stock Market, and the stock price of
broadband services and technology companies in particular, have
experienced extreme price and volume volatility. This volatility
and decline have affected many companies irrespective of or
disproportionately to the operating performance of these
companies. Additionally, industry factors may materially
adversely affect the market price of our common stock.
We
have adopted a stockholder rights plan, which, together with
provisions in our charter documents and Delaware law, may delay
or prevent an acquisition of us, which could decrease the value
of our stock.
We adopted a stockholder rights plan pursuant to which we
distributed one right for each outstanding share of common stock
held by our stockholders of record as of February 20, 2001.
If our Board of Directors believes that a particular acquisition
is undesirable, the rights may substantially dilute the stock
ownership of a person or group attempting a take-over of us,
even if such a change in control is beneficial to our
stockholders. As a result, the plan could make it more difficult
for a third party to acquire us, or a significant percentage of
our outstanding capital stock, without first negotiating with
our Board of Directors.
Provisions of our Certificate of Incorporation and our Bylaws
could make it more difficult for a third party to acquire
control of us in a transaction not approved by our Board of
Directors. We are also subject to the anti-takeover provisions
of Section 203 of the Delaware General Corporation Law. Any
provision of our Certificate of Incorporation, Bylaws,
stockholder rights plan or Delaware law that has the effect of
delaying or preventing a change in control could limit the
opportunity for our stockholders to receive a premium for their
shares of our common stock.
We
rely on complex information technology systems and networks to
operate our business. Any significant system or network
disruption could have a material adverse impact on our
operations, sales and financial performance.
We rely on the efficient and uninterrupted operation of complex
information technology systems and networks. All information
technology systems are potentially vulnerable to damage or
interruption from a variety of sources, including but not
limited to computer viruses, security breach, energy blackouts,
natural disasters, terrorism, war and telecommunication
failures. There also may be system or network disruptions if new
or upgraded business management systems are defective or are not
installed properly. We have implemented various measures to
manage our risks related to system and network disruptions, but
a system failure or security breach could negatively impact our
operations and financial results. In addition, we may incur
additional costs to remedy the damages caused by these
disruptions or security breaches.
We,
our sole manufacturer and our customers are vulnerable to
earthquakes, disruptions to power supply, labor issues and other
unexpected events.
Our corporate headquarters, the majority of our research and
development activities and our sole source manufacturer are
located in California, an area known for seismic activity. An
earthquake, or other significant natural disaster, could result
in an interruption in our business or the operations of our
manufacturer. Some of the other locations in which we and our
customers conduct business are prone to natural disasters. If
there is a natural disaster in any of the locations where our
customers are located, we face the risk that our customers may
incur losses or substantial business interruptions which may
impair their ability to continue to purchase their products from
us.
Our California operations may also be subject to disruptions in
power supply, such as those that occurred in 2001. In addition,
the cost of electricity and natural gas has risen significantly.
Power outages could disrupt our business operations and those of
our suppliers, and could cause us to fail to meet the
commitments to our customers. Our business may also be impacted
by labor issues related to our operations
and/or those
of our manufacturer, network operators and content aggregators,
or customers. Such an interruption could harm our
36
current and prospective business relationships and adversely
impact our operating results. We may not carry sufficient
business interruption insurance to compensate for any losses
that we may sustain as a result of any natural disasters or
other unexpected events. Disruptions in power supply, labor
issues and other unexpected events impacting our customers may
affect their purchasing decisions and thus adversely impact our
financial performance.
SPECIAL
NOTE ON FORWARD-LOOKING STATEMENTS
This Annual Report on
Form 10-K
contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 which
are subject to the safe harbor created by those sections. All
statements included or incorporated by reference in this report,
other than statements that are purely historical in nature, are
forward-looking statements. Forward-looking statements are
generally written in the future tense
and/or are
preceded by words such as may, will, should, expect, plan,
anticipate, believe, estimate, predict, future, intend, or
certain or the negative of these terms or similar expressions to
identify forward-looking statements. Forward-looking statements
include, among other things, statements regarding:
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Our belief that our current cash balances will be sufficient to
satisfy our cash requirements for at least the next
12 months;
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Our belief that we are well positioned to capitalize on the
emerging digital video market because of the success our digital
video products have had with the major U.S. cable operators
and satellite providers, as well as our current success in
digital ad insertion;
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Our belief that by focusing our business on higher margin
digital video products, our margins may increase;
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Our belief that we are well positioned to capitalize on the
growing demand for network operators to provide advanced video
services to their subscribers;
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Our belief that the ongoing migration of network operators and
content aggregators to all-digital networks represents a
significant opportunity for companies similar to ours with
products and technologies that enable our customers to maximize
their bandwidth, to utilize important new transport methods and
to deploy new services;
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Our belief that networks operators and content aggregators will
increasingly rely on overlay to maintain or even increase their
advertising revenues and that our digital video processing
systems will enable them to do this more cost-effectively;
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Our belief that network operators will continue their
investments in equipment to provide advanced services in a
cost-effective manner to increase average revenues per unit from
their subscribers;
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Our belief that there will be increasing competition to our
digital video products, which may increase price competition and
lead to decreased revenue and margins;
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Our expectation that research and development expenses will
remain constant in 2007; and
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Our expectation that general and administrative expenses will
decrease in 2007.
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Forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, including those
discussed in Item 1A of this Report. The forward-looking
statements contained in this report are based on information
that is currently available to us and expectations and
assumptions that we deemed reasonable at the time the statements
were made. We do not undertake any obligation to update any
forward-looking statements in this report or in any of our other
communications, except as required by law. All such
forward-looking statements should be read as of the time the
statements were made and with the recognition that these
forward-looking statements may not be complete or accurate at a
later date. The business risks discussed in Item 1A of this
Report on
Form 10-K,
among other things, should be considered in evaluating our
prospects and future financial performance.
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Item 1B.
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Unresolved
Staff Comments
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Not applicable.
Our principal executive offices are located in Santa Clara,
California, where we lease approximately 63,000 square feet
under a lease that expires in September 2009. We
sub-sublease
approximately 141,000 square feet of space in
Santa Clara, California under a sublease that expires in
October 2009 with the
sub-sublease
expiring on the same date as the sublease. In the United States,
we also leased an additional facility in Costa Mesa, California
that was subleased; the lease expired in March 2006 and the
sublease expired in September 2005.
In addition, we lease properties worldwide. We lease premises in
Brussels, Belgium; Shanghai, China; Tel Aviv, Israel; and Seoul,
Korea. We previously leased premises in Hong Kong and the lease
expired in June 2006. We had a facility in Ottawa, Ontario,
Canada that we subleased and the lease and sublease expired in
June 2006. We had a facility lease in Tel Aviv, Israel that
expired in February 2007 and we entered into a subsequent
agreement whereby we rent space on a
month-to-month
basis. We believe that our existing facilities are adequate to
meet our needs for the foreseeable future. For additional
information regarding obligations under leases, see Note 4,
Commitments, to Consolidated Financial Statements.
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Item 3.
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Legal
Proceedings
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Beginning in April 2000, several plaintiffs filed class action
lawsuits in federal court against us and certain of our officers
and directors. Later that year, the cases were consolidated in
the United States District Court for the Northern District of
California (Court) as In re Terayon Communication Systems,
Inc. Securities Litigation. The Court then appointed lead
plaintiffs who filed an amended complaint. In 2001, the Court
granted in part and denied in part defendants motion to
dismiss, and plaintiffs filed a new complaint. In 2002, the
Court denied defendants motion to dismiss that complaint,
which, like the earlier complaints, alleged that the defendants
violated the federal securities laws by issuing materially false
and misleading statements and failing to disclose material
information regarding our technology. On February 24, 2003,
the Court certified a plaintiff class consisting of those who
purchased or otherwise acquired our securities between
November 15, 1999 and April 11, 2000. On
September 8, 2003, the Court heard defendants motion
to disqualify two of the lead plaintiffs and to modify the
definition of the plaintiff class. On September 10, 2003,
the Court issued an order vacating the hearing date for the
parties summary judgment motions, and, on
September 22, 2003, the Court issued another order staying
all discovery until further notice and vacating the trial date,
which had been scheduled for November 4, 2003. On
February 23, 2004, the Court issued an order disqualifying
two of the lead plaintiffs and ordered discovery, which was
conducted. In February 2006, we mediated the case with
plaintiffs counsel. As part of the mediation, we reached a
settlement of $15.0 million. After this mediation, our
insurance carriers agreed to tender their remaining limits of
coverage, and we contributed approximately $2.2 million to
the settlement. On March 17, 2006, we, along with
plaintiffs counsel, submitted the settlement to the Court
and the shareholder class for approval. The Court held a hearing
to review the settlement of the shareholder litigation on
September 25, 2006. To date, the Court has not approved the
settlement.
On October 16, 2000, a lawsuit was filed against us and the
individual defendants (Zaki Rakib, Selim Rakib and Raymond
Fritz) in the Superior Court of California, San Luis Obispo
County. This lawsuit was titled Bertram v. Terayon
Communication Systems, Inc. The factual allegations in the
Bertram complaint were similar to those in the federal class
action, but the Bertram complaint sought remedies under state
law. Defendants removed the Bertram case to the United States
District Court, Central District of California, which dismissed
the complaint. Plaintiffs appealed this order, and their appeal
was heard on April 16, 2004. On June 9, 2004, the
United States Court of Appeals for the Ninth Circuit affirmed
the order dismissing the Bertram case.
In 2002, two shareholders filed derivative cases purportedly on
behalf of us against certain of our current and former
directors, officers, and investors. (The defendants differed
somewhat in the two cases.) Since the cases were filed, the
investor defendants have been dismissed without prejudice, and
the lawsuits have been
38
consolidated as Campbell v. Rakib in the Superior
Court of California, County of Santa Clara. We are a
nominal defendant in these lawsuits, which allege claims
relating to essentially the same purportedly misleading
statements that are at issue in the securities class action
filed in April 2000. In that securities class action, we
disputed making any misleading statements. The derivative
complaints also allege claims relating to stock sales by certain
of the director and officer defendants. On September 15,
2006, we entered into a Stipulation of Settlement of Derivative
Claims. On September 18, 2006, the Superior Court of
California, County of Santa Clara approved the final
settlement of the derivative litigation entitled In re
Terayon Communication Systems, Inc. Derivative Litigation
(Case No. CV 807650). In connection with the
settlement, we paid $1.0 million in attorneys fees
and expenses to the derivative plaintiffs counsel and
agreed to adopt certain corporate governance practices.
On June 23, 2006, a putative class action lawsuit was filed
against us in the United States District Court for the Northern
District of California by I.B.L. Investments Ltd. purportedly on
behalf of all persons who purchased our common stock between
October 28, 2004 and March 1, 2006. Zaki Rakib, Jerry
D. Chase, Mark Richman and Edward Lopez are named as individual
defendants. The lawsuit focuses on our March 1, 2006
announcement of the restatement of financial statements for the
year ended December 31, 2004, and for the four quarters of
2004 and the first two quarters of 2005. On November 8,
2006, Adrian G. Mongeli was appointed lead plaintiff in the
case, replacing I.B.L. Investments Ltd. On January 8, 2007,
Mongeli filed an amended complaint, purportedly on behalf of all
persons who purchased our common stock between June 28,
2001 and March 1, 2006. The amended complaint adds Ray
Fritz, Carol Lustenader, Matthew Miller, Shlomo Rakib, Doug
Sabella, Christopher Schaepe, Mark Slaven, Lewis Solomon, Howard
W. Speaks, Arthur T. Taylor and David Woodrow as individual
defendants, and also names Ernst & Young as a
defendant. The amended complaint incorporates the prior
allegations and includes new allegations relating to the
restatement of our consolidated historical financial statements
as reported in our
Form 10-K
filed on December 29, 2006. The plaintiffs are seeking
damages, interest, costs and any other relief deemed proper by
the court. An unfavorable ruling in this legal matter could
materially and adversely impact our results of operations. On
March 9, 2007, Terayon and the individual defendants filed
a motion to dismiss the amended complaint. That motion is
scheduled to be heard on June 5, 2007.
On April 22, 2005, we filed a lawsuit in the Superior Court
of California, County of Santa Clara against Adam S. Tom
(Tom) and Edward A. Krause (Krause) and a company founded by Tom
and Krause, RGB Networks, Inc. (RGB). We sued Tom and Krause for
breach of contract and RGB for intentional interference with
contractual relations based on breaches of the Noncompetition
Agreements entered into between us and Tom and Krause,
respectively. On May 24, 2006, RGB, Tom, and Krause filed a
Notice of Motion and Motion For Leave To File a Cross-Complaint,
in which the defendants stated that they intended to file
counter-claims against us for misappropriation of trade secrets,
unfair competition, tortious interference with contractual
relations, and tortious interference with prospective economic
advantage. On July 6, 2006, the court granted the
defendants motion, and on July 20, 2006, defendants
filed a cross-complaint for misappropriation of trade secrets,
unfair competition, tortious interference with contractual
relations, and tortious interference with prospective economic
advantage. On August 21, 2006, we filed a demurrer to
certain of those claims. The court granted our demurrer as to
RGBs request for declaratory judgment. On November 9,
2006, we filed our answer to RGBs complaint. On
March 26, 2007, we entered into a stipulation for
settlement with RGB amicably resolving all outstanding
litigation between the parties.
On September 13, 2005, a case was filed by Hybrid Patents,
Inc. (Hybrid) against Charter Communications, Inc. (Charter) in
the United States District Court for the Eastern District of
Texas for patent infringement related to Charters use of
equipment (cable modems, cable modem termination systems (CMTS)
and embedded multimedia terminal adapters (eMTAs)) meeting the
Data Over Cable System Interface Specification (DOCSIS) standard
and certain video equipment. Hybrid has alleged that the use of
such products violates its patent rights. Charter has requested
that we and others supplying it with equipment indemnify Charter
for these claims. We and others have agreed to contribute to the
payment of the legal costs and expenses related to this case and
we have entered into a joint defense and cost sharing agreement
with all named defendants in the suit. On May 4, 2006,
Charter filed a cross-complaint asserting its indemnity rights
against us and a number of companies that supplied Charter with
cable modems. To date, this cross-complaint has not been
39
dismissed. Trial is scheduled on Hybrids claims for
July 2, 2007. At this point, the outcome is uncertain and
we cannot assess damages. However, the case may be expensive to
defend and there may be substantial monetary exposure if Hybrid
is successful in its claim against Charter and then elects to
pursue other cable operators that use the allegedly infringing
products.
On July 14, 2006, a case was filed by Hybrid against Time
Warner Cable (TWC), Cox Communications Inc. (Cox), Comcast
Corporation (Comcast), and Comcast of Dallas, LP (together, the
MSOs) in the United States District Court for the Eastern
District of Texas for patent infringement related to the
MSOs use of data transmission systems and certain video
equipment. Hybrid has alleged that the use of such products
violates its patent rights. To date, we have not been named as a
party to the action. The MSOs have requested that we and others
supplying them with cable modems and equipment indemnify the
MSOs for these claims. We and others have agreed to contribute
to the payment of legal costs and expenses related to this case
and we have entered into a joint defense and cost sharing
agreement with all named defendants in the suit. Trial is
scheduled on Hybrids claims for July 2, 2007. At this
point, the outcome is uncertain and we cannot assess damages.
However, the case may be expensive to defend and there may be
substantial monetary exposure if Hybrid is successful in its
claim against the MSOs and then elects to pursue other cable
operators that use the allegedly infringing products.
On September 16, 2005, a case was filed by Rembrandt
Technologies, LP (Rembrandt) against Comcast in the United
States District Court for the Eastern District of Texas alleging
patent infringement. In this matter, Rembrandt alleged that
products and services sold by Comcast infringe certain patents
related to cable modem, voice-over internet, and video
technology and applications. To date, we have not been named as
a party in the action, but we have received a subpoena for
documents and a deposition related to the products we sold to
Comcast. We continue to comply with this subpoena. Comcast has
made a request for indemnity related to the products that we and
others sold to them. We and others have agreed to contribute to
the payment of legal costs and expenses related to this case and
we have entered into a joint defense and cost sharing agreement
with all named defendants in the suit. On February 1, 2007,
the Court entered an order disqualifying Rembrandts
counsel and vacated all scheduled dates pending Rembrandt
obtaining new counsel. At this point, the outcome is uncertain
and we cannot assess damages. However, the case may be expensive
to defend and there may be substantial monetary exposure if
Rembrandt is successful in its claim against Comcast and then
elects to pursue other cable operators that use the allegedly
infringing products.
On June 1, 2006, a case was filed by Rembrandt against
Charter, Cox, CSC Holdings, Inc. (CSC), and Cablevision Systems
Corp. (Cablevision) in the United States District Court for the
Eastern District of Texas alleging patent infringement. In this
matter, Rembrandt alleged that products and services sold by
Charter infringe certain patents related to cable modem,
voice-over internet, and video technology applications. To date,
we have not been named as a party in the action, but Charter has
made a request for indemnity related to the products that we and
others have sold to them. We have not received an indemnity
request from Cox, CSC and Cablevision but we expect that such
request will be forthcoming shortly. To date, we and others have
not agreed to contribute to the payment of legal costs and
expenses related to this case. Trial date of this matter is not
known at this time. At this point, the outcome is uncertain and
we cannot assess damages. However, the case may be expensive to
defend and there may be substantial monetary exposure if
Rembrandt is successful in its claim against Charter and then
elects to pursue other cable operators that use the allegedly
infringing products.
On June 1, 2006, a case was filed by Rembrandt against TWC
in the United States District Court for the Eastern District of
Texas alleging patent infringement. In this matter, Rembrandt
alleged that products and services sold by TWC infringe certain
patents related to cable modem, voice-over internet, and video
technology applications. To date, we have not been named as a
party in the action, but TWC has made a request for indemnity
related to the products that we and others have sold to them. We
and others have agreed to contribute to the payment of legal
costs and expenses related to this case. Trial date of this
matter is not known at this time. At this point, the outcome is
uncertain and we cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Rembrandt is successful in its claim against TWC and
then elects to pursue other cable operators that use the
allegedly infringing products.
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On September 13, 2006, a second case was filed by Rembrandt
against TWC in the United States District Court for the Eastern
District of Texas alleging patent infringement. In this matter,
Rembrandt alleged that products and services sold by TWC
infringe certain patents related to the DOCSIS standard. To
date, we have not been named as a party in the action, but TWC
has made a request for indemnity related to the products that we
and others have sold to them. We and others have agreed to
contribute to the payment of legal costs and expenses related to
this case. Trial date of this matter is not known at this time.
At this point, the outcome is uncertain and we cannot assess
damages. However, the case may be expensive to defend and there
may be substantial monetary exposure if Rembrandt is successful
in its claim against TWC and then elects to pursue other cable
operators that use the allegedly infringing products.
On February 2, 2007, a case was filed by GPNE Corp. (GPNE)
against Time Warner Inc. (TWI), Comcast and Charter in the
United States District Court for the Eastern District of Texas
alleging patent infringement. In this matter, GPNE alleged that
products and services sold by TWI, Comcast and Charter infringe
certain patents related to the DOCSIS standard (data
transmission). To date, we have not been named as a party in the
action, but TWI has made a request for indemnity related to the
products that we and others have sold to them. We believe that
Comcast and Charter will also make indemnity requests. We and
others have agreed to contribute to the payment of legal costs
and expenses related to this case. Trial date of this matter is
not known at this time. On February 2, 2007, TWC filed a
lawsuit against GPNE in the United States District Court for the
District of Delaware requesting a declaratory judgment of
non-infringement. At this point, the outcome is uncertain and we
cannot assess damages. However, the case may be expensive to
defend and there may be substantial monetary exposure if GPNE is
successful in its claim against TWI, Comcast and Charter and
then elects to pursue other cable operators that use the
allegedly infringing products.
We have received letters claiming that our technology infringes
the intellectual property rights of others. We have consulted
with our patent counsel and reviewed the allegations made by
such third parties. If these allegations were submitted to a
court, the court could find that our products infringe third
party intellectual property rights. If we are found to have
infringed third party rights, we could be subject to substantial
damages
and/or an
injunction preventing us from conducting our business. In
addition, other third parties may assert infringement claims
against us in the future. A claim of infringement, whether
meritorious or not, could be time-consuming, result in costly
litigation, divert our managements resources, cause
product shipment delays or require us to enter into royalty or
licensing arrangements. These royalty or licensing arrangements
may not be available on terms acceptable to us, if at all.
Furthermore, we have in the past agreed to, and may from time to
time in the future agree to, indemnify a customer of our
technology or products for claims against the customer by a
third party based on claims that its technology or products
infringe intellectual property rights of that third party. These
types of claims, meritorious or not, can result in costly and
time-consuming litigation, divert managements attention
and other resources, require us to enter into royalty
arrangements, subject us to damages or injunctions restricting
the sale of our products, require us to indemnify our customers
for the use of the allegedly infringing products, require us to
refund payment of allegedly infringing products to its customers
or to forgo future payments, require us to redesign certain of
our products, or damage our reputation, any one of which could
materially and adversely affect our business, results of
operations and financial condition.
We may, in the future, take legal action to enforce our patents
and other intellectual property rights, to protect our trade
secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs
and diversion of resources and could negatively affect our
business, results of operations and financial condition.
In December 2005, the Commission issued a formal order of
investigation in connection with our accounting review of a
series of contractual arrangements with Thomson Broadcast. These
matters were previously the subject of an informal Commission
inquiry. We have been cooperating fully with the Commission and
will continue to do so in order to bring the investigation to a
conclusion as promptly as possible.
We are currently a party to various other legal proceedings, in
addition to those noted above, and may become involved from time
to time in other legal proceedings in the future. While we
currently believe that
41
the ultimate outcome of these proceedings, individually and in
the aggregate, will not have a material adverse effect on our
financial position or overall results of operations, litigation
is subject to inherent uncertainties. Were an unfavorable ruling
to occur in any of our legal proceedings, there exists the
possibility of a material adverse impact on our financial
condition and results of operations for the period in which the
ruling occurs. The estimate of the potential impact on our
financial position and overall results of operations for any of
the above legal proceedings could change in the future.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
There were no matters submitted to a vote of security holders
during the year ended December 31, 2006.
PART II
|
|
Item 5.
|
Market
for the Registrants Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
|
(a) Prior to April 4, 2006, our common stock was
traded on The NASDAQ Stock Market under the symbols
TERN and TERNE. Our common stock was
delisted from The NASDAQ Stock Market on April 4, 2006 and
currently is quoted on the Pink Sheets under the symbol
TERN.PK. The following table sets forth, for the
periods indicated, the high and low per share sale prices of our
common stock as reported on the Pink Sheets and on The NASDAQ
Stock Market, for the respective periods.
|
|
|
|
|
|
|
|
|
|
|
High
|
|
|
Low
|
|
|
Year Ended December 31, 2006
|
|
|
|
|
|
|
|
|
First Quarter(1)
|
|
$
|
2.91
|
|
|
$
|
1.63
|
|
Second Quarter(2)
|
|
$
|
2.24
|
|
|
$
|
1.18
|
|
Third Quarter
|
|
$
|
1.38
|
|
|
$
|
0.74
|
|
Fourth Quarter
|
|
$
|
2.25
|
|
|
$
|
0.94
|
|
Year Ended December 31, 2005
|
|
|
|
|
|
|
|
|
First Quarter(1)
|
|
$
|
3.73
|
|
|
$
|
1.99
|
|
Second Quarter(1)
|
|
$
|
3.78
|
|
|
$
|
2.52
|
|
Third Quarter(1)
|
|
$
|
4.10
|
|
|
$
|
2.91
|
|
Fourth Quarter(1)
|
|
$
|
3.95
|
|
|
$
|
1.97
|
|
|
|
|
(1) |
|
Reflects trading on The NASDAQ Stock Market. |
|
(2) |
|
Reflects trading on The NASDAQ Stock Market from April 1,
2006 to April 3, 2006. |
(a) As of March 9, 2007, the closing price of our
common stock on the Pink Sheets was $2.07.
(b) As of March 9, 2007, there were approximately 504
holders of record of our common stock, as shown on the records
of our transfer agent. The number of record holders does not
include shares held in street name through brokers.
(c) We have not declared or paid any cash dividends on our
common stock. We currently expect to retain future earnings, if
any, for use in the operation and expansion of our business and
do not anticipate paying any cash dividends in the foreseeable
future.
42
(d) The following table provides certain information about
our common stock that may be issued under our equity
compensation plans as of December 31, 2006. Information is
included for both equity compensation plans approved by our
stockholders and equity compensation plans not approved by our
stockholders.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
Available for Future
|
|
|
|
Common Stock
|
|
|
|
|
|
Issuance Under
|
|
|
|
to be Issued
|
|
|
Weighted Average
|
|
|
Equity Compensation
|
|
|
|
Upon Exercise of
|
|
|
Exercise Price of
|
|
|
Plans (Excluding
|
|
|
|
Outstanding Options
|
|
|
Outstanding Options
|
|
|
Securities Reflected
|
|
|
|
and Rights
|
|
|
and Rights
|
|
|
in Column (a))
|
|
Plan Category
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
Equity compensation plans approved
by Terayon stockholders(1)
|
|
|
9,664,399
|
|
|
$
|
4.25
|
|
|
|
7,529,114
|
|
Equity compensation plans not
approved by Terayon stockholders(2)
|
|
|
2,505,310
|
|
|
$
|
6.82
|
|
|
|
1,719,164
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
12,169,709
|
|
|
$
|
4.78
|
|
|
|
9,248,278
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes options to purchase common stock outstanding under the
Terayon Communication Systems, Inc. 1995 Stock Option Plan, as
amended (1995 Plan), the Terayon Communication Systems, Inc.
1997 Equity Incentive Plan, as amended (1997 Plan), and the
Terayon Communication Systems, Inc. 1998 Non-Employee Directors
Stock Option Plan, as amended (1998 Plan). Does not include
600,371 shares of our common stock that were available for
issuance under the Terayon Communication Systems, Inc. 1998
Employee Stock Purchase Plan, as amended, which was also
approved by our stockholders, including the Terayon
Communication Systems, Inc. 1998 Employee Stock Purchase Plan
Offering for Foreign Employees. The 1997 Plan was amended on
June 13, 2000 to, among other things, provide for an
increase in the number of shares of our common stock on each
January 1 beginning January 1, 2001 through January 1,
2007, by the lesser of 5% of our common stock outstanding on
such January 1 or 3,000,000 shares. In May 2003, the 1997
Plan was amended to reduce the number of authorized shares in
the 1997 Plan by 6,237,826 shares. In May 2005, the 1997
Plan was amended to reduce the number of authorized shares in
the 1997 Plan by 4,000,000 shares. |
|
(2) |
|
Includes options to purchase common stock outstanding under the
Terayon Communication Systems, Inc. 1999 Non-Officer Equity
Incentive Plan, as amended (1999 Plan), Mainsail Equity
Incentive Plan, TrueChat Equity Incentive Plan, and options
issued outside of any equity incentive plan. See Note 9,
Stockholders Equity, to Consolidated Financial
Statements for additional information regarding the provisions
of the 1999 Plan. |
43
Stock
Performance Graph
This performance graph shall not be deemed to be
soliciting material, and shall not be deemed
filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (Exchange Act) or
otherwise subject to the liabilities under that Section, and
shall not be deemed to be incorporated by reference into any
filing of the Company under the Securities Act of 1933, as
amended or the Exchange Act.
The following graph compares the cumulative total stockholder
return of an investment of $100 in cash from December 31,
2001 through December 31, 2006 for (i) the
Companys common stock, (ii) the Standards &
Poors 500 Index (S&P 500) and (iii) the
NASDAQ Telecommunications Index (NASDAQ Telecom). All values
assume reinvestment of the full amount of all dividends and are
calculated as of the last trading day of each year listed. Such
returns are based on historical results and are not intended to
suggest future performance.
Comparison
of Five-Year Cumulative Return for Terayon, S&P 500 and
NASDAQ Telecom
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
Terayon
|
|
|
$
|
100.00
|
|
|
|
$
|
24.79
|
|
|
|
$
|
54.41
|
|
|
|
$
|
32.77
|
|
|
|
$
|
27.93
|
|
|
|
$
|
26.96
|
|
S&P 500
|
|
|
|
100.00
|
|
|
|
|
76.63
|
|
|
|
|
96.85
|
|
|
|
|
105.56
|
|
|
|
|
108.73
|
|
|
|
|
123.54
|
|
NASDAQ Telecom
|
|
|
|
100.00
|
|
|
|
|
45.97
|
|
|
|
|
77.58
|
|
|
|
|
83.78
|
|
|
|
|
77.74
|
|
|
|
|
99.32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
44
|
|
Item 6.
|
Selected
Financial Data
|
The following selected consolidated statement of operations data
set forth below for each of the five years ended
December 31, 2006, 2005, 2004, 2003 and 2002 (unaudited),
and the selected consolidated balance sheet data as of
December 31, 2006, 2005, 2004, 2003 and 2002 (unaudited),
are derived from our consolidated financial statements. The
following selected historical consolidated financial and other
data are qualified by reference to, and should be read in
conjunction with, our consolidated financial statements, the
related notes and Managements Discussion and
Analysis of Financial Condition and Results of Operations
included elsewhere in this Annual Report on
Form 10-K.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(In thousands, except per share data)
|
|
|
Consolidated statement of
operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
76,430
|
|
|
$
|
90,664
|
|
|
$
|
136,484
|
|
|
$
|
130,187
|
|
|
$
|
130,730
|
|
Cost of goods sold
|
|
|
30,848
|
|
|
|
55,635
|
|
|
|
101,887
|
|
|
|
103,835
|
|
|
|
101,808
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
45,582
|
|
|
|
35,029
|
|
|
|
34,597
|
|
|
|
26,352
|
|
|
|
28,922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
Research and development
|
|
|
17,377
|
|
|
|
17,650
|
|
|
|
33,199
|
|
|
|
42,634
|
|
|
|
58,696
|
|
Sales and marketing
|
|
|
17,897
|
|
|
|
22,534
|
|
|
|
24,145
|
|
|
|
26,781
|
|
|
|
35,704
|
|
General and administrative
|
|
|
24,944
|
|
|
|
20,356
|
|
|
|
12,039
|
|
|
|
11,934
|
|
|
|
15,639
|
|
Restructuring charges, executive
severance and asset write-offs(1)
|
|
|
199
|
|
|
|
2,257
|
|
|
|
12,336
|
|
|
|
2,803
|
|
|
|
8,922
|
|
Total operating expenses
|
|
|
60,417
|
|
|
|
62,797
|
|
|
|
81,719
|
|
|
|
84,152
|
|
|
|
118,961
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(14,835
|
)
|
|
|
(27,768
|
)
|
|
|
(47,122
|
)
|
|
|
(57,800
|
)
|
|
|
(90,039
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income (expense) and
other income (expense), net
|
|
|
1,200
|
|
|
|
966
|
|
|
|
(59
|
)
|
|
|
1,891
|
|
|
|
(618
|
)
|
Gain on sale of assets(2)
|
|
|
9,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on early extinguishment of
debt(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50,983
|
|
Income tax benefit (expense)
|
|
|
(180
|
)
|
|
|
(149
|
)
|
|
|
76
|
|
|
|
(316
|
)
|
|
|
(238
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,831
|
)
|
|
$
|
(26,951
|
)
|
|
$
|
(47,105
|
)
|
|
$
|
(56,225
|
)
|
|
$
|
(39,912
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per
share
|
|
$
|
(0.05
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(0.62
|
)
|
|
$
|
(0.76
|
)
|
|
$
|
(0.55
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing basic and
diluted net loss per share(4)
|
|
|
77,637
|
|
|
|
77,154
|
|
|
|
75,751
|
|
|
|
74,074
|
|
|
|
72,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and
short-term investments
|
|
$
|
20,313
|
|
|
$
|
101,301
|
|
|
$
|
97,735
|
|
|
$
|
138,640
|
|
|
$
|
206,503
|
|
Working capital
|
|
|
22,852
|
|
|
|
22,045
|
|
|
|
107,052
|
|
|
|
138,035
|
|
|
|
178,091
|
|
Total assets
|
|
|
51,970
|
|
|
|
146,648
|
|
|
|
156,981
|
|
|
|
213,099
|
|
|
|
279,169
|
|
Convertible debentures
|
|
|
|
|
|
|
65,367
|
|
|
|
65,588
|
|
|
|
65,809
|
|
|
|
66,030
|
|
Long-term obligations (less
current portion)
|
|
|
1,399
|
|
|
|
1,455
|
|
|
|
2,076
|
|
|
|
1,356
|
|
|
|
1,936
|
|
Accumulated deficit
|
|
|
(1,066,269
|
)
|
|
|
(1,062,438
|
)
|
|
|
(1,035,487
|
)
|
|
|
(988,382
|
)
|
|
|
(932,157
|
)
|
Total stockholders equity
|
|
|
19,822
|
|
|
|
20,657
|
|
|
|
44,943
|
|
|
|
90,563
|
|
|
|
142,191
|
|
|
|
|
(1) |
|
See Note 6, Restructuring Charges and Asset
Write-Offs, to Consolidated Financial Statements for an
explanation of restructuring charges and asset write-offs. |
45
|
|
|
(2) |
|
See Note 14, Sale of Certain Assets, to
Consolidated Financial Statements for an explanation of the gain
on the sale of certain assets. |
|
(3) |
|
See Note 7, Convertible Subordinated Notes, to
Consolidated Financial Statements for an explanation of the
repurchase of subordinated convertible notes and
reclassification of related gains. |
|
(4) |
|
See Note 2, Summary of Significant Accounting
Policies, to Consolidated Financial Statements for an
explanation of the method employed to determine the number of
shares used to compute per share data. |
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Executive
Overview
We currently develop, market and sell digital video equipment to
network operators and content aggregators who offer video
services. Our primary products include the Network
CherryPicker®
line of digital video processing systems and the CP 7600 line of
digital-to-analog
decoders. Our products are used for multiple digital video
applications, including the rate shaping of video content to
maximize the bandwidth for standard definition (SD) and high
definition (HD) programming, grooming customized channel
line-ups,
carrying local ads for local and national advertisers, and
branding by inserting corporate logos into programming. Our
products are sold primarily to cable operators, telecom carriers
and satellite providers in the United States, Europe (including
the Middle East) and Asia.
We were founded in 1993 to provide cable operators with a cable
data system enabling them to offer high-speed, broadband
Internet access to their subscribers. By 1999, we were primarily
selling this cable data system composed of cable
modems and cable modem termination systems (CMTS)
which utilized our proprietary Synchronous Code
Division Multiple Access (S-CDMA) technology. Also in 1999,
we initiated an acquisition strategy that ultimately included
the acquisition of ten companies to expand our product offerings
within the cable industry and outside of the cable industry to
the telecom and satellite industries. With the market downturn
in 2000, we refocused our business to target the cable industry
and began selling data and voice products based on industry
standard specifications, particularly the Data Over Cable System
Interface Specification (DOCSIS), thereby beginning our
transition from proprietary-based products to standards-based
products. Also at this time, we focused our business on
providing digital video products to cable operators and
satellite providers. Since 2000, we have terminated our
data-over-satellite
business and all of our acquired telecom-focused businesses and
incurred restructuring charges in connection with these actions.
In 2004, we refocused the Company to make digital video products
and applications the core of our business. In particular, we
began expanding our focus beyond cable operators to more
aggressively pursue opportunities for our digital video products
with television broadcasters, telecom carriers and satellite
television providers. As part of this strategic refocus, we
elected to continue selling our home access solutions (HAS)
product, including cable modems, embedded multimedia terminal
adapters (eMTA) and home networking devices, but ceased future
investment in our CMTS product line. This decision was based on
weak sales of the CMTS products and the anticipated extensive
research and development investment required to support the
product line in the future. As part of our decision to cease
investment in the CMTS product line, we incurred severance,
restructuring and asset impairment charges. The decision to
cease investment in the CMTS product line was also the basis of
the lawsuit filed by Adelphia Communications Coroporation
(Adelphia) against us. In March 2005, we sold certain modem
semiconductor assets to ATI Technologies, Inc. and terminated
our internal semiconductor group.
In January 2006, we announced that the Company would focus
solely on digital video product lines, and as a result, we
discontinued our HAS product line. We determined that there were
no short- or long-term synergies between our HAS product line
and digital video product lines which made the HAS products
increasingly irrelevant given our core business of digital
video. Though we continued to sell our remaining inventory of
HAS products and CMTS products in 2006, the profit margins for
our cable modems and eMTAs have continued to decrease due to
competitive pricing pressures and the ongoing commoditization of
the products.
46
We have not been profitable since our inception. At
December 31, 2006, our accumulated deficit was
$1.1 billion. We had a net loss of $3.8 million or
$0.05 per share for the year ended December 31, 2006,
a net loss of $27.0 million or $0.35 per share for the
year ended December 31, 2005 and a net loss of
$47.1 million or $0.62 per share for the year ended
December 31, 2004. Our ability to grow our business and
attain profitability is dependent on our ability to effectively
compete in the marketplace with our current products and
services, develop and introduce new products and services,
contain operating expenses and improve our gross margins, as
well as continued investment in equipment by network operators
and content aggregators. Finally, we expect to benefit from a
lower expense base resulting in part from the series of cost
reduction initiatives that occurred in 2005 and 2006, along with
continued focus on cost containment. However, despite these
efforts, we may not succeed in attaining profitability in the
near future, or at all.
At December 31, 2006, we had $20.3 million in cash,
cash equivalents and short-term investments as compared to
$101.3 million at December 31, 2005 and
$97.7 million at December 31, 2004. The
$81.0 million decrease from December 31, 2005 to
December 31, 2006 is primarily related to the repurchase in
full of our outstanding convertible subordinated notes (Notes)
due August 2007 including all accrued and unpaid interest and
related fees in March 2006 for $65.6 million, operating
activities and legal, accounting and consulting costs associated
with our internal investigation and the re-audit and restatement
of our financial statements for the years ended
December 31, 2003, 2004, and for the first two quarters of
2005. The decrease in the amount of cash, cash equivalents and
short-term investments in 2005 as compared to 2004 primarily
resulted from the lower uses of cash for operating activities,
payments for inventory and restructuring charges and the
monetization of CMTS inventory. Although we believe that our
current cash balances will be sufficient to satisfy our cash
requirements for at least the next 12 months, we may need
to raise additional funds in order to support more rapid
expansion, develop new or enhanced services, respond to
competitive pressures, acquire complementary businesses or
technologies or respond to unanticipated requirements. There can
be no assurance that additional financing will be available on
acceptable terms, if at all. If adequate funds are not available
or are not available on acceptable terms, we may be unable to
continue operations, develop products, take advantage of future
opportunities or respond to competitive pressures or
unanticipated requirements, which could have a material adverse
effect on our business, financial condition, operating results
and liquidity.
A more detailed description of the risks to our business can be
found in Item 1A Risk Factors in this
Form 10-K.
Changes
to Previously Announced Fourth Quarter and Fiscal Year 2006
Results
On March 22, 2007, we announced our preliminary financial
results for the fourth quarter and the fiscal year ended
December 31, 2006. Subsequent to the announcement, we
entered into a Termination Agreement with General Electric
Capital Corporation (GECC) terminating the Aircraft Lease
Agreement, dated as of February 8, 2002, under which we
previously leased an aircraft from GECC. Pursuant to the
Termination Agreement, on March 28, 2007, GECC returned to
Terayon approximately $6.8 million of the $7.5 million
cash deposit held by GECC as collateral for the jet aircraft,
and GECC will retain $0.7 million in collateral subject to
GECCs completion of certain repairs, tests, inspections
and corrections to the jet aircraft, which GECC has estimated
will cost $0.6 million. As a result, in accordance with
GAAP, the preliminary financial results for the fourth quarter
and fiscal year ended December 31, 2006 have been adjusted
by a $0.6 million reduction in net income, reflecting the
$0.6 million of estimated repair costs. This resulted in an
increase of net loss per share of $0.01, from a net loss of
$0.04 to $0.05 per share for the fiscal year ended
December 31, 2006.
Restatement
of Consolidated Financial Statements
In our Annual Report on Form 10-K for the year ended
December 31, 2005, filed on December 29, 2006, we
restated our consolidated financial statements for the years
ended December 31, 2003 and 2004, and for the four quarters
of 2004 and the first two quarters of 2005. All financial
information included in this Annual Report on Form 10-K reflects
the restatement.
47
Results
of Operations
Comparison
of Years Ended December 31, 2006 and 2005
Revenues
Our revenues decreased 16% to $76.4 million for the year
ended December 31, 2006, compared to $90.7 million for
the year ended December 31, 2005. While revenues from our
DVS products increased during these periods, the overall
decrease in revenues was primarily due to decreased sales of our
HAS and CMTS products following our discontinuation of both
product lines. We expect overall revenues to decrease in 2007
compared to 2006 due to lower CMTS and HAS product revenues, as
we sell off remaining inventory. We expect revenues from the
sale of our DVS products to increase in 2007 compared to 2006,
primarily due to the introduction of new software applications,
sales to an expanded customer base which includes
telecommunication and broadcast satellite companies, increased
international opportunities and additional sales to MSOs as they
build out their digital networks.
Our ability to grow DVS revenues will depend upon several
factors including the continued investment of our MSO customers
in their digital video network infrastructure; our ability to
compete on quality and price in an increasingly competitive
marketplace; our ability to maintain or improve market share
with MSOs; our ability to diversify our customer base to
additional MSOs; our ability to increase sales and revenues from
overseas customers; our ability to sell outside of the cable
industry, namely to digital broadcast satellite operators,
telecom companies and potential new video service providers; and
our ability to continue to develop product modifications and
upgrades that meet customers needs.
Revenues
by Groups of Similar Products
The following table presents revenues for groups of similar
products (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Revenues by product:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DVS
|
|
$
|
58,547
|
|
|
$
|
41,806
|
|
|
$
|
16,741
|
|
|
|
40.0
|
%
|
HAS
|
|
|
13,569
|
|
|
|
41,061
|
|
|
|
(27,492
|
)
|
|
|
(67.0
|
)%
|
CMTS
|
|
|
4,314
|
|
|
|
7,797
|
|
|
|
(3,483
|
)
|
|
|
(44.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
76,430
|
|
|
$
|
90,664
|
|
|
$
|
(14,234
|
)
|
|
|
(15.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from the sale of HAS products decreased to
$13.6 million, or 18% of revenues for the year ended
December 31, 2006, compared to $41.1 million, or 45%
of revenues for the year ended December 31, 2005. In
January 2006, we announced that we were discontinuing the HAS
product line to focus solely on digital video. As a result, we
continue to sell our remaining HAS inventory and collect the
remaining receivables with respect to our HAS products, and we
expect revenue from the sale of our HAS products to continue to
decline in 2007. We anticipate that all remaining HAS
inventories will be sold during 2007. CMTS revenues decreased to
$4.3 million, or 6% of revenues for the year ended
December 31, 2006, compared to $7.8 million, or 9% of
revenues for the year ended December 31, 2005. The
continued decline in CMTS product revenue resulted from our
decision to cease investment in CMTS products in the fourth
quarter of 2004 and the resulting decrease in CMTS sales. We do
not believe that sales of CMTS products will be material in 2007.
Revenues from the sale of DVS products increased to
$58.5 million for the year ended December 31, 2006,
compared to $41.8 million for the year ended
December 31, 2005.
48
The following is a breakdown of DVS revenue by period invoiced
(in millions, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
DVS product revenue invoiced and
recognized in current period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total invoiced in current period
|
|
$
|
45.5
|
|
|
$
|
53.9
|
|
|
$
|
(8.4
|
)
|
|
|
(15.6
|
)%
|
Less: Invoiced in current period
and recognized in future periods
|
|
|
4.0
|
|
|
|
27.4
|
|
|
|
(23.4
|
)
|
|
|
(85.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total invoiced and recognized in
current period
|
|
|
41.5
|
|
|
|
26.5
|
|
|
|
15.0
|
|
|
|
56.6
|
%
|
DVS product revenue invoiced in
prior fiscal years and recognized in current period
|
|
|
17.0
|
|
|
|
15.3
|
|
|
|
1.7
|
|
|
|
11.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total DVS product revenue
recognized in current period
|
|
$
|
58.5
|
|
|
$
|
41.8
|
|
|
$
|
16.7
|
|
|
|
40.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Although total revenue recognized from the sale of DVS products
increased in the year ended December 31, 2006 compared to
the same period in 2005, the amount of DVS product revenue
invoiced in 2006 decreased compared to the same period in 2005.
The amount of DVS product revenue invoiced in 2006 and 2005 was
$45.5 million and $53.9 million, respectively,
representing a decrease of 16%. Of the DVS product revenue
invoiced during 2006 and 2005, $41.5 million and
$26.5 million, respectively, was recognized as revenue
during 2006 and 2005, while the remaining amounts of
$4.0 million and $27.4 million, respectively, will be
recognized as revenue in future periods. The increase in revenue
invoiced and recognized in the current period and the
corresponding decrease in revenue invoiced in the current period
but deferred and recognized in future periods is primarily
attributable to our establishment of vendor specific objective
evidence (VSOE) of fair value for the post-contract support
(PCS) element of the DVS products in the first quarter of 2006.
Additionally, primarily due to the lack of establishing VSOE of
fair value of the PCS element of the DVS products prior to the
first quarter of 2006, $17.0 million and $15.3 million
of DVS product revenue invoiced in prior periods was recognized
during the years ended December 31, 2006 and 2005,
respectively.
Revenues
by Geographic Region
The following table is a breakdown of revenues by geographic
region (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Revenues by geographic region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
54,387
|
|
|
$
|
52,838
|
|
|
$
|
1,549
|
|
|
|
2.9
|
%
|
Americas, excluding United States
|
|
|
2,932
|
|
|
|
1,871
|
|
|
|
1,061
|
|
|
|
56.7
|
%
|
Europe, Middle East and Africa
(EMEA), excluding Israel
|
|
|
11,236
|
|
|
|
15,314
|
|
|
|
(4,078
|
)
|
|
|
(26.6
|
)%
|
Israel
|
|
|
3,427
|
|
|
|
7,645
|
|
|
|
(4,218
|
)
|
|
|
(55.2
|
)%
|
Asia, excluding Japan
|
|
|
3,078
|
|
|
|
11,544
|
|
|
|
(8,466
|
)
|
|
|
(73.3
|
)%
|
Japan
|
|
|
1,370
|
|
|
|
1,452
|
|
|
|
(82
|
)
|
|
|
(5.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
76,430
|
|
|
$
|
90,664
|
|
|
$
|
(14,234
|
)
|
|
|
(15.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues in the United States increased to $54.4 million
for the year ended December 31, 2006, compared to
$52.8 million for the year ended December 31, 2005.
The increase in revenue in the United States was primarily
attributable to the recognition of deferred revenue from prior
periods, as well as continued build-out of all-digital simulcast
(ADS) networks by several major multiple system operators (MSOs)
in 2006 and increased purchases of our DM platform to provide
localized advertising. We expect that sales to MSOs in the
United States will continue to be the main source of our overall
revenues in 2007 due to
49
the expected build-out of ADS networks by second- and
third-tier MSOs and the increasing importance of ad
insertion within the United States market. The decrease in
international revenues is primarily attributable to the
discontinuation of our CMTS and HAS products which typically
accounted for the majority of our revenues outside the United
States. We anticipate that total international revenues will
continue to decrease in 2007 based on the continued decline in
sales of our CMTS and HAS products as we exhaust the remaining
inventory of these products. DVS product revenues outside the
United States have been nominal, and we expect such revenues to
continue to be nominal in the foreseeable future, in part
because ad insertion is less popular and often not feasible
outside the United States.
Significant
Customers
Two customers, Comcast Corporation (Comcast) and Harmonic, Inc.
(Harmonic), each accounted for 10% or more of total revenues
(20% and 15%, respectively) for the year ended December 31,
2006. Three customers, Harmonic, Thomson Broadcast and Comcast
each accounted for 10% or more of our total revenues (12%, 11%
and 10%, respectively) for the year ended December 31, 2005.
Two customers, Comcast and Ascent Media, each accounted for 10%
or more of accounts receivable (40% and 18%, respectively) as of
December 31, 2006. Four customers, Comcast, HOT Telecom,
Wharf T&T Limited and CSC Holdings, each accounted for 10%
or more of accounts receivable (16%, 11%, 11% and 11%,
respectively) as of December 31, 2005.
Cost of
Goods Sold and Gross Profit
Total cost of goods sold consists of direct product costs as
well as the cost of our manufacturing operations. The cost of
manufacturing includes contract manufacturing, test and quality
assurance for products, warranty costs and associated costs of
personnel and equipment.
Total cost of goods sold decreased to $30.8 million in the
year ended December 31, 2006 from $55.6 million in the
year ended December 31, 2005.
Direct cost of goods sold for our HAS products was
$9.3 million and $33.3 million, respectively, for the
years ended December 31, 2006 and 2005. The direct cost of
goods sold for our HAS products decreased due to declining sales
of our HAS products following our decision to discontinue the
product line in January 2006. The direct cost of goods sold for
our CMTS products was $1.5 million and $4.8 million,
respectively, for the years ended December 31, 2006 and
2005. The direct cost of goods sold for our CMTS products
decreased as total units sold for our CMTS products decreased
because of our decision to cease investment in the CMTS product
line in the fourth quarter of 2004.
Direct cost of goods sold related to our DVS products increased
to $14.1 million in the year ended December 31, 2006,
compared to $8.7 million in the year ended
December 31, 2005.
50
The following is a breakdown of DVS cost of goods sold by period
invoiced (in millions, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Cost of goods sold related to DVS
product invoiced and recognized in current period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product invoiced in current period
|
|
$
|
9.7
|
|
|
$
|
13.4
|
|
|
$
|
(3.7
|
)
|
|
|
(27.6
|
)%
|
Less: Cost of goods sold related
to DVS product invoiced in current period and recognized in
future periods
|
|
|
0.1
|
|
|
|
7.4
|
|
|
|
(7.3
|
)
|
|
|
(98.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product invoiced and recognized in current period
|
|
$
|
9.6
|
|
|
$
|
6.0
|
|
|
$
|
3.6
|
|
|
|
60.0
|
%
|
Cost of goods sold related to DVS
product invoiced in prior fiscal years and recognized in current
period
|
|
|
4.2
|
|
|
|
2.7
|
|
|
|
1.5
|
|
|
|
55.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product recognized in current period
|
|
$
|
13.8
|
|
|
$
|
8.7
|
|
|
$
|
5.1
|
|
|
|
58.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the years ended December 31, 2006 and 2005, the cost of
goods sold related to DVS products invoiced during the period
was $9.7 million and $13.4 million, respectively,
representing a decrease of $3.7 million. Cost of goods sold
related to revenue invoiced and recognized on DVS products
during 2006 and 2005 was $9.6 million and
$6.0 million, respectively. In the first quarter of 2006,
we established VSOE of fair value for the PCS element of our DVS
products, which allowed us to recognize revenue and cost of
goods sold related to the hardware component of our DVS products
when all criteria of Staff Accounting
Bulletin No. 101, Revenue Recognition
(SAB 101), as amended by SAB 104, and American
Institute of Certified Public Accountants Statement of Position
97-2,
Software Revenue Recognition
(SOP 97-2),
had been met. Accordingly, cost of goods sold related to DVS
products invoiced in 2006 and recognized in future periods was
$0.1 million, compared to $7.4 million for 2005 due to
the lack of established VSOE of fair value for all elements of
our DVS products in periods prior to the first quarter of 2006.
Additionally, $4.2 million and $2.7 million,
respectively, of cost of goods sold were recognized during 2006
and 2005 for DVS products invoiced in prior periods. The
breakdown of DVS cost of goods sold by period invoiced does not
include non-warranty DVS repairs of $0.3 million and
$0.1 million for the years ended December 31, 2006 and
2005, respectively, or trial and demonstration orders of nominal
amounts.
For the year ended December 31, 2006, gross profit was
$45.6 million, or 60% of revenues. This represented a
$10.6 million increase compared to the year ended
December 31, 2005, in which gross profit was
$35.0 million, or 39% of revenues. The increase in our
gross profit as a percentage of revenues was primarily
attributable to an increase in revenues from the sales of our
higher margin DVS products and a decrease in revenues from our
lower margin HAS and CMTS products. Gross profit for the year
ended December 31, 2006 reflected a $1.5 million
benefit related to the sale of inventories that were reserved at
December 31, 2005 as excess and obsolete compared to a
$3.9 million benefit for the year ended December 31,
2005 related to the sale of inventories that were reserved at
December 31, 2004 as excess and obsolete, as well as
accrued vendor cancellation charges. The $1.5 million
benefit in 2006 was offset by a $0.9 million increase in
excess and obsolete inventory reserve requirements. The
$3.9 million benefit in 2005 was offset by a
$2.6 million increase in excess and obsolete inventory
reserve requirements and vendor cancellation charges.
During 2007, we will continue to focus on improving sales of our
higher margin DVS products and reducing product manufacturing
costs. As we complete the transition to a digital video company,
our revenues will primarily consist of DVS products, and thus,
we expect our gross profit margin percentages to increase as a
result of increased revenues from higher margin DVS products as
a percentage of our overall revenues.
51
Operating
Expenses
Research and development, sales and marketing, general and
administrative expenses and restructuring charges, executive
severance and asset write-offs are summarized in the following
table (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Research and development
|
|
$
|
17,377
|
|
|
$
|
17,650
|
|
|
$
|
(273
|
)
|
|
|
(1.5
|
)%
|
Sales and marketing
|
|
|
17,897
|
|
|
|
22,534
|
|
|
|
(4,637
|
)
|
|
|
(20.6
|
)%
|
General and administrative
|
|
|
24,944
|
|
|
|
20,356
|
|
|
|
4,588
|
|
|
|
22.5
|
%
|
Restructuring charges, executive
severance and asset write-offs
|
|
|
199
|
|
|
|
2,257
|
|
|
|
(2,058
|
)
|
|
|
(91.2
|
)%
|
Research
and Development.
Research and development expenses consist primarily of personnel
costs, internally designed prototype material expenditures,
expenditures for outside engineering consultants, and testing
equipment and supplies required to develop and enhance our
products. For the year ended December 31, 2006, research
and development expenses were $17.4 million, or 23% of
revenues, compared to $17.7 million, or 19% of revenues for
the year ended December 31, 2005. The $0.3 million
decrease in research and development expenditures in the year
ended December 31, 2006 was primarily attributable to
reductions in research and development based on the
discontinuation of our CMTS product and decreased spending on
HAS product innovation, which were offset by increased costs for
DVS product development, including increased expenditures
related to outsourced development services. We believe it is
critical for us to continue to make significant investments in
research and development to create innovative technologies and
products that meet the current and future requirements of our
customers. We anticipate that our overall research and
development expenses will remain constant in 2007.
Sales
and Marketing.
Sales and marketing expenses consist primarily of salaries and
commissions for sales personnel, salaries for marketing and
support personnel and costs related to marketing communications,
consulting and travel. Sales and marketing expenses decreased to
$17.9 million, or 23% of revenues for the year ended
December 31, 2006, compared to $22.5 million, or 25%
of revenues for the year ended December 31, 2005. The
reduction in sales and marketing expense was partly attributable
to a $0.6 million reduction in compensation and employee
benefits expenses, a $0.5 million decrease in travel
expenses that resulted from headcount reductions implemented in
2006, a $1.2 million decrease in marketing expenses
primarily related to a reduction in tradeshows and advertising
expenses, and a $0.7 million reduction in spending on
outside sales and marketing professional services.
General
and Administrative.
General and administrative expenses consist primarily of salary
and benefits for administrative officers and support personnel,
travel expenses and legal, accounting and consulting fees. For
the year ended December 31, 2006, general and
administrative expenses were $24.9 million, or 33% of
revenues, compared to $20.4 million, or 22% of revenues for
the year ended December 31, 2005. Higher general and
administrative expenses were primarily a result of increased
legal, auditing, financial consulting, and contractor costs of
$4.2 million, compensation expenses of $0.7 million
related to bonus plans and severance payments, $0.6 million
of repair expense related to the termination of our aircraft
lease and $0.8 million related to facility expenses and
moving costs. These increases were partially offset by decreases
in recruiting expenses of $0.3 million, decreased
depreciation and amortization of $0.4 million and decreases
to employee benefits of $0.1 million.
52
We have incurred substantial expenses for legal, accounting, tax
and other professional services in connection with the internal
review of our historical financial statements, the re-audit of
our historical financial statements for the years ended
December 31, 2004 and 2003 and the review of the four
quarters of 2004 and 2005, the preparation of the restated
financial statements, the Commission investigation and inquiries
from other governmental agencies, the related class action
litigation and the repayment in full of our 5% convertible
subordinated notes (Notes). Excluding the $65.6 million
that we paid to the holders of the Notes in March 2006, which
consisted of the face value of the Notes and the accrued and
unpaid interest and related costs, these expenses amounted to
approximately $10.6 million through December 31, 2006.
We anticipate that our overall general and administrative
expense will decrease in 2007.
Restructuring
Charges, Executive Severance and Asset Write-offs.
Restructuring charges, executive severance and asset write-offs
for the year ended December 31, 2006 were
$0.2 million. The amount consists primarily of a decrease
in an accrual of $0.8 million due to a change in estimate
for excess leased facilities and $1.0 million charge for
the write-off of leasehold improvements related to the
Santa Clara facility. Restructuring charges, executive
severance and asset write-offs for the year ended
December 31, 2005 totaled $2.3 million and related
primarily to severance and benefit costs.
Restructuring charges, executive severance and asset write-offs
are summarized as follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Restructuring charges
|
|
$
|
|
|
|
$
|
1,003
|
|
|
$
|
(1,003
|
)
|
|
|
(100.0
|
)%
|
Executive severance
|
|
|
|
|
|
|
15
|
|
|
|
(15
|
)
|
|
|
(100.0
|
)%
|
Long-lived assets written-off
|
|
|
962
|
|
|
|
85
|
|
|
|
877
|
|
|
|
1031.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
962
|
|
|
|
1,103
|
|
|
|
(141
|
)
|
|
|
(12.8
|
)%
|
Restructuring (recovery/change in
estimate in prior year plans)
|
|
|
(763
|
)
|
|
|
1,154
|
|
|
|
(1,917
|
)
|
|
|
(166.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges, executive
severance and asset write-offs
|
|
$
|
199
|
|
|
$
|
2,257
|
|
|
$
|
(2,058
|
)
|
|
|
(91.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For further detail, refer to Note 6, Restructuring
Charges and Asset Write-offs, to Condensed Consolidated
Financial Statements
Non-operating
Expenses
Interest income (expense), net and other income, net were as
follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2006
|
|
|
2005
|
|
|
Dollars
|
|
|
Percent
|
|
|
Interest income (expense), net
|
|
$
|
1,178
|
|
|
$
|
(189
|
)
|
|
$
|
1,367
|
|
|
|
(723.3
|
)%
|
Other income, net
|
|
|
22
|
|
|
|
1,155
|
|
|
|
(1,133
|
)
|
|
|
(98.0
|
)%
|
Interest income (expense), net relates primarily to
$1.6 million of income generated from investments in
high-quality fixed income securities, offset by
$0.4 million of interest expense on our Notes. We expect
our interest income (expense), net to decrease in future periods
based upon our reduction in short-term investments resulting
from the repurchase of our Notes in the first quarter of 2006.
Other income, net is generally comprised of realized foreign
currency gains and losses, realized gains or losses on
investments, and income attributable to non-operational gains
and losses. The decrease in other income, net for the years
ended December 31, 2006 compared to the year ended
December 31, 2005 was largely attributable to the
recognized gain on the sale of Terayon Communication Systems
Ltd. to Megabridge in 2005 and increased amortization of bond
issuance costs due to the retirement of our Notes in 2006.
53
Income
Tax (Expense) Benefit
With the exception of the three months ended June 30, 2006,
we have generated losses since our inception. We have not
recorded a tax provision based on net income for the year ended
December 31, 2006, due to the large net operating loss
carry forwards we have to offset any federal and state tax
liability. Income tax expense for the years ended
December 31, 2006 and 2005 is nominal and primarily related
to foreign taxes.
Stock-Based
Compensation
On January 1, 2006, we adopted Statement of Financial
Accounting Standards (SFAS) No. 123(R), Share-Based
Payment, (SFAS 123(R)), which requires the
measurement and recognition of stock-based compensation expense
for share-based payment awards. We elected to adopt
SFAS 123(R) using the modified prospective recognition
method. The modified prospective recognition method requires us
to recognize compensation cost for new and unvested stock
options, restricted stock, restricted stock units and employee
stock purchase plan shares. Under the modified prospective
recognition method, prior period financial statements are not
restated.
Prior to the adoption of SFAS 123(R) on January 1,
2006, we accounted for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board
(APB) Opinion 25, Accounting for Stock Issued to
Employees (APB 25). Under APB 25, compensation
cost was measured as the excess, if any, of the quoted market
price of our stock at the date of grant over the exercise price
of the stock option granted. Under APB 25, compensation
cost for stock options, if any, was recognized over the vesting
period using the straight-line single option method.
During the year ended December 31, 2006, we recorded
$2.5 million in stock-based compensation compared to zero
stock-based compensation recorded during the year ended
December 31, 2005. At December 31, 2006, unamortized
compensation expense related to outstanding unvested stock
options that are expected to vest was approximately
$2.9 million. This unamortized compensation expense is
expected to be recognized over a weighted average period of
approximately 2.2 years.
Comparison
of Years Ended December 31, 2005 and 2004
Revenues
Our revenues declined 34% to $90.7 million for the year
ended December 31, 2005 from $136.5 million in 2004,
due to sales of HAS and CMTS products decreasing from 2004 to
2005 by $41.0 million or 50% of HAS revenue, and
$22.4 million or 74% of CMTS revenue, respectively. The
decline in CMTS revenue is directly related to our announcement
in October 2004 that we would cease investment in future
development of CMTS. The decline in our HAS revenue resulted
from decreased market demand for traditional, data-only modems
and the inability for our voice-enabled eMTA modems to find
widespread market acceptance. Revenue from our DVS product line
increased 74% to $41.8 million in 2005, up from
$24.1 million in 2004. The increase in DVS revenue was
driven primarily by demand from our MSO customers in the United
States which continued to upgrade their networks as part of
their efforts to implement ADS networks that included digital
program insertion capabilities as well as ADS build out by the
second tier MSOs.
Revenue in 2004 and 2005 was impacted by the recognition of
sales invoiced in prior periods as well as sales invoiced in the
current period recognized in future periods. In 2004 and 2005,
$9.7 million and $15.9 million, respectively, of
revenue was recognized from sales invoiced in prior periods
including deferred revenues. Deferred revenue recognized in 2005
includes $7.8 million of revenue related to sales of our BP
5100 product to Thomson Broadcast that was previously recognized
in 2004 but deferred to the quarter ended December 31, 2005
in connection with the restatement. In 2004 and 2005,
$15.6 million and $30.4 million, respectively, of
revenue billed in the current period was recognized in future
periods.
54
Revenues
by Groups of Similar Products
The following table presents revenues for groups of similar
products (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Revenues by product:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DVS
|
|
$
|
41,806
|
|
|
$
|
24,102
|
|
|
$
|
17,704
|
|
|
|
73.5
|
%
|
HAS
|
|
|
41,061
|
|
|
|
82,068
|
|
|
|
(41,007
|
)
|
|
|
(50.0
|
)%
|
CMTS
|
|
|
7,797
|
|
|
|
30,210
|
|
|
|
(22,413
|
)
|
|
|
(74.2
|
)%
|
Other
|
|
|
|
|
|
|
104
|
|
|
|
(104
|
)
|
|
|
(100.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
90,664
|
|
|
$
|
136,484
|
|
|
$
|
(45,820
|
)
|
|
|
(33.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue from the sale of our HAS products decreased from
$82.1 million or 60% of revenue for the year ended
December 31, 2004 to $41.1 million or 45% of revenue
for the year ended December 31, 2005. The decrease in HAS
product revenue was primarily driven by the failure of our eMTA
modems to find widespread market acceptance among MSOs due to
the lack of features and functionality demanded by MSOs and
provided by our competitors in their eMTA modems. In 2005, MSOs
increasingly purchased eMTA modems versus traditional modems,
which resulted in the decline of our traditional modem revenues.
As a result of this decrease and the failure of our eMTA modems
to gain widespread market acceptance, our overall modem revenues
decreased. HAS sales were also negatively impacted by our
decision to cease investment in our CMTS products in 2004, as we
were no longer able to bundle and sell our HAS and CMTS products
as an
end-to-end
solution, as well as customer concerns regarding our commitment
to continue to sell and support modems in future periods. In
January 2006, we announced that we would focus solely on our DVS
products.
Revenue from the sale of our CMTS products decreased 74% from
$30.2 million and 22% of revenue as of December 31,
2004, to $7.8 million and 9% of revenue as of
December 31, 2005. The decrease in CMTS product revenue
resulted from our decision to cease investment in CMTS products
in the fourth quarter of 2004 and the resulting decrease in CMTS
sales. CMTS also decreased as a percentage of revenue due to a
significant decrease in sales of CMTS products and an increase
in sales of the DVS products.
Revenue from the sale of our DVS products increased from
$24.1 million or 18% of revenue, for the year ended
December 31, 2004 to $41.8 million or 46% of revenue,
for the year ended December 31, 2005. The increase in the
revenue of the DVS products as a percentage of sales in 2005
compared to 2004 was driven by increased sales of DVS products
and the recognition of $7.8 million of revenue related to
the sale of our BP 5100 product and service to Thomson Broadcast
that was deferred from 2004 to the fourth quarter of 2005. DVS
also increased as a percentage of revenue due to a significant
decline in sales of and revenue generated by the sale of HAS and
CMTS products in 2005 compared to 2004.
55
The following is a breakdown of DVS revenue by period invoiced
(in millions, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
DVS product revenue invoiced and
recognized in current period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total invoiced in current period
|
|
$
|
53.9
|
|
|
$
|
36.8
|
|
|
$
|
17.1
|
|
|
|
46.5
|
%
|
Less: Invoiced in current period
and recognized in future periods
|
|
|
27.4
|
|
|
|
15.0
|
|
|
|
12.4
|
|
|
|
82.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total invoiced and recognized in
current period
|
|
$
|
26.5
|
|
|
$
|
21.8
|
|
|
$
|
4.7
|
|
|
|
21.6
|
%
|
DVS product revenue invoiced in
prior fiscal years and recognized in current period
|
|
|
15.3
|
|
|
|
2.3
|
|
|
|
13.0
|
|
|
|
565.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total DVS product revenue
recognized in current period
|
|
$
|
41.8
|
|
|
$
|
24.1
|
|
|
$
|
17.7
|
|
|
|
73.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total DVS product revenue recognized in the current period
increased significantly in the year ended December 31, 2005
compared to 2004. Total DVS product revenue recognized in the
years ended December 31, 2005 and 2004 was
$41.8 million and $24.1 million, respectively, which
represented an increase of $17.7 million, or 73%, in 2005
compared to 2004. The total DVS product revenue invoiced during
the current period increased in the year ended December 31,
2005 compared to 2004. In the years ended December 31, 2005
and 2004, the amount of DVS product revenue invoiced was
$53.9 million and $36.8 million, respectively, which
represents an increase of $17.1 million, or 47%, in 2005
compared to 2004. In the years ended December 31, 2005 and
2004, the amount of DVS product revenue invoiced and recognized
during the period invoiced was $26.5 million and
$21.8 million, respectively, with an increase of
$4.7 million, or 22%, in 2005 compared to 2004. Of the DVS
product revenue invoiced, $27.4 million and
$15.0 million, respectively, was recognized in future
periods, which represented an increase of $12.4 million, or
83%, in 2005 compared to 2004. During the years ended
December 31, 2005 and 2004, $15.3 million and
$2.3 million of DVS product revenue recognized,
respectively, had been invoiced in prior periods, which
represents an increase of $13.0 million, or 565%.
Revenues
by Geographic Region
The following table is a breakdown of revenues by geographic
region (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Revenues by geographic areas:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
52,838
|
|
|
$
|
72,838
|
|
|
$
|
(20,000
|
)
|
|
|
(27.5
|
)%
|
Americas, excluding United States
|
|
|
1,871
|
|
|
|
4,930
|
|
|
|
(3,059
|
)
|
|
|
(62.0
|
)%
|
Europe, Middle East and Africa
(EMEA), excluding Israel
|
|
|
15,314
|
|
|
|
17,640
|
|
|
|
(2,326
|
)
|
|
|
(13.2
|
)%
|
Israel
|
|
|
7,645
|
|
|
|
16,645
|
|
|
|
(9,000
|
)
|
|
|
(54.1
|
)%
|
Asia, excluding Japan
|
|
|
11,544
|
|
|
|
15,259
|
|
|
|
(3,715
|
)
|
|
|
(24.3
|
)%
|
Japan
|
|
|
1,452
|
|
|
|
9,172
|
|
|
|
(7,720
|
)
|
|
|
(84.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
90,664
|
|
|
$
|
136,484
|
|
|
$
|
(45,820
|
)
|
|
|
(33.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues in all geographic markets declined due to decreased
sales of HAS and CMTS products to MSOs. Revenues in the United
States decreased 28% to $52.8 million in the year ended
December 31, 2005, down from $72.8 million in 2004.
However, revenue in the United States increased as a percentage
of sales from 53% of total revenues at December 31, 2004 to
58% of total revenues at December 31, 2005 due primarily to
a decrease in sales of HAS and CMTS products, where sales were
concentrated outside the United
56
States. Revenues in EMEA, excluding Israel, decreased 13% to
$15.3 million in the year ended December 31, 2005,
compared to $17.6 million in 2004, due to decreased sales
of our CMTS and HAS products, partially offset by sales of the
remaining CMTS and HAS inventory to MSOs in Eastern Europe.
Sales of our DVS product in Europe were nominal in both the
years ended December 31, 2005 and December 31, 2004.
Revenue for Israel decreased 54% to $7.6 million in the
year ended December 31, 2005, down from $16.6 million
in the year ended December 31, 2004, as a result of
decreased HAS sales. Sales of our DVS product in Israel were not
material. Revenue in Asia, excluding Japan, decreased 24% to
$11.5 million in the year ended December 31, 2005,
down from $15.3 million in 2004. This decrease resulted
from the significant decline in the sale of CMTS and HAS
products due to our decision to cease investment in the CMTS
product line in 2004. Sales of our DVS product in Asia,
excluding Japan, were nominal. Revenue in Japan decreased 84% to
$1.5 million from $9.2 million in 2004. This decrease
was a result of a significant decline in the sale of CMTS and
HAS products due to our decision to cease investment in the CMTS
product line in 2004. Sales of our DVS product in Japan were
nominal.
In 2005, we focused our sales activities on selling DVS products
in the United States, which is the primary geographic market for
our DVS products. As a result of increased revenues from MSO
customers in the United States, our revenues from sales of DVS
products outside the United States decreased from 18% of total
DVS sales to 9% of total DVS sales between 2004 and 2005.
Significant
Customers
Three customers, Harmonic, Thomson Broadcast and Comcast (12%,
11% and 10%, respectively), accounted for more than 10% each of
our total revenues for the year ended December 31, 2005.
Two customers, Adelphia and Comcast (20% and 13%, respectively),
accounted for more than 10% each of our total revenues for the
year ended December 31, 2004. In 2005, Adelphia ceased to
be a significant customer following our decision to cease
investment in the CMTS products.
Cost of
Goods Sold and Gross Profit
Cost of goods sold consists of direct product costs as well as
the cost of our manufacturing operations. The cost of
manufacturing includes contract manufacturing, test and quality
assurance for products, warranty costs and associated costs of
personnel and equipment. In 2005, cost of goods sold was
$55.6 million, or 61% of revenues, compared to
$101.9 million, or 75% of revenues in 2004. Cost of goods
sold in 2005 included the recognition of $2.7 million of
direct development costs related to the sale of our BP 5100
product and service to Thomson Broadcast that was deferred from
prior periods.
The cost of goods sold for our HAS products was
$33.3 million and $60.4 million, respectively, for the
years ended December 31, 2005 and 2004. The cost of goods
sold for HAS decreased as total unit sales of HAS products
decreased due to declining sales and improved pricing on
component pricing. The cost of goods sold for our CMTS products
was $4.8 million and $12.1 million, respectively, for
the years ended December 31, 2005 and 2004. The cost of
goods sold for our CMTS products decreased as total units sold
for our CMTS products decreased due to our decision to cease
investment in the CMTS product line and the related write-off of
CMTS inventory in the three months ended December 31, 2004
that was deemed excess and obsolete.
57
The following is a breakdown of DVS cost of goods sold by period
invoiced (in millions, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Cost of goods sold related to DVS
product invoiced and recognized in current period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product invoiced in current period
|
|
$
|
13.4
|
|
|
$
|
7.8
|
|
|
$
|
5.6
|
|
|
|
71.8
|
%
|
Less: Cost of goods sold related
to DVS product invoiced in current period and recognized in
future periods
|
|
|
7.4
|
|
|
|
2.7
|
|
|
|
4.7
|
|
|
|
174.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product invoiced and recognized in current period
|
|
$
|
6.0
|
|
|
$
|
5.1
|
|
|
$
|
0.9
|
|
|
|
17.6
|
%
|
Cost of goods sold related to DVS
product invoiced in prior fiscal years and recognized in current
period
|
|
|
2.7
|
|
|
|
0.5
|
|
|
|
2.2
|
|
|
|
440.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of goods sold related
to DVS product recognized in current period
|
|
$
|
8.7
|
|
|
$
|
5.6
|
|
|
$
|
3.1
|
|
|
|
55.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total DVS product of cost goods sold recognized in the current
period increased significantly in the year ended
December 31, 2005 compared to 2004. Total DVS product cost
of goods sold recognized in the years ended December 31,
2005 and 2004 was $8.7 million and $5.6 million,
respectively, which represents an increase of $3.1 million,
or 55%, in 2005 compared to 2004. Total DVS product cost of
goods sold in the current period increased in the year ended
December 31, 2005 compared to 2004. In the years ended
December 31, 2005 and 2004, the cost of goods sold related
to DVS products invoiced in the current period was
$13.4 million and $7.8 million, respectively, which
represents an increase of $5.6 million, or 72%, in 2005
compared to 2004. Cost of goods related to revenue invoiced and
recognized on DVS products during the years ended
December 31, 2005 and 2004 was $6.0 million and
$5.1 million, respectively, which represents an increase of
$0.9 million, or 18%, in 2005 compared to 2004. In the
years ended December 31, 2005 and 2004, cost of goods sold
related to DVS products invoiced in the current period and
recognized in future periods was $7.4 million and
$2.7 million, respectively, which represents an increase of
$4.7 million, or 174%. Cost of goods sold related to
revenue on DVS products invoiced in prior periods and recognized
in the current period was $2.7 million and
$0.5 million in the years ended December 31, 2005 and
2004, respectively, which represents an increase of
$2.2 million, or 440%, in the year ended December 31,
2005 compared to 2004.
Our gross profit increased $0.4 million to
$35.0 million, or 39% of revenue, in the year ended
December 31, 2005 compared to $34.6 million, or 25% of
revenue, in 2004. Offsetting the reduction in revenues, our
increase in gross profit in 2005 was primarily related to the
sales mix which consisted of increased sales of higher margin
DVS products, as well as the sale of product previously reserved
as excess and obsolete.
Cost of goods sold in 2005 included a $3.9 million benefit
related to the sale of inventories that were reserved in prior
periods as excess and obsolete and accrued vendor cancellation
charges compared to $3.1 million for the year ended
December 31, 2004. The $3.9 million benefit in 2005
was offset by a $2.6 million increase in excess and
obsolete inventory reserve requirements and vendor cancellation
charges. The $3.1 million benefit in 2004 was offset by a
$12.3 million increase in excess and obsolete inventory
reserve requirements and vendor cancellation charges. Excess and
obsolete and vendor cancellation charges in 2004 included net
charges of $9.2 million related to our decision to cease
investment in the CMTS product line.
58
Operating
Expenses
Research and development, sales and marketing, general and
administrative expenses and restructuring charges, executive
severance and asset write-offs are summarized in the following
table (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Research and development
|
|
$
|
17,650
|
|
|
$
|
33,199
|
|
|
$
|
(15,549
|
)
|
|
|
(46.8
|
)%
|
Sales and marketing
|
|
|
22,534
|
|
|
|
24,145
|
|
|
|
(1,611
|
)
|
|
|
(6.7
|
)%
|
General and administrative
|
|
|
20,356
|
|
|
|
12,039
|
|
|
|
8,317
|
|
|
|
69.1
|
%
|
Restructuring charges, executive
severance and asset write-offs
|
|
|
2,257
|
|
|
|
12,336
|
|
|
|
(10,079
|
)
|
|
|
(81.7
|
)%
|
Research
and Development
Research and development expenses consist primarily of personnel
costs, internally designed prototype material expenditures, and
expenditures for outside engineering consultants, equipment and
supplies required in developing and enhancing our products. For
the year ended December 31, 2005, research and development
expenses were $17.7 million, or 19% of revenue. This was a
decrease of $15.5 million from research and development
expenses in 2004, which were $33.2 million, or 24% of
revenue. The reduction in research and development resulted from
our decision in the quarter ended December 31, 2004 to
cease investment in future development of our CMTS product line,
decreased spending on research and development for the HAS
products and the sale of our semiconductor division to ATI in
March 2005.
Sales
and Marketing
Sales and marketing expenses consist primarily of personnel
costs, including salaries and commissions for sales personnel,
salaries for marketing and support personnel, costs related to
trade shows, consulting and travel. For the year ended
December 31, 2005 sales and marketing expenses were
$22.5 million or 25% of revenue. This was a
$1.6 million decrease compared to 2004 where sales and
marketing expenses were $24.1 million or 18% of revenue.
However, sales and marketing expenses increased as a percentage
of revenue from 2004 to 2005. The largest component of the
decrease in total sales and marketing expenses was a
$1.9 million reduction in compensation related expenses
related to reductions in headcount, offset by a
$0.9 million increase related to advertising and tradeshow
expenses.
General
and Administrative
General and administrative expenses consist primarily of
personnel costs of administrative officers and support
personnel, and legal, accounting and consulting fees. For the
year ended December 31, 2005, general and administrative
expenses were $20.4 million, or 22% of revenue. This was an
increase of $8.3 million from general and administrative
expenses in 2004, which were $12.0 million, or 9% of
revenue. Factors that contributed to the increase included a
$2.6 million net expense related to the Adelphia litigation
settlement; $3.2 million related to the settlement of our
shareholder class action and derivative litigation; an increase
in outside legal fees of $2.5 million, of which
$0.9 million related to the independent investigation and
$1.0 million related to increased litigation expenses; and
an increase of $0.2 million in financial audit fees.
59
Restructuring
Charges, Executive Severance and Asset Write-offs
Restructuring charges, executive severance and asset write-offs
are summarized as follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Restructuring charges
|
|
$
|
1,003
|
|
|
$
|
6,784
|
|
|
$
|
(5,781
|
)
|
|
|
(85.2
|
)%
|
Executive severance
|
|
|
15
|
|
|
|
3,451
|
|
|
|
(3,436
|
)
|
|
|
(99.6
|
)%
|
Long-lived assets written-off
|
|
|
85
|
|
|
|
2,401
|
|
|
|
(2,316
|
)
|
|
|
(96.5
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
1,103
|
|
|
|
12,636
|
|
|
|
(11,533
|
)
|
|
|
(91.3
|
)%
|
Restructuring (recovery/change in
estimate in prior year plans)
|
|
|
1,154
|
|
|
|
(300
|
)
|
|
|
1,454
|
|
|
|
(484.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges, executive
severance and asset write-offs
|
|
$
|
2,257
|
|
|
$
|
12,336
|
|
|
$
|
(10,079
|
)
|
|
|
(81.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring
During 2005, we continued restructuring activities related to
our decision to cease investment in our CMTS product line. In
the quarters ended March 31, 2005 and June 30, 2005,
we incurred net restructuring charges of $0.7 million and
$0.3 million, respectively, related to employee termination
costs.
In the first three quarters of 2005, we re-evaluated the charges
for excess leased facilities accrued as part of the 2001
restructuring plan and the 2004 restructuring plan. During the
three quarters ended September 30, 2005, we decreased the
accrual by $0.3 million for the 2001 restructuring plan and
increased the accrual by $0.9 million for the 2004
restructuring plan. During the fourth quarter of 2005, we
incurred restructuring charges in the amount of
$0.3 million related to excess leased facilities for the
2004 restructuring plan.
Net charges for restructuring that occurred in 2005 totaled
$2.2 million, comprised of $1.0 million for employee
terminations, $1.1 million for excess leased facilities and
$0.1 million related to the aircraft lease.
As of December 31, 2005, $0.1 million remains accrued
for the 2001 restructuring plan related to excess leased
facilities, and $2.6 million remains accrued for the 2004
restructuring plan, which is comprised of $0.5 million for
the aircraft lease and $2.1 million for excess leased
facilities.
The reserve for leased facilities, net of sublease income,
approximates the difference between our current costs for the
excess leased facilities, which is our former principal
executive offices located in Santa Clara, California, and
the estimated income derived from subleasing the facilities,
which was based on information derived by our brokers that
estimated real estate market conditions as of the date of our
implementation of the restructuring plan and the time it would
likely take to fully sublease the excess leased facilities.
Executive
Severance
In August 2004, we entered into an employment agreement with an
executive officer who resigned effective December 31, 2004
with a termination date of February 3, 2005. We recorded a
severance provision of $0.4 million related to termination
costs for this officer in the quarter ended December 31,
2004. Most of the severance costs related to this officer were
paid in the quarter ended March 31, 2005 with nominal
amounts for employee benefits payable through the quarter ended
March 31, 2006.
Asset
Write-offs
There were no material asset write-offs in 2005. As a result of
CMTS product line restructuring activities in 2004, we
recognized a fixed asset impairment charge of $2.4 million.
The impairment charge reflected a write-down of the assets
carrying value to a fair value based on a third party valuation.
60
Non-operating
Expenses
Interest expense, net and other income, net were as follows (in
thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Variance in
|
|
|
Variance in
|
|
|
|
2005
|
|
|
2004
|
|
|
Dollars
|
|
|
Percent
|
|
|
Interest expense, net
|
|
$
|
(189
|
)
|
|
$
|
(1,090
|
)
|
|
$
|
901
|
|
|
|
(82.7
|
)%
|
Other income, net
|
|
|
1,155
|
|
|
|
1,031
|
|
|
|
124
|
|
|
|
12.0
|
%
|
Interest expense, net relates primarily to interest on our
Notes, offset by interest income generated from investments in
high-quality fixed income securities.
Other income, net is generally comprised of realized foreign
currency gains and losses, realized gains or losses on
investments, and income attributable to non-operational gains
and losses.
Income
Tax (Expense) Benefit
In 2005 we recorded an income tax expense of $0.1 million
which was primarily related to foreign taxes, and in 2004 we
recorded an income tax benefit of $0.1 million. The foreign
tax expense of approximately $0.3 million in 2004 was
offset by a tax benefit resulting principally from the reversal
of tax accruals due to the sale of certain subsidiaries.
Litigation
See Item 3 Legal Proceedings.
Off-Balance
Sheet Financings and Liabilities
Other than lease commitments and unconditional purchase
obligations incurred in the normal course of business, we do not
have any off-balance sheet financing arrangements or
liabilities, guarantee contracts, retained or contingent
interests in transferred assets or any obligation arising out of
a material variable interest in an unconsolidated entity. All of
our majority-owned subsidiaries are included in the condensed
consolidated financial statements.
Liquidity
and Capital Resources
At December 31, 2006, we had $20.3 million in cash and
cash equivalents and short-term investments compared to
$101.3 million as of December 31, 2005. The reduction
in cash and cash equivalents and short-term investments of
$81.0 million since December 31, 2005 was primarily
attributable to the repayment in March 2006 of
$65.6 million in the aggregate principal amount of the
Notes, including all accrued and unpaid interest and related
fees, and the funding of operating activities.
On November 7, 2005, we announced that the filing of our
periodic report on
Form 10-Q
for the quarter ended September 30, 2005 would be delayed
pending completion of the accounting review. We were required
under our Indenture, dated July 26, 2000 (Indenture), to
file with the Commission and the trustee of our Notes all
reports, information and other documents required pursuant to
Section 13 or 15(d) of the Exchange Act. On
January 12, 2006, holders of more than 25% of the aggregate
principal amount of the Notes, in accordance with the terms of
the Indenture, provided written notice to us that we were in
default under the Indenture based on our failure to file our
Form 10-Q
for the quarter ended September 30, 2005. We were unable to
cure the default within 60 days of the written notice,
March 13, 2006, which triggered an Event of Default under
the Indenture. The Event of Default enabled the holders of at
least 25% in aggregate principal amount of Notes outstanding to
accelerate the maturity of the Notes by written notice and
declare the entire principal amount of the Notes, together with
all accrued and unpaid interest thereon, to be due and payable
immediately. On March 16, 2006, we received a notice of
acceleration from holders of more than 25% of the aggregate
principal amount of the Notes. On March 21, 2006, we paid
in full the entire principal amount of the outstanding Notes,
including all accrued and unpaid interest thereon and related
fees, for a total of $65.6 million.
61
Cash used in operating activities for year ended
December 31, 2006 was $14.0 million compared to cash
provided by operating activities of $2.6 million in the
same period in 2005. For the year ended December 31, 2006,
we incurred a $3.8 million net loss which included an
$8.6 million non-cash gain related to the recognition of a
deferred gain on the sale of ATI Technologies, Inc., a
$2.5 million non-cash charge related to stock-based
compensation expenses, and a $2.9 million non-cash charge
related to inventory provision. During 2006, the cash used in
operating activities was further affected by contributions to
cash of $7.5 million from the decrease in other assets,
$5.7 million from the decrease in inventory, and
$3.0 million from the decrease of long-term cost of goods
sold. These contributions were offset by a $12.9 million
decrease in deferred revenue and a $5.3 million increase in
other current assets. In 2005, the $2.6 million provided to
cash was driven by a net loss of $27.0 million, offset by a
net contribution of cash of $8.0 million from accounts
receivable, $4.0 million from inventory, and a
$12.6 million increase in deferred revenue. In 2004, the
$39.7 million usage of cash was driven by the net loss of
$47.1 million, a $11.9 million in increased inventory
and a $17.4 million reduction in accounts payable offset by
a $11.6 million non-cash inventory provision, a
$8.4 million decrease in accounts receivable and an
$11.9 million increase in deferred revenues.
On March 9, 2005, we sold certain of our cable modem
semiconductor assets to ATI Technologies, Inc. (ATI). Under the
terms of the agreement, ATI was required to pay us
$7.0 million at the closing, with a balance of
$7.0 million subject to our achieving milestones for
certain conditions, services and deliverables up to June 9,
2006. Upon the closing, we received $8.6 million in cash,
which was comprised of the $7.0 million for the initial
payment and $1.9 million for having met the first
milestone, minus $0.3 million to pay for Company funded
retention bonuses for employees that accepted employment with
ATI. In June 2006, ATI paid us $1.1 million from the amount
that was released from escrow in June 2006 and we forfeited
$0.8 million, the remaining amount that was held in escrow,
for failing to obtain vendor author status for ATI with Cable
Television Laboratories, Inc. (CableLabs) by June 9, 2006.
Despite receiving cash payments for the sale of assets to ATI,
we did not recognize the $9.9 million gain on the ATI
transaction until the quarter ended June 30, 2006, based
upon the completion of milestones and the termination of the
supply arrangement between ATI and us. This gain represented the
purchase price of $12.5 million, less transaction related
costs of $2.6 million.
In connection with our operating lease arrangement to lease a
corporate aircraft, we deposited and pledged an aggregate amount
of $7.5 million in cash (Deposit) in 2004 with the aircraft
lessor, General Electric Capital Corporation (GECC), to secure
our obligations under the lease. In August 2004, we entered into
an aircraft sublease, which terminated on January 14, 2007.
On March 28, 2007, GECC returned to us approximately
$6.8 million of the $7.5 million cash deposit held by
GECC as collateral for the aircraft lease. GECC will retain
$0.7 million in collateral (Repair Collateral) subject to
GECCs completion of repairs, tests, inspections, and
corrections to the aircraft, which GECC has estimated will cost
$0.6 million. The remaining amount of the Repair
Collateral, if any, will be returned to us.
Investing activities consisted primarily of net purchases and
sales of short-term investments. Cash provided by investing
activities for the year ended December 31, 2006 was
$58.5 million compared to cash used by investing activities
of $19.6 million in the same period in 2005. The proceeds
from the $61.0 million sale of short-term investments in
the first quarter of 2006 were required to repay the Notes as
described above. Cash provided by investing activities for the
year ended December 31, 2004 was $50.8 million.
Cash used by financing activities of $65.1 million in the
year ended December 31, 2006 was due to the repayment of
$65.1 million of face value for the Notes. Cash provided by
financing activities in the year ended December 31, 2005
was $3.1 million, due to proceeds from the exercise of
stock options. Cash provided by financing activities for the
year ended December 31, 2004 was $1.6 million.
We currently believe that our current unrestricted cash, cash
equivalents and short-term investment balances will be
sufficient to satisfy our cash requirements for at least the
next 12 months. In order to achieve profitability in the
future, we will need to increase revenues, primarily through
sales of more profitable products, and decrease costs and
operating expenses. These statements are forward-looking in
nature and involve risks and uncertainties. Actual results may
vary as a result of a number of factors, including those
discussed under Item 1A Risk Factors. We may
need to raise additional funds in order to support more
62
rapid expansion, develop new or enhanced services, respond to
competitive pressures, acquire complementary businesses or
technologies or respond to unanticipated requirements. We may
seek to raise additional funds through private or public sales
of securities, strategic relationships, bank debt, and financing
under leasing arrangements or otherwise. If additional funds are
raised through the issuance of equity securities, the percentage
ownership of our current stockholders will be reduced,
stockholders may experience additional dilution or such equity
securities may have rights, preferences or privileges senior to
those of the holders of our common stock. We cannot assure that
additional financing will be available on acceptable terms, if
at all. If adequate funds are not available or are not available
on acceptable terms, we may be unable to continue operations,
develop our products, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements,
which could have a material adverse effect on our business,
financial condition and operating results.
Contractual
Obligations
The following table summarizes our contractual obligations as of
December 31, 2006, and the effect such obligations are
expected to have on our liquidity and cash flows in future
periods (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less than
|
|
|
1 - 3
|
|
|
4 - 5
|
|
|
After
|
|
|
|
Total
|
|
|
1 Year
|
|
|
Years
|
|
|
Years
|
|
|
5 Years
|
|
|
Unconditional purchase obligations
|
|
$
|
6.4
|
|
|
$
|
6.4
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Operating lease obligations
|
|
|
11.0
|
|
|
|
3.9
|
|
|
|
7.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
17.4
|
|
|
$
|
10.3
|
|
|
$
|
7.1
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have unconditional purchase obligations to certain of our
suppliers that support our ability to manufacture our products.
The obligations require us to purchase minimum quantities of the
suppliers products at a specified price. As of
December 31, 2006, we had approximately $6.4 million
of purchase obligations, of which $0.1 million is included
in the Consolidated Balance Sheet as accrued vendor cancellation
charges, and the remaining $6.3 million is attributable to
open purchase orders. The remaining purchase obligations become
payable at various times throughout 2007.
We entered into a lease agreement for $2.3 million to lease
a facility of approximately 63,000 square feet from October
2006 through September 2009. We entered into a
sub-sublease
for $6.7 million to
sub-sublease
a facility with approximately 141,000 square feet from
October 2006 through October 2009.
The following table presents other commercial commitments,
primarily required to support operating leases (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of Commitment Expiration per Period
|
|
|
|
|
|
|
Less than
|
|
|
1 - 3
|
|
|
4 - 5
|
|
|
After
|
|
|
|
Total
|
|
|
1 Year
|
|
|
Years
|
|
|
Years
|
|
|
5 Years
|
|
|
Deposits
|
|
$
|
7.5
|
|
|
$
|
7.5
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Standby letters of credit
|
|
|
0.4
|
|
|
|
|
|
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
7.9
|
|
|
$
|
7.5
|
|
|
$
|
0.4
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2002, we entered into an operating lease arrangement to lease
a corporate aircraft. This lease arrangement was secured by a
$9.0 million letter of credit. The letter of credit was
reduced to $7.5 million in February 2003. During 2004, the
$7.5 million letter of credit was converted to a cash
deposit. This lease commitment is included in the table above.
In March 2004, in connection with our worldwide restructuring,
we notified GECC of our intentions to locate a purchaser for our
remaining obligations under this lease. In August 2004, we
entered into an agreement with a third party to sublease the
corporate aircraft through December 31, 2006, which
sublease was subsequently extended through January 14,
2007. On March 28, 2007, GECC returned to us approximately
$6.8 million of the $7.5 million cash deposit held by
GECC as collateral for the aircraft lease. GECC will retain
$0.7 million in collateral (Repair Collateral) subject to
GECCs completion of repairs, tests, inspections, and
corrections to the aircraft, which GECC has estimated
63
will cost $0.6 million. The remaining amount of the Repair
Collateral, if any, will be returned to us. As a result of our
real estate lease commitments, we have $0.4 million of
letters of credit outstanding.
Critical
Accounting Policies
We consider certain accounting policies related to revenue
recognition, deferred revenue and deferred cost of goods sold,
allowance for doubtful accounts, inventory valuation, warranty
reserves, restructuring, contingencies and income taxes to be
critical policies due to the estimation processes involved in
each. We discuss each of our critical accounting policies, in
addition to certain less significant accounting policies, with
senior members of management and the audit committee, as
appropriate.
Revenue
Recognition
In accordance with Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition (SAB 101), as amended by
SAB 104, for all products and services, we recognize
revenue when persuasive evidence of an arrangement exists,
delivery has occurred or services are rendered, the fee is fixed
or determinable, and collectibility is reasonably assured. In
instances where final acceptance of the product, system, or
solution is specified by the customer, revenue is not recognized
until all acceptance criteria have been met. Contracts and
customer purchase orders are used to determine the existence of
an arrangement. Delivery occurs when product is delivered to a
common carrier. Certain products are delivered on a
free-on-board
(FOB) destination basis and the Company does not recognize
revenue associated with these transactions until the delivery
has occurred to the customers premises. We assess whether
the fee is fixed or determinable based on the payment terms
associated with the transaction and whether the sales price is
subject to adjustment. We assess collectibility based primarily
on the creditworthiness of the customer as determined by credit
checks and analysis, as well as the customers payment
history.
In establishing its revenue recognition policies for our
products, we assess software development efforts, marketing and
the nature of post contract support (PCS). Based on its
assessment, we determined that the software in the HAS and CMTS
products is incidental and therefore, we recognize revenue on
HAS and CMTS products under SAB 101, as specifically
amended by SAB 104. Additionally, based on our assessment
of the DVS products, we determined that software was more than
incidental, and therefore, we recognize revenue on the DVS
products under American Institute of Certified Public
Accountants Statement of Position (SOP)
97-2,
Software Revenue Recognition
(SOP 97-2)
and
SOP 81-1,
Accounting for Performance of Construction-Type and
Certain Production-Type Contracts
(SOP 81-1).
We determined that the software in the DVS products is more than
incidental because the DVS platforms contained multiple embedded
software applications, the software is actively marketed and we
have a practice of providing upgrades and enhancements for the
software to its existing users periodically. While the software
is not sold on a stand-alone basis with the ability to operate
on a third party hardware platform, the software is marketed and
sold separately in the form of software license keys to activate
embedded software applications. Additionally, as part of our
customer support contracts, we routinely provide our customers
with unspecified software upgrades and enhancements.
When a sale involves multiple elements, such as sales of
products that include services, the entire fee from the
arrangement is allocated to each respective element based on its
fair value and recognized when revenue recognition criteria for
each element are met. Fair value for each element is established
based on the sales price charged when the same element is sold
separately. In order to recognize revenue from individual
elements within a multiple element arrangement under
SOP 97-2,
we must establish vendor specific objective evidence (VSOE) of
fair value for each element.
Prior to 2006, for DVS products, we determined that we did not
establish VSOE of fair value for the undelivered element of PCS,
which required us to recognize revenue and the cost of goods
sold of both the hardware element and PCS element ratably over
the period of the customer support contract. We amortized the
cost of goods sold for DVS products ratably over the period of
the customer support contract. Revenue and the related cost of
goods sold for DVS products that contain multiple element
arrangements in each quarter of 2003, 2004 and 2005 were
restated to reflect this accounting policy.
64
Beginning in the first quarter of 2006, we determined that we
established VSOE of fair value of the PCS element for DVS
product sales as a result of maintaining consistent pricing
practices for PCS, including consistent pricing of renewal rates
for PCS. For DVS products sold beginning in 2006 that contain a
multiple element arrangement, we recognize revenue from the
hardware component when all criteria of SAB 104 and
SOP 97-2
have been met and revenue related to PCS element ratably over
the period of the PCS.
We sell our products directly to broadband service providers,
and to a lesser extent, resellers. Revenue arrangements with
resellers are recognized when product meets all criteria of
SAB 104 and
SOP 97-2.
Deferred
Revenue, Deferred Cost of Goods Sold
Deferred revenue and deferred cost of goods sold are a result of
our recognizing revenues on the DVS under
SOP 97-2.
Under
SOP 97-2,
we must establish VSOE of fair value for each element of a
multiple element arrangement. Until the first quarter of 2006,
we did not establish VSOE of fair value for PCS when PCS was
sold as part of a multiple element arrangement. As such, for DVS
products sold with PCS, revenue and the cost of goods sold
related to the delivered element, the hardware component, were
deferred and recognized ratably over the period of the PCS.
Allowance
for Doubtful Accounts
We perform ongoing credit evaluations of our customers and
generally require no collateral. We evaluate our trade
receivables based upon a combination of factors. Credit losses
have historically been within managements expectations.
When we become aware of a customers inability to pay, such
as in the case of bankruptcy or a decline in the customers
operating results or financial position, we record an allowance
to reduce the related receivable to an amount we reasonably
believe is collectible. We maintain an allowance for potentially
uncollectible accounts receivable based on an estimate of
collectibility. We assess collectibility based on a number of
factors, including history, the number of days an amount is past
due (based on invoice due date), changes in credit ratings of
customers, current events and circumstances regarding the
business of our clients customers and other factors that
we believe are relevant. If circumstances related to a specific
customer change, our estimates of the recoverability of
receivables could be further reduced. In addition, we made other
adjustments to the allowance for doubtful accounts to offset the
accounts receivable and related reserve related to customers who
were granted extended payment terms, experiencing financial
difficulties or where collectibility was not reasonably assured.
Accordingly, we classify these customers as those with
extended payment terms or with collectibility
issues. At December 31, 2006 and 2005, the allowance
for potentially uncollectible accounts was $0.2 million and
$2.8 million, respectively.
Inventory
Valuation
We value inventory at the lower of cost or market in accordance
with Chapter 3 of Accounting Research
Bulletin No. 43. Our policy for valuation of inventory
and commitments to purchase inventory, including the
determination of obsolete or excess inventory, requires us to
perform a detailed assessment of inventory at each balance sheet
date which includes a review of, among other factors, an
estimate of future demand for products within specific time
horizons, generally twelve months or less as well as product
lifecycle and product development plans. Given the rapid
technological change in the technology and communications
equipment industries as well as significant, unpredictable
changes in capital spending by our customers, we believe that
assessing the value of inventory using generally a twelve-month
time horizon is appropriate.
The estimates of future demand that we use in the valuation of
inventory are the basis for the revenue forecast, which is also
consistent with our short-term manufacturing plan. Based on this
analysis, we reduce the cost of inventory that we specifically
identify and consider obsolete or excessive to fulfill future
sales estimates. We define excess inventory as inventory that
will no longer be used in the manufacturing process. Excess
inventory is generally defined as inventory in excess of
projected usage, and is determined using our best estimate of
future demand at the time, based upon information then available.
We purchase components from a variety of suppliers and use
several contract manufacturers to provide manufacturing services
for our products. During the normal course of business, in order
to manage
65
manufacturing lead times (often ranging from three to six
months) and to help ensure adequate component supply, we enter
into agreements with contract manufacturers and suppliers that
either allow them to procure inventory based upon criteria as
defined by us or that establish the parameters defining our
component supply requirements. If we were to curtail or cease
production of certain products or terminate these agreements, we
may be liable for vendor cancellation charges.
We record losses on commitments to purchase inventory in
accordance with Statement 10 of Chapter 4 of
Accounting Research Bulletin No. 43. We accrue for
vendor cancellation charges (which increase cost of goods sold)
which represent managements estimate of our financial
exposure to vendors should our management curtail or cease
production of certain products or terminate a vendor or supplier
agreement. Estimates of exposure are determined using vendor
inventory data. Should we change our short-term manufacturing
plans such that further products or components would no longer
be used, additional vendor cancellation charges may occur. If
product is received and booked into inventory for which a vendor
cancellation reserve had been previously established, the vendor
cancellation reserve attributable to this inventory is
transferred to the reserve for excess and obsolete inventory. At
December 31, 2006, accrued vendor cancellation charges were
$0.1 million, which are expected to become payable in the
next three to six months. At December 31, 2005 and 2004,
accrued vendor cancellation charges were $1.5 million and
$0.5 million, respectively. From time to time we have been
able to reverse portions of our vendor cancellation accrual as
we were able to negotiate downward certain vendor cancellation
charges. Such reversals of vendor cancellation charges cause a
decrease in cost of goods sold in the period during which such
charges are reversed. For the years ended December 31, 2006
and 2005, we reversed nominal amounts of vendor cancellation
charges accrued at December 31, 2005 and 2004,
respectively. For the year ended December 31, 2004, we
reversed $2.4 million of vendor cancellation charges
accrued at December 31, 2003 as a result of favorable
negotiations with vendors and revised forecasts of demand.
Warranty
Reserves
We provide a standard warranty for most of our products, ranging
from one to five years from the date of purchase. We provide for
the estimated cost of product warranties at the time revenue is
recognized. Our warranty obligations are affected by product
failure rates, material usage and service delivery costs
incurred in correcting a product failure. Our estimate of costs
to service our warranty obligations is based on historical
experience and our expectation of future conditions. Should
actual product failure rates, material usage or service delivery
costs differ from our estimates, revision to the warranty
liability would be required, resulting in decreased gross
profits. Warranty reserves totaled $1.2 million and
$2.9 million, for the years ended December 31, 2006
and 2005, respectively.
Restructuring
and Other Related Charges
Between 2001 and 2005, we implemented restructuring programs to
focus and streamline our business and reduce operating expenses.
In connection with these programs, we reduced headcount,
abandoned facilities and wrote off inventory. As a result of
these actions, we recorded restructuring and other related
charges primarily consisting of cash severance payments made to
terminated employees, lease payments related to property
abandoned as a result of our facilities consolidation and lease
payments related to an aircraft lease. Each reporting period, we
review these estimates based on the execution of our
restructuring plans and changing market conditions, such as the
real estate market and other assumptions and, as needed, record
appropriate adjustments. To the extent that these assumptions
change, the ultimate restructuring expenses could vary.
Contingencies
We are subject to proceedings, lawsuits and other claims related
to labor, acquisitions and other matters. We are required to
assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. In
order to establish any reserve for contingent obligations, the
contingent obligation must be probable and quantifiable. A
determination of the amount of reserves required, if any, for
these contingencies is made after careful analysis of each
individual issue. The required reserves may change
66
in the future due to new developments in each matter or changes
in approach such as a change in settlement strategy in dealing
with these matters, any of which may result in higher net loss.
Income
Taxes
We determine our provision for income taxes using the asset and
liability method. Under this method, deferred tax assets and
liabilities are recognized for the future tax effects of
temporary differences between the financial statement carrying
amounts of existing assets and liabilities and their respective
tax bases. Future tax benefits of tax loss and credit
carryforwards are also recognized as deferred tax assets. We
evaluate the realizability of our deferred tax assets by
assessing the likelihood of future profitability and available
tax planning strategies that could be implemented to realize our
net deferred tax assets. The ultimate realization of our net
deferred tax assets will require profitability. We have assessed
the future profit plans and tax planning strategies together
with the years of expiration of carryforward benefits, and have
concluded that the deferred tax assets will be not be currently
realized and have recorded a valuation allowance against the
entire amount of the deferred tax assets. Should our operating
performance improve future assessments could conclude that a
reduction to the valuation allowance will be needed to reflect
deferred tax assets. In addition, we operate within multiple
taxing jurisdictions and are subject to tax audits in these
jurisdictions. These audits can involve complex issues, which
may require an extended period of time to resolve. While we
believe we have provided adequately for our income tax
liabilities in our consolidated financial statements, adverse
determinations by taxing authorities could have a material
adverse effect on our consolidated financial condition and
results of operations.
Recently
Issued Accounting Standards
In February 2006, the FASB issued SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments
(SFAS 155) which amends SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities (SFAS 133) and
SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities (SFAS 140). Specifically, SFAS 155
amends SFAS 133 to permit fair value remeasurement for any
hybrid financial instrument with an embedded derivative that
otherwise would require bifurcation, provided the whole
instrument is accounted for on a fair value basis. Additionally,
SFAS 155 amends SFAS 140 to allow a qualifying special
purpose entity to hold a derivative financial instrument that
pertains to a beneficial interest other than another derivative
financial instrument. SFAS 155 applies to all financial
instruments acquired or issued after the beginning of an
entitys first fiscal year that begins after
September 15, 2006, with early application allowed. The
adoption of SFAS 155 is not expected to have a material
impact on the Companys results of operations or financial
position.
In March 2006, the FASB issued SFAS No. 156,
Accounting for Servicing of Financial Assets
(SFAS 156), to simplify accounting for separately
recognized servicing assets and servicing liabilities.
SFAS 156 amends SFAS 140. Additionally, SFAS 156
applies to all separately recognized servicing assets and
liabilities acquired or issued after the beginning of an
entitys fiscal year that begins after September 15,
2006, although early adoption is permitted. The adoption of
SFAS 156 is not expected to have a material impact on our
results of operations or financial position.
In July 2006, the FASB issued FASB Interpretation 48,
Accounting for Uncertainty in Income Taxes
(FIN 48) an interpretation of FASB
No. 109, Accounting for Income Taxes.
FIN 48 prescribes a comprehensive model for recognizing,
measuring, presenting and disclosing in the financial statements
tax positions taken or expected to be taken on a tax return,
including decisions on whether or not to file in a particular
jurisdiction. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes. The
provisions of FIN 48 are to be applied to all tax positions
upon initial adoption of this standard. Only tax positions that
meet a more-likely-than-not recognition threshold at
the effective date may be recognized or continue to be
recognized upon adoption of FIN 48. The cumulative effect
of applying the provisions of FIN 48 are reported as an
adjustment to the opening balance of retained earnings
FIN 48 is effective for years beginning after
December 15, 2006, therefore, we will adopt FIN 48 as
of January 1, 2007. We expect that adoption of this
accounting standard will increase the level of disclosure that
we provide regarding our tax
67
positions. The adoption of FIN 48 is not expected to have a
material impact on our consolidated financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (SFAS 157), which
defines fair value, establishes guidelines for measuring fair
value and expands disclosures regarding fair value measurements.
SFAS 157 does not require any new fair value measurements
but rather eliminates inconsistencies in guidance found in
various prior accounting pronouncements. SFAS 157 is
effective for fiscal years beginning after November 15,
2007. Earlier adoption is permitted, provided the company has
not yet issued financial statements, including for interim
periods, for that fiscal year. We are currently evaluating the
impact of SFAS 157, but do not expect adoption to have a
material impact on our consolidated financial position, results
of operations or cash flows.
In September 2006, the Commission released Staff Accounting
Bulletin (SAB) No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements (SAB 108).
SAB 108 provides guidance on how the effects of prior-year
uncorrected financial statement misstatements should be
considered in quantifying a current year misstatement.
SAB 108 requires registrants to quantify misstatements
using both an income statement (rollover) and balance sheet
(iron curtain) approach and evaluate whether either approach
results in a misstatement that, when all relevant quantitative
and qualitative factors are considered, is material. If prior
year errors that had been previously considered immaterial are
now considered material based on either approach, no restatement
is required as long as management properly applied its previous
approach and all relevant facts and circumstances were
considered. If prior years are not restated, the cumulative
effect adjustment is recorded in opening retained earnings as of
the beginning of the fiscal year of adoption. SAB 108 is
effective for fiscal years ending on or after November 15,
2006. The adoption of SAB 108 did not have a material
impact on our financial statements.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Liabilities (SFAS 159), which includes an amendment
to FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities. SFAS 159
provides companies with an irrevocable option to report selected
financial assets and liabilities at fair value with changes in
fair value reported in earnings. SFAS 159 is effective for
fiscal years beginning after November 15, 2007. We are
currently evaluating the impact of SFAS 159, but do not
expect adoption to have a material impact on our consolidated
financial position, results of operations or cash flows.
|
|
Item 7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
Interest Rate Risk. Our exposure to market
risk for changes in interest rates relates primarily to our
investment portfolio. The primary objective of our investment
activities is to preserve principal while maximizing yields
without significantly increasing risk. This is accomplished by
investing in widely diversified short-term investments,
consisting primarily of investment grade securities,
substantially all of which mature within the next twenty-four
months. A hypothetical 50 basis point increase in interest
rates would not have a material impact on the fair value of our
available-for-sale
securities.
Foreign Currency Risk. A substantial majority
of our revenue, expense and capital purchasing activity are
transacted in U.S. dollars. However, we do enter into
transactions from Belgium, United Kingdom, Hong Kong and Canada.
If foreign currency rates were to fluctuate by 10% from the
rates at December 31, 2006, our financial position, results
of operations and cash flows would not be materially affected.
However, we cannot guarantee that there will not be a material
impact in the future.
68
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
TERAYON
COMMUNICATION SYSTEMS, INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
69
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Terayon Communication Systems, Inc.:
We have audited the accompanying consolidated balance sheets of
Terayon Communication Systems, Inc. as of December 31, 2006
and 2005, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2006. Our audits
also included the financial statement schedule listed in the
Index at accompanying Item 15(a)(2). These financial
statements and schedule are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Terayon Communication Systems, Inc. as of
December 31, 2006 and 2005, and the results of its
operations and its cash flows for each of the three years in the
period ended December 31, 2006 in conformity with
accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As discussed in Note 2 to the Consolidated Financial
Statements, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R),
Share-Based Payment (SFAS 123(R)) on
January 1, 2006.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Terayon Communication Systems, Inc.s
internal control over financial reporting as of
December 31, 2006, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) and our report dated March 29, 2007
expressed an unqualified opinion on managements assessment
of internal control over financial reporting and an adverse
opinion on the effectiveness of internal control over financial
reporting.
/s/ Stonefield
Josephson, Inc.
San Francisco, California
March 29, 2007
70
TERAYON
COMMUNICATION SYSTEMS, INC.
CONSOLIDATED
BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
8,362
|
|
|
$
|
28,867
|
|
Short-term investments
|
|
|
11,951
|
|
|
|
72,434
|
|
Accounts receivable, net of
allowance for doubtful accounts
|
|
|
10,914
|
|
|
|
9,879
|
|
Other current receivables
|
|
|
1,296
|
|
|
|
1,606
|
|
Inventory, net
|
|
|
2,324
|
|
|
|
10,915
|
|
Deferred cost of goods sold
|
|
|
2,289
|
|
|
|
3,351
|
|
Deposits
|
|
|
8,248
|
|
|
|
|
|
Other current assets
|
|
|
1,532
|
|
|
|
3,427
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
46,916
|
|
|
|
130,479
|
|
Property and equipment, net
|
|
|
3,309
|
|
|
|
3,915
|
|
Restricted cash
|
|
|
395
|
|
|
|
332
|
|
Long-term deferred cost of goods
sold
|
|
|
1,338
|
|
|
|
4,351
|
|
Other assets, net
|
|
|
12
|
|
|
|
7,571
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
51,970
|
|
|
$
|
146,648
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
STOCKHOLDERS EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
5,495
|
|
|
$
|
5,036
|
|
Accrued payroll and related
expenses
|
|
|
3,650
|
|
|
|
2,105
|
|
Deferred revenues
|
|
|
9,329
|
|
|
|
13,952
|
|
Deferred gain on asset sale
|
|
|
|
|
|
|
8,631
|
|
Accrued warranty expenses
|
|
|
1,246
|
|
|
|
2,887
|
|
Accrued restructuring and
executive severance
|
|
|
149
|
|
|
|
1,305
|
|
Accrued vendor cancellation charges
|
|
|
124
|
|
|
|
1,508
|
|
Accrued other liabilities
|
|
|
4,071
|
|
|
|
6,287
|
|
Interest payable
|
|
|
|
|
|
|
1,356
|
|
Current portion of subordinated
convertible notes
|
|
|
|
|
|
|
65,367
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
24,064
|
|
|
|
108,434
|
|
Long-term obligations
|
|
|
1,399
|
|
|
|
1,455
|
|
Accrued restructuring and
executive severance
|
|
|
193
|
|
|
|
1,381
|
|
Long-term deferred revenue
|
|
|
6,492
|
|
|
|
14,721
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
32,148
|
|
|
|
125,991
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
(Notes 4 and 8)
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par
value: 5,000,000 shares authorized; no shares issued and
outstanding
|
|
|
|
|
|
|
|
|
Common stock: $0.001 par
value, 200,000,000 shares authorized Issued
77,793,844 in 2006 and 77,794,186 in 2005
Outstanding 77,637,177 in 2006 and 2005
|
|
|
78
|
|
|
|
78
|
|
Additional paid-in capital
|
|
|
1,089,278
|
|
|
|
1,086,817
|
|
Accumulated deficit
|
|
|
(1,066,269
|
)
|
|
|
(1,062,438
|
)
|
Treasury stock, at cost;
156,009 shares
|
|
|
(773
|
)
|
|
|
(773
|
)
|
Accumulated other comprehensive
loss
|
|
|
(2,492
|
)
|
|
|
(3,027
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
19,822
|
|
|
|
20,657
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders equity
|
|
$
|
51,970
|
|
|
$
|
146,648
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
71
TERAYON
COMMUNICATION SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands, except per share data)
|
|
|
Revenues
|
|
$
|
76,430
|
|
|
$
|
90,664
|
|
|
$
|
136,484
|
|
Cost of goods sold
|
|
|
30,848
|
|
|
|
55,635
|
|
|
|
101,887
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
45,582
|
|
|
|
35,029
|
|
|
|
34,597
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
17,377
|
|
|
|
17,650
|
|
|
|
33,199
|
|
Sales and marketing
|
|
|
17,897
|
|
|
|
22,534
|
|
|
|
24,145
|
|
General and administrative
|
|
|
24,944
|
|
|
|
20,356
|
|
|
|
12,039
|
|
Restructuring charges, executive
severance and asset write-offs
|
|
|
199
|
|
|
|
2,257
|
|
|
|
12,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
60,417
|
|
|
|
62,797
|
|
|
|
81,719
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(14,835
|
)
|
|
|
(27,768
|
)
|
|
|
(47,122
|
)
|
Gain on sale of assets
|
|
|
9,984
|
|
|
|
|
|
|
|
|
|
Interest income (expense), net
|
|
|
1,178
|
|
|
|
(189
|
)
|
|
|
(1,090
|
)
|
Other income, net
|
|
|
22
|
|
|
|
1,155
|
|
|
|
1,031
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income tax expense
|
|
|
(3,651
|
)
|
|
|
(26,802
|
)
|
|
|
(47,181
|
)
|
Income tax benefit (expense)
|
|
|
(180
|
)
|
|
|
(149
|
)
|
|
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,831
|
)
|
|
$
|
(26,951
|
)
|
|
$
|
(47,105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per
share
|
|
$
|
(0.05
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(0.62
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing basic and
diluted net loss per share
|
|
|
77,637
|
|
|
|
77,154
|
|
|
|
75,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
72
TERAYON
COMMUNICATION SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Common Stock
|
|
|
Additional
|
|
|
Accumulated
|
|
|
Deferred
|
|
|
Comprehensive
|
|
|
Treasury Stock
|
|
|
Stockholders
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Paid-in Capital
|
|
|
Deficit
|
|
|
Compensation
|
|
|
Income (loss)
|
|
|
Shares
|
|
|
Amount
|
|
|
Equity
|
|
|
|
(In thousands, except share amounts)
|
|
|
Balance at December 31,
2003
|
|
|
74,874,001
|
|
|
$
|
75
|
|
|
$
|
1,082,034
|
|
|
$
|
(988,382
|
)
|
|
$
|
(22
|
)
|
|
$
|
(2,368
|
)
|
|
|
156,009
|
|
|
$
|
(773
|
)
|
|
$
|
90,563
|
|
Exercise of option for cash to
purchase common stock
|
|
|
225,645
|
|
|
|
|
|
|
|
494
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
494
|
|
Re-valuation of options to
non-employees
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
Issuance of common stock for
Employee Stock Purchase Plan
|
|
|
1,197,419
|
|
|
|
1
|
|
|
|
1,186
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,187
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase to unrealized gain on
short term investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(520
|
)
|
|
|
|
|
|
|
|
|
|
|
(520
|
)
|
Cumulative translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
307
|
|
|
|
|
|
|
|
|
|
|
|
307
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(47,105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(47,105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(47,319
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2004
|
|
|
76,297,065
|
|
|
|
76
|
|
|
|
1,083,709
|
|
|
|
(1,035,487
|
)
|
|
|
|
|
|
|
(2,582
|
)
|
|
|
156,009
|
|
|
|
(773
|
)
|
|
|
44,943
|
|
Exercise of option for cash to
purchase common stock
|
|
|
1,340,112
|
|
|
|
2
|
|
|
|
3,056
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,058
|
|
Accelerated Vesting of Options
|
|
|
|
|
|
|
|
|
|
|
52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase to unrealized gain on
short term investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
16
|
|
Cumulative translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(461
|
)
|
|
|
|
|
|
|
|
|
|
|
(461
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(26,951
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(26,951
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(27,396
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2005
|
|
|
77,637,177
|
|
|
|
78
|
|
|
|
1,086,817
|
|
|
|
(1,062,438
|
)
|
|
|
|
|
|
|
(3,027
|
)
|
|
|
156,009
|
|
|
|
(773
|
)
|
|
|
20,657
|
|
Stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
2,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,461
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase to unrealized gain on
short term investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
425
|
|
|
|
|
|
|
|
|
|
|
|
425
|
|
Cumulative translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
110
|
|
|
|
|
|
|
|
|
|
|
|
110
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,831
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,831
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,746
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2006
|
|
|
77,637,177
|
|
|
$
|
78
|
|
|
$
|
1,089,278
|
|
|
$
|
(1,066,269
|
)
|
|
$
|
|
|
|
$
|
(2,492
|
)
|
|
|
156,009
|
|
|
$
|
(773
|
)
|
|
$
|
19,822
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
73
TERAYON
COMMUNICATION SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,831
|
)
|
|
$
|
(26,951
|
)
|
|
$
|
(47,105
|
)
|
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
2,059
|
|
|
|
3,148
|
|
|
|
5,860
|
|
Stock based compensation
|
|
|
2,461
|
|
|
|
|
|
|
|
|
|
Amortization of subordinated
convertible notes premium
|
|
|
(286
|
)
|
|
|
(221
|
)
|
|
|
(221
|
)
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
17
|
|
Accretion of discounts on
short-term investments
|
|
|
(126
|
)
|
|
|
(114
|
)
|
|
|
(107
|
)
|
Realized gains on sales of
short-term investments
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
Inventory provision
|
|
|
2,940
|
|
|
|
2,732
|
|
|
|
11,550
|
|
Provision for doubtful accounts
|
|
|
(25
|
)
|
|
|
132
|
|
|
|
590
|
|
Restructuring provision
|
|
|
|
|
|
|
2,068
|
|
|
|
6,513
|
|
Write-off of fixed assets
|
|
|
1,092
|
|
|
|
602
|
|
|
|
3,045
|
|
Warranty provision
|
|
|
673
|
|
|
|
(165
|
)
|
|
|
3,075
|
|
Vendor cancellation provision
|
|
|
(1,040
|
)
|
|
|
1,143
|
|
|
|
387
|
|
Recognition of deferred gain on
asset sale
|
|
|
(8,631
|
)
|
|
|
|
|
|
|
|
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net
|
|
|
(700
|
)
|
|
|
7,986
|
|
|
|
8,404
|
|
Inventory
|
|
|
5,651
|
|
|
|
4,019
|
|
|
|
(11,939
|
)
|
Other current assets
|
|
|
(5,291
|
)
|
|
|
(3,262
|
)
|
|
|
(311
|
)
|
Long-term deferred cost of goods
sold
|
|
|
3,013
|
|
|
|
(2,543
|
)
|
|
|
(1,458
|
)
|
Other assets
|
|
|
7,496
|
|
|
|
2,896
|
|
|
|
2,172
|
|
Accounts payable
|
|
|
459
|
|
|
|
(2,810
|
)
|
|
|
(17,440
|
)
|
Accrued payroll and related expenses
|
|
|
1,545
|
|
|
|
(2,829
|
)
|
|
|
(1,984
|
)
|
Deferred revenues
|
|
|
(12,852
|
)
|
|
|
12,624
|
|
|
|
11,852
|
|
Deferred gain on asset sale
|
|
|
(2,314
|
)
|
|
|
8,631
|
|
|
|
|
|
Accrued warranty expenses
|
|
|
(2,344
|
)
|
|
|
(1,618
|
)
|
|
|
(3,634
|
)
|
Accrued restructuring charges
|
|
|
(344
|
)
|
|
|
(4,507
|
)
|
|
|
(4,355
|
)
|
Accrued vendor cancellation charges
|
|
|
|
|
|
|
(156
|
)
|
|
|
(2,735
|
)
|
Other accrued liabilities
|
|
|
(3,628
|
)
|
|
|
1,793
|
|
|
|
(1,830
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
operating activities
|
|
|
(14,023
|
)
|
|
|
2,598
|
|
|
|
(39,656
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(44,707
|
)
|
|
|
(89,957
|
)
|
Proceeds from sales and maturities
of short-term investments
|
|
|
61,034
|
|
|
|
26,919
|
|
|
|
143,480
|
|
Purchases of property and equipment
|
|
|
(2,545
|
)
|
|
|
(1,811
|
)
|
|
|
(2,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
investing activities
|
|
|
58,489
|
|
|
|
(19,599
|
)
|
|
|
50,823
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal payments on capital leases
|
|
|
|
|
|
|
|
|
|
|
(126
|
)
|
Debt extinguishment of convertible
debt
|
|
|
(65,081
|
)
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common
stock
|
|
|
|
|
|
|
3,110
|
|
|
|
1,682
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used for)
financing activities
|
|
|
(65,081
|
)
|
|
|
3,110
|
|
|
|
1,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of foreign currency exchange
rate changes
|
|
|
110
|
|
|
|
(460
|
)
|
|
|
307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash
equivalents
|
|
|
(20,505
|
)
|
|
|
(14,351
|
)
|
|
|
13,030
|
|
Cash and cash equivalents at
beginning of year
|
|
|
28,867
|
|
|
|
43,218
|
|
|
|
30,188
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
8,362
|
|
|
$
|
28,867
|
|
|
$
|
43,218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash
flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
36
|
|
|
$
|
111
|
|
|
$
|
138
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
1,817
|
|
|
$
|
3,254
|
|
|
$
|
3,268
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing
activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred compensation relating to
common stock issued to
non-employee
|
|
$
|
|
|
|
$
|
|
|
|
$
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
74
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Description
of Business
Terayon Communication Systems, Inc. (Company) was incorporated
under the laws of the State of California on January 20,
1993. In June 1998, the Company reincorporated in the State of
Delaware.
The Company develops, markets and sells digital video equipment
to network operators and content aggregators who offer video
services.
In 2004, the Company refocused to make digital video the core of
its business. As part of this strategic refocus, the Company
elected to continue selling its home access solutions (HAS)
product, including cable modems, embedded multimedia terminal
adapters (eMTA) and home networking devices, but ceased future
investment in its cable modem termination systems (CMTS) product
line. In January 2006, the Company announced it was
discontinuing its HAS product line.
|
|
Note 2.
|
Summary
of Significant Accounting Policies
|
Basis
of Consolidation
The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All intercompany
balances and transactions have been eliminated.
Use of
Estimates
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles (GAAP)
in the United States requires management to make estimates and
assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Estimates are based
on historical experience, input from sources outside of the
Company, and other relevant facts and circumstances. Actual
results could differ from those estimates. Areas that are
particularly significant include the Companys revenue
recognition policy, the valuation of its accounts receivable and
inventory, warranty obligations, accrued vendor cancellation
charges, the assessment of recoverability and the measurement of
impairment of fixed assets, and the recognition of restructuring
liabilities.
Foreign
Currency Translation
The Company records the effect of foreign currency translation
in accordance with Statement of Financial Accounting Standards
(SFAS) No. 52, Foreign Currency Translation.
For operations outside the United States that prepare financial
statements in currencies other than the U.S. dollar,
results of operations and cash flows are translated at average
exchange rates during the period, and assets and liabilities are
translated at
end-of-period
exchange rates. Translation adjustments are included as a
separate component of accumulated other comprehensive loss in
stockholders equity. Realized foreign currency transaction
gains and losses are included in results of operations as
incurred.
Treasury
Stock
The Company accounts for treasury stock under the cost method
and discloses treasury stock as a separate line item in the
shareholders equity section of the consolidated balance
sheet.
Concentrations
of Credit Risk, Customers, Suppliers and Products
The Company performs ongoing credit evaluations of its customers
and generally requires no collateral. Credit losses have
historically been within managements expectations. The
Company maintains an allowance for potentially uncollectible
accounts receivable based on an assessment of collectibility.
The Company
75
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
assesses collectibility based on a number of factors, including
past history, the number of days an amount is past due (based on
invoice due date), changes in credit ratings of customers,
current events and circumstances regarding the business of the
Companys clients customers and other factors that
the Company believes are relevant. At December 31, 2006 and
2005, the allowance for potentially uncollectible accounts was
$0.2 million and $2.8 million, respectively. A
relatively small number of customers account for a significant
percentage of the Companys revenues and accounts
receivable. The Company expects the sale of its products to a
limited number of customers and resellers to continue to account
for a high percentage of revenues.
The Company relies on single source suppliers of materials and
labor for the significant majority of its product inventory.
Should the Companys current suppliers not produce and
deliver inventory for the Company to sell on a timely basis,
operating results may be adversely impacted.
The Company places its cash and cash equivalents in several
financial institutions and limits the amount of credit exposure
through diversification and by investing in only high-grade
government and commercial issuers.
The Company invests its excess cash in debt instruments of
governmental agencies, and corporations with credit ratings of
AA/AA or better, or A1/P1 or better, respectively. The Company
has established guidelines relative to diversification and
maturities that attempt to maintain safety and liquidity. The
Company has not experienced any significant losses on its cash
equivalents or short-term investments.
Revenue
Recognition
In accordance with Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition (SAB 101), as amended by
SAB 104, for all products and services, the Company
recognizes revenue when persuasive evidence of an arrangement
exists, delivery has occurred or services were rendered, the fee
is fixed or determinable, and collectibility is reasonably
assured. In instances where final acceptance of the product,
system, or solution is specified by the customer, revenue is not
recognized until all acceptance criteria have been met.
Contracts and customer purchase orders are used to determine the
existence of an arrangement. Delivery occurs when product is
delivered to a common carrier. Certain products are delivered on
a
free-on-board
(FOB) destination basis and the Company does not recognize
revenue associated with these transactions until the delivery
has occurred to the customers premises. The Company
assesses whether the fee is fixed or determinable based on the
payment terms associated with the transaction and whether the
sales price is subject to adjustment. The Company assesses
collectibility based primarily on the creditworthiness of the
customer as determined by credit checks and analysis, as well as
the customers payment history.
In establishing its revenue recognition policies for its
products, the Company assesses software development efforts,
marketing and the nature of post contract support (PCS). Based
on its assessment, the Company determined that the software in
the HAS and CMTS products is incidental and therefore, the
Company recognizes revenue on HAS and CMTS products under
SAB 101, as specifically amended by SAB 104.
Additionally, based on its assessment of the DVS products, the
Company determined that software was more than incidental, and
therefore, the Company recognizes revenue on the DVS products
under American Institute of Certified Public Accountants
Statement of Position (SOP)
97-2,
Software Revenue Recognition
(SOP 97-2)
and
SOP 81-1,
Accounting for Performance of Construction-Type and
Certain Production-Type Contracts
(SOP 81-1).
The Company determined that the software in the DVS products is
more than incidental because the DVS platforms contained
multiple embedded software applications, the software is
actively marketed and the Company has a practice of providing
upgrades and enhancements for the software to its existing users
periodically. While the software is not sold on a stand-alone
basis with the ability to operate on a third party hardware
platform, the software is marketed and sold separately in the
form of software license keys to
76
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
activate embedded software applications. Additionally, as part
of the Companys customer support contracts, the Company
routinely provides its customers with unspecified software
upgrades and enhancements.
When a sale involves multiple elements, such as sales of
products that include services, the entire fee from the
arrangement is allocated to each respective element based on its
fair value and recognized when revenue recognition criteria for
each element are met. Fair value for each element is established
based on the sales price charged when the same element is sold
separately. In order to recognize revenue from individual
elements within a multiple element arrangement under
SOP 97-2,
the Company must establish vendor specific objective evidence
(VSOE) of fair value for each element.
Prior to 2006, for the DVS product, the Company determined that
it did not establish VSOE of fair value for the undelivered
element of PCS, which required the Company to amortize the sale
price of both the hardware element and PCS element ratably over
the period of the customer support contract. The Company
amortized the cost of goods sold for the DVS product ratably
over the period of the customer support contract. Revenue and
the related cost of goods sold for DVS products that contain
multiple element arrangements in each quarter of 2004 and 2005
were deferred and recognized ratably over the contract service
period.
Beginning in the first quarter of 2006, the Company determined
that it established VSOE of fair value of the PCS element for
DVS product sales as a result of maintaining consistent pricing
practices for PCS, including consistent pricing of renewal rates
for PCS. For DVS products sold beginning in 2006 that contain a
multiple element arrangement, the Company recognizes revenue
from the hardware component when all criteria of SAB 104
and
SOP 97-2
have been met and revenue related to PCS element ratably over
the period of the PCS.
The Company sells its products directly to broadband service
providers, and to a lesser extent, resellers. Revenue
arrangements with resellers are recognized when product meets
all criteria of SAB 104 and
SOP 97-2.
Deferred
Revenue, Deferred Cost of Goods Sold
Deferred revenue and deferred cost of goods sold are a result of
the Company recognizing revenues on the DVS product under
SOP 97-2.
Under
SOP 97-2,
the Company must establish VSOE of fair value for each element
of a multiple element arrangement. Until the first quarter of
2006, the Company did not establish VSOE of fair value for PCS
when PCS was sold as part of a multiple element arrangement. As
such, for DVS products sold with PCS, revenue and the cost of
goods sold related to the delivered element, the hardware
component, were deferred and recognized ratably over the period
of the PCS.
Accounts
Receivable, Net of Allowance for Doubtful Accounts
The Company performs ongoing credit evaluations of its customers
and generally require no collateral. The Company evaluates its
trade receivables based upon a combination of factors. Credit
losses have historically been within managements
expectations. When the Company becomes aware of a
customers inability to pay, such as in the case of
bankruptcy or a decline in the customers operating results
or financial position, it records an allowance to reduce the
related receivable to an amount it reasonably believes is
collectible. The Company maintains an allowance for potentially
uncollectible accounts receivable based on an estimate of
collectibility. The Company assesses collectibility based on a
number of factors, including history, the number of days an
amount is past due (based on invoice due date), changes in
credit ratings of customers, current events and circumstances
regarding the business of its clients customers and other
factors that it believes are relevant. If circumstances related
to a specific customer change, its estimates of the
recoverability of receivables could be further altered. In
addition, the Company made other adjustments to the allowance
for doubtful accounts to offset the accounts receivable and
related reserve related to customers who were granted extended
payment terms, experiencing financial difficulties or where
collectibility was not reasonably assured.
77
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Accordingly, the Company classifies these customers as those
with extended payment terms or with
collectibility issues.
Research
and Development Expenses
With the exception of the series of contractual arrangements
with Thomson Broadcast entered into to develop a customized
product, research and development expenses are charged to
expense as incurred. As a part of the restatement, the Company
recognized revenue under this series of contractual arrangements
in accordance with
SOP 97-2,
SAB 104 and
SOP 81-1.
As a result, all revenue and research and development expenses
associated with the contract were recognized in the quarter
ended December 31, 2005. The Company generally does not
engage in project-based contracts with its customers that may
result in the deferral of research and development expenditures
in future periods.
Shipping
and Handling Costs
Costs related to shipping and handling are included in cost of
goods sold for all periods presented.
Advertising
Expenses
The Company accounts for advertising costs as expense in the
period in which they are incurred. Advertising expense for the
years ended December 31, 2006, 2005 and 2004 was
$0.3 million, $0.6 million and $0.1 million,
respectively.
Net
Loss Per Share
Shares used in the calculation of basic and diluted net loss per
share are as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net loss
|
|
$
|
(3,831
|
)
|
|
$
|
(26,951
|
)
|
|
$
|
(47,105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per
share
|
|
$
|
(0.05
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(0.62
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing basic and
diluted net loss per share
|
|
|
77,637
|
|
|
|
77,154
|
|
|
|
75,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase 12,169,709, 13,031,986 and
16,802,838 shares of common stock were outstanding at
December 31, 2006, 2005 and 2004, respectively. These
common stock equivalents were not included in the computation of
diluted net loss per share since the effect would have been
anti-dilutive. There were no warrants outstanding at
December 31, 2006, 2005 and 2004.
Cash,
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and
debt instruments and considers all highly liquid debt
instruments purchased with an original maturity of 90 days
or less to be cash equivalents. Investments with an original
maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date
as all investments are classified as
available-for-sale
and can be readily liquidated to meet current operational needs.
The Company determines impairment related to its debt and equity
investments in accordance with SFAS No. 115,
Accounting for Certain Investments in Debt and Equity
Securities, and SAB 59, Accounting for
Noncurrent Marketable Equity Securities, which provide
guidance on determining when an investment is
other-than-temporarily
impaired. Applying this guidance requires judgment. In making
this judgment, the Company evaluates, among other factors, the
duration and extent to which the fair value of an investment is
78
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
less than its cost, the financial health of and business outlook
for the investee, including factors such as industry and sector
performance, changes in technology, and operational and
financing cash flow, available financial information and the
Companys intent and ability to hold the investment. The
Company also relies upon guidance from Financial Accounting
Standards Board (FASB), Emerging Issues Task Force (EITF)
03-01
The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments, in
determining possible impairment as it relates to its debt
investments. As of December 31, 2006, the Company had
approximately $49,000 in unrealized losses on cash, cash
equivalents and short term investments in Other Comprehensive
Loss on the Consolidated Balance Sheet. The unrealized losses
relating to investments in federal agency securities were caused
by interest rate increases. The Company purchased these
securities at par, and the contractual cash flows of these
investments are guaranteed by an agency of the
U.S. government. Accordingly, it is expected that the
securities would not be settled at a price less than the
amortized cost of the Companys investment. Because the
decline in market value is attributable to changes in interest
rates and not credit quality and because the Company has the
ability and intent to hold these investments until a recovery of
fair value, which may be at maturity, the Company does not
consider these investments to be
other-than-temporarily
impaired at December 31, 2006. Further the Company has a
history of holding these types of investments to maturity and
assesses this issue quarterly.
The Companys short-term investments, which consist
primarily of commercial paper, U.S. government and
U.S. government agency obligations and fixed income
corporate securities are classified as
available-for-sale
and are carried at fair market value. Realized gains and losses
and declines in value judged to be
other-than-temporary
on
available-for-sale
securities are included in interest income. The cost of
securities sold is based on the specific identification method.
The Company had no material investments in short-term equity
securities at December 31, 2006 and 2005.
Other
Current Receivables
As of December 31, 2006 and 2005, other current receivables
are primarily composed of interest, taxes, and non-trade
receivables, and included approximately $0.5 million and
$0.2 million, respectively, due from contract manufacturers
for raw materials purchased from the Company.
Inventory
Inventory is stated at the lower of cost
(first-in,
first-out) or market. The components of inventory are as follows
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Raw materials
|
|
$
|
203
|
|
|
$
|
58
|
|
Work-in-process
and Finished goods
|
|
|
2,121
|
|
|
|
10,857
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,324
|
|
|
$
|
10,915
|
|
|
|
|
|
|
|
|
|
|
The Company records losses on commitments to purchase inventory
in accordance with Statement 10 of Chapter 4 of
Accounting Research Bulletin No. 43. The
Companys policy for valuation of inventory and commitments
to purchase inventory, including the determination of obsolete
or excess inventory, requires it to perform a detailed
assessment of inventory at each balance sheet date, which
includes a review of, among other factors, an estimate of future
demand for products within specific time horizons, generally
twelve months or less as well as product lifecycle and product
development plans. Given the rapid change in the technology and
communications equipment industries as well as significant,
unpredictable changes in capital spending by the Companys
customers, the Company believes that assessing the value of
inventory using generally a twelve-month time horizon is
appropriate.
79
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The estimates of future demand that the Company uses in the
valuation of inventory are the basis for the revenue forecast.
Based on this analysis, the Company reduces the cost of
inventory that it specifically identifies and considers obsolete
or excessive to fulfill future sales estimates. Excess inventory
is generally defined as inventory in excess of projected usage,
and is determined using the Companys best estimate of
future demand at the time, based upon information then available.
Deposits
As of December 31, 2006, deposits primarily consisted of
$7.5 million related to the corporate aircraft and $0.7
related to professional services retainers.
Property
and Equipment
Property and equipment are carried at cost less accumulated
depreciation and amortization. Property and equipment are
depreciated for financial reporting purposes using the
straight-line method over the estimated useful lives, generally
three to seven years. Leasehold improvements are amortized using
the straight-line method over the shorter of the useful lives of
the assets or the terms of the leases. In 2006, the Company
recorded $1.6 million in leasehold improvements on the
facility it leased for its corporate headquarters in August
2006. The recoverability of the carrying amount of property and
equipment is assessed based on estimated future undiscounted
cash flows, and if an impairment exists, the charge to
operations is measured as the excess of the carrying amount over
the fair value of the assets. Based upon this method of
assessing recoverability, the Company recorded
$1.1 million, $0.6 million and $3.0 million in
disposals and asset impairments primarily related to
restructuring activities for the years ended December 31,
2006, 2005 and 2004, respectively.
Property and equipment are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Software and computers
|
|
$
|
10,742
|
|
|
$
|
11,117
|
|
Furniture and fixtures
|
|
|
436
|
|
|
|
357
|
|
Office equipment
|
|
|
92
|
|
|
|
175
|
|
Leasehold improvements
|
|
|
1,615
|
|
|
|
2,455
|
|
Machinery and equipment
|
|
|
13,042
|
|
|
|
14,231
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
25,927
|
|
|
|
28,335
|
|
Accumulated depreciation and
amortization
|
|
|
(22,618
|
)
|
|
|
(24,420
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
3,309
|
|
|
$
|
3,915
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense for the years ended December 31, 2006,
2005 and 2004 was $1.8 million, $3.1 million and
$5.9 million, respectively.
Restricted
Cash
Restricted cash at December 31, 2006 and 2005 primarily
relates to securing real estate leases.
Other
Assets, Net
Other assets, net as of December 31, 2006 consisted of
non-current deposits related to a facility lease. As of
December 31, 2005, other assets, net consisted primarily of
a prepaid licensing agreement and a deposit related to the
Companys corporate aircraft lease, respectively.
80
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Warranty
Obligations
The Company provides a standard warranty for most of its
products, ranging from one to five years from the date of
purchase. The Company provides for the estimated cost of product
warranties at the time revenue is recognized. The Companys
warranty obligation is affected by product failure rates,
material usage and service delivery costs incurred in correcting
a product failure. Expense estimates are based on historical
experience and expectation of future conditions. See
Note 13, Product Warranty.
Stock-Based
Compensation
On January 1, 2006, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 123(R) which is a
revision of SFAS 123, Share-Based Payment
(SFAS 123(R)), which requires the measurement and
recognition of compensation expense for all share-based payment
awards made to employees and directors, including employee stock
options and employee stock purchases related to the Employee
Stock Purchase Plan based on estimated fair values.
SFAS 123(R) supersedes the Companys previous
accounting under Accounting Principles Board (APB)
Opinion 25, Accounting for Stock Issued to
Employees (APB 25), for periods beginning
January 1, 2006. In March 2005, the Commission issued
SAB No. 107, Share-based Payment
(SAB 107), relating to SFAS 123(R). SAB 107
provides guidance on the initial implementation of
SFAS 123(R). In particular, the statement includes guidance
related to share-based payment awards with non-employees,
valuation methods and selecting underlying assumptions such as
expected volatility and expected term. It also gives guidance on
the classification of compensation expense associated with
share-based payment awards and accounting for the income tax
effects of share-based payment awards upon the adoption of
SFAS 123(R). The Company has applied the provisions of
SAB 107 in its adoption of SFAS 123(R).
Under the modified prospective method of adoption for
SFAS 123(R), the compensation cost recognized by the
Company beginning in 2006 includes (a) compensation cost
for all equity incentive awards granted prior to, but not yet
vested as of January 1, 2006, based on the grant-date fair
value estimated in accordance with the original provisions of
SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123), and (b) compensation
cost for all equity incentive awards granted on or subsequent to
January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R).
The Company uses the straight-line attribution method to
recognize share-based compensation costs over the service period
of the award. Upon exercise, cancellation, or expiration of
stock options, deferred tax assets for options with multiple
vesting dates are eliminated for each vesting period on a
first-in,
first-out basis as if each vesting period was a separate award.
Options currently granted by the Company generally expire six
years from the grant date and vest over a three year period.
Options granted prior to the second quarter of 2005 generally
expire ten years from the grant date and vest over a four to
five year period. The Company may use other types of equity
incentives, such as restricted stock and stock appreciation
rights. The Companys equity incentive awards also allow
for performance-based vesting.
On November 10, 2005, the FASB issued FASB Staff Position
No. FAS 123(R)-3, Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards
(FAS 123(R)-3). The Company has elected to adopt the
alternative transition method provided in FAS 123(R)-3 for
calculating the tax effects of stock-based compensation pursuant
to SFAS 123(R). The alternative transition method includes
simplified methods to establish the beginning balance of the
additional paid-in capital pool (APIC Pool) related to the tax
effects of employee stock-based compensation, and to determine
the subsequent impact on the APIC Pool and Consolidated
Statements of Cash Flows of the tax effects of employee
stock-based compensation awards that are outstanding upon
adoption of SFAS 123(R).
Share-based compensation recognized in 2006 as a result of the
adoption of SFAS 123(R) as well as share-based compensation
calculated for pro forma disclosures according to the original
provisions of
81
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
SFAS 123 for periods prior to the adoption of
SFAS 123(R) use the Black-Scholes valuation methodologies
for estimating fair value of options granted under the
Companys equity incentive plans and rights to acquire
stock granted under the Companys stock participation plan.
Accumulated
Other Comprehensive Loss
Accumulated other comprehensive loss presented in the
accompanying consolidated balance sheets and consolidated
statements of stockholders equity consists of net
unrealized gain (loss) on cash equivalents and short-term
investments and accumulated net foreign currency translation
losses.
The following are the components of accumulated other
comprehensive loss (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Cumulative translation
adjustments, net
|
|
$
|
(2,443
|
)
|
|
$
|
(2,554
|
)
|
Unrealized loss on
available-for-sale
investments, net
|
|
|
(49
|
)
|
|
|
(473
|
)
|
|
|
|
|
|
|
|
|
|
Total accumulated other
comprehensive loss
|
|
$
|
(2,492
|
)
|
|
$
|
(3,027
|
)
|
|
|
|
|
|
|
|
|
|
Reclassifications
Certain prior year amounts have been reclassified to conform to
current year presentation.
Recently
Issued Accounting Standards
In February 2006, the FASB issued SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments
(SFAS 155) which amends SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities (SFAS 133) and
SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities (SFAS 140). Specifically, SFAS 155
amends SFAS 133 to permit fair value remeasurement for any
hybrid financial instrument with an embedded derivative that
otherwise would require bifurcation, provided the whole
instrument is accounted for on a fair value basis. Additionally,
SFAS 155 amends SFAS 140 to allow a qualifying special
purpose entity to hold a derivative financial instrument that
pertains to a beneficial interest other than another derivative
financial instrument. SFAS 155 applies to all financial
instruments acquired or issued after the beginning of an
entitys first fiscal year that begins after
September 15, 2006, with early application allowed. The
adoption of SFAS 155 is not expected to have a material
impact on the Companys results of operations or financial
position.
In March 2006, the FASB issued SFAS No. 156,
Accounting for Servicing of Financial Assets
(SFAS 156), to simplify accounting for separately
recognized servicing assets and servicing liabilities.
SFAS 156 amends SFAS 140. Additionally, SFAS 156
applies to all separately recognized servicing assets and
liabilities acquired or issued after the beginning of an
entitys fiscal year that begins after September 15,
2006, although early adoption is permitted. The adoption of
SFAS 156 is not expected to have a material impact on the
Companys results of operations or financial position.
In July 2006, the FASB issued FASB Interpretation 48,
Accounting for Uncertainty in Income Taxes
(FIN 48) an interpretation of FASB
No. 109, Accounting for Income Taxes.
FIN 48 prescribes a comprehensive model for recognizing,
measuring, presenting and disclosing in the financial statements
tax positions taken or expected to be taken on a tax return,
including a decision on whether or not to file in a particular
jurisdiction. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes. The
provisions of FIN 48 are to be applied to all tax positions
upon initial adoption of this standard. Only tax positions that
meet a more-likely-than-not recognition threshold at
the effective date may be recognized or
82
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
continue to be recognized upon adoption of FIN 48. The
cumulative effect of applying the provisions of FIN 48 is
reported as an adjustment to the opening balance of retained
earnings. FIN 48 is effective for years beginning after
December 15, 2006; therefore, the Company will adopt
FIN 48 as of January 1, 2007. The Company expects that
adoption of this accounting standard will increase the level of
disclosure that the Company provides regarding its tax
positions. The adoption of FIN 48 is not expected to have a
material impact on the Companys consolidated financial
position and results of operations.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (SFAS 157), which
defines fair value, establishes guidelines for measuring fair
value and expands disclosures regarding fair value measurements.
SFAS 157 does not require any new fair value measurements
but rather eliminates inconsistencies in guidance found in
various prior accounting pronouncements. SFAS 157 is
effective for fiscal years beginning after November 15,
2007. Earlier adoption is permitted, provided the company has
not yet issued financial statements, including for interim
periods, for that fiscal year. The Company is currently
evaluating the impact of SFAS 157, but does not expect the
adoption of SFAS 157 to have a material impact on its
consolidated financial position, results of operations or cash
flows.
In September 2006, the Commission released Staff Accounting
Bulletin (SAB) No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements (SAB 108).
SAB 108 provides guidance on how the effects of prior-year
uncorrected financial statement misstatements should be
considered in quantifying a current year misstatement.
SAB 108 requires registrants to quantify misstatements
using both an income statement (rollover) and balance sheet
(iron curtain) approach and evaluate whether either approach
results in a misstatement that, when all relevant quantitative
and qualitative factors are considered, is material. If prior
year errors that had been previously considered immaterial are
now considered material based on either approach, no restatement
is required as long as management properly applied its previous
approach and all relevant facts and circumstances were
considered. If prior years are not restated, the cumulative
effect adjustment is recorded in opening retained earnings as of
the beginning of the fiscal year of adoption. SAB 108 is
effective for fiscal years ending on or after November 15,
2006. The adoption of SAB 108 did not have a material
impact on the Companys financial statements.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Liabilities (SFAS 159), which includes an amendment
to FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities. SFAS 159
provides companies with an irrevocable option to report selected
financial assets and liabilities at fair value with changes in
fair value reported in earnings. SFAS 159 is effective for
fiscal years beginning after November 15, 2007. The Company
is currently evaluating the impact of SFAS 159, but does
not expect adoption to have a material impact on its
consolidated financial position, results of operations or cash
flows.
|
|
Note 3.
|
Fair
Value of Financial Instruments
|
The amounts reported as cash and cash equivalents approximate
fair value due to their short-term maturities. The fair value
for the Companys investments in marketable debt and equity
securities is estimated based on quoted market prices.
83
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following estimated fair value amounts have been determined
using available market information. However, considerable
judgment is required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that the
Company could realize in a current market exchange.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
December 31, 2006
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
Investments maturing in less than
1 year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Government agency obligations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments maturing in
1-2 years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income corporate securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Government agency obligations
|
|
|
12,000
|
|
|
|
|
|
|
|
(49
|
)
|
|
|
11,951
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
12,000
|
|
|
|
|
|
|
|
(49
|
)
|
|
|
11,951
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
12,000
|
|
|
$
|
|
|
|
$
|
(49
|
)
|
|
$
|
11,951
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
December 31, 2005
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
Investments maturing in less than
1 year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
$
|
7,950
|
|
|
$
|
|
|
|
$
|
(3
|
)
|
|
$
|
7,947
|
|
Government agency obligations
|
|
|
47,000
|
|
|
|
|
|
|
|
(325
|
)
|
|
|
46,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
54,950
|
|
|
|
|
|
|
|
(328
|
)
|
|
|
54,622
|
|
Investments maturing in
1-2 years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income corporate securities
|
|
|
3,959
|
|
|
|
|
|
|
|
(9
|
)
|
|
|
3,950
|
|
Government agency obligations
|
|
|
13,998
|
|
|
|
|
|
|
|
(136
|
)
|
|
|
13,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
17,957
|
|
|
|
|
|
|
|
(145
|
)
|
|
|
17,812
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
72,907
|
|
|
$
|
|
|
|
$
|
(473
|
)
|
|
$
|
72,434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There were no realized gains or losses on short-term investments
in either the years ended December 31, 2006 or 2005,
respectively.
Leases
The Company leases its facilities and certain equipment under
operating leases. Effective in August 2006, the Company entered
into a
sub-sublease
agreement to
sub-sublease
its then current principal executive offices located in
Santa Clara, California and consisting of approximately
141,000 square feet of office space. The
sub-sublease
agreement expires on October 31, 2009 which is the same day
as the Companys agreement to sublease the premises
expires. Concurrently, the Company entered into a lease
agreement to lease approximately 63,000 square feet of
office space through September 2009 at another location in
Santa Clara, California to serve as the Companys new
principal executive offices. The facility in Belgium is leased
through June 30, 2013 with a right to terminate at the end
of each three-year period commencing on July 1, 2004. The
84
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Company had a lease in Israel that expired in February 2007. The
Company rents the remainder of its facilities on a
month-to-month
basis. Rent expense was approximately $2.8 million,
$3.2 million and $4.3 million, for the years ended
December 31, 2006, 2005 and 2004, respectively. Prior to
the expiration of certain leases, the Company subleased a
portion of its facilities to third parties and currently
subleases its former principal executive offices in Santa Clara,
California to a third party. See Note 6,
Restructuring Charges and Asset Write-offs. The
Companys sublease rental income was approximately
$0.7 million, $1.4 million and $1.6 million for
the years ended December 31, 2006, 2005 and 2004,
respectively.
In 2002, the Company entered into an operating lease arrangement
to lease a corporate aircraft. This lease arrangement was
secured by a $9.0 million letter of credit at
December 31, 2002. The letter of credit was reduced to
$7.5 million in February 2003. The $7.5 million letter
of credit was converted to a cash deposit in 2004. In August
2004, the Company entered into a
28-month
aircraft sublease terminating on December 31, 2006, which
was amended in December 2006 to terminate on January 14,
2007. The lease commitment for the aircraft is included in the
table below. On January 14, 2007, the Company returned the
corporate aircraft to the lessor of the aircraft and no
additional rental payments were due to the lessor after October
2006. The Company paid lease obligations related to the
corporate aircraft of $1.5 million, $1.4 million and
$1.4 million for the years ended December 31, 2006,
2005 and 2004, respectively. The Company received payments
related to its sublease of the corporate aircraft of
$1.2 million, $1.2 million and $0.3 million for
the years ended December 31, 2006, 2005 and 2004,
respectively.
The Company has the following operating lease commitments:
|
|
|
|
|
|
|
Operating
|
|
|
|
Leases
|
|
|
2007
|
|
$
|
3,930
|
|
2008
|
|
|
3,898
|
|
2009
|
|
|
3,185
|
|
2010
|
|
|
|
|
Thereafter
|
|
|
|
|
|
|
|
|
|
Total minimum payments
|
|
$
|
11,013
|
|
|
|
|
|
|
As of December 31, 2006 there are approximately
$6.2 million of future minimum sublease payments for the
leased facility in Santa Clara, California to be received
under non-cancelable subleases not reflected in the table above.
Purchase
Obligations
The Company has purchase obligations to certain of its suppliers
that support the Companys ability to manufacture its
products. The obligations consist of open purchase orders placed
with vendors for goods and services of the vendors
products at a specified price. As of December 31, 2006,
$6.4 million of purchase obligations were outstanding. As a
result of declines in its forecasts, the Company has canceled
certain purchase orders with its contract manufacturers that had
existing inventory on hand, or on order in anticipation of the
Companys earlier forecasts. Consequently, the Company
accrued for vendor cancellation charges in amounts that
represented managements estimate of the Companys
exposure to vendors for its inventory commitments. At
December 31, 2006, accrued vendor cancellation charges were
$0.1 million and the remaining $6.3 million was
attributable to open purchase orders that are expected to be
utilized in the normal course of business and are expected to
become payable at various times throughout 2007.
85
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Letters
of Credit
As of December 31, 2006, the Company had $0.4 million
in available letters of credit primarily required to support
operating leases which expire at various dates through 2009. As
of December 31, 2006, the Company had a $7.5 million
deposit with the lessor of its corporate aircraft. The lease on
the aircraft expired on January 14, 2007. On March 28,
2007, the lessor of the aircraft, General Electric Capital
Corporation (GECC) returned to the Company approximately
$6.8 million of the $7.5 million cash deposit held by
GECC as collateral for the aircraft lease. GECC will retain
$0.7 million in collateral (Repair Collateral) subject to
GECCs completion of repairs, tests, inspections, and
corrections to the aircraft, which GECC has estimated will cost
$0.6 million. The remaining amount of the Repair
Collateral, if any, will be returned to the Company.
|
|
Note 5.
|
Retention
and Bonus Plans
|
The Company adopted a 2006 Section 16 Executive Officer
Bonus Plan and 2006 Corporate Bonus Plan (Bonus Plans), as well
as entered into retention agreements with certain of its key
employees. The Compensation Committee of the Board of Directors
has approved the Bonus Plans and the Companys entry into
these agreements. The agreements provide for certain bonus
payments in cash under specified circumstances as an additional
incentive for certain key individuals to remain employed in good
standing with the Company. The retention payments generally
vested in the time period spanning 2006 and through the end of
2007 and total payments to employees of approximately
$0.2 million was paid in 2006 and $2.2 million was
accrued as of December 31, 2006 and will be paid in 2007 if
all the participants qualify for the payments. In accordance
with the SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, the cost will
accrue ratably over the term of the agreements. Additionally,
the Company has entered into certain change of control
agreements with key employees that are in addition to the Bonus
Plans and retention agreements.
|
|
Note 6.
|
Restructuring
Charges and Asset Write-offs
|
The Company accrues for termination costs in accordance with
paragraph 3 of SFAS No. 146, Accounting for
Costs Associated with Exit or Disposal Activities, and
SFAS No. 112, Employers Accounting for
Post Employment Benefits. Liabilities are initially
measured at their fair value on the date in which they are
incurred based on plans approved by the Companys Board of
Directors. Accrued employee termination costs principally
consist of three components: (i) a lump-sum severance
payment based upon the years of service (e.g., two weeks per
year of service); (ii) COBRA insurance based on years of
service and rounded up to the month; and (iii) an estimate
of costs for outplacement services immediately provided to the
affected employees. Substantially all employees were terminated
on the date of notification, so there was no additional service
period required to be included in the determination of accrued
termination costs. Where such services were required for a
period over 60 days, the Company amortized termination
costs ratably over the required service period.
2004
Restructurings
During the quarter ended March 31, 2004, the Company
initiated a restructuring plan to bring operating expenses in
line with revenue levels and incurred restructuring plan charges
related to employee termination costs, termination costs for an
aircraft lease, and costs for excess leased facilities. In the
quarter ended December 31, 2004, to further conform the
Companys expenses to its revenue and to cease investment
in the CMTS product line, the Companys Board of Directors
approved a restructuring plan related to employee terminations.
Additionally, in 2004, the Company re-evaluated and adjusted
restructuring charges incurred in the first and second quarters
of 2004 related to employee severance, excess facilities and the
aircraft lease termination.
86
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Company anticipates the remaining restructuring accrual
related to excess leased facilities to be utilized for servicing
operating lease payments through October 2009.
The reserve for the aircraft lease approximates the difference
between the Companys current costs for the aircraft lease
and the estimated income derived from subleasing, which was to
terminate in December 2006 but was extended to January 14,
2007. During October 2006, the Company made its final lease
payment related to the aircraft lease.
The amount of net charges accrued under the 2004 restructuring
plans assumed that the Company would successfully sublease
excess leased facilities. The originally established reserve for
the excess leased facilities included the estimated income
derived from subleasing, which was based on information from the
Companys real estate brokers, who estimated it based on
assumptions relevant to the real estate market conditions as of
the date of the Companys implementation of the
restructuring plan and the time it would likely take to sublease
the excess leased facility. The Company
sub-subleased
its former principal executive offices in August 2006. As a
result, the Company revised the reserve to reflect the income
that will be derived from the
sub-sublease.
The following table summarizes the accrued restructuring
balances related to the 2004 restructurings as of
December 31, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Involuntary
|
|
|
Excess Leased
|
|
|
Aircraft Lease
|
|
|
|
|
|
|
Terminations
|
|
|
Facilities
|
|
|
Termination
|
|
|
Total
|
|
|
Charges
|
|
$
|
2,298
|
|
|
$
|
2,523
|
|
|
$
|
933
|
|
|
$
|
5,754
|
|
Cash payments
|
|
|
(1,467
|
)
|
|
|
(850
|
)
|
|
|
(1,194
|
)
|
|
|
(3,511
|
)
|
Changes in estimates
|
|
|
(239
|
)
|
|
|
324
|
|
|
|
954
|
|
|
|
1,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
592
|
|
|
|
1,997
|
|
|
|
693
|
|
|
|
3,282
|
|
Charges
|
|
|
1,037
|
|
|
|
|
|
|
|
|
|
|
|
1,037
|
|
Cash payments
|
|
|
(1,534
|
)
|
|
|
(1,190
|
)
|
|
|
(344
|
)
|
|
|
(3,068
|
)
|
Changes in estimates
|
|
|
(95
|
)
|
|
|
1,246
|
|
|
|
149
|
|
|
|
1,300
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
|
|
|
|
2,053
|
|
|
|
498
|
|
|
|
2,551
|
|
Charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash payments
|
|
|
|
|
|
|
(1,109
|
)
|
|
|
(281
|
)
|
|
|
(1,390
|
)
|
Changes in estimates
|
|
|
|
|
|
|
(601
|
)
|
|
|
(217
|
)
|
|
|
(818
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
$
|
|
|
|
$
|
343
|
|
|
$
|
|
|
|
$
|
343
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2001
Restructuring
As part of the restructuring plan initiated in 2001 (2001 Plan),
the Company incurred restructuring charges in the amount of
$12.7 million. In 2005, the Company decreased the
restructuring reserve by $0.3 million to reflect a decrease
for improving tenant sublease conditions in Israel that was
partially offset by an increase in the reserve for excess leased
facilities due to the use of the wrong lease term in its initial
estimate. The Company applied the remaining $0.1 million
against the reserve for excess leased facilities in the first
quarter of 2006. At December 31, 2006, nothing remained in
the reserve for the 2001 Plan.
Asset
Write-offs
For the year ended December 31, 2006, the Company wrote-off
$1.0 million related to the impairment of leasehold
improvements. For the year ended December 31, 2005, asset
write-offs related to restructuring were $0.1 million.
87
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 7.
|
Convertible
Subordinated Notes
|
On November 7, 2005, the Company announced that the filing
of its periodic report on
Form 10-Q
for the quarter ended September 30, 2005 would be delayed
pending completion of the accounting review. The Company was
required under its Indenture, dated July 26, 2000
(Indenture), to file with the Commission and the trustee of the
Companys 5% convertible subordinated notes (Notes)
all reports, information and other documents required pursuant
to Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (Exchange Act). On January 12, 2006,
holders of more than 25% of the aggregate principal amount of
the Notes, in accordance with the terms of the Indenture,
provided written notice to the Company that it was in default
under the Indenture based on the Companys failure to file
its
Form 10-Q
for the quarter ended September 30, 2005. The Company was
unable to cure the default within 60 days of the written
notice, March 13, 2006, which triggered an Event of Default
under the Indenture. The Event of Default enabled the holders of
at least 25% in aggregate principal amount of Notes outstanding
to accelerate the maturity of the Notes by written notice and
declare the entire principal amount of the Notes, together with
all accrued and unpaid interest thereon, to be due and payable
immediately. On March 16, 2006, the Company received a
notice of acceleration from holders of more than 25% of the
aggregate principal amount of the Notes. On March 21, 2006,
the Company paid in full the entire principal amount of the
outstanding Notes, including all accrued and unpaid interest
thereon and related fees, for a total of $65.6 million. In
addition, as of March 31, 2006, the Company amortized the
remaining bond premium of $0.3 million into interest income
and expensed $0.5 million related to the bond issuance
costs to other income.
Litigation
Beginning in April 2000, several plaintiffs filed class action
lawsuits in federal court against the Company and specific
officers and directors of the Company. Later that year, the
cases were consolidated in the United States District Court for
the Northern District of California (Court) as In re Terayon
Communication Systems, Inc. Securities Litigation. The Court
then appointed lead plaintiffs who filed an amended complaint.
In 2001, the Court granted in part and denied in part
defendants motion to dismiss, and plaintiffs filed a new
complaint. In 2002, the Court denied defendants motion to
dismiss that complaint, which, like the earlier complaints,
alleged that the defendants violated the federal securities laws
by issuing materially false and misleading statements and
failing to disclose material information regarding the
Companys technology. On February 24, 2003, the Court
certified a plaintiff class consisting of those who purchased or
otherwise acquired the Companys securities between
November 15, 1999 and April 11, 2000. On
September 8, 2003, the Court heard defendants motion
to disqualify two of the lead plaintiffs and to modify the
definition of the plaintiff class. On September 10, 2003,
the Court issued an order vacating the hearing date for the
parties summary judgment motions, and, on
September 22, 2003, the Court issued another order staying
all discovery until further notice and vacating the trial date,
which had been scheduled for November 4, 2003. On
February 23, 2004, the Court issued an order disqualifying
two of the lead plaintiffs and ordered discovery, which was
conducted. In February 2006, the Company mediated the case with
plaintiffs counsel. As part of the mediation, the Company
reached a settlement of $15.0 million. After this
mediation, the Companys insurance carriers agreed to
tender their remaining limits of coverage, and the Company
contributed approximately $2.2 million to the settlement.
On March 17, 2006, the Company, along with plaintiffs
counsel, submitted the settlement to the Court and the
shareholder class for approval. As a result, the Company accrued
$2.2 million to litigation settlement expense in the fourth
quarter of 2005. The Court held a hearing to review the
settlement of the shareholder litigation on September 25,
2006. To date, the Court has not approved the settlement.
On October 16, 2000, a lawsuit was filed against the
Company and the individual defendants (Zaki Rakib, Selim Rakib
and Raymond Fritz) in the Superior Court of California,
San Luis Obispo County. This lawsuit was titled
Bertram v. Terayon Communication Systems, Inc. The
factual allegations in the Bertram complaint
88
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
were similar to those in the federal class action, but the
Bertram complaint sought remedies under state law. Defendants
removed the Bertram case to the United States District Court,
Central District of California, which dismissed the complaint.
Plaintiffs appealed this order, and their appeal was heard on
April 16, 2004. On June 9, 2004, the United States
Court of Appeals for the Ninth Circuit affirmed the order
dismissing the Bertram case.
In 2002, two shareholders filed derivative cases purportedly on
behalf of the Company against certain of its current and former
directors, officers and investors. (The defendants differed
somewhat in the two cases.) Since the cases were filed, the
investor defendants have been dismissed without prejudice, and
the lawsuits have been consolidated as Campbell v. Rakib
in the Superior Court of California, County of
Santa Clara. The Company is a nominal defendant in these
lawsuits, which allege claims relating to essentially the same
purportedly misleading statements that are at issue in the
securities class action filed in April 2000. In that securities
class action, the Company disputed making any misleading
statements. The derivative complaints also allege claims
relating to stock sales by certain of the director and officer
defendants. On September 15, 2006, the Company entered into
a Stipulation of Settlement of Derivative Claims. On
September 18, 2006, the Superior Court of California,
County of Santa Clara approved the final settlement of the
derivative litigation entitled In re Terayon Communication
Systems, Inc. Derivative Litigation (Case No. CV
807650). In connection with the settlement, the Company paid
$1.0 million in attorneys fees and expenses to the
derivative plaintiffs counsel and agreed to adopt certain
corporate governance practices. As a result, the Company accrued
$1.0 million to litigation settlement expense in the fourth
quarter of 2005.
On June 23, 2006, a putative class action lawsuit was filed
against the Company in the United States District Court for the
Northern District of California by I.B.L. Investments Ltd.
purportedly on behalf of all persons who purchased the
Companys common stock between October 28, 2004 and
March 1, 2006. Zaki Rakib, Jerry D. Chase, Mark Richman and
Edward Lopez are named as individual defendants. The lawsuit
focuses on the Companys March 1, 2006 announcement of
the restatement of financial statements for the year ended
December 31, 2004, and for the four quarters of 2004 and
the first two quarters of 2005. On November 8, 2006, Adrian
G. Mongeli was appointed lead plaintiff in the case, replacing
I.B.L. Investments Ltd. On January 8, 2007, Mongeli filed
an amended complaint, purportedly on behalf of all persons who
purchased the Companys common stock between June 28,
2001 and March 1, 2006. The amended complaint adds Ray
Fritz, Carol Lustenader, Matthew Miller, Shlomo Rakib, Doug
Sabella, Christopher Schaepe, Mark Slaven, Lewis Solomon, Howard
W. Speaks, Arthur T. Taylor and David Woodrow as individual
defendants, and also names Ernst & Young as a
defendant. The amended complaint incorporates the prior
allegations and includes new allegations relating to the
restatement of the Companys consolidated historical
financial statements as reported in the Companys
Form 10-K
filed on December 29, 2006. The plaintiffs are seeking
damages, interest, costs and any other relief deemed proper by
the court. An unfavorable ruling in this legal matter could
materially and adversely impact the Companys results of
operations. On March 9, 2007, Terayon and the individual
defendants filed a motion to dismiss the amended complaint. That
motion is scheduled to be heard on June 5, 2007.
On April 22, 2005, the Company filed a lawsuit in the
Superior Court of California, County of Santa Clara against
Adam S. Tom (Tom) and Edward A. Krause (Krause) and a company
founded by Tom and Krause, RGB Networks, Inc. (RGB). The Company
sued Tom and Krause for breach of contract and RGB for
intentional interference with contractual relations based on
breaches of the Noncompetition Agreements entered into between
the Company and Tom and Krause, respectively. On May 24,
2006, RGB, Tom and Krause filed a Notice of Motion and Motion
For Leave To File a Cross-Complaint, in which the defendants
stated that they intended to file counter-claims against the
Company for misappropriation of trade secrets, unfair
competition, tortious interference with contractual relations
and tortious interference with prospective economic advantage.
On July 6, 2006, the court granted the defendants
motion, and on July 20, defendants filed a cross-complaint
for misappropriation of trade secrets, unfair competition,
tortious interference with contractual relations and tortious
interference with prospective economic advantage. On
August 21, 2006, the
89
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Company filed a demurrer to certain of those claims. The court
granted the Companys demurrer as to RGBs request for
declaratory judgment. On November 9, 2006, the Company
filed the Companys answer to RGBs complaint. On
March 26, 2007, the Company entered into a stipulation for
settlement with RGB amicably resolving all outstanding
litigation between the parties.
On September 13, 2005, a case was filed by Hybrid Patents,
Inc. (Hybrid) against Charter Communications, Inc. (Charter) in
the United States District Court for the Eastern District of
Texas for patent infringement related to Charters use of
equipment (cable modems, cable modem termination systems (CMTS)
and embedded multimedia terminal adapters (eMTAs)) meeting the
Data Over Cable System Interface Specification (DOCSIS)
standards and certain video equipment. Hybrid has alleged that
the use of such products violates its patent rights. Charter has
requested that the Company and others supplying it with
equipment indemnify Charter for these claims. The Company and
others have agreed to contribute to the payment of the legal
costs and expenses related to this case and the Company has
entered into a joint defense agreement with all named defendants
in the suit. On May 4, 2006, Charter filed a
cross-complaint asserting its indemnity rights against the
Company and a number of companies that supplied Charter with
cable modems. To date, this cross-complaint has not been
dismissed. Trial is scheduled on Hybrids claims for
July 2, 2007. At this point, the outcome is uncertain and
the Company cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Hybrid is successful in its claim against Charter
and then elects to pursue other cable operators that use the
allegedly infringing products.
On July 14, 2006, a case was filed by Hybrid against Time
Warner Cable (TWC), Cox Communications Inc. (Cox), Comcast
Corporation (Comcast), and Comcast of Dallas, LP (together, the
MSOs) in the United States District Court for the Eastern
District of Texas for patent infringement related to the
MSOs use of data transmission systems and certain video
equipment. Hybrid has alleged that the use of such products
violate its patent rights. To date, the Company has not been
named as a party to the action. The MSOs have requested that the
Company and others supplying them with cable modems and
equipment indemnify the MSOs for these claims. The Company and
others have agreed to contribute to the payment of legal costs
and expenses related to this case and the Company has entered
into a joint defense and cost sharing agreement with all named
defendants in the suit. Trial is scheduled on Hybrids
claims for July 2, 2007. At this point, the outcome is
uncertain and the Company cannot assess damages. However, the
case may be expensive to defend and there may be substantial
monetary exposure if Hybrid is successful in its claim against
the MSOs and then elects to pursue other cable operators that
use the allegedly infringing products.
On September 16, 2005, a case was filed by Rembrandt
Technologies, LP (Rembrandt) against Comcast in the United
States District Court for the Eastern District of Texas alleging
patent infringement. In this matter, Rembrandt alleged that
products and services sold by Comcast infringe certain patents
related to cable modem, voice-over internet, and video
technology applications. To date, the Company has not been named
as a party in the action, but the Company has received a
subpoena for documents and a deposition related to the products
the Company sold to Comcast. The Company continues to comply
with this subpoena. Comcast has made a request for indemnity
related to the products that the Company and others sold to
them. The Company and others have agreed to contribute to the
payment of legal costs and expenses related to this case and the
Company has entered into a joint defense and cost sharing
agreement with all named defendants in the suit. On
February 1, 2007, the Court entered an order disqualifying
Rembrandts counsel and vacated all scheduled dates pending
Rembrandt obtaining new counsel. At this point, the outcome is
uncertain and the Company cannot assess damages. However, the
case may be expensive to defend and there may be substantial
monetary exposure if Rembrandt is successful in its claim
against Comcast and then elects to pursue other cable operators
that use the allegedly infringing products.
On June 1, 2006, a case was filed by Rembrandt against
Charter, Cox, CSC Holdings, Inc. (CSC) and Cablevisions Systems
Corp. (Cablevision) in the United States District Court for the
Eastern District of Texas alleging patent infringement. In this
matter, Rembrandt alleged that products and services sold by
Charter
90
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
infringe certain patents related to cable modem, voice-over
internet, and video technology applications. To date, the
Company has not been named as a party in the action, but Charter
has made a request for indemnity related to the products that
the Company and others have sold to them. The Company has not
received an indemnity request from Cox, CSC, and Cablevision but
the Company expects that such request will be forthcoming
shortly. To date, the Company and others have not agreed to
contribute to the payment of legal costs and expenses related to
this case. Trial date of this matter is not known at this time.
At this point, the outcome is uncertain and the Company cannot
assess damages. However, the case may be expensive to defend and
there may be substantial monetary exposure if Rembrandt is
successful in its claim against Charter and then elects to
pursue other cable operators that use the allegedly infringing
products.
On June 1, 2006, a case was filed by Rembrandt against TWC
in the United States District Court for the Eastern District of
Texas alleging patent infringement. In this matter, Rembrandt
alleged that products and services sold by TWC infringe certain
patents related to cable modem, voice-over internet, and video
technology applications. To date, the Company has not been named
as a party in the action, but TWC has made a request for
indemnity related to the products that the Company and others
have sold to them. The Company and others have agreed to
contribute to the payment of legal costs and expenses related to
this case. Trial date of this matter is not known at this time.
At this point, the outcome is uncertain and the Company cannot
assess damages. However, the case may be expensive to defend and
there may be substantial monetary exposure if Rembrandt is
successful in its claim against TWC and then elects to pursue
other cable operators that use the allegedly infringing products.
On September 13, 2006, a second case was filed by Rembrandt
against TWC in the United States District Court for the Eastern
District of Texas alleging patent infringement. In this matter,
Rembrandt alleged that products and services sold by TWC
infringe certain patents related to the DOCSIS standard. To
date, the Company has not been named as a party in the action,
but TWC has made a request for indemnity related to the products
that the Company and others have sold to them. The Company and
others have agreed to contribute to the payment of legal costs
and expenses related to this case. Trial date of this matter is
not known at this time. At this point, the outcome is uncertain
and the Company cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Rembrandt is successful in its claim against TWC and
then elects to pursue other cable operators that use the
allegedly infringing products.
On February 2, 2007, a case was filed by GPNE Corp. (GPNE)
against Time Warner Inc. (TWI), Comcast and Charter in the
United States District Court for the Eastern District of Texas
alleging patent infringement. In this matter, GPNE alleged that
products and services sold by TWI, Comcast and Charter infringe
certain patents related to the DOCSIS standard (data
transmission). To date, the Company has not been named as a
party in the action, but TWI has made a request for indemnity
related to the products that the Company and others have sold to
them. The Company believes that Comcast and Charter will also
make indemnity requests. The Company and others have agreed to
contribute to the payment of legal costs and expenses related to
this case. Trial date of this matter is not known at this time.
On February 2, 2007, TWC filed a lawsuit against GPNE in
the United States District Court for the District of Delaware
requesting a declaratory judgment of non-infringement. At this
point, the outcome is uncertain and the Company cannot assess
damages. However, the case may be expensive to defend and there
may be substantial monetary exposure if GPNE is successful in
its claim against TWI, Comcast and Charter and then elects to
pursue other cable operators that use the allegedly infringing
products.
The Company has received letters claiming that its technology
infringes the intellectual property rights of others. The
Company has consulted with its patent counsel and reviewed the
allegations made by such third parties. If these allegations
were submitted to a court, the court could find that the
Companys products infringe third party intellectual
property rights. If the Company is found to have infringed third
party rights, the Company could be subject to substantial
damages
and/or an
injunction preventing the Company from conducting its
91
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
business. In addition, other third parties may assert
infringement claims against the Company in the future. A claim
of infringement, whether meritorious or not, could be
time-consuming, result in costly litigation, divert the
Companys managements resources, cause product
shipment delays or require the Company to enter into royalty or
licensing arrangements. These royalty or licensing arrangements
may not be available on terms acceptable to the Company, if at
all.
Furthermore, the Company has in the past agreed to, and may from
time to time in the future agree to, indemnify a customer of its
technology or products for claims against the customer by a
third party based on claims that its technology or products
infringe intellectual property rights of that third party. These
types of claims, meritorious or not, can result in costly and
time-consuming litigation, divert managements attention
and other resources, require the Company to enter into royalty
arrangements, subject the Company to damages or injunctions
restricting the sale of its products, require the Company to
indemnify its customers for the use of the allegedly infringing
products, require the Company to refund payment of allegedly
infringing products to its customers or to forgo future
payments, require the Company to redesign certain of its
products, or damage its reputation, any one of which could
materially and adversely affect its business, results of
operations and financial condition.
The Company has also provided an indemnity to ATI where the
Companys liability is set at $14.0 million for
breaches of representations and warranties made by the Company
and assumed by the Company. This indemnity is provided for a
period of three years for non-tax issues and six years for tax
issues.
The Company may, in the future, take legal action to enforce its
patents and other intellectual property rights, to protect its
trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of
infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could
negatively affect the Companys business, results of
operations and financial condition
In December 2005, the Commission issued a formal order of
investigation in connection with the Companys accounting
review of a series of contractual agreements with Thomson
Broadcast. These matters were previously the subject of an
informal Commission inquiry. The Company has been cooperating
fully with the Commission and will continue to do so in order to
bring the investigation to a conclusion as promptly as possible.
The Company is currently a party to various other legal
proceedings, in addition to those noted above, and may become
involved from time to time in other legal proceedings in the
future. While the Company currently believes that the ultimate
outcome of these proceedings, individually and in the aggregate,
will not have a material adverse effect on its financial
position or overall results of operations, litigation is subject
to inherent uncertainties. Were an unfavorable ruling to occur
in any of the Companys legal proceedings, there exists the
possibility of a material adverse impact on the Companys
financial condition and results of operations for the period in
which the ruling occurs. The estimate of the potential impact on
the Companys financial position and overall results of
operations for any of the above legal proceedings could change
in the future.
|
|
Note 9.
|
Stockholders
Equity
|
Stockholder
Rights Plan
In February 2001, the Companys Board of Directors approved
the adoption of a Stockholder Rights Plan under which all
stockholders of record as of February 20, 2001 received
rights to purchase shares of a new series of preferred stock.
The rights were distributed as a non-taxable dividend and will
expire in ten years from the record date. The rights will be
exercisable only if a person or group acquires 15% or more of
the Companys common stock or announces a tender offer for
15% or more of the Companys common stock. If a person or
group acquires 15% or more of the Companys common stock,
all rights holders except the buyer
92
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
will be entitled to acquire the Companys common stock at a
discount. The Board of Directors may terminate the Stockholder
Rights Plan at any time or redeem the rights prior to the time a
person or group acquires more than 15% of the Companys
common stock.
Common
Stock Reserved
Common stock reserved for issuance is as follows:
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
Common stock options
|
|
|
21,395,432
|
|
Employee stock purchase plan
|
|
|
600,371
|
|
|
|
|
|
|
Total
|
|
|
21,995,803
|
|
|
|
|
|
|
Stock
Option and Stock Purchase Plans
The Companys 1995 Stock Option Plan (1995 Plan) and 1997
Equity Incentive Plan (1997 Plan) provide for incentive stock
options and nonqualified stock options to be issued to
employees, directors and consultants of the Company. Exercise
prices of incentive stock options may not be less than the fair
market value of the common stock at the date of grant. Exercise
prices of nonqualified stock options may not be less than 85% of
the fair market value of the common stock at the date of grant.
Options are immediately exercisable and vest over a period not
to exceed five years from the date of grant. Any unvested stock
issued is subject to repurchase by the Company at the original
issuance price upon termination of the option holders
employment. Unexercised options expire six to ten years after
the date of grant. The 1997 Plan also provides for the sale of
restricted shares of common stock to employees, directors and
consultants, and the Company has provided such awards in prior
years and may provide such awards in the future. The 1995 Plan
expired in 2005 and only stock options that were granted under
the 1995 Plan prior to its expiration remain outstanding.
The Companys 1998 Non-Employee Directors Stock
Option Plan (1998 Plan) provides for non-discretionary
nonqualified stock options to be issued to the Companys
non-employee directors automatically as of the effective date of
their election to the Board of Directors and annually following
each annual stockholder meeting. Exercise prices of nonqualified
options may not be less than 100% of the fair market value of
the common stock at the date of grant. Options generally vest
and become exercisable over a period not to exceed three years
from the date of grant. Unexercised options expire ten years
after the date of grant.
The Companys 1999 Non-Officer Equity Incentive Plan (1999
Plan) provides for nonqualified stock options to be issued to
non-officer employees and consultants of the Company. Prices for
nonqualified stock options may not be less than 85% of the fair
market value of the common stock at the date of the grant.
Options generally vest and become exercisable over a period not
to exceed five years from the date of grant. Unexercised options
expire ten years after date of grant. The 1999 Plan also
provides for the sale of restricted shares of common stock to
employees, directors and consultants and the Company has
provided such awards in prior years and may provide such awards
in the future.
As of December 31, 2006, and from inception, the Company
had authorized an aggregate of 2,643,442, 19,796,362, 800,000
and 7,208,501 shares of common stock for issuance under the
1995 Plan, the 1997 Plan, the 1998 Plan and the 1999 Plan,
respectively. As of December 31, 2006, a total of zero
shares, 7,449,147 shares, 79,967 shares, and
1,699,164 shares were available for issuance under the 1995
Plan, the 1997 Plan, the 1998 Plan and the 1999 Plan,
respectively.
The following is a summary of additional information with
respect to the 1995 Plan, the 1997 Plan, the 1998 Plan, the 1999
Plan, Mainsail Equity Incentive Plan, TrueChat Equity Incentive
Plan, other outside equity
93
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
plans and outstanding options assumed by the Company in
conjunction with its business acquisitions and option grants
made outside the plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
Options Outstanding
|
|
|
|
Available
|
|
|
Number of
|
|
|
Weighted-Average
|
|
|
|
for Grant
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
Balance at December 31, 2003
|
|
|
8,545,010
|
|
|
|
17,463,959
|
|
|
$
|
6.20
|
|
Options authorized
|
|
|
3,000,000
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
(4,738,944
|
)
|
|
|
4,738,944
|
|
|
$
|
1.96
|
|
Options exercised
|
|
|
|
|
|
|
(225,645
|
)
|
|
$
|
2.19
|
|
Options canceled
|
|
|
5,174,420
|
|
|
|
(5,174,420
|
)
|
|
$
|
5.19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
11,980,486
|
|
|
|
16,802,838
|
|
|
$
|
5.37
|
|
Options authorized
|
|
|
(8,500,000
|
)
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
(2,911,675
|
)
|
|
|
2,911,675
|
|
|
$
|
3.01
|
|
Options exercised
|
|
|
|
|
|
|
(1,341,112
|
)
|
|
$
|
2.28
|
|
Options canceled
|
|
|
5,341,415
|
|
|
|
(5,341,415
|
)
|
|
$
|
6.31
|
|
Shares expired
|
|
|
(383,804
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
5,526,422
|
|
|
|
13,031,986
|
|
|
$
|
4.78
|
|
Options authorized
|
|
|
3,000,000
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
(577,000
|
)
|
|
|
577,000
|
|
|
$
|
2.05
|
|
Options exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Options canceled
|
|
|
1,439,277
|
|
|
|
(1,439,277
|
)
|
|
$
|
3.66
|
|
Shares expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
|
9,388,699
|
|
|
|
12,169,709
|
|
|
$
|
4.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In addition, the following table summarizes information about
stock options that were outstanding and exercisable at
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
Shares
|
|
|
Remaining
|
|
|
Average
|
|
|
Exercisable
|
|
|
Average
|
|
Range of Exercise Prices
|
|
Outstanding
|
|
|
Contractual Life
|
|
|
Exercise Price
|
|
|
Options
|
|
|
Exercise Price
|
|
|
$0.00 - $1.99
|
|
|
2,515,238
|
|
|
|
7.59
|
|
|
$
|
1.76
|
|
|
|
1,825,007
|
|
|
$
|
1.75
|
|
$2.01 - $2.74
|
|
|
2,584,067
|
|
|
|
6.27
|
|
|
|
2.41
|
|
|
|
2,064,307
|
|
|
|
2.47
|
|
$2.90 - $4.01
|
|
|
2,458,259
|
|
|
|
4.84
|
|
|
|
3.06
|
|
|
|
1,440,205
|
|
|
|
3.07
|
|
$4.08 - $6.52
|
|
|
1,049,260
|
|
|
|
4.92
|
|
|
|
5.71
|
|
|
|
980,301
|
|
|
|
5.71
|
|
$6.81 - $66.38
|
|
|
3,562,885
|
|
|
|
3.99
|
|
|
|
9.54
|
|
|
|
3,559,385
|
|
|
|
9.55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
12,169,709
|
|
|
|
5.47
|
|
|
$
|
4.78
|
|
|
|
9,869,205
|
|
|
$
|
5.30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006, there were no shares of the
Companys common stock subject to repurchase by the Company.
Employee
Stock Purchase Plan
In June 1998, the Board of Directors approved, and the Company
adopted, the 1998 Employee Stock Purchase Plan (ESPP), which is
designed to allow eligible employees of the Company to purchase
shares of common stock at semi-annual intervals through periodic
payroll deductions. An aggregate of 4,400,000 shares of
common stock are reserved for the ESPP, and
3,799,629 shares had been issued through December 31,
94
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2006. The ESPP is implemented in a series of successive offering
periods, each with a maximum duration of 24 months.
Eligible employees can have up to 15% of their base salary
deducted to purchase shares of the common stock on specific
dates determined by the Board of Directors (up to a maximum of
$25,000 per year based upon the fair market value of the
shares at the beginning date of the offering). The price of
common stock purchased under the ESPP will be equal to 85% of
the lower of the fair market value of the common stock on the
commencement date of each offering period or the specified
purchase date. In November 2002 the Companys Board of
Directors suspended the ESPP after the final offering period
expired on July 31, 2004.
The Company has elected to follow APB 25 and related
interpretations in accounting for its employee stock plans
because, as discussed below, the alternative fair value
accounting provided for under SFAS 123 requires the use of
valuation models that were not developed for use in valuing
employee stock instruments. Under APB 25, when the exercise
price of the Companys employee stock options equals the
market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Valuation
and Expense Information under SFAS 123(R)
On January 1, 2006, the Company adopted SFAS 123(R),
which required the measurement and recognition of compensation
expense for all share-based payment awards made to the
Companys employees and directors including employee stock
options and employee stock purchases related to the stock option
plans based on estimated fair values. The Company elected to
adopt SFAS 123(R) using the modified prospective
recognition method, which requires the Company to recognize
compensation cost for new and unvested stock options, restricted
stock, restricted stock units and employee stock purchase plan
shares. The following table summarizes stock-based compensation
expense related to employee stock options and employee stock
purchases under SFAS 123(R) for the year ended
December 31, 2006 which is allocated as follows (in
thousands, except per share data):
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
Cost of goods sold
|
|
$
|
302
|
|
Research and development
|
|
|
624
|
|
Sales and marketing
|
|
|
792
|
|
General and administrative
|
|
|
743
|
|
|
|
|
|
|
Share-based compensation effect in
income before taxes
|
|
|
2,461
|
|
Income taxes
|
|
|
|
|
|
|
|
|
|
Net share-based compensation
effect in net loss
|
|
$
|
2,461
|
|
|
|
|
|
|
Impact on net loss per share
|
|
$
|
0.03
|
|
|
|
|
|
|
Shares used in computing share
amounts
|
|
|
77,637
|
|
|
|
|
|
|
At December 31, 2006, unamortized compensation expense
related to outstanding unvested stock options that are expected
to vest was approximately $2.9 million. This unamortized
compensation expense is expected to be recognized over a
weighted average period of approximately 2.2 years.
95
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table presents pro forma information required
under SFAS 123 for periods prior to 2006, which assumes the
Companys application of the fair value recognition
provisions of SFAS 123 to options granted under the
Companys equity incentive plans (in thousands, except per
share data):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
Net loss, as reported
|
|
$
|
(26,951
|
)
|
|
$
|
(47,105
|
)
|
Less: Total share-based employee
compensation determined under the fair value method recognition
provisions of SFAS 123 for all rewards, net of tax
|
|
|
4,144
|
|
|
|
13,947
|
|
|
|
|
|
|
|
|
|
|
Pro forma net loss
|
|
$
|
(31,095
|
)
|
|
$
|
(61,052
|
)
|
|
|
|
|
|
|
|
|
|
Reported basic and diluted net
loss per share
|
|
$
|
(0.35
|
)
|
|
$
|
(0.62
|
)
|
|
|
|
|
|
|
|
|
|
Pro forma basic and diluted income
per share
|
|
$
|
(0.40
|
)
|
|
$
|
(0.81
|
)
|
|
|
|
|
|
|
|
|
|
Shares used in computing pro forma
basic and diluted net loss per share
|
|
|
77,154
|
|
|
|
75,751
|
|
|
|
|
|
|
|
|
|
|
Share-based compensation recognized in 2006 as a result of the
adoption of SFAS 123(R), as well as pro forma disclosures
according to the original provisions of SFAS 123 for
periods prior to the adoption of SFAS 123(R), use the
Black-Scholes option pricing model for estimating fair value of
options granted under the companys equity incentive plans
and rights to acquire stock granted under the companys
stock purchase plan. The weighted average estimated values of
employee stock option grants and right granted under the stock
purchase plan, as well as the weighted average assumptions that
were used in calculating such values during 2006 and 2005, were
based on the estimates at the date of grant as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Weighted average estimated fair
value of grant
|
|
$
|
0.90
|
|
|
$
|
1.42
|
|
Expected life (in years)
|
|
|
2.2
|
|
|
|
2.1
|
|
Risk-free interest rate
|
|
|
4.75
|
%
|
|
|
3.93
|
%
|
Volatility
|
|
|
71.1
|
%
|
|
|
58.0
|
%
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
The Company used its historical stock price volatility as the
expected volatility assumption. The expected life of employee
stock options represents the weighted average period the stock
options are expected to remain outstanding. The expected term is
based on the observed and expected time to post-vesting exercise
of options by employees. The risk-free interest rate assumption
is based upon observed interest rates appropriate for the term
of the Companys employee stock options.
96
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Options outstanding that have vested and are expected to vest as
of December 31, 2006 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Average
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
Life
|
|
|
Value(1)
|
|
|
|
|
|
|
|
|
|
(In years)
|
|
|
|
|
|
Vested
|
|
|
9,869,205
|
|
|
$
|
5.30
|
|
|
|
5.4
|
|
|
$
|
884
|
|
Expected to vest
|
|
|
2,025,490
|
|
|
$
|
2.54
|
|
|
|
5.9
|
|
|
|
341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
11,894,695
|
|
|
$
|
4.83
|
|
|
|
5.5
|
|
|
$
|
1,225
|
|
|
|
|
(1) |
|
These amounts represent the differences between the exercise
price and $2.23, the closing price of Terayon stock on
December 29, 2006 as reported on the Pink Sheets for all
in-the-money
options outstanding. |
The benefit (expense) for income taxes consists of (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
State
|
|
|
(30
|
)
|
|
|
|
|
|
|
(40
|
)
|
Foreign
|
|
|
(150
|
)
|
|
|
(149
|
)
|
|
|
116
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current
|
|
|
(180
|
)
|
|
|
(149
|
)
|
|
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
|
|
|
|
|
|
|
|
|
|
State
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred
|
|
$
|
(180
|
)
|
|
$
|
(149
|
)
|
|
$
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The reconciliation of income tax benefit attributable to net
loss applicable to common stockholders computed at the
U.S. federal statutory rates to income tax benefit
(expense) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Tax benefit at U.S. statutory
rate
|
|
$
|
1,085
|
|
|
$
|
9,418
|
|
|
$
|
16,513
|
|
Loss for which no tax benefit is
currently recognizable
|
|
|
(1,085
|
)
|
|
|
(9,418
|
)
|
|
|
(16,513
|
)
|
Other, net
|
|
|
(180
|
)
|
|
|
(149
|
)
|
|
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(180
|
)
|
|
$
|
(149
|
)
|
|
$
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purposes.
97
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Significant components of the Companys deferred tax assets
and liabilities as of December 31, 2006 and 2005 are as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
127,718
|
|
|
$
|
156,229
|
|
Tax credit carryforwards
|
|
|
13,879
|
|
|
|
13,607
|
|
Reserves and accruals
|
|
|
4,595
|
|
|
|
9,469
|
|
Capitalized research and
development
|
|
|
1,605
|
|
|
|
2,270
|
|
Intangible asset amortization
|
|
|
24,534
|
|
|
|
24,929
|
|
Deferred revenue
|
|
|
6,019
|
|
|
|
14,239
|
|
Other, net
|
|
|
8,422
|
|
|
|
9,078
|
|
|
|
|
|
|
|
|
|
|
Gross deferred tax assets
|
|
|
186,722
|
|
|
|
229,821
|
|
Valuation allowance
|
|
|
(186,722
|
)
|
|
|
(229,821
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Realization of deferred tax assets is dependent on future
earnings, if any, the timing and the amount of which are
uncertain. Accordingly, a valuation allowance has been
established to reflect these uncertainties as of
December 31, 2006 and 2005. The valuation allowance
decreased $43.1 million for the year ended
December 31, 2006 as compared to the year ended
December 31, 2005.
The Company is tracking the portion of its deferred tax assets
attributable to stock option benefits in a separate memo account
pursuant to SFAS 123(R). Therefore, these amounts are no
longer included in the Companys gross or net deferred tax
assets. Pursuant to SFAS 123(R), footnote 82, the
benefit of these stock option benefits will only be recorded to
equity when they reduce cash taxes payable. As a result,
$43.7 million of the change in the valuation allowance in
2006 related to amounts accounted for in the memo account.
As of December 31, 2006 the Company had federal and
California net operating loss carryforwards of approximately
$435.9 million and $307.2 million, respectively. The
Company also had federal and California tax credit carryforwards
of approximately $8.8 million and $11.8 million,
respectively, as of December 31, 2006. The federal and
California net operating loss and credit carryforwards will
expire at various dates beginning in the years 2007 through
2025, if not utilized. The federal research credits expire at
various dates beginning in the years 2009 through 2022, if not
utilized. The California research credits have no expiration
date.
As of December 31, 2006, the federal and state net
operating loss carryforwards being accounted for in the memo
account were $115.0 million and $59.9 million,
respectively.
Utilization of net operating loss and tax credit carryforwards
may be subject to a substantial annual limitation due to the
ownership change limitations provided by the Internal Revenue
Code of 1986, as amended, and similar state provisions. The
annual limitation may result in the expiration of net operating
loss and tax credit carry-forwards before full utilization.
|
|
Note 11.
|
Defined
Contribution Plan
|
During 1995, the Company adopted a 401(k) Profit Sharing Plan
and Trust that allows eligible employees to make contributions
subject to certain limitations. The Company may make
discretionary contributions based on profitability as determined
by the Board of Directors. No amount was contributed by the
Company to the plan during the years ended December 31,
2006, 2005 and 2004.
98
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 12.
|
Segment
Information
|
In late 2000, the worldwide telecom and satellite industries
experienced severe downturns that resulted in significantly
reduced purchases of equipment. Because of that decrease in
demand, the Company refocused its efforts on sales of its data
products to the cable industry and its digital video products to
the cable and satellite industry, and significantly reduced and
then ultimately eliminated its telecom and satellite businesses.
Consequently, beginning in 2003, the Companys previously
reported telecom segment no longer meets the quantitative
threshold for disclosure and the Company now operates as one
business segment.
Since 2004, the Company increased its focus on the development,
marketing and sale of its digital video products versus its data
products, which consisted of the CMTS, modem and eMTA products,
and ultimately, refocused the Company as a digital video
company. The decreased focus on the data products was due to the
pressures of competing in a standards based marketplace versus a
proprietary based marketplace. In 2001 and 2002, the Company
switched from selling proprietary data products based on its
Synchronous Code Division Multiple Access (S-CDMA)
technology to Data Over Cable System Interface Specification
(DOCSIS) compliant products. Additionally, in 2001, the Company
licensed its S-CDMA technology to Cable Television Laboratories,
Inc. (CableLabs) on a non-exclusive, perpetual, worldwide,
royalty-free basis for inclusion in the DOCSIS 2.0 standard (and
later standards) and therefore, any competitive edge previously
provided by the proprietary technology was eliminated. In 2004,
the Company ceased investment in its CMTS product line due to
these competitive pressures, declining sales and costs
associated with research and development efforts to develop the
next generation of CMTS products. In January 2006, the Company
discontinued its line of modems and eMTAs for the same reasons.
The Company operates solely in one business segment, the
development and marketing of digital video products and related
services. However, the Company will continue to sell through the
existing inventory of its modem and eMTA products. The
Companys foreign operations consist of sales, marketing
and support activities through its foreign subsidiaries. The
Companys Chief Executive Officer has responsibility as the
chief operating decision maker (CODM) as defined by
SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. The CODM reviews
financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues and
certain direct expenses by geographic region for purposes of
making operating decisions and assessing financial performance.
The Companys assets are primarily located in its corporate
office in the United States and are not allocated to any
specific region, therefore the Company does not produce reports
for, or measure the performance of, its geographic regions based
on any asset-based metrics.
|
|
Note 13.
|
Product
Warranty
|
The Company provides a standard warranty for most of its
products, ranging from one to five years from the date of
purchase. The Company estimates product warranty expenses at the
time revenue is recognized. The Companys warranty
obligations are affected by product failure rates, material
usage and service delivery costs incurred in correcting a
product failure. The estimate of costs to service its warranty
obligations is based on historical experience and the
Companys expectation of future conditions. Should actual
product failure rates, material usage or service delivery costs
differ from the Companys estimates, revision to the
warranty
99
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
liability would be required. An analysis of changes in the
liability for product warranties is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Balance at beginning of year
|
|
$
|
2,887
|
|
|
$
|
4,670
|
|
Additions (reductions) charged to
costs and expenses
|
|
|
673
|
|
|
|
(166
|
)
|
Settlements
|
|
|
(2,314
|
)
|
|
|
(1,617
|
)
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
1,246
|
|
|
$
|
2,887
|
|
|
|
|
|
|
|
|
|
|
Guarantees,
Including Indirect Guarantees of Indebtedness of
Others
In addition to product warranties, the Company, from time to
time, in the normal course of business, indemnifies other
parties with whom it enters into contractual relationships,
including customers, lessors, and parties to other transactions
with the Company, with respect to certain matters. These
obligations primarily relate to certain agreements with the
Companys officers, directors and employees, under which
the Company may be required to indemnify such persons for
liabilities arising out of their employment relationship. The
Company has agreed to hold the other party harmless against
specified losses, such as those arising from a breach of
representations or covenants, third party claims that the
Companys products when used for their intended purpose(s)
infringe the intellectual property rights of such third party,
or other claims made against certain parties. Beginning in late
2005, a number of third parties have filed lawsuits against the
cable operators alleging that products used by the cable
operators in data and video transmission infringe their patents.
As part of the Companys sale of products to its customers,
the Company provides intellectual property indemnities. The
cable operators have requested and the Company, along with other
vendors, has agreed to pay certain fees and costs associated
with these lawsuits. Additionally, the Company has also received
subpoenas requesting information related to its products as part
of these cases. In 2006, the Company incurred substantial legal
expenses related to these intellectual property infringement
lawsuits and the Company expects to continue to incur
substantial expense in the future. It is not possible to
determine the maximum potential amount of liability under these
indemnification obligations due to the limited history of prior
indemnification claims and the unique facts and circumstances
that are likely to be involved in each particular claim.
|
|
Note 14.
|
Sale of
Certain Assets
|
On March 9, 2005, the Company sold certain of its cable
modem semiconductor assets to ATI Technologies, Inc. (ATI).
Under the agreement, ATI acquired the Companys cable modem
silicon intellectual property and related software, entered into
a sublease and hired approximately 25 employees from the
Companys design team. Under the terms of the agreement,
ATI was required to pay the Company $7.0 million at the
closing, with a balance of $7.0 million subject to its
achieving milestones for certain conditions, services and
deliverables up to June 9, 2006. Upon closing, the Company
received $8.6 million in cash, which was comprised of the
$7.0 million for the initial payment and $1.9 million
for having met the first milestone, minus $0.3 million to
pay for Company funded retention bonuses for employees that
accepted employment with ATI. In June 2005, ATI paid the Company
$2.5 million for delivering certain documentation and
validation deliverables. On September 9, 2005, the Company
forfeited $0.8 million for failing to obtain vendor author
status for ATI with CableLabs. In June 2006, ATI paid the
Company $1.1 million from the amount that was released from
escrow and the Company forfeited $0.8 million, the
remaining amount that was held in escrow, for failing to obtain
vendor author status for ATI with CableLabs by June 9,
2006. Additionally, in June 2006, the Company and ATI amended
the agreement to (i) transfer assets related to the
manufacture of the semiconductors to ATI and (ii) engage
ATI to provide technical assistance to the Company. The
Companys maximum liability is set at $14.0 million
for breaches of representations and warranties made by the
Company
100
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
and obligations assumed by the Company. In June 2006, the
Company recognized a $9.9 million gain from the sale of
assets to ATI, which represented the purchase price of
$12.5 million, less transaction related costs of
$2.6 million. Despite receiving cash payments for the sale
of assets to ATI, the Company did not recognize the gain on the
ATI transaction until the quarter ended June 30, 2006 based
upon the completion of milestones and the termination of the
supply arrangement between ATI and the Company.
In 2001, the insurer of the second layer of the Companys
directors and officers insurance, Reliance Insurance Company
(Reliance), filed for liquidation under the laws of the
Commonwealth of Pennsylvania. Because of Reliances filing
for liquidation, the Company self-insured the Reliance layer of
$2.5 million and paid the $2.5 million as part of the
securities class action lawsuit filed against the Company and
certain of its officers and directors in 2000. The Company filed
a claim for $2.5 million against Reliance with its
liquidator. In April 2005, the liquidator for Reliance provided
the Company with a notice of determination that allowed its
claim against Reliance. In June 2006, the Company sold its claim
against Reliance to Prime Shares World Market LLC and
recognized other income of $1.0 million.
|
|
Note 15.
|
Settlement
of Litigation
|
On September 15, 2006, the Company entered into a
Stipulation of Settlement of Derivative Claims with respect to
the derivative litigation entitled In re Terayon
Communication Systems, Inc. Derivative Litigation, Case
No. CV 807650, pending in the Superior Court of California,
County of Santa Clara. On September 18, 2006, the court
approved the final settlement of the derivative litigation. In
connection with the settlement, the Company paid
$1.0 million in attorneys fees and expenses to the
derivative plaintiffs counsel and agreed to adopt certain
corporate governance practices. The Company accrued
$1.0 million to litigation settlement expense in the fourth
quarter of 2005. For a description of the derivative litigation
and the settlement, see Note 8, Contingencies,
to Consolidated Financial Statements.
On March 17, 2006, the Company entered into a Memorandum of
Understanding (MOU) providing for the settlement of the
securities class action entitled In re Terayon Communication
Systems, Inc. Securities Litigation, Case
No. C-00-1967-MHP,
pending in the United States District Court for the Northern
District of California. As previously disclosed, the amended
complaint alleged that the Company and certain of its officers
and directors (collectively, Defendants) violated the federal
securities laws by issuing materially false and misleading
statements and failing to disclose material information
regarding the Companys technology. The class action
included claims for damages on behalf of those who purchased or
otherwise acquired the Companys securities (Affected
Securities) during the class period of November 15, 1999 to
April 11, 2000 (Plaintiff Class).
In accordance with the settlement outlined in the MOU, the
Defendants agreed to pay to the Plaintiff Class
$15.0 million with the Company contributing approximately
$2.2 million of this amount, and its insurance carriers
paying the remaining amount. As a result, the Company accrued
$2.2 million to litigation settlement expense in the fourth
quarter of 2005. The Court held a hearing to review the
settlement of the shareholder litigation on September 25,
2006. To date, the Court has not approved the settlement.
In consideration of the payment of the settlement funds
described above, the Plaintiff Class agreed, upon final court
approval, to dismiss the class action with prejudice and release
all known and unknown claims arising out of or relating to, or
in connection with the purchase or acquisition of the Affected
Securities during the class period which have been or could have
been asserted by any member of the Plaintiff Class.
|
|
Note 16.
|
Subsequent
Events
|
Corporate
Aircraft
In 2002, the Company entered into an operating lease arrangement
to lease a corporate aircraft. This lease arrangement was
secured by a $9.0 million letter of credit at
December 31, 2002. The letter of credit was
101
TERAYON
COMMUNICATION SYSTEMS, INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
reduced to $7.5 million in February 2003. The
$7.5 million letter of credit was converted to a cash
deposit in 2004. In August 2004, the Company entered into a
28-month
aircraft sublease terminating on December 31, 2006, which
was amended in December 2006 to terminate on January 14,
2007. On January 14, 2007, the last day of the operating
lease, the Company returned the corporate aircraft to the lessor
of the aircraft, General Electric Capital Corporation (GECC),
and no additional rental payments were due to the lessor after
October 2006.
On March 22, 2007, the Company entered into a Termination
Agreement with (GECC), terminating the Aircraft Lease Agreement
dated as of February 8, 2002 under which the Company
previously leased a jet aircraft from GECC. Pursuant to the
Termination Agreement, On March 28, 2007, GECC returned to
the Company approximately $6.8 million of the
$7.5 million cash deposit held by GECC as collateral for
the aircraft lease. GECC will retain $0.7 million in
collateral (Repair Collateral) subject to GECCs completion
of repairs, tests, inspections, and corrections to the aircraft,
which GECC has estimated will cost $0.6 million. The
remaining amount of the Repair Collateral, if any, will be
returned to the Company.
RGB
litigation Settlement
On March 26, 2007, Terayon entered into a stipulation for
settlement with RGB Networks, Inc. amicably resolving all
outstanding litigation between the parties.
|
|
Note 17.
|
Unaudited
Quarterly Financial Data
|
Summarized quarterly financial data for 2006 and 2005 is as
follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
|
|
2006
|
|
1st
|
|
|
2nd
|
|
|
3rd
|
|
|
4th
|
|
|
Revenues
|
|
$
|
21,490
|
|
|
$
|
20,425
|
|
|
$
|
16,828
|
|
|
$
|
17,687
|
|
Gross profit
|
|
|
10,774
|
|
|
|
11,957
|
|
|
|
11,624
|
|
|
|
11,227
|
|
Operating expenses
|
|
|
14,437
|
|
|
|
14,599
|
|
|
|
14,961
|
|
|
|
16,419
|
|
Net (loss) income (1)
|
|
|
(3,944
|
)
|
|
|
8,344
|
|
|
|
(3,065
|
)
|
|
|
(5,166
|
)
|
Net (loss) income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.05
|
)
|
|
$
|
0.11
|
|
|
$
|
(0.04
|
)
|
|
$
|
(0.07
|
)
|
Diluted
|
|
$
|
(0.05
|
)
|
|
$
|
0.11
|
|
|
$
|
(0.04
|
)
|
|
$
|
(0.07
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
|
|
2005
|
|
1st
|
|
|
2nd
|
|
|
3rd
|
|
|
4th
|
|
|
Revenues
|
|
$
|
17,813
|
|
|
$
|
18,925
|
|
|
$
|
23,440
|
|
|
$
|
30,486
|
|
Gross profit
|
|
|
6,550
|
|
|
|
7,347
|
|
|
|
6,441
|
|
|
|
14,691
|
|
Operating expenses
|
|
|
15,609
|
|
|
|
13,747
|
|
|
|
15,686
|
|
|
|
17,755
|
|
Net loss
|
|
|
(9,233
|
)
|
|
|
(6,487
|
)
|
|
|
(8,120
|
)
|
|
|
(3,111
|
)
|
Net loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.12
|
)
|
|
$
|
(0.08
|
)
|
|
$
|
(0.11
|
)
|
|
$
|
(0.04
|
)
|
Diluted
|
|
$
|
(0.12
|
)
|
|
$
|
(0.08
|
)
|
|
$
|
(0.11
|
)
|
|
$
|
(0.04
|
)
|
|
|
|
(1) |
|
This amount in the second quarter of 2006 includes
$9.9 million from a gain on the sale of assets to ATI. See
Note 14, Sale of Certain Assets, to
Consolidated Financial Statements. |
102
|
|
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
Information regarding the change in accountants is incorporated
herein by reference to
Forms 8-K
and 8-K/A
filed on September 27, 2005 and October 17, 2005,
respectively.
Item 9A.
Controls and Procedures
a) Evaluation
of Disclosure Controls and Procedures
The Company is required to maintain disclosure controls and
procedures that are designed to ensure that information required
to be disclosed in its reports under the Securities Exchange Act
of 1934, as amended (Exchange Act), is recorded, processed,
summarized and reported within the time periods specified in the
Commissions rules and forms, and that such information is
accumulated and communicated to management, including the
Companys Chief Executive Officer (CEO) and Chief Financial
Officer (CFO) as appropriate, to allow timely decisions
regarding required disclosure.
In connection with the preparation of this
Form 10-K
for the year ended December 31, 2006, management, under the
supervision of the CEO and CFO, conducted an evaluation of
disclosure controls and procedures. A control system, no matter
how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control
systems are met. Based on that evaluation, the CEO and CFO
concluded that the Companys disclosure controls and
procedures were not effective at a reasonable assurance level as
of December 31, 2006 due to the material weaknesses
discussed below under Managements Report on Internal
Control over Financial Reporting. Because the material
weaknesses described below have not been remediated as of the
filing date of this
Form 10-K,
the CEO and CFO continue to conclude that the Companys
disclosure controls and procedures are not effective as of the
filing date of this
Form 10-K.
b) Managements
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining an
adequate internal control structure and procedures over
financial reporting (as defined in
Rules 13a-15(e)
and 15d-15(e)) under the Exchange Act. Management conducted an
assessment of the effectiveness of the Companys internal
control over financial reporting as of December 31, 2006
based on the framework set forth in Internal Control
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Internal
control over financial reporting cannot provide absolute
assurance of achieving financial reporting objectives because of
its inherent limitations. Internal control over financial
reporting is a process that involves human diligence and
compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Because of such limitations,
there is a risk that material misstatements may not be prevented
or detected on a timely basis by internal control over financial
reporting. Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate. Management engaged experienced consultants to
assist management with the Companys assessment of the
effectiveness of internal control over financial reporting.
A material weakness in internal control over financial reporting
is defined by the Public Company Accounting Oversight
Boards Auditing Standard No. 2 as being a significant
deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements would
not be prevented or detected. A significant deficiency is a
control deficiency, or combination of control deficiencies, that
adversely affects the companys ability to initiate,
authorize, record, process or report external financial data
reliably in accordance with generally accepted accounting
principles (GAAP) such that there is more than a remote
likelihood that a misstatement of the companys annual or
interim financial statements that is more than inconsequential
will not be prevented or detected.
103
As disclosed in the Companys Annual Report on
Form 10-K
for the year ended December 31, 2005, and in its Quarterly
Reports on
Form 10-Q
for each of the first three quarters of 2006. the following
material weaknesses remained ongoing as of December 31,
2006 and as of the date of this filing:
Communication of Financial
Information. The Company had insufficient
controls related to the identification, capture and timely
communication of financially significant information between
certain parts of the organization and the accounting and finance
department to enable these departments to account for
transactions in a complete and timely manner;
Lack of Technical Accounting Expertise and Qualified
Accounting Personnel. The Company did not have
sufficient personnel with technical accounting expertise in the
accounting and finance department, adequate review and approval
procedures, and sufficient analysis and documentation in the
analysis of GAAP to prepare external financial statements in
accordance with GAAP. The Company did not have adequate
personnel in its accounting and finance department, and
additionally lacked sufficient qualified accounting and finance
personnel to identify and resolve complex accounting issues in
accordance with GAAP.
The Use of Estimates. The Company
lacked policies and procedures for determining estimates and
monitoring and adjusting balances related to certain accruals
and provisions, and also lacked support for its conclusions on
those estimates. The Company did not have controls in place to
accurately estimate the accruals including the adequate review
and approval of all significant accruals by management personnel.
Inadequate
Controls over Documentation and Record Keeping.
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The Company did not have sufficient controls in place to ensure
the proper authorization and review of manual journal entries
and the associated support documentation.
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The Company did not have sufficient controls to address the
amendment of sales orders with its customers. Sales orders could
be amended through the amendment of the sales orders, purchase
orders and agreements. When sales were amended through sales or
purchase orders, the person processing the amendments would
exercise discretion in inputting the revised terms and
conditions and there was no consistent policy requiring the
accounting and finance department to approve such amendments or
even informing the accounting and finance department of such
amendments.
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The Company did not keep adequate documentation related to the
analysis and reconciliation of certain general ledger accounts.
|
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|
The Company did not retain certain corporate records in
connection with the sale of certain subsidiaries to third
parties.
|
Because of these material weaknesses, the CEO and CFO concluded
that the Company did not maintain effective internal control
over financial reporting as of December 31, 2006 or at the
date of this filing.
The Companys independent registered public accounting
firm, Stonefield Josephson, Inc. (Stonefield), has issued an
attestation report on managements assessment and the
effectiveness of the Companys internal control over
financial reporting as stated in their report which appears
herein.
c) Remediation
of Previously Disclosed Material Weakness
As disclosed in the Companys Annual Report on
Form 10-K
for the year ended December 31, 2005, and in its Quarterly
Reports on
Form 10-Q
for each of the first three quarters of 2006, the Company
reported a material weakness in internal control over financial
reporting related to revenue recognition. Based on the
remediation steps detailed below and the subsequent testing of
these remediation steps, as of December 31, 2006, the
Company remediated the previously reported material weakness in
internal control over financial reporting related to revenue
recognition.
104
Revenue
Recognition.
The Company previously did not properly recognize revenue on its
video products in accordance with GAAP, specifically
SOP 97-2,
SAB 104 and EITF
00-21, and
previously did not properly account for deferred revenue and
related cost of goods sold. The Company previously acquired its
video products as part of acquisitions completed by the Company
in 1999 and 2000, and at that time determined that the products
would be accounted for under SAB 101, as amended by
SAB 104. The Company did not sufficiently evaluate its
video products and continued to account for its video products
in accordance with SAB 104 when revenue on the video
products should have been accounted for in accordance with the
software revenue recognition principles under
SOP 97-2,
SAB 104 and EITF
00-21.
Additionally, the Company previously sold maintenance support
contracts that included software upgrades with its video
products and did not establish vendor specific objective
evidence (VSOE) of fair value on the pricing of such maintenance
contracts in accordance with
SOP 97-2,
SAB 104 and EITF
00-21.
Because the Company continued to account for the video products
and maintenance sold with the video products under SAB 104,
the Company did not take the steps necessary to establish VSOE
of fair value on the pricing of its maintenance products and
revenue was recognized during incorrect periods.
The Company previously incorrectly recorded deferred revenue and
cost of goods sold on the balance sheet for certain
transactions. As a result of the Companys focus on revenue
recognition described above, the Company identified invoices for
which deferred revenue for these sales had been recognized but
the criteria for revenue recognition had not been met.
Accordingly, the Company corrected these errors in deferred
revenue, deferred cost of goods sold, inventory and accounts
receivable accounts and recognized revenue when title
transferred or customer payments were reasonably assured and all
criteria for revenue recognition were met. The Company has
implemented the following remediation steps:
Remediation
Steps:
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The Company engaged the services of experienced accounting
consultants to review the Companys books and close
procedures on a monthly basis to assist management in ensuring
that the Companys financial statements are being recorded
in accordance with GAAP.
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During the quarter ended September 30, 2006, the Company
established a process where all significant accruals must be
reviewed and approved by the Corporate Controller.
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During the first three quarters of 2006, the Companys
accounting and finance department, with the assistance of
outside consultants, implemented procedures to recognize sales
of its video products under the software accounting rules under
SOP 97-2
in accordance with GAAP.
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In 2006, the Company established pricing guidelines and internal
procedures to ensure consistent pricing to allow for the
establishment of VSOE of fair value for sales made with multiple
element arrangements.
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During the second and third quarters of 2005, the accounting and
finance department established procedures surrounding the
month-end close process to ensure that the information and
estimates necessary for recognizing revenue in accordance with
SOP 97-2
were available.
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The Company provided its accounting staff with training on
revenue recognition, including software accounting and project
accounting, and GAAP, including attending seminars and
conferences. Additional training will be provided on a regular
and periodic basis and updated as considered necessary.
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During the quarter ended March 31, 2006, the Company hired
an experienced revenue accountant to review all revenue
transactions and to ensure that revenues, cost of goods sold,
deferred revenue and deferred cost of goods sold are properly
accounted for in accordance with GAAP and the Companys
policies.
|
105
d) Remediation
Steps to Address Continuing Material Weaknesses
In an effort to remediate the Companys identified
continuing material weaknesses, management is in the process of
implementing the following steps. While these continuing
material weaknesses did not result in adjustments to the
Companys 2006 consolidated financial statements, it is
reasonably possible that, if not remediated, these material
weaknesses could result in a material misstatement of the
Companys financial statement accounts that might result in
a material misstatement to a future annual or interim period.
Management does not anticipate that the continuing material
weaknesses will be remediated until the second half of the year
ended December 31, 2007.
Communication
of Financial Information.
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During the quarter ended June 30, 2005, the Company
established procedures to document the review of press releases
to account for transactions in a complete and timely manner.
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During the quarter ended June 30, 2005, the Company also
improved the internal process of drafting and reviewing periodic
reports by implementing additional management and external legal
counsel review prior to their submission to the Companys
independent registered public accounting firm.
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|
Continue to monitor the communication channels between the
Companys senior management and the Companys
accounting and finance department and take prompt action, as
necessary, to further strengthen these communication channels;
|
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|
|
Implement training procedures for new employees and/or
consultants in the accounting and finance department on the
Companys disclosure procedures and controls, the Company
and the Companys actions in previous reporting periods; and
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|
Take steps to ensure that the Company senior management has
timely access to all material financial and non-financial
information concerning our business.
|
Use of
Estimates.
|
|
|
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|
The Company has engaged the services of experienced accounting
consultants to review the Companys books and close
procedures on a monthly basis to assist management in ensuring
that the Companys financial statements are being recorded
in accordance with GAAP.
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The Company continues to engage the services of an outside tax
accounting firm to assist with the calculation of the
Companys tax liabilities.
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|
During the quarter ended September 30, 2006, the Company
established a process where all significant accruals must be
reviewed and approved by the Corporate Controller.
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|
During the quarter ended June 30, 2006, the Company
implemented a process to obtain and assess accruals for legal
costs and expenses owed to third party vendors whereby the
Companys legal department obtains monthly estimates from
the third party vendors and reviews the amount reported by third
party vendors for accuracy.
|
Lack
of Technical Accounting Expertise and Qualified Accounting
Personnel.
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|
During the quarter ended June 30, 2006, the Company engaged
experienced accounting consultants to act as the VP Finance,
Corporate Controller and Revenue Recognition Accountant.
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|
During the second, third and fourth quarters of 2006, the
Company engaged expert accounting consultants to assist the
Companys accounting and finance department with the
management and implementation of controls surrounding revenue
recognition, the administration of existing controls and
procedures, the preparation of the Companys periodic
reports and the documentation of complex accounting transactions.
|
106
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The Company is increasing staffing in the accounting and finance
department, and re-allocating duties to persons within the
accounting and finance organization to maximize their skills and
experience.
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|
The Company continues to take steps to recruit additional
qualified senior accounting personnel, including certified
public accountants personnel with recent public accounting firm
experience. The Company is looking to hire an accountant with
SEC reporting experience.
|
Inadequate
Controls over Documentation and Record Keeping.
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|
During the quarter ending March 31, 2007, the
Companys employees involved in order entry will receive
training regarding the controls and procedures surrounding the
amendment of sales orders. Additional training will be provided
on a regular and periodic basis and updated as necessary to
reflect any changes in the Companys or its customers
business practices or activities.
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|
The Company has established policies and procedures for the
review and approvals of all manual journal entries.
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|
The Company has adopted a policy requiring it to retain a copy
of all corporate records in connection with dispositions of
assets to third parties.
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|
Improve the review process that occurs prior to providing the
initial draft of the periodic report to our independent auditors
for review.
|
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|
The Company has developed monthly close schedules which include
the timeline for completion and approval of reconciliations by
the Corporate Controller.
|
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|
During the quarter ended June 30, 2006, the Company entered
into agreements with third parties that purchased assets from
the Company in Israel. These agreements provide the Company with
access to the corporate records and require the third parties to
retain documents in accordance with Israeli law.
|
e) Subsequent
Changes in Internal Control over Financial Reporting
Except for the changes in connection with the remediation of the
previously reported material weakness and the remediation
efforts performed in regard to the material weaknesses described
above, there were no changes in the Companys internal
control over financial reporting that occurred during the year
ended December 31, 2006 that have materially affected, or
are reasonably likely to materially affect, the Companys
internal control over financial reporting.
107
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board
of Directors and Shareholders of Terayon Communication Systems,
Inc.
We have audited managements assessment, included in
Managements Report on Internal Control Over Financial
Reporting in Item 9A, that Terayon Communication Systems,
Inc. (Terayon) did not maintain effective internal
control over financial reporting as of December 31, 2006
because of the effect of the material weaknesses identified in
managements assessment, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Terayons management is responsible for
maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the
effectiveness of the companys internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of
control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. The
following material weaknesses have been identified and included
in managements assessment:
Communication of Financial
Information. The Company had insufficient
controls related to the identification, capture and timely
communication of financially significant information between
certain parts of the organization and the accounting and finance
department to enable these departments to account for
transactions in a complete and timely manner; and
Lack of Technical Accounting Expertise and Qualified
Accounting Personnel. The Company did not have
sufficient personnel with technical accounting expertise in the
accounting and finance department, adequate review and approval
procedures, and sufficient analysis and documentation in the
analysis of GAAP to prepare external financial statements in
accordance with GAAP. The Company did not have adequate
personnel in its accounting and finance department, and
additionally lacked sufficient qualified accounting and finance
personnel to identify and resolve complex accounting issues in
accordance with GAAP.
108
The Use of Estimates. The Company
lacked policies and procedures for determining estimates and
monitoring and adjusting balances related to certain accruals
and provisions, and also lacked support for its conclusions on
those estimates. The Company did not have controls in place to
accurately estimate the accruals including the adequate review
and approval of all significant accruals by management personnel.
Inadequate
Controls over Documentation and Record Keeping.
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|
|
|
|
The Company did not have sufficient controls in place to ensure
the proper authorization and review of manual journal entries
and the associated support documentation.
|
|
|
|
The Company did not have sufficient controls to address the
amendment of sales orders with its customers. Sales orders could
be amended through the amendment of the sales orders, purchase
orders and agreements. When sales were amended through sales or
purchase orders, the person processing the amendments would
exercise discretion in inputting the revised terms and
conditions and there was no consistent policy requiring the
accounting and finance department to approve such amendments or
even informing the accounting and finance department of such
amendments.
|
|
|
|
The Company did not keep adequate documentation related to the
analysis and reconciliation of certain general ledger accounts.
|
|
|
|
The Company did not retain certain corporate records in
connection with the sale of certain subsidiaries to third
parties.
|
These material weaknesses were considered in determining the
nature, timing, and extent of audit tests applied in our audit
of the 2006 consolidated financial statements, and this report
dose not affect our report dated March 29, 2007, on those
financial statements.
In our opinion, managements assessment that Terayon
Communication Systems, Inc. did not maintain effective internal
control over financial reporting as of December 31, 2006 is
fairly stated, in all material respects, based on criteria
established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Also, in our opinion, because of the
effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Terayon
Communication Systems, Inc. has not maintained effective
internal control over financial reporting as of
December 31, 2006, based on criteria established in
Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Terayon Communication Systems,
Inc. as of December 31, 2006 and 2005 and the related
consolidated statements of operations, stockholders equity
and cash flows for each of the three years in the period ended
December 31, 2006, and our report dated March 29,
2007, expressed an unqualified opinion on those consolidated
financial statements.
/s/ Stonefield
Josephson, Inc.
San Francisco, California
March 29, 2007
109
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|
Item 9B.
|
Other
Information
|
Not applicable.
PART III
|
|
Item 10.
|
Directors,
Executive Officers and Corporate Governance
|
Information relating to our directors, executive officers and
corporate governance will be presented in our definitive proxy
statement for the 2007 annual stockholders meeting and is
incorporated herein by reference. Our definitive proxy statement
will be filed no later than 120 days after the end of the
fiscal year covered by this report.
|
|
Item 11.
|
Executive
Compensation
|
Information relating to execution compensation will be presented
in our definitive proxy statement for the 2007 annual
stockholders meeting and is incorporated herein by reference.
Our definitive proxy statement will be filed no later than
120 days after the end of the fiscal year covered by this
report.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
Information relating to security ownership will be presented in
our definitive proxy statement for the 2007 annual stockholders
meeting and is incorporated herein by reference. Our definitive
proxy statement will be filed no later than 120 days after
the end of the fiscal year covered by this report.
|
|
Item 13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
Information relating to related party transactions and director
independence will be presented in our definitive proxy statement
for the 2007 annual stockholders meeting and is incorporated
herein by reference. Our definitive proxy statement will be
filed no later than 120 days after the end of the fiscal
year covered by this report.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
Information relating to our principal accountant fees and
services will be presented in our definitive proxy statement for
the 2007 annual stockholders meeting and is incorporated herein
by reference. Our definitive proxy statement will be filed no
later than 120 days after the end of the fiscal year
covered by this report.
PART IV
|
|
Item 15.
|
Exhibits,
Financial Statement Schedules
|
(a) (1) The following documents are included as part
of this
Form 10-K.
Reference is made to the Index to Consolidated Financial
Statements of Terayon Communication Systems, Inc. under
Item 8 in Part II of this
Form 10-K.
(2) Financial Statement Schedules:
Schedules not included herein have been omitted because they are
not applicable or the required information is in the
consolidated financial statements or notes thereto.
110
(3) The following exhibits are filed as a part of this
Form 10-K
and this list includes the Exhibit Index.
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Exhibit
|
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Number
|
|
Exhibit Description
|
|
|
3
|
.1
|
|
Amended and Restated Certificate
of Incorporation of Terayon Communication Systems, Inc.(11)
|
|
3
|
.2
|
|
Bylaws of Terayon Communication
Systems, Inc.(11)
|
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3
|
.3
|
|
Certificate of Amendment to
Amended and Restated Certificate of Incorporation of Terayon
Communication Systems, Inc.(11)
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3
|
.4
|
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Certificate of Designation of
Series A Junior Participating Preferred Stock.(4)
|
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4
|
.1
|
|
Specimen Common Stock
Certificate.(2)
|
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4
|
.2
|
|
Amended and Restated Information
and Registration Rights Agreement, dated April 6, 1998.(1)
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4
|
.3
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|
Form of Security for Terayon
Communication Systems, Inc.s 5% Convertible
Subordinated Notes due August 1, 2007.(3)
|
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4
|
.4
|
|
Registration Rights Agreement,
dated July 26, 2000, among Terayon Communication Systems,
Inc. and Deutsche Bank Securities, Inc. and Lehman Brothers,
Inc.(3)
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4
|
.5
|
|
Indenture, dated July 26,
2000, between Terayon Communication Systems, Inc. and State
Street Bank and Trust Company of California, N.A.(3)
|
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4
|
.6
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|
Rights Agreement, dated
February 6, 2001, between Terayon Communication Systems,
Inc. and Fleet National Bank.(4)
|
|
10
|
.1
|
|
Form of Indemnification Agreement
between Terayon Communication Systems, Inc. and each of its
directors and officers.(15)
|
|
10
|
.2*
|
|
1995 Stock Option Plan, as
amended.(1)
|
|
10
|
.3*
|
|
1997 Equity Incentive Plan, as
amended.(6)
|
|
10
|
.4*
|
|
1998 Employee Stock Purchase Plan,
as amended.(9)
|
|
10
|
.5*
|
|
1998 Non-Employee Directors
Stock Option Plan, as amended.(9)
|
|
10
|
.6*
|
|
1998 Employee Stock Purchase Plan
Offering for Foreign Employees.(5)
|
|
10
|
.7*
|
|
1999 Non-Officer Equity Incentive
Plan, as amended.(10)
|
|
10
|
.8
|
|
Data Over Cable Service Interface
Specifications License Agreement, dated December 21, 2001,
between Terayon Communication Systems, Inc. and Cable Television
Laboratories, Inc.(6)
|
|
10
|
.9
|
|
Amendment to DOCSIS IPR Agreement
to cover DOCSIS 2.0, dated December 21, 2002, between
Terayon Communication Systems, Inc. and Cable Television
Laboratories, Inc.(6)
|
|
10
|
.10
|
|
Lease Agreement, dated
September 18, 1996, between Sobrato Interests III and
VeriFone.(7)
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10
|
.11
|
|
Triple Net Sublease, dated
April 1, 2002, by and between Terayon Communication
Systems, Inc. and Hewlett-Packard Company.(7)
|
|
10
|
.12
|
|
Aircraft Lease Agreement, dated
February 8, 2002, between Terayon Communication Systems,
Inc. and General Electric Capital Corporation.(8)
|
|
10
|
.13
|
|
First Amendment to Aircraft Lease
Agreement and Security Deposit Pledge Agreement, dated
December 31, 2003, between Terayon Communication Systems,
Inc. and General Electric Capital Corporation.(13)
|
|
10
|
.14
|
|
Notification Letter of Intent to
Terminate or Sublease the Aircraft Lease Agreement, dated
March 12, 2004.(13)
|
|
10
|
.15*
|
|
Employment Agreement, dated
July 22, 2005, between Terayon Communication Systems, Inc.
and Jerry Chase.(16)
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|
10
|
.16
|
|
Proprietary Information and
Inventions Agreement, dated July 22, 2004, between Terayon
Communication Systems, Inc. and Jerry Chase.(12)
|
|
10
|
.17
|
|
Aircraft Sublease Agreement, dated
August 24, 2004, between Terayon Communication Systems,
Inc. and United Furniture Equipment Rental, Inc.(12)
|
|
10
|
.18*
|
|
Employment Agreement, dated
July 22, 2005, between Terayon Communication Systems, Inc.
and Mark Richman.(16)
|
|
10
|
.19
|
|
Proprietary Information and
Inventions Agreement, dated November 10, 2004, between
Terayon Communication Systems, Inc. and Mark Richman.(15)
|
111
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Exhibit Description
|
|
|
10
|
.20*
|
|
Form of Option Agreement for the
Terayon Communication Systems, Inc. 1997 Equity Incentive
Plan.(14)
|
|
10
|
.21*
|
|
Form of Option Agreement for the
Terayon Communication Systems, Inc. 1998 Non-Employee Directors
Stock Option Plan.(15)
|
|
10
|
.22
|
|
Lease, dated August 9, 2006
between Sobrato Development Companies #871 and Terayon
Communication Systems, Inc.(17)
|
|
10
|
.23
|
|
Triple Net
Sub-Sublease
Agreement, effective as of August 9, 2006, as amended,
between Terayon Communication Systems, Inc. and Citrix Systems,
Inc.(17)
|
|
10
|
.24*
|
|
Employment Agreement, dated
July 27, 2005, between Terayon Communication Systems, Inc.
and Matt Aden. (16)
|
|
10
|
.25
|
|
Proprietary Information and
Inventions Agreement, dated July 27, 2005, between Terayon
Communication Systems, Inc. and Matthew J. Aden.(16)
|
|
10
|
.26*
|
|
Amendment No. 1 to the
Terayon Communication Systems, Inc. 1997 Equity Incentive
Plan.(17)
|
|
10
|
.27*
|
|
Non-Employee Director Equity
Compensation Policy.(17)
|
|
10
|
.28*
|
|
Non-Employee Director Equity
Compensation Policy Nonstatutory Stock Option Agreement.(17)
|
|
10
|
.29*
|
|
2006 Executive Sales Commission
Plan.(17)
|
|
10
|
.30*
|
|
2006 Section 16 Executive
Officer Bonus Plan.(17)
|
|
10
|
.31
|
|
Termination Agreement, effective
as of March 22, 2007, between Terayon Communications
Systems, Inc. and General Electric Capital Corporation
|
|
14
|
.1
|
|
Code of Business Conduct.(17)
|
|
21
|
.1
|
|
List of Subsidiaries.
|
|
24
|
.1
|
|
Power of Attorney (see signatures
of this
Form 10-K).
|
|
31
|
.1
|
|
Certification of the Chief
Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31
|
.2
|
|
Certification of the Chief
Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32
|
.1
|
|
Certification of the Chief
Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
32
|
.2
|
|
Certification of the Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
99
|
.1
|
|
Audit Committee Charter of Terayon
Communication Systems, Inc.(17)
|
|
99
|
.2
|
|
Compensation Committee Charter of
Terayon Communication Systems, Inc.(17)
|
|
99
|
.3
|
|
Nominating and Governance
Committee Charter of Terayon Communication Systems, Inc. (17)
|
|
|
|
(1) |
|
Incorporated by reference to exhibits to our Registration
Statement on
Form S-1
filed on June 16, 1998 (File
No. 333-56911). |
|
(2) |
|
Incorporated by reference to exhibits to our Registration
Statement on
Form S-1/A
filed on July 31, 1998 (File
No. 333-56911). |
|
(3) |
|
Incorporated by reference to our Registration Statement on
Form S-3
filed on October 24, 2000 (File
No. 333-48536). |
|
(4) |
|
Incorporated by reference to our Report on
Form 8-K
filed on February 9, 2001. |
|
(5) |
|
Incorporated by reference to our Report on
Form 10-K
filed on April 2, 2001. |
|
(6) |
|
Incorporated by reference to our Report on
Form 10-K
filed on April 1, 2002. |
|
(7) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on May 15, 2002. |
|
(8) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 27, 2003. |
|
(9) |
|
Incorporated by reference to our Report on Registration
Statement on
Form S-8
filed on August 30, 2002. |
|
(10) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on August 14, 2003. |
|
(11) |
|
Incorporated by reference to our Report on
Form 8-K
filed on November 21, 2003. |
112
|
|
|
(12) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on November 9, 2004. |
|
(13) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 15, 2004. |
|
(14) |
|
Incorporated by reference to our Report on
Form 8-K
filed on September 14, 2004. |
|
(15) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 15, 2005. |
|
(16) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on August 9, 2005. |
|
(17) |
|
Incorporated by reference to our Report on
Form 10-K
filed on December 29, 2006. |
|
* |
|
Management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 15(b) of Form
10-K. |
(4)(d)
Financial Statement Schedules
Schedules not included herein have been omitted because they are
not applicable or the required information is in the
consolidated financial statements or notes thereto.
Schedule II Valuation and Qualifying Accounts
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
|
Period
|
|
|
Charges
|
|
|
Deductions
|
|
|
End of Period
|
|
|
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful
accounts U.S.
|
|
$
|
2,809
|
|
|
$
|
(25
|
)
|
|
$
|
(2,540
|
)
|
|
$
|
244
|
|
Reserve for inventory valuation
|
|
|
7,853
|
|
|
|
2,940
|
|
|
|
(5,198
|
)
|
|
|
5,595
|
|
Valuation allowance on deferred
tax assets (1)
|
|
|
229,821
|
|
|
|
|
|
|
|
(43,099
|
)
|
|
|
186,722
|
|
December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful
accounts U.S.
|
|
$
|
2,254
|
|
|
$
|
132
|
|
|
$
|
423
|
|
|
$
|
2,809
|
|
Reserve for inventory valuation
|
|
|
12,267
|
|
|
|
2,732
|
|
|
|
(7,146
|
)
|
|
|
7,853
|
|
Valuation allowance on deferred
tax assets (1)
|
|
|
226,560
|
|
|
|
|
|
|
|
3,261
|
|
|
|
229,821
|
|
December 31, 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful
accounts U.S.
|
|
$
|
6,037
|
|
|
$
|
4,014
|
|
|
$
|
(7,797
|
)
|
|
$
|
2,254
|
|
Allowance for doubtful
accounts International
|
|
|
473
|
|
|
|
|
|
|
|
(473
|
)
|
|
|
|
|
Total Allowance for doubtful
accounts
|
|
|
6,510
|
|
|
|
4,014
|
|
|
|
(8,270
|
)
|
|
|
2,254
|
|
Reserve for inventory valuation
|
|
|
12,291
|
|
|
|
11,550
|
|
|
|
(11,574
|
)
|
|
|
12,267
|
|
Valuation allowance on deferred
tax assets (1)
|
|
|
227,978
|
|
|
|
|
|
|
|
(1,418
|
)
|
|
|
226,560
|
|
|
|
|
(1) |
|
This deduction represents the change in a deferred tax asset. |
113
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has caused this
report to be signed on its behalf by the undersigned, thereunto
due authorized, in County of Santa Clara, State of
California, on the 30th day of March, 2007.
TERAYON COMMUNICATION SYSTEMS, INC.
Jerry D. Chase
Chief Executive Officer
Each person whose signature appears below constitutes Jerry D.
Chase his true and lawful
attorney-in-fact
and agent, each acting alone, with full power of substitution
and re-substitution, for him and in his name, place and stead,
in any and all capacities, to sign any or all amendments to this
Form 10-K,
and to file the same, with all exhibits thereto, and all
documents in connection therewith, with the Commission, granting
unto said
attorney-in-
fact and agent, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as
he might or could do in person, hereby ratifying and confirming
all that said
attorney-in-fact
and agent, each acting alone, or his or her substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
/s/ Jerry
D. Chase
Jerry
D. Chase
|
|
Chief Executive Officer and
Director
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Mark
A. Richman
Mark
A. Richman
|
|
Chief Financial Officer
(Principal Financial Officer,
Principal Accounting Officer)
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Zaki
Rakib
Dr.
Zaki Rakib
|
|
Chairman of the Board of Directors
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Shlomo
Rakib
Shlomo
Rakib
|
|
Director
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Lewis
Solomon
Lewis
Solomon
|
|
Director
|
|
March 30, 2007
|
|
|
|
|
|
/s/ David
Woodrow
David
Woodrow
|
|
Director
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Matthew
Miller
Dr.
Matthew Miller
|
|
Director
|
|
March 30, 2007
|
|
|
|
|
|
/s/ Howard
W.
Speaks, Jr.
Howard
W. Speaks, Jr.
|
|
Director
|
|
March 30, 2007
|
114
Exhibit
Index
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Exhibit Description
|
|
|
3
|
.1
|
|
Amended and Restated Certificate
of Incorporation of Terayon Communication Systems, Inc.(11)
|
|
3
|
.2
|
|
Bylaws of Terayon Communication
Systems, Inc.(11)
|
|
3
|
.3
|
|
Certificate of Amendment to
Amended and Restated Certificate of Incorporation of Terayon
Communication Systems, Inc.(11)
|
|
3
|
.4
|
|
Certificate of Designation of
Series A Junior Participating Preferred Stock.(4)
|
|
4
|
.1
|
|
Specimen Common Stock
Certificate.(2)
|
|
4
|
.2
|
|
Amended and Restated Information
and Registration Rights Agreement, dated April 6, 1998.(1)
|
|
4
|
.3
|
|
Form of Security for Terayon
Communication Systems, Inc.s 5% Convertible
Subordinated Notes due August 1, 2007.(3)
|
|
4
|
.4
|
|
Registration Rights Agreement,
dated July 26, 2000, among Terayon Communication Systems,
Inc. and Deutsche Bank Securities, Inc. and Lehman Brothers,
Inc.(3)
|
|
4
|
.5
|
|
Indenture, dated July 26,
2000, between Terayon Communication Systems, Inc. and State
Street Bank and Trust Company of California, N.A.(3)
|
|
4
|
.6
|
|
Rights Agreement, dated
February 6, 2001, between Terayon Communication Systems,
Inc. and Fleet National Bank.(4)
|
|
10
|
.1
|
|
Form of Indemnification Agreement
between Terayon Communication Systems, Inc. and each of its
directors and officers.(15)
|
|
10
|
.2*
|
|
1995 Stock Option Plan, as
amended.(1)
|
|
10
|
.3*
|
|
1997 Equity Incentive Plan, as
amended.(6)
|
|
10
|
.4*
|
|
1998 Employee Stock Purchase Plan,
as amended.(9)
|
|
10
|
.5*
|
|
1998 Non-Employee Directors
Stock Option Plan, as amended.(9)
|
|
10
|
.6*
|
|
1998 Employee Stock Purchase Plan
Offering for Foreign Employees.(5)
|
|
10
|
.7*
|
|
1999 Non-Officer Equity Incentive
Plan, as amended.(10)
|
|
10
|
.8
|
|
Data Over Cable Service Interface
Specifications License Agreement, dated December 21, 2001,
between Terayon Communication Systems, Inc. and Cable Television
Laboratories, Inc.(6)
|
|
10
|
.9
|
|
Amendment to DOCSIS IPR Agreement
to cover DOCSIS 2.0, dated December 21, 2002, between
Terayon Communication Systems, Inc. and Cable Television
Laboratories, Inc.(6)
|
|
10
|
.10
|
|
Lease Agreement, dated
September 18, 1996, between Sobrato Interests III and
VeriFone.(7)
|
|
10
|
.11
|
|
Triple Net Sublease, dated
April 1, 2002, by and between Terayon Communication
Systems, Inc. and Hewlett-Packard Company.(7)
|
|
10
|
.12
|
|
Aircraft Lease Agreement, dated
February 8, 2002, between Terayon Communication Systems,
Inc. and General Electric Capital Corporation.(8)
|
|
10
|
.13
|
|
First Amendment to Aircraft Lease
Agreement and Security Deposit Pledge Agreement, dated
December 31, 2003, between Terayon Communication Systems,
Inc. and General Electric Capital Corporation.(13)
|
|
10
|
.14
|
|
Notification Letter of Intent to
Terminate or Sublease the Aircraft Lease Agreement, dated
March 12, 2004.(13)
|
|
10
|
.15*
|
|
Employment Agreement, dated
July 22, 2005, between Terayon Communication Systems, Inc.
and Jerry Chase.(16)
|
|
10
|
.16
|
|
Proprietary Information and
Inventions Agreement, dated July 22, 2004, between Terayon
Communication Systems, Inc. and Jerry Chase.(12)
|
|
10
|
.17
|
|
Aircraft Sublease Agreement, dated
August 24, 2004, between Terayon Communication Systems,
Inc. and United Furniture Equipment Rental, Inc.(12)
|
|
10
|
.18*
|
|
Employment Agreement, dated
July 22, 2005, between Terayon Communication Systems, Inc.
and Mark Richman.(16)
|
|
10
|
.19
|
|
Proprietary Information and
Inventions Agreement, dated November 10, 2004, between
Terayon Communication Systems, Inc. and Mark Richman.(15)
|
|
10
|
.20*
|
|
Form of Option Agreement for the
Terayon Communication Systems, Inc. 1997 Equity Incentive
Plan.(14)
|
|
10
|
.21*
|
|
Form of Option Agreement for the
Terayon Communication Systems, Inc. 1998 Non-Employee Directors
Stock Option Plan.(15)
|
|
10
|
.22
|
|
Lease, dated August 9, 2006
between Sobrato Development Companies #871 and Terayon
Communication Systems, Inc.(17)
|
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Exhibit Description
|
|
|
10
|
.23
|
|
Triple Net
Sub-Sublease
Agreement, effective as of August 9, 2006, as amended,
between Terayon Communication Systems, Inc. and Citrix Systems,
Inc.(17)
|
|
10
|
.24*
|
|
Employment Agreement, dated
July 27, 2005, between Terayon Communication Systems, Inc.
and Matt Aden. (16)
|
|
10
|
.25
|
|
Proprietary Information and
Inventions Agreement, dated July 27, 2005, between Terayon
Communication Systems, Inc. and Matthew J. Aden.(16)
|
|
10
|
.26*
|
|
Amendment No. 1 to the
Terayon Communication Systems, Inc. 1997 Equity Incentive
Plan.(17)
|
|
10
|
.27*
|
|
Non-Employee Director Equity
Compensation Policy.(17)
|
|
10
|
.28*
|
|
Non-Employee Director Equity
Compensation Policy Nonstatutory Stock Option Agreement.(17)
|
|
10
|
.29*
|
|
2006 Executive Sales Commission
Plan.(17)
|
|
10
|
.30*
|
|
2006 Section 16 Executive
Officer Bonus Plan.(17)
|
|
10
|
.31
|
|
Termination Agreement, effective
as of March 22, 2007, between Terayon Communications
Systems, Inc. and General Electric Capital Corporation
|
|
14
|
.1
|
|
Code of Business Conduct.(17)
|
|
21
|
.1
|
|
List of Subsidiaries.
|
|
24
|
.1
|
|
Power of Attorney (see signatures
of this
Form 10-K).
|
|
31
|
.1
|
|
Certification of the Chief
Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31
|
.2
|
|
Certification of the Chief
Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32
|
.1
|
|
Certification of the Chief
Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
32
|
.2
|
|
Certification of the Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
99
|
.1
|
|
Audit Committee Charter of Terayon
Communication Systems, Inc.(17)
|
|
99
|
.2
|
|
Compensation Committee Charter of
Terayon Communication Systems, Inc.(17)
|
|
99
|
.3
|
|
Nominating and Governance
Committee Charter of Terayon Communication Systems, Inc. (17)
|
|
|
|
(1) |
|
Incorporated by reference to exhibits to our Registration
Statement on
Form S-1
filed on June 16, 1998 (File
No. 333-56911). |
|
(2) |
|
Incorporated by reference to exhibits to our Registration
Statement on
Form S-1/A
filed on July 31, 1998 (File
No. 333-56911). |
|
(3) |
|
Incorporated by reference to our Registration Statement on
Form S-3
filed on October 24, 2000 (File
No. 333-48536). |
|
(4) |
|
Incorporated by reference to our Report on
Form 8-K
filed on February 9, 2001. |
|
(5) |
|
Incorporated by reference to our Report on
Form 10-K
filed on April 2, 2001. |
|
(6) |
|
Incorporated by reference to our Report on
Form 10-K
filed on April 1, 2002. |
|
(7) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on May 15, 2002. |
|
(8) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 27, 2003. |
|
(9) |
|
Incorporated by reference to our Report on Registration
Statement on
Form S-8
filed on August 30, 2002. |
|
(10) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on August 14, 2003. |
|
(11) |
|
Incorporated by reference to our Report on
Form 8-K
filed on November 21, 2003. |
|
(12) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on November 9, 2004. |
|
(13) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 15, 2004. |
|
(14) |
|
Incorporated by reference to our Report on
Form 8-K
filed on September 14, 2004. |
|
(15) |
|
Incorporated by reference to our Report on
Form 10-K
filed on March 15, 2005. |
|
(16) |
|
Incorporated by reference to our Report on
Form 10-Q
filed on August 9, 2005. |
|
(17) |
|
Incorporated by reference to our Report on
Form 10-K
filed on December 29, 2006. |
|
* |
|
Management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 15(b) of Form
10-K. |