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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 June 30, 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)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of August 13, 2001, registrant had outstanding 68,390,823 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 June 30, 2001 (unaudited)
and December 31, 2000......................................... 3
Consolidated Statements of Operations for the three months and
six months ended June 30, 2001 and 2000 (unaudited)........... 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 2001 and 2000 (unaudited)............................ 5
Notes to Consolidated Financial Statements...................... 6
2
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
June 30, December 31,
---------- ------------
2001 2000
---------- ----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents....................................... $ 250,878 $ 347,015
Short-term investments.......................................... 143,151 215,442
Accounts receivable, less allowance for doubtful
accounts of $4,997 in 2001 and $6,542 in 2000.................. 31,277 42,772
Accounts receivable from related parties........................ 15,475 17,454
Other current receivables....................................... 19,489 32,027
Inventory....................................................... 39,402 87,767
Other current assets............................................ 2,537 7,021
---------- ----------
Total current assets.......................................... 502,209 749,498
Property and equipment, net....................................... 32,813 33,533
Intangibles and other assets...................................... 34,346 643,696
---------- ----------
Total assets.................................................. $ 569,368 $1,426,727
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 52,325 $ 123,994
Accrued payroll and related expenses............................ 12,855 13,105
Deferred revenues............................................... 4,396 4,998
Warranty reserves............................................... 8,445 5,925
Accrued purchase price payable.................................. -- 14,138
Other accrued liabilities....................................... 40,435 25,719
Current portion of long-term debt............................... 6,187 10,853
Short-term debt................................................. -- 2,697
Current portion of capital lease obligations.................... 109 131
---------- ----------
Total current liabilities..................................... 124,752 201,560
Long-term debt.................................................... 2,060 119
Long-term portion of capital lease obligations.................... 254 358
Other long-term obligations....................................... 2,638 3,444
Convertible subordinated notes.................................... 304,403 500,000
Deferred tax liability............................................ 455 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--68,004,355 in 2001
and 67,396,539 in 2000......................................... 68 68
Additional paid in capital...................................... 1,039,097 1,037,891
Accumulated deficit............................................. (899,852) (329,148)
Deferred compensation........................................... (4,896) (6,788)
Stockholders' notes receivable.................................. -- (3)
Accumulated other comprehensive income(loss).................... 389 661
---------- ----------
Total stockholders' equity.................................... 134,806 702,681
---------- ----------
Total liabilities and stockholders' equity.................... $ 569,368 $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 Six Months Ended
June 30, June 30,
------------------ ----------------------
2001 2000 2001 2000
-------- -------- --------- --------
Revenues:
Product revenues............................ $ 40,119 $55,709 $ 84,008 $89,344
Related party product revenues.............. 25,614 36,310 35,709 62,012
-------- -------- --------- --------
Total revenues............................. 65,733 92,019 119,717 151,356
-------- -------- --------- --------
Cost of goods sold:
Cost of product revenues.................... 35,889 48,087 84,803 77,188
Cost of related party product revenues...... 16,871 18,413 22,810 33,260
Special charges............................. 28,704 -- 28,704 --
-------- -------- --------- --------
Total cost of goods sold................... 81,464 66,500 136,317 110,448
-------- -------- --------- --------
Gross profit (loss).......................... (15,731) 25,519 (16,600) 40,908
Operating expenses:
Research and development.................... 19,152 16,566 41,779 27,134
Cost of product development assistance
agreement.................................. -- -- -- 9,563
In-process research and development......... -- 13,085 -- 19,835
Sales and marketing......................... 16,334 10,796 31,817 18,472
General and administrative.................. 8,664 5,761 16,611 9,946
Goodwill amortization....................... 322 15,215 22,804 21,650
Restructuring costs and asset write-offs.... 2,549 -- 577,293 --
-------- -------- --------- --------
Total operating expenses................... 47,021 61,423 690,304 106,600
-------- -------- --------- --------
Loss from operations......................... (62,752) (35,904) (706,904) (65,692)
Interest income.............................. 4,512 1,916 11,246 3,334
Interest expense............................. (4,304) (335) (10,048) (353)
Other income(expense)........................ 317 (41) (121) (47)
-------- -------- --------- --------
Loss before extraordinary gain and
tax benefit............................... (62,227) (34,364) (705,827) (62,758)
Income tax expense (benefit)................. 277 -- (13,629) --
-------- -------- --------- --------
Loss before extraordinary gain............. (62,504) (34,364) (692,198) (62,758)
Extraordinary gain on early retirement of
debt........................................ -- -- 121,494 --
-------- -------- --------- --------
Net loss..................................... ($62,504) ($34,364) ($570,704) ($62,758)
======== ======== ========= ========
Basic and diluted net loss per share before
Extraordinary gain.......................... ($0.93) ($0.57) ($10.25) ($1.09)
Extraordinary gain on early retirement of
debt........................................ -- -- 1.80 --
-------- -------- --------- --------
Basic and diluted net loss per share....... ($0.93) ($0.57) ($8.45) ($1.09)
======== ======== ========= ========
Shares used in computing basic and
diluted net loss per share.................. 67,493 60,692 67,542 57,696
======== ======== ========= ========
See accompanying notes.
4
TERAYON COMMUNICATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Month Ended
June 30,
---------------------
2001 2000
-------- --------
Net cash, provided by (used in) operating
activities............................................ ($90,102) $ 4,880
-------- --------
Investing activities:
Purchases of short-term investments..................... (172,211) (30,686)
Proceeds from sales and maturities of
short-term investments................................ 238,502 49,016
Purchases of property and equipment..................... (4,182) (7,359)
Issuance of short-term receivable....................... -- (703)
Purchase of other assets................................ -- (2,006)
Cash received from acquisitions......................... -- 7,988
Cash paid for acquisition of businesses................. -- (3,010)
-------- --------
Net cash provided by (used in) investing
activities............................................ 62,109 13,240
-------- --------
Financing activities:
Principal payments on capital leases.................... (34) (2)
Principal payments and current maturities
on long-term debt..................................... (104) (241)
Exercise of options and warrant to purchase
common stock.......................................... 453 7,729
Proceeds from issuance of common stock.................. -- 1,014
Retirement of debt...................................... (68,459) --
-------- --------
Net cash provided by (used in) financing
activities............................................ (68,144) 8,500
-------- --------
Net increase(decrease) in cash and cash
equivalents........................................... (96,137) 26,620
Cash and cash equivalents at beginning of period........ 347,015 32,398
-------- --------
Cash and cash equivalents at end of period.............. $250,878 $ 59,018
======== ========
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
primarily of normal recurring accruals) necessary for a fair presentation of the
financial statements at June 30, 2001 and for the three months and six months
ended June 30, 2001 and 2000 have been included.
The unaudited consolidated financial statements include the accounts of the
Company and its wholly owned and majority owned subsidiaries. The minority
interests in net losses of its majority owned subsidiaries were insignificant
for all periods presented. All intercompany balances and transactions have been
eliminated.
Results for the three months and six months ended June 30, 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-K405 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
6
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 June 30, 2001 or December 31, 2000.
Other Current Receivables
As of June 30, 2001 and December 31, 2000, other current receivables
includes approximately $12.2 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):
June 30, December 31,
-------- ------------
2001 2000
-------- ------------
Finished goods.............. $16,506 $64,987
Work-in-process............. 4,393 1,736
Raw materials............... 18,503 21,044
------- -------
$39,402 $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 34,993,219 and
21,489,536 shares of common stock were outstanding at June 30, 2001 and December
31, 2000, respectively, and warrants to purchase 2,684,700 and 2,384,700 shares
of common stock were outstanding at June 30, 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. For the three months ended
June 30, 2001 and 2000 the Company's comprehensive loss was approximately
$63,170,000 and $33,933,000, respectively. For the six months ended June 30,
2001 and 2000 the Company's comprehensive loss was approximately $570,976,000
and $62,823,000, respectively.
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 statements 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
7
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
June 30, 2001 or December 31, 2000, the adoption of Statement 133 had no impact
on the financial statements of the Company at June 30, 2001.
New Accounting Pronouncements
On June 29, 2001, the Financial Accounting Standards Board approved the
issuance of Statements of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations" and No. 142, "Goodwill and Other Intangible Assets."
SFAS 141, which is effective for all business combinations subsequent to July 1,
2001, eliminates the pooling-of-interests method of accounting for business
combinations and includes new criteria to recognize intangible assets separately
from goodwill. Under Statement 142, goodwill and other intangible assets with
indefinite lives are no longer amortized but are reviewed at least annually for
impairment. Separable intangible assets that are deemed to have a definite life
will continue to be amortized over the estimated useful life. SFAS 142 is
effective with respect to the non-amortization of goodwill and certain
intangible assets on January 1, 2002 for amounts currently recorded on Terayon's
balance sheet and will apply to any goodwill and certain intangible assets
acquired after June 30, 2001. At June 30, 2001 goodwill approximated $2.8
million. Goodwill amortization was $0.32 million and $22.8 million for the three
and six months ended June 30, 2001, respectively.
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 assessments. 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 and six months
ended June 30, 2001 and 2000 is as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2001 2000 2001 2000
--------- --------- -------- ---------
Cable Broadband Access Segment:
Revenues $ 57,931 $ 83,057 $ 102,297 $140,173
Operating loss (44,602) (33,345) (429,800) (61,864)
Total assets 561,835 606,843 561,835 606,843
Telecom Broadband Access Segment:
8
Revenues 7,802 8,962 17,420 11,183
Operating loss (18,150) (2,559) (277,104) (3,828)
Total assets 7,533 139,464 7,533 139,464
Operating income:
Operating income by reportable segments (62,752) (35,904) (706,904) (65,692)
Unallocated amounts:
Interest and other income, net 525 1,540 1,077 2,934
Income tax (277) -- 13,629
Extraordinary gain -- -- 121,494 --
-------- -------- --------- --------
Net loss $(62,504) $(34,364) $(570,704) $(62,758)
======== ======== ========= ========
Geographic areas:
Revenues:
United States $ 13,644 $ 20,845 $ 33,229 $ 32,761
Canada 24,827 36,783 36,070 62,485
Europe and Israel 8,506 17,251 17,700 29,867
Asia 18,268 13,420 32,188 20,706
South America 488 3,720 530 5,537
-------- -------- --------- --------
Total $ 65,733 $ 92,019 $ 119,717 $151,356
======== ======== ========= ========
Assets:
United States $535,479 $370,663 $ 535,479 $370,663
Canada 15,475 15,720 15,475 15,720
Europe and Israel 6,801 359,924 6,801 359,924
Asia 624 -- 624 --
South America 10,989 -- 10,989 --
-------- -------- --------- --------
Total $569,368 $746,307 $ 569,368 $746,307
======== ======== ========= ========
Two customers accounted for 10% or more of total revenues (37% and 19%) for
the three months ended June 30, 2001. Two customers accounted for 10% or more of
total revenues (24%, and 15%) for the three months ended June 30, 2000. Two
customers accounted for 10% or more of total revenues (26% and 16%) for the six
months ended June 30, 2001. Three customers accounted for 10% or more of total
revenues (22%, 19%, and 10%) for the six months ended June 30, 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. During
2001, 124 employee positions are expected to be eliminated in the United States
and Israel. As of June 30, 2001, 106 employees have been terminated and the
Company paid a total of approximately $0.5 million for severance costs in excess
of amounts provided by Israeli law.
In June 2001, the Company's Board of Directors approved additions to the
restructuring plan and accrued $0.9 million for additional costs relating to
excess facility lease costs. As of June 30, 2001, the Company had $3.3 million
in accrued restructuring which relates to excess leased facilities. Also, the
company recorded a charge of $1.6 million resulting from the write-down of
impaired assets.
In the first quarter, the Company 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
9
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 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. Furthermore, 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 $405.9 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 a
pretax extraordinary gain of approximately $121.5 million. In addition, in July
and August 2001, the Company repurchased approximately $104.3 million of its
Convertible Subordinated Notes for $45.0 million in cash, resulting in a pretax
extraordinary gain of approximately $56.5 million.
5. Common Stock
In June 2001, the Company issued 160,000 shares of the Company's common
stock to their Board of Advisors. The fair market value of the common stock,
$0.6 million, is recorded as compensation expense. The shares are fully vested
as of the date of grant. The previous stock options issued were cancelled as of
the new grant date.
6. 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.
7. 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.
8. Common Stock Warrant
In June 2001, we issued a fully vested, immediately exercisable, warrant to
purchase 100,000 shares of the company's Common Stock at a price of $5.98 per
share to Philips Semiconductors Inc. in consideration for the continuation of
their strategic relationship with the company.
10
9. Debt Obligations
In June 2000, Mainsail Networks (Mainsail) issued a $3,520,000 Senior
Secured Promissory Note. The note is secured by the general assets of Mainsail
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.
10. Purchase Commitments
In June 2001, the Company established an irrevocable letter of credit with
a supplier in the amount of $20.9 million for purchase commitments. The letter
of credit will expire by November 2001.
11. Cost of Goods Sold - Special Charges
The Company recorded a special charge totaling $28.7 million during the
second quarter of 2001 related to inventory reserves and vendor cancellation
charges. This additional charge was due to a sudden and significant decrease in
forecasted revenue and was calculated based on inventory levels in excess of
forecasted demand for each specific product.
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, two large cable operators,
Rogers Cable Inc. (formerly Rogers Cablesystems Limited)(Rodgers) and Shaw
Communications (Shaw) 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. These include Qwest
Communications, Bell Atlantic, Southwestern Bell Communications and Verizon. As
a result of the nature of the cable industry and our strategic focus, a small
number of customers have
11
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 June 30,
2001, two customers (one of which is a related party) accounted for
approximately 56% of our revenues. This compares to approximately 39% of our
revenues from two customers (both of which are related parties) during the same
period in 2000. During the six months ended June 30, 2001, two customers (one of
which is a related party) accounted for approximately 42% of our revenues. This
compares to approximately 51% of our revenues from three customers (two of which
are related parties) 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
acquisitions in 1999 and 2000, we expanded our portfolio of broadband products
to support high-speed delivery of voice, data and video services over cable, DSL
and wireless.
For more information relating to the acquisitions, see Note 15, "Business
Combinations" of the Notes to Consolidated Financial Statements in our Form 10-
K405 Annual Report for the year ended December 31, 2000. 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 $570.7 million for the six months ended June 30,
2001, which included an extraordinary gain of $121.5 million. We had an
accumulated deficit of $899.9 million as of June 30, 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 invest in technical development and sales and
marketing as we engage in activities related to product enhancement, cost
reduction and increasing market penetration. Additionally, we expect to increase
our capital expenditures and other operating expenses in order to support our
operations. We anticipate that we will spend approximately $15 million to $20
million on capital expenditures and approximately $80 million to $90 million on
research and development during the year ending December 31, 2001. Anticipated
capital expenditures consist of purchases of test equipment to support our
research and development efforts and new product introduction.
Results of Operations
Three Months and Six Months Ended June 30, 2001 and 2000
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 $65.7 million for the
three months ended June 30, 2001 from $92.0 million in 2000 and to $119.7
million for the six months ended June 30, 2001 from $151.4 million in 2000. The
decreased revenues in 2001 are largely attributable to the economic slowdown of
demand, which has affected and continues to affect our customers' sales 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
12
recognized when: (1) persuasive evidence that an arrangement exists, (2)
delivery has occurred or services have been rendered, (3) the price 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 June 30, 2001, we incurred cost of goods sold of $81.5
million compared to $66.5 million in 2000. In the six months ended June 30,
2001, we incurred cost of goods sold of $136.3 million compared to $110.4
million in 2000. Cost of goods sold for the three months and six months ended
June 30, 2001 also included approximately $0.72 million and $12.5 million,
respectively, of amortization of acquired intangible assets as compared to $8.5
million and $14.8 million, respectively, for the same periods in 2000. Our cost
of goods sold increased in the three months and six months ended June 30, 2001,
compared to 2000, primarily due to a charge relating to reserves and vendor
cancellation charges in the amount of $28.7 million and a slower demand for our
products.
Gross Profit. We had a gross loss of $15.7 million and $16.6 million for
the three months and six months ended June 30, 2001, respectively, compared to a
gross profit of $25.5 million and $40.9 million for the same periods in 2000.
Gross profit for the three months and six months of 2001 declined as the result
of lower revenues, additional inventory and vendor cancellation charges and a
shift in the mix of products shipped.
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 sales mix 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 designed prototype material
expenditures, equipment and supplies required to develop and to enhance our
products. Research and development expenses increased to $19.2 million and $41.8
million in the three months and six months ended June 30, 2001, respectively,
from $16.6 million and $27.1 million for the same periods in 2000. The increase
was primarily due to personnel costs resulting in the expansion of our employee
base and the inclusion of employees from acquired companies as we continued to
focus our efforts on developing new products. Workforce intangible amortization
in the three months and six months accounted for approximately $1.1 million and
$3.2 million, respectively, of the increase. The Company believes it is
critical to continue to make significant investments in research and development
to ensure the availability of innovative technology that meets the current and
future requirements of its customers. Accordingly, the Company expects in future
years to continue to devote substantial resources to research and development
programs.
Cost of Product Development Assistance Agreement. In March 1999, we entered
into a one-year Product Development Assistance Agreement with Rogers. 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
13
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 six months ended June 30, 2000 include non-cash
charges 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. 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 generally expected, it is not assured.
In-process technology acquired relating to the acquisition of Telegate in
2000, 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.
In-process technology acquired relating to the acquisition of ANE in 2000,
valued at approximately $750,000, consisted primarily of additions to ANE's core
technology, which were related to ANE's planned development of new features. A
portion of the intended functionality of these new features was not supported by
ANE's existing technology. The resultant technology is intended to allow the
transmission from a 56 Kbps modem without the loss of transmission rate.
In-process technology acquired relating to the acquisition of Combox in
2000, valued at approximately $8 million consists primarily of additions to
Combox's core technology, which were related to Combox's planned development of
new features. A portion of the intended functionality of these new features was
not supported by Combox's existing technology. We have decided to discontinue
our development efforts in Combox's technology.
In-process technology acquired relating to the acquisition of Internet
Telecom in 2000, valued at approximately $2.6 million, consisted primarily of
additions to Internet Telecom's core technology, which were related to Internet
Telecom's planned development of new features. A portion of the intended
functionality of these new features was not supported by Internet Telecom's
current technology. Intended new features include network management switches
and software to enhance product performance and marketability.
In-process technology acquired relating to the acquisition of Ultracom in
2000, valued at approximately $1.8 million, consists primarily of additions to
Ultracom's core technology, which were related to Ultracom's planned development
of new features. A portion of the intended functionality of these new features
was not supported by Ultracom's existing technology. We have decided to
discontinue our development efforts in Ultracom's technology.
Except as indicated above, and notwithstanding the Company's expectations
that the acquired in-process technology will be successfully developed, there
remain significant technical challenges that must be continually resolved.
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 $16.3 million and $31.8 million, respectively, in the
three months and six months ended June 30, 2001 from $10.8 million and $18.4
million fore the same periods 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 and
increased payroll and associated costs from the expansion in our employee base
resulting from acquired companies. Workforce intangible amortization in the
three months and six months accounted for approximately $0.5 million and $1.8
million, respectively, of the increase. As a
14
result of downturn which led to the restructuring, we expect sales and marketing
expenses to remain constant through the third quarter of 2001.
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 $8.7 million and $16.6 million for the
three months and six months ended June 30, 2001, respectively, from $5.8 million
and $9.9 million the same periods 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, as well as the intangible amortization in the amount of $1.1 and $2.4
million for the three and six months ended. As a result of downturn which led to
the restructuring, we expect general and administrative expenses will remain
constant through the third quarter of 2001.
Goodwill Amortization. The goodwill amortization decreased significantly in
the three months ended June 30, 2001 due to the impairment of goodwill in the
first quarter of 2001.
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 primarily related to severance and cost of
excess leased facilities. During 2001, 124 employee positions are expected to
be eliminated in the United States and Israel. As of June 30, 2001, 106
employees have been terminated and the Company paid a total of approximately
$0.5 million for severance costs.
In June 2001, the Company's Board of Directors approved an addition to the
restructuring plan and accrued $0.9 million for additional costs relating to
excess leased facilities. As of June 30, 2001, we had $3.3 million in accrued
restructuring which relates to excess facility lease costs. Also, we recorded a
charge of $1.6 million resulting from the write-down of impaired assets.
In March 2001, the Company evaluated the carrying value of certain long-
lived assets and acquired intangibles, consisting primarily of goodwill recorded
on its balance sheet. 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 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
fiscal 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 $405.9
million.
Interest Income and Expense. Interest income was $4.5 million and $11.2
million for the three months and six months ended June 30, 2001, respectively,
compared to $1.9 million and $3.3 million the same periods in 2000. Interest
expense was $4.3 million and $10.0 million for the three months and six months
ended June 30, 2001, respectively, compared to $0.34 million and $0.35 million
for the same periods in 2000 The increases to interest income and interest
expense were due to the sale in July 2000 of $500 million of 5% Convertible
Subordinate Notes due in
15
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 Income and Expense. Other income and expense for the three months
ended June 30, 2001 consisted of approximately $0.3 million of income that
relates to interest received from a foreign customer offset by the amortization
of debt costs. For the six months ended June 30, 2001 other expense in the
amount of $0.12 million was due to the amortization of debt costs.
Income Taxes. We have generated operating losses since our inception. For
the three months ended June 30, 2001 we had a provision for income taxes of
$0.28 million for foreign income taxes and had a benefit of $13.6 million for
the six months ended June 30, 2001 which consisted of a reduction of deferred
tax liabilities related to the Combox, Radwiz, Telegate and Ultracom
acquisitions and a $0.8 million provision for foreign taxes. There were no
provisions for income taxes in the comparable periods in 2000.
Operating Segment Information
We view our business as having two principal operating segments: Cable
Systems and Telecom 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, ANE, acquired in April 2000 and
Mainsail, acquired in September 2000. Operating losses increased as a result of
the increase in intangibles amortization.
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 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 us,
claiming that the Company formed and operated a conspiracy to deprive plaintiffs
of the opportunity to invest in Imedia, a company that we acquired in 1999.
Plaintiffs argue that, prior to our purchase of the Imedia shares, we knew of an
alleged, pre-existing financing agreement between plaintiffs and Imedia that
contained a "no shop" clause,
16
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 filed a demurrer
challenging the legal sufficiency of the two causes of action. Other defendants
demurred also. The demurrer hearing was held on January 16, 2001. Prior to the
Court issuing a final ruling at that hearing, Plaintiffs agreed to amend their
complaint. Plaintiffs filed a second amended complaint and, in response, we (and
all other defendants) filed demurrers challenging all the causes of action. The
Company's demurrer was heard on May 22, 2001, and the Court ruled (by subsequent
written decision) that three contract claims and the tortious interference with
the prospective economic advantage claims should be dismissed. The Court also
dismissed the two fraud claims with leave to amend.
The Plaintiffs have now filed a third amended complaint, and the defendants
each have file (or will soon file) additional challenges to that pleading. A
trial date is set for March 18, 2002. 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 moved to dismiss this amended
complaint on June 15, 2001. Plaintiffs' opposition to this motion is due on
July 27, 2001, and Defendants' reply in support of the motion will be filed on
or before August 24, 2001. A hearing has been set on September 10, 2001.
The lawsuit seeks 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
17
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 eventually entered into a
stipulation to go forward in the Northern District. On July 9, 2001, a status
conference was held in this case before Judge Patel. Plaintiffs did not appear
for the conference, and the court requested that defendants submit an order
dismissing the Bertram action with prejudice. 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 June 30, 2001, we had approximately $250.9 million in cash and cash
equivalents, $143.1 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 of the
Convertible Subordinated Notes for $68.5 million in cash, resulting in a pretax
extraordinary gain of approximately $121.5 million. In addition, in July and
August 2001, we repurchased approximately $104.3 million of the Convertible
Subordinated Notes for $45.0 million in cash, resulting in a pretax
extraordinary gain of approximately $56.5 million.
Cash used in operating activities for the six months ended June 30, 2001
was $90.1 million compared to $4.9 million provided in 2000. Cash provided by
investing activities was $62.1 million in 2001 compared to $13.2 million in
2000. Investing activities consisted primarily of the purchase and sale of
short-term investments in 2001 and 2000. Cash used in financing activities was
$68.1 million in 2001 compared to $8.5 million provided in 2000. In 2001,
financing activities consisted primarily of payments from the retirement of our
convertible subordinated notes as well as proceeds from the exercise of options.
In 2000, financing activities consisted primarily of proceeds from the issuance
of common stock as well as proceeds from the exercise of options.
As of June 30, 2001, we had approximately $87.0 million of purchase
obligations. We anticipate that these obligations will become payable at various
times through mid-2002. We intend to make these payments out of available
working capital. In the fourth quarter of 2000 and second quarter of 2001, we
recorded special charges of $19.0 million and $4.9 million for vendor
cancellation fees relating to purchase obligations. In May 2001, we entered
into a $200,000 irrevocable letter of credit to fulfill our lease obligation in
one of our leased facilities to return the premises to original condition.
Furthermore, in June 2001, we established an irrevocable letter of credit with a
supplier in the amount of $20.9 million for purchase commitments. The letter of
credit will expire by November 2001.
We believe that our current cash balances will be sufficient to satisfy our
cash requirements for at least the next 12 months. This estimate is a forward-
looking statement that involves risks and uncertainties, and actual results may
vary as a result of a number of factors, including those discussed under "Our
Operating Results May Fluctuate" below and elsewhere herein. We may need to
raise additional funds in order to support more rapid expansion, develop new or
enhanced services, respond to competitive pressures, acquire complementary
businesses or technologies or respond to unanticipated requirements. We may seek
to raise additional funds through private or public sales of securities,
strategic relationships, bank debt,
18
financing under leasing arrangements or otherwise. If additional funds are
raised through the issuance of equity securities, the percentage ownership of
the stockholders of the Company will be reduced, stockholders may experience
additional dilution or such equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock. There can be no
assurance that additional financing will be available on acceptable terms, if at
all. If adequate funds are not available or are not available on acceptable
terms, we may be unable to develop our products, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
which could have a material adverse effect on our business, financial condition
and operating results.
Recent Financial Accounting Pronouncements
On June 29, 2001, the Financial Accounting Standards Board approved the
issuance of Statements of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations" and No. 142, "Goodwill and Other Intangible Assets."
SFAS 141, which is effective for all business combinations subsequent to July 1,
2001, eliminates the pooling-of-interests method of accounting for business
combinations and includes new criteria to recognize intangible assets separately
from goodwill. Under Statement 142, goodwill and other intangible assets with
indefinite lives are no longer amortized but are reviewed at least annually for
impairment. Separable intangible assets that are deemed to have a definite life
will continue to be amortized over the estimated useful life. SFAS 142 is
effective with respect to the non-amortization of goodwill and certain
intangible assets on January 1, 2002 for amounts currently recorded on Terayon's
balance sheet and will apply to any goodwill and certain intangible assets
acquired after June 30, 2001. At June 30, 2001 goodwill approximated $2.8
million. Goodwill amortization was $0.32 million and $22.8 million for the three
and six months ended June 30, 2001, respectively.
In June 1998, the Financial Accounting Standard Board (FASB) issued
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133) which establishes accounting and reporting standard for
derivatives instruments and hedging activities. The statement requires
recognition of all derivatives at fair value in the financial statements. FASB
Statement No. 137 "Accounting for Derivative Instruments and Hedging Activities
Deferral of the Effective Date of FASB Statement No. 133" an amendment of FASB
Statement No. 133, defers implementation of SFAS No. 133 until fiscal years
beginning after June 15, 2000. The Company has adopted the standard effective
January 1, 2001. The adoption of SFAS 133 did not affect the Company's
financial condition or results of operations.
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial also may impair our business
operations. If any of the following risks actually occur, our business could be
harmed. In such case, the trading price of our common stock could decline, and
you may lose all or part of your investment.
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 June 30, 2001, we had an accumulated deficit of $899.9 million. We
believe that we will continue to experience net losses for the foreseeable
future. 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 increased expenses for the foreseeable future to support
increased sales, marketing and technical support costs. In addition, significant
delays in our commercialization of new products may adversely affect our
business. Moreover, even though we have experienced significant revenue growth
since our inception, the profit potential of our business remains unproven. We
had negative gross margins from our inception
19
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
infrastructures;
. 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
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 costs of manufacturing our products and the effectiveness of
our cost reduction measures.
We anticipate that unit ASPs of our products will continue to decline in
the future. This could cause a decrease in the gross margins for these
products. In addition, the gross margins we realize from the sale of our
products are affected by the mix of product sales between higher margin, lower
volume headend equipment and lower margin, higher volume consumer premise
equipment (CPE). We typically sell more headend equipment in connection with
new deployments of our cable data access systems. As deployments mature, we
tend to sell more CPE into the deployments compared to headend equipment. Sales
of our CPE have constituted and we expect will continue to constitute a
significant portion of our revenues for the foreseeable future.
Our expenses generally vary from quarter to quarter depending on the level
of actual and anticipated business activities. Research and development expenses
will vary as we begin development of new products and as our development
programs move to wafer fabrication and prototype development, which results in
higher engineering expenses.
We also anticipate that our operating results will be impacted by sales,
gross profit and operating expenses of any acquired companies.
We Are Dependent on a Small Number of Customers.
20
Two customers (one of which is a related party) accounted for approximately
56% of our revenues for the three months ended June 30, 2001 and two customers
(two of which are related parties) accounted for approximately 39% of our
revenues for the three months ended June 30, 2000. Two customers (one of which
is a related party) accounted for approximately 42% of our revenues for the six
months ended June 30, 2001 and three customers (two of which are related
parties) accounted for approximately 51% of our revenues for the six months
ended June 30, 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 incumbent local exchange carriers (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 may decide to purchase
competitive products from other vendors at any time and can reschedule or cancel
purchase orders on short notice. When purchasing product from us, these
customers may also 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 these acquired business
into our business and operations has been risky and may create unforeseen
operating difficulties and expenditures going forward. The areas in which we may
face difficulties with these acquisitions include:
. Diversion of management time (both ours and that of the acquired companies)
for 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.
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
21
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 for our products typically is lengthy, often lasting six
months to a year and, in some cases, even longer. 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 more than
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 revenues and 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 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. 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.
22
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 data access 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 products with advanced PHY capabilities from multiple suppliers. We may be
unable to produce DOCSIS compliant cable products with advanced PHY capabilities
more quickly or at lower cost than our competitors. The inclusion of our S-CDMA
technology in a 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 data access systems, called the EuroDocis standard,
has been formalized, and some European cable system operators have embraced it.
We intend to develop and sell products that comply with the EuroDocis standard
and to pursue having portions of our S-CDMA technology included in a future
version of the EuroDocis 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, market
and sell new products in a timely manner. We also must respond to competitive
pressures, evolving industry standards and technological advances. Although we
do sell DOCIS systems, our S-CDMA products, which were developed internally, 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 our
prototype will be successful or, if successful, 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 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
Network Equipment Building System (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 the 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
23
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 revenue and 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 and may not 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
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 S-CDMA, while several of our competitors utilize TDMA (Time
Division Multiple Access) and Frequency Division Multiple Access or FDMA. Our S-
CDMA 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.
24
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.
We may not be successful in marketing and selling these products.
We Need to Develop Additional Distribution Channels.
We presently market our products to providers of broadband services. With
changes in the industry, we may need to establish new, additional distribution
channels. For example, we believe that much of the North American market for
CPE may shift to a retail distribution model. Accordingly, we may need to
redirect our future marketing efforts to sell our CPE directly to retail
distributors and end users. This shift would require us to establish new
distribution channels for these products.
We face many challenges in establishing these new distribution channels.
. We may be unable to hire the additional personnel necessary to establish
and enhance these new distribution channels.
. 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.
. 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.
The vast majority of our sales are to larger, more established service
providers that are critical to our business. We do not have access to smaller or
geographically diverse broadband service providers. Although we intend to
establish strategic relationships with leading distributors worldwide to access
these customers, 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 their customers. Some of our competitors have already
established, long-standing relationships with these service providers that may
limit our and our distributors' ability to sell our products to those customers.
Even if we were to sell our products to those customers, it would likely not be
based on long-term commitments, and those customers would be able to terminate
their relationships with us at any time.
We Are Dependent on Broadband Service Providers Choosing to Offer Additional
Services to Their Customers.
We depend on service providers to purchase our products. Service providers
have a limited amount of available bandwidth over which they can offer new
services,
25
and they may choose not to provide these new services to their customers. When
service providers choose to provide these new services, we depend upon them to
market these services to their customers, to install our equipment and to
provide support to end-users. In addition, we depend on these service providers
to continue to maintain their infrastructures 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 providers of broadband services, such as Excite@Home's @Home Network and Road
Runner, a joint venture between MediaOne Group Inc. and Time Warner Cable.
Sales of Our Cable Products Are Dependent on the Cable Industry Upgrading to
Two-Way Cable Infrastructure.
Demand for our cable 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 hybrid fiber coaxial (HFC) in areas of
higher penetration of data services. If service providers 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. Service providers may not choose to
upgrade existing residential cable systems or to install new cable systems to
serve business locations.
The success and future growth of our cable 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;
. 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 broadband services;
. Competitive pressures (including the availability of alternative data
transmission and access technologies);
. Discretionary consumer spending patterns; and
. General economic conditions.
In recent years, the United States cable market has been characterized by
the acquisition of smaller and independent cable operators by larger service
providers. We cannot predict the effect, if any, that such consolidation will
have on overall capital spending patterns by service providers. The effect on
our business of further industry consolidation also is uncertain.
Supply of Our Products Depends On Our Ability to Forecast Demand
Accurately.
The emerging nature of the broadband access services market makes it
difficult for us to forecast accurately demand for our products. Our inability
to forecast accurately the actual demand for our products may result in too much
or too little supply of product or an over/under capacity of manufacturing or
testing resources at any given point in time. The existence of any one or more
of these situations could have a negative impact on our business, operating
results or financial condition. We had unconditional purchase obligations of
approximately $87.0 million as of June 30, 2001, primarily to purchase minimum
quantities of
26
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 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 manufacture,
assembly or testing of 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 lead times. We could experience
significant delays in the shipment of our products if we are unable to provide
this testing equipment to our contract manufacturers in a timely manner.
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;
27
. 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 crises 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
to prohibit, terminate or delay the construction of new broadband services
infrastructures 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 engage in foreign currency hedging
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
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;
28
. 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.
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 proprietary TeraComm system, including the
higher margin head-end products. Any increased price competition or reduction in
sales of our head-end 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.
29
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 may 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 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.
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. We have limited experience with the problems that could arise with
each new generation of products. However, the limitation of liability provisions
contained in our terms and conditions of sale 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
30
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 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
31
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 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 broadband access services 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
service providers' ability to upgrade to support our products. Service providers
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
32
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 facilities housing our corporate headquarters, the majority of our
research and development activities and our in-house manufacturing operations
are located in California, an area known for seismic activity. In addition, the
operations of some of our key suppliers are also located in this area and in
other areas known 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, during 2001, 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.
Our Indebtedness Could Adversely Affect our Financial Condition; We May Incur
Substantially More Debt.
As of August 13, 2001, we had approximately $200.1 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;
33
. 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.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk.
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. The primary objective of our investment activities
is to preserve principal while maximizing yields without significantly
increasing risk. This is accomplished by investing in widely diversified short-
term investments, consisting primarily of investment grade securities,
substantially all of which 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 $384,750 decline (less
than 0.2%) 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 local currencies from Belgium, United Kingdom, Hong Kong, Brazil 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 $1.1 million.
All of the potential changes noted above are based on sensitivity analyses
performed as of June 30, 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
34
(c) In June 2001, we issued a fully vested, immediately exercisable,
warrant to purchase 100,000 shares of the Company's Common Stock at a price of
$5.98 per share to Philips Semiconductors Inc. in consideration for the
continuation of their strategic relationship with the Company. 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) therof 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
Item 4. Submission of Matters to a Vote of Security Holders.
(a) The registrant's Annual Meeting of Stockholders was held on June 20,
2001.
(b) The meeting involved the election of two officers Dr. Zaki Rakib and
Christopher Schaepe. The following directors terms continued after the meeting:
Lewis Solomon, Mark A. Stevens, Michael D'Avella, Schlomo Rakib and Alek
Krstajic.
(c) There were two matters voted on at the Meeting. A brief description of
each of these matters, and the results of the votes thereon, are as follows:
1. Election of Directors
Nominee For Withheld
------- --- ---------
Dr. Zaki Rakib 40,724,376 1,292,490
Christopher Schaepe 41,645,312 371,554
2. Ratification of the appointment of Ernst & Young LLP as the
registrant's auditors for the fiscal year ending December
31, 2001
Broker
For Against Abstain Nonvotes
--- ------- ------- --------
41,852,727 100,923 63,216 -0-
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.
Incorporated by reference to Terayon Communication Systems Form 10-Q
filed with the Commission on May 15, 2001.
(b) REPORTS ON FORM 8-K
None
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.
35
Date: August 14, 2001 TERAYON COMMUNICATION SYSTEMS, INC.
By /s/ Ray M. Fritz
-------------------------------
Ray M. Fritz
Chief Financial Officer