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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ---------------TO ---------------.
COMMISSION FILE NUMBER: 000-24647
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TERAYON COMMUNICATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0328533
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2952 BUNKER HILL LANE
SANTA CLARA, CALIFORNIA 95054
(408) 727-4400
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
-----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of May 14, 2001, registrant had outstanding 67,751,538 shares of Common
Stock.
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains forward-looking statements of Terayon
Communication Systems, Inc. within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are
subject to the "safe harbor" created by those sections. The forward-looking
statements include, but are not limited to: statements related to industry
trends and future growth in the markets for cable modem systems; our strategies
for reducing the cost of our products; our product development efforts; the
effect of GAAP accounting pronouncements on our recognition of revenues; our
future research and development; the timing of our introduction of new products;
the timing and extent of deployment of our products by our customers; and future
profitability. We usually use 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. Discussions containing such forward-looking
statements may be found throughout the document. These forward-looking
statements involve certain risks and uncertainties that could cause actual
results to differ materially from those in such forward-looking statements. We
disclaim any obligation to update these forward-looking statements as a result
of subsequent events. The business risks discussed in Part 1, Item 2 of this
Report on Form 10-Q, among other things, should be considered in evaluating our
prospects and future financial performance.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TERAYON COMMUNICATION SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Balance Sheets as of March 31, 2001 (unaudited)
and December 31, 2000........................................ 3
Consolidated Statements of Operations for the three months 4
ended March 31, 2001 and 2000(unaudited).....................
Consolidated Statements of Cash Flows for the three months
ended March 31, 2001 and 2000 (unaudited).................... 5
Notes to Consolidated Financial Statements.................... 6-9
2
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, December 31,
---------- ------------
2001 2000
---------- ------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents........................... $ 296,734 $ 347,015
Short-term investments.............................. 130,629 215,442
Accounts receivable, less allowance for doubtful
accounts of $7,032 in 2001 and $6,542 in 2000...... 31,114 42,772
Accounts receivable from related parties............ 8,654 17,454
Other current receivables........................... 21,879 32,027
Inventory........................................... 91,544 87,767
Other current assets................................ 4,677 7,021
---------- ----------
Total current assets.............................. 585,231 749,498
Property and equipment, net.......................... 33,545 33,533
Intangibles and other assets......................... 36,783 643,696
---------- ----------
Total assets...................................... $ 655,559 $1,426,727
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................... $ 87,978 $ 123,994
Accrued payroll and related expenses................ 12,627 13,105
Deferred revenues................................... 3,243 4,998
Warranty reserves................................... 6,922 5,925
Accrued purchase price payable...................... -- 14,138
Other accrued liabilities........................... 28,980 25,719
Current portion of long-term debt................... 2,711 10,853
Short-term debt..................................... -- 2,697
Current portion of capital lease obligations........ 113 131
---------- ----------
Total current liabilities......................... 142,574 201,560
Long-term debt....................................... 4,577 119
Long-term portion of capital lease obligations....... 314 358
Other long-term obligations.......................... 6,342 3,444
Convertible subordinated notes....................... 304,403 500,000
Deferred tax liability............................... 503 18,565
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares--5,000,000
Issued and outstanding shares--none................ -- --
Common stock, $.001 par value:
Authorized shares--200,000,000
Issued and outstanding shares--67,601,677 in 2001
and 67,396,539 in 2000............................. 68 68
Additional paid in capital.......................... 1,038,170 1,037,891
Accumulated deficit................................. (837,348) (329,148)
Deferred compensation............................... (5,099) (6,788)
Stockholders' notes receivable...................... -- (3)
Accumulated other comprehensive income (loss)........ 1,055 661
---------- ----------
Total stockholders' equity........................ 196,846 702,681
---------- ----------
Total liabilities and stockholders' equity........ $ 655,559 $1,426,727
========== ==========
See accompanying notes.
3
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended
March 31,
---------------------
2001 2000
--------- ---------
Revenues:
Product revenues.......................... $ 43,889 $ 33,635
Related party product revenues............ 10,095 25,702
--------- --------
Total revenues.......................... 53,984 59,337
--------- --------
Cost of goods sold:
Cost of product revenues.................. 48,914 24,967
Cost of related party product revenues.... 5,939 18,981
--------- --------
Total cost of goods sold................ 54,853 43,948
--------- --------
Gross profit (loss)......................... (869) 15,389
Operating expenses:
Research and development.................. 22,627 10,568
Cost of product development assistance
agreement............................... -- 9,563
In-process research and development....... -- 6,750
Sales and marketing....................... 15,483 7,676
General and administrative................ 7,947 4,185
Goodwill amortization..................... 22,482 6,435
Restructuring costs and asset write-offs 574,744 --
--------- --------
Total operating expenses................ 643,283 45,177
--------- --------
Loss from operations........................ (644,152) (29,788)
Interest income............................. 6,734 1,415
Interest expense............................ (5,744) --
Other expense............................... (438) (21)
--------- --------
Loss before extraordinary gain and
tax benefit (643,600) (28,394)
Income tax benefit.......................... 13,906 --
--------- --------
Loss before extraordinary gain.......... (629,694) (28,394)
Extraordinary gain on early retirement of
debt...................................... 121,494 --
--------- --------
Net loss.................................... ($508,200) ($28,394)
========= ========
Basic and diluted loss per share before
extraordinary gain........................ ($ 9.33) ($0.52)
Extraordinary gain on early retirement of
debt...................................... 1.80 --
--------- --------
Basic and diluted net loss per share.... ($7.53) ($0.52)
========= ========
Shares used in computing basic and
diluted net loss per share................ 67,488 54,512
========= ========
See accompanying notes.
4
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
March 31,
2001 2000
--------- --------
Net cash, provided by (used in) operating
activities................................................. ($60,659) $ 5,807
--------- ---------
Investing activities:
Purchases of short-term investments......................... (108,022) (18,432)
Proceeds from sales and maturities of
short-term investments..................................... 189,835 35,891
Purchases of property and equipment......................... (3,184) (2,602)
Purchase of other assets.................................... -- (525)
Cash received from acquisitions............................. -- 1,415
Cash paid for acquisition of businesses..................... -- (2,515)
--------- ---------
Net cash provided by (used in) investing
activities................................................. 78,629 13,232
--------- ---------
Financing activities:
Principal payments on capital leases........................ (30) (1)
Principal payments on long-term debt........................ (44) (31)
Exercise of options and warrant to purchase
common stock............................................... 279 2,257
Proceeds from issuance of common stock...................... -- 1,014
Retirement of debt.......................................... (68,459) --
--------- ---------
Net cash provided by financing activities................ (68,251) 3,239
--------- ---------
Net (decrease) increase in cash and cash
equivalents................................................ (50,281) 22,278
Cash and cash equivalents at beginning of period 347,015 32,398
--------- ---------
Cash and cash equivalents at end of period.................. $296,734 $ 54,676
========= =========
See accompanying notes.
5
TERAYON COMMUNICATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Terayon Communication Systems, Inc. (the Company) was incorporated under
the laws of the State of California on January 20, 1993. In October 1997, the
Company changed its legal name from Terayon Corporation. In July 1998, the
Company reincorporated in the State of Delaware.
The Company develops, markets and sells broadband access systems that
enable cable operators and other providers of broadband access services to
deploy broadband access services over cable, copper wire and wireless systems.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and in accordance with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) necessary for a fair presentation of the financial
statements at March 31, 2001 and for the three months ended March 31, 2001 and
2000 have been included.
Results for the three months ended March 31, 2001 are not necessarily
indicative of results for the entire fiscal year or future periods. These
financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Company's Form
10-K dated April 2, 2001, as filed with the U.S. Securities and Exchange
Commission and as amended on April 30, 2001. The accompanying balance sheet at
December 31, 2000 is derived from audited financial statements at that date.
Reclassifications
Certain amounts in the 2000 financial statements have been reclassified to
conform to the 2001 presentation.
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 three months 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 accounts for investments in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". Management determines the appropriate
classification of debt securities at the time of purchase and reevaluates such
designation as of each balance sheet date. The Company's 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 amortized cost which approximates 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 equity securities at either
March 31, 2001 or December 31, 2000.
Other Current Receivables
6
As of March 31, 2001 and December 31, 2000, other current receivables
includes approximately $14.0 million and $20.1 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):
March 31, December 31,
--------- ------------
2001 2000
------ ------
Finished goods..... $62,324 $64,987
Work-in-process.... 2,388 1,736
Raw materials...... 26,832 21,044
------- -------
$91,544 $87,767
======== ========
Net Loss Per Share
Basic and diluted net loss per share were computed using the weighted
average number of common shares outstanding. Options to purchase 37,597,007 and
21,489,536 shares of common stock were outstanding at March 31, 2001 and
December 31, 2000, respectively, and warrants to purchase 2,584,700 and
2,384,700 shares of common stock were outstanding at March 31, 2001 and December
31, 2000, respectively, but were not included in the computation of diluted net
loss per share, since the effect would be antidilutive.
Comprehensive Net Loss
Accumulated other comprehensive income presented in the accompanying
consolidated balance sheets consists of net unrealized gains on short-term
investments and accumulated net translation losses.
Derivative Financial Instruments
As of January 1, 2001, the Company adopted Financial Accounting Standards
Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities (Statement 133). As a result of the adoption of Statement 133, the
Company will recognize all derivative financial instruments, such as foreign
exchange contracts, in the consolidated financial instruments at fair value
regardless of the purpose or the intent for holding the instrument. Changes in
the fair value of derivative financial instruments are either recognized
periodically in income or in shareholders' equity as a component of
comprehensive income depending on whether the derivative financial instrument
qualifies for hedging accounting, and if so, whether it qualifies as a fair
value hedge or cash flow hedge. Generally, changes in fair values of derivatives
accounted for as fair value hedges are recorded in income along with the
portions of the changes in the fair values of the hedged items that relate to
the hedged risk(s). Changes in fair values of derivatives accounted for as cash
flow hedges, to the extent they are effective as hedges, are recorded in other
comprehensive income net of deferred taxes. Changes in fair value of derivatives
used as hedges of the net investment in foreign operations are reported in other
comprehensive income as part of the cumulative translation adjustment. Changes
in fair value of derivatives not qualifying as hedges are reported in income.
As the Company had no derivative financial instruments outstanding as of
March 31, 2001 or December 31, 2000, the adoption of Statement 133 had no impact
on the financial statements of the Company at January 1, 2001.
7
2. Segments of an Enterprise and Related Information
The Chief Executive Officer has been identified as the Chief Operating
Decision Maker (CODM) because he has final authority over resource allocation
decisions and performance assessment. The CODM allocates resources to each
segment based on their business prospects, competitive factors, revenues and
operating results.
The Company views its business as having two principal operating segments:
Cable Broadband Access Systems ("Cable") and Telecom Carrier Access Systems
("Telecom"). The Cable segment consists primarily of the TeraComm system, the
CherryPicker Digital Video Management Systems, and the Multigate Telephony and
Data Access Systems which are sold primarily to cable operators for the
deployment of data, video and voice services over the existing cable
infrastructure. The Telecom segment consists primarily of the Miniplex DSL
Systems, the IPTL Converged Voice and Data Service System and the Highlink,
which are sold to providers of broadband services for the deployment of voice
and data services over the existing copper wire infrastructure.
Information on reportable segments for the three months ended March 31,
2001 and 2000 is as follows (in thousands):
Three Months Ended
March 31,
------------------------
2001 2000
------------ -----------
Cable Broadband Access Segment:
Revenues $ 44,366 $ 57,116
Operating loss (385,197) (28,519)
Total assets (637,654) 445,441
Telecom Broadband Access Segment:
Revenues 9,618 2,221
Operating loss (258,955) (1,269)
Total assets 17,905 4,715
Operating loss:
Operating loss by reportable segments (644,152) (29,788)
Unallocated amounts:
Interest and other income, net 552 1,394
Income tax benefit 13,906 --
Extraordinary gain 121,494 --
---------- --------
Net loss ($508,200) ($28,394)
========== ========
Geographic areas:
Revenues:
United States $ 19,585 $ 11,916
Canada 11,243 25,702
Europe and Israel 9,194 12,616
Asia 13,920 7,286
South America 42 1,817
---------- --------
Total $ 53,984 $ 59,337
========== ========
Assets:
United States $ 574,138 $248,440
Canada 8,654 13,104
Europe and Israel 63,176 188,612
Asia 284 --
South America 9,307 --
---------- --------
Total $ 655,559 $450,156
========== ========
8
Two customers accounted for 10% or more of total revenues (13% and 13%) for
the three months ended March 31, 2001. Two customers accounted for 10% or more
of total revenues (25% and 19%) for the three months ended March 31, 2000. No
other customer accounted for more than 10% of revenues during these periods.
3. Restructuring and Asset Write-offs
In January 2001, the Company's Board of Directors approved a restructuring
plan to streamline the Company's organizational structure worldwide. The Company
recorded a restructuring charge of $2.9 million in the first quarter. Over the
first half of 2001, 124 employee positions are expected to be eliminated in the
United States and Israel. As of March 31, 2001, 74 employees have been
terminated and the Company paid a total of approximately $495,000 for severance
costs. As of March 31, 2001 the Company had $2.4 million in accrued
restructuring which related to excess facility lease costs.
The Company has evaluated the carrying value of certain long-lived assets
and acquired intangibles, consisting primarily of goodwill recorded on its
balance sheet at March 31, 2001. Pursuant to accounting rules, the majority of
the goodwill was recorded based on stock prices at the time acquisition
agreements were executed and announced. Goodwill and other long-lived assets are
reviewed for impairment whenever events such as product discontinuance, plant
closures, product dispositions or other changes in circumstances indicate that
the carrying amount may not be recoverable. When such events occur, the Company
compares the carrying amount of the assets to undiscounted expected future cash
flows. If this comparison indicates that there is an impairment, the amount of
the impairment is based on the fair value of the assets, typically calculated
using discounted expected future cash flows. The discount rate applied to these
cash flows is based on the Company's weighted average cost of capital, which
represents the blended after-tax costs of debt and equity.
Downturns in the broadband access and telecommunications markets have
created unique circumstances with regard to the assessment of goodwill and other
intangible assets for recoverability. As a result of management's decision to
suspend certain product lines and product development efforts during the first
quarter of 2001, intangible assets totaling $165.8 million relating to certain
acquisitions were written off. Further, the aforementioned downturns in the
principal markets in which the Company operates, have negatively impacted the
forecasted revenues and cash flows from certain other businesses acquired during
1999 and 2000. In accordance with the Company's policy, the comparison of the
discounted expected future cash flows to the carrying amount of the related
intangible assets resulted in a write-down of these assets of $406.0 million.
4. Convertible Subordinated Notes
In February 2001, the Company repurchased approximately $195.6 million of
its Convertible Subordinated Notes for $68.5 million in cash, resulting in an
extraordinary gain of approximately $121.5 million.
5. Stock Options
On February 14, 2001, the Company's Board of Directors granted options to
purchase a total of 15,049,866 shares at $6.8125 per share. The options vest at
various rates up to four years, however the options will not be exercisable
until November 14, 2001.
6. Stockholder Rights Plan
In February 2001, the Company's 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 percent or more of the Company's Common Stock or announces a
tender offer for 15 percent or more of the Company's Common Stock. If a person
or group acquires 15 percent or more of the Company's Common Stock, all
rightsholders except the buyer will be entitled to acquire the Company's Common
Stock at a discount. The Board may terminate the Rights Plan at any time or
redeem the rights prior to the time a person or group acquires more than 15
percent of the Company's Common Stock.
7. Common Stock Warrant
In February 2001, the Company issued a warrant to purchase 200,000 shares
of the Company's common stock at a price of $5.4375 per share in connection with
the December 2000 acquisition of TrueChat, Inc. Under terms of the warrant
100,000 shares are vested and exercisable immediately and the remaining 100,000
shares vest and become exercisable at the rate of 1/24/th/ per month, beginning
January 31, 2001. The fair value of the warrant of approximately $682,000 was
added to the purchase price of TrueChat, Inc.
8. Debt Obligations
In June 2000, Mainsail Networks issued a $3,520,000 Senior Secured
Promissory Note. The note is secured by the general assets of Mainsail Networks
and bears an interest rate equal to ten percent per annum. Interest is accrued
monthly and the note automatically matures and is due and payable on May 31,
2001. The promissory note was subsequently paid in full on April 30, 2001.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
our consolidated financial statements and notes thereto.
Overview
We develop, market and sell broadband access systems that enable cable
operators and other providers of broadband services to cost-effectively deploy
reliable voice, video and data services over cable, copper wire, and satellite
systems.
Since our inception in January 1993, we have focused on the development of
our patented S-CDMA (Synchronous Code Division Multiple Access) technology, as
well as certain other core technologies, to enable broadband transmission of
data over cable networks. We began the specification and design of our first
ASIC (Application Specific Integrated Circuit) in October 1994 and produced the
first version of this ASIC in September 1996. At the same time, we developed an
end-to-end broadband access system, the TeraComm system, around the ASIC. We
commenced volume shipments of our TeraComm system in the first quarter of 1998.
We sell our products to cable operators and other providers of broadband
services through direct sales forces in North America, South America, Europe and
Asia. We also distribute our products via distributors and system integrators.
Our strategy is to supply the leading providers of broadband services worldwide.
Consistent with this strategy, our initial target market consisted of the ten
largest cable companies in each major geographic area. In most markets, a small
number of large cable operators often provide services to a majority of the
subscribers in a specific region and thus influence the purchase decisions of
smaller cable operators. In North America, three of the largest cable operators,
Rogers Cable Inc. (formerly Rogers Cablesystems Limited), Shaw and TCA Cable TV
(a subsidiary of Cox Communications, Inc.), are using our TeraComm system. In
Europe, our TeraComm system is being used by UPC, one of Europe's largest
broadband communications companies. Companies currently using our DSL products
include major ILEC's (Incumbent Local Exchange Carriers) in the United States,
including Southwestern Bell Communications, Bell South, and Verizon. As a result
of the nature of the cable industry and our strategic focus, a small number of
customers have accounted for the majority of our revenues to date, and we expect
that the majority of our revenues will continue to be generated from a small
number of customers for the foreseeable future. During the three months ended
March 31, 2001, two customers (one of which is a related party) accounted for
approximately 26% of our revenues. This compares to approximately 44% of our
revenues from two customers during the same period in 2000. We anticipate that
the timing and maturity of these customers' deployments of the TeraComm system
will result in variations in revenues generated from these customers.
The evolution of broadband has resulted in cable television operators,
providers of telephone service and other service providers seeking to provide a
bundle of voice, data and video services to their residential and commercial
subscribers over existing and new infrastructures. Through a series of recent
acquisitions, we have expanded our portfolio of broadband products to support
high-speed delivery of voice, data and video services over cable, DSL and
wireless.
. In September 1999, we acquired Imedia Corporation (Imedia) and the
CherryPicker digital video management system.
. In November 1999, we acquired Radwiz Ltd. (Radwiz), a provider of
communication access systems based on high-speed IP routing integrated with
telephony.
. In January 2000, we acquired Telegate Ltd. (Telegate), a developer and
manufacturer of telephony and data access platforms that are deployed by service
providers to deliver efficient carrier-class voice services over cable.
. In April 2000, we acquired Combox Ltd. (Combox), a manufacturer of broadband
data systems and satellite communications based on international standards.
Combox's
10
cable data access systems conform to the growing EuroModem international
specification, based on the Digital Video Broadcasting (DVB) standard.
. In April 2000, we acquired certain assets of Internet Telecom Ltd.
(Internet Telecom), a supplier of PacketCable and other standards-based, voice-
over IP systems and technologies.
. In April 2000, we acquired Ultracom Communications Holdings (1995) Ltd.
(Ultracom), a supplier of broadband systems on silicon.
. In April 2000, we acquired Access Network Electronics, a division of Tyco
Electronics Corporation (ANE), a producer of DSL systems that provide multiple
phone lines over existing copper telephony of a single pair of copper wires.
. In September 2000, we acquired Mainsail Networks, Inc. (Mainsail), a
developer of broadband networks that enable telecommunication carriers to
deliver multiple services over a single network infrastructure.
. In September 2000, we acquired Digital Transmission Equipment (Digitrans), a
provider of digital equipment solutions that enable broadcasters, satellite
operators and television system operators to optimize network services.
. In December 2000, we acquired TrueChat, Inc. (TrueChat), a developer of
digital communications systems that enable multimedia teleconferencing and
provide increased control over teleconference parameters.
All of our acquisitions were accounted for under the purchase method of
accounting and, accordingly, this Report on Form 10-Q presents our financial
results through the entire period and combined with results from the acquired
entities for the portion of the period following the date of the respective
closings. As a result, the information contained herein may not be comparable to
results in previous periods.
The intensely competitive nature of the market for broadband access systems
has resulted in significant price erosion over time. We have experienced and
expect to continue to experience downward pressure on our unit ASP (average
selling price). A key component of our strategy is to decrease the cost of
manufacturing our products to offset the decline in ASP. We intend to continue
to implement cost reduction efforts, including the further integration of ASIC
components, other design changes and manufacturing efficiencies.
We sustained a net loss of $180.8 million for the year ended December 31,
2000 and a net loss of $508.2 million for the three months ended March 31, 2001,
which included an extraordinary gain of $121.5 million on the early retirement
of debt. We had an accumulated deficit of $837.3 million as of March 31, 2001.
Our operating expenses are based in part on our expectations of future sales,
and we expect that a significant portion of our expenses will be committed in
advance of sales. We expect to continue to increase our expenditures in
technical development and sales and marketing as we engage in activities related
to product enhancement, cost reduction and increasing market penetration. In
addition, we anticipate that our expenses will increase as a result of the
expenses associated with our recent acquisitions, including amortization.
Additionally, we expect to increase our capital expenditures and other operating
expenses in order to support our operations. We anticipate that we will spend
approximately $30 million to $35 million on capital expenditures and
approximately $90 million to $100 million on research and development during the
year ending December 31, 2001. Anticipated capital expenditures consist of
purchases of additional test equipment to support higher levels of production
and computer hardware, furniture and leasehold improvements for our facilities,
expanded geographical implementation of an enterprise resource planning system
and software and equipment for newly hired employees. As a result of these
anticipated increased operating expenses, we expect to continue to incur losses
for the foreseeable future.
Results of Operations
Three Months Ended March 31, 2001 and 2000
11
Revenues. Revenues consist primarily of sales of broadband access systems
to new and existing customers providing broadband access services over cable and
copper wire infrastructures. Our revenues decreased to $53.9 million for the
three months ended March 31, 2001 from $59.3 million in 2000. The decreased
revenues in 2001 were largely attributable to the general economic downturn,
which affected our customers' sales to end users and their rebalancing of their
inventory levels.
We sell our products directly to broadband access service providers, system
resellers and distributors. Revenues related to product sales are generally
recognized when: (1) persuasive evidence that an arrangement exists, (2)
delivery has occurred or services have been rendered, (3) the seller's price to
the buyer is fixed or determinable, and (4) collectablity is reasonably assured.
A provision is made for estimated product returns as product shipments are made.
Our existing agreements with our system resellers and distributors do not
contain price protection provisions and do not grant return rights beyond those
provided by our standard warranty.
Cost of Goods Sold. Cost of goods sold consists of direct product costs as
well as the cost of our manufacturing operations group. The cost of the
manufacturing operations group includes assembly, test and quality assurance for
products, warranty costs and associated costs of personnel and equipment. In the
three months ended March 31, 2001, we incurred cost of goods sold of $54.8
million compared to $43.9 million in 2000. Cost of goods sold for the three
months ended March 31, 2001 also included approximately $ 11.8 million of
amortization of acquired intangible assets as compared to $6.3 million for 2000.
Our cost of goods sold increased in the three months ended March 31, 2001,
compared to 2000, primarily due to higher indirect manufacturing costs and the
increase in amortization expense relating to acquired intangible assets.
Gross Profit. We incurred a gross loss of $869,000 for the three months
ended March 31, 2001 compared to a gross profit of $15.4 million in 2000. Gross
profit for the first quarter of 2001 declined as the result of lower revenues, a
shift in the mix of product shipped, higher indirect manufacturing costs and the
increase in amortization expense relating to acquired intangible assets.
Our gross profit is influenced by the level of sales of products of
acquired companies, which produce varying gross profit results. We expect that
our gross profit will fluctuate in future periods as a result of these
acquisitions.
The broadband access systems market has been characterized by erosion of
average selling prices. We expect this to continue. This erosion is due to a
number of factors, including competition, rapid technological change and price
performance enhancements. The ASPs for our products may be lower than expected
as a result of competitive pricing pressures, our promotional programs and
customers who negotiate price reductions in exchange for longer term purchase
commitments. We anticipate that ASPs and gross margins for our products will
decrease over product life cycles.
Our gross profit is also influenced by the sales mix of TeraLink Master
Controllers, TeraLink Gateways and TeraPro cable modems and the maturity of
TeraComm system deployments in any quarter. TeraPro cable modems have lower
margins than the TeraLink Master Controllers and TeraLink Gateway headend
products. New deployments of TeraComm systems typically include a higher mix of
headend equipment and involve smaller quantities of product sold. Products sold
in connection with new deployments thus generally are sold at higher margins
than products associated with more mature deployments of the TeraComm system,
which generally involve larger quantities of products, primarily cable modems.
We expect that the introduction of new customers and the relationship of
revenues generated from the sale of TeraPro cable modems to our overall revenues
will result in fluctuations in our gross profit in future periods.
Research and Development. Research and development expenses consist
primarily of personnel costs, as well as prototype materials, equipment and
supplies required to develop and to enhance our products. Research and
development expenses increased to $22.6 million in the three months ended March
31, 2001 from $10.6 million in 2000. The increase in research and development
expenses was primarily the result of increased personnel costs and the
intangible amortization of $2.1 million. The increased personnel costs were a
result of the expansion of our employee base
12
and the inclusion of employees from acquired companies as we continued to focus
our efforts on developing new products. We intend to continue our investment in
research and development as a result of these and other activities.
Cost of Product Development Assistance Agreement. In March 1999, we entered
into a one-year Product Development Assistance Agreement with Rogers
Communications Inc. Under the terms of the Development Agreement, Rogers was
obligated to assist us with the characterization and testing of our subscriber-
end and head-end voice-over-cable equipment. In addition, Rogers was obligated
to provide us with technology to assist us with our efforts to develop high
quality, field proven technology solutions that are DOCSIS- compliant and packet
cable-compliant. The Development Agreement had a term of one year. In
consideration of Rogers entering into the Development Agreement, we issued
Rogers two fully vested and non-forfeitable warrants, each to purchase 2.0
million shares of common stock on a cashless basis. One warrant had an exercise
price of $0.50 per share and one warrant had an exercise price of $18.50 per
share. The fair value of the two warrants was approximately $45.0 million and
resulted in a non-cash charge included in operations over the one-year term of
the Development Agreement. As a result of the Development Agreement, our results
for the three months ended March 31, 2000 include a non-cash charge of $9.6
million compared to none in 2001. In March 2000, Rogers purchased 3,687,618
shares of our common stock on a net exercise basis, resulting in no proceeds to
us.
In-Process Research and Development. In-process technology acquired
relating to the acquisition of Telegate, valued at approximately $7.5 million,
consisted primarily of major additions to Telegate's core technology, which
related to Telegate's planned development of new features. The majority of the
intended functionality of these new features was not supported by Telegate's
existing technology. Intended new features include: connection on demand
functionality to extend the product's ISDN compatibility; the ability to use
cordless technology for either voice or data applications; and, a subscriber end
unit that can be used in multi- dwelling units. Charges of approximately $6.8
million relating to the in-process technology at Telegate as of the date of
acquisition were recognized during the three months ended March 31, 2000. The
projects identified as in-process will require additional effort in order to
establish technological feasibility. These projects have identifiable
technological risk factors that indicate that even though successful completion
is expected, it is not assured.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions for sales personnel, marketing and support personnel,
and costs related to trade shows, consulting and travel. Sales and marketing
expenses increased to $15.5 million in the three months ended March 31, 2001
from $7.7 million in 2000. The increase in sales and marketing expenses was due
to increased payroll costs related to additional sales and support personnel
necessary to support the expansion of our customer base, increased payroll and
associated costs from the expansion in our employee base resulting from acquired
companies and increased commissions related to higher sales. Intangible
amortization accounted for approximately $1.3 million of the increase. We expect
sales and marketing expenses to continue to increase as we expand our
operations.
General and Administrative. General and administrative expenses primarily
consist of salary and benefits for administrative officers and support
personnel, travel expenses, legal, accounting and consulting fees. General and
administrative expenses increased to $7.9 million for the three months ended
March 31, 2001 from $4.2 million in 2000. The increase was primarily due to
costs associated with the increased infrastructure required to support our
expanded activities and increased personnel costs associated with acquired
companies and the intangible amortization in the amount of $1.3 million. We
expect general and administrative expenses will continue to increase in the near
term as a result of these factors.
Goodwill Amortization. Goodwill arising from acquisitions completed during
2000 totaled $417.1 million and accounted for $22.5 million in goodwill
amortization in the three months ended March 31, 2001 as compared to $6.4
million in the comparable period in 2000. Amortization of goodwill and other
intangibles related to acquisitions will increase in future periods due to the
full year impact of the acquisitions made during 2000.
13
Restructuring Costs and Asset Write-offs. In January 2001, the Company's
Board of Directors approved a restructuring plan to streamline the Company's
organizational structure worldwide. The Company recorded a restructuring charge
of $2.9 million in the first quarter. Over the first half of 2001, 124 employee
positions are expected to be eliminated in the United States and Israel. As of
March 31, 2001, 74 employees have been terminated and the Company paid a total
of approximately $495,000 for severance costs. As of March 31, 2001 the Company
had $2.4 million in accrued restructuring which related to excess facility lease
costs.
The Company has evaluated the carrying value of certain long-lived assets
and acquired intangibles, consisting primarily of goodwill recorded on its
balance sheet at March 31, 2001. Pursuant to accounting rules, the majority of
the goodwill was recorded based on stock prices at the time acquisition
agreements were executed and announced. Goodwill and other long-lived assets are
reviewed for impairment whenever events such as product discontinuance, plant
closures, product dispositions or other changes in circumstances indicate that
the carrying amount may not be recoverable. When such events occur, the Company
compares the carrying amount of the assets to undiscounted expected future cash
flows. If this comparison indicates that there is an impairment, the amount of
the impairment is based on the fair value of the assets, typically calculated
using discounted expected future cash flows. The discount rate applied to these
cash flows is based on the Company's weighted average cost of capital, which
represents the blended after-tax costs of debt and equity.
Downturns in the broadband access and telecommunications markets have
created unique circumstances with regard to the assessment of goodwill and other
intangible assets for recoverability. As a result of management's decision to
suspend certain product lines and product development efforts during the first
quarter of 2001, intangible assets totaling $165.8 million relating to certain
acquisitions were written off. Further, the aforementioned downturns in the
principal markets in which the Company operates, have negatively impacted the
forecasted revenues and cash flows from certain other businesses acquired during
1999 and 2000. In accordance with the Company's policy, the comparison of the
discounted expected future cash flows to the carrying amount of the related
intangible assets resulted in a write-down of these assets of $406.0 million.
Interest Income and Expense. Interest income was $6.7 million for the three
months ended March 31, 2001 compared to $1.4 million in 2000. Interest expense
was $5.7 million for the three months ended March 31, 2001 compared to none in
2000. The increases to interest income and interest expense were due to the sale
of $500 million of 5% Convertible Subordinate Notes due in August 2007,
resulting in net proceeds to us of approximately $484.5 million. In February
2001, we repurchased approximately $195.6 million in principal of the notes, at
an extraordinary gain of approximately $121.5 million. This repurchase will
reduce interest income and expense in future periods.
Other Expense. Other expense for the three months ended March 31, 2001
consisted primarily of amortization of debt issuance costs.
Income Taxes. We have generated operating losses since our inception. Due
to our inability to recognize a benefit from these operating losses, we had no
provision for income taxes for the three months ended March 31, 2000 and a
benefit of $14.4 million for the three months ended March 31, 2001 which
consisted of a reduction of deferred tax liabilities related to the Combox and
Ultracom acquisitions and a $485,000 provision for foreign taxes.
Operating Segment Information
We view our business as having two principal operating segments: Cable
Broadband Access Systems and Telecom Access Systems. The Cable segment consists
primarily of the TeraComm system, the CherryPicker Digital Video Management
Systems, and the Multigate Telephony and Data Access Systems which are sold
primarily to cable operators for the deployment of data, video and voice
services over the existing cable infrastructure. The Telecom segment consists
primarily of the Miniplex DSL Systems, the IPTL Converged Voice and Data Service
System and the Highlink, which are sold to providers of broadband services for
the deployment of voice and data services over the existing copper wire
infrastructure. We sell directly to providers of broadband access services and
to distributors and resellers throughout the world.
Cable. In 2001, the revenues for the cable segment were largely
attributable to continuing deployments of our TeraComm system by new and
existing customers. In addition, sales of acquired products contributed to the
revenues. Operating losses increased as a result of the increase in intangibles
amortization.
Telecom. Revenues and operating losses in 2001 were attributable to the
operations of Radwiz, acquired in November 1999, and ANE, acquired in April
2000.
Litigation
In September 1999, Imedia, now our subsidiary, was named as a defendant in
a case alleging that Imedia breached its term sheet agreement with the
plaintiffs by negotiating with us while a no-shop provision was in place and
refusing to allow the plaintiffs to invest in Imedia. The plaintiffs are seeking
damages in excess of $12.0 million. As part of the terms of the Imedia Agreement
and Plan of Merger and Reorganization, shares of our common stock to be issued
to the former shareholders of Imedia were placed in escrow to indemnify us for
any damages that are directly or indirectly suffered as a result any claim
brought by any person who was a prospective investor in Imedia and was not a
security holder of Imedia on the
14
closing date of the Imedia acquisition. The value of the escrowed shares was
approximately $10.0 million based on the market value of our common stock on the
closing date.
On or about September 5, 2000, the Company received an amended complaint
("Complaint") in a matter captioned Evergreen Canada Israel Management, Ltd. v.
Imedia Corporation, case no. 306185, pending in the Superior Court of the State
of California for the City and County of San Francisco. The Complaint alleges
both (i) intentional interference with contractual relations and (ii)
intentional interference with prospective economic advantage against the
Company, claiming that the Company formed and operated a conspiracy to deprive
plaintiffs of the opportunity to invest in Imedia, a company that the Company
acquired in 1999. Plaintiffs argue that, prior to the Company's purchase of the
Imedia shares, the Company knew of an alleged, pre-existing financing agreement
between plaintiffs and Imedia that contained a "no shop" clause, prohibiting
Imedia from seeking or obtaining financing from any other sources, including
(apparently, in plaintiffs' view) a prohibition against Imedia selling its own
stock or engaging in related transactions that preceded the acquisition. The
Company was subsequently served with the Complaint and has filed a demurrer
challenging the legal sufficiency of the two causes of action. The hearing
occurred January 16, 2001, prior to a final ruling from the court, plaintiffs
amended the complaint. The case is in its initial stages, and no trial date has
been established. We have reviewed the amended allegations made by the
plaintiffs, and we intend to vigorously defend the lawsuit. We do not believe
that the outcome will have a negative impact on our financial position, results
of operations or cash flows.
In April 2000, a lawsuit against us and certain of our officers and
directors, entitled Birnbaum v. Terayon Communication Systems, Inc., was filed
in the United States District Court for the Central District of California. The
venue for the lawsuit was moved to the Northern District of California. The
plaintiff purports to be suing on behalf of a class of stockholders who
purchased or obligated themselves to purchase our securities during the period
from February 2, 2000 to April 11, 2000. The complaint alleges that the
defendants violated the federal securities laws by issuing materially false and
misleading statements and failing to disclose material information regarding our
technology. Several other lawsuits similar to the Birnbaum suit have since been
filed. On August 24, 2000, the lawsuits against us and other named individual
defendants were consolidated in the U.S. District Court of the Northern District
of California and lead plaintiffs and lead plaintiffs' counsel was appointed
pursuant to the Private Securities Litigation Reform Act. On September 21, 2000,
plaintiffs filed a Consolidated Class Action Complaint for violation of federal
securities laws. The consolidated complaint contains allegations nearly
identical to the Birnbaum suit. Defendants filed a motion to dismiss the
consolidated complaint on October 30, 2000, and plaintiffs filed an opposition.
On January 8, 2001, the court held a hearing on defendants' motion, and on March
14, 2001, the court, in part, dismissed the consolidated complaint and granted
plaintiffs thirty (30) days to file a new, amended complaint. Plaintiffs filed
an amended complaint on April 13, 2001. Defendants intend on filing a motion to
dismiss this amended complaint. The lawsuits seek an unspecified amount of
damages, in addition to other forms of relief. We consider the lawsuits to be
without merit and we intend to defend vigorously against these allegations.
However, the litigation could prove to be costly and time consuming to defend,
and there can be no assurances about the eventual outcome.
On October 18, 2000, a lawsuit was filed against the Company and the
individual defendants (Zaki Rakib, Selim Rakib, and Raymond Fritz) in the
superior court of San Luis Obispo County, California. This lawsuit is titled
Bertram v. Terayon Communications Systems, Inc., Case No. CV 000900. The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action under
California Business & Professions Code Sections 17200 et seq. and 17500 et seq.
for unlawful business practices, unfair and fraudulent business practices, and
false and misleading advertising. Plaintiffs purport to bring the action on
behalf of themselves and as representatives of "all persons or entities in the
State of California and such other persons or entities outside California that
have been and are adversely affected by defendants' activity, and as the Court
shall determine is not inconsistent with the exercise of the Court's
jurisdiction." Plaintiffs seek equitable and injunctive relief. Defendants filed
a motion to dismiss the complaint
15
on January 19, 2001. A hearing on defendants' motion was held March 26, 2001,
and the court granted Defendants' motion to dismiss the action and denied
Plaintiffs' motion requesting remand. On April 5, 2001, Defendants moved for an
order requiring further proceedings, if any, to take place in the Northern
District of California. Plaintiffs' did not oppose this motion, and Defendants
now understand that Plaintiffs will consent to entry of the requested order. The
parties are now preparing a stipulation to that effect. The Company believes
that these allegations, as with the allegations in the federal securities case,
are without merit and intends to contest the matter vigorously.
Liquidity and Capital Resources
At March 31, 2001, we had approximately $296.7 million in cash and cash
equivalents, $130.6 million in short-term investments and a $2.5 million
revolving line of credit. There were no outstanding borrowings under the line of
credit.
In July 2000, we issued $500 million of 5% Convertible Subordinated Notes
due in August 2007, resulting in net proceeds to us of approximately $484.5
million. The notes are our general unsecured obligation and are subordinated in
right of payment to all of our existing and future senior indebtedness and to
all of the liabilities of our subsidiaries. The Convertible Notes are
convertible into shares of our common stock at a conversion price of $84.01 per
share at any time on or after October 24, 2000 through maturity, unless
previously redeemed or repurchased. Interest is payable semiannually. Debt
issuance costs related to the notes were approximately $15.5 million.
In February 2001, we repurchased approximately $195.6 million in principal
of the notes, for $68.5 million in cash resulting in an extraordinary gain of
approximately $121.5 million.
Cash used by operating activities for the three months ended March 31, 2001
was $60.7 million compared to $5.8 million provided in 2000. In March 2001,
operating activities included a significant amount for intangible amortization
compared to the same period of 2000. Cash used by investing activities was $78.6
million in 2001 compared to $13.2 million in 2000. This amount included a
significant amount for the purchase and sales of short-term investments in March
2001 compared to the same period of 2000. Investing activities consisted
primarily of the purchase and sale of short-term investments in 2001 and 2000.
Cash used by financing activities was $68.3 million in 2001 compared to $3.2
million provided in 2000. In 2001, financing activities consisted primarily of
the retirement of convertible subordinated debt.
As of March 31, 2001, we had approximately $102.6 million of purchase
obligations. We anticipate that these obligations will become payable at various
times through third quarter 2002. We intend to make these payments out of
available working capital. In the fourth quarter of 2000 we recorded a special
charge of $19.0 million for vendor cancellation fees relating to purchase
obligations.
We believe that our current cash balances will be sufficient to satisfy our
cash requirements for at least the next 12 months.
Recent Financial Accounting Pronouncements
As of January 1, 2001, the company adopted Financial Accounting Standards
Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities (Statement 133), which was issued in June 1998 and its amendments
Statement 137, Accounting for Derivative Instruments and Hedging Activities-
Deferral of the Effective Date of FASB No. 133 and 138, Accounting for
Derivative Instruments and Certain Hedging Activities issued in June 1999 and
June 2000, respectively (collectively referred to as Statement 133).
As a result of the adoption of Statement 133, the Company will recognize
all derivative financial instruments, such as foreign exchange contracts, in the
consolidated financial instruments at fair value regardless of the purpose or
the intent for holding the instrument. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or in
shareholders' equity as a component of comprehensive income depending on whether
the
16
derivative financial instrument qualifies for hedging accounting, and if so,
whether it qualifies as a fair value hedge or cash flow hedge. Generally,
changes in fair values of derivatives accounted for as fair value hedges are
recorded in income along with the portions of the changes in the fair values of
the hedged items that relate to the hedged risk(s). Changes in fair values of
derivatives accounted for as cash flow hedges, to the extent they are effective
as hedges, are recorded in other comprehensive income net of deferred taxes.
Changes in fair value of derivatives used as hedges of the net investment in
foreign operations are reported in other comprehensive income as part of the
cumulative translation adjustment. Changes in fair value of derivatives not
qualifying as hedges are reported in income.
As the Company had no derivative financial instruments outstanding as of
December 31, 2000, the adoption of Statement 133 had no impact on the financial
statements of the Company at March 31, 2001.
RISK FACTORS
We Have a Limited Operating History and a History of Losses.
We have a limited operating history, and it is difficult to predict our
future operating results. We began shipping products commercially in June 1997,
and we only have been shipping products in volume since the first quarter of
1998. As of March 31, 2001, we had an accumulated deficit of $837.3 million. We
believe that we will continue to experience net losses for the foreseeable
future. Most of our expenses are fixed in advance, and we generally are unable
to reduce our expenses significantly in the short term to compensate for any
unexpected delay or decrease in anticipated revenues. We expect to continue to
increase expenses for the foreseeable future to support increased sales and
marketing and technical support costs. Any significant delay in our anticipated
revenues or commercialization of new products would harm our business. The
revenue and profit potential of our business and our industry are unproven. We
had negative gross margins from our inception until the fourth quarter of 1998,
and any future revenue growth may not result in positive gross margins or
operating profits in future periods.
Our Operating Results May Fluctuate.
Our quarterly revenues are likely to fluctuate significantly in the future
due to a number of factors, many of which are outside our control. Factors that
could affect our revenues include the following:
. Variations in the timing of orders and shipments of our products;
. Variations in the size of the orders by our customers;
. New product introductions by competitors;
. Delays in our introduction of new products;
. Delays in our receipt of and cancellation of orders forecasted by
customers;
. Delays by our customers in the completion of upgrades to their cable
infrastructure;
. Variations in capital spending budgets of broadband access service
providers;
. Adoption of industry standards and the inclusion in or compatibility
of our technology with any such standards; and
. Delays in obtaining regulatory approval for commercial deployment of
cable modem systems.
Our expenses generally will vary from quarter to quarter depending on the
level of actual and anticipated business activities. Research and development
expenses will vary as we begin development of new products and as our
development
17
programs move to wafer fabrication and prototype development, which results in
higher engineering expenses.
A variety of factors affect our gross margin, including the following:
. The sales mix of our products;
. The volume of products manufactured;
. The type of distribution channel through which we sell our products;
. The average selling prices, or ASP, of our products; and
. The effectiveness of our cost reduction measures.
We anticipate that unit ASPs of our products will decline in the future.
This could cause a decrease in the gross margins for these products. In
addition, the maturity of TeraComm system deployments affects our gross margin.
New deployments of the TeraComm system involve the sale of headend equipment
(which has higher margins) and generally involve smaller quantities of product.
New deployments typically are sold at higher margins than the larger volume
sales of product associated with more mature deployments of the TeraComm system.
The sales mix of TeraLink 1000 Master Controllers, TeraLink Gateways and
TeraPro cable modems also affects our gross margin. The TeraPro cable modems
have significantly lower margins than the TeraLink 1000 Master Controller and
TeraLink Gateway headend products. We expect to achieve significantly lower
margins on the TeraPro cable modems for the foreseeable future. Further, we
expect that sales of TeraPro cable modems will continue to constitute a
significant portion of our revenues for the foreseeable future.
We also anticipate that our operating results will be impacted by sales,
gross profit and operating expenses of acquired companies.
We Are Dependent on a Small Number of Customers.
Two customers (one of which is a related party) accounted for approximately
26% of our revenues for the three months ended March 31, 2001 and two customers
accounted for approximately 44% of our revenues for the three months ended March
31, 2000. We believe that a substantial majority of our revenues will continue
to be derived from sales to a relatively small number of customers for the
foreseeable future. In addition, we believe that sales to these customers will
be focused on a limited number of projects.
The cable industry is undergoing significant consolidation in North America
and internationally, and a limited number of cable operators controls an
increasing number of cable systems. Currently, ten cable operators in the United
States own and operate facilities passing approximately 86% of total homes
passed. In addition, the North American DSL market is concentrated with the
major ILECs, constituting a significant percentage of the market. As a result,
our sales will be largely dependent upon product acceptance by the leading
broadband service providers. Currently, the timing and size of each customer's
order is critical to our operating results. Our major customers are likely to
have significant negotiating leverage and may attempt to change the terms,
including pricing, upon which we do business with them. These customers also may
require longer payment terms than we anticipate, which could require us to raise
additional capital to meet our working capital requirements. Reduced spending in
the cable and telecom industries will also have a negative impact on our
operations.
Acquisitions Could Result In Dilution, Operating Difficulties and Other Adverse
Consequences.
We have acquired ten businesses since September 1999: Imedia in September
1999; Radwiz in November 1999; Telegate in January 2000; ANE in April 2000;
ComBox, Ltd. in April 2000; assets of Internet Telecom in April 2000; Ultracom
in April 2000; Mainsail in September 2000; Digitrans in September 2000 and
TrueChat in December 2000. The process of integrating any acquired business into
our business
18
and operations is risky and may create unforeseen operating difficulties and
expenditures. The areas in which we may face difficulties include:
. Diversion of management time (both ours and that of the acquired companies)
during the period of negotiation through closing and after closing from
the ongoing development of our businesses, issues of integration and
future products;
. Decline in employee morale and retention issues resulting from changes in
compensation, reporting relationships, future prospects or the direction
of the business;
. The need to integrate each company's accounting, management information,
human resource and other administrative systems to permit effective
management, and the lack of control if this integration is delayed or not
implemented; and
. The need to implement controls, procedures and policies appropriate for a
larger public group of companies that prior to acquisition had been
smaller, private companies.
We have very limited experience in managing this integration process.
Moreover, the anticipated benefits of any or all of these acquisitions may not
be realized.
Future acquisitions could result in potentially dilutive issuances of
equity securities, the incurrence of additional debt, contingent liabilities or
amortization expenses related to goodwill and other intangible assets, any of
which could harm our business. Future acquisitions also could require us to
obtain additional equity or debt financing, which may not be available on
favorable terms or at all. Even if available, this financing may be dilutive.
The Sales Cycle for Our Products Is Lengthy.
The sales cycle associated with our products typically is lengthy, often
lasting six months to a year. Our customers typically conduct significant
technical evaluations of competing technologies prior to the commitment of
capital and other resources. In addition, purchasing decisions may be delayed
because of our customers' internal budget approval procedures. Sales also
generally are subject to customer trials, which typically last three months.
Because of the lengthy sales cycle and the large size of customers' orders, if
orders forecasted for a specific customer for a particular quarter do not occur
in that quarter, our operating results for that quarter could suffer.
There Are Many Risks Associated with Our Participation in the Establishment of
Advanced Physical Layer Specifications to Be Added to DOCSIS.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2 (Data Over
Cable Service Interface Specifications), an enhanced version of the DOCSIS cable
modem specification based in part on our S-CDMA technology. In September 1999,
CableLabs indicated that it intended to proceed with the advanced physical layer
(PHY) work on two parallel tracks: one for the development of a prototype based
on our S-CDMA technology and one for the inclusion of Advanced TDMA technology
(Time Division Multiple Access), as proposed by other companies. In February
2000, CableLabs further clarified the status of the advanced PHY project
regarding a separate release that will include TDMA technologies. In addition,
CableLabs reiterated that it is continuing to work with us on the development of
a DOCSIS specification that could include our S-CDMA technology. To that end,
CableLabs has requested that we submit a prototype of a DOCSIS system that
incorporates an S-CDMA advanced PHY capability for testing. CableLabs has stated
that if the testing of this prototype reveals that the S-CDMA advanced PHY
works as claimed (including proper backwards compatibility and coexistence with
the other aspects of DOCSIS), and if the costs for adding S-CDMA to DOCSIS
products are in line with estimates, then it is likely, but not certain, that
S-CDMA advanced PHY capabilities will be included in a future version of the
DOCSIS specification. The prototype we submit to CableLabs may fail to
demonstrate the level of performance that CableLabs seeks; even if it does meet
performance expectations there can be no guarantee that
19
CableLabs will incorporate the technology into a future version of DOCSIS
specifications. In addition, if CableLabs does proceed to include S-CDMA in a
future DOCSIS specification, there can be no guarantee that the DOCSIS S-CDMA
specification will be the same as the specification we incorporated in the
prototype submitted for tests, which may require us to further develop our
prototype.
Our future revenues and operating results are likely to suffer if S-CDMA is
not included in a future release of DOCSIS. We also may incur substantial
additional research and development expenditures to adapt our specifications to
the version adopted by CableLabs. CableLabs has not established a schedule for
adding the S-CDMA capabilities to the DOCSIS specifications. Delays in the
establishment of a final specification for S-CDMA in DOCSIS could harm our plans
to sell DOCSIS compatible modems and headend equipment. In particular, if the
final DOCSIS S-CDMA specification is not approved prior to the time when we are
ready to ship DOCSIS products with S-CDMA features included, then we may be
required to delay the introduction of those products until the DOCSIS S-CDMA
specification is released or to introduce the S-CDMA features as proprietary
enhancements to a standard DOCSIS product. Either one of these events could harm
revenues and operating results.
We have already given CableLabs assurances that we will contribute some
aspects of our proprietary S-CDMA technology to a royalty-free intellectual
property pool, if S-CDMA is included in a future version of DOCSIS
specifications. This royalty-free pool has been established by CableLabs to
facilitate the participation of as many vendors as possible in providing
equipment that is compatible with the DOCSIS specifications. As a result, any of
our competitors who join the DOCSIS intellectual property pool would have access
to some aspects of our technology and would not be required to pay us any
royalties or other compensation. If a competitor is able to duplicate the
functionality and capabilities of our technology, we could lose some or all of
the time-to-market advantage we might otherwise have, which could harm our
future revenues and operating results.
We believe the addition of advanced upstream PHY capabilities to DOCSIS
will increase the overall market for DOCSIS-compatible products, and as such
will result in increased competition in the cable modem market. This competition
could come from existing competitors or from new competitors who enter the
market as a result of the enhancements to the specifications. This increased
competition is likely to result in lower ASPs of cable modem systems and could
harm revenues and gross margins. Because our competitors will be able to
incorporate some aspects of our technology into their products, our current
customers may choose alternate suppliers or choose to purchase DOCSIS-compliant
cable modems with advanced PHY capabilities from multiple suppliers. We may be
unable to produce DOCSIS compliant cable modems with advanced PHY capabilities
more quickly or at lower cost than our competitors. The inclusion of our S-CDMA
technology in future DOCSIS specification could result in increased competition
for the services of our existing employees who have experience with S-CDMA. The
loss of these employees to one or more competitors could harm our business.
DOCSIS standards have not yet been accepted in Europe and Asia. An
alternate standard for cable modem systems, called the EuroModem standard, or
DAVIC/DVB, has been formalized, and some European cable system operators have
embraced it. We intend to develop and sell products that comply with the
EuroModem standard and to pursue having portions of our S-CDMA technology
included in a future version of the EuroModem standard. We may be unsuccessful
in these efforts.
We Need to Develop New Products in Order to Remain Competitive.
Our future success will depend in part on our ability to develop, introduce
and market new products in a timely manner. We also must respond to competitive
pressures, evolving industry standards and technological advances. Our current
S-CDMA products are not DOCSIS-compliant. We are currently developing a
prototype of a DOCSIS system that incorporates an S-CDMA advanced PHY capability
for testing and potential eventual inclusion in the DOCSIS standard. There is no
guarantee that we will be successful in developing the prototype or that the
prototype, if successfully developed, will be included in a future release of
the DOCSIS standard. We anticipate that during the year 2001, existing or
potential customers may delay or cancel purchases of our TeraComm system in
order to purchase systems that comply with the DOCSIS standard. In addition,
potential new customers could decide to
20
purchase DOCSIS-compliant products from one or more of our competitors rather
than from us. In order to promote sales of our current products, we may be
required to reduce our prices for sales to existing customers. This would harm
our operating results and gross margin.
As a result of the inclusion of TDMA technology in the new DOCSIS version
announced by CableLabs in February 2000, we will have to incorporate advanced
TDMA technology into our DOCSIS-compliant products. If we are unable to do this
effectively, or in a timely manner, we will lose some or all of the time-to-
market advantage we might otherwise have had.
Our future success will also depend on our ability to develop and market
products for broadband applications over DSL and wireless networks. The markets
for these broadband applications are also subject to evolving standards, such as
NEBS compliance in the North American DSL market, and technological advances in
these arenas. There is no guarantee that we will be successful in developing
products that are compliant with these standards or that we will be successful
in keeping pace with future technological advances in this arena.
Average Selling Prices of Broadband Access Equipment Typically Decrease.
The broadband access systems market has been characterized by erosion of
average selling prices. We expect this to continue. This erosion is due to a
number of factors, including competition, rapid technological change and price
performance enhancements. The ASPs for our products may be lower than expected
as a result of competitive pricing pressures, our promotional programs and
customers who negotiate price reductions in exchange for longer term purchase
commitments. We anticipate that ASPs and gross margins for our products will
decrease over product life cycles. In addition, we believe that the widespread
adoption of industry standards is likely to further erode ASPs, particularly for
cable modems and other similar consumer premise equipment. It is likely that the
widespread adoption of industry standards will result in increased retail
distribution of cable modems and other similar consumer premise equipment, which
could put further price pressure on our products. Decreasing ASPs could result
in decreased revenues even if the number of units sold increases. As a result,
we may experience substantial period-to-period fluctuations in future operating
results due to ASP erosion. Therefore, we must continue to develop and introduce
on a timely basis next-generation products with enhanced functionalities that
can be sold at higher gross margins. Our failure to do this could cause our
revenues and gross margin to decline.
We Must Achieve Cost Reductions.
Certain of our competitors currently offer products at prices lower than
ours. Market acceptance of our products will depend in part on reductions in the
unit cost of our products. We expect that as headend equipment becomes more
widely deployed, the price of cable modems and other similar consumer premise
equipment will decline. In particular, we believe that the widespread adoption
of industry standards such as DOCSIS will cause increased price competition for
consumer premise equipment. However, we may be unable to reduce the cost of our
products sufficiently to enable us to compete with other suppliers. Our cost
reduction efforts may not allow us to keep pace with competitive pricing
pressures or lead to gross margin improvement.
Some of our competitors are larger and manufacture products in
significantly greater quantities than we intend to for the foreseeable future.
Consequently, these competitors have more leverage in obtaining favorable
pricing from suppliers and manufacturers. In order to remain competitive, we
must significantly reduce the cost of manufacturing our cable modems through
design and engineering changes. We may not be successful in redesigning our
products. Even if we are successful, our redesign may be delayed or may contain
significant errors and product defects. In addition, any redesign may not result
in sufficient cost reductions to allow us to significantly reduce the list price
of our products or improve our gross margin. Reductions in our manufacturing
costs will require us to use more highly integrated components in future
products and may require us to enter into high volume or long-term purchase or
21
manufacturing agreements. Volume purchase or manufacturing agreements may not be
available on acceptable terms. We could incur expenses without related revenues
if we enter into a high volume or long-term purchase or manufacturing agreement
and then decide that we cannot use the products or services offered by the
agreement. We have incurred cancellation charges in the past and may incur such
charges in the future.
We Must Keep Pace with Rapid Technological Change to Remain Competitive.
The markets for our products are characterized by rapid technological
change, evolving industry standards, changes in end-user requirements and
frequent new product introductions and enhancements. Our future success will
depend upon our ability to enhance our existing products and to develop and
introduce new products that achieve market acceptance. Providers of broadband
access services may adopt alternative technologies or they may deploy
alternative services that are incompatible with our products.
The demand for broadband access services has resulted in the development of
several competing modulation technologies. For example, some of our cable
products utilize a modulation technology known as S-CDMA, while several of our
competitors utilize modulation technologies known as TDMA and Frequency Division
Multiple Access or FDMA. Our headend equipment and cable modem products
currently are not interoperable with the headend equipment and modems of other
suppliers of broadband access products. As a result, potential customers who
wish to purchase broadband access products from multiple suppliers may be
reluctant to purchase our products. Although our technology may be incorporated
into a future version of a DOCSIS specification or another industry standard, we
cannot be certain that major cable operators will adopt these standards. Major
cable operators may not adopt products or technologies based on our current
proprietary S-CDMA technology or on any future industry standard S-CDMA
technology. Further, major cable operators may adopt products or standards
technologies based on competing modulation technologies. If competitors using
other modulation technologies can incorporate functionality and capabilities
currently found in S-CDMA, the value of our S-CDMA technology would be
diminished.
Broadband Access Services Have Not Achieved Widespread Market Acceptance, and
Many Competing Technologies Exist.
Our success will depend upon the widespread commercial acceptance of
broadband access services by service providers and end users of broadband access
services. The market for these services is not fully developed. We cannot
accurately predict the future growth rate or the ultimate size of the market for
broadband access services. Potential users of our products may have concerns
regarding the security, reliability, cost, ease of installation and use and
capability of broadband access services in general.
The market for our products may be impacted by the development of other
technologies that enable the provisioning of broadband access services and the
deployment of services over other media. Widespread acceptance of other
technologies or deployment of services over media not supported by our products
could materially limit acceptance of our broadband access systems. Broadband
access services based on our products and technology may fail to gain widespread
commercial acceptance by providers of broadband access services and end users.
In addition, we only recently began to offer products based on alternate
technologies such as DSL. We may not be successful in marketing and selling
these products.
We Need to Develop Additional Distribution Channels.
We presently market our TeraComm system to cable operators and systems
integrators. We believe that much of the North American cable modem market may
shift to a retail distribution model. Accordingly, we may need to redirect our
future marketing efforts to sell our cable modems directly to retail
distributors and end users. This shift would require us to establish new
distribution channels for our products.
We May Be Unable to Establish These Additional Distribution Channels.
If we do establish them, we may be unable to hire the additional personnel
necessary to foster and enhance such distribution channels. In addition, if the
cable modem market shifts to a retail distribution model, we may not
successfully
22
establish a retail distribution presence. To the extent that large consumer
electronics companies enter the cable modem market, their well-established
retail distribution capabilities would provide them with a significant
competitive advantage. We may be unable to market effectively to broadband
access service providers. Our growth and future success will be substantially
dependent upon our ability to convince providers of broadband access services to
adopt our technologies, purchase our products and effectively market our
products to end users. Our potential customers are likely to prefer purchasing
products from established manufacturing companies that can demonstrate the
capability to supply large volumes of products on short notice. In addition,
many of our potential customers may be reluctant to adopt technologies that have
not gained acceptance among other providers of similar services. This reluctance
could result in lengthy product testing and acceptance cycles for our products.
Consequently, the impediments to our initial sales may be even greater than
those to later sales.
No established distribution network in the cable modem industry exists that
would provide us with easy access to smaller or geographically diverse cable
operators. Therefore, our initial sales to larger, more established cable
operators are critical to our business. Although we intend to establish
strategic relationships with leading distributors worldwide, we may not succeed
in establishing these relationships. Even if we do establish these
relationships, the distributors may not succeed in marketing our products to
cable operators. Some of our competitors have already established relationships
with certain cable operators. These established relationships may further limit
our ability to sell products to those cable operators. We do not have long,
well-established relationships with those cable operators. If we were to sell
our products to those cable operators, it would likely not be based on long-term
contracts and those customers would be able to terminate their relationships
with us at any time.
In addition, one or more of our current customers could cancel its
relationship with us at any time. We have recently begun marketing and selling
our products to providers of DSL and wireless broadband services and thus we
have very limited experience. We do not have long, well-established
relationships with these providers, and we may not be successful in establishing
these relationships.
We Are Dependent on Broadband Service Providers Choosing to Offer Additional
Services to Their Customers.
We depend on cable operators to purchase our cable modem systems and to
provide our cable modems to end-users. Cable operators have a limited amount of
available bandwidth over which they can offer robust data services, and they may
not choose to provide these data services to their customers. If cable operators
choose to provide these services, we also will depend upon them to market these
services to cable customers, to install our equipment and to provide support to
end-users. In addition, we will be highly dependent on cable operators to
continue to maintain their cable infrastructure in a manner that allows us to
provide consistently high performance and reliable services. Our success also
will depend upon the acceptance of our products by other providers of services
to the cable industry, such as Excite@Home's @Home Network and Road Runner, a
joint venture between MediaOne Group Inc. and Time Warner Cable. Sales of our
DSL and wireless products are also dependent on service providers choosing to
purchase our products and to provide additional services to their end users.
Sales of Our Cable Products Are Dependent on the Cable Industry Upgrading to
Two-Way Cable Infrastructure.
Demand for our products will depend, to a significant degree, upon the
magnitude and timing of capital spending by cable operators for implementation
of access systems for data transmission over cable networks. This involves the
enabling of two-way transmission over existing coaxial cable networks and the
eventual upgrade to HFC in areas of higher penetration of data services. If
cable operators fail to complete these upgrades of their cable infrastructures
in a timely and satisfactory manner, the market for our products could be
limited. In addition, few businesses in the United States currently have cable
access. Cable operators may not choose to upgrade existing residential cable
systems or to install new cable systems to serve business locations.
23
The success and future growth of our business will be subject to economic
and other factors affecting the cable television industry generally,
particularly its ability to finance substantial capital expenditures. Capital
spending levels in the cable industry in the United States have fluctuated
significantly in the past, and we believe that such fluctuations will occur in
the future. We are currently experiencing reduced levels of spending in the
cable industry. The capital spending patterns of cable operators are dependent
on a variety of factors, including the following:
. The availability of financing;
. Cable operators' annual budget cycles, as well as the typical
reduction in upgrade projects during the winter months;
. The status of federal, local and foreign government regulation and
deregulation of the telecommunications industry;
. Overall demand for cable services;
. Competitive pressures (including the availability of alternative data
transmission and access technologies);
. Discretionary consumer spending patterns; and
. General economic conditions.
In recent periods, the United States cable market has been characterized
by the acquisition of smaller and independent cable operators by large cable
operators. We cannot predict the effect, if any, that consolidation in the
United States cable industry will have on overall capital spending patterns by
cable operators. The effect on our business of further industry consolidation
also is uncertain.
Supply of Our Products May Be Limited by Our Ability to Forecast Demand
Accurately.
The emerging nature of the broadband access services market makes it
difficult for us to accurately forecast demand for our products. Our inability
to accurately forecast the actual demand for our products could result in
supply, manufacturing or testing capacity constraints. These constraints could
result in delays in the delivery of our products or the loss of existing or
potential customers, either of which could have a negative impact on our
business, operating results or financial condition. In addition, we had
unconditional purchase obligations of approximately $102.6 million as of March
31, 2001, primarily to purchase minimum quantities of materials and components
used to manufacture our products. We must fulfill these obligations even if
demand for our products is lower than we anticipate.
We Are Dependent on Key Third-Party Suppliers.
We manufacture all of our products using components or subassemblies
procured from third-party suppliers. Some of these components are available from
a single source and others are available from limited sources. All of our sales
are from products containing one or more components that are available only from
single supply sources.
In addition, some of the components are custom parts produced to our
specifications. For example, we currently rely on Philips Semiconductors, Inc.
to supply a custom ASIC that is used in our products. Other components, such as
the radio frequency tuner and some surface acoustic wave filters, are procured
from sole source suppliers. Any interruption in the operations of vendors of
sole source parts could adversely affect our ability to meet our scheduled
product deliveries to customers. We are dependent on semiconductor manufacturers
and are affected by worldwide conditions in the semiconductor market. If we are
unable to obtain a sufficient supply of components from our current sources, we
could experience difficulties in obtaining alternative sources or in altering
product designs to use alternative components. Resulting delays or reductions in
product shipments could
24
damage customer relationships. Further, a significant increase in the price of
one or more of these components could harm our gross margin or operating
results.
We May Be Unable to Migrate to New Semiconductor Process Technologies
Successfully or on a Timely Basis.
Our future success will depend in part upon our ability to develop
products that utilize new semiconductor process technologies. These technologies
change rapidly and require us to spend significant amounts on research and
development. We continuously evaluate the benefits of redesigning our integrated
circuits using smaller geometry process technologies to improve performance and
reduce costs. The transition of our products to integrated circuits with
increasingly smaller geometries will be important to our competitive position.
Other companies have experienced difficulty in migrating to new semiconductor
processes and, consequently, have suffered reduced yields, delays in product
deliveries and increased expense levels. Moreover, we depend on our relationship
with our third-party manufacturers to migrate to smaller geometry processes
successfully.
Our Ability to Directly Control Product Delivery Schedules and Product Quality
Is Dependent on Third-Party Contract Manufacturers.
Most of our products are assembled and tested by contract manufacturers
using testing equipment that we provide. As a result of our dependence on these
contract manufacturers for 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 manufacturers. The production and
assembly of testing equipment typically requires significant time. 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.
There Are Many Risks Associated with International Operations.
We expect sales to customers outside of the United States to continue to
represent a significant percentage of our revenues for the foreseeable future.
International sales are subject to a number of risks, including the following:
. Changes in foreign government regulations and communications standards;
. Export license requirements, tariffs and taxes;
. Other trade barriers;
. Difficulty in protecting intellectual property;
. Difficulty in collecting accounts receivable;
. Difficulty in managing foreign operations; and
. Political and economic instability.
If our customers are affected by currency devaluations or general
economic crises, such as the recent economic crisis affecting many Asian and
Latin American economies, their ability to purchase our products could be
reduced significantly. Payment cycles for international customers typically are
longer than those for customers in the United States. Foreign markets for our
products may develop more slowly than currently anticipated. Foreign countries
may decide not to construct cable infrastructure or may prohibit, terminate or
delay the construction of new cable plants for a variety of reasons. These
reasons include environmental issues, economic downturns, the availability of
favorable pricing for other communications services or the availability and cost
of related equipment. Any action like this by foreign countries would reduce the
market for our products.
We anticipate that our foreign sales generally will be invoiced in U.S.
dollars, and we currently do not plan to engage in foreign currency hedging
25
transactions. However, as we commence and expand our international operations,
we may be paid in foreign currencies and exposure to losses in foreign currency
transactions may increase. We may 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 those foreign customers could result in decreased sales.
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 broadband access systems, particularly in the initial
deployment and implementation stages. To date our sales have been concentrated
in a small number of customers. We have limited experience with widespread
deployment of our products to a diverse customer base. We may not have adequate
personnel to provide the levels of support that our customers may require during
initial product deployment or on an ongoing basis. 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 relationship with our customers and could prevent
us from gaining new customers.
Our Industry Is Highly Competitive with Many Established Competitors.
The market for broadband access systems is extremely competitive and is
characterized by rapid technological change. Our direct competitors in the cable
access systems arena include Cisco Systems, Com21, General Instrument,
Matsushita Electric Industrial (which markets products under the brand name
"Panasonic"), Motorola, Nortel Networks, Vyyo, Thomson Consumer Electronics
(which markets products under the brand name "RCA"), Samsung, Scientific-
Atlanta, Sony, 3Com, Toshiba and Zenith Electronics. We also compete with
companies that develop integrated circuits for broadband access products, such
as Broadcom, Conexant and Texas Instruments. We also sell products that compete
with existing data access and transmission systems utilizing the
telecommunications networks, such as those of 3Com. Additionally, our controller
and headend system products face intense competition from well-established
companies such as Cisco, Nortel and 3Com. In addition, we compete with companies
in the DSL arena such as ECI, Charles Industries, Pairgain, Copper Mountain,
Accelerated Networks, Integral Access and VINA Technologies. As standards, such
as DOCSIS, are developed for broadband access systems, other companies may enter
the broadband access systems market. The principal competitive factors in our
market include the following:
. Product performance, features and reliability;
. Price;
. Size and stability of operations;
. Breadth of product line;
. Sales and distribution capability;
. Technical support and service;
. Relationships with providers of broadband access services; and
. Compliance with industry standards.
Some of these factors are outside of our control. The existing conditions
in the broadband access market could change rapidly and significantly as a
result of technological advancements. The development and market acceptance of
alternative technologies could decrease the demand for our products or render
them obsolete. Our competitors may introduce broadband access products that are
less costly, provide superior performance or achieve greater market acceptance
than our products.
26
Many of our current and potential competitors have significantly greater
financial, technical, marketing, distribution, customer support and other
resources, as well as greater name recognition and access to customers than we
do. The anticipated widespread adoption of DOCSIS and other industry standards
is likely to cause increased worldwide price competition, particularly in the
North American market. The adoption of DOCSIS and these other standards also
could result in lower sales of our TeraComm system, including the higher margin
headend products. Any increased price competition or reduction in sales of our
headend products would result in downward pressure on our gross margin. We
cannot accurately predict how the competitive pressures that we face will affect
our business.
Our Business Is Dependent on the Internet and the Development of the Internet
Infrastructure.
Our success will depend in large part on increased use of the Internet to
increase the need for high-speed broadband access networks. Critical issues
concerning the commercial use of the Internet remain largely unresolved and are
likely to affect the development of the market for our products. These issues
include security, reliability, cost, ease of access and quality of service. Our
success also will depend on the growth of the use of the Internet by businesses,
particularly for applications that utilize multimedia content and thus require
high bandwidth. The recent growth in the use of the Internet has caused frequent
periods of performance degradation. This has required the upgrade of routers,
telecommunications links and other components forming the infrastructure of the
Internet by service providers and other organizations with links to the
Internet. Any perceived degradation in the performance of the Internet as a
whole could undermine the benefits of our products. Potentially increased
performance provided by our products and the products of others ultimately is
limited by and reliant upon the speed and reliability of the Internet backbone
itself.Consequently, the emergence and growth of the market for our products
will depend on improvements being made to the entire Internet infrastructure to
alleviate overloading and congestion.
Our Failure to Manage Growth Could Adversely Affect Us.
The growth of our business has placed, and is expected to continue to
place, a significant strain on our limited personnel, management and other
resources. Our management, personnel, systems, procedures and controls may be
inadequate to support our existing and future operations. To manage any future
growth effectively, we will need to attract, train, motivate, manage and retain
employees successfully, to integrate new employees into our overall operations
and to continue to improve our operational, financial and management systems.
We Are Dependent on Key Personnel.
Due to the specialized nature of our business, we are highly dependent on
the continued service of, and on the ability to attract and retain qualified
engineering, sales, marketing and senior management personnel. The competition
for personnel is intense. The loss of any of these individuals, particularly our
Chairman, President and Chief Technical Officer, Shlomo Rakib, and our Chief
Executive Officer, Zaki Rakib, would harm our business. In addition, if we are
unable to hire additional qualified personnel as needed, we may be unable to
adequately manage and complete our existing sales commitments and to bid for and
execute additional sales. Further, we must train and manage our growing employee
base, which is likely to require increased levels of responsibility for both
existing and new management personnel. Our current management personnel and
systems may be inadequate, and we may fail to assimilate new employees
successfully.
Highly skilled employees with the education and training that we require,
especially employees with significant experience and expertise in both data
networking and radio frequency design, are in high demand. We may not be able to
continue to attract and retain the qualified personnel necessary for the
development of our business. We do not have "key person" insurance coverage for
the loss of any of our employees. Any officer or employee of our company can
terminate his or her relationship with us at any time. Our employees generally
are not bound by non-competition agreements with us.
27
Our Business Is Subject to the Risks of Product Returns, Product Liability and
Product Defects.
Products as complex as ours frequently contain undetected errors or
failures, especially when first introduced or when new versions are released.
Despite testing, errors may occur. The occurrence of errors could result in
product returns and other losses to our company or our customers. This
occurrence also could result in the loss of or delay in market acceptance of our
products. Due to the recent introduction of our products, we have limited
experience with the problems that could arise with this generation of products.
However, the limitation of liability provision contained in our purchase
agreements 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. We have not experienced any product liability claims to date, but the
sale and support of our products entails the risk of such claims. In addition,
any failure by our products to properly perform could result in claims against
us by our customers. 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 management time and 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. Our pending patent applications may not be granted. Even if they
are granted, the claims covered by the patents may be reduced from those
included in our applications. Any patent might be subject to challenge in court
and, whether or not challenged, might not be broad enough to prevent third
parties from developing equivalent technologies or products without taking a
license from us. We have entered into confidentiality and invention assignment
agreements with our employees, and we enter into non-disclosure agreements with
some of our suppliers, distributors and appropriate customers so as to limit
access to and disclosure of our proprietary information. These statutory and
contractual arrangements may not prove sufficient to prevent misappropriation of
our technology or to deter independent third-party development of similar
technologies. In addition, the laws of some foreign countries might not protect
our products or intellectual property rights to the same extent as do the laws
of the United States. Protection of our intellectual property might not be
available in every country in which our products might be manufactured, marketed
or sold.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an
enhanced version of the DOCSIS cable modem specification based in part on our S-
CDMA technology. In September 1999, CableLabs indicated that it intended to
proceed with the advanced PHY work on two parallel tracks: one for the
development of a prototype based on our S-CDMA technology and one for the
inclusion of Advanced TDMA technology, as proposed by other companies. In
February 2000, CableLabs further clarified the status of the advanced PHY
project regarding a separate release that will include TDMA technologies. In
addition, CableLabs reiterated that it is continuing to work with us on the
development of a DOCSIS specification that could include our S-CDMA technology.
To that end, we have indicated to CableLabs that we would contribute some
aspects of our S-CDMA technology to the DOCSIS intellectual property pool if a
DOCSIS specification is approved that includes our S-CDMA technology.
We would contribute our technology pursuant to a license agreement with
CableLabs that we would execute at that time, and which contains the terms that
CableLabs has established for the inclusion of any intellectual property from
any source in the DOCSIS specifications. Under the terms of the proposed license
agreement, we would grant to CableLabs a royalty-free license for those aspects
of our S-CDMA technology that are essential for compliance with the DOCSIS cable
modem standard. So-called "implementation know how" is not covered by this
license-only those aspects of the technology that are essential to implementing
a compliant product. CableLabs would have the right to extend royalty-free
sublicenses to companies that wish to build DOCSIS-compatible products. These
sublicenses would allow participating companies to utilize and incorporate the
essential portions of
28
the S-CDMA technology on a royalty-free basis for the limited use of making and
selling products or systems that comply with the DOCSIS cable modem
specification. We have already joined the DOCSIS intellectual property pool and,
as a result, we have a royalty-free sublicense that allows us to ship DOCSIS-
compatible products which contain intellectual property submitted by other
companies. The scope of this license would not extend to the use of the S-CDMA
technology in other areas; only for products that comply with the DOCSIS
specifications. As a result, any of our competitors who join or have joined the
DOCSIS intellectual property pool will have access to some aspects of our
technology without being required to pay us any royalties or other compensation.
If we submit S-CDMA to the DOCSIS Intellectual Property pool, we are in no way
restricted from entering into royalty-bearing license agreements with companies
that wish to use the S-CDMA technology for purposes other than implementing
DOCSIS compatible products, or that do not wish to enter into the DOCSIS
intellectual property pool. Further, some of our competitors have been
successful in reverse engineering the technology of other companies, and the
inclusion of S-CDMA in a future DOCSIS specification would expose some aspects
of our technology to those competitors. DOCSIS specifications are available on
an open basis once they are approved, not only to companies that are members of
the DOCSIS intellectual property Pool. If a competitor is able to duplicate the
functionality and capabilities of our technology, we could lose all or some of
the time-to-market advantage we might otherwise have. Under the terms of the
proposed license agreement, if we sue certain parties to the proposed license
agreement on claims of infringement of any copyright or patent right or
misappropriation of any trade secret, those parties may terminate our license to
the patents or copyrights they contributed to the DOCSIS intellectual property
pool. If a termination like this were to occur, we would continue to have access
to some aspects of the DOCSIS intellectual property pool, but we would not be
able to develop products that fully comply with the DOCSIS cable modem
specification. Also, even if we were to be removed from the DOCSIS intellectual
property pool, we would not be prevented from developing and selling products
that fully comply with the DOCSIS specifications, but we would not be able to do
this with the benefit of a royalty-free license, which would increase the cost
of our products, assuming we were able to obtain a license agreement for the
required technology. Because of these terms, we may find it difficult to enforce
our intellectual property rights against certain companies, even in areas that
are not directly related to DOCSIS specifications and products.
We anticipate that developers of cable modems increasingly will be
subject to infringement claims as the number of products and competitors in our
industry segment grows. We have received letters from two individuals claiming
that our technology infringes patents held by these individuals. We have
reviewed the allegations made by these individuals and, after consulting with
our patent counsel, we do not believe that our technology infringes any valid
claim of these individuals' patents. If the issues are submitted to a court, the
court could find that our products infringe these patents. In addition, these
individuals may continue to assert infringement. If we are found to have
infringed these individuals' patents, we could be subject to substantial damages
and/or an injunction preventing us from conducting our business. In addition,
other third parties may assert infringement claims against us in the future. An
infringement claim, whether meritorious or not, could be time-consuming, result
in costly litigation, cause product shipment delays or require us to enter into
royalty or licensing agreements. These royalty or licensing agreements may not
be available on terms acceptable to us or at all. Litigation also may be
necessary to enforce our intellectual property rights.
We pursue the registration of our trademarks in the United States and
foreign countries and have applications pending to register several of our
trademarks. However, the laws of certain foreign countries might not protect our
products or intellectual property rights to the same extent as the laws of the
United States. This means that effective trademark, copyright, trade secret and
patent protection might not be available in every country in which our products
might be manufactured, marketed or sold.
Our Business Is Subject to Communications Industry Regulations.
Our business and our customers are subject to varying degrees of federal,
state and local regulation. The jurisdiction of the Federal Communications
Commission extends to the communications industry, including our broadband
access
29
products. The FCC has promulgated regulations that, among other things, set
installation and equipment standards for communications systems. Although FCC
regulations and other governmental regulations have not materially restricted
our operations to date, future regulations applicable to our business or our
customers could be adopted by the FCC or other regulatory bodies. For example,
FCC regulatory policies affecting the availability of cable services and other
terms on which cable companies conduct their business may impede our penetration
of certain markets. In addition, regulation of cable television rates may affect
the speed at which cable operators upgrade their cable infrastructures to two-
way HFC. In addition, the increasing demand for communications systems has
exerted pressure on regulatory bodies worldwide to adopt new standards for such
products and services. This process generally involves extensive investigation
of and deliberation over competing technologies. The delays inherent in this
governmental approval process have in the past, and may in the future, cause the
cancellation, postponement or rescheduling of the installation of communications
systems by our customers.
If other countries begin to regulate the cable modem industry more
heavily or introduce standards or specifications with which our products do not
comply, we will be unable to offer products in those countries until our
products comply with those standards or specifications. In addition, we may have
to incur substantial costs to comply with those standards or specifications. For
instance, should the Digital Audio Visual Counsel (DAVIC) standards for ATM-
based digital video be established internationally, we will need to conform our
cable modems to compete. Further, many countries do not have regulations for
installation of cable modem systems or for upgrading existing cable network
systems to accommodate our products. Whether we currently operate in a country
without these regulations or enter into the market in a country where these
regulations do not exist, new regulations could be proposed at any time. The
imposition of regulations like this could place limitations on a country's cable
operators' ability to upgrade to support our products. Cable operators in these
countries may not be able to comply with these regulations, and compliance with
these regulations may require a long, costly process. For example, we
experienced delays in product shipments to a customer in Brazil due to delays in
certain regulatory approvals in Brazil. Similar delays could occur in other
countries in which we market or plan to market our products. In addition, our
customers in certain parts of Asia, such as Japan, are required to obtain
licenses prior to selling our products, and delays in obtaining required
licenses could harm our ability to sell products to these customers.
Our Business Is Subject to Other Regulatory Approvals and Certifications.
In the United States, in addition to complying with FCC regulations, our
products are required to meet certain safety requirements. For example, we are
required to have our products certified by Underwriters Laboratory in order to
meet federal requirements relating to electrical appliances to be used inside
the home. Outside the United States, our products are subject to the regulatory
requirements of each country in which the products are manufactured or sold.
These requirements are likely to vary widely. We may be unable to obtain on a
timely basis or at all the regulatory approvals that may be required for the
manufacture, marketing and sale of our products. In addition to regulatory
compliance, some cable industry participants may require certification of
compatibility.
We Are Vulnerable to Earthquakes, Power Outages and Other Unexpected Events.
The facility housing our corporate headquarters, the majority of our
research and development activities and our in-house manufacturing operations is
located in an area of California known for seismic activity. In addition, the
operations of some of our key suppliers are also located in this area and in
other areas know for seismic activity, such as Taiwan. An earthquake, or other
significant natural disaster, could result in an interruption in our business or
that of one or more of our key suppliers. Such an interruption could harm our
operating results. In addition, in recent months there has been a shortage of
electricity in California. As a result, many regions, including the San
Francisco Bay Area, where our headquarters are located, have experienced rolling
power outages as capacity has failed to satisfy demand. Continued power
shortages, a power failure or other similar unexpected events could impair our
ability to operate our business. 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.
30
Our Indebtedness Could Adversely Affect our Financial Condition; We May Incur
Substantially More Debt.
As of May 11, 2001, we had approximately $316 million of indebtedness
outstanding. Our high level of indebtedness could have important consequences to
our stockholders including the following:
. Make it more difficult for us to satisfy our obligations with respect
to our indebtedness;
. Increase our vulnerability to general adverse economic and industry
conditions;
. Limit our ability to obtain additional financing;
. Require the dedication of a substantial portion of our cash flow from
operations to the payment of principal of, and interest on, our
indebtedness, thereby reducing the availability of our cash flow to
fund our growth strategy, working capital, capital expenditures and
other general corporate purposes;
. Limit our flexibility in planning for, or reacting to, changes in our
business and the industry; and
. Place us at a competitive disadvantage relative to our competitors with
less debt.
We may incur substantial additional debt in the future. The terms of our
outstanding debt do not fully prohibit us from doing so. If new debt is added to
our current levels, the related risks described above could intensify.
Our Stock Price Has Been and Is Likely to Continue To Be Volatile.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to a
variety of factors, including the following:
. Actual or anticipated variations in quarterly operating results;
. Announcements of technological innovations;
. New products or services offered by us or our competitors;
. Changes in financial estimates by securities analysts;
. Conditions or trends in the broadband access services industry;
. Changes in the economic performance and/or market valuations of
Internet, online service or broadband access service industries;
. Changes in the economic performance and/or market valuations of other
Internet, online service or broadband access service companies;
. Our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
. Adoption of industry standards and the inclusion of or compatibility of
our technology with such standards;
. Adverse or unfavorable publicity regarding us or our products;
. Additions or departures of key personnel;
. Sales of common stock; and
. Other events or factors that may be beyond our control.
31
In addition, the stock markets in general, and the Nasdaq National Market
and the market for broadband access services and technology companies in
particular, have experienced extreme price and volume volatility and a
significant cumulative decline in recent months. This volatility and decline has
affected many companies irrespective of or disproportionately to the operating
performance of these companies. Our stock price has declined significantly in
recent weeks and months and these broad market and industry factors may
materially adversely further affect the market price of our common stock,
regardless of our actual operating performance.
In April 2000, a lawsuit against us and certain of our officers and
directors, entitled Birnbaum v. Terayon Communication Systems, Inc., was filed
in the United States District Court for the Central District of California. The
venue for the lawsuit was moved to the Northern District of California. The
plaintiff purports to be suing on behalf of a class of stockholders who
purchased or obligated themselves to purchase our securities during the period
from February 2, 2000 to April 11, 2000. The complaint alleges that the
defendants violated the federal securities laws by issuing materially false and
misleading statements and failing to disclose material information regarding our
technology. Several other lawsuits similar to the Birnbaum suit have since been
filed. On August 24, 2000, the lawsuits against us and other named individual
defendants were consolidated in the U.S. District Court of the Northern District
of California and lead plaintiffs and lead plaintiffs' counsel was appointed
pursuant to the Private Securities Litigation Reform Act. On September 21, 2000,
plaintiffs filed a Consolidated Class Action Complaint for violation of federal
securities laws. The consolidated complaint contains allegations nearly
identical to the Birnbaum suit. Defendants filed a motion to dismiss the
consolidated complaint on October 30, 2000, and plaintiffs filed an opposition.
On January 8, 2001, the court held a hearing on defendants' motion, and on March
14, 2001, the court, in part, dismissed the consolidated complaint and granted
plaintiffs thirty (30) days to file a new, amended complaint. Plaintiffs filed
an amended complaint on April 13, 2001. Defendants intend on filing a motion to
dismiss this amended complaint. The lawsuits seek an unspecified amount of
damages, in addition to other forms of relief. We consider the lawsuits to be
without merit and we intend to defend vigorously against these allegations.
However, the litigation could prove to be costly and time consuming to defend,
and there can be no assurances about the eventual outcome.
On October 18, 2000, a lawsuit was filed against the Company and the
individual defendants (Zaki Rakib, Selim Rakib, and Raymond Fritz) in the
superior court of San Luis Obispo County, California. This lawsuit is titled
Bertram v. Terayon Communications Systems, Inc., Case No. CV 000900. The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action under
California Business & Professions Code Sections 17200 et seq. and 17500 et seq.
for unlawful business practices, unfair and fraudulent business practices, and
false and misleading advertising. Plaintiffs purport to bring the action on
behalf of themselves and as representatives of "all persons or entities in the
State of California and such other persons or entities outside California that
have been and are adversely affected by defendants' activity, and as the Court
shall determine is not inconsistent with the exercise of the Court's
jurisdiction." Plaintiffs seek equitable and injunctive relief. Defendants filed
a motion to dismiss the complaint on January 19, 2001. A hearing on defendants'
motion was held March 26, 2001, and the court granted Defendants' motion to
dismiss the action and denied Plaintiffs' motion requesting remand. On April 5,
2001, Defendants moved for an order requiring further proceedings, if any to
take place in the Northern District of California. Plaintiffs' did not oppose
this motion, and Defendants now understand that Plaintiffs will consent to entry
of the requested order. The parties are now preparing a stipulation to that
effect. The Company believes that these allegations, as with the allegations in
the federal securities case, are without merit and intends to contest the matter
vigorously.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
32
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 either mature within the next twelve months or have
characteristics of short-term investments. A hypothetical 50 basis point
increase in interest rates would result in an approximate $130,600 decline (less
than 0.20%) in the fair value of our available-for-sale debt 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
in Belgium, United Kingdom, Hong Kong, and Israel. We have not engaged in
hedging transactions to reduce our exposure to fluctuations that may arise from
changes in foreign exchange rates. An adverse change of 10% in exchange rates
would result in a decline in income before taxes of approximately $1.4 million.
All of the potential changes noted above are based on sensitivity analyses
performed as of March 31, 2001.
PART II. OTHER INFORMATION
ITEM 3. LEGAL PROCEEDINGS
See "Litigation" under PART I, ITEM 2, MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) In February 2001, we issued a warrant to purchase 200,000 shares of the
Company's common stock at a price of $5.4375 per share to YAS Corporation. Under
terms of the warrant 100,000 shares are vested and exercisable as of January 1,
2001 and the remaining 100,000 shares vest and become exercisable at the rate of
1/24th per month, beginning January 31, 2001. The issuance of the warrant was
intended to be exempt from registration under the Securities Act of 1933, as
amended by virtue of Section 4(2) thereof due to, among other things, the fact
that the securities were only issued to one entity and the warrant contained a
statement to the effect that such warrant had not been registered under the
Securities Act of 1933, amended and may not be sold, assigned, transferred or
otherwise disposed of except in compliance with the requirements of, or an
exemption under, such Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Incorporated by reference to Terayon Communication Systems Form 10-K-A
filed with the Commission on April 30, 2001.
33
EXHIBIT INDEX
Exhibit Exhibit Description
Number
2.1 Agreement and Plan of Merger, dated as of July 15, 1999, by and among
Terayon Communication Systems, Inc., Cherry Acquisition Corporation
and Imedia Corporation. (6)
2.2 Share Purchase Agreement, dated October 12, 1999, by and among Terayon
Communication Systems, Inc. and the shareholders of Radwiz Ltd. and
Radwiz Ltd. (7)
2.3 Share Purchase Agreement, dated October 14, 1999, by and among Terayon
Communication Systems, Inc. and the shareholders of Telegate Ltd. and
Telegate Ltd. (7)
2.4 Share Purchase Agreement, dated February 3, 2000, by and among Terayon
Communication Systems, Inc. and ComBox Ltd. (9)
2.5 Asset Purchase Agreement, dated March 12, 2000, by and among Terayon
Communication Systems, Inc., Telegate Ltd. and Internet Telecom Ltd.
(9)
2.6 Amended and Restated Asset Purchase Agreement, dated February 10,
2000, by and between Terayon Communication Systems, Inc. and Tyco
Electronics Corporation. (9)
2.7 Share Purchase Agreement, dated March 26, 2000, by and among Terayon
Communication Systems, Inc., the shareholders of Ultracom
Communications Holdings (1995) Ltd. and Ultracom Communications
Holdings (1995) Ltd. (9)
2.8 Stock Purchase Agreement, dated September 27, 2000, by and among
Terayon Communication Systems, Inc., Digital Transmission Equipment,
The D.W. Thomas Companies, Inc. and Donald W. Thomas. (10)
2.9 Agreement and Plan of Merger and Reorganization, dated September 29,
2000, by and among Terayon Communication Systems, Inc., MN Acquisition
Corp., Mainsail and Certain Stockholders of Mainsail Networks, Inc.
(10)
2.10 First Amendment to Agreement and Plan of Merger and Reorganization,
dated September 29, 2000, by and among Terayon Communication Systems,
Inc., MN Acquisition Corp., Mainsail and Certain Stockholders of
Mainsail Networks, Inc. (10)
2.11 Agreement and Plan of Merger and Reorganization, dated December 20,
2000, by and among Terayon Communication Systems, Inc., True
Acquisition, Inc. and TrueChat, Inc. (11)
3.1 Amended and Restated Certificate of Incorporation of Terayon
Communication Systems, Inc. (12)
3.2 Bylaws of Terayon Communication Systems, Inc. (1)
3.3 Certificate of Amendment to Amended and Restated Certificate of
Incorporation of Terayon Communication Systems, Inc. (14)
3.4 Certificate of Designation of Series A Junior Participating Preferred
Stock. (12)
4.1 Specimen common stock Certificate. (1)
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. (13)
4.4 Registration Rights Agreement by and among Terayon Communication
Systems, Inc. and Deutsche Bank Securities, Inc. and Lehman Brothers,
Inc. (13)
4.5 Indenture between Terayon Communication Systems, Inc. and State Street
Bank and Trust Company of California, N.A. dated July 26, 2000. (13)
10.1 Form of Indemnity Agreement between Terayon Communication Systems,
Inc. and each of its directors and officers. (1)
10.2 1995 Stock Option Plan, as amended on March 26, 1996. (1)
10.3 1997 Equity Incentive Plan, as amended on July 31, 2000. (14)
10.4 1998 Employee Stock Purchase Plan, as amended on July 31, 2000. (14)
10.5 1998 Non-Employee Directors Stock Option Plan. (1)
10.6 1998 Employee Stock Purchase Plan Offering for Foreign Employees,
adopted July 31, 2000. (14)
10.7 Lease Agreement dated January 23, 1996 between Terayon Communication
Systems, Inc. and Arrillaga Family Trust and Richard T. Peery Separate
Property Trust. (1)
34
10.8 Employment Agreement between Terayon Communication Systems, Inc. and
Dr. Zaki Rakib dated February 1993. (1)
10.9 Loan and Security Agreement, dated August 10, 1998, between Terayon
Communication Systems, Inc. and Silicon Valley Bank and Schedule to
Loan and Security Agreement, dated August 10, 1998, between Terayon
Communication Systems, Inc. and Silicon Valley Bank. (3)
10.10 Streamline Facility Agreement dated October 30, 1998 between Terayon
Communication Systems, Inc. and Silicon Valley Bank. (2)
10.11 Anti-Dilution Warrant to Purchase Shares of common stock, dated April
6, 1998, issued to Shaw Communications Inc. (1)
10.12 Amendment No. 1 to Lease, dated April 8, 1999, between Terayon
Communication Systems, Inc. and John Arrillaga Survivor's Trust and
Richard T. Peery Separate Property Trust. (4)
10.13 Lease Agreement, dated April 8, 1999, between Terayon Communication
Systems, Inc. and John Arrillaga Survivor's Trust and Richard T. Peery
Separate Property Trust. (4)
10.14 Lease Agreement, dated April 20, 1998, between Imedia Corporation and
Martin CL Associate, L.P. (5)
10.15 Sublease Agreement, dated November 15, 1999, between Imedia
Corporation and ISP Channel, Inc. (5)
10.16 1999 Non-Officer Equity Incentive Plan, as amended February 14, 2001.
(14)
10.17 Form of Non-Statutory Stock Option Agreement Used in Connection with
the 1999 Non-Officer Equity Incentive Plan. (8)
10.18 Real Property Lease, dated March 1, 1990, among Menlo Business Park,
Patrician Associates, Inc. and Raychem Corporation (predecessor of
Tyco Electronics Corporation).
10.19 Assignment and Guarantee Agreement dated April 22, 2000, by among
Terayon Communication Systems, Inc., Tyco Electronics Corporation and
Menlo Business Park, L.L.C.
21.1 List of Subsidiaries. (14)
___________________
(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 filed on December 24, 1998 (File No. 333-69699).
(3) Incorporated by reference to our Report on Form 10-Q filed on November
12, 1998.
(4) Incorporated by reference to our Report on Form 10-Q filed on August 13,
1999.
(5) Incorporated by reference to our Report on Form 10-Q filed on November
15, 1999.
(6) Incorporated by reference to our Report on Form 8-K filed on October 1,
1999.
(7) Incorporated by reference to our Report on Form 8-K filed on December 13,
1999.
(8) Incorporated by reference to our Registration Statement on Form S-8 filed
on December 29, 1999 (File No. 333-93779).
(9) Incorporated by reference to our Report on Form 8-K filed on May 3, 2000.
(10) Incorporated by reference to our Report on Form 8-K filed on October 5,
2000.
(11) Incorporated by reference to our Report on Form 8-K filed on January 9,
2001.
(12) Incorporated by reference to our Report on Form 10-K filed on March 30,
2000.
(13) Incorporated by reference to our Registration Statement on Form S-3 filed
on October 24, 2000 (File No. 333-48486).
(14) Incorporated by reference to our Report on Form 10-K filed on April 2,
2001, as amended on April 30, 2001.
(b) REPORTS ON FORM 8-K
35
On January 9, 2001, we filed a Report on Form 8-K with the Securities and
Exchange Commission relating to our acquisition of TrueChat, Inc.
On February 9, 2001 we filed a Report on Form 8-K with the Securities and
Exchange Commission relating to the adoption of a Share Purchase Rights Plan.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 2001 TERAYON COMMUNICATION SYSTEMS, INC.
By /s/ Ray M. Fritz
-----------------------------------
Ray M. Fritz
Chief Financial Officer
36